Innovation in China: harmonious transformation?

INNOVATION IN CHINA: HARMONIOUS TRANSFORMATION?

Edited by

SHULIN GU and MARK DODGSON School of Economics and Management, Tsinghua University and University of Queensland Business School ISBN 0-9757422-4-8

e C ontent

PTY

management LTD

Sydney • Amsterdam • Palo Alto

INNOVATION: MANAGEMENT, POLICY & PRACTICE ISBN 0-9757422-4-8 iv + 212 pages softcover

·

VOLUME 8

·

ISSUE 1–2

Published in Australia by: eContent Management Pty Ltd PO Box 1027 Maleny, QLD 4552 Australia Tel. +61-(0)7-5435 2900 Fax: +61-(0)7-5435 2911 E-mail: [email protected] ABN 87 091 432 567 Affiliates in: Sydney, Amsterdam, Palo Alto A special issue of the Innovation: Management, Policy & Practice journal: Volume 8 Issue 1–2 (July 2006) ISSN 1447-9338 Innovation in China: Harmonious Transformation? Bibliography ISBN 0-9757422-4-8 1. China industries. 2. Innovation systems. 3. Economic development. 4. Social transformation [Series: Innovation: Management, Policy & Practice (Maleny QLD): vol. 8/1–2] © 2006, eContent Management Pty Ltd This publication is copyright. Other than for purposes of and subject to the conditions prescribed under the Copyright Act, no part of it may in any form or by any means (electronic, mechanical, microcopying, photocopying, recording or otherwise) be reproduced, stored in a retrieval system or transmitted without prior written permission. Inquiries should be addressed to the Publisher at: [email protected] Publisher: James H Davidson, eContent Management Pty Ltd (Queensland) Designer and Desktop Publisher: Karen Enkelaar, Do Write (New South Wales) Printed in Malaysia by Vivar Printing Sdn Bhd, Selangor D.E. (Malaysia)

·

JULY 2006

INNOVATION IN CHINA: HARMONIOUS TRANSFORMATION? INNOVATION: MANAGEMENT, POLICY & PRACTICE

CONTENTS 1

27

·

VOLUME 8

·

ISSUE 1–2

·

JULY 2006

INTRODUCTION: China’s innovation system and the move toward harmonious growth and endogenous innovation — Shulin Gu and Bengt-Åke Lundvall LEARNING AND INNOVATION: THE KEY TO LONG-TERM SUCCESSFUL DEVELOPMENT Regional innovation systems in Asian countries: A new way of exploiting the benefits of transnational corporations — Bjorn Asheim and Jan Vang

45

Work globally, develop locally: Diaspora networks as springboards of knowledge-based development — Yevgeny Kuznetsov and Charles F. Sabel

62

Twin innovation systems, intermediate technology and economic development: History and prospect for China — Andrew Tylecote

84

DEVELOPMENT AND LEARNING IN HIGH-TECH INDUSTRIES The evolving role of research consortia in East Asia — Mark Dodgson, John Matthews and Tim Kastelle

102

The interaction between regulation and market and technology opportunities: A case study of the Chinese mobile phone industry — Hengyuan Zhu, Yan Yang, Marin T. Tintchev and Guisheng Wu

113

Policy design and intervention in the innovation diffusion process: The cases of China’s communication sector — Jiang Yu and Xin Fang

120 128

DEVELOPMENT AND LEARNING IN TRADITIONAL INDUSTRIES Learning in local cluster in the context of global value chain: A case study of the Yunhe wood toy cluster in Zhejiang, China — Yanwei Zheng and Shihao Sheng Institutional innovation for technology transfer: Some new patterns of regional agro-innovation systems in China — Jun Tu Continues .../

Published by

e C ontent

PTY

management LTD

SAN 902-4964

PO Box 1027, Maleny, QLD 4552, Australia [email protected]

Volume 8, Issue 1–2, July 2006

ISSN 1447-9338 • www.innovation-enterprise.com 2006 © eContent Management Pty Ltd

Listed with: EBSCO Publishing; ProQuest; IBSS; AIPS; and DEST Register of Refereed Journals Registered with the Copyright Agency Ltd: www.copyright.com.au INNOVATION: management, policy & practice

iii

INNOVATION IN CHINA: HARMONIOUS TRANSFORMATION? INNOVATION: MANAGEMENT, POLICY & PRACTICE

CONTENTS 144 153

160

·

VOLUME 8

·

ISSUE 1–2

·

JULY 2006

Enterprise patenting in Zhejiang province — Minghua Xu, Jinqi Chen and Haibo Bao ‘Patent pool’ initiatives in manufacturing clusters in Zhejiang — Haibo Bao, Minghua Xu and Shulin Gu REGIONAL INNOVATION SYSTEMS China’s consumer goods manufacturers – with special reference to Wenzhou footwear cluster — Jici Wang

171

Regional innovation performance: Evidence from domestic patenting in China — Xibao Li

193

From trade hub to innovation hub: The role of Hong Kong’s innovation system in linking China to global markets — Erik Baark and Naubahar Sharif

210

APPENDIX: Innovation with Chinese characteristics: Towards harmonious transformation. Report on speech by President Hu Jintao at China’s Fourth National Conference on Science & Technology, Beijing, 9 January 2006 — Adapted from Zhang Lihong (Editor), Xinhua (Source)

N O W AV A I L A B L E S E PA R AT E LY I N N O V AT I O N I N C H I N A : H ARMONIOUS T RANSFORMATION ? ISBN 0-9757422-4-8; iv + 212 pages; softcover; July 2006 A special issue of Innovation: Management, Policy & Practice (Volume 8 Issue 1–2 July 2006) is available for purchase as a book, Innovation in China: Harmonious Transformation?

P L E A S E S E E T H E O R D E R F O R M O N PA G E 2 6 O F T H I S I S S U E eContent Management Pty Ltd, PO Box 1027, Maleny QLD 4552, Australia Tel.: +61-7-5435-2900; Email: [email protected] www.innovation-enterprise.com/8.1/toc.html

iv

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Copyright © eContent Management Pty Ltd. Innovation: management, policy & practice (2006) 8: 1–26.

INTRODUCTION China’s innovation system and the move towards harmonious growth and endogenous innovation BENGT-ÅKE LUNDVALL

SHULIN GU Visiting Professor School of Economics and Management Tsinghua University Beijing, China

1. INTRODUCTION

O

bservers around the world are impressed by the rapid growth of China’s economy, some with hope and others with fear. Some hope that China will offer the unique experience of successful economic growth and catch-up under the new World Trade Organization (WTO) regime; some see the rise of China as a threat to the current world order and to the powers that currently dominate the world in terms of economy, technology and politics. While outside observers tend to focus on the success story of unprecedented growth, policy documents and recent domestic debates in China have pointed to the need for a shift in the growth trajectory, with stronger emphasis on ‘endogenous innovation’ and ‘harmonious development’. In this paper we make an attempt to capture the current characteristics of China’s production and innovation system; how they were shaped by history and what major challenges they raise for the future. Volume 8, Issue 1–2, July 2006

Professor Department of Business Studies Aalborg University Aalborg, Denmark, and Special Term Professor School of Economics and Management Tsinghua University Beijing, China

In Section 2 we present data on China’s postwar growth experience. We show how the shift in policy around 1980 toward decentralization, privatization and openness established an institutional setting that, together with other factors such as the presence of a wide ‘Chinese Diaspora’, has resulted in extremely high rates of capital accumulation, especially in manufacturing. The section ends by pointing to some inherent contradictions in the current growth pattern. In Section 3, we take a closer look at how the policy shift in the ’80s affected the institutional framework shaping R&D activities in particular, and learning and innovation in general. The attempt to break down the barrier between the science and technology infrastructure on the one hand and the production sphere on the other was highly successful, as compared to the development in the former Soviet Union. However, the original intentions were not fully realized. Rather than establishing markets for science and technology, the reforms led knowledge producers to INNOVATION: management, policy & practice

1

Shulin Gu and Bengt-Åke Lundvall

engage in mergers or forward vertical integration and they became, to a large extent, involved in production activities. Referring back to analysis of the sustainability of the growth model and the unfinished reform of the innovation system, Section 4 introduces the recent decision by China’s government to promote endogenous innovation and harmonious development. Applying the innovation system perspective, we argue that these broadly defined objectives can be realized only through a strategic adjustment towards ‘innovation driven growth and learning based development’ and we discuss what important policy elements such a strategic adjustment needs to encompass. In Section 5, we conclude that imperfections, in the division of labour and in the interaction between users and producers of knowledge and innovation behind the reforms of the ’80s, remain central concerns. In order to raise the long-term efficiency of the massive accumulation of production capital, it is necessary to promote the formation of social capital and to be more considerate when exploiting natural capital.

2. TRANSITION OF CHINA’S ECONOMY How do we explain the extraordinary growth performance of China? What are the unique features of its production system? In this section, we will see how the development paths of the past define the strengths and weaknesses of the TABLE 1: GROWTH

OF

CHINA’S

ECONOMY

Farming, Fishery & Forestry Industry Construction Transport & Communications Commerce & Restaurants Other Services (incl. Government) GDP Per Capita GDP Export Volume

2

national production systems, as well as the bottlenecks and challenges that confront China today. It is useful to distinguish between two periods in China in the second half of the 20th century. The crucial shift takes place in 1978 when DENG Xiaoping took over the political leadership after Chairman MAO and initiated economic reform and the opening of the economy to international trade. The first was a period of development under a centrally planned economic regime and the second a period with market-oriented reforms and economic transition. To characterize the economic performance of the two periods, we use data summarized by Angus Maddison (1998) depicted in Table 1 and Figures 1 and 2. At the time of the revolution, the economy was still dominated by agriculture; in 1952 about 60 percent of GDP was generated by the agricultural (primary) sector, as shown in Figure 2. Both the first and the second period were dominated by industrialization, rather than the ‘post-industrialization’ that took place after WWII in developed and most less developed countries. As a result, China was highly ‘industrialized’ by the end of the century. In 2003, its GDP structure was 12.5 per cent primary, 46 per cent secondary and 41.5 per cent tertiary. The growth in manufacturing and the relative shrinkage of agriculture continued in the 1990s, and the value addedshare of the service sectors remained almost unchanged until the late 1990s.

1890–1995 (AT

CONSTANT PRICES )

1890–1952

1952–1978

1978–1995

1952–1995

0.3 1.7 1.6 0.9 0.8 1.1 0.6 0.0 1.6

2.2 9.6 7.2 6.0 3.3 4.2 4.4 2.3 6.4

5.1 8.5 11.1 10.0 9.9 6.7 7.5 6.0 13.5

3.4 9.2 8.7 7.6 5.9 5.2 5.6 3.8 9.2

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

China’s innovation system and the move towards harmonious growth and endogenous innovation 140 120

USA UK Japan China Korea

100 80 60 40 20 0 1820

1870

1900

1913

1950

FIGURE 1: PER CAPITA GDP

IN

1973

1992

COMPARISON , USA=100

100% 80% Services

60% Industry & construction

40%

Agriculture

20% 0% 1890

1952

FIGURE 2: GDP STRUCTURE

OF

1978

1995

CHINA’S ECONOMY

AT CONSTANT PRICES

Source: Maddison 1998: 56, Tables 3.1 and 3.2

As we shall see below, however, the economic structure looks quite different when the focus is employment rather than value-added. The proportion of the labour force working in agriculture remains as high as 50% in the beginning of the new millennium. The growth in manufacturing value-added reflects more than anything a very high rate of accumulation of fixed capital accompanied by high rates of growth in labour productivity. Behind high growth rates and restructuring of the economy in the second period lie extraordinary rates of savings and capital accumulation. In order to understand how these could be realized in a poor country like China, it is necessary to look at the institutional changes that took place with the shift in the political climate. Volume 8, Issue 1–2, July 2006

Reforms and development performance in the 1980s and 1990s The policies transforming the economy from a centrally planned towards a market-oriented regime may be seen as following two parallel and mutually reinforcing lines of action, aimed at decentralization and privatization (Wu 2003: Ch. 2). The first line of action, ‘bureaucratic decentralization’, began with increasing the autonomy of firms in decision-making on production planning, investment and acquisition of technology, marketing, pricing and personnel and with more autonomy to local governments in financial, budgetary and administrative issues. Initially, decentralization was based on ad hoc negotiations in individual cases. It was not until the mid-1990s, that nationwide reforms formalized INNOVATION: management, policy & practice

3

Shulin Gu and Bengt-Åke Lundvall

the relationships and introduced more transparent and coherent rules. This was the period when reforms in taxation, the banking system and governance structure of state-owned enterprises – ‘corporatization’ of previous state ownership – were initiated. This policy learning dynamic, where experiences from local and regional experimentation were gradually diffused at the national level, has been one major characteristic of the reform period. The second line of action loosened restrictions first for township and village enterprises in the early 1980s and later for private initiatives in the mid-1990s. It included the creation of ‘Special Economic Zones’ for FDI-related investment with various favorable regulations. In provinces like Zhejiang, this led to private initiatives by entrepreneurs. Here limited arable land, poor mineral deposits, high population density and little accumulation in modern industry, in combination with local historical experience in commercial activities, led to the start-up of private firms based on small family workshops (Xu, Chen and Bao (2006): this issue pp. 144–52; and Bao, Zu and Gu (2006): this issue pp. 153–59). But most importantly it gave local governments greater opportunities to engage in initiatives promoting local accumulation of capital. They did so by establishing and expanding Township and Village Enterprises (TVEs) sometimes owned by the local governments, sometimes representing joint enterprises with private capital or through initiatives which attracted private capital from local, national or international sources. ‘Diaspora networks’ played an important part in re-enforcing rapid capital accumulation from foreign investment (Kuznetsov (2006): this issue pp. 45–61). Throughout the ’80s, the opening to FDI and international trade attracted partners mainly from the Greater China area – Hong Kong, Chinese Taipei, Singapore, and overseas Chinese from other continents. It was not until the second half of the ’90s that multinational companies from North America and West Europe came into China on a large scale. Hong 4

INNOVATION: management, policy & practice

Kong, together with Taiwan, remains the first and primary source of FDI, holding about half of China’s total FDI. The fact that members of the Diaspora could communicate directly with local authorities reduced investor uncertainties. The second line of action, also called ‘incremental reform’, opened up new spaces for economic activities outside the entities inherited from the central planning era. As a result, the ownership structure of industrial enterprises changed rapidly. As can be seen from Figure 3, by 2003, each of the three types of ownership – state-owned, FDI-related and other domestic – were responsible for roughly one-third of output. It is important to note that a large proportion of firms belonging to the category of ‘other domestic’ enterprise primarily reflects the rapid growth in number and size of township and village firms over which local governments have some influence. The township and village enterprises – that played a major role in industrialization in many regions in China – outnumber both domestic private and state-owned firms undergoing a transformation from collective to private ownership in the mid-1990s.

Export-led growth International trade was initially pushed by favourable policies and gradually pulled by FDI and intra-trade within global value chains. Today China’s economy has reached a much higher level of openness than all other large economies in the world, developed or developing (Table 2 and Figure 4). Export structures have been upgraded (Figure 5). The share of primary products, such as foodstuffs, agricultural products and mineral fuels, has been reduced from half of the total in 1980 to less than 10 percent by 2002, while the share of manufactured goods increased to more than 90 percent. In manufactured exports, electric and machinery products, including electronic products, demonstrated the fastest growth rate, although light and textile products and apparel also increased considerably. Volume 8, Issue 1–2, July 2006

China’s innovation system and the move towards harmonious growth and endogenous innovation 100% 90% 44505

80% 70%

123393 Other domestic

60% 44358

50%

FDI related State owned

40% 30%

38581

20%

53408

10%

34248

0% Firm number

Turnover

FIGURE 3: OWNERSHIP

STRUCTURE : I NDUSTRY BY

2003

Source: based on China statistical yearbook Table 14-2 2004http://www.stats.gov.cn/tjsj/ndsj/yb2004-c/indexch.htm Note: the calculation is for all the firms which have annual turnover higher than 500 million

TABLE 2: OPENNESS

OF

CHINA

GDP (¥100 million) Sum import and export (¥100 million)

TO THE

GLOBAL ECONOMY

1978

1989

3624.1

16917.8

355.0

4156.0

1997

2002

2003

78973

120333

135823

26967.2

51378.2

70483.5

Source (for Table 2 and Figure 4): based on China Statistical Yearbook 2004; http://www.stats.gov.cn/tjsj/ndsj/yb2004c/indexch.htm, http://www.stats.gov.cn/tjdt/zygg/P020060109431083446682.doc.

60

Percentage of firms

50 40 30 20 10 0 1978

1989

1997

FIGURE 4: OPENNESS

Volume 8, Issue 1–2, July 2006

2002

2003

TO GLOBAL ECONOMY

INNOVATION: management, policy & practice

5

Shulin Gu and Bengt-Åke Lundvall 100% 15.7

80%

4.7

12.7 2.8

22.1

60%

34.6

31.1

33.1

39

17.1

16.3

14.4

10.2

8.8

1995

2000

2002

36.7 20.4

16.4 9 21.1 20.3

40%

21.1 50.2

50.6

20% 25.5

0% 1980

1985

1990

1 Primary products

2 Chemicals

3 Light & textile products

4 Electric & machinery products

5 Miscellaneous incl. Apparel

6 Other products

FIGURE 5: EXPORT STRUCTURE Source: Reproduced based on Wu (2004) Table 8.7

Beyond quantitative growth, qualitative or structural change has been radical. It is useful to make a distinction between global production chains driven mainly by demand factors – buyerdriven chains and those driven mainly by supply factors – and producer-driven chains (Gereffi 1999; UNIDO 2002). For products of buyerdriven chains such as apparel, footwear and toys (included in Category 3 and partly in Category 5 in Figure 5), China has become the preferred manufacturing location of a global ‘Triangle relationship. The consumption sites are largely in North America and West Europe while Hong Kong and Taiwanese businesses play a role as relational coordinators. Many of these goods are produced in factories owned by Taiwanese or Hong Kong investors, and some are produced in Chinese-owned firms but produced in subcontracting relationships (Zheng Y and Sheng S (2006): this issue pp.120–27). In the producer-driven industries such as computer and IT products (included in Category 4, Figure 5), exports are mainly manufactured in 6

INNOVATION: management, policy & practice

factories owned by Western and Taiwanese investors. For 2003 it was reported that 61.9 percent of high-tech export was produced by fully foreign-owned and 21.4 percent by partly foreign-owned firms; altogether FDI-related manufacturing produced more than 80 percent of high-tech export from China (China S&T Indicators 2004). This reflects overall trends in China’s innovation system characterized by easy access to foreign technology, while remaining weak in local and domestic clustering. We discuss this point in Sections 3 and 4.

Domestic demand and investment The domestic market has also played a role in development during this period. Domestic demand experienced at least two rounds of surge and growth, the first through the 1980s and early ’90s, led by household durables and necessities, as illustrated by color televisions in Table 3 and Figure 6. The centrally planned economy had left huge shortages in consumer goods industries. The combination of bureaucratic decentralizaVolume 8, Issue 1–2, July 2006

China’s innovation system and the move towards harmonious growth and endogenous innovation TABLE 3: GROWTH

IN REPRESENTATIVE PRODUCTS

Year

Air-conditioner 10000 set

Color television 10000 set

1978 1980 1985 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

0.02 1.32 12.35 37.47 24.07 63.03 158.03 346.41 393.42 682.56 786.21 974.01 1156.87 1337.64 1826.67 2333.64 3135.11 4820.86

0.38 3.21 435.28 940.02 1033.04 1205.06 1333.08 1435.76 1689.15 2057.74 2537.60 2711.33 3497.00 4262.00 3936.00 4093.70 5155.00 6541.40

Rolled steel products Cement Passenger car 10000 ton 10000 ton 10000 set 2208.00 2716.00 3693.00 4859.00 5153.00 5638.00 6697.00 7716.00 8428.00 8979.80 9338.02 9978.93 10737.80 12109.78 13146.00 16067.61 19251.59 24108.01

6524.00 7986.00 14595.00 21029.00 20971.00 25261.00 30822.00 36788.00 42118.00 47560.59 49118.90 51173.80 53600.00 57300.00 59700.00 66103.99 72500.00 86208.11

Microcomputer 10000 set

0.54 0.90 3.58 3.50 6.87 16.17 22.29 26.87 33.70 38.29 48.60 50.71 57.10 60.70 70.36 109.20 202.01

7.54 8.21 16.25 12.62 14.66 24.57 83.57 138.83 206.55 291.40 405.00 672.00 877.65 1463.51 3216.70

7000

10000 9000

6000 8000 5000

7000 6000

4000 5000 3000 4000 3000

2000

2000 1000 1000 0

0 1978 1980 1985 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 Air-conditioner 10000 set

Color television 10000 set

Rolled steel products 100000 ton

Cement 100000 ton

Passenger car 1000 set

Microcomputer 10000 set

FIGURE 6: GROWTH

IN REPRESENTATIVE PRODUCTS

Source (for Table 3 and Figure 6): China Statistical Yearbook 2004; http://www.stats.gov.cn/tjsj/ndsj/yb2004-c/indexch.htm

Volume 8, Issue 1–2, July 2006

INNOVATION: management, policy & practice

7

Shulin Gu and Bengt-Åke Lundvall

tion and incremental reforms stimulated investment in the supply capacity of these industries. The second surge begun around 1999 and was focused on real estate, passenger cars and personal computers and telecommunications, as illustrated by microcomputers and passenger cars in Table 3 and Figure 6. Cement and rolled steel products are intermediate products and both surges stimulated demand, although the second period of demand-led growth (strongly weighted towards large-scale activities such as construction and car production, which consume those products in great quantities) explains the accelerated growth of the latter years. To expand production capacity a very high rate of growth in investment was necessary. This second surge in manufacturing was more directly induced by central monetary and industrial policies. In order to cope with the stagnation and deflation that appeared in 1998– 1999, diagnosed as being caused by lack of effective demand, the government engaged in ‘active fiscal policies’ to increase public investment in highways, telecommunications and power generation stations. The banking system was also engaged to stimulate ‘domestic demand’ in consumption. It created loans for individual housing and car consumers at reduced interest rates.

A unique pattern of economic growth For about a quarter of a century, China’s economy has been characterised by high rates of economic growth and capital accumulation. Some of the mechanisms behind that growth pattern are unique while some have parallels with the institutional set up that promoted capital accumulation in England in the 18th century (Qian 1996). Reforms initiated more than 25 years ago unleashed restrained material needs. It was explicitly argued that some concentration of wealth among the few was a first step toward making everybody better off; making the strive for material wealth ideologically legitimate. 8

INNOVATION: management, policy & practice

Slumbering entrepreneurship was awoken to engage in production and trade both within and outside the public sector. The most important driver behind capital investment and economic growth was a specific local fusion of political and economic interests. Local authorities and local entrepreneurs were able to promote simultaneously their political career and own economic interests by stimulating industrial growth in their region, province, town or village. Most of the extra income created remained under local control and the incentives to reinvest the surplus were strong. Foreign direct investment, initially emanating primarily from overseas Chinese investors and subsequently from wider sources, is also an important factor. Joint ventures offer good opportunities for public and private rewards for local policy makers. The same is true for attracting direct investment of purely foreign-owned enterprises to the locality. Building infrastructure and supplying cheap labour, energy and land are now key concerns for local administrators. This mixture of political and economic interests constitutes a new kind of concentration of power at the local level, not always balanced by local political democracy and local rule of law, and it may explain why local administration is less popular than the central government among Chinese citizens (Saich 2004). The dynamics of reform have also been driven by competition between localities to provide the most attractive framework conditions, sometimes by offering cheap resources and lax regulations in relation to environment and workers’ safety. But there are also examples of forward-looking ideas developed locally and then spread nation-wide.

Limits to growth The development trajectory behind this high speed growth is now confronted with barriers for further growth. Some of these are external and refer to potential trade conflicts. Others reflect domestic problems regarding social and ecologiVolume 8, Issue 1–2, July 2006

China’s innovation system and the move towards harmonious growth and endogenous innovation

rates, the impact upon other countries’ trade balances is significant; an upper limit for China’s trade surplus may have to be set before trade quotas or other forms of retaliation are triggered. The current trend of massive penetration into global markets may not last much longer.

cal sustainability. There are indications of serious weaknesses in the innovation system and the call for ‘harmonious development’ may be interpreted as an attempt to give new direction to recognized unsustainable growth patterns.

Remarkable global impact and trade disputes

‘Jobless growth’

China’s economic growth has had a very visible impact on the global economy. With China’s exports and imports growing at double digit

In terms of GDP structure (Figure 7 and Figure 8 compare China with four big developing or transitional economies: Brazil, South Africa,

100% 90%

23.7

80%

32

34.4

41.5

51

70%

62

65

59

60% 48.2

50%

43

40%

47.5

24

46

30%

29

20% 28.1

10%

25

18.1

25 12.5

9

2003

Brazil 1999

0% 1978 First

1989

1997

Second

34

30

Tertiary

FIGURE 7: GDP STRUCTURE

IN

7

5 S Africa India 2000 1999

Russia 1999

COMPARISON

Source: For the data on China: Statistical Yearbook 2004 (http://www.stats.gov.cn/tjsj/ndsj/yb2004-c/indexch.htm ), for the Data on Brazil, South Africa, India and Russia: World Facts and Figures at http://worldfactsandfigures.com

100% 12.2

90% 80%

18.3

26.4

18 29.3

17.3 23.7

60%

45

53.2

21.6

70%

15

55

21.6

50% 25

40%

70.5

30%

60.1

20%

23.7 49.9

67

30

49.1 30

23.1

10%

15

0% 1978 First

1989 Second

1997

2003 Tertiary

Brazil 1999

FIGURE 8: EMPLOYMENT STRUCTURE

Volume 8, Issue 1–2, July 2006

S Africa India 2000 1999 IN

Russia 1999

COMPARISON

INNOVATION: management, policy & practice

9

Shulin Gu and Bengt-Åke Lundvall

India and Russia) China appears to be overwhelmingly ‘industrialized’. However, China is faced with the challenge of ‘jobless growth’ in the manufacturing sector. Figure 8 shows that, in terms of employment structure, China appears as an agricultural economy, half of its labour remaining in this sector. Only India has a bigger proportion of the labour force in agriculture. Combining the two sets of data, it is obvious that China is characterized by high and rapidly growing capital–labour ratio in the manufacturing sector. While there was net job creation in the first years of the reform period, the increase in employment slowed in the 1980s and has stagnated since the 1990s. This displacement of employment exacerbates ‘structural unemployment’ (Lewis 1955). Jobless growth, in addition to inequality in wealth distribution and redistribution, entails social instability and endangers sustainable development.

Widening income gaps and negative environmental externalities Gaps between the urban and the rural, between regions, and between the rich and poor in the same region are widening. Working conditions and workers’ safety have been largely neglected. Negative externalities also include environmental degradation such as pollution of air and water and exploitation and wasteful use of other nonrenewable resources. The current development mode entails intense consumption of non-renewable raw materials and energy sources. Especially when these inputs are under the control of local groups with vested interests, there may be a tendency to set prices too low and to be lax in terms of safety regulations.

Slow pace in competence and competitiveness upgrading The industrialization process has not resulted in building a widespread and robust indigenous innovation capability in Chinese firms. After 20 years as the origin of manufactured goods ‘madein-China’, China’s economy has not been able to 10

INNOVATION: management, policy & practice

embark upon the competence upgrading track. This contrasts with the catch-up history of the United States and Japan where ‘made-in-USA’ and ‘made-in-Japan’ were preludes to those countries, within one generation, reaching a world frontier in innovativeness and competitiveness. China remains specialized in low value-added products with profit margins trapped at a meager 2–5 percent, or in some areas even lower.1 Recent policy documents and the general debate have pointed to these problems and contradictions, and to the need for a shift in development strategy with stronger emphasis on ‘harmonious development’ and ‘endogenous innovation’. What adjustments of the development strategy are needed to realize the intentions signaled by these concepts? Before discussing this issue in Section 4, it is necessary to analyze the innovation system reform that accompanied decentralization and privatization. Analysis of reform and its outcome points to weaknesses in the current innovation system, which helps us to specify the reforms required to make innovation endogenous and for it to contribute to harmonious development. We will argue that efforts to stimulate endogenous innovation may go hand in hand with promoting harmonious development.

3. TRANSFORMATION OF CHINA’S INNOVATION SYSTEM

We now turn to the transformation of the innovation system in China, in the context of marketoriented economic reform. It is interesting to note that motivation for reform of the R&D-system initiated in 1985 was ‘highly systemic’ in the sense that the focus was on re-shaping the division of labour and the interaction between producers and users of knowledge and innovation. As we shall see, problems remaining after the reform can also be defined as ‘highly systemic’. The fundamental weakness of the system, having a negative impact both on absorption of foreign technology and on domestic innovation, has to Volume 8, Issue 1–2, July 2006

China’s innovation system and the move towards harmonious growth and endogenous innovation

do with an economic structure that does not support learning by interaction in organized markets.

Attempt to reconfigure user–producer relationships China has an old civilization and historically has made important contributions to global science and technology (such as the compass, gunpowder and paper). In China’s older history, however, science and technology as it evolved in Western Europe was not regarded as important or as carrying social status. While Confucious’ heritage gave high prestige to intellectuals, it was to those engaged in humanistic science and in TABLE 4: CHINA’S INVESTMENT

IN

political and administrative affairs. Scientific and technological knowledge was seen as based upon practical experience, rather than as a modern type of scholarship. Whereas Research and Development (R&D) establishments commenced elsewhere throughout the 1920s and ’30s, China only began the process of nationwide institutionalization of modern science and technology in 1950. The R&D system established in the first period of development was designed in accordance with the centrally planned regime. One prominent feature was its huge size, a reflection of the Marxist idea of science as a societal force of pro-

R&D

Year

Percentage of R&D Expenditure Based on National Income

Year

Percentage of R&D Expenditure Based on GDP

1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978

0.1 0.2 0.3 0.6 0.6 1.0 1.6 2.8 2.0 1.5 1.9 2.1 2.0 1.6 1.0 1.0 1.5 1.6 1.8 1.7 1.5 1.5 1.6 1.6 1.6 1.8 (1.5 of GDP)

1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

1.5 (1.8 of national income) 1.5 1.5 1.3 1.3 1.4 1.4 1.2 1.3 1.0 0.8 0.8 0.8 0.8 0.7 0.7 0.7 0.6 0.6 0.6 0.7 0.8 1.0 1.1 1.2 1.3

Sources: China Statistical Yearbook on Science and Technology various issues; National Statistics Bureau 1990: 207, and http://www.sts.org.cn/KJNEW/maintitle/MainTitle.htm.

Volume 8, Issue 1–2, July 2006

INNOVATION: management, policy & practice

11

Shulin Gu and Bengt-Åke Lundvall

duction, and also a result of the self-reliance development strategy in that centrally planned period (Table 4). The second feature was the separation of industrial R&D centres from productive enterprises. The centrally planned regime introduced mechanisms to link R&D activity with production: All R&D institutes, except those belonging to the Chinese Academy of Sciences (assigned as the national top organization for comprehensive natural and engineering science) were organized under the jurisdiction of sector specific ministries or bureaus, independently outside enterprises. The ministries or bureaus took responsibility for planned production tasks as well. They were therefore in command of both R&D and production (Gu 1999: 151–176). It is interesting to note that this model of specialization according to product category, both for R&D centres and enterprises, and separation of firms from innovative activities, was common for all former centrally planned economies (Granick 1967 – for former Soviet Union; Hanson and Pavitt 1987 – for more general discussion). Organizational separation between innovation and production blocked the system of vital and intimate interactions between producers and users, which was important especially for innovation in sophisticated producer goods technology (von Hippel 1994; Kline and Rosenberg 1986; Lundvall 1988). The institutional setting was reflected in innovation characteristics. For example, the machinery industry of China was strong in ‘general purpose’ machinery, and weak in technologies fulfilling particular machining tasks since these could only be developed through interactive learning and close producer–user communications (Gu 1999: 127–135). The low degree of effectiveness of the centrally planned institutional settings was well acknowledged at the end of the 1970s. This became an important motive for the launch of reforms. The crucial event for R&D system reform came in 1985, lagging slightly behind agricultur12

INNOVATION: management, policy & practice

al and industrial reforms which started in 1978 and 1984 respectively. A 1985 Decision of the Central Committee of the Communist Party of China initiated reforms in Science and Technology System Management. The central theme for reform was to rearrange the relationship between knowledge producers and users and their relationships with the government. In a context where demand, supply and coordination factors were changing, reform of the S&T system was seen as essential. The size and complexity of the S&T system made reform crucial for economic growth. By 1980 there were 4,690 research institutes affiliated to administration bodies higher than ‘county’ level, i.e. to central, provincial and regional/city governments, with some additional 3000 institutes at county level, the lowest level of the nation’s administration hierarchy with an independent budget (White Paper No. 1: 232, 235). 323,000 scientists and engineers worked in these institutes. The then Prime Minister Mr. Zhao Ziyang interpreted the reform as follows: The current science and technology institution in our country has evolved over the years under special historical situations. The advantages embodied in this system manifested themselves in concerted efforts to tackle major scientific and technological projects, which were achieved with great success. However, there is growing evidence to show that the system can no longer accommodate the situation in the four modernizations programme, which depends heavily on scientific and technological progress. One of the glaring drawbacks of this system is the disconnection of science and technology from production, a problem, which is a source of great concern for all of us … By their very nature, there is an organic linkage between scientific research and production. For this linkage a horizontal, regular, many-leveled and many-sided channel should be provided. The management system as practiced until now has actually clogged this direct Volume 8, Issue 1–2, July 2006

China’s innovation system and the move towards harmonious growth and endogenous innovation

linkage, so that research institutes were only responsible to the leading departments above, in a vertical relationship, with no channels for interaction with the society as a whole or for providing consultancy services to production units. This is the root cause of the inability of our scientific research to meet our production needs over the years.... This state of affairs can hardly be altered if we confine ourselves to the beaten track. The way out lies in a reform. (Zhao Ziyang 1985)

Adaptive policy process and the recombination of competences To reform the S&T system, a two-pronged policy was designed. On the one hand, ‘technology markets’ were established to function as distributive institutions for R&D outputs (Decision: Section III). On the other hand, excellence-based allocation mechanisms were introduced for allocation of public R&D funds (Decision: Section II). In order for R&D institutes to be able to respond to opportunities in the market place, some degree of autonomy, in terms of hiring personnel, engaging in contracted projects, and acceptance and use of contractual fees, were assigned (Decision: Section VII). At the same time subsidies from the government were gradually reduced (Decision: Sections I and II). It was expected that by push and pull, previously publicly funded R&D institutes would move to serve their clients via regular and multiple linkages.2 The actual process of S&T system reform, as with reforms of the overall economic system, unfolded through trial and error and entailed continuous policy adjustment (Gu 1999). The technology market solution, central to the initial design, was soon recognized as being difficult to realize in its original form. Users were not capable of absorbing transferred technology, and the market was too small to secure R&D institutes with enough earnings. Buyers and sellers experienced serious uncertainty in assessing the use value of technology, giving rise to disputes during the writing and implementing of contracts. Volume 8, Issue 1–2, July 2006

In response, in 1987, reform policy began to promote the merger of R&D institutes into existing enterprises or enterprise groups. The merger process was however not easy to realize. Huge gaps between the merging parties, from differences in work culture and administrative affiliations, were difficult to overcome immediately. In 1988, the Torch Programme was launched to encourage organizations akin to spin-off enterprises – called New Technology Enterprises (NTEs) – from existing R&D institutes and universities. Local governments contributed to investment in infrastructure and supporting institutions for New and High-Tech Industry Zones that became incubation bases for NTEstartups. Scientists and engineers, often with support from their parent institutions, sought commercial application of their inventions and expertise by means of the NTEs. By the early 1990s, reform policy included a solution to change individual R&D institutes into production entities. This was also an adaptation of the actual evolution already realized by many industrial R&D institutes. The reforms came to a form of conclusion when, in 1999, an official decision pointed to the need to clarify the actual character of previously government-run industrial technology R&D institutes. By 2001 some 1,200 industrial technology R&D institutes had re-registered their business type.3 Of them more than 300 were merger cases, having cancelled their independent position and become part of an enterprise. Six-hundred plus became profitable firms and a few joined universities. Table 5 indicates the changed structure of R&D performers. In 2000 the proportion of R&D performed by ‘enterprises’ leaped abruptly (Table 5: Line 3) largely because many R&D institutes registered as enterprises or part of existing enterprises. Table 4 also depicts the scope of technology market and spin-offs, growing steadily over time (Lines 1 and 2), and illustrating the complementary effects of various transformation means. Lines 3, 4 and 5 show the changed structure in technology INNOVATION: management, policy & practice

13

Shulin Gu and Bengt-Åke Lundvall TABLE 5: SELECTIVE

INDICATORS TO CHANGES OF THE

CHINA NIS (All measures at current price)

1985 (1) Technology Market Contract fees (RMB Billion)

2.30

(2) Spin-offs Number of NTEs Annual turnover (RMB Billion) Export (USD Billion)

– – –

(3) Domestic R&D expenditure (RMB Billion) in which Enterprises (%) Independent R&D institutes (%) Universities (%) (4) Import of capital goods (USD Billion) (5) FDI (USD Billion)

1990 7.51

1995

2000

26.83

65.07

12,937 151.2 1.55

20,796 920.9 13.81

12.54 n.a.

34.87 43.7

89.57 60.0

54.7 15.9

n.a. n.a.

42.1 12.1

28.8 8.6

16.24

16.85

52.64

69.45 (1999)

1.96

3.49

37.52

40.72

1,690 5.94 0.69 (RMB Billion)

6.74 (1987) 29.3

Sources: China Statistical Year Book on Science and Technology various issues; http://www.most.gov.cn; http://www.stats.gov.cn/ndsj/zgnj/2000/Q05c.htm; http://www.moftec.gov.cn/article/200303/20030300072333_1.xml; http://www.sts.org.cn/REPORT_3/documents/2002/0220.htm; http://www.sts.org.cn/REPORT_3/documents/2002/02hdb01.htm

sources. China, not so long ago almost closed to international exchange in technology and knowledge, has developed a widely open innovation system, with enormous inflows of technology in forms of international capital goods and FDI. Adaptive policy, evolving through trial and error, characterizes ‘gradual reforms’ in the whole process of China’s economic transition. The great uncertainties associated with foreseeing the impact of major political reform made adaptive policy learning necessary. Only policy-making that was responsive and adaptive to feedback on reform impacts could preserve the feasibility for success of any radical social innovation program (Metcalfe 1995; Gu and Lundvall 2006).

Review of the transformation of the innovation system On the basis of discussion above, Figure 9 illustrates China’s National Innovation System as it looked before (Part A) and after (Part B) the transformation, embracing: 1. innovation actors – R&D institutes, capital goods industries that embodied technology 14

INNOVATION: management, policy & practice

for user sectors, domestic end-product manufacturers; 2. inflows of technology – by means of technology licensing (TL), sample machine procurement (SMP), equipment procurement (PE), foreign direct investment (FDI) and original equipment manufacturing (OEM); 3. interactive relationships between actors and with domestic and international markets. Arrows with different line boldness illustrate the intensity of various links and provide an impression of the significant changes transformation has brought into the system. The transformation was constructive in safeguarding and recombining technological capabilities in the context of market reform. It not only opened China to the global economy but supported rapid economic growth as a whole. For example, a number of NTEs like Huawei, Datang and Linovo grew into key ICT enterprises, leading to a fundamental restructuring of China’s ICT industry (Gu and Steinmueller 1996/2000). The achievements are especially Volume 8, Issue 1–2, July 2006

China’s innovation system and the move towards harmonious growth and endogenous innovation

A

B

TL, SMP

R&D Institutes

Capital Goods Industries

TL, PE, FDI + academic exchange

R&D Institutes and Universities

Domestic Manufactures

Capital goods Industries

Domestic Manufactures

PE, FDI, TL

OEM

Domestic Market Domestic and International Markets TL: Technology Licensing SMP: Sample Machine Procurement PE: Procurement of Equipment FDI: Foreign Direct Investment OEM: OEM Assembly

Figure 9 Transformation of the China’s NIS

FIGURE 9: TRANSFORMATION

impressive when compared with Russia where scientific and technological capabilities were destroyed on a huge scale. Nonetheless, the system still has some prominent weaknesses.

Easy access to foreign technology while remaining weak in local and domestic clustering Firstly, the system resulted in weaker domestic links and interactions, although mastery of international links remained passive, dominated by import of the foreign technology embodied in machinery and other process equipment. The capital goods industry has not played a role as an innovation centre for the whole economy by providing appropriately advanced production means for various users; they were instead largely integrated into respective global value chains. Many regions of China, for which the autonomy of policy decision-making was strengthened during the market reform, are weak in geographical proximity-based clustering or networking even when there is some firm agglomeration (Wang and Tong 2000). In general potential local or domestic links along and between value chains have been slow to develop and hard to expand. Small firms in tradiVolume 8, Issue 1–2, July 2006

OF THE

CHINA’S NIS

tional manufacturing sectors, and agriculture and rural development, have received inadequate support from the national and regional technological infrastructures, showing a separation between the modern and traditional parts of the system (Tylecote (2006): this issue pp. 62–83).

Missing technological infrastructure and supportive institutional development Second, the transformation ignored the development of technological infrastructure and supportive institutions. The remarkable aspect of the reform is that the initial intention – to establish technology markets for existing R&D institutes and existing enterprises – was not realized. Instead unforeseen adaptations ‘saved’ the reform. A general tendency was for vertical integration of R&D and design with production activities, either through merger into enterprises or through establishment of downstream production. This was true not only for R&D institutes for industrial technology, but also for institutes engaged in health and agricultural R&D, and even for universities. As a result, the reconfiguration of the scientific and technological infrastructure was not INNOVATION: management, policy & practice

15

Shulin Gu and Bengt-Åke Lundvall

completed during the market reforms, which has resulted in a weak capability to provide S&T inputs and supportive services to innovation in firms; a capability that is fundamentally important for knowledge-based growth (Nelson 2004; David 2003). There were several reasons for the drive toward vertical integration. One reason was the peculiar pattern of division of labour for R&D institutes inherited from the centrally planned system in which they had already been involved in many ‘down-stream’ activities.4 Weak absorptive capacity and less developed social capital were other reasons for the difficulties in establishing technology markets. The phenomenon of factories integrating vertically at all stages in their production process was common in centrally planned economies (Granick 1967). Kornai (1980) explained this as a combination of the factories’ hunger for investment and paternalistic relations with the planning authority. Vertically integrated factories were left almost untouched by the market reforms, and this obstructed networking in the core part of the economy. Vertically integrated enterprises survived, mainly in what had been seen as strategic sectors, and especially in the machinery industry which was given high priority before the reform.

4. PROBLEMS, DEBATES AND CHALLENGES

By the end of 1990, symptoms increasingly indicated that the development dynamics created by reforms were about to be exhausted and negative sides of the growth model came into focus. The accession to WTO added to the need for China to move into a new period of economic and NIS transition. This was the background for the 1999 Decision by the Communist Party and the State Council, where it declared the need for ‘enhancing technological innovation, developing high technologies and promoting commercial production of S&T achievements’ (White Paper No. 1 1985: 238).5 However there has not been much 16

INNOVATION: management, policy & practice

change in economic policy and in the orientation of development, except in ‘active fiscal policies’ which targeted material infrastructure construction and a considerable increase in public investment in R&D. With the further accumulation of problems, the government has now decided to make ‘endogenous innovation’ and ‘harmonious development’ key components of its renewal of the development strategy. In this section, we analyze the problems and introduce policy debate around ‘endogenous innovation’. Starting from the innovation system perspective and taking into account its historical transition, we propose an interpretation of endogenous innovation where it is understood as a move toward innovation-driven growth and learning-based economic development.

Endogenous innovation6 and policy debates In October 2005, the Communist Party Central Committee and China’s Government stipulated the Guiding Vision for the 11th National Economic and Social Development Program (2006– 2010). It emphasizes the importance of a development strategy which economizes on material inputs; upgrades economic structures and innovative capabilities; considers environmental protection; balances urban and rural development and that between eastern, middle and western regions; and maintains job creation and social equality (CCCPC 2005). The key for realizing the new strategy is endogenous innovation (zizhu-chuang-xin) and continuous reforms to build harmonious development. One can see that the new strategic vision accommodates several of the problems discussed above. Policy debates on endogenous innovation following this decision may be considered as followup on earlier long-lasting debates.7 A first focus concerns the theoretical rationale for alternative development strategies – whether the strategy should be based on comparative advantages, or if it should involve strategic industrial policy aimed at catch-up and leapfrogging. Another debate Volume 8, Issue 1–2, July 2006

China’s innovation system and the move towards harmonious growth and endogenous innovation

focus relates to the buy-or-make question of technology. Here, one opinion insists on the necessity of increasing investment in domestic R&D so as to develop national brands, competence in core technologies and technological capabilities, and to build independent capabilities in relation to defense, health care and other national specific needs. The opposing view argues in favor of buying/borrowing technologies from abroad, claiming that high R&D investment to date has brought advantages for neither the country nor enterprises. A third focus is on FDI policies. Whether, and to what extent does FDI contribute to technology acquisition and upgrade? Were policies successful that aimed at attracting FDI by opening the huge domestic market? Should favorable treatment for FDIs continue or should regulatory conditions be identical for domestic and FDI-related businesses? The several different issues of the debate have not always been clearly focused. The emphasis on promoting free market and trade liberalization in policy spheres was, to some extent, unavoidable in a period when China was engaged in economic and social transition away from its centrally planned regime. Nonetheless, current debate recognises that free markets alone have their limits when it comes to guiding social and economic transition and development.

Endogenous innovation as a strategic element of innovationdriven growth and learning-based economic development In order to clarify the current debates, we believe it is necessary to elevate the central theme: ‘how to embark on innovation-driven growth and learning-based economic development’. Otherwise much of the debate might go nowhere. For example, purchasing technology from overseas and domestic development of technology are both important; they are complementary in most innovation processes. To see policies that encourage domestic firms’ innovation as conflicting with policies that aim to acquire foreign techVolume 8, Issue 1–2, July 2006

nologies would be misleading. Comparative advantages are necessary reference points for operational planning, while strategic planning needs to consider how existing comparative advantages can be renewed and upgraded. To promote endogenous innovation, a conventional and simplistic response would be to invest more in science and technology, and reinforce the tendency of R&D organizations to move into downstream activities. It is highly questionable if such an effort would make any major difference and overcome the weakness in competence upgrading at the firm level and in internal clustering and dynamics. The crucial question is how to overcome the weaknesses encountered by the Chinese economy and innovation system; and for this it is essential to define endogenous innovation as a strategy for innovation-driven growth and learning-based development. We believe that the fundamental challenge is still to make the innovation system as a whole work in such a way that it contributes to economic growth and harmonious development. This is actually what the Chinese Government’s Guiding Vision for the 11th National Economic and Social Development Program (2006–2010) declares.

Reconfiguring innovation systems in the context of the globalizing learning economy The idea that economic development is a process where the degree of specialization and division of labour grows and become more complex, and mastery of knowledge generation and application becomes increasingly sophisticated, goes back to Adam Smith, and has been discussed widely by economic historians (Madisson 1991; Fei & Ranis 1997; Hayami 1997). Human learning, which takes place by doing and through sciencebased innovation, is the most important source of economic growth and involves the deepening of the division of labour and increasing scale economies as well as dynamic effects (North 1996; Lundvall and Johnson 1994). In the curINNOVATION: management, policy & practice

17

Shulin Gu and Bengt-Åke Lundvall

rent context of global competition, deregulation and radical technical change, the dynamic effects become increasingly important. Acceleration of the rate of change implies that the speed of learning become increasingly important for firms’ competitiveness and national systems. One of the authors has referred to this change in context as ‘a globalizing learning economy’ (Lundvall and Borras 1998; Archibugi and Lundvall 2002). China’s experience has shown that, to facilitate a rapid learning pace and intensify development, a globalizing learning economy is essential. One of the major focuses of the innovation system perspective (Nelson and Winter 1982; Freeman 1987; Lundvall 1992; Nelson 1993) is about how an innovation system generalizes and diffuses knowledge through learning. Learning takes place in specialized R&D centres that transform local experiences and laboratory experiments into more general knowledge, diffused through training and publication. But learning also takes place in production and consumption. Producer learning does result in productivity growth and consumer learning can alter the composition of final demand (Pasinetti 1981). Learning by using enables users of complex systems or advanced process equipment to become more proficient as they experience and solve problems (Rosenberg 1982). However, development of new products and processes, especially capital goods and sophisticated devices, has to involve an interaction and information exchange between users and producers (Lundvall 1985). Interactive learning is pervasive in a modern economy, which is characteristic of sophisticated patterns in division of labour. More fundamentally, ‘learning by interacting’ generalizes and spreads initial, local learning consequences throughout the whole economy, in the form of new machinery, new components or new software-systems embodying knowledge, and tacit and human-embedded competences and business solutions (Lundvall 2006). How a system becomes interactive and works well is crucial for innovation and development performance of a national economy. Interactive 18

INNOVATION: management, policy & practice

learning is carried out in a hybrid structure of governance consisting of markets, organizations and networks, called ‘organized markets’ (Lundvall 1985). Perfect competition at arm’s length, with anonymous relationships between customers and sellers, cannot support product innovation. Vertically integrated firms also exclude product innovation and an economic structure dominated by such firms would make an economy less rich in terms of learning experiences, as well as more rigid and therefore quite vulnerable to market turbulence (Lundvall 2006; Richardson 2002). Learning takes place through user–producer interaction when, for instance, a producer of machinery absorbs information about user experiences from many diverse users. Interaction at this level may be seen as an important dynamo for innovation-driven economic growth. Different from conventional thought, the perspective of interactive learning points to the importance of the structure of the production and innovation system: the absence of a strong domestic capital goods sector would constitute a serious handicap for the innovation system. Similar considerations apply to knowledge intensive business services. Today such services play an increasingly important role for economic growth. While it is necessary for production enterprises to have in house R&D-activities in order to absorb knowledge from the outside, having access to knowledge intensive business services is a great advantage. Empirical studies from different countries show that firms that outsource the production of such services experience rapid productivity growth (Tomlinson 2001). Network formation is crucial for the improvement of interactive learning by augmenting and mediating ‘complementary’ but not ‘similar’ innovative activities (Saxenian 1996; Baldwin and Clark 1997; Langlois 2003). Social capital supports networking and interactive learning across organizational boarders (Woolcock 1998) and may, in this connection, be defined as ‘the willingness and capability of citizens and organizations to make commitments to each other, colVolume 8, Issue 1–2, July 2006

China’s innovation system and the move towards harmonious growth and endogenous innovation

laborate with each other and trust each other in processes of exchange and interactive learning.’ The above paragraphs illustrate the importance of applying a systemic perspective when designing a policy aimed at endogenous innovation. From the NIS-perspective the promotion of endogenous innovation needs to be built upon an understanding of two major themes: interactive learning and system efficiency. The policy discussion in the following sections draws on ideas developed above. We see some of the major challenges for reform of China’s innovation system as having to do with a need to reconfigure user–producer relationships and to stimulate new forms for user–producer interaction in the context of innovation.

Innovation policies to overcome the limits to growth and foster endogenous innovation and harmonious development At the end of Section 2, we listed a number of problems from China’s current trajectory of economic growth. Section 3 pointed to weaknesses of the current innovation system. In what follows we will, from the innovation system perspective, briefly present some ideas for the next transition of the innovation system to respond to these problems and weaknesses and to take the global context into account.

Address domestic needs An inexorable factor for innovation is demand characteristics; requiring both incentives and demand information. China’s enterprises should not miss the rich domestic market resources, reflecting heterogeneous regional, habitual and cultural variation in needs, both advanced and basic. A general shift toward home markets would also reduce international trade friction. One way to promote harmonious and sustained development is to direct innovation activities toward domestic social and ecological needs such as health services, education, transport, energy and environment. China has the necesVolume 8, Issue 1–2, July 2006

sary planning capacity to coordinate R&D and to develop industrial competence and qualified demand, using a pragmatic mixture of market and administrative governance.8 To respond to the demands emerging domestically would open ways to stimulate and nurture novel ideas for endogenous innovation. In the longer run that would eventually make it possible for China to contribute both to international market demands and to human wellbeing. In short, addressing domestic needs is a necessary ground for ‘peaceful’ and harmonious development.

Engage in product innovation and improve engineering capability At the level of a single firm, product innovation addresses new market needs and is therefore an important factor in market growth. Process innovation, on the other hand, improves the efficiency of the production process. Both types of innovations are important for survival of the firm. But for the innovation system as a whole, product innovation may be more efficient in promoting innovation-driven growth and job creation because it enriches the division of labour and provides greater opportunities for interactive learning. While product innovation creates jobs, process innovation alone tends to reduce jobs (Pianta 2005). This distinction is especially important in an economy with big labour reserves and jobless growth in its most dynamic sector. Jobless growth results partly from lack of product innovation, and partly from a weak engineering capability, reflected in the massive import of production means such as machinery and poor indigenous provision. Engineering capability is the ability to implement and realize innovation based upon innovative ideas, which in themselves are experiencing dramatic change and improvement (Dodgson, Gann and Salter 2005). Policies that stimulate domestic firms to develop new products, in the form of new process equipment for use by domestic firms, would certainly promote endogenous innovation INNOVATION: management, policy & practice

19

Shulin Gu and Bengt-Åke Lundvall

through stimuli for interaction at the core of the system it represents. Product innovation takes place also in the form of new services and increasingly the knowledge intensive business services that have become strategic parts of the innovation system (Tomlinson 2001). They interact with many users who profit from development of more efficient services that embody the requirements of those diverse users. From a strategic perspective, building a strong and dynamic business services sector may be a necessary step toward innovation-driven growth in China. Growth in this sector has until recently been slow and there is also great potential for job creation here.

Building user competences and institutions supporting SME competence Since user–producer interaction is crucial for the success of innovation, it is not sufficient merely to promote supplier competence and knowledge creation. One important reason why the 1985 reform did not succeed in building markets for science and technology was that the potential users had no competence to absorb advanced knowledge. This is why the dominant pattern became vertical integration and knowledge producers moved into production. To improve interactive learning, user competence is as important as the competence of the producer, and in China this constitutes a major bottleneck for learning and innovation. Competence refers to scientific capabilities as well as to the capacity to engage in learning by doing and organizational learning. To promote scientific capabilities, incentives for enterprises to engage in R&D-activities may be combined with incentives to hire highly educated personnel. To stimulate the diffusion of organizational learning among firms, a combination of benchmarking good practice in terms of organizational and inter-organizational learning may be combined with competence-based selection and job rotation among top managers. 20

INNOVATION: management, policy & practice

For small and medium-sized firms in traditional sectors, including agro-food business, specific institutes and self-organizing initiatives with the task of diffusing technical innovations and good organizational practice may be supported by the public sector. Such firms have a need for inexpensive access to technological services and knowledge institutions. Especially in periods of unemployment for graduate engineers and scientists, public support might be considered for such firms to hire their first engineer/graduate.

Develop a responsive science and engineering base The 1985 reform resulted in a structure where universities and other institutions with responsibilities for basic research were strongly involved in commercial activities. With improvement of competency levels within firms, universities and public R&D centres should redefine their roles and withdraw gradually from downstream commercial activities that are not easily combined with the search for excellence in science and technology. Improvement of public funds management, and development of scientific community-based academic evaluation, would largely increase the efficiency of knowledge production. Such a shift may actually be combined with a more intense communication with industry, both in research and in higher education.9 In a greater global knowledge society, it is also important to participate in international academic communities and to expose academic research to international competition. Such changes would certainly increase the rate of return from the increased investment in R&D that the Chinese Government is beginning to implement.

Develop new forms of participatory governance of economic organizations There are different forms of governance, and the degree to which people tolerate social gaps differs even in wealthy nations. Some advanced counVolume 8, Issue 1–2, July 2006

China’s innovation system and the move towards harmonious growth and endogenous innovation

tries operate with wide social gaps while others are more egalitarian. The first group includes the United States and United Kingdom where ordinary people are less participatory; they are expected to adapt passively to new technologies. The second group includes the small European welfare states where ordinary workers take an active part in innovation as well as sharing in the benefits that innovation creates. In China, one way to stimulate participation in change processes is to establish cooperative ownership of firms. This might be especially relevant for densely populated agricultural regions. The International Labour Office (ILO 2003) calls for rediscovery of the cooperative advantage to reduce poverty, warning at the same time that people have to learn lessons from negative experiences of the past. One lesson is to let cooperatives grow through self-organization and learning; another is to support development of the qualifications of leaders and participants.

Improving education and stimulating the mobility of skilled labour The most fundamental and dynamic resource in the innovation system is people. Every single person is a potential user and producer of technology and knowledge. One of the basic means of enhancing user competence and facilitating interaction between users and producers is improvement of education and training. Universal secondary education in poor rural areas would prepare residents for participation in knowledge and skill-intensive agricultural and related activities, or to join the new generation of urban residents. The curricula design and pedagogical methods of the education system must be modified to promote the problem-solving capacity of students. Increasingly interaction will depend upon experts who are creative and co-operative. Elite education needs to be complemented with uniVolume 8, Issue 1–2, July 2006

versal and life-long continuous education as a strategy of endogenous innovation and harmonious development. But not all competencies emanate from formal education and training. With rapid change the learning that takes place at work ill become more and more important. Stimulating diffusion of ‘learning organization’ practices among enterprises is fundamental for endogenous innovation and for the ongoing upgrade of skills in the workforce. The mobility of people across organizational borders shapes social connections and interaction. Enterprise employees and managers with a university education will have the least difficulty establishing collaboration with university researchers. Therefore schemes that make it attractive to move back and forth between academia and the enterprise sector may be especially important.

Develop networking and learning regions Regions can be springboards for endogenous innovation, if they develop and exploit specialized strengths based on firm networks with tacit knowledge (Cooke and Morgan 1998). The local and regional dimension has become crucial for growth in China through reforms leading to bureaucratic decentralization, but development of learning regions has been less impressive. There is a need for a new incentive structure and for policy capacity-building at a regional and local level. Reform should aim at rewarding innovative solutions that promote networking and save scarce resources. There is also a need to give central government a stronger role in the redistribution of wealth between provinces and regions. Central government could also play a more important role as promoter of regional policy and managerial learning within the regions.

Social capital and endogenous innovation In summary, endogenous innovation and harmoINNOVATION: management, policy & practice

21

Shulin Gu and Bengt-Åke Lundvall

nious development require a new set of efforts, rather different from those of the 1980s and 1990s. It will involve reform of institutions that support markets and make contracts trustworthy but must also involve broader social changes to support the interaction between economic agents. Corruption and irregularities in the use of legal systems undermine trust and thereby undermine a critical prerequisite for interactive learning across organizational borders. Innovation, because of its inherently uncertain character, is especially vulnerable to lack of trust. To foster the rule of law and a competent and honest public administration is therefore an integral element of any strategy for innovation and learning-based development. In the current context, fostering good governance, especially at the local and enterprise level, may be a key to enhancing innovation. One way to illustrate the promotion of endogenous innovation and harmonious development is to present it in terms of four types of capital (Table 6). Production capital can be relatively easily produced and reproduced. The same is true for intellectual capital. But production capital loses much of its user value when natural capital is eroded – once the land and drinking water are polluted, it is immensely expensive to clean it up. Intellectual capital is created through interactive learning and depends strongly on social capital. In a society where people trust institutions and each other, and are ready to co-operate willingly even outside the most narrow group, learning will flourish. Endogenous innovation and harmonious development implies a growth model that gives attention not only to production capital and

intellectual capital. Avoiding the degradation of natural capital must be a key element in any strategy favoring harmonious development. Stimulating the formation of social capital is a key to long-term success in promoting endogenous innovation. Social capital is the basis for interactive learning and therefore the lubrication that will make the innovation system work smoothly.

5. CONCLUSION In this paper, we have analysed the forces behind China’s rapid growth. We have shown that pragmatic policies and policy learning have been central to its success. We have also identified challenges posed by its growth pattern and remaining weaknesses in its innovation system. These challenges and weaknesses are reflected in the new political signals giving priority to concepts of endogenous innovation and harmonious development. Building upon the historical experience, we argue that the best way to interpret these concepts is to see them as signalling innovation-driven economic growth and learningbased economic development. The global context and historical starting point is different than it was in 1985 but the basic perspective for reform, with its focus on interaction between users and producers of knowledge and technology, remains pertinent when designing the next major transition. Strengthening domestic demand and the competence of domestic technology users is a key to success. Enhancing the knowledge base of strategic sectors producing processing equipment and knowledge-intensive business services for the market is another important element. Investing in social capital – designing institutions so that

TABLE 6: RESOURCES

FUNDAMENTAL FOR ECONOMIC GROWTH REPRODUCIBLE DIMENSIONS

22

–

COMBINING TANGIBLE AND

Easily reproducible resources

Less reproducible resources

Tangible resources

Production capital

Natural capital

Intangible resources

Intellectual capital

Social capital

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

China’s innovation system and the move towards harmonious growth and endogenous innovation

citizens more readily collaborate and learn from each other – is a way to promote endogenous innovation. Many aspects of the successes and problems that China has experienced were unforeseen in its previous catch-up history and in its existing theories of economic development. This is true for the limits of export-led development strategies, the inadequacy of manufactured exports in spreading learning effects, the extreme rate of substitution of capital for labour, and the severe structural unemployment phenomenon. The response to these accumulated challenges sees China embark on a new development strategy characterized by endogenous innovation and harmonious development, which we have interpreted as a strategy of innovation-driven growth and learning-based development. As China pursues harmonious development, it will become clear that it represents no economic threat to other countries. For those who wish China a uniquely successful experience, we must point out that the actual process of adjustment will unavoidably involve uncertainties and setbacks. We trust that innovation studies can serve an instrumental and positive role, and believe that these studies can also learn from China’s transition in future years.

2

3 4

Endnotes 1 Low profitability of commodities made in China is common knowledge, although the 2–5 percent is a rough estimation. For example, the TV industry, which has a well developed competitive advantage, has rather thin profit margins because key components for final products are imported from Japan, Korea and Taiwan. It is reported that in 2005 average net profit of the TV industry was as low as or less than 3 percent, and for some firms it was lower than 1 percent, even though the industry had introduced flat panel TV sets a year ago and these were expected to improve the industry’s profitability record (Shangwu shoukan (Business Watch Magazine) 28 October 2005). Ninbo City, Zhejiang province, is an important exportmanufacturing base. It exported US$12 billion Volume 8, Issue 1–2, July 2006

5 6

7

of products such as clothing, cigarette lighters and air-conditioners in 2003. Possessing weak negotiating capacity with international buyers and being engaged in the low end of value chains, the exporting firms had net profits of around 10 percent with some lower than 5 percent. (IT jingli shijie (CEO & CIO China) 9 November 2004). Note that the Decision recognized the diversity of R&D institutes in terms of function. It divided them into ‘technology development type’, ‘basic research type’, and ‘public welfare and infrastructure services type’. The reduction of public funds was mainly applied to the technology development type and it was done gradually for completion over five years. Consequently by 1991, the 2000 plus, out of 4000 in total, technology development institutes had had their public ‘operation fees’ entirely or partly cut. Roughly the sum of the reduction accounted to slightly less than RMB 1 billion (or USD 200m), or about one-tenth of the overall government S&T budget in 1985. See: http://www.sts.org.cn/report_3/documen ts/2002/0207.htm. Data show that in 1985 the centrally affiliated R&D institutes engaged mainly in ‘experiment development’ and ‘design and production engineering’. According to international standards. half of their works were not ‘R&D’ but downstream innovation-related activities such as ‘design and production engineering’ and ‘diffusion and technical services’. Locally affiliated R&D institutes went downward even further, and to a lesser extent, similar phenomenon were observed in other centrally planned systems. For the full document, refer to http://www. most.gov.cn/t_a3_zcfgytzgg_a.jsp. There are different English translations of the Chinese term zi-zhu-chuang-xin; here we use ‘endogenous innovation’.We tend to disagree with ‘independent innovation’ which appears quite often in English versions of Chinese media reports, as it is misleading. In Chinese to put an adjective ‘zi-zhu’ to ‘innovation’ is to emphasize that strategically China has to be proactive to do something new and not passively remain with existing and imported technologies. Readers should better understand the fashionable Chinese term zi-zhu-chuang-xin simply as ‘innovation’. The discussion is based on various sources from media reports and personal exchanges.

INNOVATION: management, policy & practice

23

Shulin Gu and Bengt-Åke Lundvall 8 It is interesting to note that the market economy par excellence, the United States, has a much more active government policy to support science and technology than Japan and Europe. But these policies appear as part of health and space-related programs, not as industrial policy. 9 A stronger element of practical experience and a more problem-oriented learning method in the academic training of scientists, engineers and managers would be a most efficient way to create stronger links between universities and enterprises. The same would be true for more systematic efforts by universities to offer lifelong learning in these categories. But the most important change would come from increased hiring of academic personnel by the enterprises.

References Archibugi D and Lundvall B-Å (Eds) (2001) Europe in the Globalising Learning Economy, Oxford University Press, Oxford. Baldwin CY and Clark KB (1997) Managing in an age of modularity, Harvard Business Review, Sept/Oct. Bao H, Xu M and Gu S (2006) ‘Patent pool’ initiatives in manufacturing clusters in Zhejiang, Innovation: Management, Policy & Practice 8(1–2): 153–159. China Science and Technology Indicator (1988) (in Chinese), Centre for Science and Technology for Development of China and the Information Centre, State Science and Technology Commission 1990, China. China Statistical Yearbook on Science and Technology (2004) Accessible at http://www.stats.gov.cn/tjsj /ndsj/yb2004-c/indexch.htm, updated 2005. Accessible at http://www.stats.gov.cn/tjdt /zygg/P020060109431083446682.doc. Christensen JL and Lundvall B-Å (Eds) (2004) Product Innovation, Interactive Learning and Economic Performance, Elsevier, Amsterdam. Cooke P and Morgan K (1998) Evolutionary Processes and Regional Practices in Cooke P and Morgan K The Associational Economy, Ch. 8, Oxford University Press, Oxford. David PA (2003) The Economic Logic of ‘Open Science’ and the Balance between Private Property Rights and the Public Domain in Scientific Data and Information: A Primer, Stanford Institute for Economic Policy Research SIEPR Discussion Paper No. 02-30. Dodgson M, Gann D and Salter A (2005) Think, 24

INNOVATION: management, policy & practice

Play, Do, Technology, Innovation and Organization, Oxford University Press, Oxford. Dosi G (1982) Technological paradigms and technological trajectories. Research Policy 11: 147–162. Fei JC and Ranis G (1997) Growth and Development From an Evolutionary Perspective, Blackwell Publishers, Malden USA and Oxford UK. Freeman C (1987) Technology Policy and Economic Performance: Lessons from Japan, Pinter, London. Gereffi G (1999) International Trade and Industrial Upgrading in the Apparel Commodity Chain. Journal of International Economics 48: 37–70. Granick D (1967) Soviet Metal-Fabricating and Economic Development, Practice versus Policy, The University of Wisconsin Press, Madison, London. Gu S (1999) China’s Industrial Technology, Market Reform and Organizational Change, Routledge with UNU Press, London and New York. Gu S and Lundvall B-Å (2006) Policy learning as a key process in the transformation of the Chinese Innovation Systems, in: Lundvall B-Å, Intarakumnerd P and Vang J (Eds) Asian innovation systems in trasition, Edward Elgar, London. Gu S and Steinmueller WE (1996/2000) National Innovation Systems and the Innovative Recombination of Technological Capability in Economic Transition in China: Getting Access to the Information Revolution, UNU/INTECH Discussion Paper 2002-3, Maastricht, The Netherlands. Hanson P and Pavitt K (1987) The Comparative Economics of Research Development and Innovation in East and West: A Survey, Harwood Academic, London. Hayami Y (1997) Development Economics, from the Poverty to the Wealth of Nations, Oxford University Press, Oxford. International Labour Office (2003) Rediscovering the cooperative advantage: Poverty reduction through self-help, Johnston Birchall, Cooperative Branch, ILO, Geneva. Kline SJ and Rosenberg N (1986) An Overview of Innovation, in: Landau R and Rosenberg N (Eds) The Positive Sum Strategy, Harnessing Technology for Economic Growth, National Academy Press, Washington DC. Konai J (1980) Economics of Shortage, NorthHolland Publishing Company, The Netherlands. Langlois RN (2003) The Vanishing Hand: the Changing Dynamics of Industrial Capitalism, Industrial and Corporate Change April 12(2): 351–385. Volume 8, Issue 1–2, July 2006

China’s innovation system and the move towards harmonious growth and endogenous innovation Lewis WA (1970) (9th edn.) Theory of Economic Growth, Allen & Unwin, London. Lundvall B-Å (1985) Product Innovation and User–Producer Interaction, Aalborg University Press, Aalborg, Denmark. Lundvall B-Å (1988) Innovation as Interactive Process: From User–Producer Interaction to the National System of Innovation, in: Dosi, Freeman, Nelson, Silverberg and Soete (Eds) Technical Change and Economic Theory, Ch. 17: 349–369, Pinter, London. Lundvall B-Å (Ed) (1992) National Systems of Innovation, Pinter, London. Lundvall B-Å (1992) Explaining Inter-firm Cooperation and Innovation – Limits of the Transaction Cost Approach, in: Grabher G (ed.) The Embedded Firm: On the Socioeconomics of Industrial Networks, Routledge, London. Lundvall B-Å and Johnson B (1994) The learning economy, Journal of Industry Studies 1(2): 23–42. Lundvall B-Å and Borras S (1998) The Globalising Learning Economy: Implications for Innovation Policy, European Commission, Brussels. Lundvall B-Å (2006) Interactive learning, social capital and economic performance, in: Foray D and Kahin B (Eds) Advancing Knowledge and the Knowledge Economy, Harvard University Press, Cambridge MA. Maddison A (1998) Chinese Economic Performance in the Long Run, OECD Paris. Maddison A (1991) Dynamic Forces in Capitalist Development, A long-run Comparative View Oxford University Press, Oxford. Metcalf JS (1995) The Economic Foundations of Technology Policy: Equilibrium and Evolutionary Perspectives, in: Stoneman P (Ed.) Handbook of the Economics of Innovation and Technological Change, Blackwell, Oxford. National Statistical Bureau China (1990) zhongguo kexue jishu sishi nian (Statistics on Science and Technology of China 1949–1989), zhongguo tongji chubanshe (Statistics Publishing House of China). Nelson RR (Ed.) (1993) National Innovation Systems: A comparative analysis, Oxford University Press, New York. Nelson RR (2004) The market economy, and the scientific commons, Research Policy 33: 455–471. Nelson RR and Winter SG (1982) An Evolutionary Theory of Economic Change, Harvard University Press, Cambridge MA. North D (1996) Organizations, institutions and Volume 8, Issue 1–2, July 2006

market competition. Working paper, Washington University, St Louis MD. Pasinetti L (1981) Structural Change and Economic Growth, Cambridge University Press, Cambridge. Piñata M (2005) Innovation and Employment, in: Fagerberg J, Mowery DC and Nelson RR (eds) The Oxford Handbook of Innovation, Ch. 21, Oxford University Press, Oxford. Qian Y and Weingast BR (1996) China’s Transition to Markets: Market-Preserving Federalism, Chinese Style, Journal of Policy Reform 1(2): 149–185. Richardson GB (2002) The organisation of industry revisited, Druid working paper no. 02-15. Rosenberg N (1982) Inside the black box: Technology and economics, Cambridge University Press, Cambridge. Saich A (2004) (2nd edn) The Governance and Politics of China, Palgrave Macmillan, London. Saxenian AL (1996) Inside-Out: Regional Networks and Industrial Adaptation in Silicon Valley and Route 128, Cityscape: A Journal of Policy Development and Research, May 2(2): 41–60. Tomlinson M (2001) A new role for business services in economic growth, in: Archibugi D and Lundvall B-Å (Eds) Europe in the Globalising Learning Economy, Oxford University Press, Oxford. Tylecote A (2006) Twin innovation systems, intermediate technology and economic development: History and prospect for China Innovation: Management, Policy & Practice 8(1–2): 62–83. UNIDO (2002) Industrial Development Report 2002–3. von Hipple E (2004) The Source of Innovation, Oxford University Press, Oxford. von Hippel E and Tyre M (2005) How learning by doing is done: Problem identification and novel process equipment, Research Policy 24(1): 1–12. Woolcock M (1998) Social capital and economic development: Toward a theoretical synthesis and policy framework, Theory and Society 27(2): 151–207. Wang J and Tong X (2000) Industrial Clusters in China: Alternative Pathways Towards local–local Linkages, paper presented at the International High-Level Seminar on Technological Innovation, co-sponsored by the Ministry of Science and Technology of China and United Nations University, Beijing, September 5–7. Wu J (2004) dangdai zhongguo jingji gaige (China’s Economic Reform, in Chinese), Shanghai yuangong chubanshe (Shanghai Far East Publisher). White Paper No. 1 (1986) State Science and INNOVATION: management, policy & practice

25

Shulin Gu and Bengt-Åke Lundvall Technology Commission (SSTC) zhongguo kexue jishu zhengce zhinan 1986, kexue jishu baipishu di’yihao (Guide to China’s Science and Technology Policy for 1986, White Paper on Science and Technology No. 1). Xu M, Chen J and Bao H (2006) Enterprises’ Patenting in Zhejiang, Innovation: Management, Policy & Practice 8(1–2): 144–152.

Zhao Z (1985) Speech to the National Working Conference of Science and Technology (6 March in White Paper No. 1: 293–297). Zheng Y and Sheng S (2006) Learning in local cluster in the context of global value chain: A case study of the Yunhe wood toy cluster in Zhejiang, China, Innovation: Management, Policy & Practice 8(1–2): 120–127.

ORDER FORM I NNOVATION

IN

C HINA

H ARMONIOUS T RANSFORMATION ? Edited by Shulin Gu, School of Economics and Management, Tsinghua University, and Mark Dodgson, UQ Business School ISBN 0-9757422-4-8; iv + 212 pages; softcover A special issue of Innovation: management, policy & practice (Volume 8, Issue 1–2, July 2006) North America, Europe, North East Asia & Middle East: Institutions US$148.50; Individuals US$88.00, incl. airmail Australia, New Zealand, Pacific, China, South & South East Asia, South America & Africa: Institutions AU$148.50; Individuals AU$88.00, incl. GST and airmail Number of copies:

Total: US$

Total: AU$

A cheque made payable to eContent Management Pty Ltd is enclosed OR Please charge this purchase to my Mastercard/Visa (a 2% merchant fee applies): My full card number is:

/

/

/

Expiry date:

Cardholder Name:

/

Signature:

Please send this order to the address below by airmail: Name of Institution:

Name of Individual:

Street address (or PO Box): City: Tel. (with area code):

State:

Zipcode:

Country:

Fax (with area code):

Email:

Your reference:

Fax the completed order form to +61-7-5435-2911 or post with cheque to: eContent Management Pty Ltd, PO Box 1027, Maleny QLD 4552, Australia Tel.: +61-7-5435-2900; Email: [email protected] www.innovation-enterprise.com

26

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Copyright © eContent Management Pty Ltd. Innovation: management, policy & practice (2006) 8: 27–44.

Regional innovation systems in Asian countries: A new way of exploiting the benefits of transnational corporations SUMMARY

KEY WORDS regional innovation system; regional development; social capital; absorptive capacity; embeddedness

This paper argues for the importance of using the regional innovation systems (RIS) approach as both an analytical framework and a policy tool for generating economic development in developing countries. The paper reconceptualizes the RIS model to developing countries. RIS is normally based on endogenous growth models; however, in this paper we extend it to external capital, transnational knowledge sources and transnational corporations (TNCs). In particular we stress in this paper: (a) the importance of developing firm and regional absorptive capacity; (b) the importance of embedding TNCs in the region; and (c) regional policies for attaining these goals. These factors, we argue, are important for achieving sustainable economic development, building on exogenous sources of capital and knowledge. Finally, we illustrate the relevance of RIS for analyzing as well as formulating regional development policies by referring to two of Asia’s most significant cases: the regional innovation systems of Shanghai (China) and Bangalore (India). Received 9 June 2005

Accepted 18 October 2005

BJORN ASHEIM Professor Center for Innovation, Research and Competence in the Learning Economy (CIRCLE), and Department of Social and Economic Geography Lund University, Sweden, and Centre for Technology, Innovation and Culture University of Oslo, Sweden

INTRODUCTION

D

uring the last decade, regional analysts, scientists, consultants and policymakers have reached the conclusion that earlier state-driven regional policies based on standardized formulas Volume 8, Issue 1–2, July 2006

JAN VANG Assistant Professor Center for Innovation, Research and Competence in the Learning Economy (CIRCLE), and Department of Social and Economic Geography Lund University, Sweden

and incentive programs aimed at the atomistic firm have failed (Amin 1999). Regional innovation systems (RIS) have increasingly been recognized as a fruitful alternative analytical framework and tool for generating economic policies in the

INNOVATION: management, policy & practice

27

Bjorn Asheim and Jan Vang

developed world (Amin 1999; Barthelt et al. 2004; Asheim 2001; Asheim and Gertler 2005; Asheim and Isaksen 2002; Cooke 2001, Cooke et al. 2000; Maskell and Malmberg 1999). There have however been only a limited number of studies addressing the relevance of RIS for regionally and socially cohesive economic development in developing countries (for exceptions, see Hassink 2002). The study of RIS in developed countries has traditionally focused on local linkages. However, RIS in developing countries seem to be much more dependent on external linkages (Giuliani et al, 2005). This points to the need of unpacking the relevance of the RIS framework for developing countries. The main task of the paper is to assert how RIS can be used for analyzing and generating industrial upgrading policies for two of the most remarkable cases of regional economic development in Asia: Shanghai’s and Bangalore’s ‘regional innovation systems’.1 The two RISs are interesting in several ways. Most paradigmatic studies on rapid economic development, growth and upgrading have until recently focused on the Tiger economies (e.g. South Korea, Taiwan, Hong Kong and Singapore) (Amsden 1989, Hassink 2002) or their younger siblings in South East Asia (e.g. Malaysia, Thailand, Philippines and (earlier) Indonesia). There is however a need for decomposing other development models. Especially development models resulting in rapid economic growth based on other means than the state-centered models characterizing East Asia. The RISs in China and India live up to these criteria. This does not imply that their success can be copied uncritically to other countries, as central in RIS are the institutional and systemic dynamics. Institutional and systemic dynamics tend to display idiosyncratic and path-dependent traits. RIS has so far been applied mostly in the context of developed countries. Traditionally, RIS is based on mobilizing and refining endogenous economic potentials in a region. However, developing countries, due to limited capital, limited training and formal education, and limited developed industrial knowledge bases, often have to 28

rely on exogenous sources of capital, technology and knowledge. This paper pays special attention to the strategic coupling between the absorptive capacity of the region (RIS) and these transnational sources of capital, technology and knowledge (Dicken et al. 2002; Dicken 2000) widening the RIS concept to capture the specific characteristics of developing countries. Particularly the paper focuses on TNCs and to minor extent transnational communities as the external sources (thus other external sources are bracketed). Special attention is paid to: a) the regional absorptive capacity, aiming at building an institutional framework that stimulates ‘the firm’s ability to identify, assimilate and exploit knowledge from the environment (Cohen and Levinthal 1990); and b) the strategy for embedding the TNCs in a local network based on traded and untraded interdependencies between TNCs and local firms as well as between the local firms, thus increasing the ‘exit costs’ for the TNCs. The rest of the paper is structured as follows. We begin with a presentation of the RIS concept where the differences in respect to National Systems of Innovation (NSI) are stressed. The differences are considered crucial as we argue in favor of placing the regional government bodies in a more central position than is the case in NSI. Subsequently, RIS is adapted to the specificities characterizing developing countries; particularly the frequent need to rely on transnational corporations (TNCs) as a central source of capital, technology and knowledge. This is followed by a section paying attention to the importance of building the regional absorptive capacity required for embedding these transnational flows of knowledge, technology and capital in the regional context. This is what Dickens and colleagues have labeled ‘strategic coupling’ (Coe et al. 2004). As it is beyond the scope of the paper to engage in a thorough theoretical stocktaking and empirical assessment of the entire TNC literature this section focuses mainly on strategic coupling (and how we position ourselves in contrast to general positions within TNC literature). The theoretical

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Regional innovation systems in Asian countries

part is followed by two illustrative cases: the Shanghai regional innovation system and the Bangalorian regional innovation system. The paper is rounded of with some concluding remarks.

RIS: AN INTRODUCTION This section presents the central concepts in the RIS approach and adapts it to the particularities of developing countries. It provides the background for the following sections on development and upgrading in developing countries as well as the derived implications on the RIS policies in the context of regions in developing countries. The success stories in the nineties of Emilia-Romagna, (Piore and Sabel 1984), Baden Württemberg (Staber 1996) and Silicon Valley (Cohen and Fields 1998; Cooke and Morgan 1998; Saxenian 1994,) has turned the attention of many researchers and policymakers to the region as the designated scale for innovation support. In many OECD countries this led to a strong focus on constructing or building selfcontained regional innovation systems (Asheim 2002; Bathelt 2003; Morgan 2004) in an attempt to emulate the success of the triad regions. The relevance of the traditional self-contained regional innovation systems to construct competitive advantage (Sabel 2005; Isaksen 2001) for developing countries is often limited as the have to rely on TNCs, thus the challenge is to develop an exogenously driven RIS that allows regions in developing countries to benefit from TNCs investments. Thus the RIS needs to be re-conceptualized.

What is meant by RIS? According to Cooke et al. (1998), a RIS is defined as a system in which firms and other organizations are systematically engaged in interactive learning through an institutional milieu characterized by local embeddedness. The crux of this definition lies in the notion of embeddedness. This refers to the importance of personal relations and networks ingrained in local social and cultural institutions Volume 8, Issue 1–2, July 2006

(Granovetter 1985). Without it the definition would equal the definition of a national innovation system written small. Additionally, a regional innovation system can be conceptualized as regional clusters surrounded by ‘supporting’ knowledge organizations (Asheim and Isaksen 2002). Thereby the regional innovation system is boiled down to two main types of actors and the interactions between them. The first concerns the companies in the main industrial clusters in a region, as well as their support industries (e.g. customers, suppliers). The second type of actors – those backing up the innovative performance of the first – include research and higher education institutes (universities, technical colleges and R&D institutes), technology transfer agencies, vocational training organizations, business associations and finance institutions. These knowledge-creating and diffusing organizations hold important competence, train labor and provide necessary funding for the innovativeness of the RIS; it is however not assumed that they always function either in developed or in developing countries. To avoid confusions RIS does not maintain that innovation is mainly an activity in high tech industries in developed countries/ regions but that innovation (and interactive learning) might take place in all industries. The concept ‘region’ recognizes the existence of an important level of industry governance between the national and the local (cluster or firms) (Asheim and Cooke 1999). Regions are thus seen as important bases of economic coordination at the meso-level: ‘the region is increasingly the level at which innovation is produced through regional networks of innovators, local clusters and the cross-fertilizing effects of research institutions’ (Lundvall and Borrás 1997: 39).2 The systemic dimension of RIS derives in part from this partner-based character associated with innovation in networks. While, as Lundvall (1992) puts it, an innovation system is a set of relationships between entities or nodal points involved in innovation, it is really much more than this. Such relationships, to be systemic,

INNOVATION: management, policy & practice

29

Bjorn Asheim and Jan Vang

must involve some degree of inter-dependence; not all relationships may be equally strong all of the time, but some may. Stressing interdependency is crucial in a developmental context where the challenge for regions in developing countries often seems to be to attract TNCs (and other capital influxes) investments (and outsourced activities) and gradually develop a situation of interdependency between the TNC and local/ regional firm as well as between TNCs and the institutional support system. This aims at making the TNCs investments and commitments ‘sticky’. ‘Sticky’ refers to that when regional cost advantages diminish, the TNCs exit costs (costs of relocating the investment to another region) will be high and cause several problems. Finally, RIS stresses the importance of interactive learning. For firms and regions to engage efficiently in interactive learning and thus upgrading, a prerequisite is a developed and continuously developing absorptive capacity (Cohen and Levinthal 1990; Narula 2004; Zahra and George 2002). Absorptive capacity as conceptualized in this paper is considered a dynamic capability (capability because it refer to skills, routines and habits constituting absorptive capacity) (Nelson and Winter 1982) that allow firms and/or regions to benefit from knowledge and information in their environment, process it and use it for upgrading purposes. We argue that: (a) in accordance with Cohen and Levinthal (1990) a firm’s absorptive capacity is a function of its prior internal knowledge – being tacit or codified – and the institutional setting within which the firm is embedded. The latter refers among other aspects to how social capital shapes knowledge dissemination and knowledge spillovers and to how public organizations can support knowledge dissemination. (b) a region has an collective absorptive capacity (which is a function of the individual firms absorptive capacity, as well as the local human and social capital; that is, goes beyond the individual firm’s capabilities). 30

Hence we oppose seeing regional absorptive capacity as simply an aggregate of individual firms’ absorptive capacity. Contrary to more traditional definitions, we emphasize the dynamic and systemic propensities of the absorptive capacity. Following among others Narula (2004) this requires developing and applying a systemic approach to absorptive capacity that addresses the required changes in the organizational structure and support systems to respond to the needs of the firms with upgrading potential. Absorptive capacity building is about investing in formal training (human capital) including vocational training and possible engaging in collaboration (i.e. interactive learning) between firms and universities (not necessarily co-located universities due to the high reliance on codified practices and modular processes). It is also about interacting with other organizations (other firms, universities, etc). This allows firms to develop their internal absorptive capacity as well as utilizing other firms’ and organizations’ competencies. Regional government bodies might play a crucial role in building absorptive capacity by for example financing development projects that include private firms.

RIS AND DEVELOPING COUNTRIES Building absorptive capacity As pointed out in the previous section, developing countries are much more dependent on external sources of knowledge and technology. In order to attract external flows of technology and knowledge they need to build their absorptive capacity, which is based on local endowments of: • physical capital (hard infrastructure); • social capital (soft infrastructure); • human capital (formal education and training); and • financial capital. These variables are generally acknowledged to be important facilitators or constraints for devel-

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Regional innovation systems in Asian countries

opment, growth and upgrading in developing countries. The RIS-approach contributes to this literature by emphasizing the systemic propensities between these variables; the systemic propensities have previously been treated in an insufficient manner. Central in this is conceptualizing regional absorptive capacity in a systemic perspective. In this chapter we pay special attention to the role of human and social Capital (soft infrastructure). Hard infrastructure we consider more of a contingency than an actual part of more theoretical aspects, thus it will be treated only in this manner. Lack of financial capital in most developing countries is taken as an assumption with no further elaboration.3 Most attention will be paid to the latter with special attention to absorptive capacity and the development of local embeddedness of the TNCs. The importance of the different factors varies across industries and regions, depending on the dominant industrial knowledge base and the regions human and social capital ‘endowment’.4

Social capital (soft infrastructure) Social capital refers to the institutions, relationships, and norms that shape the quality and quantity of a society’s social interactions... Social capital is not just the sum of the institutions which underpin a society – it is the glue that holds them together. (The World Bank 1998) Soft infrastructure varies significantly across regions and is strongly dependent on local culture (however heterogeneous and dynamic that might be measured in terms of normative dispositions, values and subsequent behavioral regularities).5 Social capital consists of at least two dimensions: (a) Trust, which can be divided into generalized trust (to society as such) and specific trust (constrained to one group), and (b) Cooperative ability, or people’s ability to work together (Paldam 2000). Trust is considered a precondition for the type of interactive learning involved in upgrading. Volume 8, Issue 1–2, July 2006

Social capital (and the related concept as trust) might facilitate the interaction between agents/ nodes in the RIS for example interactive learning between TNCs and local firms or between local firms. Contrary to that envisioned by standard economists, economic interaction of relevancy for upgrading and growth cannot primarily be conceptualized as a market-based exchange of (tangible) goods by anonymous agents regulated by a complete contract (in the context of efficient contract enforcement). On the contrary, knowledge exchange (i.e. interactive learning) relies on incomplete contracts, either due to the lack of possibilities for creating complete contracts (because of the disadvantages in terms of a low degree of flexibility build into complete contracts) or because of inefficient contract enforcement, thus knowledge exchange and interactive learning depend on the mutual trust of partners involved in the transaction. Unless there is trust fear of opportunistic behavior will prevent exchange of valuable knowledge. Hence unless there is a high degree of generalized social capital-based cooperation interactive learning is likely to be limited or at least confined to the ‘in-groups’ which greatly reduces the localized knowledge spillovers. Therefore the social capital and trustworthiness of local firms influences the TNCs incentive to engage in extensive collaboration with local firms in activities involving critical and valuable knowledge. Thus it shapes the morphology of input/output linkages (i.e. interactive learning) between TNCs and local firms and the possibilities for more general localized spillovers. Additionally, absence of dense local input/output linkages increases the TNC degree of ‘footlooseness’, hence ceteris paribus reduces the TNCs exit costs. A dense local network between the TNCs and the local firms might counterbalance the decreased cost advantages derived from a certain degree of development. Otherwise, TNCs might consider re-locating elsewhere. In short, absence of social capital in turn reduces the local firms’ prospects of getting access to relevant knowledge for upgrading, constraints

INNOVATION: management, policy & practice

31

Bjorn Asheim and Jan Vang

general knowledge spillovers and reduces the regions bargaining power and thus constrains upgrading, growth and development. Having said this we wish to emphasize that we do not subscribe to a view of the social capital rich region as conflict-free. Nor do we suggest that intra-regional competition is not conducive to regional development. We merely state that the destructive elements of conflicts and competition can be somewhat avoided in the context of a high degree of generalized non-exclusive social capital.

Human capital According to Gary Becker ‘Human capital refers to the skills, education, health and training of individuals’ (1998: 1). Human capital is considered crucial for upgrading, growth and development (Romer 1990). Human capital of relevance to modern industrial production in general tends to be scarce in developing countries. There are limited resources for formal education; at least after primary school. According to the World Bank (World Development 2003), secondary school enrolment in developing countries is typically around 50 percent while about 90–100 percent in the developed world. For example, the enrolment number for the two countries, China and India, included in this study is respectively 55 and 44 percent. Thus formal training including the socialization into working with codified abstract concepts – which follows enrolment in the formal educational system at a higher level – is scarce. This has implications for the type of industrial activities that can be undertaken by the TNCs subsidiaries or outsourced to the local firms, thus for the type of localized knowledge spillovers. OECD states it this way: While FDI inflows create a potential for spillovers of knowledge to the local labour force, at the same time the host country’s level of human capital determines how much FDI it can attract and whether local firms are able to absorb the potential spillover benefits. (OECD 2002:10) 32

Not only basic human capital constrains type of FDI, TNCs possibilities for outsourcing to the region and the subsequent possibilities for interactive learning and knowledge spillovers managerial skills are also crucial. As a result of scarce management skills in developing countries (even in those with a successful development strategy such as India and China), the application of modern management techniques aiming at mastering the processes involved in upgrading tend to be scarce. Additionally, the competences needed for valuable incremental improvement, reorganization of production processes and so forth are also considered scarce. Hence the local firms tend to have a limited absorptive capacity only which prevents them from taking advantage of TNCs investments (Kaplinsky 2005). Additionally, the regions in developing countries often lack the organizational setting providing the formal and vocational training that is needed for supporting the local firms that aim at upgrading by interacting with TNCs but lacks the managerial and ‘blue color’ competencies. Human capital can be developed through nonformal interactions with agents located in other regions or through analyzing published information (e.g., websites, business magazines) (Gertler 2003). While this type of information tends to be downplayed in the literature, its value depends on absorptive capacity of the agents/firms; that is the ability to transform the inputs into competencies in the firms. In short, absence of human capital reduces the relevance of a given region as a locational choice for TNCs to establish offshore plants or outsource to local subcontractors (at least for industrial activities that require some competencies). This limits the options for local firms to gain access to relevant the knowledge (i.e., engage in interactive learning) for moving up the global value chain (or to be included in global value chains at all). Therefore, even in regions characterized by a high degree of generalized social capital, absence of human capital prevents utilization of the social capital for upgrading, growth and

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Regional innovation systems in Asian countries

development in which the TNCs could have played an active role or rather been forced to play an active role in.

Strategic coupling with TNCs How can RIS facilitate economic development in developing countries? We begin by stressing the strategic coupling with the TNCs. Then we turn to more traditional RIS policy measures. There is not a best practice for this type of strategic coupling with TNCs as it varies accordingly to the regional particularities and specificities; being the institutional endowment/support system, the local firms’ competencies and human capital in general, the social capital, and, to paraphrase Schmitz’s (2004), the structure of the global value chains (more particular if it is a buyer- or supplier-dominated value chain) (Gereffi 1999). We suggest paying most attention to the weakest link in the system, while continuing to strengthen areas in which regions hold some degree of competitive advantage. These policy measures are developed with the aim of increasing regional absorptive capacity and embedding the TNCs.

TNCs and spillovers While transnational capital can be acquired through numerous sources (the World Bank, IMF and members of the transnational community), we mainly focus on TNCs and to a lesser degree transnational communities. TNCs have always been a controversial source of capital, technology and knowledge (Lipsey 2002; Gorg and Strobl 2001; Smarzynska 2002; Guerrieri and Pietrobelli 2004; Lall and Narula 2004). They provide foreign direct investment (FDI) and outsource industrial activities, thus indirectly reduce the scarcity of financial capital in the host developing country; they also increase local competition, thus eliminating inefficient producers (Narula and Marin 2005) and occasionally promising local producers. But, numerous studies also illustrate that TNCs use developing countries mainly as cheap labor pools and hence suggests that TNCs do not play a central role in facilitating the knowledge spillover Volume 8, Issue 1–2, July 2006

that is needed for upgrading in the local firms and hence for growth and development. Studies focusing explicitly on indirect spillovers, for example, do not find strong support suggesting that abundant indirect spillovers are frequent phenomena (and where it does, there are major methodological problems involved) (Narula and Marin 2005). When it comes to direct spillovers the situation is not significantly different. According to Fosfuri et al. (2001), TNCs only provide investment in training of subsidiaries located on offshore locations when they are in need of specific superior capabilities. TNCs also reduce unintended knowledge spillovers (i.e. employees leaving and working for a local firm) by maintaining wage incentives – that is paying higher wages than local firms – for the local competent workers to keep them working for their firm (Fosfuri et al. 2001; Narula and Marin 2005). Contrary to suggestions for regional policies in the developed world, developing countries do not have the same possibilities to ground development on indigenous capital and knowledge. Thus, despite the difficulties summarized above, developing countries often have to rely on TNCs. It is not a question of relying on local buzz and importing knowledge via global pipelines (Depner and Bathelt 2003; Bathelt et al. 2004) or applying similar strategies as is currently being suggested for developed countries. Regional innovation systems in developing countries are ‘doomed’ to rely on TNCs and the TNCs impact on regional development depends significantly on the type of strategic coupling between regional and TNCs assets (Coe et al. 2004); tradeable and untradeable (Storper 1997; Dosi 1988). Thus the challenge is to embed transnational capital, TNCs and knowledge ‘flows’ in the potential regional innovation system and to build an absorptive capacity at firm and regional levels. This is crucial for developing regions that wishes to push a development strategy based on moving up the global value chain by facilitating the local firms upgrading strategies.6 The political economy literature emphasizes

INNOVATION: management, policy & practice

33

Bjorn Asheim and Jan Vang

that TNCs locate labor-intensive and mature industries with limited direct and indirect spillover effects into the local economy. They often out-compete the local industry and remain footloose, relocating the production facility when the host regions comparative (cost) advantages decline. This is even more evident in developing regions/countries which are weak on the stipulated measures of hard and soft infrastructure (social capital and human capital). These often have only few resources to offer the TNC’s, apart from cheap labor, hence their bargaining power is limited. The result is that they enter the ‘race to the bottom’ with other regions and countries not having more to offer than cheap labor, low taxes, poor environmental regulation and ‘flexible’ labor market laws (Schmitz 2004). In a RIS perspective it is not considered a law of nature that TNCs cannot provide valuable input into the economic development process in regions in developing countries. By emphasizing interactive learning, knowledge spillovers and the involvement of regional government bodies, the literature on RIS suggests that the role of the TNCs in the regional development depends on the following factors:7 (a) The bargaining power of the host country/ region (Coe et al. 2004). Regions with only ubiquitous competencies to offer do not have a bargaining position where they can ‘force’ the TNCs to make commitments to local economic development (i.e. transfer knowledge to local firms or engage in collaborative projects with local firms). (b) The right allocation of decision making powers between the central and regional government bodies in the host country (Lundvall et al. 2006 in press). It is often the case that regions need to have autonomy, competencies and formal decision power to engage in direct negotiations with TNCs as central government tend not to have the required local knowledge on competencies etc. and might also have less clear cut incentives for hard negotiations with the TNCs. Central govern34

(c)

(d)

(e)

(f)

ments should, however, prevent regions from entering the ‘race to the bottom’ and could occasionally reduce the power of local corrupted bureaucrats and firms (Lundvall et al. 2006 in press). The local firms absorptive capacity. TNCs investments might have spillover potential but if the local firms lack absorptive capacity these are not utilized and the investment does not lead to regional development (Lall and Narula 2004). The ability of the regional government to exploit the already developed absorptive capacity in a way that stimulates the development of interactive learning between the TNC and the local firms so that it creates an interdependency that increases the TNCs exit costs. The quality and size of the local training and competency building institutions, where these do exist, and more specifically their ability to focus explicitly on the specific needs of the activity or industry in question. The need for being able to provide an efficient hard infrastructure and provision of services such as health care, since without these services TNCs tend to avoid particular regions. This is, however, outside the RIS domain.

Role of transnational communities When regions possess the important ingredients in this cocktail and there are possibilities that is can initiate the processes that stimulates interactive learning between the TNC and the local firms and subsequent facilitate knowledge spillovers. In other words RIS gives a certain perspective on how TNCs can function as important sources of capital, technology and knowledge in a way that underpins the local development processes. In the longer run firms embedded in these types of regions have been witnessed to start to move up the global value chain by providing services and goods to other customers and eventually develop more strategic localized learning alliances, as we have witnessed in the Dragon

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Regional innovation systems in Asian countries

economies (Mathews 2002) and in certain regions in India (Vang and Chaminade, 2006). The discussion on the usefulness of different types of strategic coupling with TNCs cannot be reduced to the structure of the value chain nor the degree of maturity of the industry in question, as is often the case within global value chains or global commodity chain studies (Pietrobelli and Rabellotti 2004) as well as some versions of RIS, but depends on local conditions as the support structure, social capital and human capital etc., as explained above. Centrally placed members of a country or region’s transnational community can function as an important source of knowledge about the host country (Vang and Overby 2006 in press; Saxenian 1994, 2002). Usually working in a TNC, members of the transnational community can provide knowledge of market demands, sources of finance, new innovations and possible collaboration partners. Transnational communities can also provide capital (remittance) and venture capital; influence outsourcing decision-making in the host country; help establish local firms; stimulate knowledge transfer in terms of entrepreneurial start-up; and provide policy recommendations based on experience abroad, and consultancy and teaching (Vang and Overby 2006 in press; Saxenian 1994, 2002). They might also function as a boundary spanner between the different cultural or institutional setting (Depner and Bathelt 2003) which could have prevented the TNCs from investing in their ‘home’ country. Moreover, transnational communities can help reduce the mistrust between TNCs and their local counterparts since they can use their local network as partners (these networks are often regional and not national). These aspects are crucial for many developing countries where institutional immaturity and non-transparency can cause TNCs to refrain from investment in developing countries from fear of opportunistic behavior such as abuse of patents or copyrights, thus preventing the TNCs from engaging in interactive collaboration with local firms (Vang and Overby 2006 in press). Volume 8, Issue 1–2, July 2006

SHANGHAI AND BANGALORE: ILLUSTRATIVE CASES We have outlined above the motivation, potentials and theoretical aspects of RIS. The aim of this section is to provide some illustrative cases – read through the RIS lens – to demonstrate the relevancy of RIS as an analytical framework and critical tool for policy prescriptions. The cases are chosen as so-called critical cases (Flyvbjerg 2004) since they are among the most successful cases of regional development, but nonetheless their development strategy can be greatly improved. The cases are merely illustrative and do not claim in any way to exhaust the complexity of the two regional development models.

Shanghai’s regional innovation system Situated on the coast in China, Shanghai, with a population of 20 million, has always been one of the most important regions for economic development in communist China (Chen 2004; Depner and Bathelt 2003); the other two being Beijing, where the most important public institutions including prestigious universities are located, and Guangzhou, which has benefited from its proximity to Hong Kong and served as an entry point to mainland China for foreign investments (including illegal investment from Taiwan). Shanghai is host to eight major clusters (Depner and Bathelt 2003): • the steel industry in the north; • the chemical industry in the south (including BPBASF and BAYER); • microelectronics in the southeast (including Intel and IBM); • automobile industry in the northwest; • electrical power equipment industry in the southwest; • aerospace industry in the southwest; • ship building in the east; and • biotech and pharmaceutical industry in the east.

Shanghai’s autonomy Shanghai has been one of the most important

INNOVATION: management, policy & practice

35

Bjorn Asheim and Jan Vang

manufacturing centres in China and especially since Deng Xiao Ping introduced his economic market reforms which included a gradual dissolution of the central planning system – including spatial planning where industry was located, according to developmental needs, in poor regions – and decentralization of the decision structure in China, giving regions such as Shanghai a high degree of autonomy (Yeung et al. 2006). To illustrate this, Shanghai can decide, collect and use local taxes (and does it as part of the incentive structure by providing tax breaks and tax return to TNCs) although the Shanghai government does not have decision power in relation to the federal tax; this is controlled by Beijing.

Strategies behind Shanghai’s RIS: Transnational connections Shanghai’s regional innovation system that supports these eight clusters is the result of a deliberate and well-functioning strategy on strategic coupling with TNCs, the Chinese transnational community located in the US, and development of an important absorptive capacity (Leydesdorff and Guoping 2001).8 Initially the city region’s industrial profile was manufacturing but, since the 1990s, the Shanghai regional government has worked deliberately to attract foreign investment in high tech industries having a tremendous success. Manufacturing industries have been relocated to less central areas in the Shanghai city region, now redeveloped as one of China’s most important high tech centers. Initially, what made China attractive – as in the Bangalorian case described below – were pure Ricardian factors. China could offer low wages, a disciplined work force and limited environmental regulations. Moreover, when the Chinese economy opened up, it was a gigantic unexplored market for foreign firms. The Shanghai regional government did not settle for remaining a cheap subcontractor region but worked actively on attracting foreign knowledge-intensive investment. For doing so, it invested heavily in the qualification of human capital, 36

for example supporting national universities in Shanghai. Initially, TNCs offshored their production or outsourced to local Chinese firms with the aim of re-exporting or adjusting products to their local market but the TNCs investments and outsourced industrial activities have gradually included industrial activities higher up on the global value chain. Today, TNCs locate research subsidiaries locally as part of a global strategy of knowledge input into global products. On an anecdotic level the US GE Global Research Center located in Shanghai employs approximately 500 top engineers and, according to Chen (2004) plans to employ 2000 within a few years. These firms are increasingly being embedded in the Shanghai city region due to an aggressive educational policy from the Shanghai regional government. That is, human capital becomes a crucial element to attract knowledge intensive activities to the region.

Human capital The Shanghai government has worked on building human capital. Although the best universities are in Beijing, the Shanghai government has worked hard to improve the standard of its local universities and targeted underfinanced national universities in Shanghai to engage them in an economic partnership (Chen 2004). Universities are thus more tuned to the needs of the regional economy. Shanghai has thus produced the necessary candidates with high scientific qualifications, though with limited experience of practical application of their skills/competencies. Universities are, for example, involved in collaboration with private firms in the biotech industry and in speech technology development in the telecommunications industry.

Embedding the TNCs: The social capital challenge The Shanghai regional government has also established a degree of network relations between TNCs and local subcontractors. However, the

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Regional innovation systems in Asian countries

structure of the social capital in the Shanghai region and in China as such is an obstacle that needs further development. Taking trust as an example, China is to a large extent a family-oriented society (i.e. specific trust) while trust outside the family is low (i.e. generalized trust), partly owing to Chinese history and the Cultural Revolution. The family is not to be misunderstood as an atomistic unit. Families and individuals are connected to other individuals and families through their guanxi or trans-family connections, which play a crucial role for individuals in deciding with whom to corporate. Guanxi has not reduced fear of opportunism in China when it comes to the relationship between TNCs and subcontractors. Hence, R&D is usually in-house, and seldom collaborative. Even with ‘collaboration’, it is often subcontracted as a one-time deal or basic research, with no immediate monetary value to the subcontractor. In short, one can argue that the absence of a high degree of generalized social capital still limits the embeddedness of TNCs in respect to engaging in interactive learning with local. The Shanghai government has deliberately targeted Chinese members of the transnational community in the US, offering them favorable economic deals such as low taxes, high salaries and minor housing costs to return to China (Yeung and Li 2000). Returning Chinese have been motivated by the financial incentives but even more by a nationalistic pride in building China’s capabilities. This community has been targeted to help establish trust (social capital) between TNCs and local subcontractors, initially by reducing uncertainty in the business environment through unclear or undeveloped institutional structures/formal regulations, and use of hooligan methods by Chinese subcontractors to solve conflicts with smaller TNCs. Lately this transnational community has functioned more as a cultural bridge, or boundary spanner, especially between the US and China (Shanghai) where they can take advantage of their social and cultural capital. While Chinese firms often provide qualified Volume 8, Issue 1–2, July 2006

technical staff, management skills (human capital) are still scarce and hinder firms’ development of an absorptive capacity (already constrained by lack of generalized social capital and reduced knowledge spillovers from TNCs). Chinese subcontractors therefore tend to be dependent on lead firms in the global value chain. Moreover, own brand manufacturing is still scarce. (Although we do not look at the dark side of the Chinese model in this paper, one should be aware of the country’s working conditions and other factors.)

Summing up The Shanghai government has had a high degree of success in building up a high-tech regional innovation system but it still suffers from the constraints of lack of social capital and a low degree of TNC embedding. Local subcontractors’ autonomy from lead firms is still limited. Moreover, the absorptive capacity of local firms is constrained by the absence of management competencies. Thus, there is a need for public procurement in terms of projects to help build trust between firms and individuals not connected through guanxi; that is building generalized trust. This will enable more local sourcing based on competencies than pure networking and thus extent at least the localized interactive learning which in turn will help to boost the absorptive capacity of the involved firms. This in turn will make the local firms attractive as collaborative partners for the TNCs and possible stimulate increased interactive learning between TNCs and local firms and thus spur a virtuous circle.

Bangalore’s regional innovation system Situated 1000 km from Bombay, in Karnataka State, Bangalore has become one of the most important IT clusters outside the US. Bangalore city, with around 1 million inhabitants, is the centre of the Bangalore region. The technical knowledge base of the IT industry draws on a combination of technical and engineering skills. Routine activities basically draw on codified pro-

INNOVATION: management, policy & practice

37

Bjorn Asheim and Jan Vang

gramming skills while sophisticated tasks are based on a combination of codified programming competencies and firm specific – tacit and quasicodified – competencies developed through customized programs.

Regional autonomy Karnataka State is an autonomous state although the degree of autonomy appears smaller than in Shanghai. For example, local governments have little taxation power while the power of state governments is mostly limited to indirect taxes (e.g. sales tax). Development of this particular cityregion is shaped more by industrial development in the US than by local cluster-effects and regional government body policies. While it should be stressed that Bangalore’s growth until the late 1980s (the beginning of the software export boom) relied on local, largely public sector investment in a rather poor physical infrastructure, it should also be noted that Bangalore had a privileged position in comparison to other Indian regions. Bangalore already had a dense organizational setting; it was/is the center for advanced science and military research – mainly for physical, geographical reasons such as dust-free air for military testing – and had a number of good educational institutions already, mainly funded by the central authorities. This human capital advantage in combinations with a rather business friendly and efficient regional government were behind the Bangalore’s ‘first mover’ advantages. This spurred a cumulative causation process which Bangalore benefits from today.

Bangalore: Background Until the late 1980s, when the first US firms set up subsidiaries in India, IT service outsourcing was mainly a Silicon Valley phenomena, while East Coast IT firms were vertically integrated (Saxenian 1994). The earliest were the East Coast firms led by hardware producer Digital Equipment, with Texas Instruments (not East Coast or Silicon Valley) following soon after (Vang and Overby 2006 in press). 38

This is also principally a Ricardian story as Bangalore’s most important advantage is low cost labor, a 12-hour time zone difference, widespread English usage and skilled technicians. However, these factors are not sufficient to explain why India was chosen as a location for outsourcing of these activities. As with other developing countries, India was about to dismantle the ISI-strategy and had not yet developed an internal institutional structure/regulation adapted to the IT industry or pro export-oriented. Apart from providing basic sound macro-economical policies, the state did little to enhance development of an IT industry in India, or subsequently Bangalore (Parthasarathy 2004), although one should not ignore the Government of India’s Computer Policy of 1984 and the National IT Task Force of 1998, and we acknowledge establishment of Information Technology Park in Bangalore as a direct step by the Karnataka government in the early ‘90s. The crucial difference between India and other developing countries, however, was a highly developed human capital infrastructure. The Indian state has developed high quality IT colleges which many Indians consider attractive.

Absorptive capacity and human capital Several studies have documented that, during the first phase, US firms mainly outsourced routine IT services such as maintenance of existing codes or reengineering codes from one programming language to another to India (many of these activities were undertaken onsite by Indian software professionals under the direct guidance of the client’s IT staff or a consultant). The human capital base in India – more particularly Bangalore – was characterized by well-educated engineers perfectly capable of undertaking these activities. The skills needed were simple IT skills and Indians undertaking these activities were most often over-qualified for the task. Body shopping was prevalent in this period (Parthasarathy 2004) and the strategy did not provide much knowledge transfer or interactive

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Regional innovation systems in Asian countries

learning, nor did it enhance local firms’ absorptive capacity since the engineers involved left whenever a more attractive offer was made. This was the case despite high general investment in human capital by the Indian state and an excess of supply of competent engineers. Firms’ absorptive capacity was thus mainly a function of formal technical skills acquired in an IT college or similar, whereas firms’ specific knowledge or specific knowledge of customer demands was scarce. In recent years, Indian firms have to some extent moved up the global value chain, as a result of building up absorptive capacity. This is partly as a result of change in strategy from ‘body shopping’ to distance work (in Bangalore), which is in part facilitated by advances in ICT technologies, as well as deliberate strategies among TNCs to modularize and standardize IT processes. This provides a distance work background which in turn allowed Indian firms to maintain a broader knowledge base at home (Parthasarathy 2004) hence securing better absorptive capacity. They have also invested in development of management competencies; an important constraint for Indian firms to moving up the value chain. The broader knowledge base, combined with the existence and gradual building of reputation in the US market, plus an aggressive certifying strategy by most Indian firms, has allowed their upgrading in the global value chain (Vang and Chaminade 2006).

Social capital and the transnational connections The social capital of the Indian transnational community played (and is playing, for qualifying interpretations, see Vang and Overby 2006 in press) a crucial role in the upgrading industry. To secure access to orders, capital and more sophisticated knowledge, Indian firms were forced to target transnational corporations. However, US IT firms had only limited experience with outsourcing IT activities to developing countries. Combined with poorly developed regulations, the lack of experience generated a high degree of uncertainty for US Volume 8, Issue 1–2, July 2006

firms in terms of subcontractor competencies and trustworthiness, bureaucratic obstacles and cultural dilemmas they might face. This uncertainty enabled the Indian transnational community, with important positions in US firms, to play a significant role in shaping US outsourcing decisions (Vang and Overby 2006 in press). Thus the Indian transnational community helped overcome the distance between US and Bangalore by reducing uncertainties. Moreover, its cultural capital functioned as a bridge builder between different cultural settings.

Autonomy of local firms and the limited embedding of TNCs In recent years, there has been significant growth in interaction between Bangalorian, US and European firms, as well as a diversification of the profiles of firms investing in Bangalore. Today, for example, pharmaceutical firms are also outsourcing to Bangalore. Bangalorian firms have developed a certain degree of autonomy from lead(ing) firms in the US and Europe. As this autonomy is a function of investments in human capital and new managerial strategies, they can now provide all types of services from the highest end of the value chain to the bottom, which has allowed them to move up the chain. Part of this process has been facilitated by increased cluster effect and spin-offs from different universities in Bangalore. However, Indian firms engage to only a limited extent in mutual learning and knowledge exchange, compared to firms in Silicon Valley (the exception is in embedded software) (Vang and Chaminade 2006). The regional state has not done sufficient to spur a new development model based on local interaction and public procurement. Hence, we can picture Indian firms in Bangalore as small islands where the main knowledge transfer takes place between clients abroad, especially in the US, and the US firm (Parthasarathy 2004) while only including minor interactive learning between the TNC and their local first tier supplier.9 Lately however, a number of professional institutions and

INNOVATION: management, policy & practice

39

Bjorn Asheim and Jan Vang

industry–academy partnerships have been promoted to strengthen the technical community, particularly in niche areas such as chip design. If and how this will strengthen social capital in this industry remains to be seen.

Summing up with some implications for RIS policies Bangalore diseconomies of agglomeration have also been revealed, as salaries have increased by up to 40 percent and eroded cost advantages. Thus Bangalore’s competitive advantage (or the Bangalorian model) is diminishing and there is a need for RIS-based policies such as strategic procurement from the state or regional authorities. These policies should stress the regional collaboration dimension and aim to bring Indian firms closer together. Despite the difficulties of building social capital, this aim should be clearly integrated in public procurement polices. Individual firms have the technical skills (human capital) to take advantage of more local cooperation and, apart from limitations in the general level of management, absorptive capacity is highly developed. However, in industry where this physical proximity to lead users is crucial, Bangalore suffers a major drawback.

CONCLUSION In conclusion, we have provided arguments for the importance of RIS as an approach for analyzing and generating policies for economic development in developing countries. We have extended RIS from being primarily based on endogenous growth models towards a development model relying on external capital, transnational knowledge sources and TNCs. In this respect, we have stressed the importance of developing firms and regions absorptive capacity. In this context we have paid special attention to the importance of collective absorptive capacity, hence on human capital and generalized social capital. In both cases we have found that human capital and especially lack of generalized social capital has prevented the local firms upgrading process, and 40

thus constrained the regional development process. Moreover, we have aimed at highlighting the systemic dimensions of the interactive learning between TNCs and local firms as well as alluded to the role that the public sector plays or can play in terms of providing support and use public procurement. The latter aspect however requires more research on government capacity, government failures, etc. to be operationalized. Additionally, we have emphasized the importance of involving the regional government bodies in the development process as this is a prerequisite for efficient policies . We do however nuance the regional devolution ideas that seems to dominate at least parts of contemporary economic geography. Finally, we have also underscored the importance of ‘gluing’ the TNCs to the region as well as economic policies related to this to stimulate more sustainable economic development. The general aim is to stimulate interactive learning and knowledge spillovers and this is a precondition for long term economical sustainable growth and development. The relevancy of these insights is discussed in two specific illustrative cases: the Shanghai and Bangalore regional innovation systems. The paper does not attempt to cover all aspects of the cases but merely illustrate how applying a RIS can be useful for capturing aspects not normally caught by standard economics and thus point to different types of policies.

Acknowledgements Professor Yun-Chung Chen (Hong Kong University on Science and Technology) and Drs. Ping Gao (Copenhagen Business School) for valuable information on China; Drs. Tine Aage (Copenhagen Business School) for stimulating discussions on absorptive capacity; Prof. Balaji Parthasarathy, India, for information on Bangalore, India; and As. Prof. Cristina Chaminade for invaluable assistance in finishing, sharpening and editing the paper.

Endnotes 1 Emphasis is on how RIS can be used rather than on typological discussions about whether Shang-

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Regional innovation systems in Asian countries

2

3

4

5

6

7

hai and Bangalore qualify as being RIS, clusters or merely a co-location of related firms. This supports the plea in favor of some degree of devolution of decision-making structures in most developed and developing countries. The degree of devolution is however a delicate one as national governments tend to have a stronger bargaining power vis-à-vis the TNCs and can prevent a ‘race-to-the-bottom’ but lack local knowledge (Lundvall et al. 2006 in press). To varying degrees, regional governance is expressed in both private representative organizations such as branches of industry associations and chambers of commerce, and public organizations such as regional ministries with devolved powers concerning enterprise and innovation support. In addition while financial capital is crucial in many regions and countries in developing countries this is less the case in the included cases, thus we find it more appropriate to deal with this in a subsequent paper. Physical capital as infrastructure is crucial for economic development but this is not the core area of RIS hence we just refer to UNDP (2004) for detailed elaborations on this topic. We do not disagree with Amin (2004) on the normative implications of defining a culture in singularies (‘Americans’, ‘Indians’, ‘Danes’) but this does not prevent us from pointing to the importance of regularities when discussing empirical realities. By culture we refer to the informal and formal rules of the game (North 1990) which is shared by the relevant – due to the question in mind – segment of the population and provides non-deterministic guidelines for action. Apart from this we refrain from defining culture (see Gertler 2004). It should be stressed that upgrading to fullfledged regional innovation systems in developing countries – at least outside the Asia NIC’s – remains to be seen. It is possible to distinguish between resources and management issues. Notably, the bargaining power of the host country or the ability of the regional government to exploit the absorptive capacity refer to how the government manages the resources of the region. Those resources can be the absorptive capacity of the firms, the organizations providing knowledge to the local firms or the hard infrastructure. In other words, the government might provide the resources but this is not enought unless it has the capacity to manage efficiently those resources to atract the Volume 8, Issue 1–2, July 2006

TNC to the region and build the right linkages with the local productive systems. 8 Due to China’s importance as a future market, embedding TNCs has been an almost automatic process. 9 Occasionally, the TNCs operate with a three layer subcontractor system: gold, silver and bronze. Only gold firms are involved in important interactive learning.

References Amin A (1999) An institutionalist perspective on regional development. International Journal of Urban and Regional Research 2: 365–378. Amin A. (2004) Regions unbound: towards a new politics and place. Geografiska Annaler B 86(1): 31–42. Amsden A (1989) Asia’s next giant: South Korea and late industrialization. New York, Oxford University Press. Asheim B (2001) Learning regions as development coalitions: Partnership as governance in European workfare states? Concepts and Transformation. International Journal of Action Research and Organizational Renewal 6(1): 73–101. Asheim, B. T. (2002) Temporary organizations and spatial embeddedness of learning and knowledge creation. Geografiska Annaler 84B(2): 111–124 Asheim B and Cooke P (1999) Local learning and interactive innovation networks in a global economy, in Malecki E and Oinäs P (eds) Making Connections. Ashgate, Aldershot: 145–178. Asheim B and Gertler MS (2005) Regional Innovation Systems and the Geographical Foundations of Innovation, in Fagerberg J, Mowery D and Nelson R (eds) The Oxford Handbook of Innovation. Oxford, Oxford University Press. Asheim B and Isaksen A (2002) Regional Innovation Systems: The Integration of Local ‘Sticky’ and Global ‘Ubiquitous’ Knowledge. Journal of Technology Transfer 27:77–86. Bathelt H (2003) Growth regimes in spatial perspective 1: innovation, institutions and social systems. Progress in Human Geography 27: 789–804. Bathelt H, Malmberg A and Maskell P (2004) Clusters and Knowledge: Local Buzz Global Pipelines and the Process of Knowledge Creation. Progress in Human Geography 28: 31–56.

INNOVATION: management, policy & practice

41

Bjorn Asheim and Jan Vang

Becker G (1998) Human capital and poverty. Religion and Liberty 8(1), Available at: http://www.acton.org/publicat/randl/article .php?id=258. Chen YC (2004) Restructuring the Shanghai Innovation Systems: The Localization of Multinational Corporation R&D Centers in Shanghai, presented at the First ASIALICS International Conference: Innovation Systems and Clusters in Asia – Challenges and Regional Integration, Bangkok Thailand, April 1–2 2004. Coe NM, Hess M, Yeung H, Dicken P and Henderson J (2004) ‘Globalizing’ regional development: a global production networks perspective. Transactions of the Institute of British Geographers 29(4): 468–484. Cooke P (2001) Regional Innovation Systems Clusters and the Knowledge Economy. Industrial & Corporate Change 10: 945–974. Cooke P and Morgan K (1998) The Associational Economy. OUP: Oxford. Cooke P, Uranga M G and Etxebarria G (1998) Regional Systems of Innovation: An Evolutionary Perspective. Environment and Planning A 30: 1563–1584. Cooke P, Boekholt P and Tödtling F (2000) The Governance of Innovation in Europe. Regional Perspectives on Global Competitiveness. London, Pinter. Cohen S and Fields G (1998) Social Capital and Capital Gains, or Virtual Bowling in Silicon Valley. BRIE working paper. http://ist-socrates. berkeley. edu/~briewww/ publications/ WP132.pdf Cohen W and Levinthal D (1990) Absorptive Capacity: A New Perspective on Learning and Innovation. Administrative Science Quarterly 35: 128–152. Depner H and Bathelt H (2003) Cluster growth and institutional barriers: The development of the automobile industry cluster in Shanghai P.R. China. SPACES 2003 09. Marburg: Fachbereich Geographie Philipps-Universität. Dicken PJ, Henderson M, Hess N, Coe HW and Yeung C (2002) Global production networks and the analysis of economic development. Review of International Political Economy 9: 436–464. Dicken P (2000) Places and flows: situating international investment, in Clark G, Gertler 42

M and Feldman M-A (eds) A Handbook of Economic Geography. Oxford: Oxford University Press, Ch. 14. Dosi G (1988) The nature of the innovative process, in Dosi G, Freeman Ch, Nelson R, Silverberg G and Soete L (eds) Technical Change and Economic Theory. Pinter, London/New York, 221–238. Flyvbjerg B (2004) Five misunderstandings about case-study research, in Seale C, Gobo G, Gubrium JF and Silverman D (eds) Qualitative Research Practice. London, Thousand Oaks CA: Sage, 420–434. Fosfuri A, Motta M and Roende T (2001) Foreign direct investment and spillovers through workers’ mobility. Journal of International Economics 53: 205–222. Gereffi G (1999) International trade and industrial upgrading in the apparel commodity chain. Journal of International Economics 48(1): 37–70. Gertler M (2003) Tacit knowledge and the economic geography of context or The indefinable tacitness of being (there). Journal of Economic Geography 3: 75–99. Gertler M (2004) Manufacturing Culture, The Institutional Geography of Industrial Practice. New York: Oxford University Press. Gorg H and Strobl E (2001) Multinational Companies Technology Spillovers and Plant Survival: Evidence for Irish Manufacturing, European Economy Group Working Papers 8. European Economy Group. Granovetter M (1985) Economic action and social structure: the problem of embeddedness. American Journal of Sociology 91: 481–510. Guerrieri P and Pietrobelli C (2004) Industrial districts’ evolution and technological regimes: Italy and Taiwan. Technovation 24(11): 899–914. Hassink R (2002) Regional Innovation Support Systems: Recent Trends in Germany and East Asia. European Planning Studies 10: 153–164. Isaksen . (2001) Building regional innovation systems: Is endogenous industrial development possible in the global economy? Canadian Journal of Regional Science 24(1): 101–123. Kaplinsky R 2005 Globalization, Poverty and Inequality: Between A Rock And A Hard Place, London: Polity Press. Lall S and Narula R (2004) FDI and its Role in

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Regional innovation systems in Asian countries

Economic Development: Do We Need a New Agenda? European Journal of Development Research 16(3): 447–464. Leidersdorff L and Guoping Z (2001) University– Industry–Government relations in China: an emergent national system of innovation. Industry and Higher Education 15(3):179–182. Lipsey R (2002) Home and host country effects of FDI, NBER Working Paper No. 9293. Lundvall B-Å (ed.) (1992) National Systems of Innovation: Towards a Theory of Innovation and Interactive Learning. London: Pinter Publishers. Lundvall B-Å and Borras S (1997) The Globalising Learning Economy: Implications for Innovation Policy. Luxembourg: European Communities. Lundvall B-Å, Intarakumnerd P and Vang J (2006) Asia’s innovation systems in transition – an introduction, in Asia’s innovation systems in transition, London: Elgar, in press. Maskell P and Malmberg A (1999) Localised learning and industrial competitiveness. Cambridge Journal of Economics 23: 167–86. Mathews J (2002) Dragon Multinational: A New Model for Global Growth, New York: Oxford University Press. Morgan K (2004) The exaggerated death of geography: learning, proximity and territorial innovation systems. Journal of Economic Geography 4 (1): 3–22. Narula R (2004) Understanding absorptive capacities in an ‘innovation systems’ context: consequences for economic and employment growth, Research Memoranda 004 Maastricht: MERIT Maastricht Economic Research Institute on Innovation and Technology. Narula R and Marin A (2005) Exploring the relationship between direct and indirect spillovers from FDI in Argentina, MERIT-Infonomics Research Memorandum series 2005-024. Nelson R and Winter S (1982) An Evolutionary Theory of Economic Change, Cambridge MA: Harvard University Press. North D (1990) Institutions Institutional Change and Economic Performance. New York: Norton OECD (2002) Foreign Direct Investment and Intellectual Capital Formation in Southeast Asia. DEV Centre WP 194. Paldam M (2000) Social Capital: One or Many? Definition and Measurement. Journal of Economic Surveys 14 (5): 629–53. Parthasarathy B (2004) India’s Silicon Valley or Volume 8, Issue 1–2, July 2006

Silicon Valley’s India? Socially Embedding the Computer Software Industry in Bangalore. International Journal of Urban and Regional Research 28(3): 664–85. Pietrobelli C and Rabellotti R (2004) Upgrading in Clusters and Value Chains in Latin America Boston MA: The MIT PRESS for the InterAmerican Development Bank. Piore M and Sabel C (1984) The Second Industrial Divide: Possibilities for Prosperity. New York: Basic Books. Putnam RD (1993) Making Democracy Work. Civic Traditions in Modern Italy. Princeton N.J.: Princeton University Press. Romer P (1990) Endogenous Technological Change, Journal of Political Economy 98(5): 71–102. Sabel C (2005) Globalisation, New Public Services, Local Democracy: What’s the Connection? in Local Governance and the Drivers of Growth, Paris: OECD: 111–131. Saxenian AL (1994) Regional Advantage: Culture and Competition in Silicon Valley and Route 128. Cambridge: Harvard University Press USA. Saxenian AL (2002) Transnational Communities and the Evolution of Global Production Networks: Taiwan China and India. Industry and Innovation 9(3): 183–202. Schmitz H (2004) Local Upgrading in global chains: recent findings. Druid paper. Available at: www.druid.dk. Smarzynska B (2002) Does Foreign Direct Investment Increase the Productivity of Domestic Firms, in Search of Spillovers through Backward Linkages. World Bank Working Papers 2923. Staber U (1996) Accounting for variations in the performance of industrial districts: The case of Baden-Württemberg. International Journal of Urban and Regional Research 20: 299–316. Storper M (1997) The regional world. Territorial development in a global economy. New York and London: The Guilford Press. UNDP (2004) Unleashing entrepreneurship: Making business work for the poor. UNDP report. Vang J and Chaminade C (2006) Building RIS in Developing Countries: Policy Lessons from Bangalore, India. CIRCLE Electronic Working Paper n. 2006/04. Available at http://www. circle.lu.se. INNOVATION: management, policy & practice

43

Bjorn Asheim and Jan Vang

Vang J and Overby M (2006) Transnational Communities TNCs and Development: The Case of the Indian IT-services Industry, in Lundvall B-Å, Patarapong I and Vang J (eds) Asia’s Innovation Systems in Transition. London: Elgar, in press. World Bank (1998) Social Capital in Africa. Available at: http://www.worldbank.org. World Bank (2003) World Development Indicators. Washington: World Bank. Yeung H and Li X (2000) Transnational corporationa and Local embeddedness:

company case studies from Shanghai, China. The Professional Geographer 52(4): 624–635. Yeung, H, Lui, L and Dicken P (Forthcoming 2006) Transnational corporations and network effects of a local manufacturing cluster in mobile telecommunications equipment in China. World Development 34. Zahra SA and George G (2002) Absorptive capacity: A review reconceptualization and extension. Academy of Management Review 27(2):185–203.

S P E C I A L I NNOVATION

AND

LESSONS

I S S U E

E CONOMIC D EVELOPMENT

FROM

L AT I N A M E R I C A

ISBN 0-9750436-5-X; iv + 244 pages; softcover

Edited by Gabriela Dutrénit and Mark Dodgson Metropolitan Autonomous University and UQ Business School Introduction co-authored by Jorge Katz A special issue of Innovation: Management, Policy & Practice ( Volume 7 Issue 2–3 April–August 2005) Contents, Abstracts, Editorials, Articles and Order Form at: www.innovation-enterprise.com/7.2/ ‘... the real challenge for policy and decision makers is how to progress from circumstantial activities to a “pro-active” technological strategy that would allow major innovation effort and technological generation activity to drive the development process.’ – Introduction Course co-ordinators are invited to contact the Publisher for an adoption copy. eContent Management Pty Ltd, PO Box 1027, Maleny QLD 4552, Australia Tel.: +61-7-5435-2900; Fax. +61-7-5435-2911; [email protected] www.e-contentmanagement.com

44

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Copyright © eContent Management Pty Ltd. Innovation: management, policy & practice (2006) 8: 45–61.

Work globally, develop locally: Diaspora networks as entry point to knowledge-based development SUMMARY KEY WORDS diasporas of highly skilled; economic development; diaspora networks; search networks; serendipity

This article examines ways to increase the chances that migration of high-skill workers will benefit sending countries. It explores the formation of diaspora networks as search networks or bridge institutions linking global opportunities to the local capabilities of sending countries. It contributes to an emerging literature that sees the development of problem-solving skills and certain types of managerial culture as at least as crucial to economic development as such traditionally cited factors as clearly defined property rights or anti-inflationary monetary policies. Received 9 June 2005

Accepted 19 October 2005

CHARLES F. SABEL YEVGENY KUZNETSOV

Maurice T. Moore Professor of Law Columbia Law School New York, NY

Senior Economist World Bank Institute Washington, DC

CO-EVOLUTION OF DIASPORAS AND DEVELOPING ECONOMIES

A

ctors in developing economies must have the capacity to acquire new knowledge – to learn new ways of doing things – if they are to compete in the world economy. Learning, in turn, supposes and contributes to the ability to search out and usefully recombine scattered information about production methods, markets and resources. Because development depends on learning and learning on searching, development almost Volume 8, Issue 1–2, July 2006

invariably depends on linking the domestic economy to the larger, foreign world, for even the strongest economies quickly rediscover (if they have ever forgotten) that they cannot generate all world-beating ideas in isolation. Historically, contact with the outside world was often established through skilled migrants and the ethnic or religious communities they founded in the host country. Examples include the contribution of the Huguenots in France; the Jews in Monterrey, Mexico; the Chinese in Indonesia,

INNOVATION: management, policy & practice

45

Yevgeny Kuznetsov and Charles F. Sabel

Malaysia and the Philippines; and the Indians in East Africa and later Great Britain. During much of the twentieth century, multinational firms facilitated knowledge transfers by establishing facilities – usually for the manufacture or assembly of mature products – in developing countries, often with the assistance of local elites. Viewed from this historical perspective, network diasporas are but the latest bridge institutions connecting developing economy insiders, with their risk-mitigating knowledge and connections, to outsiders in command of technical know-how and investment capital. At least for developing economies, the attraction of diaspora networks over immigrant communities and multinational firms is that networks promise to depoliticize the relation between domestic actors and the foreign actors from whom they learn, transforming a volatile, often irrational struggle for power into a mutually beneficial economic exchange. Learning is often connected to ugly frictions. Economically powerful ethnic minorities have traditionally been suspected of having greater loyalty to their ethnic community than to the host country and of being tempted to exploit the latter to benefit the former. Powerfully autonomous and often footloose, multinational firms are viewed as the agents, even the masters, of economic imperialism rather than partners in development. The actors in diaspora networks, in contrast, are native sons and daughters. Even if they are wealthy or connected to wealthy families or important multinationals, they seldom command the resources attributed to economically potent minorities (whose riches, though real enough, are often magnified by envy), and they are not manifestly at the command of the world’s largest companies. They are, at least potentially, a connection to the indispensable world of foreign knowledge that can be domesticated and then used to discipline the behavior of ethnic communities and multinationals. That the members of network diasporas are likely to be suspected in their host countries of putting personal gain or ethnic ties above managerial professionalism makes them, 46

from the point of view of the sending country, more pliant and more willing to cooperate on a truly equal footing. That diaspora networks seem to form spontaneously, as the result of both the shortcomings and the successes of the mesh of individual and national strategies for economic advancement, only completes the picture of the new institution as the market/manna solution to a crucial problem of coordinated learning too long fraught with political passions. The reality of network diasporas is far more complex and unruly than this juxtaposition suggests. Whether diasporas are seen as adjuncts to rather than adversaries of domestic elites depends on how the two groups have interacted historically. Whether, and in what way, diasporas connect domestic and world economies depends on the interaction of changes in the global production or supply chain patterns, changes in domestic growth opportunities, and changes in the economic activities and strategies of the diaspora members themselves. Diasporas are thus mirrors of national development, reflecting the migratory pushes of national crises and the pull of the global economy. Network diasporas are not a self-generating, context-free solution to the perennial problem of learning from abroad without being victimized by the foreign master; they co-evolve with the political and economic contexts within which they operate.

FACILITATING SERENDIPITY: INSTITUTIONALIZING NASCENT DIASPORA NETWORKS

In 1997 Ramón L. García, a Chilean applied geneticist and biotechnology entrepreneur with a PhD from Iowa State University, contacted Fundación Chile. Fundación is a private–public innovation organization that, among other missions, helps provide the technical infrastructure that allows Chilean agribusiness to develop domestically viable variants of crops typical of California’s Central Valley. García is the chief executive officer of InterLink Biotechnologies, a

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Work globally, develop locally

Princeton, New Jersey, company he co-founded in 1991. Interlink developed a way to identify novel chemical entities derived from microorganisms for use in new pharmaceuticals and enzyme additives for human food, animal feed, and biocontrol agents. It markets its technical expertise to other firms interested in transferring and licensing new biotechnologies. After jointly reviewing their portfolios of initiatives, Interlink and Fundación founded a new, co-owned company, Biogenetic S.A., to undertake the long-term research and development projects needed to transfer to Chile technologies key to the continuing competitiveness of its rapidly growing agribusiness sector. Without García’s deep knowledge of Chile, advanced U.S. education, exposure to U.S. managerial practice, and experience as an entrepreneur, the new company would have been inconceivable. Biogenetic has successfully developed a technology platform that uses biotechnology to improve grapes and stone fruits, two export crops that are very important to the Chilean economy. The company genetically modified grapes to make them resistant to diseases and was instrumental in developing a program for developing pine trees resistant to an important insect pest. It is developing the technology to introduce important quality traits in stone fruits. The fact that skilled expatriates can create enormous benefits for their countries of origin has come to attention in recent years through the conspicuous contributions that the large, highly skilled, and manifestly prosperous and wellorganized Chinese and Indian diasporas have made to their home countries. But García’s collaboration with Fundación Chile suggests that diasporas do not need to be large to have an impact: ten Ramón Garcías could transform entire sectors of the economy in relatively small countries, such as Chile or Armenia. Moreover, García’s collaboration with Fundación Chile suggests that even the sparsely populated, informal diaspora networks linking small home countries with their talent abroad are not without some Volume 8, Issue 1–2, July 2006

institutional resources and may prove capable of developing more. However, this is as far as the anecdote takes us. García’s collaboration with Fundación Chile was serendipitous. While the story tantalizes and inspires those who search for keys to economic development, it scarcely hints at how to proceed from the happy accidents of the Ramón Garcías in the emerging business diasporas of Chile and other countries to the robust and systematic diaspora involvement exemplified by China and India. Indeed, on closer inspection there seems to be a schism between the demonstrated success of mature diaspora networks in triggering knowledge-intensive activities in their home countries and the disappointing results in promoting diasporas’ engagement in development of home countries. This paper seeks to bridge this divide. It presents a compact framework for understanding the large and related transformations in labor and product markets and in industrial organizations that are reflected in and furthered by the growing role of diasporas of both relatively low-skill workers as well as highly educated professionals. It then analyzes what has worked and what has not in facilitating diaspora networks and extracts some tentative and preliminary policy recommendations, addressed primarily to leaders of business communities and public organizations anxious to learn from and scale up the Ramón García case. To illustrate this co-evolution of network diasporas with their environments and to identify potential obstacles, this introductory paper describes the development of the ‘mature’ diasporas of China, India, and Armenia which are related in more detail in the paper. All three are large, well organized, and centuries old. The first two have been enormously successful. The success of the Chinese diaspora grew out of – although it is no longer limited to – the traditional investment behavior of emigrant families that made their fortunes overseas. The success of the Indian diaspora is much more closely tied to recent changes in

INNOVATION: management, policy & practice

47

Yevgeny Kuznetsov and Charles F. Sabel

supply-chain organization and the pattern of linkage, as opposed to the investment-based investing these changes make possible. Although a decade ago its success seemed nearly certain, the Armenian diaspora has failed to contribute substantially to domestic development (at least relative to its potential). The political divisions between the diaspora and the post-Soviet political class in Armenia combined with the philanthropic generosity of the overseas Armenians thwarted development and buffered domestic actors from the costs of their actions. This experience suggests that the political context requires as much attention as the economic setting. Following this review, the paper looks at South Africa’s efforts to institutionalize relations with its diaspora. Examination of South Africa’s successes and failures suggests how policymakers can address the crucial problems of turning an emerging diaspora into a mature institution of economic development by bootstrapping (making a series of incremental steps, each suggested by the lessons learned in the preceding ones).

PERSPECTIVE ON THE LITERATURE The focus of this paper – interaction of expatriate talent with their countries of origin – has been treated at some length in the literature. In a broad brush, the literature on brain drain evolved in three quite distinct generations. The first generation of the literature is illustrated by the 1968 debate between Harry Johnson and Don Patinkin, in one of the first anthology of papers on the ‘brain drain’ (Adams 1968). Harry Johnson set forth ‘cosmopolitan liberal argument’ emphasizing individual welfare gains for the migrating talent while Don Patinkin stressed welfare losses for the country of origin. These welfare losses are particularly significant when the country looses certain ‘critical mass’ of skills with a risk of its intellectual community turning into ghetto. The differences in these positions notwithstanding, a common focus was on physical movement of people and the policy preoccupation was physical return of migrants to their home countries – 48

return migration (Bhagwati.& Partington 1976). By the 1980s the debate about brain drain had dissipated and did not receive attention again until the 1990s. The sharp increase in skilled emigration from developing countries renewed the brain drain debate (that flow increased due to the increase of highly skilled immigrants to US, Canada and Western Europe). The focus of the second generation of literature are the networks of professionals organized in diasporas and other forms of brain circulation networks (Scientific diasporas 2003; Saxenian 2000; Brown 2003; Kapur 2004). Partly because the physical return of expatriate professionals has proved plainly unrealistic, a new focus is how to leverage the expertise and capital of expatriate professionals without physically returning them to their country of origin. This literature is insightful in outlining a potential of expatriate professionals as a source of capital and knowledge, yet skilled diasporas in this literature tend to fall as manna from heaven. Diasporas and the brain circulation network appear to be a newly found magic solution allowing leveraging expatriates abroad for the benefit of countries of origin. The literature recognizes, of course, that the reality is more complex and that much more understanding is needed to uncover intricacies of the evolution of diaspora networks and their endogenous dynamics. Yet, since little systematic information on the internal diversity of diasporas is usually available, this subject does not receive a proper examination. This paper seeks to summarize and contribute to a third generation of the literature which, while barely emerging, is nonetheless quite promising (Ellerman 2004; Saxenian 2005). Co-evolution of home country institutions and diasporas (as a rule, non-linear) is a central thrust of this emerging approach. Such a co-evolution can be summarized in four themes. First theme is the emphasis on both heterogeneity of a country’s talent abroad and its mode of interaction with the home countries. We focus on a diversity of different loosely organized dias-

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Work globally, develop locally

pora networks (self-organized groups of expatriates) rather than a traditional notion of diaspora as a relatively homogeneous whole bringing together the majority of expatriates living outside home countries. The critical importance of institutions in the home country is a second central theme. However large and entrepreneurial are networks of diaspora professionals, one needs institutions at home which are interested in, and capable of, joint projects with expatriates abroad. Foundation Chile is one such example. But institutions at home are also heterogeneous: some are better and more capable than others. Diaspora networks are conceptualized as search networks linking better performing segments of home country institutions with forward looking segments of diaspora and have a potential to generate a virtuous cycle which develops both home country institutions and diaspora networks abroad. The search network theme is a third major theme of the paper. Finally, a non-linearity of home country– diaspora interaction is a most promising hypothesis from a policy perspective. The non-linearity means that small interventions can make both a big difference (positive feedback mechanism) and a slow and flat learning curve, a sense of being ‘stuck’ (negative feedback mechanism). The Ramon Garcia story and discussion on India (under ‘Mature diasporas’, below) provide an example of a positive feedback mechanism while the discussion on Armenia (under ‘Mature diasporas’) is an example of a negative feedback mechanism.

DIASPORA NETWORKS AS SEARCH NETWORKS

The global circulation of high-skill and low-skill labor from poor economies to rich and back is opening new possibilities for economic development. The changes are most noticeable in the behavior of the highest skilled workers. The brain-drain pattern of migration long drew many of the most promising students from poor countries to lucrative and challenging careers in develVolume 8, Issue 1–2, July 2006

oped countries. Today this pattern shows signs of turning into a back and forth movement, or diaspora network, in which talented students still go abroad to continue their studies and work in the developed economies but then use their own global networks, and especially those of their diasporas, to help build new establishments in their home countries. There are also signs that emigrants with fewer skills, forced by poverty to go abroad but long confined to dead-end jobs in developed economies, are also finding new career possibilities. Increasingly, the entry-level jobs they take in factory production or the health care sector in host countries demand and teach problem-solving skills that blur the line between management and labor. Whether these new skills can be redeployed back home is an open question. But the changing nature of migrants’ work suggests the possibility that these ‘birds of passage’, traditionally in transit between a native land that cannot support them and a rich country that remains alien, may one day form distinctive, medium-skill diaspora networks that complement the diasporas of managers and entrepreneurs. Behind these developments is the long-term, accelerating decentralization of decision-making responsibility from end-producers in the public and private sectors to their suppliers, and the decentralization within public and private establishments from managers to front-line work teams. To take a frequently cited example, recognizing that they cannot possibly remain abreast of all the key technologies that make a car, automakers have largely divested themselves of their component-producing capacity. They codesign virtually every subassembly of the vehicle with independent suppliers. Facing analogous limits to their own managerial capacities, public administrations in developed countries routinely outsource the provision of new services to not-forprofit organizations and certain routine functions, such as servicing complaints, to for-profit call centers. This decentralization of production often allows firms to relocate activity in developing

INNOVATION: management, policy & practice

49

Yevgeny Kuznetsov and Charles F. Sabel

countries, creating many of the investment opportunities within reorganizing supply chains that members of the high-skill diaspora networks seize. The managerial limits that propel decentralization of production to suppliers also compel a shift from hierarchy to teamwork in end-producers and suppliers alike. As product lifecycles shorten from years to months (in consumer electronics, cell phones, and computers, for instance) and quality expectations rise, it is impossible to shift from one production set-up to another – and to solve the inevitable start-up problems each changeover brings – without the active cooperation of the workers who will be doing the assembly. Organized as production and problem-solving teams, front-line workers are routinely asked to criticize and suggest improvements in the set-up of their workplaces, the flow of production, and the provision of support services. They are asked to share in the quintessentially managerial task of co-designing the organization within which they are working. New programs in problem solving and teamwork help equip them for this task. This entry-level exposure to problem solving and the new forms of training with which it is associated create a bridge between the traditional world of the immigrant worker and the knowledge economy. In doing so, they may open the way to the formation of a medium-skill diaspora. The decentralization of production to suppliers, as well as the shift from hierarchy to teamwork by end-producers and suppliers, can be viewed as part of a profound change in the principles of organizational design. In traditional organizations – the kind found in mass-production factories and large public bureaucracies – complex operations are accomplished by decomposing them into tasks sufficiently limited to be manageable by actors with ‘bounded rationality’. Hierarchy is the result. But as a rapidly changing world has made decomposition of tasks too time consuming and costly to be practicable, organizations have stumbled on an alternative solution. Instead of responding to bounded rationality by 50

simplifying the problems actors face, organizations create the infrastructure that allows actors charged with a task to find other actors – outside the organization as well as within – who are already solving (part of ) the problem. Put another way, organizations shift from hierarchies in which subordinates execute their superiors’ plans to search networks in which collaborators, through the very process of identifying one another, come to define the tasks they will jointly accomplish. In a world of search networks, changes in labor markets (who works with whom) can easily lead to changes in product markets (what businesses make) and even industrial organization (how firms are structured internally and connected to one another). From this point of view, modern diasporas networks, as the García–Fundación Chile anecdote suggests, are just an especially conspicuous (because publicly visible) variant of the search networks under rapid construction in firms worldwide. The shift from brain drain to brain circulation marks the shift from a world in which the function of (long-range) labor markets was to fill jobs with relatively fixed requirements to a world in which filling a job changes not only the definition of what needs to be done but also the setting in which future needs are defined. The emergence of diasporas as a type of search network – a network that lets members find and collaborate with those who already know what they need to learn – poses new challenges for the articulation of coordinated training and economic development strategies within individual sending and receiving countries and for increased coordination between senders and receivers as distinct but more and more intricately connected groups. Individual sending countries will presumably want to encourage the formation of diaspora networks by helping high-skill emigrants stay in touch with one another and the home country and by creating individual and corporate incentives for their re-engagement with the domestic economy. A key aspect of increasing the attractiveness of the domestic economy to potential

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Work globally, develop locally

investors will be introducing problem-solving skills in the public school curriculum and in continuing education programs, in order to create a domestic workforce with the skills required by the new wave of decentralizing firms. Broad provision of these skills will also increase the chances that young job seekers who do not find work at home will be able to take advantage of new career possibilities afforded by entry-level jobs abroad. Receiving countries have reasons of their own to encourage diaspora networks. Obstructing mobility in an epoch of decentralization imposes stay-or-go choices on energetic, ambitious immigrant elite, potentially spurring the return en masse of high-skill expatriates. Promoting the circulation of high-skill labor from home country to adopted home and back reduces this risk and is thus almost surely in the long-term economic interest of the receiving countries. With their aging populations and low birth rates, traditional receiving countries will also likely find it useful to recruit immigrants for low-level jobs in the (public) service sector and manufacturing. But the blurring of managerial and executive tasks means that foreign entry-level workers – even those familiar with the new problem-solving – will need complementary training in ‘soft’ social skills particular to the host country if they are to use their abilities to good effect. Ideally, of course, sending and receiving countries will develop these new, complementary programs in concert. The content of the problem-solving training in developing countries should profit from the extensive experience that global firms and host country training systems have already accumulated. Host countries’ ‘softskill’ acculturation programs will benefit from ongoing consultation with sending countries about the best ways to address cultural frictions that arise. By the same token, both sending and receiving countries can gain from meshing their efforts to support diaspora networks, and there is likely to be strong pressure from the high-skill members of such networks for them to do so. Both have interests in jointly regulating the workVolume 8, Issue 1–2, July 2006

ing conditions and environmental responsibilities of decentralizing supply chains in order to prevent protectionist reactions to offshore ventures by rich countries and local protests against multinational imperialism in poorer ones. Political realities, of course, will often obstruct the realization of potential gains. But an appreciation of the possibilities will help improve outcomes even when ideal solutions are beyond reach.

TALE OF TWO MIGRATION STREAMS Global labor migration today can be divided into high-skill and low-skill streams. The superficial differences between the two conceal important common sources, features and even consequences. The high-skill stream is made up of diaspora networks. In the past decade, expatriates have come to play a critical and highly visible role in accelerating technology exchange and foreign direct investment in China, India, Israel, and the United States. Some expatriates became pioneer investors before the widespread decentralization of supply chains and internal decentralization of authority assured major capital markets that these developing economies had rosy futures. Some of these pioneers had, and continue to have, nonfinancial motives for early-stage participation. Others had, and have, means of mitigating risk unavailable to other investors by virtue of their knowledge of language, culture, institutions and counterparts. The contribution of US-based Indian managers to a spectacular surge in information technology and related services in India is a paradigmatic win–win situation, in which migration of highly skilled professionals benefits both the sending and receiving country. Other countries may be nearing the threshold of repeating the Indian or Chinese experience, in that they have both successful expatriate communities and high-risk economies that scare off mainstream investors but provide the opportunities from which diaspora networks grow. Still other economies, such as those in Latin American and the European Union accession countries, are struggling to move to more knowledge-inten-

INNOVATION: management, policy & practice

51

Yevgeny Kuznetsov and Charles F. Sabel

sive development, despite significant foreign direct investment in recent decades. Their hope is that diaspora networks can overcome obstacles to deeper integration by serving as an entry point into new markets. Discovered only recently, diaspora networks mesh so well with the architecture of the modern knowledge society that they are coming to be seen as one of its natural building blocks. Workers in the low-skill migration stream have no advanced degrees; they may not be able to show prospective employers any school-leaving certificate or indeed any official documentation at all. They are not entrepreneurs, at least not founders of high-tech firms. They often live in poor, high-crime neighborhoods, and their children are frequently at home neither in their parents’ culture nor in their country of residence. Where the diaspora networks seem to have emerged from nowhere to become part of a new cosmopolitan elite, low-skill immigrants are frequently depicted as unchanging, indeed determined not to change, out of loyalty to the pre-modern cultures from which they come. Official and public reaction to the two migratory streams underscores these differences: highskill talent is welcomed in virtually every country, while most low-skill immigrants are illegal. Highskill professionals provide tangible benefits to receiving country in terms of new business creation and human capital; unskilled immigrants are perceived as draining the budget for social expenditures and threatening solidarity. Despite the apparent differences between the two streams, there are common features that do not figure in public discussion. First, the acquisition and development of skills is crucial to both streams. This is obvious in the case of the Indian with a PhD who emigrates to the United States, but it is also true of the secondary school graduate from Mali who emigrates to take a cleaning job in a nursing home in France. Given the paucity of its current developmental possibilities, Mali is likely to have a comparative advantage in the production of such human capital. And as the health system crisis revealed by the European heat 52

wave in the summer of 2003 showed, the need for the kinds of skills such workers offer is high in advanced countries. Put another way, many ‘lowskill’ migrants are low skilled only in comparison to certified professionals. They are far from unskilled compared with the bulk of the population in their country of origin, and they have skills that are in demand in the host country. Managerial skills are a case in point. After working for several years in Japan, Luis Miyashiro, a Peruvian national, came to Lima and founded Norkys, a chain of chicken restaurants. The chain, the first of its kind in an Andean country, combined Western standards of cleanliness and efficiency with the familiar corner foodstand concept common in Latin America. The idea for, and expertise needed to manage, the chain were acquired in Japan. Second, both migratory streams are being redirected and transformed by profound and pervasive economic restructuring that creates important opportunities and entry points. For skilled workers, the global restructuring of supply chains is turning brain drain into brain circulation, creating or strengthening network diasporas in the process. In the case of the unskilled and illegal, the restructuring of the public administration that provides key social services, together with the restructuring of shop-floor work, is beginning to create career opportunities where earlier generations in similar positions faced dead ends. This is not to romanticize entry-level work in the new economy. But there is at least anecdotal evidence that even hamburger-flipping jobs now often lead somewhere and that public-sector restructuring – just now coming to public notice – will accelerate this tendency. Third, in both migration streams, social networks emerge as naturally occurring or spontaneous solutions to complex coordination problems: like manna, they fall from the sky, allowing emigrants to match themselves to jobs or entrepreneurial possibilities. In connecting emigrants to the world, these networks create new possibilities for policymakers to learn, from and with key

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Work globally, develop locally

social actors, how to redirect institutions and incentives to meet emerging needs. Much of labor market theory in the late twentieth century focused on industrial jobs. It was common, perhaps standard, to treat migration between countries as concerning low-skilled workers and to treat skill acquisition as occurring through learning on the job within a large, hierarchically organized corporation. Given the organization of production in these firms, most learning was plant or firm specific. It followed from the decomposition of large projects, such as design and production of a car, into small, linked tasks, that the machines needed for any step would be highly specialized and tightly matched in specifications to the machine that produced its input and the machine that used its output. Machines designed to be used only with other machines in such a sequence are called asset specific; they have no value for any other use. By the same logic, the skills needed to operate each machine consisted of the largely tacit knowledge of the peculiarities of each machine in relation to upstream and downstream operations. (The knowledge was almost sure to be largely tacit, because the machines were effectively unique; formalization, at least in the then current view, was the statement of the general features of some process or situation.) Workers with little or no formal education learned these skills by progressing from machine to machine, acquiring the highly specialized knowledge they needed from more experienced colleagues, not from papers. These job sequences are called job ladders. It was a sign of the importance of tacit knowledge in these job ladders and the economy as a whole that returns to formal education were low. For many workers in the United States, for instance, there was little penalty, in terms of lifetime earnings, for quitting high school or skipping college, because in many cases the skills needed for highpaying jobs could be acquired by an industrial apprenticeship in a factory or firm. In this world view, migration and skill acquisition were viewed as distinct phenomena. Volume 8, Issue 1–2, July 2006

Migrants were presumed, correctly, to be seeking higher incomes and vastly increased possibilities for savings, not new skills, when they went abroad. Their goal was to remit as much as possible to their families at home while working in the receiving country and to return as soon as possible, with as much wealth as possible, to their home countries. They were not interested in investing in skill acquisition, because they were not planning to stay abroad long enough to reap the returns to their investment. Unattractive, lowskill jobs were acceptable, because they paid wages that were extraordinarily high by home country standards. Given these goals, these migrants were birds of passage, living in a no man’s land between their home and temporary countries, often circulating back and forth between the two, as economic and family circumstances dictated. The guest workers brought to Western European factories in the 1960s and 1970s fit this pattern perfectly, but they had many forebears from the late nineteenth century on. A central problem for these birds of passage was, and remains, the identification of plentiful, geographically concentrated supplies of low-skill jobs over long distances. The jobs had to be plentiful and close together because, being low skilled and thus undifferentiated, there could be no guarantee that any particular job would prove stable. The potential instability of any one job was compensated for by the availability of others, sufficiently close to each other, that changing jobs did not require changing homes. Finding such jobs required scanning many possible destinations to determine whether jobs were available there for unskilled immigrants. An efficient way to scan was to rely on a network of relatives, friends and acquaintances from one’s home village, who were looking for similar jobs themselves. Members or nodes in this network know little about each other – they have rarely worked or done business together – but they know all that migrants need to know, for the purposes of joint search, about labor market conditions. Links of this kind – rich in information about a

INNOVATION: management, policy & practice

53

Yevgeny Kuznetsov and Charles F. Sabel

particular, thin slice of the world; poor in information about the character and abilities of the network members – are called weak ties. The migration flows that result from a network of weak ties directing migrants from a given origin to follow the news of plentiful, low-skill jobs to a common destination is a migration chain. A key consequence of the shift to networked, organization-based search networks rather than hierarchy is to ‘despecify’ machines and skills – to make both more general purpose. Assume that a firm knows in advance that it cannot be sure what products it will be making two years hence or how any of those products will be designed. In this case, it sacrifices some of the efficiency that comes with using a machine that can do only one thing and buys general purpose machines that can easily be reprogrammed to do many different operations. That change means learning to shift from operation to operation with a given, large domain and, more broadly, learning to learn and master skills, each based on substantial bodies of formal knowledge. There is less and less wholly unskilled work, and even the relatively unskilled work is no longer plant specific (think of the general team-working skills needed by workers in just-in-time factories). A crude but revealing measure of this shift is the rapidly increasing returns to formal education and the corresponding increase in the gap between the lifetime wages of unskilled and skilled workers. Potential migrants notice this shift. Those with good educational prospects at home go abroad to take advantage of still better opportunities, finding jobs that enable them to learn more than they could at home. Those with fewer opportunities at home start to think about improving their prospects by going abroad, fearing that their long-term employability depends on doing so. Instead of looking for destinations with plentiful unskilled jobs, migrants begin to look for destinations that offer many possibilities for skill acquisition, at work or school. As job ladders are transformed into more open, inter-firm, and formally skilled labor markets, and weak ties among 54

migrants begin to communicate information about learning possibilities, migration chains become open mobility networks – means for discovering where to go to learn how to prosper in the reorganizing economy. High-skill diasporas are a conspicuous example of such networks. The proliferation of professional associations of diaspora members is evidence of this transition from thin to thick search networks. Associations such as the association of doctors of Armenian origin in the United States or the Association of Engineers from Latin America are thick networks that help members identify opportunities for professional advancement. Mentoring is a central feature of these associations. Perhaps the most successful organization of this kind, the Indus Entrepreneurs (TiE), was started in 1992 as a conduit for experienced Indians to mentor others and provide a broad forum for networking and learning for its members. TiE is an institutionalized search network that helps its members move up their migration chains. This change now extends beyond migrants with tertiary degrees. Hometown associations of migrants of Mexican origin (of which there are more than 70 in the United States) were started in the 1950s with the primary objective of defending the rights of (often illegal) labor migrants from Mexico, the vast majority of them unskilled. Hometown associations used to be paragons of institutionalized but thin search networks that identified job opportunities and provided mutual help (including practical ways to live and work as an illegal immigrant). Migrants from Zacatecas (a poor state in the center-north of Mexico), for instance, have a hometown association in almost every major US city. With time, and as many migrants became legal and progressed in their migration chains from hamburger-flippers to supervisors of hamburgerflippers, two things have started to happen. First, an acute shortage of native-speaking supervisors and shop-floor managers has emerged. Migrants from Mexico do not speak fluent English. For this reason alone, they prefer to work for Mexi-

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Work globally, develop locally

can managers. So significant is the shortage of Spanish-speaking immigrants in certain managerial positions that identifying and training such managers is now a central task of the Association of Latin American Professionals. Open-ended migrants’ organizations, such as Mexico’s hometown associations, have contributed to this transformation by also introducing mentoring. For example, they direct their members to appropriate training programs and other job advancement opportunities. What started as a paragon of a thin search network of low-skilled migrants is showing signs of transformation to thick search networks to move members along their migration chain (Torres 2004). Second, as migrants progress along their migration chain and acquire the self-confidence that comes with personal and professional success, they start thinking about giving to and helping not just their families but their home communities. Hometown associations from Zacatecas, in collaboration with the state government of Zacatecas, designed and cofinanced a highly successful 3 × 1 program of investment in community infrastructure (secondary roads, schools, hospitals) in their home communities (Torres 2004). The program is called 3 × 1 because for every peso the hometown associations put in, state and federal governments each contribute another peso. Although the vast majority of members of hometown associations is not wealthy, the binding constraint for this program of collective remittances has always been contributions from the Mexico government, not the donations of the migrants. Financial transfers are not the most important aspect of collective remittance; governance and monitoring are. Community infrastructure projects need to be identified, financed and managed through a network of very diverse stakeholders – municipal government, users of the infrastructure, migrants, and others – that (used to) have little trust in one another. As migrants are contributing their own money, they are highly motivated to make the project succeed, avoiding the Volume 8, Issue 1–2, July 2006

decay that often characterizes public works projects. To make these projects work, migrants need to monitor them, both from abroad and through frequent visits to their home towns. The diaspora network in this example is a transnational search network: diaspora members work with stakeholders at home to design, co-finance, and govern projects to benefit their communities at home. Studying diaspora networks helps uncover the partial solutions that are working. It helps formalize the networks, rendering them more effective as incubators for new programs and as governance structures for new projects. It also reveals potential win–win dynamics benefiting both sending and receiving countries. Such a potential has already been realized in case of mature diaspora networks as illustrated by China and India.

MATURE DIASPORAS: CHINA AND INDIA VERSUS ARMENIA The diasporas of China and India have had a highly beneficial impact on their home countries. In contrast, the wealthy Armenian diaspora has failed to help move the country up global value chains.

China The story of the post-War Chinese diaspora is one of geographic mobility and economic diversification: the construction of a ‘bamboo network’ linking Hong Kong (China), Taiwan (China), Singapore, Malaysia, Indonesia, Thailand and the Philippines to one another and to China through meshed webs of family firms operating first in traditional trading and manufacturing, then in high tech and finance. For many refugees, the years following the Communist victory in 1949 were a time of testing, relieved – some would say redeemed – by rags to riches stories. In the conventional telling, frugal, canny traders, often with nothing but the clothes on their back, worked their way up from factory floor to great wealth. Once they laid the foundations of their enterpris-

INNOVATION: management, policy & practice

55

Yevgeny Kuznetsov and Charles F. Sabel

es in one host country, they diversified and expanded geographically. Just as the House of Rothschild’s pater familias sent his sons from Frankfurt to Paris, London and Naples, the overseas Chinese internationalized their businesses, delegating family members to set up firms in other promising locations within what was becoming, from their vantage point, Greater China. The new firms drew on the founder’s capital and his rich social connections. But as the opportunities suggested by these connections were only accidentally connected to the founder’s original business interests, internationalization typically went hand in hand with diversification across areas of business activity. In time the family firms grew into dynasties, operating a myriad of small and medium-size firms in many sectors and countries, all under the direct but secretive control of the founding family. In a vast geographic zone with underdeveloped financial markets and fragile legal institutions, the family and ethnic loyalties of the overseas Chinese – backed by the credible threat to blacklist anyone who violated the community norms of fair dealing – reduced the cost to this group of organizing complex business transaction. The greater the reach of the bamboo network, the greater, in principle, the competitive advantage. Soon the overseas Chinese held key positions in real estate development, component manufacturing and construction – sectors that put a premium on the ability to combine trading and productive skills. At the same time, Taiwan (China) was developing a distinctive style of business organization that fused elements of the traditional small Chinese firm and the Silicon Valley start-up. With the start of Deng Xiaping’s Open Door policy in 1978, China turned away from isolation and autarky and welcomed successful overseas Chinese as investors. The influx from Taiwan (China) and Hong Kong (China) was particularly great because of proximity and historical ties. Multinational firms flocked to the mainland, partly to decentralize existing operations to a lowcost location, partly to participate in the widely 56

anticipated growth of a huge market, and partly because partnering with key members of the Chinese diaspora was often regarded as indispensable to navigating an opaque political environment. Today, traditional lines of business are increasingly being abandoned in favor of the most modern sectors of the economy. Having helped transform China, the Chinese diaspora is now being transformed by the developments it encouraged.

India The contribution of the Chinese network diaspora to Chinese development started and was long sustained by investments in manufacturing. In contrast, the contribution of the Indian diaspora to domestic development began by linking domestic and foreign firms in the service sector. The Chinese experience shows that certain traditional forms of risk-mitigating investment behavior are by no means limited to traditional industries. The Indian experience shows that new models of business organization emerging in the continuing reorganization of supply chains can give rise to new patterns of development, in which economic learning begins through service provision, rather than industrial activity, and in which the key investments are in education and training, rather than equipment and plant. The Indian software industry grew 40 percent a year in the 1990s. Revenues reached $10.2 billion in 2002, $7.7 billion of them from exports. During the same period, employment grew from 56,000 to 360,000, absorbing most of the 75,000 new information technology graduates India produces every year. The number of firms more than quadrupled, from 700 to more than 2800, and the largest firms, such as Wipro and Infosys, are executing increasingly complex and valuable projects. India has demonstrated that success in low-level business services outsourcing can be a building block for higher valueadded services. The emergence of the Indian software industry was in some ways a fortunate accident that

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Work globally, develop locally

almost surely cannot be reproduced by other countries. But it was an accident waiting to happen, dependent on structural conditions that can indeed by influenced by policy. The Indian government’s emphasis on higher education, especially scientific education, created a surplus of well-trained scientists, engineers, and technicians just when the Internet and telecom booms and the Y2K problem produced a massive need for these professionals in the West. Still more providentially, excess US demand for programmers developed just when a critical number of Indian expatriates, who had emigrated to the United States in the 1970s and 1980s, had become CEOs and senior executives at American technology companies. These executives played a critical role in giving their companies the confidence to outsource work to India. They were also patient sponsors as Indian firms gradually learned how to meet US quality and delivery requirements. Even with these propitious coincidences, however, Western firms could not have outsourced work extensively to India had the Indian government – unaware that software firms could become major employers and producers of tradable goods – not exempted the industry’s largely white-collar workforce from much of the labor regulation that hampers India’s traditional manufacturing. Even India’s much criticized isolationist policy toward the computer industry proved fortuitous: by the early 1990s, when regulations were relaxed, isolation had weaned an entire generation of programmers from mainframes and forced them to master emerging client server and personal computer standards. No other country or industry should expect to duplicate India’s software luck. But India’s experience demonstrates that outsourced business services can make a primary contribution to economic development in the twenty-first century and that diaspora networks can play a crucial role in establishing long-range collaboration in the supply chain. Business service-based growth eases the burden on developing countries in at least two important ways. First, unlike manufacturing, Volume 8, Issue 1–2, July 2006

business services do not require (much) advanced infrastructure or large capital investments. The minimal requirements are educational – Englishspeaking workers with various technical proficiencies. Most developing countries have or can be expected to develop such human resources. Second, as a new industry in developing countries, business services face neither entrenched domestic competitors (with, perhaps, privileged access to government officials who set the rules of competition) nor trade unions (allied, perhaps, with ministries of labor). Traditional forms of regulation, however legitimate in the historical context in which they arose, are thus unlikely to burden the development of business relations in a novel and largely uncharted situation. The emergence of the high-skill diaspora also reduces the burden on the developing country. The success of the diaspora equips its members with high-level, internationally current managerial skills of a kind that would, at best, be available to tiny elites at home. The apprenticeship that leads to the acquisition of such skills is long, even in the fast-paced sectors of the world economy: the average CEO of a major US corporation took office at age 48 (Pandey et al. 2004). Purely managerial training, moreover, is complemented by a broader political education which makes the successful members of the diaspora well suited to bridging the differences between home and host cultures. First-generation immigrants typically try to remain inconspicuous in their host countries. They know that their ethnicity can be a disadvantage: at best merely excluding them from the informal associations through which natives mentor their successors; at worst exposing them to outright discrimination. Reticence born of such concerns is noticeable in the Indian American community. Individuals with the ambition and prospects of becoming CEO of a publicly traded company must face and overcome such obstacles. Their success makes them symbols and spokespersons of their community in the host country, and host-country recognition gives new weight to their opinions at home.

INNOVATION: management, policy & practice

57

Yevgeny Kuznetsov and Charles F. Sabel

Despite their different starting positions, the relationship of the Chinese and Indian diasporas to home country development seems to be converging. Recent surveys of their disposition to invest in the home country, to discuss possible reforms and business opportunities with national officials, and to consider returning permanently themselves, do not suggest that the Chinese diaspora is more disposed to investment while the Indian diaspora focuses on relations among firms. Whether or not initial differences are being effaced by continuing development, the two diasporas continue to be alike in that both are manna solutions, win–win outcomes that fell from the sky.

ARMENIA When home-country elites see development as at least as great a threat as an opportunity, they may hesitate to cooperate with, let alone systematically enlarge, the role of a capable diaspora in the domestic economy. The case of Armenia illustrates the politics of the diaspora and how, perhaps, to mitigate them. At the beginning of the 1990s, after the fall of the Soviet Union, Armenia seemed well positioned for transition to a developed, market economy. It was the most educated and most industrial of the Soviet republics. It was considered the Silicon Valley of the Soviet Union, with a major concentration of high-tech industries and developed infrastructure and a workforce known for its tenacity and ability. In addition, Armenia (with about 3.5 million inhabitants in 1990) expected to be supported by its diaspora, which included more than 1 million Armenians living in the United States and at least 1 million living in Europe, the Middle East and Latin America. This diaspora is successful both economically and professionally; it is also well organized politically and socially. Another 1.5 million Russian Armenians, traditionally quite influential in the Kremlin, could be counted on as well. The territorial conflict in Karabakh mobilized Armenians worldwide, strengthening ethnic identity and advancing national consolidation. While Armenia also 58

had serious economic disadvantages – its landlocked location, the impact of the 1988 earthquake, and loss of markets in the Soviet Union – on balance the country had a great potential for development. In the event, despite – indeed partly because of – its diaspora, Armenia was unable to realize its potential for rapid growth. The chief obstacle to development was a domestic elite composed – like the elite of many contemporary stalled states – of (communist) bureaucrats, security service officers, and managers of large state-owned enterprises. This elite did, and does, push aggressively for economic liberalization and privatization but in a way that allows its own members (especially enterprise managers) to capture the major benefits of reforms. While such elites, in Armenia and elsewhere, welcome economic and political support from the diaspora, they do not want to see diaspora activists and investors perturb their own privileged position at home. They treat the diaspora primarily as a potential political and economic competitor. The upshot is that the Armenian government has been mostly interested in receiving humanitarian aid and long-term unrestricted loans – sources of funding they can control much more easily than direct investments. And because state officials benefit so much from imports, which remain the most lucrative business, many oppose an influx of investments that could replace them with domestic production. The hostility of insiders has thwarted most of the diaspora’s attempts to invest. Compounding the problem, major diaspora organizations have never systematically tried to protect their members from the elite’s abuse. The diaspora tends to limit its public criticism out of concern for the government’s reputation. It has not attempted to evaluate rigorously the results of the massive assistance it has provided in the past decade. For this diaspora, like others in similar situations, the act of giving seems more important than the actual effect. While the regime in Yerevan has been heavily dependent on the dias-

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Work globally, develop locally

pora’s support, the diaspora did not use this reliance to secure a more active role in Armenia’s development process. Just the opposite: the diaspora gave unconditional financial and political support to a regime that has been blocking the diaspora’s attempts to expand productive investments. The diaspora’s support relieves pressure on the domestic elite, thereby undermining demand for further reforms, especially for improvements in the business environment. The ruling elite gets additional resources for survival that provide a breathing space for delaying necessary reforms despite extreme poverty and emigration of the most skilled. The principal lesson of the Armenian experience is that absent a deep knowledge of the depth and direction of domestic reform, massive assistance by the diaspora is not sustainable unless complemented by an active business support and investment program. By itself, assistance fuels emigration and the concentration of economic power and delays resolution of the most important challenges of development. This type of support is manna gone sour, even turned poisonous.

EXPERIENCE OF AN EMERGING DIASPORA: CASE OF SOUTH AFRICA Skilled South Africans began emigrating in large numbers before the end of apartheid and the turn to democracy in 1994. The data do not permit an accurate estimate of the skills lost, as the South African Department of Home Affairs and Statistics takes into account only emigrants who report themselves as such; the actual number of emigrants could be as much as three times the official figures. Nonetheless, it is widely agreed that skilled workers continue to leave South Africa. Fully two-thirds of workers with the potential to emigrate have considered doing so, and the highly skilled – of all races – are most likely to be drawn abroad (Marks 2004). A recent World Bank survey of US-based expatriate alumni of the University of Natal confirms that the professional diaspora of South Africa resembles the mature diasporas in being Volume 8, Issue 1–2, July 2006

highly educated (73 percent have graduate degrees or professional certificates); autonomous (35 percent are independent professionals or small business owners); and in intimate contact with South Africa (the majority go home every year or two, 22 percent have ongoing business contact with South Africa, and 20 percent maintain contact through academic exchanges and relationships) (Marks 2004). The survey respondents have substantial power and influence in the United States, with one-third reporting that they have considerable influence over the investment decisions of their organizations. Fully 96 percent of respondents feel that as South African expatriates they have a distinct advantage doing business in South Africa; most cite ongoing personal relationships and personal knowledge of the country as the reason for this. Half of all respondents are involved in professional and business networks, and half of these networks have established contact with or had operations in South Africa. These ties notwithstanding, only 15 percent of respondents see any probability of doing business in South Africa within the next two years – a very low figure compared with those of other diaspora communities (55 percent of the Armenian diaspora, 82 percent of the Cuban.) More than 65 percent of respondents see little or no probability of investing or doing business in South Africa. These results confirm that the South African diaspora is indeed emerging, not mature. As South Africa has struggled to integrate itself into the world economy, while struggling with the AIDS/HIV pandemic, crime and sharp fluctuations in the rand/dollar exchange rate, enhancing relations with the diaspora has become a salient concern. To that end, South Africa has initiated two diaspora networks, one encouraging direct collaboration and other transactions among members, the other encouraging the formation of mentoring relations between members already active in international markets and others aiming to become active. Together these networks suggest the range of activities that public–private partnerships of different sorts can use to explore

INNOVATION: management, policy & practice

59

Yevgeny Kuznetsov and Charles F. Sabel

the possibilities for directing diasporas in the direction of manna solutions. The transactions-oriented South African Network of Skills Abroad (SANSA) was established in 1998 by the University of Cape Town’s Science and Technology Policy Research Center and a leading French agency for scientific cooperation, the Institute of Research for Development (IRD). SANSA aims to promote collaboration between highly skilled expatriate scientists and technologists and their counterparts in South Africa. The target group is alumni of all major South African universities and technical institutes. It describes SASA’s objectives and explains how to network with other members through electronic bulletin boards, discussion groups and job postings. As of March 2002, SANSA had 2259 members in more than 60 different countries, 58 percent of whom were South African citizens. In October 2000 the National Research Foundation (NRF), part of South Africa’s National Department of Arts, Culture, Science and Technology, took over responsibility for SANSA. After some initial fumbling, the NRF is managing, with some difficulty, to stabilize the network. SANSA’s strength (the ability to facilitate transactions by enabling partners to find one another directly) is connected with a serious limitation: the inability to track the outcome of exchanges and communications between network members. Because of the way the network is structured, there are no data on the successes and failures of the network, and those who operate it cannot learn from the successes and failures of the transactions they help generate. The second, mentoring network, the South African Diaspora Network (SADN), was developed by the University of Cape Town’s Center for Innovation and Entrepreneurship, through assistance from the World Bank Development Marketplace. Founded in 2001, this network focuses on developing knowledge and entrepreneurial connections between local South African firms and well-connected individuals in the United Kingdom. Drawing on expatriate organizations such as 60

university alumni associations and the South African Business Club, an organization with members in the United Kingdom and United States, SADN aims to facilitate continuing collaboration between respected and influential exSouth African business people in key overseas markets and young, high-potential South Africanbased start-up ventures. Local clients were recruited through extensive media coverage in South Africa. More than 60 South African companies applied to be part of the project, some of which were selected to participate. About 40 overseas members (most of them well-connected ex-South Africans living in Greater London) were recruited through presentations held at the South African Business Club in London and a meeting of the London paper of the University of Cape Town’s Graduate School of Business Alumni Association. So far, the mentoring model of the network has resulted in some promising connections between growing firms and capable expatriates. But it is clear that the model will take time to yield results and that the network will have to develop the equivalent of a strategic plan to increase the number and improve the quality of the connections it encourages. A network that facilitates direct contacts between members cannot be (nearly) self-organizing. Determining which tools and additional infrastructure can make mentoring and transactional networks more effective is a major problem confronting policymakers aiming to make emerging diaspora networks mature as quickly as possible.

CONCLUSION AND FURTHER RESEARCH The goal, at once humble and ambitious, is to scale up the informal diaspora networks emerging in many countries and render them more accessible to policy interventions. It is ambitiously optimistic because emerging migration ladders open an opportunity of a win–win situation – an evolving virtuous cycle of co-development of migrant human capital and home country institutions. It is humble, however, in recognizing intricacies of policy solutions to

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Work globally, develop locally

make it happen. As a previous section showed, creation of a robust diaspora network as a search network requires substantial amount of time, patience and institutional capabilities. Above all, good expatriate networks – as any search networks – tend to generate opportunities and projects but someone else has to act on those opportunities and finance the projects. Capabilities of government and private sector stakeholders remain the key: Diaspora networks are no panacea. The specific experiences reported here reveal something about starting conditions, possibilities, and happy and unhappy endings. But they say little about steering the process of diaspora networking in fruitful directions. One lesson is to be more attentive to the effects, good and bad, of network building than the network builders discussed here have been. Creating databases on who speaks to and works with whom is important. Such information needs to be complemented by careful investigation of why some contacts work and many others do not. It is hard to improve the performance of a network without detailed information about exactly how and why it is performing. A central hypothesis is that successful diasporas co-evolve with corresponding domestic institutions. Changes in one provoke changes in the other, making both more effective. The Ramón García story illustrates this dynamic. García acted as a systems integrator, bringing together key pieces of intellectual property regarding genes and DNA manipulation techniques. Once these pieces were in place, research teams could be assembled in Chile to apply the resources to solving particular problems. Collaboration with Ramón García did not simply bridge existing Chilean capacities with new opportunities; the capacities were the result, not the starting point, of the search for the key elements of the project. Perhaps even more importantly, collaboration with Ramón García taught him and Fundación Chile new forms of network integration and proj-

Volume 8, Issue 1–2, July 2006

ect direction. It could be transferable within Chile, as well as conceivably to other countries. Specifying conditions to institutionalize the kind of nascent search networks as illustrated by the Ramon Garcia anecdote should be, in our opinion, a main thrust of future research.

References Adams W (ed.) (1968) The Brain Drain. New York: Macmillan. Bhagwati J and Partington M (1976) Taxing the Brain Drain: A Proposal, Amsterdam: North Holland. Brown M (2000) Using the Intellectual Diaspora to Reverse the Brain Drain: Some Useful Examples. University of Capetown, South Africa. For SANSA publications, see: http://sansa.nrf.ac.za /interface/Publications.htm. Ellerman D (2003) Policy Research on Migration and Development. World Bank Policy Research Working Papers (3117): 1–64. Kapur D (2001) Diasporas and Technology Transfer. Journal of Human Development 2(2): 265–86. Marks J (2004) Expatriate Professionals As An Entry Point Into Global Knowledge-intensive Value Chains: South Africa, Consultants’ Report for the World Bank. Pandey A, Aggarwal A, Devane R and Kuznetsov Y (2004) India’s Transformation to Knowledge-based Economy – Evolving Role of the Indian Diaspora. Report prepared for the World Bank. Saxenian A L (2000) The Bangalore Boom: From Brain Drain to Brain Circulation? in: Bridging the Digital Divide: Lessons from India Kennistan K and Kumar D (Eds) Bangalore: National Institute of Advanced Study. Saxenian A L (2005) The International Mobility of Entreprenuers and Regional Upgrading in India and China. A paper prepared for ECLA-WIDER project on international mobility of talent. Scientific Diasporas (2003) How can developing countries benefit from expatriate scientists and engineers? Institute de Recherche Pour Le Development, Paris. Torres F and Kuznetsov Y (2004) Mexico: Migrants’ Capital for Small-scale Infrastructure and Small Enterprise Development. Report prepared for the World Bank.

INNOVATION: management, policy & practice

61

Copyright © eContent Management Pty Ltd. Innovation: management, policy & practice (2006) 8: 62–83.

Twin innovation systems, intermediate technology and economic development: History and prospect for China SUMMARY KEY WORDS national system of innovation; intermediate technology; lower-level national system of innovation; mainland China’s technological development

This paper argues that less developed countries (LDCs) need twin national systems of innovation: systems with one, ‘upper’ level or sub-system to engage with advanced technology and develop industries which use it; and (cooperating with the upper level) a ‘lower’ level to help to improve the economy’s existing, traditional technology. The focus is on the lower level. The process there should involve the development and use of intermediate technologies. These are much better suited to the LDC’s factor endowment, and maximise opportunities for learning by doing. Most LDCs lack such a lower level, and lose much from this; Brazil is an example. Japan and Taiwan developed twin NSIs and gained accordingly, until success caused the levels to merge. 19th Century Denmark and Malaysia are other cases in point recently. Mainland China failed to build on its 1950s beginnings and the lower level of its NSI is now weak. Received 9 June 2005

Accepted 6 December 2005

• The traditional part uses more-or-less traditional technology. ANDREW TYLECOTE Professor Economics & Management of Technological Change Sheffield University Management School Sheffield, England

INTRODUCTION: LEVELS OF TECHNOLOGY AND OF NATIONAL SYSTEMS OF INNOVATION

D

eveloping countries have a fairly clear-cut division of their economies into two parts, ‘modern’ and ‘traditional’: • The modern part uses more-or-less advanced technology derived from developed countries;

62

To some extent this division will go by sector: there are inevitably high-technology sectors like aircraft which must be modern to exist at all, and sectors providing traditional staple foods and traditional services to the domestic market which tend mostly to use traditional technology. A sector may however in a given country have both advanced and traditional technology either in distinct sub-sectors (up-market and down-market) or working together – as where transformation processes are advanced and transfer processes traditional (Amsalem 1982, for Brazil). As developed countries continue to innovate, the gap between ‘advanced’ technology and ‘traditional’ technology tends to widen.

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Twin innovation systems, intermediate technology and economic development

It is with regard to developing country firms and sectors using advanced technology (hereinafter called the ‘modern economy’) that one can recognise an NSI much like that of a typical developed country. The country’s institutions of research and higher education are likely to be mainly focused on needs; as are the banking system and the policy-making parts of government, and state-owned utilities (who provide support in the form of contracts). What is of course unlike a typical developed country is that there is little really innovative activity: most of the effort is devoted to finding, accessing, mastering and, to a modest degree, adapting technology already developed elsewhere. Since there is a great deal of all that taking place in every developed country, the resemblance is still quite close. The concentration of the NSI on the ‘modern economy’ is partly because it genuinely needs help in order to survive, particularly once exposed to international competition. Partly it is because it is believed that progress is about using advanced technology and that nothing less will do. Inevitably such concentration is expensive. Two means of economising on the cost of such progress are now accepted: 1. Foreign direct investment, in which foreign multinational firms bear all or most of the cost of bringing advanced technology into a country. 2. Specialisation for export in labour-intensive sectors (like clothing), and in labour-intensive operations in other sectors (like electronics), in which sufficiently-advanced technology is relatively easy and cheap to acquire and master. To rely mainly on FDI for advanced technology would mean ceding control of the economy to foreigners, and would therefore for most developing countries (including China) be an unacceptable way of saving resources, and in the long run

perhaps an illusory one. As for specialisation, the larger the economy, the less scope there is to specialise in a small number of sectors or sub-sectors. Thus the challenge remains for a large developing economy to master a wide range of modern technology. As for the firms and sectors using traditional technology (hereinafter the ‘traditional economy’), in most developing countries it is hard to recognise anything which deserves the name of an innovation system, or even a technological change system. What changes there mostly trickles in from abroad or from the rest of the economy: there is nothing systematic about it. (One exception may be in agriculture where a new crop strain developed abroad or in domestic research institutes may be taken up by otherwise traditional farmers – high-yielding rice in the 1970s; genetically-modified cotton recently1). The gap between ‘modern’ and ‘traditional’ economies thus tends to grow wider, and progress is likely to take place by the wholesale importation of advanced technology into a farm or enterprise, or by the growth of ‘modern’ enterprises at the expense of the rest. The relative size of the two economies thus reflects the level of development. This paper will argue, however, that this is a poor way to achieve rapid technological development. The lower-technology parts of the economy need to be integrated within the country’s NSI even though (indeed largely because) it may be by squeezing them that most of the revenues required for nurturing the ‘modern economy’ can be obtained. Further, the ‘modern economy’ can grow much more quickly if there is available to it a large reservoir of human capital, entrepreneurs and whole businesses which already have most of the skills and capabilities required within it – developed while part of the ‘traditional economy’. Initially, however, the sub-systems of innovation of the two economies must be quite distinct. The ‘modern economy’ may replace some mechanised

1 Even here it cannot be assumed that new strains will suit traditional farmers, without adaptation by a lower level of the NSI. The hybrid rice of the Green Revolution for example demands more water and fertilisers than traditional varieties. It therefore favours large farmers using advanced agricultural technology. See under ‘Conclusions’.

Volume 8, Issue 1–2, July 2006

INNOVATION: management, policy & practice

63

Andrew Tylecote

processes by more labour-intensive ones – for example, components may be moved from one machine to the next by hand rather than by a moving belt, as Amsalem found was common in Brazil. It may save again by buying rather dated, second-hand equipment; or by working that equipment for two shifts rather than one, or three rather than two (Morris-Suzuki 1994: 87 on Japanese cotton-spinning in the late 19th century). Nevertheless, the basic processes of transformation (in a manufacturing industry; mutatis mutandis for others) will be the same as in the developed world, however unsuited they are to the developing country – however much they stretch its technological capability and strain its resources of money and skill. So the upper level of the NSI must mirror, and be closely attached to, the NSIs of the developed world. In the lower-technology parts, the ‘traditional economy’, it is necessarily different. Traditional producers must start from where they are: making traditional products and services with traditional methods and equipment. Yet they may move up and steadily close the gap between themselves and the modern economy. They will only do so, however, if there is a lower-level NSI which assists them to move incrementally through a succession of levels of technology, all of which can be described as intermediate between ‘traditional’ and ‘modern’: • intermediate in their relative use of the conventional three factors – labour, capital and natural resources; • intermediate in scale of production; and • intermediate in technological capability. Others describe them as ‘appropriate’: Appropriate technology (AT) is now recognised as the generic term for a wide range of technologies characterised by any one of several of the following features: low investment cost per work-place, low capital investment per unit of output, organizational simplicity, high adaptability to a particular social or cultural 64

environment, sparing use of natural resources, low cost of final product or high potential for employment. (Jequier & Blanc 1985: 9) ‘Appropriate’ seems a potentially misleading term, since while all the features listed by Jequier and Blanc are desirable ones, inevitably the price paid for achieving them (or some of them) will be low labour productivity and probably also low product quality. Such technologies would thus be highly inappropriate to developed countries. This paper will therefore use the term intermediate technologies as defined above. This paper thus makes a strong claim: that the best way to rapid economic development is to have (besides a strong upper level of the NSI) a vigorous lower level. There is a corollary to this proposition: if a vigorous lower level of the NSI confers such an advantage, then we cannot expect to see many (perhaps not any) clear-cut cases among present-day less-developed countries. We must look for them, instead, among the more successful cases of rapid development of the past: and we should not expect to find much trace of them in those countries now, for the natural role of a lower level of the NSI is to eliminate itself. Now you see it – now you don’t. Historical research is needed, and it is not likely to be easy, for few people take much interest in intermediate technology. We are, for example, bound to hear much more about the Chinese man in space than the modest incremental developments in greenhouse technology in China reported later in this paper – whatever their relative contribution to the Chinese economy. This paper reports on work in progress. First, it puts forward the theoretical case – in fact two cases – for ‘incrementalism’. It then presents a number of historical examples, starting with the rather well-documented case of Japan. The Japanese case is particularly valuable because it gives some clues as to what to look for. With those clues, we identify Taiwan and Denmark as virtually certain cases (at the appropriate period) of a strong lower-level NIS; the same appears to be

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Twin innovation systems, intermediate technology and economic development

true, more recently and perhaps more weakly, of Malaysia. All four of these countries are excellent examples for our argument because they were – over the appropriate period – highly successful economically. The argument also needs a counterpoint: countries which might have been expected to develop rapidly but puzzlingly failed to do so – and turn out to have been entirely devoid of a lower-level NSI. One example is offered here: Brazil. Finally, we turn to China: a case at neither extreme, and all the more interesting for that. We conclude with prescriptions for China, drawn partly from its own experience, partly from that of the other countries discussed.

THEORETICAL CASES FOR ‘INCREMENTALISM’ Case in terms of mainstream economics It can easily be shown that the type of technology most suitable for the needs of less developed country (LDC) users is likely to be quite different from that designed with developed countries in mind (Tylecote & Galvao 2001). This follows from the fact that (in the terms of mainstream economics) there is a large difference in factor endowments and therefore relative factor prices: LDCs have a relative abundance of, and therefore cheaper, low-skilled labour and a relative scarcity of, and therefore more expensive, capital – human, physical and financial. (They will also usually have a shortage of most natural resources, relative to low-skilled labour.) In fact the difference in factor prices is particularly acute if one TABLE 1: FACTOR PROPORTIONS Factor of production Unskilled/ low-skilled labour Skilled labour (‘human capital’) Physical capital

AND

considers social cost: since typically a large proportion of the low-skilled labour force is unemployed or under-employed (largely due to the choice of modern technology which employs few of them), the marginal social cost of their labour is nearly zero (Table 1). The marginal private cost – the cost to the potential employer – is considerably higher, for no-one can be expected to be honest, loyal and diligent without being (or feeling) ‘decently’ paid. There is a range of different possible process technologies which involve combining low-skilled labour with high-skilled labour and physical capital in different proportions. Figure 1, Factor Prices and Choice of Factor Proportions, shows a highly-stylised picture, in which process technology and factor proportions are infinitely variable along a curving isoquant (i.e. output remaining the same) and the optimum, which will be chosen for an optimal allocation of resources, is indicated by the point at which the budget line, showing relative factor prices, touches the isoquant. Two budget lines are given reflecting the factor endowments of developed and less-developed countries respectively. T1 shows the high-capital, low-labour, choice that will be made in a developed country, T2 shows the low-capital, high-labour choice which will be made in a less-developed country. Figure 2 is more realistic. The only technologies which are certainly available in a less developed country are the locally-known traditional technology (Tt) and the state-of-the-art modern technology (Tm). The circles labelled Tt and Tm show respectively the factor proportions in traditional technology (unchanging) and those in

OPPORTUNITY COSTS

IN

DEVELOPED

AND

LESS-DEVELOPED COUNTRIES

Abundance

Proportions in ‘modern’ DC technology

Opportunity cost in LDC

Effect of use in LDC of modern technology

LDC>DC

Low


Lower marginal social cost

DC>LDC DC>LDC

High High

>DC >DC

Higher marginal social cost Higher marginal social cost

Volume 8, Issue 1–2, July 2006

INNOVATION: management, policy & practice

65

Andrew Tylecote

FIGURE 1: FACTOR

FIGURE 2: TRAJECTORIES

66

PRICES AND CHOICE OF FACTOR PROPORTIONS

OF MODERN TECHNOLOGIES AND FROM TRADITIONAL TECHNOLOGIES

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Twin innovation systems, intermediate technology and economic development

FIGURE 3: OPTIMUM

SOCIAL AND PRIVATE CHOICES OF TECHNOLOGIES

modern technology (at a point in time). The isoquant shows, for the current state of scientific knowledge, the whole range of technologies which it is possible in principle to develop. There are two dotted lines. The first comes down from Tt, marking out a possible and desirable trajectory of incremental, intermediate technological development. This combines some changes which save all factors with some which substitute capital (human and physical) for labour. (Capitalusing changes do not dominate capital-saving because the relative price of capital is so high.) The second dotted line passes through Tm, showing past and future technological development of modern technology by and for developed counVolume 8, Issue 1–2, July 2006

tries, which is dominated by the substitution of capital for labour. Figure 3 shows Tt, Tm and their trajectories again, with budget lines which represent relative prices of the factors, with two alternative slopes: the first reflecting marginal social cost in a lessdeveloped country, the second reflecting marginal private cost in the same country. (The difference in slope is because labour is assumed to be cheaper if calculated at MSC – see above.) The optimum choice of technology, according to the logic we are using, is that which is on the innermost budget line: for that shows the lowest cost combinations of factors. So which is optimum? We can best make our comparisons taking two alterna-

INNOVATION: management, policy & practice

67

Andrew Tylecote

tives at a time. Comparing modern technology with un-improved traditional technology, and considering private costs, Tm is preferable, for MPC(ii) on which Tm stands, passes to the inside of Tt, which stands on the outermost budget line MPC(iii). However if social costs were considered, Tt would be preferable, for MSC(ii) on which Tt stands is inside MSC(iii) on which Tm stands. However improved, intermediate technology, Ti, is preferable to either of the others, whether social or private cost is considered. Its advantage over Tt is greater if private cost is considered (MPC(i), that over Tm, greater if one considers social cost (MSC(i)). The conclusion is clear: the use of intermediate technology will be far more efficient from the point of view of the less-developed economy than the use of modern technology. The advantage from the point of view of a firm in that economy will be less. If there is no intermediate technology available, only traditional, then there may well be no advantage at all: the ‘private optimum’ may be the modern technology – to anyone in a position to get hold of it.

Case in terms of the ‘learning economy’ The economy posited by the national systems of innovation literature is not that of the mainstream, neoclassical economist: it is a learning economy, in which producers move from one technological position to another – with changing combinations of factors of production – only with the assistance of processes of private and social learning (Lundvall 1992; Lundvall & Johnson 1994). Our example in 2.1 in fact to some degree implies a learning economy, because our trajectories in Figures 2 and 3 trace out paths along which – given time and resources for learning – the ‘state of the art’ may move. But there is still a distance from the realities of the learning economy. A choice apparently exists between (at least) Tt and Tm. This choice, however, is not in reality available to firms currently at Tt: they would have to learn a great deal in order to move 68

to Tm, and it is inconceivable that they could get there in one bound, so to speak. Foreign multinationals can choose Tm; perhaps some native firms supported by the cream of the upper-level NSI may do so. But any other firm, to instal the technology of Tm, must be dependent on firms – probably foreign ones – which have the appropriate technological capability. Its installation of Tm does not then represent the relevant learning, and may not be followed by it. Its dependence may remain, and even intensify, because it may learn no faster than Tm moves forward. There is another difference between the respective trajectories which Tt may follow potentially and Tm will follow definitely which is not brought out by the mainstream analysis: the degree of competition. The existence of a substantial number of competing producers in a limited space, such as a developing economy or a region within it, confers three advantages: • variety; • incentive; • selection. Variety: The more producers, the more variety of approach, in terms of technology and organisation, and thus the more likelihood that one producer will come up with a clear improvement. Selection: The more producers, the more intense the competition, and thus those more likely to be driven out of business are producers who cling to inferior technology or organisational methods. Incentive: The more intense the competition, the more effort each producer will make (in generating or copying improvements) to avoid being driven out of business. Almost inevitably there will be more producers on the traditional–intermediate trajectory than on the modern one, since scale is smaller and entry barriers (particularly those of capital and technological capability) are lower. We can conclude that the rate of DUI – learn-

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Twin innovation systems, intermediate technology and economic development

ing by doing, using and interacting – will be much higher on the traditional–intermediate trajectory than on the modern one; other things being equal. (Of course other things which may not be equal include the availability of resources and outside assistance of various kinds.) Unfortunately the development of each technology has a cost. The optimal policy for an LDC, with scarce resources available for innovation (and diffusion) would appear to be, then: 1. ‘Upgrade’ some traditional technologies, blending them where possible with advanced technologies which represent a particular leap in productivity or which are particularly easy to assimilate. (On ‘technology blending’ see for example Bhalla 1996: Ch. 3.) 2. Take some DC ‘cast-offs’: technology now superseded, embodied in equipment which is cheaply available second-hand (and whose use can be taught by experts who may also now be ‘obsolete’ in the DCs). 3. Adopt DC technology without much adaptation, where it represents a particular leap in productivity or is particularly easy to assimilate. 4. Buy in from the DCs products which seem necessary and not available through routes 1, 2 or 3. Routes 1 and 2 involve intermediate technology: in the first case newly-developed, in the second case borrowed from the technological past of the DCs. In practice they could be combined in various ways – a second-hand motor, say, being used to power a more-or-less traditional loom. On both routes there should be a sequence of intermediate technologies, each requiring more technological capability than its predecessor, and combining each unit of low-skilled labour with more physical and human capital. A technology policy which takes much of the economy on such a sequence of intermediate technologies from traditional to modern could thus be described as incrementalist.

The part of a national system of innovation which assists the development and diffusion of the relevant intermediate technologies could be described as the lower level of the NSI. The theoretical argument for incrementalism – that the best and fastest way to develop is to have a strong lower level of the NSI as well as a strong upper level – has now been made. It may be noted that it becomes the stronger as time goes on, for as developed countries develop further, with higher and higher labour productivity, and technological sophistication, some at least of the less developed countries lag behind, and thus the distance between the most and the least advanced countries (and regions), and between ‘traditional’ and ‘modern’ technology, increases. The greater that distance, the stronger the case for intermediate technology.

HISTORY OF SUCCESSFUL INCREMENTALISM: JAPAN Meiji beginnings 2 The development of the upper level of the NSI in Japan is well known. After the Meiji Revolution of 1868 the Japanese government was committed to rapid technological development. The central government in Tokyo spent heavily on bringing foreign experts to Japan and on establishing universities. During the 1870s it also set up (initially) state-owned firms in key high-technology industries, selling most of them cheaply during the 1880s to private entrepreneurs who were the progenitors of the zaibatsu conglomerates. Another massive state investment was made in the first decade of the 20th century in the Yawata steelworks, opened in 1901 after going five times over budget, and profitable only from 1910 (Morris-Suzuki 1994: 80). Such direct state intervention was largely due to the unequal treaties forced on it by the United States in 1858, which expired only in 1911 and until then prevented it from imposing any tariffs over 5% (Chang 2002:

2 What follows draws heavily on Morris-Suzuki 1994, and Chang 2002.

Volume 8, Issue 1–2, July 2006

INNOVATION: management, policy & practice

69

Andrew Tylecote

2.2.7). After that, it used tariffs in a conventional way to protect its nascent modern sectors. ‘Preferential public purchasing’, particularly for the military, was used from early on: thus the key move in the development of what became Toshiba was a naval order for torpedoes in 1892 (MorrisSuzuki 1994: 79). Its aggressive policies, first in Korea, then in NE and other parts of China, can be seen largely as a means of expanding its exploited backward sectors – and of seizing the mineral resources required as inputs for the modern sectors. Meanwhile the outline of a lower level of the NSI can be discerned. Note, to begin with, that what can be called the base level of technological competence – among artisans in particular – was relatively high in Japan in relation to the ‘modern’ level of the time (Morris-Suzuki 1994: 86). Moreover the level of literacy was exceptionally high – in fact similar to that of advanced countries of the time. Primary and secondary education was rapidly improved. These were the responsibilities of local government, and it is also noteworthy that for historical reasons local government had substantial responsibility, autonomy and capability. It duly played an active role in raising the technological competences of artisans and farmers (Morris-Suzuki 1994: 89ff.). In 1872, the mayor of Kyoto, for example, even sent a small group (a silk merchant and two weavers) to France to acquire knowledge of French woven textiles and buy weaving machinery (MorrisSuzuki 1994: 92). This was a cheap version of the ambitious central government expeditions to get the highest Western technologies: the Kyoto expedition brought back rather simple equipment and knowledge which was quickly incorporated into local craftsmen’s workshops. The craftsmen and merchants themselves formed trade associations in order to spread knowledge of improved technologies which could be adopted quickly and cheaply by their members (Morris-Suzuki 1994: 94–5). Many of these improvements were developed by Japanese inventors, mostly craftsmen themselves: 70

From 1899–1905, 73% of the patents granted went to Japanese inventors, most of them for new developments in traditional areas such as better weaving looms and improved farm tools …. This grassroots innovation, however, was not just a matter of individual entrepreneurship …. Between central government [which was focusing on the acquisition of high technology for the internal core] and private citizen stood an immensely complex layer of intermediate social institutions – local government, trade associations etc – which were vital to the spread of technological knowledge in the Meiji Era and beyond. The most important contribution of these grassroots institutions was their role as channels for the transmission of new ideas and as instruments in overcoming the innate human fear of the unfamiliar ….. Local trade associations took this process one step further ….. serving as a means of sharing the risks of innovation amongst many producers …. Both prefectural technology centres and trade associations tested and modified new techniques so that they could easily be fitted into existing production systems. (Morris-Suzuki 1994: 96–97) One such new technique was the bicycle, which became the basis of a classic example of ‘innovative technology blending’ (the term is from Bhalla 1996, the example from Morris-Suzuki 1994). A Japanese artisan in the late 1860s had the idea of combining a bicycle with a traditional handpulled carriage. The rikisha (rickshaw) quickly became the main means of passenger transport in East Asian cities – with a capital cost per passenger mile probably lower than the traditional rickshaw, and of course much higher speeds. Again, this spread in its early stages was assisted by local government (Morris-Suzuki 1994: 97). The central government was not slow to notice what was happening below it, though it took time to react. A report by the senior official Maeda Masana in 1882–1884 argued persuasively for strengthening the foundations of tradition-

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Twin innovation systems, intermediate technology and economic development

al industries. Entrepreneurs who had moved incrementally from traditional technology to major success in export industries became influential – like the Katakura silk firm which had by 1894 gone from a backyard workshop to the largest silk factory in Japan. In 1900 and 1903 laws were enacted to strengthen the position of local trade associations (Morris-Suzuki 1994: 100). In 1903 a law was introduced to encourage and regulate the establishment of technical colleges. These colleges taught middle-level technicians who went to work in private firms – a good source of innovation and in particular of technology-blending. In 1901 the Ministry of Agricultural and Commerce finally began the implementation of Maeda’s proposal for developing networks of prefectural laboratories linked to a national laboratory, though it was another four years before they put money into it. Even the national laboratories, like the Oji sericultural station, the Fermentation Laboratory and the Tokyo Industrial Research Laboratory put most of their resources into using modern science to understand traditional processes and products, so that they could be progressively improved. The lower level was also able rapidly to improve its power sources, starting from the traditional water wheels available in areas close to hills (i.e. most of Japan) and introducing relatively modest improvements following Western practice, until the upper-level NSI had got to grips with steam technology and thus made it cheaply available. (In many cases by that time it was possible to go straight on to hydroelectricity using the same fall of water (Reynolds 1983).) The dissemination of improved traditional technology through the lower level played a vital economic role: it allowed the rapid development of large internationally-competitive cotton and silk textile industries, which earned most of the foreign exchange that paid for the modern part’s imports. These were dominated by small and medium businesses. The lower level of the NSI was expanding the surplus which could be creamed off for the modern economy. Volume 8, Issue 1–2, July 2006

Twentieth century Once Japan had got back its freedom of action in tariff matters, modern industry became increasingly profitable and became dominated by the great privately-owned zaibatsu conglomerates, which had used either connections in government (e.g. Mitsubishi) or their own resources as merchant trading houses (Mitsui) to get established. At some point in the 20th century, an important force for the convergence of the upper and lower levels began to appear, in the shape of what became known as kinyu keiretsu (vertical groups): the big modern-economy companies established more and more close relationships with small firms to which they could subcontract relatively simple and labour-intensive processes. Often indeed they would be set up at the instance of the large firm, which might suggest that one of its skilled workers take some of its old machinery back to his own village and supply it from there, more cheaply than it could make it in-house. (That same skilled worker might have learned most of his skills within the lower level before being recruited.) The beauty of this system from an economic point of view was that the smaller the firm, the smaller the village in which it could be located, and the cheaper the labour on which it could draw: peasant labour when it was not required in the fields (or at school) had a very low opportunity cost. In effect, the traditional economy was paying most of the cost of these workers, so long as they stayed on the farm: and the modest contribution of their employment in those subcontractors helped them to do just that. The feudal traditions of the Japanese countryside encouraged the arrangement of these subcontractors in tiers, forming an inverted pyramid, so that Toyota for example developed a three-tier system in which the third tier supplied the second, which supplied the first, which supplied Toyota. They also encouraged the forging of close relationships, which facilitated the concerted upgrading of technology. It is notable that the Japanese motor industry’s leading role in the development of CNC equipment in the 1960s

INNOVATION: management, policy & practice

71

Andrew Tylecote

and 70s has been explained by the prevalence at the outset of pre-Fordist methods among their subcontractors, who simply had too short production runs to be able to afford dedicated Fordist equipment – but for whom CNC was affordable because it could be re-programmed to deal with a long series of short runs. This could be called the culmination of the co-operation between the Japanese upper and lower levels, and the point at which (in the motor industry at least) they merged. It was however not only subcontractors of firms like Toyota which emerged from the lower level of the NSI. Much bigger firms did that. Toyota did, rather gradually, going from loom manufacture (and invention) to motor vehicles. Others did it in one generation. Soichiro Honda was a mere bicycle mechanic who got hold of a motor cycle engine which he managed to fix to a bicycle. That and the rest is (company) history. Konosuke Matsushita started in business with similar origins by inventing, then making, a simple adaptor which allowed one or two electrical appliances to be powered from the same wire that led to a poor Japanese family’s solitary light bulb. These were highly innovative entrepreneurs whose ultimate ability to run a large high-technology business was based on practice in running a very small one whose technology and markets they thoroughly understood. Only the lower level of the NSI could nurture such people: in the modern economy, success naturally depended much more on ability to get on well with the rich and the powerful. To appreciate the relative merits of the two types of business leader and of firm, contrast the histories of Honda and Nissan, or of Matsushita and Mitsubishi Electric.

FRAGMENTS OF HISTORY Introduction: What to look for The Japanese case gives some clear indications of circumstances in which a strong lower level of the

NSI will develop and continue. First, institutional: there were local government institutions and trade associations which were vigorous and autonomous. Second, social: the general level of literacy at the beginning was high. (There was probably a connection between these two circumstances, in both directions. Thus the vigour of trade associations must depend to some extent on the educational standards of their members. They will probably not be high if local government has not been doing a good job.) This is not to say that circumstances were ideal. National government was slow to respond to, and reinforce, the initiatives of local government. A large proportion of the rural population remained desperately poor until the 1950s, partly due to the pattern of land ownership (land reform only came after the Second World War). This made it difficult to build on the good educational beginning. What then shall we look for? A low Gini coefficient for household income is one sign of favourable social conditions in which one would expect the educational level of the mass of the population to be high (Elsenhans 1983). It may equally be a sign that a lower level of the NSI has begun to deliver: if the poor have access to intermediate technology rather than merely traditional technology they will be less poor. We must also look out for a dense network of lower-level institutions such as in Japan, though not necessarily with so high a degree of autonomy: in a smaller country, and with a committed national government, fairly tight central control may do little harm. Three likely examples emerge: Taiwan, 1950–1980; Denmark, 1850–1910 (approx.); and Malaysia (1960–2000). A counter-example of a virtually non-existent lower level of the NSI appears to be Brazil (1950–2005). We look at them in that order.

Taiwan3 Until 1945 Taiwan had of course been under Japanese rule and to some limited degree shared

3 What follows draws on Fei et al. 1979; Clark and Roy 1997 and Hobday 1995.

72

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Twin innovation systems, intermediate technology and economic development

in what has been described above. Under the Guo Min government after 1950 it developed a similar, and equally successful, twin innovation system. Again, of course, the story of the upper level of the NSI is much better known. During the 1950s there was a rather standard policy of industrial tariff protection. (The Guo Min government, like that of Japan and South Korea, had the luxury of complete freedom of action in economic policy, due to the US fear of the PRC. This freedom extended to all sorts of theft of intellectual property; an activity particularly popular in Taiwanese industry.) This protection was refined in the 1960s to include selective support for what could be defined as medium-technology export industries: industries which were able with such support quickly to establish competitive advantage on international markets. Key hightechnology industries were identified by the government, which set up state-owned firms in those sectors. However a key characteristic of the rapid move up-market (and ‘up-technology’) that followed during the 1970s and 80s, was the prominent role of SMEs in Taiwanese exports (Hobday 1995). These do not appear to have been the recipients of substantial government aid, and yet they moved steadily and successfully up-market. No doubt they got some benefit from relatively cheap and high quality inputs provided by the state-owned high-tech firms, and from government spending on research institutes and universities; in other words, from a well-functioning upper-level NSI. Yet, more important are the technological and entrepreneurial capabilities they had before they started exporting. Where did they – that is the entrepreneurs themselves, and their employees – get them from? As with Honda and Matsushita, it appears that most of them originated from the lower level of the NSI. As of 1950 the large majority of the population of Taiwan were peasants, and so that is where

the lower level of the NSI started from. The Japanese had created a fairly good rural infrastructure of dirt roads and other facilities. In the early 50s, the Guo Min government carried through far-reaching land reform, which left the peasantry owners of the smallholdings on which they lived and worked.4 This was followed by a programme of improvement to rural infrastructure, particularly focusing on roads and agricultural extension services. At the same time there was heavy spending on mass education: the emphasis was first on primary and vocational education, later on secondary, and only when economic advance had gone a long way, in the late 1970s and 80s, did the emphasis move up to higher education. These policies provided the basis for a tremendous flowering of manufacturing SMEs using progressively higher technology. Consider a typical Taiwanese peasant family of the 1950s and 60s. Partly thanks to the land reform, its food and shelter (at the minimum) was provided by a farm which was too small to need all its labour except very occasionally, and could usually spare several of its younger members for at least a standard working week. These people could work very hard for very little, and with even meagre wages the family would still have quite enough to live on and to provide the basis for a rapidly improving standard of education. On those dirt roads a bicycle or moped could bring them to work – and a simple tractor and cart could bring the family’s crops to market. Much as argued above for Japan, only more so, the SMEs for which these people worked could rapidly raise their productivity and progressively improve their products. The difference from Japan is that they generally did so without any kind of dependence on large hightechnology domestic firms already established in an upper level of the NSI. This has as good a claim to the title of ‘economic miracle’ as any. The

4 This action was extraordinary in view of their alliance with landowners on the mainland. It took place under US pressure and guidance, as did the similar land reforms carried out in South Korea and Japan at about the same time, with the aim in all of them of creating a loyal anti-Communist peasantry.

Volume 8, Issue 1–2, July 2006

INNOVATION: management, policy & practice

73

Andrew Tylecote

key seems to have been the existence of suitable networks in sub-sectors of the mechanical, electrical and electronic industries which were such as to allow a fine division of labour, allowing SMEs each to specialise in one operation or the manufacture of one component – selling largely to American and Japanese firms which could and would deal with any operation (including global marketing) which really did require large scale or high technology (Hobday 1995). The main difficulty in researching the Taiwanese lower level of the NSI is that it worked so well that it eliminated itself in an exceptionally short period. This was partly due to the quality of the institutions, partly to the favourable situation of Taiwan as a small island economy with excellent access (both in terms of transport and free trade) to world markets. It was therefore able to devote a substantial part of its economy to medium-technology labour-intensive export activities without flooding any of the markets it was supplying: this generated a comfortable surplus for reinvestment, while within the industries like electronics in which this was going on, its firms were able to find relatively cheap, incremental routes up-market (cf. the much more expensive routes up-market taken by the Korean chaebol) (Hobday 1995).

quence of these two was a third development, of a vigorous cooperative movement among farmers. What were the economic consequences of these developments? The rapid growth in the late 19th century involved a sharp reduction of income inequality. The Maximum Equalisation Coefficient [the share of national income that would have to be transferred from the persons with incomes above the mean value to the others in order to achieve an equal distribution] fell from 50% to 35% between 1870 and 1900 (Lingaerde & Tylecote 1999). There was no significant fiscal redistribution: this shows at what rate the poor (overwhelmingly rural) were increasing their earning power. Much of this took the form of steady mechanisation of their farms and increasing farm production while the labour required decreased: just as in Taiwan the children of farming families (mainly young women earning their dowries) provided a cheap and productive labour force for manufacturing firms using (we may assume) initially intermediate technology. Like Taiwan, Denmark has even now a relative preponderance of small and medium enterprises (Lundvall 2002); like Taiwan, its firms were even smaller in the early stages of development. This is clearly another case of a vigorous lower level of the NSI, based on the People’s High Schools and the cooperatives.

Denmark In the second half of the 19th century, Denmark’s economic growth was exceptionally rapid. Between 1874 and 1913 it was the fastest in Europe (Tylecote 1992: Table 9.6). We lack reliable data earlier in the century, but it appears to have been growing very rapidly (by 19th century standards) for several decades before 1874 (Lingaerde & Tylecote 1999). The key appears to have been two major institutional developments: far-reaching land reforms in the early 19th century, and the establishment, from 1844, of NFS Grundtvig’s People’s High Schools (folkehojskole) where adult men and women had the opportunity to receive theoretical and practical knowledge in the agricultural off-peak season. A natural conse74

Malaysia Malaysia is one of the more successful developing countries in its economic record over the past 50 years, though not yet quite at the point of claiming developed status. The key to the Malaysian economy is the coexistence of a very large, economically-dynamic ethnic Chinese minority, with the ethnic Malay community, which now has a narrow majority of the population and has held political power since independence in 1957. Since the Malays (or Bumiputeras) were initially much poorer, there was a strong drive by the state to increase their incomes, which was expressed immediately on independence with the establishment of FELDA, the Federal Land Development

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Twin innovation systems, intermediate technology and economic development

Authority. The preferential support for Bumiputeras became explicit with the New Economic Policy of 1971. FELDA, although it began with rubber, had a key role in the development of the oil palm industry (Rasiah 2004). Consistently the state sought, in building up Bumiputera smallholders’ cultivation of oil palms, to raise their technological level, and this could initially only be accomplished with intermediate technology. A number of state agencies were set up to encourage intermediate technology, with particular focus on agriculture and food processing, the economic heart of the Bumiputera community (Shahadan 1996). Thus again the existence of a vigorous lower level of the NSI is associated with economic success.

Brazil Brazil is resource-rich, untouched by war, and has easily the largest population in Latin America. It was accordingly well placed to benefit from the import-substituting industrialisation policies which (like other big Latin American countries) it undertook in the first half of the 20th century and more particularly in the 1930s and 40s. By 1950 it had a substantial industrial base and with that foundation launched what was called ‘the dash for growth’ which lasted until the balance of payments crisis of 1961. After a policy adjustment a further period of very fast growth followed, the ‘economic miracle’ of 1967–73. Again, it ended in balance of payments crisis, and the ensuing period of much slower growth has continued into the 21st century. Galvao and Tylecote (1990) and Tylecote and Galvao (1998) showed how this macro-economic record could be explained by the limited development of technological capability, and that in turn by social and institutional conditions. Brazil has long had a highly unequal distribution of income, which has largely arisen from an exceptionally unequal distribution of landownership. The imports which the import-substituting industrialisation aimed to substitute were accordingly largely sophisticated consumer goods bought by the richer strata Volume 8, Issue 1–2, July 2006

of the population. Producing them at home required the import of advanced technology, either through the purchase of capital goods, licenses etc. by native firms, or through foreign direct investment by multinationals. The Brazilian NSI as it developed, naturally focused on advanced technology; a focus which was all the more natural because government (and private) expenditure on education was heavily skewed towards tertiary education and away from primary and vocational education for the mass of the population. These biases proved fatal. First, the country could not punch its weight: that is, it was unable to take advantage of its large population because its industrial development (particularly consumer durables such as white goods and cars) was aimed at a market composed of an affluent minority, while the sophisticated goods they required demanded large scale production and thus markets were at best oligopolistic. Second, the sophistication of the goods required, and the desire of politicians to make them (and the associated employment) quickly available, led to technological dependence on multinationals and/or foreign suppliers of the equipment and technology. The native firms which had the resources to get involved in the more high-technology sectors were for the most part state-owned, with all the managerial weaknesses which that implied. The Brazilian NSI to this day has conspicuously failed to develop a broad base of independent technological capability outside the primary sector, and the country continues accordingly to depend on exports of primary products and to be severely balance-of-payments constrained. Government at all levels has largely ignored the needs of traditional producers and has done virtually nothing to foster the growth of a lower level of the NSI. This is not necessarily disastrous in itself: if socio-economic conditions are reasonably favourable, producers themselves may go a long way to developing an effective lower level themselves, particularly in a large country able to support a critical mass of them. The completely

INNOVATION: management, policy & practice

75

Andrew Tylecote

spontaneous growth of a flourishing truck spare parts industry next to a highway in Northern Brazil is a good example of what is possible. Unfortunately socio-economic conditions are in general highly unfavourable: • The purchasing power of the mass of the population, the likely purchasers of goods made with intermediate technology, is limited by the unequal income distribution. • There is a striking difference between the private and social cost of unskilled labour. In the 1950s and 60s the minimum wage could be blamed for that, but it has been reduced greatly in real and relative terms since then. At some periods and in some places capital has been subsidised, which again increases the relative cost of labour. The persisting and fundamental cause is that unlike the cases described above, there is no secure smallholding base in the countryside from which young healthy workers come who can and will work hard for low wages without being immiserised. In Brazil, the poor have mostly left the countryside and subsist in shanty-towns, the favelas. Their wages are likely to be their entire incomes: low pay means poverty, ill-health, absenteeism, strikes, pilfering …. and it traps the entire family in a vicious circle of poor education and earning power. In such circumstances there is effectively no cheap labour, whatever wage a business chooses to pay. The result is that there is no vigorous lower level of the NSI moving up to support and reinforce the upper level.

MAINLAND CHINA SINCE THE ESTABLISHMENT OF THE PRC: AGRICULTURAL NSI Context and historical background Mainland China now has a very clearly-marked and highly-developed upper level of the NSI (Gu 1999). The foundations for a strong modern economy were laid in the period of autarky 76

before 1979, and they have been built on with determination since then in spite of the opening to the outside: tariffs and other protective measures have remained, although now drastically reduced in line with WTO entry, and they have been accompanied by a full range of nurturing measures including the development of strong institutions of research and higher education, and ‘policy loans’ at low interest rates from state banks. It may be argued that the prospects for the success of Chinese firms (as opposed to foreign multinationals operating in China) in highertechnology sectors have been jeopardised by grave faults in industrial policy (Nolan 2001; Lu 2005) and defects in finance and corporate governance (Tylecote & Cai 2004, Cai & Tylecote 2005). At all events, the upper level of the NSI is not short of resources. The main deficiencies are in the lower level of the NSI. This was not always the case. As Wu, Tu and Gu (2003) show, after the establishment of the PRC in 1949 the new Communist Government made a great effort to develop agricultural technology. (We can take virtually all of agriculture then, and most of it ever since, as forming part of the traditional economy, and making up the bulk of it.) By 1958 a comprehensive system of technology diffusion stations had been set up, with 4549 of them, covering 55% of all counties. Just as in Taiwan, this went in parallel with fundamental social and institutional change. As of 1949 115 million acres – half the cultivated land – belonged to landlords. A Land Reform Act in 1950 redistributed all of that, and the materials to farm it, to 300 million landless peasants. The Communist government took the view that individual peasant agriculture was highly inefficient, and promoted aggregation, first through ‘farmer collective teams’, in which 40% of peasant families were involved by 1952. The size of units under collective management was progressively increased, and at the same time the degree of collective control was intensified. This process culminated in 1958 with the foundation of the People’s Communes: by the end of 1958 740,000 collective organisations had been

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Twin innovation systems, intermediate technology and economic development

recombined into 26,000 People’s Communes, involving 99% of farmer families. As is well known, this last massive aggregative step proved to be a disaster, leading to sharp falls in agricultural production and widespread famine. Nonetheless it was maintained (with only slight modification in 1962 to give more autonomy to Production Brigades) until 1978. Meanwhile agricultural research in China had scored great successes. In 1964, the distribution of semi-dwarf high-yielding rice varieties had begun there, two years the IR-8 variety was released by the International Rice Research Institute in other parts of Asia. The commercial dissemination of F1 hybrid rice in 1976 was even further ahead of the international field (Lin 1992). As Mao’s ill-considered policies convulsed the countryside, the agricultural technology services suffered with the peasantry. One third of the technology diffusion stations were closed during the 1959–61 famine. There was a similar degree of disruption during the Cultural Revolution (1966–76), with dismissal and even persecution of the workforce in addition. For better or for worse (mostly for worse) what can be called the Maoist lower level of NSI was built around the People’s Communes. It was with them that the technology diffusion stations learned to work.5 When the agricultural technology support system was reorganised and rehabilitated in 1974–6, it continued to be based on the People’s Commune structures: by the end of 1975 there were 26,872 Commune agricultural technology diffusion stations, with more than three hundred thousand agricultural technology diffusion teams (Production Brigade level), and 2.2 million agricultural technology groups, at the lowest level (Production Team) (Wu et al. 2003: 7). Between 1978 and 1984, with the replacement of the collective production system by the Household Contract-Responsibility system, the

technology diffusion structures lost their rationale, and much of their workforce left (Wu et al. 2003).

Deng and after Replacing the old structures with structures appropriate to the new individualised system of agricultural production does not seem to have been a priority of the central government, but gradually new mechanisms emerged. Public sector institutions have been remodelled, a notable turning point coming in 1985–86 with the reform programme for the science and technology R&D system (Gu 1999, 2004). Agricultural R&D institutes and extension services were pushed towards commercial earnings, though provision of operational fees from public funds was continued. The public services still take main responsibility for new crop breeding, technology diffusion and coordination. There were as of 2003 1,600 independent agricultural R&D institutes in China, with employment of nearly 147,000, of whom 44,600 are scientists and engineers (thus the average institute has less than ten employees and less than three highly-qualified ones); there are 84 agricultural universities and colleges and over 300 specialised agricultural schools (Wu et al. 2003). The 1985–86 reforms included some admirable programmes, including the Spark Programme for rural areas implemented in 1986, and directed at both agriculture and rural industry (Gabriele 2002). However the level of public inputs to agricultural R&D declined in the 1980s and 1990s as a proportion of total agricultural GDP, from 0.44% in 1977–85 (having been 0.57 in 1961–65) to 0.32 in 1995–7. Expenditures per scientist (in constant 1990 Yuan) fell from 55,983 per annum in 1966–76 to 32,480 in 1986–90, recovering slightly to 35,211 in 1995–7 (Fang & Cheng 2003: Table 1). These

5 When Mao’s faith in large-scale urban industrialisation wavered in the late 1950s (in parallel with the break with the USSR, which provided the model for it) it was mainly to the People’s Communes that he looked to develop intermediate technology manufactures – including the famous (infamous) backyard steel furnaces.

Volume 8, Issue 1–2, July 2006

INNOVATION: management, policy & practice

77

Andrew Tylecote

reductions (with incomes of qualified personnel in urban areas rising rapidly) provide a vivid indication of the changes in government priorities, and they were matched by a general fall in esteem and morale among staff. In 1996 China’s total investment in agricultural technology, with a rural population of some 800 million, was RMB3.8 billion, about one quarter of that in the Netherlands (total population 15 million, agricultural population around one million). The average for developing countries is 0.5% of the value of agricultural production: China’s is 0.2% (Wu et al. 2003:8; Huang & Hu 1999). Meanwhile the countryside has been severely squeezed for the benefit of the cities and city-dwellers. According to Wu et al. (2003), farmers pay RMB 120 Bn per year in taxes, a tax burden per person 30 times higher than that of urban residents. (This is now being phased out, between 2004 and 2007.) This open exploitation is complemented by concealed exploitation through the concentration of government spending in the cities, and the tariff protection of the modern economy’s higher-technology industries. The effect has been to reverse the brief jump in rural incomes which took place in the early 1980s with the introduction of the Household ContractResponsibility system and to reverse also (in most of the country) the brief flowering of rural industry which was associated with it. The children of the peasantry, if they want jobs in industry, have mostly to work in the sweatshops of labourintensive, rather low-technology export industry, making garments, say, or assembling electrical or electronic goods.

Shouguang case Nonetheless there is a functioning Chinese lower level of the NSI in the countryside, and Wu et al. (2003) give a useful insight into it through their case study of vegetable production in Shouguang county in Shandong Province. The story starts in the early reform period, 1978–84, with an upsurge in vegetable production in Shouguang: it was a poor area and it had a tradition of vegetable 78

growing, so when incomes and thus demand for vegetables started to rise, the local peasants seized their chance. However there was no sales and transportation system such that their vegetables could be sold in bulk outside Shouguang, and in the winter of 1983 more than 10% of their output rotted away unsold. At this point the local government intervened, and spent RMB 50,000 on building a vegetable market. This was enough to renew the momentum of expansion: the area under vegetables, which had risen from 87,000 to 240,000 Mu between 1978 and 1982, had reached 360,000 Mu by 1989. Much the largest profit was to be made from winter vegetables, but traditional greenhouses burnt coal: that meant serious pollution and was both inefficient and expensive (6 tons of coal per Mu per winter). At this point technological innovation was needed, and it came, improbably, from within Shouguang and without any help even from local government. In 1989 Wang Leyi, chief of a village in Shouguang, invented a ‘warm house’ for winter vegetables, with low cost, no pollution and high productivity. This set off a surge of imitation, and further innovation, in surrounding villages. The expertise required was soon widely diffused among the local peasantry, and by 1997 more than 3000 local peasants were making a good living in other areas (in 20 other provinces) as vegetable technicians in technical services. By that point Shouguang itself had 210,000 greenhouses, with the area under vegetables now over 500,000 Mu. Vegetable output reached 2.3 million tons. The local government helped to keep up the momentum of advance by setting up a Technology Service Centre to foster dissemination of best-practice techniques. Once again the bottleneck looked like becoming the distribution system, but by this time the local government had learnt to keep up with production: it helped in the setting up of more than 30 large specialised markets and 40 big food processing enterprises. They also took responsibility for sales relations in more than 200 cities including Beijing and Harbin, and they got central gov-

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Twin innovation systems, intermediate technology and economic development

ernment permission for special arrangements for vegetable transportation to Beijing, called the Green Channel, in 1995. They went on upmarket, concentrating on the most profitable types of vegetable, establishing their brand image abroad, and getting new planting technologies, seeds and training from foreign companies. The fourth China (Shouguang) International Vegetable S&T Fair was held in 2003, and in it contracted investment reached RMB 3bn. By this point one could say that Shouguang had moved from the traditional economy to something approaching the modern economy – but without any dependence on subsidy. It is a remarkable achievement, and very clearly an exceptional one. Other districts which have tried to emulate Shouguang have failed, as Wu et al. point out. Though there are other shining examples of peasant initiative – vide Wu Bin’s (2003) account of farmers near the Yellow River successfully combating drought – the bleak figures show stagnating or slowly rising peasant incomes overall, and a rapidly rising gap between towns and countryside. In a sense the Shouguang story shows why. It was the peasants themselves, with leadership from the very lowest levels of government – one village council – who showed the way. The county government only took a hand – with the building of a modest vegetable market – once its finances had benefited massively from the initial upsurge in vegetable production. All its moves after that were reactive too. The statefinanced institutions of the agricultural technology diffusion services were conspicuous by their absence until very late in the day, and such as they were, they were financed and organised from within Shouguang. The most reactive move of all was the decision by the central government’s Ministry of Science and Technology to set up a large fund to introduce many other counties to the experience of Shouguang. This was also the least successful, and hardly surprisingly: what was missing elsewhere, even more than in Shouguang, were strong local diffusion services which could have decided for themselves what and how their Volume 8, Issue 1–2, July 2006

area could ‘Learn from Shouguang’, as opposed to the top-down decision-making which took place. Such services needed to work with the peasants, individually and collectively.

Recent developments The government is far from concluding, from Shouguang and experience elsewhere, that more vigorous and autonomous lower-level institutions are needed. On the contrary: the command economy top-down system is to be replaced by market economy top-down: ‘Agricultural Company plus Farmer Households’ or ACFH. After various moves in this direction during the 1990s this aim was officially pronounced in the Tenth Five-Year Development Plan in 2001 (Gu 2004). Agricultural companies are expected to: 1. serve as technological supply and extension centres; and 2. act as distributional channels linking dispersed farmer households to modern production and consumption chains. They are strongly favoured with subsidies and bank loans. More than 10 billion Chinese yuan (over $1.25bn.US) of central government funds were put into leading ACs in 2002 and the flow increased in 2003 and 2004 (Gu 2004: 6). They are expected to play a particularly important role in activities outside the traditional staple crops, activities like cattle and sheep breeding and vegetable and fruit gardening, which with the rise in urban incomes, the end of staple food shortages in the mid 1990s, and the prospect of free imports of grain after WTO entry, are increasingly important. A parallel and apparently distinct strand of policy is the programme for the development of a ‘technological service system’ in rural areas (TSSRA) formally initiated by the S&T ministry in 2003 but already in being on a piecemeal basis for some years before. In fact, as Gu (2004) shows, there is not a great deal of difference between ACFH and TSSRA, since the technological service centres are encouraged to operate

INNOVATION: management, policy & practice

79

Andrew Tylecote

commercially. In one case she mentions, a goatbreeding project begun in 1998, the centre concerned did this with gusto: having introduced the technology to poor farmers in a region, it paid them 300 Yuan for goats which it then sold for 10,000, and succeeded in keeping them, as of 2002, just as poor as they were before. Clearly the ACs’ and technology service centres’ multiple monopoly power over small farmer households – in supply of technology and inputs, and in purchase of outputs – is quite opposed to what should be the aim of a balanced partnership increasing both the incomes and the technological competences of the small farmers. In order to keep their power and thus maximise their profits they will naturally restrict the competences of the farmers as far as possible – and their collective organisation. In some cases it is in fact quite infeasible to maintain such power. In another of Gu’s examples she describes how ACs set up to foster vegetable-growing failed, some going bankrupt, when the farmers they were dealing with sold on the open market and not to them. The whole project was unsuccessful, presumably because the ACs ceased to play their role when not rewarded for it. Whichever way the coin falls, the farmers lose. Heads, the ACs win (they keep their monopoly) and the farmers lose; tails, the ACs lose their monopoly – and the farmers lose (they lose the ACs’ service). Not surprisingly, given government favour, the top-down structures prevail over anything hinting at collective organisation of the peasantry. There are now over 100,000 technology associations containing 3 million members (Wu et al. 2003) – which would be impressive as a numerator, if the denominator were not of the order of 800 million. The institution with which all rural dwellers have to deal is local government, which in most parts of the country can be described as parasitic, and being appointed by and accountable to central government, is nowhere in any way accountable to local people. With industrial and urban development a new hazard has been added to the 80

parasitic behaviour of local officials: land expropriation (Guo 2001).

CONCLUSIONS This paper has used theory and history together to argue that not only the poor of developing countries, but the whole economy, gain from the development of a vigorous lower level of the NSI which helps traditional producers to move incrementally through a succession of levels of intermediate technology, resulting in increasing close connection and ultimate merger with the upper level of the NSI and its ‘modern economy’. One thing the upper level of the NSI gets from a vigorous lower level is a source of cheap inputs of components. Even more to the point of technological development, it gets reasonably skilled, if informally trained, workers with the self-confidence to fix problems on the spot rather than call in a foreign expert. In due course it gets technoentrepreneurs like Honda and Matsushita with even more self-confidence. Japan, Taiwan and Denmark at various periods and varying degrees of detail have been cited as cases in point. Brazil has been used as a counterexample of an economy held back by the lack of a vigorous lower level of the NSI. The experience of these four countries, besides supporting the main proposition, shows that: • underlying socio-economic conditions – notably the distribution of income and land and the educational levels of the poor; and • the strength and autonomy of lower-level institutions, notably local government and producer associations; matter at least as much as formal government policies, and interact with them and with each other. The discussion of the mainland Chinese lower level of the NSI, confined as it was to agriculture, shows a situation somewhere between the extremes of the first four cases. Like Taiwan and Denmark (Japan only later) China experienced far-reaching land reform at the beginning of the relevant period; but it stopped short of giving

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Twin innovation systems, intermediate technology and economic development

peasants ownership of the land they tilled. The institutions of a lower level of the NSI were initially built up systematically and reasonably well funded; but they were not given any real autonomy. Deng’s reforms after 1978 freed peasants and rural producers generally to use their initiative individually, and even to form producer associations. This led to a flowering of economic activity in the countryside, which was nipped in the bud in most regions by a fiscal squeeze and tilting of the rural/urban terms of trade to the benefit of the advanced urban areas. Over the same period, and with the same effect, government resourcing of the NSI tilted against the lower level. Greater freedom of association was offset by a top-down system of local government which was in most areas parasitic on, and nowhere accountable to, the rural population. Lacking ownership (and until recently, even secure tenure) peasants could not borrow against the collateral of their land; nor was there – or is there – a good system of rural banks. The fiscal squeeze on the countryside has now been sharply relaxed, but there has been no corresponding institutional improvement – with the government’s new emphasis on agricultural companies and TSSRAs, we are as far from bottom-up initiative as ever. China is not Brazil. Some provinces, notably Zhejiang, have seen a flowering of rural industry to the point of dominating world markets in a range of more-or-less labour-intensive sectors, through individual and collective initiative – even if the best that can be said of central and local government contributions is that they did little to get in the way. In such areas, there appears to be a functioning lower-level NSI, much though it would benefit from more support. The Chinese system of land tenure, imperfect as it has been, does provide something of a base from which young members of farming families can provide genuinely cheap labour whether in the rural areas or in the cities. Nonetheless, the inequalities of income between the rural hinterland and the advanced urban areas are now, as in Brazil, extreme, and are producing a mass permanent Volume 8, Issue 1–2, July 2006

migration of peasant families to these urban areas on a scale comparable to that which has already taken place in Brazil. This (and the one-child policy) threatens to deprive the lower-level NSI of the key ingredient of cheap peasant labour. The opportunities being missed are great. There are limits to what China could gain from the Taiwanese (and Zhejiang) style of concentrating labour-intensive industry on exports, simply because it is too large: it would (it will?) soon hit the limits of what the world market can absorb. But the obverse of this are the advantages of size. Like Japan (and indeed Brazil), only more so, China is a large economy in which there is great scope for the ‘traditional economy’ to develop technologically and industrially by supplying its own markets. This is a great advantage, because it means that producers are not bound by the product specifications required on international (particularly Northern) markets. (Galvao (1994) found for the Brazilian food processing industry that poorer consumers were more willing to buy lower-technology products, because they were cheaper.) Not only can small traditional producers start from where they are in terms of process sophistication, and increase their productivity incrementally (with occasional leaps when technology blending with advanced technologies takes place), they can do much the same in terms of product specification. They need outside help, on the Japanese model described above; and the advantage of the Chinese situation is the huge external scale economies involved – even if, as the Shouguang example shows, there must be careful modifications to reflect the different needs of different parts of the country. As the Intermediate Technology Development Group (now renamed Practical Action) has repeatedly demonstrated (www.itdb.org), important innovations in intermediate technology can be made for relatively small amounts of money. (So indeed has the Spark Programme.) The one-off costs of each R&D project can be set against the huge potential market for the new technologies. The lower level of the NSI needs to be closely

INNOVATION: management, policy & practice

81

Andrew Tylecote

coupled with the upper level of the NSI, as the Japanese example shows. Key modern technologies, such as (nowadays) ICT and biotechnology, can only be made available to the lower level of the NSI through the upper level of the NSI. In biotechnology, for example, one role of the upper level of the NSI would be to conduct genetic modification of crop plants, e.g. insect-resistant cotton – as it has been doing vigorously in China. The corresponding role of the lower level of the NSI would be to cross-breed GM crops with local varieties adapted in each area to the local soil and climate. In ICT, where the Chinese effort at upper NSI level has been massive, the lower level of the NSI needs from the upper level a tool kit of simple, robust, cheap hardware and (open source) software: with this, local agricultural cooperatives and rural producers of manufactures could, for example, develop their own websites, and their own computer-controlled equipment.

Acknowledgement Earlier versions of this paper were presented to the Second Globelics Conference in Beijing, October 2004, the Tsinghua University Department of Technology Economics and Management Staff Seminar in April 2005, and the CICALICS Doctoral Academy, Beijing, September 2005. I am grateful to participants at these meetings for their comments, and particularly to Gu Shulin and Tu Jun. Liu Jiajia provided valuable research assistance. I have also gained from the comments of three anonymous referees. The usual disclaimer applies.

References Amsalem M A (1982) Technology Choice in Developing Countries – The Textile and Pulp and Paper Industries. Cambridge, Mass: MIT Press. Bhalla A S (1996) Facing the Technological Challenge. London: Macmillan for the ILO. Cai Jing and Tylecote A (2005) A healthy hybrid: the technological dynamism of minority-stateowned firms in China. Technology Analysis and Strategic Management 17(3): 257–278. Chang Ha-Joon (2002) Kicking Away the Ladder: 82

Development strategy in historical perspective. London: Anthem. Clark C and Roy K C (1997) Comparing Development Patterns in Asia. Boulder and London: Rienner. Elsenhans H (1983) Rising mass incomes as a condition of capitalist growth: implications for the world economy. International Organisation 37(1): 1–39. Fan Shenggen and Cheng F (2003) Agricultural research and urban poverty: the case of China. World Development 31(4): 733–741. Fei J C H; Ranis G and Kuo S W Y (1979) Growth with Equity: the Taiwan Case. Oxford: OUP. Gabriele A (2002) Science and technology policies and technical progress in Chinese industry. Review of International Political Economy 9(2): 333–373. Galvao C (1994) Choice of Technology in the Brazilian Food Industry: Can Appropriate Technology Solve the Employment Problem? PhD Thesis, University of Sheffield. Gu Shulin (1999) China’s Industrial Technology, Market Reform, and Organisational Change. Routledge with UNU Press, London and New York. Gu Shulin (2004) The role of market in Transition of Agricultural Production and Innovation System, paper presented to the Second Globelics conference on Innovation and Development, Beijing, October. Available at: http://www.globel ics-beijing.cn/ppt/Shulin%20Gu.pdf. Guo Xiaolin (2001) Land Expropriation and Rural Conflicts in China. China Quarterly 422–438. Hobday M (1995) Innovation in East Asia: the challenge to Japan. Cheltenham: Edward Elgar. Huang Jikun and Hu Ruifa (1999) Zhongguo nongye keji touzi yu tizhi gaige (Agricultural Research Investment and Institutional Reform), discussion paper of China Agricultural Policy Research Centre. Jequier N and Blanc G (1985) The AT Reader: Theory and Practice in Appropriate Technology. London: Intermediate Technology Publications. Lingaerde S and Tylecote A (1999) Resource-rich countries’ success and failure in technological ascent, 1870–1970: The Nordic countries versus Argentina, Uruguay and Brazil. Journal of European Economic History 28(1) Spring: 77–112. Lu Feng (2005) The rise of competitive firms and technological advantage in China. Presentation to CICALICS workshop, Beijing, August 31–September 2nd. Lundvall B-A (1992) National Systems of Innovation:

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Twin innovation systems, intermediate technology and economic development Towards a Theory of Innovation and Interactive Learning. London: Pinter. Lundvall B-A and Johnson B (1994) The learning economy. Journal of Industry Studies 1(2): 23–41. Lundvall B-A (2002) Innovation, growth and social cohesion: The Danish model. Cheltenham: Elgar. Morris-Suzuki T (1994) The Technological Transformation of Japan: From the Seventeenth to the Twenty-first Century. Cambridge: CUP. Nolan P (2001) China and the Global Business Revolution. Basingstoke: Palgrave. Rasiah R (2004) Explaining Malaysia’s Export Expansion in Oil Palm, Desk Review for World Bank, November. Available at http://www.pass livelihoods.org.uk/default.asp?project_id=248. Reynolds T S (1983) Stronger than a Hundred Men: A history of the vertical water wheel. Baltimore and London: Johns Hopkins University Press. Shahadan F (1996) The determinants of technological innovation adoption among Bumiputera small businesses. PhD thesis, University of Sheffield. Tylecote A (1985) Inequality in the Long Wave: Trend and Cycle in Core and Periphery. EADI Bulletin 1.85: 1–22. Tylecote A (1992) The long wave in the world economy. London: Routledge. Tylecote A and Galvao C (1990) On the choice of technology in Brazilian industrialisation, pp 84–104, in: van Dijk MP and Marcussen

READINGS

IN

HW(eds), Industrialisation in the Third World: The Need for Alternative Strategies, London: Frank Cass for EADI. Tylecote A and Galvao C (2001) The missing link: innovation and the needs of less-developed country users, Ch 14, in: Coombs R et al. (eds) Technology and the Market, Cheltenham: Edward Elgar. Tylecote A and Cai Jing (2004) China’s SOE reform and technological change: a corporate governance perspective. Asian Business and Management 3(1) March. Tylecote A (2003) Finance and corporate governance in the Chinese national system of innovation, paper presented to the Globelics conference on Innovation and Development, BNDES, Rio de Janeiro, November 3–6. Wu Bin (2003) Sustainable Development in Rural China: Farmer Innovation and Self-Organisation in Marginal Areas. London: Routledge. Wu Guisheng; Tu Jun and Gu Shulin (2003) Innovation system and transformation of the agricultural sector in China, with the case of Shouguang City, paper presented to the Globelics conference on Innovation and Development, BNDES, Rio de Janeiro, November 3–6. Wu Guisheng; Tu Jun and Gu Shulin (2004) Agricultural Innovation System in China: with the case of Shouguang County, paper submitted to World Development Special Issue.

A S I A P A C I F I C I N N O V AT I O N

Innovation: Management, Policy & Practice Volume 4 Issue 1–3 carries a range of research reports and literature reviews on e-government, e-commerce, biotechnology policy and case studies on China, Japan and Singapore and Malaysia. Examples of articles from this 2002 publication include: • The determinants of foreign pharmaceutical firms’ FDI entry mode choices between joint venture and sole venture into China [4(1–3): 74–87] • The influence of Chinese American cultural values on workplace communication, innovation, and teamwork [4(1–3): 113–128] • Challenging the Chinese Managerial Paradigm: Global relations over-ride the traditional market model [4(1–3): 129–142] • The Fifth Discipline in a highly disciplined Singapore: Innovative Learning Organisations and national culture [4(1–3): 215–226] • National culture and organizational behaviour of Malaysian and Japanese firms [4(1–3): 88–98]

Articles are available in full text on www.extenza-eps.com eContent Management Pty Ltd, PO Box 1027, Maleny QLD 4552, Australia Tel.: +61-7-5435-2900; Fax. +61-7-5435-2911; [email protected] www.e-contentmanagement.com

Volume 8, Issue 1–2, July 2006

INNOVATION: management, policy & practice

83

Copyright © eContent Management Pty Ltd. Innovation: management, policy & practice (2006) 8: 84–101.

The evolving role of research consortia in East Asia SUMMARY

KEY WORDS research consortia; institutional learning; innovation in East Asia

Research consortia have played an important role in the economic success of several East Asian countries. This paper looks at the ways these consortia – which are created for strategic rather than cost-saving purposes – have evolved over time. Three models for institutional learning are suggested, and three case studies are presented of research consortia in each model. The cases demonstrate the centrality of learning in facilitating the development then transition from innovation diffusion capabilities to innovation generation capabilities in East Asian firms. Cases are provided of the Samsung Electronics in Korea, the clusters of firms that are associated with ITRI in Taiwan, and the technological development of Ericsson China. Reference is made to the use of institutional innovations in the East Asian context such as patent pools that supplement more conventional forms of R&D collaboration. Received 9 June 2005

Accepted 28 February 2006

MARK DODGSON

JOHN MATHEWS

TIM KASTELLE

Professor, Director Technology and Innovation Management Centre University of Queensland Business School St Lucia, Queensland

Professor of Strategic Management Macquarie Graduate School of Management Macquarie University Sydney, New South Wales

Casual Lecturer University of Queensland Business School St Lucia, Queensland

INTRODUCTION

T

he management of innovation is now widely seen to be an important contributor to corporate competitiveness and national wealth. As

84

the interconnectedness of economic and business processes increases, and costs and risks of research and development mount, so firms in the industrial heartlands of the USA, Europe and Japan have

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

The evolving role of research consortia in East Asia

sought new organizational forms to collaborate in managing the process of innovation. Inter-firm R&D collaborative alliances and consortia have flourished, and with them new institutional foundations and facilitative mechanisms have been discovered (Ouchi & Boulton 1988; Evan & Olk 1990; Kleinknecht & Reijnen 1992; Dodgson 1993a; Aldrich & Sasaki 1995; Sakakibara 1997a,b; Dodgson 2000; Nakamura 2003). These developments, whether called R&D alliances, R&D consortia or strategic technology partnerships, or simply collaborative innovation networks, are the subject of growing interest in management and public policy circles, and of a growing scholarly literature (Levy & Samuels 1991; Hagedoorn 1996; Vonortas 1997, 2000; Hagedoorn, Link & Vonortas 2000). Of interest in this regard is the series of collaborative R&D ventures that have emerged in East Asia, in Japan initially, and latterly in Taiwan, Korea, China and Singapore.1 The emphasis here has been less on the joint creation of new knowledge, than on the efficient dissemination of existing knowledge to firms which can utilize such knowledge. While the case of Japan has been widely studied (Sakakibara 1993, 1997a, 1997b; Aldrich & Sasaki 1995) the processes through which firms collaborate in the other East Asian countries are much less studied and understood (Mathews 2002b; Sakakibara & Dodgson 2003). Yet these cases are of great relevance for countries with intermediate technological and R&D levels, which cannot hope to excel in every facet of advanced science and technology and which therefore have to make arrangements for keeping up with developments around the world. Unlike the case of many of the collaborative innovation arrangements between established firms in the US or Europe, where mutual risk reduction is frequently the driving influence, in the case of these East Asian countries it is technological learning, upgrading and catch-up industry creation that is the object of the collaborations. In other words, the difference is between collaboration as a form of economising versus collaboration as a strategic Volume 8, Issue 1–2, July 2006

tool. This difference is what makes the East Asian countries of such interest, and of potential general application to other countries and firms around the world. Within East Asia there are massive differences in science and technology capabilities, seen particularly clearly in disparities in R&D expenditure and employment (Dodgson 2000; Lall & Urata 2003). Whilst Singapore, Taiwan, Korea and Malaysia have developing research infrastructures, particularly in some industries, and relatively coherent national innovation systems, other East Asian countries do not possess significant research capacity. With countries like Indonesia and Thailand spending around $2 per capita annually on R&D, technological collaboration is only likely to be a marginal concern for the limited number of science and technology-based organizations and firms. However, whereas the sort of research partnerships found in developed economies based on ‘pre-competitive’ R&D is likely to be extremely rare in these countries, the more ‘diffusion-orientated’ partnerships are of central importance to the development of the national technology base. Research consortia that have emerged in East Asia, in countries like Taiwan, Korea and Singapore, differ from their counterparts in the Triad regions in that their goal is rapid adoption of new technological standards, products or processes developed elsewhere, and their rapid diffusion to as many firms as possible, rather than extending the envelope of R&D (Freeman & Hagedoorn 1994). Their organizational form owes much to the R&D collaborative vehicles developed in the leading industrial centres, particularly in the way that Japan structured many relatively short-lived R&D alliances with clear technological learning goals (Sigurdson 1986/1998; Fransman 1990/ 1992; Sakakibara 1997a, 1993). But how have these research consortia changed over time? Have they evolved to enable the development of technology creating capabilities to match technology diffusing capabilities? And, more profoundly, how is what we call the strate-

INNOVATION: management, policy & practice

85

Mark Dodgson, John Mathews and Tim Kastelle

gic learning trajectory in these countries related to the evolution of the objectives and structures of research consortia? In this paper we examine the changing role of research consortia in a number of ways. There are four main types of organisational structure participating in these consortia in East Asia: large indigenous firms, clusters of small firms, foreign multinationals and intermediary organizations (research institutes, technology and innovation brokers). First, we examine a large indigenous firm, the Samsung Group in Korea – and the role that collaboration has played in its technological development. Second, we examine the interaction of collaborative research institutions with clusters of small firms. In Taiwan we consider how the success of the model built around the IT industry and institutions like ITRI and how it is attempting to be replicated, with mixed success, in the software and biotechnology industry. Third, we examine the research collaborations of a major MNC in China: Ericsson China. Through these case studies we intend to reveal how the role of research consortia is evolving and developing in the East Asian context, and how they may assist in the creation of a new generation of technology leaders there and in other locations.

THEORY OF R&D COLLABORATION The reasons why firms in the advanced countries seek to pool their development efforts within R&D consortia, and the nature of the benefits they derive, is now the subject of a burgeoning international literature. The theoretical economic arguments (Spence 1984; Katz & Ordover 1990; Kamien, Muller & Zang 1992) tend to focus on the ‘spillover’ effects of R&D, creating a socially useful externality. According to this reasoning, firms enhance social welfare through their research activities, but this may depress their incentives to continue unless a form of R&D collaboration can internalize such an externality. These arguments are of necessity couched in cost terms, with consortia seen as pooling costs, and with simplifying assumptions that reduce the 86

insights into real forms of collaboration, e.g. that cooperation either involves all firms in an industry or none (compared to the reality that cooperation usually involves a small subset of firms). Empirical testing of these points was scant until comprehensive micro econometric studies of Japan’s R&D consortia and US consortia such as Sematech demonstrated clear benefits to participants and to R&D expenditure levels generally (Branstetter & Sakakibara 1997; Link, Teece & Finan 1996). Alternative comprehensive explanations for consortia formation and governance have come from the institutional economic literature and strategic management literature. Here the focus has been on matters such as how firms formulate and achieve strategic goals through the formation of research consortia (Vonortas 1997; Martin 1996; Link & Bauer 1989); how firms and agencies combine to enhance their resource base (Mowery, Oxley & Silverman 1998); and how they can actually manage the complex processes of building inter-firm collaborative routines (Powell, Kogut & Smith-Doerr 1996; Sakakibara 1997a,b; Doz, Olk & Ring 2000; Sawhney & Prandelli 2000). These strategic goals include gaining access to technical capabilities not otherwise easily accessed, particularly complementary technological resources, which generate new business opportunities (Link & Bauer 1989; Vonortas 1997). The creation of value through interorganizational relationships, and the capturing of ‘relational advantage’ has become a topic for sustained inquiry (Saxenian 1991; Dyer & Singh 1998; Child & Faulkner 1998; Barringer & Harrison 2000). Small firms in particular have been able to take advantage of R&D consortia in order to overcome diseconomies of scale (Kleinknecht & Reijnen 1992;, Sigurdson 1986/1998). The aim is to enhance the firms’ absorptive capacity, thus giving them potential access to a wider range of technological options (Cohen & LevinthaI 1989). This provides an appropriate setting for the discussion of many East Asian consortia which have been designed to promote the inter-

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

The evolving role of research consortia in East Asia

ests of small and medium-sized firms through the transfer and sharing of resources and the collective enhancement of absorptive capacity. This paper focuses on technological collaboration as a form of strategic learning. Learning takes a central role in several of the most recent analyses of technological development in East Asia (Hobday 1994; Mathews & Cho 2000; Mathews 2002). There are several levels of analysis that can be used to evaluate the role of learning in the evolution of research consortia. At the micro level, firms can develop strategies designed to leverage learning to build competitive advantage. At a meso level, regional institutions use learning strategies to build productive industrial clusters. Finally, macro level planning takes place within National Innovation Systems (NIS) (Lundvall 1992; Edquist 1998) which use learning strategies to improve economic performance at a national level. Research consortia contribute to learning at all three levels.

FIRM LEARNING One of the key problems faced by firms in developing economies is that of trying to enter markets that are already well established and that are usually dominated by existing incumbents. While these incumbents have strong market positions, they also face a unique challenge in trying to balance the conflicting demands caused by trying to integrate into the global economy while also staying responsive to their local markets (Ghoshal 1987; Prahalad & Doz 1987). Bartlett and Ghoshal (1989) refer to the small number of firms that are able to meet both sets of demands simultaneously as transnational corporations. These firms will have strong market positions both locally and globally. However, multinational firms that struggle with this balancing act are vulnerable to attack from smaller, more flexible firms that arise in the periphery of the global economy (Mathews 2000). These ‘latecomer’ firms are usually located in developing countries, and they are resource-poor, but flexible. In order to successfully compete, Volume 8, Issue 1–2, July 2006

they must devise strategies that allow them to use external connections to leverage the resources that they do possess. Rather than building a product portfolio through product innovation based on R&D spending, these latecomers compete through the creative development of network connections (Earl 2003). In this view, the latecomers actively identify potential linkages that will give them access to the knowledge and resources that they require. As their network develops, they then use learning skills to leverage the resources obtained through their alliances. The latecomers address the local–global problem by entering global markets through their partnerships. They provide services and resources that are designed to complement the needs of incumbent firms. Global expansion then occurs as they build relationships with their multinational partners. In essence, by focusing on meeting the needs of their alliance partners, the latecomers are able to expand globally without having to meet the needs of a ‘global’ market (Mathews 2002a). Learning is the key to successfully applying this strategy (Dodgson 1993b). Through the successive application of linking and leverage strategies, latecomers utilise learning to build their own skills and resources. Furthermore, throughout this process the firms learn about what types of partnerships work best. In order to make this strategy work, latecomers target resources for leverage that are reasonably easy to imitate, transfer or substitute (cf Barney 1991; Dierickx & Cool 1989). The result is the development of competitive advantage that is based on the structure of a firm’s network rather than the possession of particular resources which provide economic rents (Black & Boal 1994).

REGIONAL LEARNING The issue of regional competitiveness, or clustering, has received increasing attention in both the strategic and economic literatures (Porter 1990; Breschi & Malerba 2001; Fujita & Krugman 2004). The success of regional clusters of related

INNOVATION: management, policy & practice

87

Mark Dodgson, John Mathews and Tim Kastelle

firms, such as the IT firms in Silicon Valley and electronics firms in Taiwan, has motivated the search for a theoretical explanation of such activity. The economic effectiveness of clusters has been attributed to factors such as increasing returns and path dependency (Krugman 1991; Arthur 1994). Learning plays a central role explaining increasing returns in particular (Boschma & Lambooy 1999). Empirical evidence shows that many of these innovative clusters share similar characteristics which include a consistent production system used by all firms in the region, a shared culture, and most importantly a ‘dynamic collective learning process’ (Camagni 1991: 130). From this perspective, learning is collective because it takes place among a set of co-located actors, resulting in lower transaction and search costs and an increase in trust leading to better economic co-ordination (Jaffe et al. 1993). Learning takes place at a regional level for several reasons. Human capital tends to be more mobile within a small region than it is across larger distances. This increases the sharing of tacit knowledge in particular within regional clusters (Boschma & Lambooy 1999). Knowledge also tends to disperse more rapidly through densely connected local networks, leading to the establishment and growth of learning regions (Morgan 1997). Finally, evidence suggests that once a sufficient number of similar firms are located in one area information or technological spillovers occur (Jaffe 1989). These learning effects contribute to the increasing returns a region experiences, leading to an agglomeration of related firms. As more firms are attracted to the region, the network benefits increase, leading to further growth.

NATIONAL LEARNING Researchers within an innovation and knowledge systems perspective argue how collaboration is influenced by differences in the institutional make-up of nations, specifically in their science and technology infrastructure, and in the quality of social relationships between, for example, users 88

and suppliers (Lundvall 1992). An important institutional mechanism for encouraging learning in an NIS is the Innovation Intermediary. These are defined as those organizations that proactively operate as a bridge between suppliers and users of technology. Their creation, operation, and nurture are argued to be one of the major elements of effective innovation policy (Dodgson & Bessant 1996). They are important means of disseminating information to firms about new technology and market opportunities. They assist firms to articulate their needs and assimilate new practices. They can play a central role within networks of firms, particularly among SMEs. Rather than being a purveyor or source of information about finance or science and technology or management capability, they coordinate and package support across these areas in a way that is sympathetic to the majority of firms’ non-strategic, time-constrained mode of operating. They are different from traditional S&T institutions, banks, venture and development capital providers, small firm support agencies, and consultants, although these institutions can fulfil the role of innovation intermediary. While governments often try to impose technology transfer conditions on MNEs in return for market access, this has no substantial long term effect unless there is an effective NIS with institutions in place to facilitate the diffusion of technology (Li & Zhong 2003). Effective NISs are characterised by the development of collective competencies associated with public/private sector collaboration and assisted by carefully managed technological diffusion and maximized technology leverage. The key question to address is how these three forms of learning contribute to the changing roles of research consortia in East Asia.

METHODOLOGY This article is based on studies of three different models of research consortia in East Asia. We have integrated information from both primary and secondary sources. The field work conducted

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

The evolving role of research consortia in East Asia

into the three cases studies has been conducted over an extended period of more than a decade, with research findings published in, for example, Dodgson and Bessant (1996); Dodgson and Kim (1997); Dodgson, (2000) and Mathews (2000a, 2000b) and Mathews and Poon (1995). This paper reports for the first time reflections on longitudinal information collected over this period and informed by numerous research visits to Korea, Taiwan and China during 2002–2004. Since the research question concerns the changing roles of research consortia, a longitudinal case study approach should provide useful information on the different evolutionary patterns that have occurred (Yin 1994). Research visits included interviews conducted with managers responsible for research collaboration in the companies concerned, with government officials responsible for industry and technology policy and with researchers in local universities and in institutions such as Science and Technology Policy Institute (STEPI) in Korea, Academica Sinica in Taiwan and the National Research Centre for Science and Technology for Development in China. As a result of the lengthy relationships developed between the researchers and many of the managers involved in research collaborations in the case study organisations, much of the information gleaned on the structure and purpose of collaboration was collected in informal situations. The interaction between the different types of learning can be illustrated through case study evidence. There are three models of development that can be used (Mathews 2002c). Model A starts with large indigenous firms which use international technology alliances to build innovative capacity. The case of Samsung electronics in Korea illustrates this model. Model B focuses on local alliances of smaller firms, with technology often diffused through government institutes. The case of ITRI and the development of several clusters around it is typical of this form of development. Finally, in Model C the government tries to attract MNCs through the encouragement of FDI. This approach is demonstrated by Volume 8, Issue 1–2, July 2006

the case of Ericsson China. The models are proposed for further development and testing.

LEARNING TO INNOVATE THROUGH COLLABORATION:

SAMSUNG ELECTRONICS The importance of R&D, particularly that undertaken through research consortia, has steadily increased within the Samsung Group. Samsung was originally formed as a trading group in fruit and dried fish in 1938. It expanded into other commodities in the 1950s, then into manufacturing in the 1960s and 1970s. Samsung started to produce consumer electronics in 1969 with the formation of Samsung Electronics. In 1991 the company re-organised into three areas of concentration, electronics, heavy industry and petrochemicals. Samsung Electronics (SEC) is the core company in the electronics group and it is currently the world’s largest producer of colour monitors and DRAM and memory chips, and the second largest producer of VCRs and microwave ovens (Dodgson and Kim 1997). In 2003, SEC: • employed over 80,000 people; • was ranked 59th in the Fortune Global 500; • was ranked 9th in the US top patenting list, with 1313 patents; • generated revenues of US$ 47.6 billion; and • generated profits of US$5.6 billion (Moon and Lee 2004). Samsung’s use of technology reflects Hobday’s (1995) model of the development of the Korean electronics industry: a progression in the industry from foreign domination, to the development of increased local capability through licensing and joint venture agreements, culminating in the development of sophisticated in-house capabilities as the firm becomes competitive internationally. As SEC has progressed along this path, the role of R&D has changed considerably. Initially, the firm focused on licensing technology, often in products that were at the end of their lifecycle (Yu 1999). The first product that

INNOVATION: management, policy & practice

89

Mark Dodgson, John Mathews and Tim Kastelle

SEC produced was a black and white television in 1971, followed by the introduction of coloured televisions in 1977. Both of these markets were either mature or declining internationally at the time that SEC entered them. SEC then licensed the technology needed to produce VCRs and microwaves, and started to primarily target the US market. During this period, Samsung’s partners were generally unwilling to share technology for higher-end products, so by focusing on mature market segments, SEC was still able to build technical capacity and learning skills through Original Equipment Manufacturing agreements with firms such as General Electric (Dodgson & Kim 1997). SEC started to invest more heavily in research in the 1980s. While SEC was building its research capacity, the learning involved with doing so increased its absorptive capacity (Cohen & Levinthal 1989). In turn this led to an increasing ability to innovate. Consequently, SEC introduced its first products that improved on existing designs, DRAM chips, in 1986 and camcorders in 1989 (Yu 1999). At this point, SEC’s technology licensing arrangements started to change. Until the end of the 1980s, nearly all of its agreements were to license technology. As described above, the technological sophistication of the technology licensed increased over time. However, once SEC started to gain significant returns from its research investment, the nature of its technology acquisition changed to start to focus on the joint development of products. By the mid-1990s, SEC stopped licensing technology and focused exclusively on developing its own technology assisted by collaboration (Dodgson & Kim 1997). The result has been a series of successful research associations with other major international firms such as Toshiba, IBM, AT&T, Fujitsu, Motorola and Hewlett Packard. By the late 1990s, SEC’s technology was competitive internationally. When it licensed its 16 m SDRAM technology to Oki, this was the first known case of technology transfer from Korea to Japan in the semiconductor indus90

try in the process becoming a ‘global player of substance’ (Mathews & Cho 2000: 139). SEC began to utilise R&D consortia more after it had developed the ability to innovate at an internationally competitive level. Its substantially increased participation in consortia has been coordinated through the Samsung Advanced Institute of Technology (SAIT), formed in 1987 to drive R&D for the Samsung Group (Dodgson & Kim 1997). As its research capacity increased, Samsung established more than 20 more R&D centres domestically and internationally. It also developed links with science parks and universities such as Cambridge and Princeton. All of the research activities undertaken have been carefully integrated with SAIT. In addition to partnerships that have been coordinated through SAIT, Samsung may soon have further opportunities as a result of government activities. The policy of the Roh government is to use the innovative capacity of firms such as Samsung to encourage research based foreign direct investment in Korea in an attempt to turn the country into an economic hub in East Asia (Lee & Hobday 2003). This demonstrates the way in which the chaebol and the national innovation system in Korea co-evolve. As noted by Sung and Carlsson (2003), the story of the evolution of the NIS in Korea is essentially the story of the interaction the chaebol and the government. SEC has taken advantage of firm level learning to increase its absorptive capacity. In turn, this has allowed it to shift from a strategy of using collaborative research arrangements for licensing mature technology at the end of the product lifecycle to one of developing new innovative capabilities through research partnerships and alliances. Firm learning has been used to facilitate a major strategic shift for SEC. While their performance has been extremely good, this pattern has been followed by a substantial number of firms throughout Southeast Asia (Duysters & Hagedoorn 2000). In this, Samsung is illustrative of a more general trend in the region.

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

The evolving role of research consortia in East Asia

R&D COLLABORATION AND TECHNOLOGY DIFFUSION: TAIWAN AND ITRI Government-supported technological and scientific research institutes acting as innovation intermediaries have been indispensable in Taiwan’s high-technology industrial development. The Industrial Technology Research Institute (ITRI) and Electronics Research and Services Organization (ERSO), for example, based in Hsinchu, have played a major role in developing local technological capabilities in firms. Weiss and Mathews (1994), for example, describe how semiconductor wafer fabrication technology developed by ITRI has been spun-off into some of Taiwan’s most successful semiconductor firms. Numbers of commentators point to the business orientation of ITRI’s leaders (Rush et al. 1996) and to the role played by ITRI in leading Taiwan’s technology diffusion strategies (Mathews & Cho 2000). The experiences of ITRI in Taiwan illustrate the process of regional level learning. Established in 1973, ITRI employs over 6000 people, including nearly 5000 R&D staff (820 with PhDs), and has an annual operating budget of $500 million. Its technology focus ranges from the high-tech Integrated Circuit (IC) industry to the textile industry, and its work on factory automation and advanced materials have also been applied in traditional industries. It currently works in 6 fields: communications and opto-electronics; materials and chemicals technology; precision machinery; sustainable development technologies; biomedical and nanotechnology; and other advanced technologies for industrial development. In 2002 it had a portfolio of nearly 1000 US registered patents (making it the third largest international patenter in Taiwan). In 2001, ITRI: • provided training programs for 70,282 people; • provided technical services (technological and managerial) to 30,427 companies; • undertook contract research for 1014 companies; • undertook joint R&D projects with 339 companies. Volume 8, Issue 1–2, July 2006

ITRI coordinates multi-partner consortia: the Taiwan New Personal Computer (TNPC) Alliance formed in 1993, for example, involved 31 partners including IBM, Apple and Motorola. The aims of the Alliance were to “bring together firms from all aspects of the IT industry with a clear focus on transferring, uptaking and diffusing the new PowerPC technology in a series of products spanning PCs, software, peripherals and applications such as multimedia” (Mathews & Poon 1995). The initiative behind TNPC lay with the Computer and Communications Laboratory, one part of ITRI. CCL selected the PowerPC as an important ‘generic’ technology and built the consortium, including negotiating with the US partners. Mathews and Poon (1995) make the observation that this consortium is as much about diffusion of existing technology as it is about technology generation. As another example of its carefully developed role as an intermediary, in 1996 ITRI opened its Open Laboratory Program based in an extensive new R&D complex in Hsinchu (next to the science park – see below). The OpenLab Program mainly provides space and facilities for joint R&D between ITRI researchers and local business, and also has space for business incubation, conference and training facilities. Business incubatees receive ‘packaged’ business and management consulting, financial and legal assistance, and office and administrative support. Entry to the business incubator requires the formal approval of a business plan. Such consultancy activity is subsidized by the Government. The co-located Hsinchu Science-based Industrial Park has operated since 1980. It was established to serve Taiwan’s high-technology industries and accelerate their development. It offers a wide range of tax incentives, low interest loans, R&D and manpower training grants, and duty-free importing of equipment and materials. Its main technology foci are electronics, particularly ICs, although this is changing with, for example, increasing interest in biotechnology. It has proven successful at attracting returned expatriates; over 1000 work at the Park. Initially the government

INNOVATION: management, policy & practice

91

Mark Dodgson, John Mathews and Tim Kastelle

directly invested in the small start-ups, but increasingly private venture capital companies are assuming this role (Bruton, Ahlstrom & Yeh 2004). Park companies have proved successful technologically, and many have demonstrated sophisticated management strategies when, for example, it comes to managing international strategic alliances (Yuan & Wang 1995). A common feature of successful technology institutions is their spatial co-location and integration, and the success of ITRI and Hsinchu Science Park as being dependent upon their coexistence and also being co-located alongside two universities. Since its creation, 13,000 ITRI staff have moved into industry, many of them in the immediate locality. Similar circumstances are to be found with the Electronics and Telecommunications Research Institute and Daejon in Korea. Local small firms, as well as having the opportunity to link with particular local institutions, are part of an ‘innovative mileu’ (Cooke & Morgan 1994). Wong (1995), points to the success of state intervention in hastening technology diffusion amongst local firms in Taiwan. Public research institutes, he argues ... ‘serve initially to assimilate advanced technology from overseas and rapidly diffuse them to local enterprises, but increasingly also to serve as the coordinating nodes to promote indigenous technology creation via R&D consortia and strategic R&D programs as well.’ (Wong 1995: 18) As intellectual property issues emerge as critical to the success or otherwise of high tech industries, the role of collaborative arrangements such as patent pools becomes important. While recognized as an important means of averting outright patent wars amongst incumbents (Bednarek & Ineichen 2004) patent pools have been limited to date to such examples as MPEG streaming video, which is controlled by a patent pool consortium. But in East Asia, and particularly in Taiwan, patent pools have emerged as an innovative form of R&D collaboration. The Flat Panel Display (FPD) industry is a 92

recent creation of Taiwan, and illustrates this new kind of R&D collaboration in the form of a defensive patent pool. In the 1990s, as ITRI/ ERSO sponsored various research programs in TFT–LCD technology, in an effort to prepare the way for Taiwanese firms’ entry to this demanding field, several patents were acquired. Once Taiwanese firms had actually broken into the industry, they were vulnerable to ‘patent attacks’ from established firms, demanding royalties for alleged patent infringements. ITRI took the initiative in forming a new collective entity, the Taiwan TFT–LCD Association (TTLA), and transferred across to the association a block of 232 patents, to provide a collective defence in the event of patent attack. The TTLA, formed in 2000, consists of all six of the leading Taiwanese firms in the TFT–LCD industry – AU Optronics, Chi Mei Optoelectronics, Chung Hwa Picture Tubes, Hannstar Display, Quanta Display, Toppoly Optoelectronics and the small producer Prime View International, as well as ERSO. The TTLA starts life as a patent pool – modeled on such successful patent pools in the US as the MPEG Association which licenses streaming video technology – but is also designed as a means of providing a communication channel between Taiwan FPD producers and international intellectual property bodies and standardization bodies such as the International Electronic Commission (IEC). The development of patent pools, which originated in Silicon Valley, indicates that ITRI has a continuing interest in learning. As these new techniques are integrated into the research systems in Taiwan, ITRI’s role continues to evolve. This evolution is also evident in the type of research clusters being promoted in Taiwan. While the TNPC and other earlier research consortia were primarily focussed on diffusing existing innovations, the newer clusters such as software and biotechnology in the new Nankang Science Park are focussing on developing technology that requires substantial upfront investments in research. In 1988 the PC firms located in

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

The evolving role of research consortia in East Asia

Hsinchu were investing 4.5% of their annual sales into R&D, while at the same the Biotech consortia were investing 3.8% of annual sales. While the figures for the PC consortia have remained stable, averaging 3.89% of annual sales from 1988–2002, investment in R&D has risen dramatically in the biotechnology firms, averaging 24.56% over the same period, with a high of 65.1% in 2000 (Hsinchu Science Park 2003). As in the case of Samsung, this represents a shift from using research alliances to promote the diffusion of existing technology to the use of alliances to generate innovations designed to compete in international markets. This has been facilitated through the use of regional learning.

COLLABORATION AND TECHNOLOGY DEVELOPMENT IN ERICSSON CHINA Learning within National Innovation Systems is often encouraged by technology transfer from MNCs. Governments therefore attempt to facilitate learning from MNCs through the development of policy. The issue of national level learning is illustrated by the experiences of Ericsson in China. Ericsson is a major international telecommunications company, operating in over 140 countries. The company has faced considerable difficulties over the past few years, with substantial job losses. It has also redefined itself from being a broad-based manufacturer of public telecoms equipment, to focus on the mobile communications market. It is transforming itself by moving away from its manufacturing heartland – exchange equipment, radio base stations and mobile handsets are now outsourced – into higher value added services, solutions and systems integration (Davies 2003). Ericsson’s mobile handsets are now all produced in its joint venture with Sony: Sony Ericsson. The problems confronting Ericsson over previous years has not impacted its China operations as much, which despite being a fiercely competitive market, has continued to grow and thrive. China’s telecom revenue in 1999 was 208 billion RMB. By 2003, this had increased to 467 billion Volume 8, Issue 1–2, July 2006

RMB, and this is estimated by the Ministry of Information Industries (MII) to increase to 630 billion RMB by 2006. By the end of 2003, China had 269 million mobile subscribers, 28 million data subscribers, and 263 million telecoms subscribers. By 2005, the Telecom Research Institute of MII estimates that mobile subscriptions in China will be around 390 million. The number of SMS messages sent in 2001 was 18 billion. This was expected to increase to 550 billion in 2004. Ericsson has a long history of working in China: it began its business ties with by selling 2000 telephone handsets in Shanghai in 1892. The China market is important to Ericsson not only because of its size, but the ways in which its supply chain and R&D support global markets. Ericsson China Company Ltd is a wholly-owned foreign enterprise. It has ten joint ventures, four wholly-owned subsidiaries and 26 sales offices in China. It has 4,500 employees and claims about 15 per cent of them work on R&D. The technology of mobile telephony is of great significance for China. Indeed, when he was Prime Minister, Zhu Rhongji claimed that it is one of the two most important technologies for China. There are numerous changes occurring in the mobile telephony market brought about by the creation of common standards (GSM, CDMA etc.), de-regulation and globalization. The technological focus of the industry has changed from being product and production oriented to focussing on software and value-added services. The implications of these technological and competitive changes are greater demand for support competence in design and operation of mobile networks. This requires very highlytrained local staff, supported by a large accessible base of R&D activities, and effective technology transfer between the global centres of technological excellence. The technological trajectory of mobile telephony is reasonably clear. The first generation of technology was analogue, the second digital, as seen in CDMA and GSM standards. The third genera-

INNOVATION: management, policy & practice

93

Mark Dodgson, John Mathews and Tim Kastelle

tion is essentially multimedia, it allows broad data transfer, moving pictures and web surfing. The increasing complexity of the technology requires substantial investments in R&D, and ever more sophisticated management of technology on an international scale. In 1998 Ericsson spent over 16 per cent of its sales on R&D, and by 2003 this number had increased to over 20 per cent, although this is declining over recent quarters. Ericsson is playing an increasingly important role in the development of China’s technological capabilities in telephony: in establishing 2G and moving into 3G. It is transferring technology, undertaking R&D in China, supporting collaborative research within China, and integrating China’s technological efforts with its global research efforts. Ericsson is pursuing this strategy as a result of the combination of its own global strategy to deal with changing technologies and market circumstances, and Chinese government policies and pressures to increase the extent of technological investments in China and the amount of local content in production. The Chinese government supports both GSM and CDMA (Code Division Multiple Access) standards, and is involved in developments of WCDMA and NGN (Next Generation Network). Ericsson has around 35 per cent market share in China in GSM, around 40 per cent in GPRS, and 15 per cent for CDMA. It is the largest mobile supplier to China Mobile. One of the most important mechanisms by which Ericsson transfers technology into China, and builds the capabilities that contribute to its international R&D efforts is through its joint ventures. According to Ericsson, it has transferred the following to its joint ventures: ‘All data, documentation, information owned by, and used by Ericsson in establishing a manufacturing facility, in its manufacture, marketing, sale and general management activities related to licensed products supplied by Ericsson to the joint venture.’ This transfer of know-how extends beyond the transfer of product and manufacturing knowhow, to general management and services train94

ing. Joint ventures are also encouraged to participate in the research programs of Ericsson’s global network of R&D centres. Beijing Ericsson Putian Mobile Communications (BMC) is one the largest joint ventures in Beijing, and provides an example of the way R&D activities are expanding. It is 51 per cent owned by Sony Ericsson and Sony Ericsson China, and the other partners include China Putian, Nanjing Panda Electronics, and Yung Shing. It was initially established by Ericsson and Post Telecommunications Industrial Corporation (PTIC), a State Owned Enterprise owned by MII. Access to China Telecom, through MII, was the primary motivation behind Ericsson’s creation of the joint venture. In 1999, BMC opened a new factory in Beijing, employing around 690 people. BMC is a major manufacturing facility for Sony Ericsson China, and its consolidation into Sony Ericsson was designed to simplify the company’s supply chain, generate cost efficiencies and lead to more efficient customization of products. In June 2004, Sony Ericsson China announced it would expand its China R&D Centre into a Development Unit, one of four global development units, which will design and develop new products for the local and global market. In 1999 BMC produced around 1 million handsets a year. In 2004 it was producing 10 million handsets a quarter. Multinational companies set up R&D facilities in China to support local production for home and export markets, to access local R&D talent, and to display a long-term commitment to investment in China. Estimates of the numbers of MNCs with R&D Centres range from 120 to 300, and these Centre’s cover the computer, telecommunications, chemical, automotive, pharmaceutical and electronics industries. Companies with R&D centre’s in China include: DuPont, Nestle, GE, Alcatel, Motorola, Bell Labs, Matsushita, Samsung, P&G, Fujitsu, Sun, Nokia, Intel, and IBM. There are regulatory restrictions on these R&D Centres; they cannot, for example, sell their parent

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

The evolving role of research consortia in East Asia

companies’ products, but they do receive favourable tax advantages (Mei & Zeng 2003). In addition to its R&D facilities in Sweden, Ericsson maintains key R&D centres in more than ten locations, including China. Ericsson China has R&D facilities in Beijing, Shanghai, Nanjing, Qingdao, Dalian and Chengdu. In May, 2002, the company established the Ericsson China R&D Institute in Beijing in order to better coordinate the activities of these Centres. Ericsson claims to aim to grow its R&D expenditure in China by 25 per cent annually. By 2005 it will have spent $500 million on R&D over the previous 5 year period, almost doubling the $290 million it invested between 1985 and 2000 (Shanghai Daily News; 25th June, 2004). By the end of 2003, the Shanghai Centre employed some 250 and the Beijing design centre employed some 100 staff. Ericsson Communication Software Research and Development (Shanghai) Co. Ltd. (RDC) provides an example of the motivations behind and practices of Ericsson’s operation of R&D Centres in China. RDC is part of Ericsson’s global R&D network, and it has the particular objective of adapting products to the Chinese market. The decisions that led to the creation and current status of RDC tell us about Ericsson’s concern for the company to function fully as a member of the global R&D network. Often R&D is conducted in an Ericsson subsidiary company, but in this case the decision was made to set up a separate R&D company on a profit and loss basis. The company had to operate as a business, and while it was to be technically driven, it was to be profit orientated. The Chinese government was very keen for the company to be created as a joint venture, and significant pressure was exerted to encourage this. Ericsson chose not to do so as if it was to contribute to, and compete as, an equal partner in Ericsson’s global technology activities it had to develop proprietary technologies. If these activities, and resulting intellectual property, were shared, it could not fulfill its planned role. The concern within Ericsson regarding IPR is that Volume 8, Issue 1–2, July 2006

while the government has introduced legislation supporting IPR, these laws have yet to be fully implemented and enforced. Further arguments supporting Ericsson included the way the company was to be a very high technology R&D company of the sort that was in much demand in China. Additionally, the company was to be export orientated. It was going to sell its services for US dollars and pay its local costs in Renminbi. RDC receives a tax break through its status as an advanced high technology company. It receives a 6-year tax holiday from VAT. RDC’s links with universities are mainly concerned with attracting recruits. It is felt that it is important to have good relationships with universities as their highly regulated nature constrains recruitment. Good relationships with professors improves the quality of the advice on, and access to, the best graduates. The RDC does not fund any labs, but it does support particular projects. It is felt that best value from research links with universities is achieved through applied, rather than basic research. In is believed in RDC that Chinese applied research is good, cheap and fast. Basic research, and inventiveness, however, is weaker in Chinese universities. According to the CEO of RDC this is not because of a characteristic lack of innovativeness – Chinese researchers can be very creative – but more because of the way the environment is not conducive to creativity. RDC works closely with the global network of Ericsson laboratories. It collaborates with a number of research groups in Sweden, and laboratories in Italy, Greece and Singapore. It collaborated with Ericsson’s Australian laboratory until its recent closure. Ericsson has a number of major research links with Chinese research institutes, including: Beijing University of Post and Telecommunications (research into wireless data analysis); Beijing Institute of Technology (investigating channel coding in mobile communication); Post and Telecommunications Design Institutes in Zhengzhou and Beijing (radio, network and frequency planning); and the Chinese

INNOVATION: management, policy & practice

95

Mark Dodgson, John Mathews and Tim Kastelle

Academy of Telecommunication Science and Technology (network technologies). The level of investment that Ericsson has made in China is partly due to their commitment to the market, but also partly due the policies of the Chinese government. The result has been substantial investment by Ericsson into R&D based in China. This directly benefits the Chinese economy, as the results are central to the development of mobile telephony in the country. Furthermore, the substantial number of joint ventures, research alliances and university research links that Ericsson is involved with, as seen in BMC and RDC, all contribute further to China’s innovative capacity. As in the other cases, the emphasis in these partnerships has shifted over time towards a greater focus on building capabilities in the development of new technology rather than just the transfer of existing technology.

DISCUSSION Traditionally, the strengths of Asian technological capabilities have been in the diffusion of existing, rather than in the creation of new, technologies. There remain many challenges for Asia in developing its technology base (World Bank 2003; Yusuf 2003). Asia is still highly reliant on science and technology created elsewhere. However, the experiences reflected in the cases of Samsung, ITRI and its small business clusters and Ericsson China demonstrate how learning can contribute

to the development of domestic innovation capacity. It is the combination of learning from both private and public-sector technological collaborations that have reinforced and supported the overall achievements in the respective innovation systems. These systems remain very dynamic, witnessed by the growth of smaller, internet-based firms in Korea and biotechnology investments in Taiwan. All three cases demonstrate the way in which learning at the levels of firm, region and nation all contribute to the co-evolution of research consortia and the National Innovations Systems in which they are embedded (Lundvall, Johnson, Andersen & Dalum 2002; Malerba 2002). Economies can take different paths to improve technological learning (Figure 1). The best choice will vary for different nations, depending on the current structure of the economy. All three of the development paths have been successful in East Asian countries, which again demonstrates that there has not been one standard ‘recipe’ for economic growth in the region (Mathews & Cho 2000).The case of Samsung in Korea demonstrates the approach taken in Model A. Firms such as Samsung have carefully leveraged their partnerships to build an impressive, and in some cases, world leading technology base. The focus in this case has primarily been on the development of research skills through international alliances, starting with Original Equipment Manufacturing production, then licensing, building research

Model A

Model B

Model C

(large domestic)

(SMEs & PSAs)

(MNCs)

Korea Taiwan Singapore

China FIGURE 1: EVOLVING

96

INSTITUTIONAL MODELS FOR TECHNOLOGICAL LEARNING

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

The evolving role of research consortia in East Asia

capacity through joint ventures and culminating in the development of strategic research alliances. Model B is illustrated by Government research institutions such as ITRI in Taiwan and (the recently privatized) Electronics and Telecommunications Research Institute in Korea have played a central role in the strategic learning that has occurred in the respective economies. These institutions have demonstrated considerable learning in their own organization and strategies. Built upon a traditional research association model from Europe, they have adapted and learned to provide services appropriate to the various stages of technology development over the past few decades. They have also been instrumental in diffusing technology amongst their constituent firms, and gradually raising the level of technological sophistication in their programs. Multinational companies have played a central role in the development of the Singapore economy, and companies such as Ericsson have played an important role in developing technological learning in China, illustrating Model C. Through the construction and continuing support of manufacturing facilities they have developed a range of capabilities which provide the basis for developing R&D capabilities. There are a range of

motivations for creating R&D Centres in China, from the desire to support local manufacturing in order to sell to local and global markets, to access local research talent, to government policy, corporate citizenship and technological imperatives. By examining the case of Ericsson in China, and its technological collaborations in a joint venture and a research centre and with a range of universities and research institutes, it can be seen how extensive these collaborations are, and how they progress from simple technology diffusion, to technology creation objectives. Importantly, once the technological capability is established, then participation in and contributions to the international networks of Ericsson’s R&D organization are facilitated. The case studies demonstrate several of the strategies available to ‘latecomer’ firms in regions outside of the triad. In all cases, alliances play a key role in the development of world class innovative skills (Figure 2). The best ways of encouraging innovation involve learning at all levels in an economy, from firm- to national-level, and research consortia can impact each level. Samsung and Ericsson China provide examples of companies that have developed firm-based innovation creating capabilities. Collaborations can Strategic Research Partnerships & Acquisitions

International Alliances

World Leadership In Own Products

Licensing & Joint Ventures Technological Assimilation & Learning

Licensing

Basic Assembly

1950s

Consortia & Networks For Diffusion

Manufacture of Components & Consumer Goods

Training

1960s

R&D Collaboration

Design & Manufacture of OEM

Technology Transfer Intermediary Development 1970s

1980s

FIGURE 2: STRATEGIC

Volume 8, Issue 1–2, July 2006

1990s

Domestic Alliances

2000s

LEARNING TRAJECTORY

INNOVATION: management, policy & practice

97

Mark Dodgson, John Mathews and Tim Kastelle

also be used to allow smaller firms to collectively act as large ones, both in the case of pooling resources to increase innovation, and also in leveraging external resources to provide patent protection, as in the case with ITRI. Ericsson China has built upon its investment in production-oriented joint ventures, and has increased its R&D investments and capacity to collaborate with domestic partners and international parts of the Ericsson R&D organization. This is an example of MNCs using research consortia to embed themselves within attractive National Innovation Systems (Lehrer & Asakawa 2002). The experience of ITRI in Taiwan demonstrates the effectiveness of public research institutes in stimulating technological learning in SMEs. This is particularly true when a technology cluster already exists, as in the case of the IT industry in Taiwan. The formation of ITRI and its co-location with the Hsinchu Science Park, were able to spur innovation within the cluster. Taiwan’s efforts in trying to develop software and biotechnology clusters will help in determining whether initiating an innovative cluster is more difficult than facilitating the growth of a cluster that has already formed (Boschma 1997). According to Boschma and Lambooy (1999), cluster initiation often depends on the general level of innovativeness in a region, and clusters often form around particular innovators, as Seattle’s software cluster formed around Microsoft. As nations like Korea (Lee & Hobday 2003) and China (Chang & Shih 2004) try to actively foster the formation of innovative technology clusters, it is important to address the general level of innovative capacity within the national innovation system and whole culture, and to also take a more reactive role in the formation of cluster rather than a directive one. The evolutionary path of research consortia in Asia is relatively clear: they are being used to develop technology creating capabilities, and there is an expansion in the number of models being used to assist this. China is in the position of being able to pursue all three models simulta98

neously. It is developing large domestic firms, either reformed State Owned Enterprises, or emerging new firms like Lenovo and Haier. It is encouraging small firm innovation in Special Economic Zones, transforming town and village enterprises, and through spin-offs from institutions like the China Academy of Sciences, and Tsinghua University. And, as we have seen in the case of Ericsson China, it is leveraging off MNC investments in the development of local capabilities (Wang, Tong & Koh 2004). China is in a position to do this because of the size and diversity of its industry and the pragmatism of its industrial policies. Questions remains as to the extent to which other countries in the region can diversify their models for technological learning using technological collaboration.

Endnote 1 The diversity in the region makes discussion of any ‘Asian’ issues nothing but a simple convenience. Asia includes China, the city state Singapore, and tiny sultanate Brunei. Its people live in affluent metropolitan Hong Kong and in poverty in rural Indonesia and Cambodia. In the late 1990s, Singapore had a higher GNP per capita than the USA. At the same time GNP per capita in Indonesia, China and the Philippines was less that $4000 (and has probably significantly declined in the case of the former). Asia is Buddhist, Confucian, Islamic and Christian in all their varieties. It has democracies, single party rule, police states, and includes governments that internationally are amongst the most and the least corrupt. Asian cultures are both modern and internationally focused and ancient and traditional, and are as rich in the arts, literature, music and design as any in the world.

References Aldrich, H.E. and Sasaki, T. (1995). R&D consortia in the United States and Japan. Research Policy, 24(2): 301–316. Arthur, W.B. (1994). Increasing returns and path dependence in the economy. Ann Arbor, MI: University of Michigan Press. Barney, J. (1991). Firm resources and sustained competitive advantage. Journal of Management Studies, 17(1): 99–120. Barringer, B.K. and Harrison, J.S. (2000). Walking

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

The evolving role of research consortia in East Asia a tightrope: Creating value through interorganizational relationships. Journal of Management, 26(3): 367–403. Bartlett, C.A. and Ghoshal, S. (1989). Transnational management: Text, cases, and readings in crossborder management (3rd Edition). New York, NY: McGraw-Hill. Bednarek, M. and Ineichen, M. (2004). Patent pools as an alternative to patent wars in emergent sectors. Intellectual Property & Technology Law Journal, 16(7): 1–5. Black, J.A. and Boal, K.B. (1994). Strategic resources: Traits, configurations and paths to sustainable competitive advantage. Strategic Management Journal, 15(Special Issue, Summer): 131–148. Boschma, R.A. (1997). New industries and windows of locational opportunity. Erdkunde, 51: 12–22. Boschma, R.A. and Lambooy, J.G. (1999). Evolutionary economics and economic geography. Journal of Evolutionary Economics, 9: 411–429. Branstetter, L. and Sakakibara, M. (1997). Japanese research consortia: A microeconometric analysis of industrial policy. NBER Working paper #6066. Cambridge, MA: National Bureau of Economic Research. Breschi, S. and Malerba, F. (2001). The geography of innovation and economic clustering: Some introductory notes. Industrial and Corporate Change, 10(4): 817–833. Bruton, G., Ahlstrom, D. and Yeh, K.S. (2004). Understanding venture capital in East Asia: The impact of institutions on the industry today and tomorrow. Journal of World Business, 39: 72–88. Camagni, R. (1991). Innovation Networks: Spatial Perspectives. London: Belhaven Press. Chang, P.L. and Shih, H.Y. (2004). The innovation systems of Taiwan and China: A comparative analysis. Technovation, 24: 529–539. Child, L. and Faulkner, D. (1998). Strategies of cooperation: Managing alliances, networks and joint ventures. Oxford: Oxford University Press. Cohen, W.M. and Levinthal, D.A. (1989). Innovation and learning: The two faces of R&D. Economic Journal, 99: 569–596. Cooke, P. and Morgan, K. (1994). The Creative milieu: A regional perspective on innovation. In M. Dodgson and R. Rothwell (Eds.), The handbook of industrial innovation (pp. 25–32). Aldershot: Edward Elgar. Davies, A. (2003). Integrated solutions: The changing business of systems integration. In A. Prencipe, Volume 8, Issue 1–2, July 2006

A. Davies and M. Hobday (Eds.), The business of systems integration. Oxford: OUP. Dierickx, I. and Cool, K. (1989). Asset stock accumulation and sustainability of competitive advantage. Management Science, 35(12): 1504–1511. Dodgson, M. (1993a). Technological collaboration in industry: Strategy, policy and internationalization in innovation. London and New York: Routledge. Dodgson, M. (1993b). Learning, trust and technological collaboration. Human Relations, 46(1): 77–95. Dodgson, M. (2000). Policies for science, technology and innovation in Asian newly industrializing economies. In L. Kim and R. Nelson, (Eds.), Technology, learning and innovation. Cambridge: Cambridge University Press. Dodgson, M. and Bessant, J. (1996). Effective innovation policy: A new approach. London and New York: Routledge. Dodgson, M. and Kim, Y. (1997). Learning to innovate – Korean style: The case of Samsung. International Journal of Innovation Management, 1(1): 53–71. Doz, Y.L, Olk, P.M., and Ring, P.S. (2000). Formation processes of R&D consortia: Which path to take? Where does it lead? Strategic Management Journal, 21(Special Issue: Strategic Networks): 239–266. Duysters, G. and Hagedoorn, J. (2000). International technological collaboration: Implications for newly industrializing economies. In L. Kim and R. Nelson, (Eds.), Technology, learning and innovation. Cambridge: Cambridge University Press. Dyer, J.H. and Singh, H. (1998). The relational view: Cooperative strategy and sources of interorganizational competitive advantage. Academy of Management Review, 23: 660–679. Earl, P.E. (2003). The entrepreneur as a constructor of connections. Advances in Austrian Economics, 6: 117–134. Evan, W.M. and Olk, P. (1990). R&D consortia: A new US organizational form. Sloan Management Review, 31(3): 37–46. Fransman, M. (1990/1992). The market and beyond: Information technology in Japan. Cambridge, UK: Cambridge University Press. Freeman, C. and Hagedoorn, J. (1994). Catching up or falling behind: Patterns in international interfirm technology partnering. World Development, 22: 771–780. Fujita, M. and Krugman, P. (2004). The new

INNOVATION: management, policy & practice

99

Mark Dodgson, John Mathews and Tim Kastelle economic geography: Past, present and the future. Papers in Regional Science, 83: 139–164. Ghoshal, S. (1987). Global strategy: An organizing framework. Strategic Management Journal, 8: 425–440. Hagedoorn, J. (1996). Trends and patterns in strategic technology partnering since the early seventies. Review of Industrial Organization, 11: 601–616. Hagedoorn, J., Link, A.N. and Vonortas, N.S. (2000). Research partnerships. Research Policy, 29: 567–586. Hobday, M. (1995). Innovation in East Asia. Cheltenham: Edgar Elgar. Hobday, M. (1994). Innovation in East Asia: Diversity and development. In M. Dodgson and R. Rothwell (Eds.), The handbook of industrial innovation (pp. 94–105). Aldershot: Edward Elgar. Hsinchu Science Park. (2003). Hsinchu Science Park Annual Report. Hsinchu, Taiwan: Hsinchu Science Park. Jaffe, A.B. (1989). Real effects of academic research. American Economic Review, 79(5): 957–970. Jaffe, A.B., Trajtenberg, M. and Henderson, R. (1993). Geographic localization of knowledge spillovers as evidenced by patent citations. Quarterly Journal of Economics, 108: 577–598. Kamien, M., Muller, E. and Zang, I. (1992). Research joint ventures and R&D cartels. American Economic Review, 82/5(Dec): 1293–1306. Katz, M.L. and Ordover, J.A. (1990). R&D cooperation and competition. In M.N. Baily and C. Winston (Eds), Brookings Papers on Economic Activity: Microeconomics (pp. 137–203). Washington, DC: Brookings Institution. Kleinknecht, A. and Reijnen, J.O.N. (1992). Why do firms cooperate on R&D? An empirical study. Research Policy, 21(4): 347–360. Krugman, P. (1991). Increasing returns and economic geography. Journal of Political Economy, 99(3): 483–499. Lall, S. and Urata, S. (2003). Competitiveness, FDI and technological activity in East Asia. Cheltenham: Edgar Elgar. Lee, Y.I. and Hobday, M. (2003). Korea’s new globalization strategy: Can Korea become a business hub in Northeast Asia? Management Decision, 41(5/6): 498–510. Lehrer, M. and Asakawa, K. (2002). Offshore knowledge incubation: The ‘third path’ for embedding R&D labs in foreign systems of innovation. Journal of World Business, 37: 297–306. 100

Levy, J.D. and Samuels, R.J. (1991). Institutions and innovation: Research collaboration as technology strategy in Japan. In L.K. Mytelka (Ed), Strategic partnerships and the world economy: States, firms and international competition. London: Pinter. Li, J. and Zhong, J. (2003). Explaining the growth of international R&D alliances in China. Managerial and Decision Economics, 24(2/3): 101–115. Link, A.N. and Bauer, L.L. (1989). Cooperative research in US. manufacturing: Assessing policy initiatives and corporate strategies. Lexington, MA: Lexington Books. Link, A.N. Teece, D.J. and Finan, W.F. (1996). Estimating the benefits from collaboration: The case of Sematech. Review of Industrial Organization, 11: 737–751 Lundvall, B.-A. (1992). National systems of innovation. London: Pinter. Lundvall, B.-A., Johnson, B., Andersen, E.S. and Dalum, B. (2002). National systems of production, innovation, production and competence building. Research Policy, 31: 213–231. Malerba, F. (2002). Sectoral systems of innovation and production. Research Policy, 31: 247–264. Martin, S. (1996). Public policies towards cooperation in research and development: The European Union, Japan and the United States. In W. Comanor, A. Goto and A. Waverman (Eds), Competition in a global economy. London: Routledge. Mathews, J.A. (2000). Accelerated internationalization from the periphery. Working Paper. European Institute of Japan Studies, Stockholm School of Economics. Mathews, J.A. (2002a). Dragon multinational: A new model for global growth. Oxford: Oxford University Press. Mathews, J.A. (2002b). The origins and dynamics of Taiwan’s R&D consortia. Research Policy, 31(4): 633–651. Mathews, J.A. (2002c). Competitive advantages of the latecomer firm: A resource-based account of industrial catch-up strategies. Asia Pacific Journal of Management, 19: 467–488. Mathews, J.A. and Cho, D.-S. (2000). Tiger technology: The creation of as semiconductor industry in East Asia. Cambridge: Cambridge University Press. Mathews, J.A. and Poon, T.S. (1995). Technological upgrading through alliance formation: The case of Taiwan’s new PC consortium. Industry of Free China, 74(6): 43–58.

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

The evolving role of research consortia in East Asia Mei, Z.J. and Zeng, J. (2003). R&D centers in China. EuroBiz Magazine, (August): 1–11. Moon, H.C. and Lee, D. (2004). The competitiveness of multinational firms: A case study of Samsung Electronics and Sony. Journal of International and Area Studies, 11(1): 1–21. Morgan, K. (1997). The learning region: Institutions, innovation and regional renewal. Regional Studies, 31(5): 491–503. Nakamura, M. (2003). Research alliances and collaborations: Introduction to the special issue. Managerial and Decision Economics, 24: 47–49. Ouchi, W. and Boulton, M.K. (1988). The logic of joint research and development. California Management Review, 30(3): 9–33. Porter, M.E. (1990). The Competitive Advantage of Nations. New York, NY: Free Press. Powell, W.W., Kogut, K.W. and Smith-Doerr, L. (1996). Interorganizational collaboration and the locus of innovation: Networks of learning in biotechnology. Administrative Science Quarterly, 41: 116–145. Prahalad, C.K. and Doz, Y.L. (1987). The multinational mission: Balancing local demands and global vision. New York, NY: Free Press. Rush, H., Arnold, E., Bessant, J. and Murray, R. (1996). Technology institutes: Strategies for best practice. London: Thomson Learning Europe. Sakakibara, K. (1993). R&D cooperation among competitors: A case study of the VLSI Semiconductor Research Project in Japan. Journal of Engineering and Technology Management, 10(4): 393–408. Sakakibara, M. (1997a). Evaluating governmentsponsored R&D consortia in Japan: Who benefits and how? Research Policy, 26(4–5): 447–473. Sakakibara, M. (1997b). Heterogeneity of firm capabilities and cooperative research and development: An empirical examination of motives. Strategic Management Journal, 18(Summer Special Issue): 143–164. Sakakibara, M. and Dodgson, M. (2003). Strategic research partnerships: Empirical evidence from Asia. Technology Analysis and Strategic Management, 15(2): 227–246. Sawhney, M. and Prandelli, E. (2000). Communities of creation: Managing distributed innovation in turbulent markets. California Management Review, 42(4): 24–54.

Volume 8, Issue 1–2, July 2006

Saxenian, A. (1991). The origins and dynamics of production networks in Silicon Valley. Research Policy, 20(5): 423–438. Sigurdson, J. (1998/1986). Industry and state partnership: The historical role of the engineering research associations in Japan. Industry and Innovation, 5(2): 209–241 (Original working paper ‘Industry and state partnership in Japan: The VLSI project’, University of Lund). Spence, A.M. (1984). Cost reduction, competition and industry performance. Econometrica, 52: 101–121. Sung, T.K. and Carlsson, B. (2003). The evolution of a technological system: The case of CNC machine tools in Korea. Journal of Evolutionary Economics, 13: 435–460. Vonortas, N.A. (2000). Multimarket contact and inter-firm cooperation in R&D. Journal of Evolutionary Economics, 10: 243–271. Vonortas, N.A. (1997). Cooperation in research and development. Boston: Kluwer. Wang, P., Tong, T.W. and Koh, C.P. (2004). An integrated model of knowledge transfer from MNC parent to China subsidiary. Journal of World Business, 39: 168–182. Weiss, L. and Mathews, J.A. (1994). Innovation alliances in Taiwan: A coordinated approach to developing and diffusing technology. Journal of Industry Studies, 1(2): 91–101 Wong, P.-K. (1995). Competing in the global electronics industry: A comparative study of the innovation networks of Singapore and Taiwan. Journal of Industry Studies, 2(2): 35–60. World Bank. (2003). East Asia integrates: A trade policy agenda for shared growth. Washington, DC: The World Bank. Yin, R.K. (1994). Case study research: Design and methods, Second edition. Thousand Oaks CA: Sage Publications. Yu, S. (1999). The growth pattern of Samsung Electronics. International Studies of Management and Organization, 28(4): 57–72. Yuan, B. and Wang, M.-Y. (1995). The influential factors for the effectiveness of international strategic alliances in high-tech industry in Taiwan. Journal of Technology Management, 10(7/8): 777–787. Yusuf, S. (2003). Innovative East Asia. New York: Oxford University Press.

INNOVATION: management, policy & practice

101

Copyright © eContent Management Pty Ltd. Innovation: management, policy & practice (2006) 8: 102–112.

The interaction between regulation and market and technology opportunities: A case study of the Chinese mobile phone industry SUMMARY KEY WORDS China market entry; regulation; modularity; Chinese mobile phone industry

In this paper, we present the case of Chinese mobile phone manufacturers and their development. Issues related to entry barriers for these manufacturers, such as technological capabilities & market dominance by multinational corporations (MNCs), are discussed, as well as the reasons for overcoming these barriers, including technology and market specifics, as well as policies and regulation dynamics. We argue that market scale, diversification of demand, as well as modular architecture of products and global supply of technologies, are the main reasons for the lowering of entry barriers. Received 9 June 2005

Accepted 17 January 2006

HENGYUAN ZHU

YAN YANG

Assistant Professor Research Center for Technology Innovation School of Economics and Management Tsinghua University Beijing, China

PhD candidate Research Center for Technology Innovation School of Economics and Management Tsinghua University Beijing, China

GUISHENG WU MARIN T. TINTCHEV PhD candidate School of Economics and Management Tsinghua University Beijing, China

102

INNOVATION: management, policy & practice

Professor Research Center for Technology Innovation School of Economics and Management Tsinghua University Beijing, China

Volume 8, Issue 1–2, July 2006

The interaction between regulation and market and technology opportunities

INTRODUCTION

T

he nature of globalization has favored wellestablished players, such as multinational corporations (MNCs), in the expansion of their activities into emerging markets (Dawar & Frost 1999). In the special case of emerging industries, such as mobile telecommunications, MNCs have had a very dominant position due to technological expertise and ownership over core technologies. Firms originating in developing countries, or even those from developed nations with no history in developing and producing technologies in a particular area, are in a very weak position to build own brands and to enter markets with own brand products. In the past two decades, in the mobile phone industry, companies from only two developing nations, China and South Korea, were able to enter successfully into the field. Korean brands, mostly originating from companies with a telecom or consumer electronics background, established their presence in the latter half of the 1990s, while the Chinese mobile phone manufacturing industry emerged at the very end of the last decade, achieving success on the local market in the early 2000s, with indications for entering international markets. The purpose of this paper is to answer the following question based on a case study of the Chinese mobile phone industry: How were local enterprises in developing countries, in an industry where core technologies are owned by MNCs, able to manage successful entry into the industry? The approach to the question required review of factors such as interaction between producers and the market, building of technological capabilities, as well as national industry policies, from a historical perspective, as a supportive factor for the development of local companies. The evolution of a China-specific value chain in this industry is also reviewed. The historical perspective approach is used to avoid limitation of the crosssectional data when analyzing the dynamics of firms and the industry. The study is based on a literature review and materials drawn from various media sources, Volume 8, Issue 1–2, July 2006

including industry reports by consulting and research organizations. Semi-structured interviews with industry professionals, policymakers and local Chinese company managers were also conducted to gain better understanding of the dynamics.

MARKET AND TECHNOLOGY BACKGROUND

Market pull and technology push are two important factors for industry development. In this section, the characteristics of the mobile phone market in China and its basic product technology are briefly summarized as background for further analysis. Also described is the basic value chain of the industry. China is the largest mobile phone market in the world with over 300 million mobile subscribers in 2005. Despite the impressive figures, the market is highly unbalanced in income distribution with the wealthiest population segment located in national and provincial capital cities and a few rich counties in coastal areas. Approximately 70% of the country’s 1.3 billion inhabitants live in rural areas. From the market structure perspective, considering such factors as income, consumer behavior, lifestyle and business environment, the market can be divided into three tiers. Tier 1 includes most capital cities of the 32 provinces, cities under direct jurisdiction of central government – Beijing, Shanghai, Tianjin and Chongqing, and highly developed cities such as Shenzhen and Suzhou. Tier 2 includes a few provincial capital cities of less developed provinces, such as Guiyang, and provincial cities such as Baoding, as well as a few rich coastal counties. Tier 3 consists mostly of less developed counties and small-size towns in less or underdeveloped areas (Letovsky, Murphy & Kenny 1997). With regard to technology, mobile phone architecture is based on modular design, where the handset can be split into independent parts assigned as modules (Baldwin & Clark 2003). The basic hardware architecture of mobile phones includes three parts: radio frequency (RF)

INNOVATION: management, policy & practice

103

Hengyuan Zhu et al.

module, intermediated frequency (IF) module, and base band (BB) module. Mobile phone software consists of three parts. First, the physical layer software, Layer 1, which is inseparable from digital signal processing (DSP), forms the core IP of a mobile phone. Second, there is the protocol stack (Layers 2 and 3), provided by Total Solutions chip-manufacturers or specific software suppliers. The third is the man–machine interface and S/W (software) (Layers 4 to 7) which determines whether the mobile phone is user-friendly and looks attractive (Zhu 2005). The basic value chain for mobile phones includes component (chip) providers, handset design, manufacturing, marketing and distribution.

CASE STUDY: INDUSTRIAL DYNAMICS OF THE CHINESE MOBILE PHONE INDUSTRY

In this section, the industrial dynamics of the Chinese mobile phone industry is studied in a longitudinal manner. The history of mobile handset manufacturing industry in China (1987– 2005) is divided into four stages. In each stage, regulation, as well as manufacturing and marketing efforts of the reigning firms, is reviewed. In the conclusion, the value chain evolution of the industry is summarized.

1987–1997: Administrated market stage In the late 1980s, the structure of the Chinese telecom sector was based on a classical system of Post, Telecom and Telegraphs (PTTs), with the Ministry of Post and Telecommunications (MPT) as sole monopolist for all kind of operations and services, including the analog mobile telephony introduced in 1987 (Nie & Zeng 2003). Further development of China’s economic reforms pushed the state to begin a process of separating operations and service provisioning from the regulatory functions of the MPT. As a first step, in March 1994, the Mobile Telecommunications Office (precursor organization to China Mobile) of MPT was established. The next step 104

taken by the State Council, with the primary goal of breaking up the monopoly, was to support the founding of China Unicom in July 1994. In its early stages, the newly formed competitor did not have a real impact on the market and was not in a position to challenge the monopoly status of MPT until 1998 (Xu & Pitt 1999). To some extent, China Unicom, established as a stateowned enterprise, facilitated the development of mobile communication and influenced the national mobile industry. Both began operating GSM standard based networks in 1994. The source of mobile phones in the market evolved from a majority of foreign imports in 1987 into a predominance of phones locally manufactured by MNCs in the first half of 1990s. Before 1997, subscribers were able to buy a mobile handset only as part of bundled services from telecom operators. As a result, locally producing enterprises such as Motorola, Ericsson, Nokia, Panasonic, NEC, Siemens, Alcatel, Philips, MTC and IPC, could not sell their products direct to users but only through China Mobile and China Unicom.

1997–1999: Terminal – services separation stage In September 1996, newly introduced regulation recognized the mobile phone as separate from the SIM (Subscriber Identity Module) card. This regulation positioned mobile phones to become independent of service packages and no longer necessitated bundling with a subscription to mobile operator services. With this freedom, consumers were able to buy mobile devices from sources other than mobile service providers. As a result, on the one hand, entry market barriers, such as administration of the value chain, were significantly lowered, allowing for new entrants. The virtual monopoly of system equipment manufacturers, the main suppliers of mobile phones and network equipment, was challenged by these new companies without any telecom system equipment manufacturing background to offer terminal handsets. On the other hand, mar-

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

The interaction between regulation and market and technology opportunities Local mobile phone manufacture

Regional sub-company

Operator

Area office

Area agent Retailer and super chain stores

Household appliances supermarkets

Customers FIGURE 1: TYPICAL

DISTRIBUTION CHANNEL FROM

keting, sales and after-sales services were no longer performed solely by mobile service providers but could be organized by manufacturers or thirdparty organizations. Before 1999, mobile phone manufacturers participated in almost all activities along the value chain, except distribution. That is, they internally developed integrated circuit chips and designed and manufactured mobile phones. There were only a few companies with such capabilities, including Nokia, Motorola, Siemens, Sony-Ericsson, LG, Samsung and NEC. According to regulations at the time, foreign enterprises were not permitted to form distribution subsidiaries, but must cooperate with locally established resellers. The typical MNC distribution channel in 1998 was a hierarchical distribution system comprising a general agent, regional agent, area agent, and the retailer (Figure 1). Accordingly, specialty sales companies such as Cellstar, Double Phosphor and TianYin emerged. After 1999, the stage was set for an explosion in the market. Many companies saw the opportunity and were poised to enter.

1999–2003: Manufacturing restricted deregulation stage In 1998, the newly established Ministry of InforVolume 8, Issue 1–2, July 2006

1997

TO

1999

mation Industry (MII) absorbed the functions of the former MPT, Ministry of Electronic Industry, State Radio Regulatory Office, State Information Office and Bureau of Special Electronic Installations. One of the first tasks of MII was to establish a framework supportive of the development of national mobile phone manufacturers – on one side, protecting local companies from global competition pressures, but on the other, establishing conditions for market competition among them (Li and Zhao 2004). As a consequence, by the end of 1998, the statement jointly issued by the National Plan Commission (which later evolved into the National Development and Reform Commission) and MII, concluded the following: • Establishment of a licensing regime for mobile phone manufacturers; • Establishment of export quotas, based on production output, for licensed foreign and JointVenture (JV) manufacturers; • Non-licensed foreign ventures or JV companies could produce locally only for overseas markets. Enforcement of the No. 5 document restricted market entry for foreign as well as local companies. In 1999, a first round of licenses was granted to nine Chinese enterprises, including Kejian, Xiahua,

INNOVATION: management, policy & practice

105

Hengyuan Zhu et al. TABLE 1: CLASSIFICATION

OF LOCAL MOBILE PHONE ENTERPRISES ACCORDING TO PRIOR BUSINESS BACKGROUND

Typical enterprises

Characteristics

Household appliances

Haier, TCL, Konka, Xiaxin

Telecommunications

Capitel, Eastcom and Panda

IT Mobile phone as the central business

Lenovo Bird

Household appliance enterprises before entry into the mobile phone business The SOEs belonging to MPT and former partners of the multinationals Engaged in IT products or services before entry Entrepreneurial high-tech enterprises from the very beginning; mobile phone their central business

Eastcom, TCL, Haier, Konka, ZTE, BIRD and Soutec. By the end of 2003, 30 GSM and 19 CDMA handset manufacturing licenses had been issued to 37 enterprises, among them 13 foreign and 24 local companies. In fact, after enaction of the No. 5 document, MII stopped licensing any new foreign enterprises – the only exception was Beijing Mitsubishi Mobile Communication Equipment Co. Ltd. which was granted a license for producing GSM handsets. In May 2000, MII decided not to issue any more licenses for mobile phone manufacturing phones but, in May, 2001 granted another GSM license to CECT. In August, 2001, another 19 CDMA handset licenses were granted, Motorola being the only foreign company recipient. After the last round of licensing to mobile

Chip manufactures, such as DSP, DAC, RF, CU

phone manufacturers, a decision was made to limit the number of licensees to 49. The mobile phone manufacturing licensing regime, to some extent, allowed companies from various industry backgrounds to enter this market segment. These mobile phones manufacturers, classified by industry background, are presented in Table 1. Local Chinese manufacturers with less or no previous experience in the telecom or mobile industry, because of existing technological barriers and lack of expertise in developing mobile phone products, engaged in procurement of OEM products, resold as company branded products, as a means of market entry. These upstream-finished products or SKD components (see Figure 2) were supplied mostly by Korean firms, such as Sewon

Software developer such as protocol, text input

Peripheral component manufactures such as PCB and LCD

EMS provider

Hardware platform chip manufactures

Mobile phone manufactures or ODM companies such as Quanta, Arimar communication, Telson, Pantech&Curitel etc.

Mobile phone brand holders as Konka, Capitel, TCL, BIRD, Soutec and Panda

FIGURE 2: OEM

106

OR

ODM

BASED PRODUCTION MODEL

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

The interaction between regulation and market and technology opportunities Chip manufactures, such as DSP, DAC, RF, CU

Peripheral component manufactures such as PCB and LCD

Software developer such as protocol, text input

EMS provider

Module or hardware platform chip manufactures

Mobile phone brand holders or manufactures as TCL, Soutec, and ZTE FIGURE 3: MODULE

OR HARDWARE PLATFORM BASED PRODUCTION MODEL

and Telson. In the beginning, this market entry model became the dominant option due to competitive pressure for local Chinese manufacturers to gain market share and establish brand identity in the shortest time possible. In 2001, TCL initiated another model based on developing its own peripheral non-key components, as well as software in Layers 4 to 7. TCL was purchasing modules produced by Wavecom, with integrated RF, IF, and BB as the main body of the design, and added its own internally developed parts (see Figure 3). Compared to the OEM/

Chip manufactures, such as DSP, DAC, RF, CU

Peripheral component manufactures such as PCB and LCD

ODM model, this model allowed TCL to control part of the phone’s appearance and benefited from low production costs, although the design time was lengthy. Before 2003, about half of the domestic mobile handset manufacturers adopted the module-based production. However, the production model was challenged by low flexibility and heavy reliance on upstream suppliers because terminal manufacturers could not control the number and type of components used. As an alternative and update to module-based production, hardware platform production model was

Software developer such as protocol, text input

EMS provider

Hardware platform chip manufactures

Mobile phone design companies as CEC Wireless, YuHua Teltech, Bellwave and Shanghai Longcheer etc.

Mobile phone brand holders as Capitel, TCL, BIRD, Soutec and Panda

FIGURE 4: DESIGN

SOLUTION BASED PRODUCTION MODEL

Volume 8, Issue 1–2, July 2006

INNOVATION: management, policy & practice

107

Hengyuan Zhu et al.

companies, also contributed to the rapid growth of Chinese handsets manufacturers. Because of this aggressive entry approach, the average price of mobile handsets decreased annually from 2,200 RMB in 1999 to 1,470 RMB in 2003; and industry spending on television advertising rose dramatically from 63,000,000 RMB in 1999 to 236,000,000 RMB in 2003. As a typical example, BIRD began building its proprietary distribution channel in August 1999. Within a year, it had 28 affiliates and more than 300 distribution offices nationwide. In 2003, the number of affiliates reached 41 one and there were more than 400 offices. Also, local companies understood that consumers preferred showy and fancy mobile handsets, seen as a status symbol. For example, the TCL was quite successful with a handset which embedded a gem on the surface. Another example was the rising popularity of clamshell handsets. After their first introduction by Motorola, local manufacturers imitated this design very quickly. In brief, that local companies have achieved a dominant position in the Chinese market is due to the advantage of local enterprises from the following: • Ability to recognize and understand local customer needs and ability to introduce products in accordance with clients’ behavior, preferences and tastes.

8000 6000 4000 2000

03 20

02

01

20

20

00 20

99

98

19

19

96

97 19

19

94

95 19

19

93

0 19

Salesofofmobile mobilephone phones(ten Sales (ten-thousand unit) thousand unit)

pushed by chip manufacturers. Today, many domestic manufacturers have R&D capabilities based on specific platforms. The third model, presented in Figure 4, is design solutions-based production where the manufacturer purchases blueprints from a design house, and production is typically done by the local manufacturer or with support from the design house. This model provides the best development speed with moderate cost. It became the mainstream model after 2003 because local manufacturers could successfully pass off re-branded third-party products in a market that was experiencing fierce product competition. During the development period from 1999 to 2002, the market underwent rapid growth as shown in Figure 5. From 1999 to 2003, Chinese local manufacturers managed to successfully capture the market, winning market share above 50%. Compared to less than 5% market share in 1998, these gains were quite spectacular (see Figure 6). Another critical element of this rapid advancement was an evolution in marketing and distribution strategies during the first part of this growth period. The traditional distribution channel, characterized by heavy hierarchy and low efficiency, was challenged by local enterprises which established a direct and less hierarchical distribution system. Heavy advertising strategies, evolving into full-blown promotion competition between local

Year FIGURE 5: GROWTH

OF MOBILE PHONE SALES IN

CHINA

Data source: Nikko CitiGroup; CCID

108

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

The interaction between regulation and market and technology opportunities

Market share

100% 80% 60% 40% 20% 0% 1999

2000

2001

2002

2003

2004

Year Domestic FIGURE 6: MARKET

Foreign

SHARE OF LOCAL MOBILE PHONE ENTERPRISES IN

CHINA

Data source: CCID

• Establishment of powerful distribution channels characterized by more direct access to client groups and sales efficiency. • Heavy advertising and promotion activities

2003–2005: Value chain fragmentation stage After 2002, competition was based less on price, distribution and advertising, and more on the ability to introduce new products. In this area of competition the market witnessed, on the one hand, establishment of a large number of mobile phone R&D centers by local MNCs. For example, LG established its research center in Beijing at the end of 2002, and NEC established its 3G R&D center in 2005. On the other hand, design houses became an important node in the value chain with respect to the new competitive situation. The number of design houses established in China reached approximately 50 in 2002, with the first, CECW, established at the end of 1999. This emphasis on product development has driven the rapid annual growth of new products introduced. For example, in 2004, the number of new products tested for certification reached 680 models, an annual growth of approximately 20% on the previous year. During this rapid growth period, MNCs realized the shortcomings of the indirect distribution Volume 8, Issue 1–2, July 2006

channel, including low efficiency, and inability successfully to penetrate the small and midsize cities which were captured by local firms with very aggressive marketing and promotion activities. The emergence and expansion of super-chain stores, such as Gome and Suning, operating nationwide and selling different household appliance brands, provided foreign companies with the opportunity to establish more direct access to their customers by making their products available to a broader range of cities, as well as benefiting from the efficiency of the distribution channels. The example was followed by local enterprises which began selling a portion of their products through super-chain store distribution channels. Market entry regulations in mobile phone production have been based for six years on Document No. 5. In February 2005, the National Development and Reform Commission (NDRC) enacted a new document, ‘Some prescriptions on mobile communication system and terminal investment projects’. According to the new regulations, licensing was now based on a so-called sanction system, which meant that any company could be granted with a license for producing mobile phones under its own brand following an application and approval process based on NDRC requirements. According to the associate chair of the China Mobile Communication Asso-

INNOVATION: management, policy & practice

109

Hengyuan Zhu et al.

Components

Before 1997

Chip manufacturer Chip manufacturer

Vertical foreign mobile phone manufacturer

Distribution

Operator

Distributor

Distributor

Local mobile phone manufacturers with license

Module supplier

Foreign manufacturer

OEM

Design house

OEM

Foreign brand manufacturer

Distributor

Direct chain stores Local mobile phone manufacturers with license

EVOLUTION OF THE MOBILE PHONE VALUE CHAIN IN

ciation, Xie Linzhen, the main difference between the previous licensing regime and the socalled sanction system is that while the government paid more attention to aggregate R&D capabilities in the former regime, with the latter system it lowered the R&D threshold and paid more attention to production or design capabilities of the whole handset, the software and the chip due to value chain segmentation. From February to October 2005, 20 enterprises in four batches have passed the approval process and acquired production licenses. In summary, the mobile phone industry value chain has undergone a gradual segmentation as shown in Figure 7.

DISCUSSION AND CONCLUSIONS The case presented shows that the main reasons for the successful entry of Chinese manufacturers into the mobile phone industry are from firms’ responses to the characteristic market demand, the distinctive features of the technology such as modularity, and to evolution of the regulatory framework. These three factors, in the different 110

Marketing

Vertical mobile phone manufacturer

Chip manufacturer (Total-solution provider)

FIGURE 7. THE

Manufacture

Vertical mobile phone manufacturer

Chip manufacturer

2005

Design

CHINA

stages of new entrants’ development, provided valuable room and timing for development of the different capabilities required to successfully compete with well-established players. Initially, the MNCs concentrated mainly on clients in the Tier 1 market through national supply agents, while Tiers 2 and 3 were mostly neglected. Meanwhile local companies, such as BIRD, understood the complexity of the market and that the low-end tiers could offer opportunities for new entrants. Light competition pressure from the MNCs in Tiers 2 and 3 allowed local companies, especially in the initial stage of their development, to accumulate technological and marketing capabilities, as well as financial stability, which enabled them to compete in higher tiers or more sophisticated markets. The complexity of mobile phone technology requires a broad range of technological capabilities, making it a difficult task for any single local enterprise to participate in all areas of the value chain. The modularity structure and availability of functional modules supported the successful entry of local companies with less or inadequate techno-

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

The interaction between regulation and market and technology opportunities

logical capabilities, thus lowering technological entry barriers. OEM and module suppliers, combined with the development of strong integration capabilities, placed local enterprises in a position to speed-up their market entry process. The successful commercialization is a consequence of well-developed abilities: to identify components and the linkages between them with respect to the product; to search and evaluate the related component technologies and source components from global market space; and to identify local demands and transform them into end products. The modularity enabled the possibility of specialization and divisions of capabilities, as well as cooperation, for effective and efficient integration between terminal mobile phone brand holders, design houses, components and module producers (Xie 2004). In comparison, MNC brand holders had a continuous vertical integrated model of production based on their technological capabilities and strategic goals. In addition, modularity also enables heterogeneous inputs to be recombined into a variety of products to meet various customer demands (Schilling 2000). Industry development was supported by various regulatory frameworks implemented in different stages by the Chinese government. Regulation with respect to production licensing, and the restrictive framework on MNCs (not allowing them to establish their own distribution networks), and limiting the number of licensed producers of mobile phones, was favorable for local enterprises to develop capabilities and increase market share. With respect to long term developments, it should be stated that successful entry does not guarantee the sustainability of good performance. During the current stage where demand for new and more technologically sophisticated products is defining competition in the market, MNCs have been able to overcome local enterprises mostly because of well developed in-house R&D and design capabilities. In comparison, local enterprises have developed limited R&D capabilities through the OEM/ODM and module-based Volume 8, Issue 1–2, July 2006

production. The benefits and limitations of product modularity have been discussed broadly (Gershenson, Prasad & Zhang 2004; Ernst D 2004). One of the limitations is the greater uncertainty that modular structure brings to the certain market, as Gershenson (ibid.) states: Even if flagships retain extensive systems integration capabilities and market power, they (the firms) may find it difficult to advance architectures in an industry. What we observed is that even though modularity lowers entry barriers, it increases the difficulties of competence upgrading after successful entry. Chinese mobile phone producers have learned something, while restrained in peripheral technologies such as MMI design, packaging and module-based production configuration development for a number of years after entry. To advance to the core technologies embedded in ‘hidden’ modules appears to be more difficult now for latecomer firms than before. Local companies in China initially enjoyed advantages from better understanding of the local market and from the changing technological structure and supply chain. Then, the MNCs learned from the locals and responded to the low end demand with sophisticated distribution channels, recently regaining some market share. The future of the mobile phone industry in China remains highly uncertain with regard to its competition status and to how Chinese firms will confront the adjusting strategies of the MNCs.

References Baldwin C and Clark K (2003) The value, costs and organizational consequences of modularity. Working paper. Dawar N and Frost T (1999) Competing with giants: Survival strategies for local companies in emerging markets. Harvard Business Review March–April: 119–129. Ernst D (2004) Limits to modularity: A review of the literature and evidence from chip design. East-West Center working paper. September No. 71.

INNOVATION: management, policy & practice

111

Hengyuan Zhu et al. Gershenson J K, Prasad G. J and Zhang Y (2004) Product modularity: definitions and benefits. Journal of Engineering Design 14(3): 295–313. Letovsky R, Murphy DM and Kenny RP (1997) Entry opportunity and environmental constraints for foreign retailers in China’s secondary cities. Multinational Business Review 5(2): 28–40. Li J and Zhao Y (2004) The development, competition and regulation on the Chinese mobile phone manufacture. Mobile Communication (in Chinese) 1: 53–57. Nie W and Zeng H (2003) The impact of China’s WTO accession on its mobile communications market. Journal of Business and Management 9: 151–170. Schilling AM (2000) Toward a general modular systems theory and its application to inter-firm

product modularity. Academy of Management Review 25(2): 312–334. Xie W (2004) Modularity and the rise of Chinese mobile phone manufacture industry. Science and Technology Management Research (in Chinese) 4: 20–22. Xu Y and Pitt D (1999) Competition in the Chinese cellular market: promise and problematic, in: Loomis DG and LD Taylor (eds), The Future of the Telecommunications Industry-Forecasting and Demand Analysis. Kluwer Academic Publishers, Dordrecht NL. Zhu H (2005) A Research on the Effects of Interfirm Product Modularity on Industrial Development: Lessons from Chinese Mobile Phone Manufacturing Industry. PhD dissertation, Tsinghua University, Beijing.

AVA I L A B L E A S A C O U R S E R E A D E R B IOTECHNOLOGY & T ELECOMMUNICATIONS I NNOVATION : D EFINING C ONDITIONS & P ROCESSES FOR E MERGING T ECHNOLOGIES Edited by Maureen McKelvey and Erik Bohlin Chalmers University of Technology, Sweden ISBN 0-9750436-7-6; softcover This special issue of Innovation: Management, Policy & Practice (Volume 7, Issue 1, 2005) is available as a course reader for Technology and Innovation students. Contents, Abstracts, Editorials, Articles and Order Form at: www.innovation-enterprise.com/7.1/

‘Understanding the driving forces behind investment in infrastructure and the effect of regulatory change on industry can help policy makers and researchers design a dynamic rate and direction of change. This can create a plausible and consensual future, shared by competing agents in an array of interdependent industries.’ – Maureen McKelvey ‘This edition provides important new knowledge of innovation processes in emerging technologies through its cross-sector exploration of specific and general aspects of innovation processes ... a resourse to be drawn on by policy decision makers ... for dynamic innovation systems.’ – Michael Christie and Anna Stephens eContent Management Pty Ltd, PO Box 1027, Maleny QLD 4552, Australia Tel.: +61-7-5435-2900; Fax. +61-7-5435-2911; [email protected] www.e-contentmanagement.com

112

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Copyright © eContent Management Pty Ltd. Innovation: management, policy & practice (2006) 8: 113–119.

Policy design and intervention in the innovation diffusion process: The case of China’s communication sector SUMMARY

KEY WORDS innovation; diffusion; telecommunication; policy design; policy intervention

The innovation diffusion process in China has varied impacts on different players in the industrial system, which can in turn either facilitate or impede the effects of innovation diffusion. Bringing not only growth possibilities to the newcomers but also high risks to the established players, the diffusion process might encounter with huge resistance in a highly regulated system, which is also called market failure. Based on intensive case studies in China’s communication sector, the paper argues that the structures of the innovation supply system will greatly influence the innovation diffusion process. Policymakers must leverage policy design and intervention to achieve expected strategic objectives. Therefore, proper policy intervention could become the trigger to launch and facilitate diffusion of emerging innovations in such a large developing country as China. Received 9 June 2005

Accepted 28 February 2006

JIANG YU

XIN FANG

Scientist CASIPM Beijing, China

Professor CAS Beijing, China

INTRODUCTION

I

nvention, innovation and diffusion is a sequential trilogy in the whole technological change process (Schumpeter 1947; Stoneman 1995). The concept of ‘diffusion’ here refers to the spreading of new technologies across potential markets. Until now, most studies on diffusion process have focused on the firm level and provided alternative Volume 8, Issue 1–2, July 2006

explanations to the dominant consensus that adoption of new technologies over time typically followed an S-curve, such as the epidemic model or probit model (Bass 1980 ; Oster 1982; Baptista 1999, Geroski 2000). Such diffusion models assumed that the innovation diffusion process was a market process of achieving long-run equilibrium by adjusting short-run equilibrium points,

INNOVATION: management, policy & practice

113

Jiang Yu and Xin Fang

with demand and supply forces affecting the diffusion process from time to time (Griliches 1980; Dixon 1980; Chatterjee & Eliashberg 1990). Furthermore, innovation transfer often occurs within a network in which different actors interact (Caputo et al. 2002; Rogers 1995). However, existing academic research on diffusion policies remains limited and fragmented. Few have explored how diffusion proceeded within a fast-changing system or the role of policymakers. The policy issue deserves more concern in a regulated context, where the boundary between regulators and players is sometimes blurred. We noticed that some argued that government could barely facilitate the process, and that SOEs (state-owned enterprises) are slow movers compared with private firms (Hannan & McDowell 1984; Rose & Joskow 1990). However, the amount of empirical studies on the impact of policy-makers is quite thin (Stoneman 2002). Based on detailed case studies of innovation diffusion in the Chinese telecommunication industry, the authors aimed to: • explore the dynamics of the innovation diffusion process under a transformational context, especially in large developing countries like China; and to • understand the changing role of policy-makers in such a diffusion process. An analytical model of policy-oriented diffusion is presented following the case studies. This article is based on an empirical study of China’s telecommunication industry, undoubtedly one of the most dynamic industries in developing countries, with an annual growth rate of 36.7% from 1996 to 2001 (MII 2001). A semistructured interview was conducted with senior managers in leading telecommunication firms as well as officials from the regulation ministries in China. Secondary data was collected from open publications including statistics, industry reports and corporate reports. This research tries to explore, from a policy perspective, how the innovation diffusion process interacts with the sys114

tematic transforming process of the industrial system.

CASE STUDIES: INNOVATION DIFFUSION IN THE TELECOM SECTOR Background In China, development of the telecommunication industry has been given the highest priority due to official recognition of its significance in the modernization process and for economic growth. Before 1998, Chinese telecommunication firms were closely affiliated to the industry regulators. The primary regulator was then the Ministry of Posts and Telecommunications (MPT); China Telecom (CT) was the monopoly telecom operator before 1993. To some extent, the MPT was responsible for the operational and financial performance of China Telecom and therefore they shared common interests (Xu 2001). As a result, potential competition was impeded. The real driving forces which placed China’s telecommunications industry on the liberalization track in 1998 came not from inside the industry but from the political vision of Chinese central government and the pressures of access to the World Trade Organization (WTO). More importantly, to boost the national economy in the face of global competition, the government was eager to vitalize the telecom sector and decided to introduce intensive competition among state-owned enterprises, instead of leaving it to the private sector. Therefore market mechanisms emerged in China. In April 1998, the Ministry of Information Industry (MII), a relatively neutral department, was formally established. It encouraged oncoming domestic competitors to improve the efficiency of the sector. In early 1999, the former China Telecom was split into four independent companies, respectively responsible for fixed-line services, mobile phone, paging and satellite communications service. The paging sector soon merged with China Unicom. In August 1999, China Netcom Corporation (CNC) was founded, with it’s building broadband backbone

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Policy design and intervention in the innovation diffusion process

networks. Beside the existing six nationwide telecom firms, (China Telecom, China Mobile, China Unicom, China Netcom, Jitong and China Sat (China Satellite Telecom)), China Railway Telecom was set up by the railway sector in 2000. A much more competitive market came into being. By 1999, the industrial reform had achieved some improvements – three new entrants (China Unicom, China Netcom and Jitong) had entered the data communication market with their constructing backbones. China Telecom, however, whose subscribers increased very fast and exceeded 100 million in 1999, still retained the biggest market share in the country. Different from China Telecom, the keen interest of its competitors was on new profitable market niches such as long distance voice service. In the PSTN (Public Switching Telephone Network market), the traditional circuit-switched fixed network, China Telecom monopolized for over 50 years, setting high entry barriers to potential entrants. The revenue from its long distance PSTN service was RMB 63.5 billion ($ 7.7 billion) in 1999 (MII 1999). This sector business is China Telecom’s mainstay, which it defends with every effort. Till now, the barriers to fixed telecommunication market entry remained as high as they were several years ago. While MII is under pressure to introduce market mechanisms and lower prices in the sector, new entrants are excluded by the high building costs of a new circuit-switched network. Therefore, in 1999, it was difficult for policy makers to find an ideal solution. Even if they did, the capacity to implement the policy would be very much restricted. In countries where Public Telecom Operators (PTOs) are regulated by independent authorities, like Canada, Britain, and the U.S., there is generally less precedent for regulatory agencies to be directly involved in technology and implementation of new technological matters of an operational nature (Milne 1997). The diffusion of innovation in a dynamic system like the telecommunication industry may lead to greatly unequal distribution of benefits among Volume 8, Issue 1–2, July 2006

industrial players. Case studies revealed that innovation diffusion, with regard to regulatory vision, has played a strategic role in the transforming process of the whole industrial system.

Characteristics of emerging innovation IP (Internet Protocol) telephony is the term used to describe the technology of carrying voice or fax over IP-based networks such as the Internet. Although there were some early applications of Internet telephony in 1996 and 1997, it was not until 1998 that services based on this new technology became significant (Wright 2001; Rinde 1999). The voice service over IP technology enables businesses and consumers to make phone calls at much lower costs than the traditional PSTN technology. Two key factors contributed to the cost-effective implementation of IP telephony recently. Firstly the price of IP equipments like network routers came down quickly. The second key factor was a reduction in bandwidth cost on international circuits in recent years (Rinde 1999). The voice quality of IP telephony has been improved with special QoS (Quality of Service) means and generic increasing bandwidth. With the quality upgrade, the users of IP telephony could make a call without caring what kind of hardware or software is at either end or in the middle. In China, the potential fixed operator can establish network gateways between its IP backbone and the local telephone networks of the incumbent to provide long distance voice service. Through the use of gateways, IP telephony users can connect directly with any other telephone in the world and finish calling through the IP-based network.

Opportunities: Policy design and intervention Under pressure from the public to break up the monopoly, neither the regulator nor the newcomers in China had any feasible solution. At that time, emerging IP telephony technology was pre-

INNOVATION: management, policy & practice

115

Jiang Yu and Xin Fang

sented to the whole industrial system, providing an opportunity to break through bottlenecked reforms. With the rapid penetration of the Internet in China, the supply of IP Telephony service became available in 1999. Among existing firms, the attitudes of China Telecom towards innovation were opposite to its competitors’. China Telecom was strongly against innovation for fear of threat to its former business based on traditional circuit switching. On the other hand, the backbones bandwidth union of China Unicom, China Netcom and Jitong reached 500 million bits/second in July 2000 (CINIC 2000) and the new competitors were eager to benefit from the innovation by making use of redundant backbone capacities to support IP Telephony services. Meanwhile, the emerging innovation also gave policy-makers a good opportunity to anticipate how the consequences of commercial adoption of IP telephony could greatly alter the existing structure of the industrial system. MII decided to open the commercial IP service to activate the fixed telecommunication market. The IP telephony service was defined as a new telecom service and was to be granted in the form of operational licenses. In April 1999, MII permitted China Telecom, China Unicom and Jitong Corporation to organize field trials of IP telephones for domestic and international long distance IP telephone and fax services. During the trial period, no settlement was made between the newcomers and the incumbent. In May 1999, MII granted an operational license to China Unicom for longdistance IP telephony services in 25 cities, closely followed by Jitong, China Netcom and China Mobile. The Ministry then published several regulations to standardize IP operation, providing technical specifications on the commercial operation of IP telephony. In March 2000, MII announced that the trial was completed and that the result, based on excited market response, was positive. Commercial licenses were then formally granted to China Telecom, China Unicom, 116

Jitong and China Netcom for commercial operations of IP telephony services. Another license was later granted to China Mobile for provision of IP telephony services using wireless application protocol (WAP). Every new competitor quickly developed an aggressive rollout plan and established network gateways between its backbone networks and the local telephone networks of China Telecom. Their subscribers could make domestic or international long-distance IP phone calls via any dialtone telephone, which meant that every original subscriber of the incumbent could become a potential subscriber of its competitors.

Facilitating diffusion process The new relationship between regulator and incumbent has given new entrants a favorable bargaining position in network interconnection with China Telecom. With permission from MII, this interconnection was available at any technically feasible point upon request from the new competitors. The new competitors had almost no interconnection fee payable to China Telecom, enabling provision of voice services at only a fraction of current costs. As a result, the diffusion of IP telephony innovation was facilitated on the supply side. Though IP telephony services did not meet the requirements (e.g. voice quality of early IP telephony) of some senior business users, it attracted most potential ordinary customers with its competitive price. The price of IP telephony fees is now set by the respective providers, with IP prices discounted from PSTN prices (set by MII) ranging from 57%, on an average domestic call, to 70%, on international calls to the US and Canada, with an IP telephony discount of 63% for other regions of the world.

Desirable consequences of diffusion? With a completely different cost structure from existing PSTN networks, and a preferential interconnection fee policy for competitors enabling

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Policy design and intervention in the innovation diffusion process         

FIGURE 1: IP-TELECOM

FR P &K LQ D 0R EL OH

&K LQ D 1H W

-L WR QJ

FR P

&K LQ D 8Q L

&K LQ D 7H

OH FR P

 

MARKET SHARE COMPARISON AMONG

CHINA TELECOM

AND ITS COMPETITORS

Source: MII

voice services to be provided at only a fraction of current cost, IP telephony enables the competitors to break the industrial barriers?to penetrate into traditional markets, and to capture value from the incumbent. The incumbent’s attitude to the launch of this emerging innovation is complex. In the long distance voice market, the domination of China Telecom has been greatly challenged by IP telephony service. Facing fierce challenges from other firms, China Telecom finally decided, after several months. to embrace the new technology to defend its market position. Figure1 sketches the IP-telephony market share comparison between China Telecom and competitors between 1999 and 2000. As a result of innovation diffusion, the fixed telecommunications industry in China ultimately evolved from monopoly to competition. Some literature forecast that IP telephony would lead to rapid adoption in developing countries around 2005 (Rinde 1999). However, the prediction came true in China much earlier than expected. IP telephony application has grown explosively in the past several years. Launched in 1999, it accounted for a mere 2% of long distance call minutes. However, this proportion had increased to 4.7% by the end of 2000 and to 32% by the end of 2001 (MII 2001). Policy intervention by the regulator has stimulated the innovation diffusion process. Under pressure Volume 8, Issue 1–2, July 2006

of competition from IP telephony providers, PSTN telephone providers reduced relevant fees in February 2000.

Subsequent diffusion in the wireless sector Encouraged by the growth in IP telephony, China Netcom and China Telecom began to challenge the mobile incumbents with the formal introduction of the personal handy phone system (PHS or ‘Little Smart’ in China), a new wireless technology. Having no mobile licenses, they are keen to promote ‘Little Smart’ more offensively to grasp market share from cellular operators. Under pressure from the decreasing price of mobile services, the regulators legalized the PHSbased service. To some extent, this policy incentive was also regarded as compensation for the delay of 3G licensing to fixed operators. The Little Smart mushroomed from small cities to big cities in 2002, threatening the existing cellular services provided by China Mobile and China Unicom. In March 2003, the PHS service was introduced into Beijing, regarded as an important milestone. With attractive pricing, the number of subscribers to Little Smart doubled to more than 13 million in 2002. The positive attitude of the policy-maker has made this rapid expansion possible. The two new entrants have grown into giants in China’s wireless sector.

INNOVATION: management, policy & practice

117

Jiang Yu and Xin Fang

Vision of policy-maker

Market demand

Available innovation

Legalization Innovationbased service

OF POLICY- ORIENTED DIFFUSION

Model of policy-oriented diffusion The practice of policy design and intervention by regulators is captured in the previous chapters. The policy-promoted diffusion process is here divided into two stages, namely policy formation stage and policy implementation stage. In the first stage, the policy-maker vision to break up the monopoly was the trigger for the formation and launch of innovation diffusion-purposed policies. And the policy formation is based on desirable consequences of further commercialized adoption. Innovation was rapidly diffused after the innovation-based service was legalized. In the second stage, the diffusion process has been facilitated and stimulated by policy implementation. As a consequence, diffusion finally changed the industrial structure. Looking into the dynamic change of the holistic system, potential users also played a key role in this process. Through case studies, a brief model of policy-promoted diffusion is developed here to facilitate understanding of the policy mechanism within the diffusion process, exhibiting the interactions between the policy-maker, and the behaviors of industrial players and innovation diffusions.

DISCUSSIONS AND CONCLUSION There are some practical and theoretical implications arising from the case studies. The innovation diffusion process has different impacts and conflicting interests among players in the given industrial system, which in turn either facilitate or 118

Consequence: Impacts on industrial structure

2.Policy implementation Stage

1.Policy formation Stage

FIGURE 2: MODEL

Facilitating the diffusion

impede innovation diffusion. Bringing not only growth possibilities to newcomers but also high risks to established players, the diffusion process might encounter huge resistance in a highly regulated system, resulting in market failure. Policymakers should carefully compare the costs of pursuing interventions with social welfare increases generated by the policy. It seems that policy interventions are desirable to push diffusion by legitimizing and spreading the emerging technology. Once initial launching barriers have been removed or decreased by policy intervention, competition between innovation suppliers can greatly impact technology improvement and price reduction. As a result, the monopolistic market structure can be broken up and consumers could finally benefit from the diffusion process. In the case study, interactions between policymakers and industrial players were explored. The article argues that the structural change in the innovation supply system will greatly impact on the diffusion process. More importantly, innovation diffusion, with support from the policymakers, could overcome barriers to further reform and enable effective competition. Policy interventions, carefully and selectively designed and implemented, were desirable to prevent confusion to the incumbent member in these circumstances. Policy intervention therefore became the real trigger to launch and facilitate diffusion of the emerging innovation. However, because of time limitations, there are still some radical prob-

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Policy design and intervention in the innovation diffusion process

lems in industry development which need to be noted. For instance, some deregulating industries in large developing countries like China are still generally administration-based. Such an institutional arrangement inevitably means that there will be many distorted behaviors and market uncertainties in future development, which can not be resolved only through diffusion of several innovations within the industrial system. We hope this paper helps to lay the foundation for future research under a broader context.

References Baptista R (1999) The diffusion of process innovations: a selective survey. International Journal of the Economics of Business 6(1):107–130. Bass F (1980) The relationship between diffusion rates, experience curves and demand elasticities for consumer durable technological innovations. Journal of Business 53: 551–567. Caputo A C; Cucchiella F; Fratocchi L; Pelagagge P M and Scacchia F A(2002) Methodological framework for innovation transfer to SMEs. Industrial Management & Data Systems 102(5): 271 –283. Chatterjee R and Eliashberg J (1990) The innovation diffusion process in a heterogeneous population: A micromodeling approach. Management Science 36(9): 1057–1079. China Internet Network Information Center, Survey Report On Internet Development In China (1999–2000). Dixon R (1980) Hybrid corn revisited. Econometrica 48(6): 1451–1461. Geroski P A (2000) Models of technology diffusion. Research Policy 29(4/5): 603–625. Griliches Z (1980) Hybrid corn revisited: A reply. Econometrica 48(6): 1463–1465.

Hannan T and McDowell J (1984) The determinants of technology adoption: The case of the banking firm. Rand Journal of Economics 15(3): 328–335. Melody W H (1997) Telecom Reform: Principles, Policies and Regulatory Practices. Denmark: DTU. MII (2001) Monthly report of Post and Telecommunications Development (December). MII (1999) Monthly report of Post and Telecommunications Development (December). MPT (1997), MII. (1998–1999) Monthly report of Post and Telecommunications Development (December). Milne C (1997) Telecom Reform: Principles, Policies and Regulatory Practices. Denmark: DTU. Rinde J (1999) Telephony in the year 2005. Computer Networks 31: 157–168. Rogers E (1995) Diffusion of innovation. New York: Free Press. Rose N and Joskow P (1990) The diffusion of new technologies: evidence from the electric utility industry. Rand Journal of Economics 21(3): 354–373. Schumpeter J A (1947) The Creative Response in Economic History. Journal of Economic History VII (November): 149–159. Science Marketing – New ways of getting research to markets: outcomes of a German/Australian cooperative project: The basic oxygen furnace. Bell Journal of Economics 13: 45–56. Stoneman P (2002) The Economics of Technological Diffusion. Oxford: Blackwell Publishers. Stoneman P (1995) The Handbook of Economics of Innovation and Technological Change, Blackwell, Cambridge MA. Wright D (2001) Voice over Packet Networks. New York: Wiley. Xu Y (2001) The Impact of the Regulatory Framework on Fixed-mobile interconnection settlements: The case of China and Hong Kong. Telecommunications Policy 25(7): 515 –532.

Innovation: Management, Policy & Practice welcomes submissions of CASE STUDIES If you have a recent study that fits the scope of the journal, please see the inside back cover of this issue for details of how to submit work on www.innovation-enterprise.com.

Volume 8, Issue 1–2, July 2006

INNOVATION: management, policy & practice

119

Copyright © eContent Management Pty Ltd. Innovation: management, policy & practice (2006) 8: 120–127.

Learning in a local cluster in the context of the global value chain: A case study of the Yunhe wood toy cluster in Zhejiang, China SUMMARY

KEY WORDS local cluster; global value chain; learning; wood toys

This paper examines learning by a local Chinese cluster from external sources, based on a detailed case study of the Yunhe wood toy cluster, in Zhejiang Province. Employing the theorems of global value chain and cluster learning, the paper explores various external channels of knowledge and the role of learning for local firms. The channels include international trade relations, FDI, expositions and domestic knowledge centers, and the Internet. The paper ends with a discussion on findings on externally sourced learning and policies for promotion of learning in the cluster. Received 9 June 2005

YANWEI ZHENG

SHIHAO SHENG

Zhejiang Administration School Hangzhou, China

Zhejiang Administration School Hangzhou, China

INTRODUCTION

T

his paper discusses the learning of local clusters from external sources from examination of the wood toy cluster in Yunhe, Zhejiang Province of China.1 Recently industrial clusters have received significant attention (Porter 1990, 1998; Nadvi & Schmitz 1999; UNIDO 2001; Hubert Schmitz 2003). Geographical proximity characterizes the firm-clustering phenomenon with varying degrees of vertical and horizontal specialization. The Yunhe wood toy cluster now consists of more than 400 firms, developed since its start in the 1970s.

120

Accepted 17 January 2006

This paper’s analysis of Yunhe wood toy cluster learning follows the theorem of learning in a global value chain (GVC) (Kaplinsky & Morris 2001; Gereffi & Kaplinsky 2001; UNIDO 2003; Gereffi, Humphrey & Sturgeon 2005). In a globalizing economy, the whole process of production is often widely dispersed geographically, and producers in developing countries are generally located at the lowest end of the value chain. Our analysis takes the stand that learning is the most important process for clusters in developing countries, if they expect to improve their situation in the value chain and to become com-

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Learning in a local cluster in the context of the global value chain

petent in innovation and competitiveness (Lorenzen 1998; Hofmaier 2001; Bathelt, Malmberg & Maskell 2004). For the learning of local firms in the global value chain, we distinguish learning from internal cluster sources and learning from external sources. Because of limits of resources in the local milieu, learning from external sources is crucial in order to avoid becoming locked-in to the low end of production (UNIDO 2003). This paper focuses on externally sourced learning. Section 2 presents the wood toy global value chain and the evolution of the Yunhe wood toy cluster. Section 3 probes the role of different external sources in learning at the local wood toy cluster in Yunhe. Section 4 discusses the findings.

YUNHE WOOD TOY CLUSTER IN A GLOBAL VALUE CHAIN

Wood toy global value chain The wood toy global value chain (Figure 1) starts with the forestry sector. Cut logs pass to the sawmill industry, which obtains its primary equipment from the machinery industry. Sawn timber moves to toy manufacturers who obtain inputs from the machinery, adhesives, paint and other industries, and also draw on design, financial support and management skill from the service sector. Through different distribution channels, toys reach the final customers. Ultimately, the toys will be recycled. This global chain connects different

Forestry

Sawmills

Logistics

Design Finance

Machinery

Wooden toy manufacturers

Paints

Fairs Distribution channels Domestic

Foreign

wholesale wholesale Domestic Foreign retail retail

Consumers

Recycling

Standards FIGURE 1: WOOD

Volume 8, Issue 1–2, July 2006

Internet

TOY GLOBAL VALUE CHAIN

INNOVATION: management, policy & practice

121

Yanwei Zheng and Shihao Sheng TABLE 1: GLOBAL

STANDARDS IN THE TOY INDUSTRY

General

Toy industry

Global

ISO9000, ISO14000 (ISO); SA8000 (SAI)

ISO8124 (ISO); International Council of Toy Industries’ Code of Business Practices (ICTI)

Nation

EC marking (EU); CCC (China)

EN-71 (EU); ASTM.F963 (USA); GB6675-2003 (China); ST (Japan)

Enterprise

Code of Business Practices of Wal-Mart, McDonald etc.

Code of Business Practices of HASBRO and MATTEL etc.

phrases relative to wood toy industry including production, design, transport, marketing, distribution, retailing and recycling all over the world. Due to different technological ability and market status, each respective stage in the chain gains varying added value. In a typical buyer-driven chain, global buyers dominate value distribution across the world (Table 1) (Gereffi 1999). Super retailers set up hundreds of retail sites, mainly in developed countries, providing toys purchased from different suppliers across the world, mainly in developing countries. By controlling distribution channels and promoting private brands, super retailers increase their influence on the global chain and gain a large share of value-added profits (Gereffi 1999). Brand markers focus on design and marketing while outsourcing toy production. Brand manufacturers like LEGO and HAPE used to produce toys themselves but since the 1990s show a preference for outsourcing. Their brand reputation and advanced technology maintain the brand markers and manufacturers in favorable positions in the global value chain over manufacturers in developing countries. Super retailers, brand markers and manufacturers constitute the group of global buyers. Producers in the toy global chain are increasingly located in developing countries. With limited design and distribution abilities, most of these focus on production only, especially the less experienced producers such as in China. For Chinese producers, Hong Kong businessmen 122

often stand between them and international buyers, linking the two ends with subcontracting and logistic services. For the global toy chain, toy expositions such as the world’s Top Three Toy Fairs of Nürnberg, New York and Hong Kong, offer channels for information dissemination. In China, toy expositions in Shanghai, Guangzhou and Yiwu are among the most important for trends in patterns, designs,demands and pricing, as well as providing platforms for communication between suppliers, buyers and competitors. Attendance at toy expositions has been one of the gateways for Chinese producers to enter and compete in the industry. Another information channel is industrial standards (Nadvi & Wältring 2003). Such standards (Table 2) address a wide range of issues including quality management procedures, health and safety norms, labor conditions, and environmental and social concerns. Various agencies such as UN agents, NGOs, national states and transnational corporations (TNCs) take keen interest in these standards. Regarding Working conditions and workers’ welfare is regulated by a Code of Business Practices for the global toy industry, introduced by the International Council of Toy Industries (ICTI) in 2001, and global buyers such as Toys R Us and Hasbro must urge supplier compliance to this Code. To meet international standards serves as motivation too for producers in developing countries to improve their technological and management capabilities.

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Learning in a local cluster in the context of the global value chain TABLE 2: GLOBAL

BUYERS IN THE WOOD TOY GLOBAL VALUE CHAIN

Type

Characteristic

Typical enterprises

Retailers

Control retail channel, understand consumption trend, own private brand, no production. Own brand, design and market ability, no production.

Wal-Mart, Target, Toys R Us Disney, McDonald

Own brand, design and market ability, own production ability, but prefer to outsource.

LEGO, HAPE

Branded Marketers Branded Manufacturer

Progress in information and communications technologies such as the widespread accessibility of the Internet has made knowledge transmission cheaper and faster. To an extent the Internet contributed to worldwide dispersion of the value chain. All nodes in the global chain – toy producers, designers, retailers and consumers – increasingly make use of the Internet in their businesses.

China is one of the most important wood toy exporters. Its wood toy production is concentrated in Zhejiang province, especially in Yunhe county in the southwest mountain area. It is known in China as ‘the hometown of wood toys’ (Figure 2). As early as the 1970s, some local firms in Yunhe had commenced toy production, and trade agents in Shanghai were responsible for product sales abroad. Massive development of the industry opened it to international trade in the ‘80s. The entry of private businesses altered the industry structure from previously state-owned and collective ownership, and a clustering divi-

sion of labor evolved. A few of the largest enterprises in China, such as XinYu and HeXin, produce end products, while small firms are developing around produce parts and components. Local suppliers for paint and adhesives and related services in transportation and package have also been established. Recently with the support of local government and self-organization of producers, the technological infrastructure is strengthening. A Wood Toy Industrial Park came into existence in Yunhe in 1992. Since 1995, initiated by the toy industry association, the Yunhe Mood Toy Productivity Center, the Wood Toy Quality Testing Center, the Wood Toy Research Institute and the Wood Toy Information Center have been established. Yunhe now has the biggest toy manufacturing and export base in China. Its production capacity constitutes one-third of China’s total. In 2003 more than 400 Yunhe wood toy producers produced outputs of 762 million Yuan (exchange rate with US Dollar: 8.3:1) of which 454 million Yuan was in exports, to 30 end consumers in North America, Europe and Japan. Back in 1983,

TABLE 3: STRUCTURE

2003

Yunhe wood toy cluster

OF

YUNHE

Type of firms Toy manufactures: Total Large firms Medium firms Small firms Accessorial firms Distributor

WOOD TOY CLUSTER IN

Numbers (unit)

Gross value (million Yuan)

459 20 128 311 38 12

761.8 450.4 251.5 59.9 7.9 647.6

Data resources: Xu Huanfen (2004), Analysis of Yunhe wood toy industry.

Volume 8, Issue 1–2, July 2006

INNOVATION: management, policy & practice

123

Yanwei Zheng and Shihao Sheng 2500 2000

China

1500

Zhejiang

1000

Yunhe

500 0 1995 FIGURE 2: GROSS

1997

1999

LEARNING FROM EXTERNAL SOURCES Learning is an interactive process, stimulated and channeled through links (Lundvall 1992). We distinguish between local learning, which proceeds through local links, and learning from external sources, which at the center include international links. With insertion of local production into the global value chain, learning from international sources played a most important role for growth of the cluster. We discuss var-

2003

YUNHE, ZHEJIANG

VALUE OF WOOD TOY INDUSTRY IN

outputs were 1.88 million Yuan, and before the reforms of 1973, they were a mere 0.1 million Yuan. Although the Yunhe cluster has grown in many aspects, it remains in a disadvantageous competitive position. One of its weaknesses is in international marketing. The majority of local firms are still heavily dependent on Hong Kong trade agents for international sales, except the few biggest which are able to manage trade with international buyers. The second weakness rests in its inadequate design capability. Most enterprises except a few, manufacture on samples provided by middlemen traders or global buyers. Yunhe producers therefore sit at the bottom of value creation chain, and price competition depresses their profit margin. In addition, local forestry resources reached their limits in the 1990s, since when Yunhe has to secure timber supplies from elsewhere. The sustainability of the industry is confronted as well with challenges from resource restrictions.

124

2001

AND

CHINA (IN

MILLION

YUAN)

ious forms of such externally sourced learning of benefit to the local cluster.

Learning from international trade relations International trade relations offered not only opportunities to explore the potential utility of locally abundant forestry resources, but also the technical and managerial knowledge to do so. Trade companies in Shanghai, Hangzhou and Ningbo, and later from Hong Kong, provided samples and quality requirements for orders which were the source of entry and initial imitative learning for local firms. Sometimes, trade agents made direct inspections and in order to fulfill requirements, local enterprises had to learn and improve. Sometimes, new techniques embodied in samples stimulated innovative effort more than imitation. For example, when an American client once provided a wood toy sample painted with broken-texture, a local enterprise was stirred to discover how. After thousands of experiments, it succeeded and the technique was granted a patent, bringing further orders to the firm. The recent prevailing investment of Yunhe firms in ISO 9000 or ISO 14000 certification can be seen as one of the consequences of increased international trade. Firms are pushed to higher business expectations, because to hold an ISO 9000 or ISO 14000 certification and to receive compliance with the ICTI Code of Business Practices is a symbol that the firm has reached an appropriate standard of production

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Learning in a local cluster in the context of the global value chain

and working conditions. This is now expected of theYunhe suppliers of global buyers such as HASBRO and Disney. However, learning from international trade relations is limited in production. Global buyers rarely extend their technical provisions in design and marketing in case local Chinese producers try to develop their own brand or market channels, and clash with the global buyers. Most Yunhe firms export toys with a global buyers’ brand. The few large enterprises, the major exporters, are inferior to their small firm counterparts in design or marketing; some of the latter producing only for the domestic market. The large firms produced 59.1 percent of the total outputs of the cluster in 2003; while patent development was disproportionately low at 12 percent.

Learning from foreign direct investment Foreign direct investment (FDI) transfers a package of productive elements including capital, technology and human resources. Since the 1990s foreign trade companies and TNCs, attracted by Yunhe, began to invest there. In 1997, a toy trade agent from Hong Kong set up a wholly owned trade company. In 1999 another Hong Kong investor set up a joint venture. In 2002 a brand wood toy manufacturer, HAPE International from Germany, also established a joint venture in Yunhe. FDI brought about advanced technology, management skills and various international links. Local firms can observe and imitate foreign subsidiaries and foreign subsidiaries may source from local enterprises to fulfill their orders. The coming of FDI hence possibly serves the local cluster as an element to promote content and structure, if policies and conditions are relevant. In Yunhe the learning effect from the presence of FDI has not been significant. One reason might be the short period since FDI was available. Another reason might be the few FDIrelated enterprises, some of which are trade companies which are basically in line with the abovementioned international trade relations. Volume 8, Issue 1–2, July 2006

Learning from expositions Learning from expositions is an initiative of local firms. Local Yunhe enterprises became active in the 1990s at expositions such as the Chinese Export Commodities Fair (Guangzhou) and the Shanghai Toy Exposition. Increasingly more local enterprises now attend international toy expositions as a good platform for local producers to communicate directly with international buyers and competitors, learning not only in technical terms but also in terms of marketing and relational capacity. This might lead to change in the so-called triangle relationship in which Hong Kong middlemen have stood between mainland Chinese producers and end users, although this triangle remains the major structure of the chain to date. Learning from expositions has been important. Since 2001, the people of Yunhe have held the China Wood Toy Fair as a twice-yearly exposition in their hometown. Besides attending expositions, entrepreneurs in Yunhe took business tours to visit the end market of their products. However, travel abroad is expensive and only a few large firms can afford it. Xinyun, for example, has improved its product design ability and expanded its share of the American market, thanks to accumulation of knowledge of the US market since its first visit to the USA in 1994.

Learning from domestic knowledge centers The Yunhe wood toy cluster seeks to establish links with domestic knowledge centers. In order to improve design and other technological capabilities, it has built cooperative relations with Tianjing University of Science and Technology and Zhejiang University of Technology. The cluster interacts with national agents such as the China Light Industry Association and the National Technical Committee of Standardization for Toy Industry. Visits and training programs by these agents in Yunhe have been useful sources of learning. In the domestic sphere, sales offices in other

INNOVATION: management, policy & practice

125

Yanwei Zheng and Shihao Sheng

regions have also served as information and learning sources. For example, in the ‘90s, HeXin Company set up a business office in Shengzhen and a manufacturing base in Chaoguan, Guangdong. It has been proven that information supplied to the Shengzhen office from Chaogan contributed greatly to the enterprise’s development.

Role of Internet The Internet has provided a wonderful learning channel for local enterprises in Yunhe. More than 20 local firms created company websites, and began online sales of wood toys. More enterprises use the Internet in search of information about buyers, partners, market trends and fashionable patterns. Progress in accession and connection to Internet has been rather rapid. For example, HeXin Company, a pioneer in e-commence in Yunhe, tripled its sales since making use of the Internet and is now able to deal with global buyers directly – 90 percent of its orders are transmitted via the Web, and no longer mediated through trade companies. Although the Internet represents new, cheaper and faster linkages for learning and innovation for local clusters in developing countries, developing an Internet-based e-commerce needs investments in hardware and support services, and more importantly in information sorting and absorption capabilities. Except the few pioneer users as mentioned, enterprises in Yunhe are still at a primitive Internet user stage.

DISCUSSIONS Nadvi and Schmitz (1999) distinguish between passive learning and active learning by clusters in the context of developing countries, even though the distinction between the two kinds of learning is conceptual and therefore vague in reality. Passive learning takes place naturally and automatically out of clustering or the international connection effects. Active learning requires that learners purposefully pursue knowledge. To achieve better learning results, an active attitude is a precondition in drawing upon external sources 126

as discussed in the section above; nevertheless, even a passive learner may learn something from the first two channels (from international trade relations and from FDI), while only active learners gain from the latter sources (expositions and knowledge centers outside the cluster). There are both passive learners and active learners in the Yenhe cluster. The discussion above shows in addition that initially they learn mainly from the first channel of international trade relations. Gradually, since the 1990s, some firms have been able to take the latter two channels and make use of the Internet, indicating that active learning requires not only an active attitude towards learning, but also technological knowledge – including searching and absorption capabilities – and financial capacity. Although this cluster has achieved limited progress, it still relies heavily on foreign technology, brand and only a few sales channels which seem to be gaining mastery of design and international marketing capabilities. In aggregate competitiveness terms, the wood toy cluster in Yunhe is still located at the low value-added portion of the global chain; it has even lagged behind competitors in Thailand and Taiwan. Disparity in learning attitudes and capacity is wide between firms in the cluster. Some leading firms stand out in willingness to take the risk associated with active learning, and in ability to acquire technological and managerial skills. They should serve as learning agents for the local cluster. Wei Jiang (2003: 115) finds similar phenomenon and contends that this is a characteristic feature of clusters in developing countries, because firms in developing clusters are inexperienced learners, and leading firms must play a role as a local center of knowledge diffusion and as examples to promote a learning and innovation culture. In this paper we focused on learning from external sources, assuming that such learning is important in the early stages of cluster development. In order to move up the learning ladder in both internal cluster learning and learning from external sources, it is urgent to strengthen supportive institutions and other means of cluster-

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Learning in a local cluster in the context of the global value chain

wide collective learning in China. A producers’ association is already in existence, to serve as an institutional basis. Training and collective efforts in design and marketing may help allow access to a higher share of profits from value creation activities. More purposeful promotion in links with external sources and internal exchanges would be conductive to better use of learning opportunities and spread of learning experiences. These are cluster-specific learning-promotion policies, and they deserve further studies.

Acknowledgement Partial results of Project 70373008 were supported by the National Natural Science Foundation of China, Project Y604289 supported by the Natural Science Foundation of Zhejiang, China, and Project N04YJ11 supported by the Social Science Foundation of Zhejiang, China.

Endnote 1 On cluster development in Zhejiang Province, China, please refer to papers by Xu, Chen, Bao and Gu in this issue (2006), 8(1–2): 144–152, 153–159.

References Bathelt H, Malmberg A & Maskell P (2004) Clusters and knowledge: Local buzz, global pipelines and the process of knowledge creation, DRUID working paper No 02-12. Available at http://www.druid.dk/wp/pdf_files/02-12.pdf. Gereffi G (1999) A Commodity Chains Framework for Analyzing Global Industries. Available at http://www.yale.edu/ccr/gereffi.doc. Gereffi G & Kaplinsky R (eds) (2001) Value of value chains. IDS Bulletins 32(3). Gereffi G, Humphrey J & Sturgeon T (2005) The Governance of Global Value Chains. Review of

International Political Economy, February, 12(1): 78–104. Hofmaier B (2001) Learning Regions – concepts, visions, and examples. Available at http://www .hh.se/hss/papers/papers/hofmaeier.pdf. Kaplinsky R & Morris M (2001) A Handbook for Value Chain Research. Available at http://www .seepnetwork.org/files/2303_file_Handbook_for _Value_Chain_Research.pdf. Lorenzen M (1998) Localised learning: Why are inter-firm learning patterns institutionalized within particular localities? Available at http://ep .lib.cbs.dk/download/ISBN/x644777655.pdf. Lundvall B-A (ed) (1992) National Systems of Innovation: Towards a Theory of Innovation and Interactive Learning, Pinter Publishers, London. Nadvi K & Schmitz H (eds) (1999) Industrial clusters in developing countries, World Development 27(9). Nadvi K & Wältring F (2003) Making sense of global standards, Ch.3, in: Hubert Schmitz H (ed) Local Enterprises in the Global Economy: Issues of Governance and Upgrading, Elgar: Cheltenham. Porter M (1998) Clusters and the new economic of competition. Harvard Business Review 76(6): 77–90. Porter M (1990) The Competitive Advantage of Nations. Free Press: New York. Schmitz H (Ed.) (2003) Local Enterprises in the Global Economy: Issues of Governance and Upgrading, Cheltenham: Elgar. UNIDO (2001) Development of clusters and networks of SMEs. Available at http://www .unido.org/userfiles/PuffK/SMEbrochure.pdf. UNIDO (2003) Industrial Development Report 2002/2003: Competing through Innovation and Learning. United Nations Industrial Development Organization: Vienna. Wei Jiang (2003) Industrial cluster: Innovation system and technological learning, Science Press: Beijing. Xu Huanfen (2004) Analysis on Yunhe wood toy industry, Investigation reports.

Innovation: Management, Policy & Practice welcomes submissions of papers on TECHNOLOGY TRANSFER If you have a recent paper that fits the scope of the journal, please see the inside back cover of this issue for details of how to submit work on www.innovation-enterprise.com

Volume 8, Issue 1–2, July 2006

INNOVATION: management, policy & practice

127

Copyright © eContent Management Pty Ltd. Innovation: management, policy & practice (2006) 8: 128–143.

Institutional innovation for technology transfer: Some new patterns of regional AIS in China SUMMARY

KEY WORDS institutional innovation; technology transfer; AIS (agro-innovation system)

As agreed broadly, technology transfer is very important for innovation in agrosectors of developing countries. An even more crucial problem is how to improve technology transfer from knowledge producers to users in the rural regions where small-scale household farming dominates. This paper explores the structure of the regional Agro-Innovation System (AIS) in rural China, which is currently evolving from linear simplicity into dynamic complexity. Based on successful case experiences, this article explores and compares four patterns of institutional innovation in regional AIS, or ‘Agricultural Company plus Farmer Households’ (ACFH), ‘Agro-clusters’, ‘Farmers’ Cooperations’ and ‘Academy–Agriculture Relations’ (AAR). It concludes that innovation policy should pay more attention to the access of small farmers to information and technology. Attempts to simply duplicate policies from successful regions cannot facilitate the diffusion of experiences and good ideas. Cultural backgrounds, factor endowments and manpower, as well as the character of different agro-technologies, should be considered when making policies for improvement of technology transfer. Received 9 June 2005

JUN TU PhD Candidate Research Center for Technological Innovation School of Economics and Management Tsinghua University Beijing, China

INTRODUCTION

D

iscussion of institutional innovation and agro-industrialization has been a hot topic of development studies in Asia, Latin America and Africa (Holloway et al. 2000; Escobal et al. 2000; Hong 2002; Huang 2000). In China,

128

Accepted 19 October 2005

rapid growth has occurred in the agro-sector since the launch of reform and opening up policies at the end of 1970s. However, compared with the fast ascent of other industries and the whole economy, the growth rate of agro-sector is in fact quite modest. In the past two decades, the average growth rate in the first industry is 4.51%, which is less than half of 9.48% for GDP growth, 11.53% for second industry growth and 10.05% for the third industry. Scholars attribute the lags partly to the nature of agriculture and partly to policy distortion in China: In the past five decades, the decision makers in China have squeezed farmers to get enough subsidies for manufacturing industry.1 Fortunately, the Chinese government is now trying to cor-

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Institutional innovation for technology transfer:

rect the serious imbalance between agro- and industrial sectors. For example, the theme of ‘No. 1 Document 2004’ of the State Council was ‘to increase the income of farmers’, and ‘No. 1 Document 2005’ was ‘to enhance the productivity of agriculture’. While urban–rural integration and urbanization are proposed (by many economists) as solutions for rural development, it is not practical to urbanize the extremely wide area of rural China in a short period. Nor is it affordable to provide direct subsidy to all peasants, which account for 70% of the population. In the near future, Chinese people will face the ineluctable problems of development of the agro-sector and rural regions. One of the most populous countries, China has to raise 21% of the global population with 9% of the world’s arable land. This country therefore is extremely short of land and water to support expansion of traditional agriculture. Scholars, whichever propositions they hold, all agree that it is time for Chinese farmers to embrace modern agriculture, instead of expanding traditional planting. In the new regime of chemical, biological and information technologies, ‘Technology’, ‘Learning’ and ‘Innovation’ have become key words of modern agriculture. While innovation studies have long been exploring the nature of technological innovation and institutional innovation, they mainly focused on manufacturing industry and high-tech industry. In the dawn of the new century, some scholars began to devote themselves to the study of innovation in rural regions of developing countries. The aspiration to rapid growth and development drives the studies of agricultural innovation in Asian and African Continents (Hall et al. 2001; 2003a; 2003b; Holloway et al. 2000; Escobal et al. 2000). Chairatana (2000), for instance, explored the key actors in the Agro-Innovation System (AIS) and catalogued them into three groups, or producers, supporters and influenced institutions. Temela (2003) analyzed the weakness of linkages of AIS in Azerbaijan with graphic methods, presenting a feasible approach to implement AIS investigation Volume 8, Issue 1–2, July 2006

and analysis. Ruttan (2002) argued that shifts in the demand for institutional innovation are induced by changes in related resource endowments and by technical changes. And institutional innovation, in the meanwhile, is the crucial reason of deviation between technology efforts and productivity growth. In China, Lin (1993) set up a series of models to analyze the relations between institutions, technology changes and growth. Huang (2000) suggested that market mechanism be introduced to the technology extension system by setting up models for investment upon agricultural R&D activities in China. The policy makers in China are also trying to improve local growth by indtroducing new institutions for technology transfer. However, only a few have achieved any success till now (Tu et al. 2004; Gu 2004). The ACFH, for example, is a very popular pattern in today’s China, being promoted in oceans of documents and papers. Meanwhile, some new AIS patterns have also emerged according to special local backgrounds. In most cases, the original technologies, breeds and seeds are from ‘outside’, for the basic research and development of technology is still very weak in local research institutes. To transform the imported technology into productivity is the core of local innovation in rural regions. In a nutshell, the innovation process of agrobusiness in rural China is eventually a process of technology acquisition, assimilation, absorption and production. In this article, the author triggers discussion of institutional innovation for technology transfer on the level of counties in China. The article employs the broad concept of institutional innovation as suggested by Ruttan (2002) – that institutional innovation includes both innovation in the structure of economic units and in the routines, norms and decision rules followed by these units.2 In the next section, the author will describe the changes of AIS in China in the past two decades. The third section, with case studies, introduces four patterns of institutional innova-

INNOVATION: management, policy & practice

129

Jun Tu

tion for technology transfer in China. The similarities and differences are analyzed in section four. Both the rational fundamental and their characters are explored and compared. The article concludes with cautions to today’s AIS as well as the implications for ongoing reforms in rural China. Based on the fieldwork in three counties and one city from two provinces, the author collects data and produces cases to support this work. Case 1 is from Fufeng County in Shannxi Province, which is a typical poor western county in China, with a population of 0.45 million. Case 2 compares two neighboring counties, Laizhou County and Shouguang County, in Shandong Province, which are relatively rich counties on the eastern coast of China. Laizhou is characterized by entrepreneurship, while Shouguang is famous for its huge vegetable trade market. Their size is similar: Each has a population of around 1 million and GDP of about 13 billion yuan (or about 1.2 billion Euro). But the pathways of their growth are very different. A small village in Laizhou County in Case 3 exhibits a special collective cooperation. Case 4 is from Baoji City in Shannxi Province, with a population of 3.65 million.

AIS IN CHINA: FROM LINEAR SIMPLICITY TO DYNAMIC COMPLEXITY Transformation of AIS in China In many developing countries including China, agro-sectors are dominated by family-based small-scale planting. This structure slows down the speed of diffusion and adoption of information and modern technology. While the Chinese agro-sector always achieved splendid performance in history, it has been laggard in the past hundreds of years, suffering from small-scale planting, obsolete technology and low added value. Since the foundation of P. R. China in 1949, China has set up the biggest Agro-Innovation System in the world by establishing numerous rural technology extension stations. As shown in Figure 1, from 1949 to the 1980s, a linear-like model characterized the AIS under the Planned Economy. Contributions from agro-firms, universities and consumers were minimal, compared with the strong government instruction executed upon the research institutes and technology extension stations. From basic research to applied research, technology development, and to the agro-business and trade market, all the links in

Applied Technology

Basic Research

Theoretic Output

Applied Research

Applied

Development

Techniques

Technology

Agrobusiness

Technology

Applied

Market Theory

Government Control FIGURE 1: TRADITIONAL

130

TECHNOLOGY EXTENSION SYSTEM IN RURAL

INNOVATION: management, policy & practice

CHINA: A

LINEAR MODEL

Volume 8, Issue 1–2, July 2006

Institutional innovation for technology transfer:

the value chain were under the strict control of government. Fairly speaking, under the Planned Economy, this institutional arrangement well suited the highly hierarchical and collective agricultural production.3 Although the system was badly damaged during the ten years of ‘Cultural Revolution’ in 1960s and 1970s, it successfully provided direct technology support to the collective production system (Wu et al. 2003). At the end of 1970s, Mao’s ‘Commune’ institutions collapsed from average rewarding and low productivity. Market reform was then launched in 1979–1980 by the central government, dissembling the previous collective groups and allowing individual farmer households to work for themselves. The ‘Household Contract Responsibility System’ undermined the basis of collective production and therefore impacted the AIS. The extension stations and research institutes were encouraged to stand on their own and participate in market competition. Many technical persons quit institutes because of falling research funds. During the transition of AIS, a vacuum of technology transfer influenced the growth of the agro-sector: Farmers, who now worked individually based on contracted land use, could not get enough training in agricultural techniques, which was provided intensively by stations and collective communes. On the one hand, the disassembled system was therefore in great difficulty with actors isolated from each other (Figure 2, in the case of Baoji City). On the other hand, the pressure of food safety and envi-

Government

broken

ronmentally friendly development made it urgent to upgrade traditional agricultural techniques. The demand for technology transfer has never been stronger than it is today. To rebuild the agricultural technology extension system, institutional innovations for technology transfer are bursting in rural China. The firms, universities and research institutes became more and more active, compared with the previous exclusive actor – the state-owned technology extension stations. The new systems vary greatly among regions, but all are much more complex and dynamic than before.

Structure of today’s AIS in China At present, the AIS are no longer simply the aggregation of extension stations. The author, in the case of Chinese economy, defines the AIS as follows: The Agro-Innovation System is a network of agricultural technology development, transfer and utilization. It consists of interactive actors including research institutes, government, technology extension agents, farmers, agroenterprises and so on. The interactions among actors in the system improve technology transfer and therefore enhance the innovation efficiency as well as local development. In this paper, discussion is focused mainly on regional AISs in China, especially at the county level. There are various stakeholders in the system, among which are nine primary actors:

Extension Stations

University

FIGURE 2: OLD

broken

Farmers

Firms

TECHNOLOGY EXTENSION SYSTEM IN RURAL

Volume 8, Issue 1–2, July 2006

BAOJI CITY

INNOVATION: management, policy & practice

131

Jun Tu

• government; • education and training; • research institutes and technology agencies; • banking and credit units; • marketing agents; • agro-material suppliers; • services; • farmers and small companies; plus • breeders and food processing companies. The details of those components are as follows.

Government The involved government policies include both senior level (central government and provincial government) and junior level (county government). Junior government in the regime of county or town has more flexible and direct influence on local development.

have boomed with the development of the national economy.

Banking and credit units Under the regulation of the Ministry of Finance, banking and credit units include almost all the commercial banks in rural China and small local rural credit unions. Rural credit has been in the midst of debate for a long time. Because of small-scaled production and poverty, farmers cannot raise loans for reproduction from banks. Entrepreneurs of small agricultural firms also complain that banks are not willing to grant them enough loans for technology development, nor can they get any venture capital. On the other hand, banking industry regards agricultural technology as highly uncertain and risky, partly because their credit standard benchmarks were produced merely for industry in past decades.

Education and training Education and training organizations include primary school, middle school, high school, colleges and universities. China keeps investment in agricultural R&D at the level of about 0.4% of GDP, which is higher than many other developing countries. Universities however account for a growing but still relatively minor share of the nation’s agricultural research resources.

Research institutes and technology agencies Before the reform and opening-up, all research institutes were owned and funded by the government, trying to do basic research and to provide technical support. Since the reform, they are required to compete in the market independently. In fact, most state-owned research institutes now receive few funds from the public sector and must raise money from the market. Therefore, research institutes and technology agencies are now important nodes of technology assimilation and localization. They are now doing more R&D in applied technologies, instead of in basic research. Meanwhile, private technology agencies 132

Marketing agents Marketing agents consist of intermediaries who bring producers into contact with existing and potential markets. Evolving from a seller’s market to a buyer’s market, agricultural product market in China is suffering the pain of over-production and product structural problems. To remain competitive in the saturated market, technological innovation is necessary and significant. More and more people are recognizing the importance of marketing in agro-business. In China, a very successful case is the International Market of Vegetables in Shouguang County. This huge market consists of networks directly covering more than 200 cities in China and nearly 100 countries (Wu et al. 2003; Tu et al. 2004). In this case, the market is not only the center of selling information and price forming, but also the center of technology transfer between producers and users. This case will be analyzed in the following section.

Agro-material suppliers Development of agricultural production requires

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Institutional innovation for technology transfer:

good supply of materials – farmers need construction materials for greenhouses, fertilizer and related chemical products, feedstuff, and agricultural machines. Considerable technology transfer is contained in equipment provided to farmers or processing companies.

Services Supporting the whole system, service business in the rural region is very active in some cases. It includes technological services such as machine renting with technician; transportation and logistic services; private consultancy services and technology training, some of whom also provide rough processing of harvest. Technology of machines, logistic business and management strategy are transferred through these services which also provide hotels and restaurants to improve the trading and marketing environment.

Farmers and small companies Farmers and small enterprises are core actors of the system and the main users of technology extension system, as well as the key to introducing innovations into production. As noted above, most farmers in China are characterized by smallscaled farming and conventional agricultural production. There are some family-run companies which are also very small. A number of successful communities based on villages has emerged, but they are suffering difficulties because of lack of modern management and timely information. We will analyze this pattern in the following section.

Breeders and food processing companies They possess a certain level of technology and management capacity. Many breeding firms and processing firms control considerable technology development capability. For promotion and marketing, many provide technical training and support to farmers, and thereby become an extremely active diffuser of technology. For this purpose, a prevailing model is ACFH, which will be analyzed in the following section. Volume 8, Issue 1–2, July 2006

Subsystems There are several actors influencing the system. A number of agricultural associations, for example, facilitate technology acquisition and assimilation by organizing training courses. What’s more, some organizations play multiple roles in the system. Therefore it is not proper to classify a unit definitely into an exclusive category. Many research institutes and universities are involved in both education and basic research. Companies with strong technological capacity also provide training courses and technical extension service. The structure of the system we propose in this article (Figure 3) is to draw a boundary of observation, for convenience of analysis and discussion. The author categorizes nine primary actors into three main subsystems (Figure 3): • Subsystem 1: Producers: Farms, small companies, breeders and processing companies are the core of the system, which are the main sources of technological innovation. They provide agricultural products and require intensive information flow both intra-subsystem and inter-subsystem. • Subsystem 2: Supporters: Research institutes and technology agencies, banking and credit units, marketing agencies, agro-material suppliers, and service agencies support the core of the system by technology extension, marketing, transportation, financing, and so forth. • Subsystem 3: Innovation environment: Government and education maintains the environment for facilitating technology transfer and encouraging innovation. By relative policy, government fosters certain actors and special linkages, smoothing technology transfer and enhancing competitiveness. Education is the fundamental of long-term development, crucial for the quality improvement of labor and emergence of innovative culture. In fact, policy and education is the basis for the growth of all the key actors.

INNOVATION: management, policy & practice

133

Jun Tu

M T E

R

F

P

G S

B

FIGURE 3: SIMPLIFIED

STRUCTURE OF TECHNOLOGY EXTENSION SYSTEM IN C HINA

Notes: government (G), education and training (E), research institutes and technology agencies (R), banking and credit (B), marketing agencies (M), agro-material suppliers (T), services (S), farmers and small companies (F), breeders and food processing companies (P).

CASES: INSTITUTIONAL INNOVATION FOR TECHNOLOGY TRANSFER IN AIS Applying the broad concept of institutional innovation, this article analyzes the changes of the institutional arrangement both inter and intra the actors of AIS, as well as the relations and institutions they follow. Every pattern has effects on special linkages of technology acquisition, assimilation, absorption or production. Through transforming small-scale farming to systematization production, some of them extended farmers’ demand for technologies. And some others achieved similar objectives by reorganizing the linkages. At present, many policy experiments are going on in rural China. Among the successful cases, we categorize the system into four patterns.4

ACFH (agricultural company plus farmer households) model ACFH is a dominating form of institution innovation in today’s rural China. Most policy makers believe this model can effectively both improve local economic growth and provide more profit to farmers. Under this arrangement, 134

the agricultural firm signs contracts with small farmers. The contract normally includes the following terms: 1. The firm provides high quality breeds (or seeds), materials, and technology training to farmers; 2. Farmers plant (or raise livestock) under the instruction of the firm; 3. Farmers sell the agricultural products to the firms with the contracted price, amount, quality and safety standard. This is a dumbbell-shaped value chain, in which the farmers only need to work out the central link with support of firms, and firms take care of input supply plus output marketing (Figure 7a). Baoji Wuyin Green Food Ltd in Fufeng County is a typically successful company in the ACFH Model. The firm was set up in 1998 and started its trial of ACFH in 1999. The main product is a famous breed of beef cattle, or Qinchuan Cattle, and the processed food (like charqui). According to the contract, the firm provides high quality calf and technology support to small and large farms. Small farms are normally able to feed a maximum of 4 head of cattle, and then send grown cattle to the large farms. Large farmers are richer and therefore equipped with better facilities. They collect tens of heads of cattle, and spend more than three months to increase the weight and quality of beef. The firm then purchases well-grown beef cattle from large farms and sells to outside markets, which normally include the Hong Kong and overseas market (Figure 4). In this case, the firm commits the feeding links to farmers. Thus, the firm is able to focus on R&D of breed improvement and processing technology, as well as marketing. In the technology transfer process, the company takes care of the acquisition and localization of high quality calf breeders and then improves the blood by crossbreeding and embryo transfer technology. The farmers need only feed the cattle under technical instruction.

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Institutional innovation for technology transfer:

Small farmers

Grown cattle

Large farmers

Cattle / Processing

Grown beef cattle

Outside markets

Firm Calf Technology Order form

Order form

Calf Technology Order form

FIGURE 4: VALUE

CHAIN OF

QINCHUAN

BEEF CATTLE BUSINESS ( IN THE CASE OF

In the past, individual farmers could not afford the technology or calf marketing information. By joining ACFH, they are supported by the firm. The firm is responsible for the upstream R&D and downstream marketing. Wuyin Company not only supplies new breeds, technical support, and cattle disease insurance, and then purchases beef cattle at an attractive price, but also deliberately adjusts the profit distribution along the value chain, to allocate more income to farmers. This helps increase income per capita in Fufeng County. Since 2000, the benefit from cattle feeding accounts for about 50% of the growth of income per capita in this small county. While the ACFH model is being advocated all over China, scholars call attention to some weaknesses in the model. Firms always have monopoly power in the cooperation, for they control both the technology and the marketing. This mechanism diminishes the farmer’s ability to learn and acquire technology. It also lessens the negotiation power of farmers, for they have access neither to the technology nor to the market. Unfortunately, the ‘Corporate Citizenship’ in Yinwu Company is not very common in China. In many cases, firms aim at profit maximum and therefore squeeze the farmers’ profit share (Gu 2004). Therefore, wealth is gradually concentrated with the entrepreneurs. The farmers, on the contrary, receive only a miserably small share of benefit. Without recognition of ‘Corporate Citizenship’ by the firms, the ACFH Model would not effectively increase the income of small farmers. Volume 8, Issue 1–2, July 2006

YINWU COMPANY)

Agro-cluster model Agro-cluster refers to a sizable agglomeration of production units in a spatially delimited area, in which interaction and learning among the actors is very active. The units could be either small and medium agricultural firms (agro-cluster type I) or small farms (agro-cluster type II). There are hundreds of clusters in rural China but most are running low-value added manufacturing or consumable goods including shoes, lighter, and clothes. Because of the character of agro-products and lack of entrepreneurship amongst farmers, clustering of agricultural firms or farms is not common. In Laizhou County for example, the small private agricultural startups are very active (Wu et al. 2002). This county historically has a tradition of technical innovation. During the market reform, some technicians quit the diffusion stations and started their own business. Many of them were well trained and able to develop new seeds or breeds. A few successful cases of forerunners in the early 1980s awakened the entrepreneurship passion and heroism spirit among local technicians. Laizhou people applaud the initiative of new startups and are tolerant of failures. Thus, under the policy encouragement and recognition of the public, those who possess certain techniques are willing to open their small business. Many of these small and medium firms are not merely working on planting. The business, called ‘technological entrepreneurs’, includes breed improvement, transgenic research, processing tech-

INNOVATION: management, policy & practice

135

Jun Tu

nology and production materials of plants, livestock and rare fish. The new breeds and seeds are high value-added products with a high technological barrier. Among hundreds of small and medium private enterprises in Laizhou, there are more than 260 ‘technological entrepreneurs’ and 96 private research institutes. These firms constitute a technology-intensive agro-cluster, with 2.3 billion yuan (or about 220 million Euro) of registered capital in total. The vegetable sector of Shouguang City exhibits another successful type (type II) of agrocluster (Wu et al. 2003). In the past 20 years, this county has developed a huge network of vegetable markets, seed markets, production material markets and technology markets. Their vegetables were directly sold to more than 200 cities all over China, as well as 37 countries and regions overseas. From 2000 to 2005, they have successfully held six sessions of the China (Shouguang) International Vegetable S&T Fair, which has attracted great attention and positive response from partners at home and abroad. At the sixth China (Shouguang) International Vegetable S&T Fair held in April 2005, contracted investment achieved up to 4.4 billion yuan (or about 4.3 million Euro). Thousands of local farmers are directly connected to and benefit from these efficient vegetable markets. The local technology reservoir also benefits from the international technology transfer through the seed markets and material markets. Since late 1990s, Shouguang has introduced over 500 varieties of vegetable from more than 30 countries. The efforts of technology assimilation in turn improved vegetable sales in international and domestic markets. Total planting acreage of green vegetables has reached 65,764 acres, and TABLE 1: INCOME AND EXPENDITURE STRUCTURE (2002 CURRENT CHINESE YUAN) (1) Case County A (Laizhou) B (Shouguang)

more than 100 species of vegetable have passed the standard test in the National Development Center of Green Vegetables. Entrepreneurship and technological capacity are both crucial in the forming of Laizhou cluster. The private firms possess abundant technology capability and market information. To some extent, it is similar to the ACFH Model. Agrocluster in Shouguang, however, is the clustering of farmers, mainly focusing on vegetable planting. The market building directly facilitates technology transfer from technology sources to farmers. As long as the prices and demand for products are transparent, farmers are able to rapidly enhance both technology capability and income. In Table 1, we compare the agro-clusters in Laizhou and Shouguang with the perspective of rural family economic status. While they have a similar income per capita, the expenditure structure shows different preference: Farmers in Shouguang tend to put more investment into production and education. The latter is 550 Yuan on a per-capita average, compared with Laizhou County at 290 Yuan (Gu 2004). A brief conclusion from this observation is that farmers are more active in participating in economic and technological activities when they have direct access to the competitive market and technology transfer sources (with low cost). The type II agro-cluster is much similar to another pattern of institutional innovation – Farmers’ Cooperation model.

Farmers’ Cooperation model Farmers’ Cooperation is a special type of farmers’ community: Farmers sign the contract agreeing to contribute a certain amount of capital and

OF RURAL RESIDENTS :

COUNTY A

AND

B COMPARISON

(2) Gross per capita income

(3) Net per capita income

(4) Overall expenditure

(5) Daily life expenditure

(6) Production expenditure

5193 7282

3947 4302

3782 5786

2389 2655

1390 3130

Source: Gu S (2004).

136

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Institutional innovation for technology transfer:

land to establish the community together, and therefore get corresponding shares. It looks similar to the disreputable ‘Commune’ in the ‘Cultural Revolution’, but the operation and rewarding institutions are totally different. The Cooperation collectively runs the whole business for farmers. The community concentrates the limited capital and resources to be scale-effective and to maintain stronger resistance to risk. It also speaks much louder than individuals when joining the market competition and negotiating with other actors. In Laizhou County, there is a Xiaocaogou Village, with a population of below 700. Different from other regions in Laizhou, this poverty village was located on barren stone hills. Under the lead of their chief, Mr. Song, the villagers set up Xiaocaogou Company collectively in the 1980s. Song was then the best-educated person in the village, working as a middle school teacher and then chief of the village. Being elected board chairman of the company, Mr. Song invested the startup fund in fruit tree planting. The Cooperation, with capital and support from all members, could afford the up-to-date facilities of irrigation, technology training and disease-resisting. Every year, revenue is divided into two parts: for the welfare of community members and for investment in reproduction. Without the Cooperation, the price fluctuation of gingko leaves over the years would have bankrupted individual farmers. Fortunately, with the accumulation of capital, investment in production infrastructures and modern facilities is continuing, and therefore leading to profitable output and technology improvement. At present the Xiaocaogou Company achieves an annual revenue of 3.5 million yuan. The income per capita from production reaches 3.5 thousand yuan. The Cooperation has transformed the whole village from poverty to riches. Farmers’ Cooperation gathers sources from individuals and directly benefits small farmers, avoiding inequality and exploitation. It also concentrates the limited resources from individuals to Volume 8, Issue 1–2, July 2006

carry on effective technology extension. However, these companies are normally managed by local entrepreneurs and based on trust in the community. These entrepreneurs are very wise and brave in facilitating the early stage. But when the enterprises grow, they lack modern management knowledge to deal with technology assimilation, R&D and international marketing. To achieve long-term development, the Farmers’ Cooperation needs to introduce up-to-date corporate governance experience and human resources.

AAR model The concept of AIR (academy–industry relations) has been broadly promoted to improve knowledge capitalization. However coordination between academies and agro-business is not as popular as AIR. The author employs the concept of AAR to explain a special institutional arrangement for technology transfer, or for cooperation between academy and agro-business. Baoji City, a typical ‘below-average’ developing city in west China, was located in a disadvantageous location and therefore short of most innovative resources: FDI, venture capital, educated manpower, and entrepreneurship spirit. To improve technology transfer, local government launched the project of ‘Courtyards for AgroExperts’ in 1999 (Tu et al. 2005). The government invited external experts to make short stays every year in the rural regions of this city, normally inside or near a village. The experts invested to build up special courtyards, which are typically two-floored buildings including sitting room, bedroom, laboratory, computer room and other necessary equipment. Normally, an area of experimental field is also allocated around the courtyard. Settled in the Courtyards, with both research and living facilities, experts are willing to stay among the farmers for a certain time every year, carrying on research and training farmers directly for free. Most successful Courtyards are close to the concept of ‘quasi firms’ (Etzkowitz 2003; Tu et al. 2005). They focus on both research (training) and proper reward.

INNOVATION: management, policy & practice

137

Jun Tu

Technical Extension

Government

FIGURE 5: TECHNOLOGY

Courtyard for Agro-experts

Farmers

University

Firms

EXTENSION SYSTEM WITH

The ‘Courtyard for Agro-experts’ rebuilds links between technology producers (universities and institutes) and users (farmers and firms). Thus the integral system was activated and applied technology could be transferred through crucial linkages; a brand new system of agroknowledge transfer system in Baoji (Figure 5). As shown in Table 2, the hybrid organizations possess flexible institutions and fix missing linkages of technology transfer. Thus, technology and information is transferred intra-system or interTABLE 2: MAIN

1 2

CHARACTERS OF QUASI - FIRMS :

FOR

AGRO-EXPERTS’

IN RURAL

BAOJI

system through these crucial linkages. Farmers are able to receive technology and training from the Courtyards for Agro-Experts with little cost. With the multiple sources of information and technology, Courtyards for Agro-experts and the farmers under their training could react rapidly to market fluctuations and technology changes. Till now, 34 Courtyards for Agro-Experts have been set up in Baoji, covering all districts and counties of this city. They have brought totally around 400 million yuan of growth to the annual

COURTYARDS

FOR AGRO - EXPERTS

Characters

Reasons

Rational and flexible management Corporate citizenship

The operation of the hybrid organizations is under control, and the experts’ interest accords with the firm’s. Realizing their social responsibility, the quasi-firms are more likely to set up local ‘trust’ environment. The farmers’ interest is fully considered. The organizations shall not abuse their monopoly power. With the support of top experts, quasi-firms incorporate strong S&T power with corporate governance. The hybrid organizations take place of former technology diffusion stations, training farmers and providing technical instruction. The experts, firms and government, even including farmers, all hold their up-to-date information in respective fields. The combination of information serves the courtyards with fastest reaction to the changes in technology, market and policy.

3

Advantages of technology

4

Knowledge diffusion

5

Fast reaction to the changes

138

‘COURTYARD

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Institutional innovation for technology transfer:

agricultural GDP of Baoji City, and about 100 yuan of growth to the average annual income per farmer, which is quite impressive for this region. (The agricultural GDP of Baoji in 2003 was 5,323 million yuan.) Since the launch of this project, the decline of growth rate of income per capita in the rural region has been stopped effectively, and in recent years has climbed quickly.

At present, the aforementioned patterns are seen as practical and successful in the respective cases. What’s more, the diffusion of the ACFH model is being used as a policy template. However, these patterns vary a good deal. And not all of them ideally benefit small farmers. These patterns all improved some actors or linkages in the AIS. Based on the AIS model of

China, as presented above and in Figure 3, we compare the structure characters of these patterns (Figure 6): 1. ACFH model improves the cooperation between farmers and firms; 2. Agro-cluster (type I) takes advantage of entrepreneurship and technological capacity to enhance competence of small and medium private producers; 3. Farmers’ cooperation (and agro-cluster II) increases self organizing of farmers and help farmers extend linkages to other actors (market agencies for example); 4. AAR model strengthens relations between academy and agro-business and therefore creates hybrid organizations such as quasi firms to facilitate the technology transfer between research institutes and farmers.

(A) ACFH

(B) AGRO-CLUSTER I

COMPARISONS AND IMPLICATIONS

(C) FARMERS’ COOPERATION

OR

AGRO-CLUSTER II

FIGURE 6: STRENGTHENED

(D) AAR

LINKAGES IN FOUR PATTERNS OF TECHNOLOGY EXTENSION SYSTEM

↔ ) refer to linkages strengthened, and black regions to actors strengthened. Notes: Bold arrows (↔ Abbreviations are defined in legend to Figure 3.

Volume 8, Issue 1–2, July 2006

INNOVATION: management, policy & practice

139

Jun Tu

The differences of institutional innovation for technology transfer lead to different performance of AIS among regions. As shown in Table 3, ACFH is a good model to boost local economy and able to work in high technology barrier fields. But since farmers are not directly benefiting from technology transfer, improved speed of technology or small farm income depends on the firms’ attitude. Agro-cluster type I requires an ‘innovative climate’ of entrepreneurship spirit. And that’s why this style takes place mainly on the east coast of China. However, this style is very close to the form of ACFH – only the new entrepreneurs possess the technology and market information. Few farmers are able to take advantages of technology acquisition and adoption. Farmers’ Cooperation concentrates individual capacity, thereby developing strong competence and distributing profits directly to small farmers. But many of them encounter management difficulties – they need a strong leader with modern management knowledge when the firm grows up. TABLE 3: COMPARISON

AMONG FOUR PATTERNS

Patterns

ACFH

Agro-cluster I

Organization example Linkages strengthened Actors strengthened Effects on small farmers

Firm+farmers

Private startups

F–P

Strength

Weakness

Initiative

140

This is the bottleneck to long-term development of Farmers’ Cooperation. Agro-cluster type II is the direct agglomeration of small farmers in the agro-sector. They are not connected to each other as closely as in the Farmers’ Cooperation model. But through well-developed factor markets, they are able to receive up-to-the-minute information on price, demand, materials and technology supply. Thus, farmers are more willing to take part in production and trade, and therefore benefit from technology transfer. The AAR model is a newly emerging type in rural China. While promotion of this model has begun in China, people still do not understand how to properly promote technology transfer through Academy–Agriculture cooperation. The Courtyards for Agro-Experts are new nodes between technology producers and users. Both farmers and small firms can get technology and market information from the experts. Meanwhile their feedback in turn improves the basic and applied research of agricultural technology. The Chinese academies are very prudent (or overprudent) about participating in agro-business.

Farmers’ Cooperation (or Agro-cluster II)

AAR Quasi firms

F–P

Farmers community (or Market+farmers) F–M

–

P

F (M)

F, P, E, R

Indirect & weak (strong when firms are willing to share) Strong capability for technology acquisition, assimilation, absorption and localization Firms may abuse monopoly power

Indirect & weak

Direct & strong

Indirect & strong

Moderate technological competence, with a certain capacity for technology assimilation and absorption

Economic and technological support on mall farmers; Strong capability for technology extension

Flexible institutions; Strong capability for technology extension; Feedback in turn improves research

Bottom–up

F, P–E, R–G

Need entrepreneurship Poor management capability Unstable organization spirit and technology capability Bottom–up Bottom–up Up–bottom

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Institutional innovation for technology transfer:

Government policy could be a lever to enhance AAR – and learn how to ameliorate the interaction of research and agriculture. These patterns are not exclusive to each other, but mutually complementary. In some regions, several forms may co-exist simultaneously. Agro-clusters, for instance, may also be connected with the ACFH Model. In Laizhou, the agro-cluster and Farmers’ Cooperation exist at the same time in different regions. Portfolios of various patterns could possibly avoid the bias of single patterns, keeping a balance between most actors in the system.

CONCLUSIONS Most developing countries are very weak in both rural economy and agro-technology compared with developed countries. Hence for the agro-sector of developing countries, modern agricultural technologies are always introduced from overseas. Thus, the first and basic argument of this paper is that the practical path of agricultural technology innovation and learning in these countries is to effectively improve technology transfer. Efficient AIS facilitate innovation and learning, and therefore accelerate economic growth and technology upgrade. However, it is not easy to change from the previous linear AIS to dynamic and complex AIS because of the path dependency of domestic policy and technology. The evolution of AIS in China, analyzed above, shows a painful process of ‘creative destruction’ under the complex impact of global economy, domestic reforming and a new technology regime. The second key point of this article is the focus on users of technology transfer. Most rural families are running extremely small farms, and therefore cannot afford market information or technology training. During institutional innovation for technology transfer, people need to balance the distribution of technology and profit among actors in the whole system. In the prevailing ACFH Model, for instance, firms are much stronger economically and technologically than small farmers. Firms are therefore able to grasp most of the profit by squeezing returns to the Volume 8, Issue 1–2, July 2006

farmer. On the contrary, Farmer’s Cooperation organizes individual farmers and thereby acts as a strong agent for them all. Agro-cluster type II also enhances farmers’ access to information and technology, forming an active market system. According to our analysis, none of the patterns is ‘perfect’ enough to ensure the success of innovation or economic growth. In rural China, a common tendency of policy learning is to simply ‘replicate’ so-called ‘perfect’ policies. Whenever there is a successful case (let’s say case X), most local governments try to directly incorporate the Case X experience into their own annual plan. However, Case X might frustrate other regions, even though it has worked well in the original place. People are always wondering why Case X does not work in their county. In fact, they should have had considered whether they needed to replicate Case X in an over simple way. And how far they could learn from good ideas? From the viewpoints of many scholars, the diagnosis in a system is to find out the missing linkages and improve institution innovation on these linkages. However, for local Agro-Innovation Systems in China, most linkages are very weak. It is impractical to develop all the linkages for the limitation of resources and knowledge pool in developing economies. According to the experiences of successful cases, the rebuilding of mere partial linkages or actors, instead of full linkages, may be enough to effectively facilitate technology transfer intra- and inter-system. Hence, the decision makers could identify local advantages deriving from local cultural background, resource endowment and manpower. This would help them find out the crucial linkages in which institutional innovations are most likely to take place. Finally, the author establishes that patterns of institutional innovation, or organizational restructuring, are closely related to characters of technology innovations.5 The innovation of embryo transfer technology, for example, could not possibly take place in an agro-cluster form, nor indeed in small farmer households. Only firms with

INNOVATION: management, policy & practice

141

Jun Tu

strong technological capacities could control the technology and the market. In these linkages, farmers are unable to get access to technology or markets. The proper distribution of benefit, in this case, possibly relies only on recognition of firms by ‘Corporate Citizenship’. Policy instruments could be advocated to encourage the firms’ social responsibility, encouraging actors to support weak and small farmers.

Acknowledgement Special thanks are given to Professor GU Shulin, who conducted the fieldwork with the author and highlighted many insights for the article. This work was supported by ‘The MOE Project of Key Research Institute of Humanities and Social Sciences in Universities’ (No. 04JJD630001) and ‘The Beijing Municipal S&T Commission Special Fund for Ph.D. Dissertations’ (No. ZZ0410). The author is responsible for any errors.

Endnotes 1 The distortion of policy includes land tenure institutions, constraint of crop prices, and lack of fiscal support, social security, medical and education infrastructures in rural regions. 2 A more inclusive definition of institutional innovation is more useful in the study of institutional innovation for technology transfer. It helps to explore the changes inside actors, between them and among systems and their effect on technology transfer. Organizations are defined as a subset of institutions involving deliberate coordination (Vanberg 1994). 3 In the early stage of MAO’s communistic policy, the countryside production system was divided into four levels: county, commune, brigade and team. All farmers were allocated to basic units (teams), attended collective work and averaged the same reward for labor. 4 While these four patterns cover most styles of institutional innovation, more patterns are, of course, emerging in the broad countryside of China. The author will trace up-to-date developments in reform in rural China and present a more holistic analysis in future work. 5 The detailed relationship between patterns of institutional innovation and technology 142

characters will also be explored in future work by the author.

References Chairatana P (2000) The economics of the agroinnovation system (AIS) Paper for DRUID’s Summer 2000 Conference, Rebuild, Denmark June 15–17. Available online at: http://www .druid.dk/summer2000/papergal.htm. Escobal J, Agreda V and Reardon T (2000) Endogenous institutional innovation and agroindustrialization on the Peruvian coast. Agricultural Economics 23: 267–277. Henry E (2003) Research groups as ‘Quasi-firms’: The invention of the entrepreneurial university. Research Policy 32:109–121. Gu S (2004) The role of market in transition of agricultural production and innovation system. Paper for Globelics Conference Beijing, Beijing. Hall A, Sulaiman R V, Clark N G and Yoganand B (2003) From measuring impact to learning institutional lessons: An innovation systems perspective on improving the management of international agricultural research. Agricultural Systems 78:213–241. Hall A, Sivamohan MVK, Clark NG, Taylor S and Bockett G (2001) Why research partnerships really matter: Innovation theory institutional arrangements and implications for developing new technology for the poor. World Development 29(5): 783–797. Hall A, Sulaiman RV, Yoganand B and Clark NG (2003) Post-harvest innovation systems in South Asia: Key features and implications for capacity development, in: Hall A et al. Post-Harvest Innovation in Innovation. DFID Crop PostHarvest Programme. Aylesford: Natural Resources International Ltd. Holloway G, Nicholson C, Delgado C, Staal S and Ehui S (2000) Agroindustrialization through institutional innovation: Transaction costs cooperatives and milk-market development in the east-African highlands. Agricultural Economics 23: 279–288. Hong Y S (2002) Problems and countermeasures on industrial development of agriculture. Journal of China Agricultural University (Social Sciences Edition) 47: 22–27. Huang JK (2000) Economics of agricultural science and technology investment in China. Beijing: Agriculture Press of China. Lin Y (1993) Endowments technology and factor

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Institutional innovation for technology transfer: markets: A natural experiment of Induced Institutional Innovation for China’s rural reform. Working paper number 689 of Department of Economics, University of California. Ruttan VW (2002) ‘Induced institutional innovation’ in Grubler A, Nakicenovic N and Nordhaus WD (eds) Technological change and the environment. Washington DC: Resources for the Future and Laxenburg Austria: International Institute for Applied Systems Analysis 2002, pp 364–388. Temela T; Janssen W and Karimov F (2003) Systems analysis by graph theoretical techniques: assessment of the agricultural innovation system of Azerbaijan. Agricultural Systems 77: 91–116. Tu J and Wu G (2004) Agricultural innovation in China: The case of Shouguang City. Science Research Management 6: 63–69.

Tu J, Gu S and Wu G (2005) A Promising New Pattern of Knowledge Transfer System in Rural China: Triple Helix of Academy–Agriculture– Government Relations. Paper for 2005 Asialics International Conference Apr. 17–20, 2005, Baoji City, China. Wu G, Tu J and Li X H (2002) Agricultural technological innovation system and development of private agricultural technology enterprises: Investigation Report of Laizhou Shandong Province. Tsinghua Review of Research on Development 20: 1–14. Wu G, Tu J and Gu S (2003) Innovation system and transformation of the agricultural sector in China with the case of Shouguang City. Paper presented to the Globelics conference on Innovation and Development, BNDES, Rio de Janeiro, Nov. 3–6.

SPECIAL ISSUE C ORPORATE S USTAINABILITY GOVERNANCE, INNOVATION STRATEGY, DEVELOPMENT AND METHODS ISBN 0-9750436-2-5; xiv + 238 pages; softcover

Edited by Andrew Griffiths, UQ Business School A special issue of Innovation: Management, Policy & Practice ( Volume 6 Issue 2 August 2004) Contents, Abstracts, Editorials, Articles and Order Form at: www.innovation-enterprise.com/6.2

Corporate Sustainability: Governance, Innovation Strategy, Development & Methods provides: 1. 2. 3. 4. 5. 6. 7. 8.

Valuable introductions to sustainable development innovation, policy, strategy and governance Ten Case Studies on sustainability initiatives, technologies, their implementation and outcomes Methods and challenges for building human and environmental capacity in organisations Developmental phases of corporate progress toward human and ecological sustainability Tools and strategies for understanding and evaluating corporate sustainability initiatives Lessons learned from new product development, trialling, assessment, success and failure Linkages between e-business, corporate sustainability, human and environmental capacity Scenarios and scenario planning for corporate, environmental and social sustainability. Course Coordinators are invited to contact the Publisher for an adoption evaluation copy. eContent Management Pty Ltd, PO Box 1027, Maleny QLD 4552, Australia Tel.: +61-7-5435-2900; Fax. +61-7-5435-2911; [email protected] www.e-contentmanagement.com

Volume 8, Issue 1–2, July 2006

INNOVATION: management, policy & practice

143

Copyright © eContent Management Pty Ltd. Innovation: management, policy & practice (2006) 8: 144–152.

Enterprise patenting in Zhejiang province SUMMARY

KEY WORDS intellectual property rights (IPR); enterprise patenting; technological capabilities; legal regimes; Zhejiang cases

Based on a survey of more than 2000 enterprises and the case analysis of a typical enterprises, this paper attempts to explore the characteristics of patenting development and the factors influencing patenting in Zhejiang in China. The paper proposes that patenting in Zhejiang enterprises is mainly affected by the technological capabilities of the enterprises and legal regime for IPR. A survey of these enterprises reveals that the technological capabilities of most are still at the stage of imitation and the number of the patents is rather small, compared with the large number of enterprises, though some leading enterprises are climbing the evolutionary ladder from primitive to creative imitation and becoming active in patenting. During the past 20 years the environment for IP protection has been greatly improved with the innovation of IP systems in Zhejiang, which encourage enterprise innovation, patent application and patenting management. The paper finally gives some suggestions on how to improve both technological capabilities and the environment for enterprise innovation. Received 9 June 2006

Accepted 17 January 2006

MINGHUA XU

JINQI CHEN

HAIBO BAO

Professor Director Soft Science Institution Zhejiang Administration School Hangzhou, China

Graduate student Zhejiang Administration School Hangzhou, China

Associate Professor Zhejiang Administration School Hangzhou, China

INTRODUCTION

P

atents are an important legal instrument for protecting intellectual property rights (IPR). Nordhaus (1969) deemed that a patent, by grant-

144

ing innovators temporary monopoly power, would stimulate the innovator to more effort in research and development (R&D) and innovative activities. Meanwhile, the patent encourages tech-

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Enterprise patenting in Zhejiang province

nology transfer through circulation of the technological information contained in the patent files. In recent years, there has been a worldwide surge in interest in patenting, in academia, in policy circles and in the business community. This heightened level of interest has generated a vast body of research focusing on patenting, in contrast to other means of intellectual property protection. Analysis of the research covers patent strategies and decision-making, and the mechanisms in which patents are employed and patented rights are enforced (Cohen, Nelson and Walsh 2000; Hall and Ziedonis 2001; Lanjouw and Schankerman 2001; Lanjouw and Lerner 2001). Research works in this area have considered whether patents play an prominent role in stimulating invention in developed countries (Scherer et al. 1959; Taylor and Silberston 1973; Mansfield 1986; Levin et al. 1987; Schankerman 1998; Cohen et al. 2000). There has, however, been little work, to our knowledge, that analyses the influences of intellectual property rights in a developing country such as China. This paper aims to fill the hole by studying factors that promote patenting firms and commercialize new technology in China. Based on a survey of patenting at firms in Zhejiang Province, the paper shows that the technological capabilities of enterprises and legal regime are among the factors that affect enterprise patenting. Zhejiang Province is located on the southeast coast of China, where the most market-oriented economic life and flourishing private companies have developed in the past twenty years. For example, in the list of the Top 500 private enterprises and Top 100 rich businessmen in China, Zhejiang Province holds one-third and one quarter respectively. Zhejiang was not, however, a magnificent place before the market reforms. Under the planned economy, it received the least central investment and therefore established few modern industries. Since China began to engage in market reforms and opened to international trade and technology, provincial development in Zhejiang has relied largely on private initiatives. Volume 8, Issue 1–2, July 2006

The private enterprises that gradually gained competitive advantage in several industries are the subjects of this paper. The paper is organized as follows. Section 2 discusses the characteristic technological capability building of enterprises in Zhejiang, and the relationship between technological capability building and patenting. Section 3 studies the development of the legal systems for IPR. Legal systems, which compose the environment where the enterprises manage their IPR, have been changing in the economy reforms. Section 4 concludes the discussion.

TECHNOLOGICAL CAPABILITIES AND PATENTING

The firms’ patenting development is, from the perspective of internal resources, related to their technological capabilities and their ability to apply acquired and developed technologies in the production of goods and services with novel utility, high quality or low price to be competitive in the marketplace (Hiroshi Ota 1992). Technological capability is one of the main factors that underpin the growth and competitiveness of firms. Utterback and Abernathy (1976) show a sequence of product and process innovation, in which during its life cycle, product innovation occurs frequently in the beginning, and process innovation follows after a dominant design is developed from competition and selection. Their work is based on observation of firms in developed economies, especially the United States. In developing countries, due to differences in political institutions, education systems, national resources endowments, as well as technological infrastructures, the nature and pattern of technological innovation is very different. Kim (1997), Kim and Nelson (2000) and Zhao and Xu (2002) argue that firms in developing countries begin their technological efforts with imitation, gradually moving to creative imitation, and finally to indigenous innovation. In line with thoughts like this, we analyze firms’ patenting in different

INNOVATION: management, policy & practice

145

Minghua Xu, Jinqi Chen and Haibo Bao TABLE 1: STAGES

OF TECHNOLOGICAL CAPABILITY AND PATENTING

Stage

Action(s)

Patenting

Imitation Creative imitation

Reverse engineering Assimilating immature technologies, or improving on mature technologies Setting up core technological capability through indigenous R&D, or integration of technology etc.

Little Low

Indigenous innovation

stages of technological capability development (see Table 1). At the first stage of ‘imitation’, relatively simple technological activities, such as reverse engineering of existing outside-sourced technologies, are involved. This stage does not require specialized investment in R&D. Learning is relatively simple; firms do not produce essentially new technologies entailing anything that can be granted a patent; they therefore possess few patents. However, even simple reverse engineering rarely occurs in a vacuum. Reverse engineering involves activities that sense the potential needs in the market, and knowledge or techniques that will meet the market needs, and infuses these two elements into a new project (Kim and Nelson 2000). In the stage of ‘creative imitation’, firms begin engaging in assimilation and incorporation of immature technologies or making improvements on mature technologies. Enterprise patenting comes into being. Nevertheless, since the acquisition of key technologies still depends largely on external sources, patenting frequency remains relatively low. At the advanced ‘indigenous innovation’ stage, pioneering activities in technological innovation

FIGURE 1: PATENTING

146

High

become indispensable. These activities should have roots in a firm’s internal competencies; whether the firm is capable of development and introduction of new products or services into the market (Kim and Nelson 2000). At this stage, the firm has to assimilate essential technologies and establish its core technological capabilities, through indigenous R&D or integration of technology, often with the help of a broad network of knowledge. Firms at this stage become active patentees in order to protect their innovation property. Our empirical survey proves that firm’s patenting behavior corresponds to their technological capabilities, and that development of technological capability brings an evolutionary process – from imitation to creative imitation and innovation. The survey on which this paper is based was mainly conducted in 2002. In support of the Intellectual Property Bureau of Zhejiang Province and Zhejiang Statistic Bureau, our investigation covered all 363 enterprises which, on the official record, have already entered patenting activities, in addition to an analysis of the general patenting trend. In terms of the general trend in patenting of firms in Zhejiang (Figure 1), patent applications were very rare in the period from 1985,

TREND IN

INNOVATION: management, policy & practice

ZHEJIANG

Volume 8, Issue 1–2, July 2006

Enterprise patenting in Zhejiang province

when the patenting system commenced operation in China, to the mid-1990s. The number of patent applications increased slowly compared with the total 600,000 firms in Zhejiang (mostly small or medium-sized). In 2000, there were some 3000 applications, of which 2500 were granted. Patent applications increased to about 3500 in 2002. Considering the total number of 600,000 firms in Zhejiang (mostly small or medium-sized), we can say with no risk that they were only in the primitive imitation stage of development until the mid-1990s. It is difficult to estimate if firms in the province have moved out of the first stage, since the 3500 patent applications in 2002 is trivial in comparison to the large firm population. This general estimation does not deny the fact that some leading enterprises are becoming active in patenting. The Zhengtai Company, to which we refer below, is climbing the evolutionary ladder from primitive imitation to creative imitation. With regard to the 363 patenting-active firms, a further survey was made as to the type of patents applied for and granted, the sources from which they developed their patents and so on. The results are summarized in Table 2. By 2002 the patenting-active firms cumulatively made 2807 patent applications, among which slightly less than 10 percent, or, 263 cases, were ‘invention patents’. The number of granted patents were 2446, in which an even less proportion, i.e. 142 were invention patents. The typology of patents indicates that the dominant proportion of patents that were generated in leading firms is located in less novel areas of innovation. On average each of the leading firms produced less than half of inventive patent. It is clear that the leading group of firms can be estimated at best in transition becoming from primitive to creative imitators. The survey indicates clearly the relationship between technological capability building, which can be approximately measured by their patenting performance, and growth and development of firms themselves. Although performance of patenting remained modest, the 363 leading firms Volume 8, Issue 1–2, July 2006

altogether earned revenue of 31,238 million Yuan from their patented products, account for considerably 43.16% of total sales in the surveyed year. In terms of profits, patented products made 3117 million Yuan, which is 36.51% of the total. Patented products contributed business taxes of 2884 million Yuan, or 34.72% of the total. Patented products constituted 1,288 million Yuan equivalent of exports, or 17.38% of the total that the firms in survey exported. A comparative sample was a group with 3209 enterprises. The Zhejiang Intellectual Property Bureau introduced this sample, which are seemingly becoming active in patenting. In our spot check, of total 62,372 products that the 3209 enterprises sold in 2003, 3032 were based on patented technology, account for merely 4.86%. The data show patenting performance is closely related to their performance in the market place of the forms. However, only a few enterprises in Zhejiang that have developed better patenting capacity. Most enterprises actually haven’t reached that level. Furthermore, the data in Table 2 show that the leading firms have mainly their internal resources employed for the generation of their patents – of 2336 patents that the firms hold as their IPR pool, the vast majority of 2238 was developed by the firms themselves. Patent licensing and transfer, as well as cooperative or contracted development of patented technologies are rare activities thus far to the group of leading patenting-active firms in Zhejiang. External sources from which patents were licensed or transferred were entirely domestic–domestic enterprises, domestic individual inventors and domestic universities and R&D institutes. Similarly partners with which collaborative patent development upon contract were mainly domestic as well, of which domestic universities and R&D institutes were at the frontier importance, followed by domestic enterprises. In this category, three foreign companies entered into existence. Now let’s introduce the case of Zhengtai Company, to illustrate the evolution of technological

INNOVATION: management, policy & practice

147

Minghua Xu, Jinqi Chen and Haibo Bao TABLE 2: PATENTING

STATUS IN

ZHEJIANG: 363

LEADING FIRMS

In which invention patents In which invention patents

263

2336

In which invention patents

176

2336

In which developed by the firms themselves

Total patent applications Total granted patents

2807

Patents that the firms hold Patents that the firms hold

2446

142

2238

Original: 1158, Improved: 1080 Applied patent: 2234, Unapplied patent: 102 Transferred patent: 4 Licensed to others: 8

Licensed from outside patent holders Transferred from outside patent holders

42

Developed in cooperation with other agent Developed with other agent upon contract

23

31

2

capability building and changes in its patenting behavior. Zhengtai produces low-voltage electric apparatus. It started in 1984 as a small family workshop with only 8 workers and having just 10,000-Yuan worth of output. Restricted by the small size, inexperience and limited capability, the company initially took imitation as its approach to technology and production. It did not have any sense of technological innovation and patent protection in that time. They earned great revenue relying on reverse engineering, and even counterfeits or clones of products appeared from wherever – that was possible because weak IP protection was posed on firms then in China. Zhengtai succeeded in the first stage by means of producing 148

Reasons for unapplied patents: 1. As technological reserve 2. As technical strategy 3. Low benefit 4. Technically immature 5. Big business risk

Transferred or licensed from: 1. Domestic universities or R&D institutes: 10, average price 1.4 million RMB 2. Domestic enterprise: 29, average price 5.0 million RMB 3. Individual patent holders: 19, average price 1.1 million RMB. Co-developer or contracted developer: 1. Domestic university: 11 2. Domestic R&D institute: 6 3. Domestic enterprises: 4 4. Innovative individual: 1 5. Foreign: 3

products with good quality, while imitating technologies developed by others. Afterwards with established market and disposable resource, Zhengtai began to invest greatly to develop new products, through assimilating some immature technologies and improving on the mature technologies. For doing this they recruited experienced engineers from Shanghai, the big industrial center in the Yangtze Delta. Nevertheless, in this period, Zhengtai protected its technologies mainly by keeping them in secret, patenting was seldom employed because there were not many creative elements in the products, even though the company had developed them as new. In the 1990s, Zhengtai consolidated its competitiveness, and Zhengtai is now attempting to

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Enterprise patenting in Zhejiang province

penetrate into international market. Zhengtai strengthened its market competitiveness based on creative imitation. This is signaled by the fact that Zhengtai developed its own product series, some of which are with patent protection, There are similar stories with a dozen of leading firms in Zhejiang such as the ‘001 Group’, Sunlight Group Co. Ltd, Zhejiang Canlight Medicine Corporation, Fortile Kitchenware Co. Ltd, Shaosheng Group, and Yuhuan Kangkang Medical Instrument Co. Ltd. Commonly they have developed their patented technologies and strengthened competitive positions in the market place. They are pioneers in creative imitation, and it seems that some of them would possibly upgrade further in innovative capabilities in accelerating paces in the coming years. We learned in our field survey that in recent years the firms have perceived the pressure on making original innovation, from the fierce competition and from the changed competition environment since China’s accession to WTO. Quite some of the firms exemplified have formulated explicit innovation and patenting strategy as an important part of their strategic management.

LEGAL SYSTEM FOR IPR IN ZHEJIANG China is experiencing transformation from a centrally planned economy towards a market-oriented. Legal system for IPR protection has been in change as well. We use Figure 2 to illustrate how legal protection institutions give influence on cost–benefit relations of an innovating firm, and

FIGURE 2: CHANGES

Volume 8, Issue 1–2, July 2006

hence to their attitude towards investment in innovation and patenting.1 In Figure 2, t1 refers to the time when an innovation enters into the market; t2 refers to the time when innovator’s profit equals to the innovation cost (area A = area B); t3 refers to the time of patent expiration; and t4 refer the time when the product can no longer be used. The area above the horizontal axis represents profits, as curves L1 (the social benefit curve), L2 (the innovator’s profit curve without illegal imitator) and L3 (the innovator’s profit curve with illegal imitator) indicate; while the area below the horizontal axis is the cost, as the cost curve L0 indicates. The figure is drafted by assuming that the profit is to be realized in real monetary terms, with no changes in exchange rate of currency and no uncertainties with regard to market demand or technological opportunity. In a real world these assumptions hardly exist; however, the figure is nevertheless informative to illustrate the relationship between legal institutions and the innovator’s behavior. Although there exist many practical difficulties in judging private–social profit rate (Griliches 1992), social benefit L1 is often above private benefit L2. This is because patented technology, as an intangible asset, has the public-goods nature; it can be spilled over through personnel flow, informal contacts, reverse engineering by competitors, or invalid protection (Mansfield et al. 1977, Mansfield 1985, Bernstein 1989, Jones and Williams 1977). Barzel (1989) points out that by transferring part of attributions of the

IN

IPR

INSTITUTION

INNOVATION: management, policy & practice

149

Minghua Xu, Jinqi Chen and Haibo Bao

original property, the property owner’s net profit always increases. Obviously, brutal illegal imitation impedes innovator’s profit earning seriously, it depresses curve L2 towards curve L3; Where imitation becomes vastly unlimited, the innovator’s profit might fall to be lower than the cost, and to that point onwards, firms would no longer have any incentive and capacity for innovation. This was the situation under the planned economy. Under the planned economy, some other institutional arrangement was employed to maintain necessary innovation activities, namely innovative activities were organized separately in government-run technological institutes, and investment in innovation was entirely allocated through public financing. It had worked in China in the 1950s to 1970s, but with low efficiency and that was partly and importantly the reason why market reforms initiated in the late 1970s. To cope with the transition of the economic regime, the legal system for IPR had to be reinstituted. China introduced Patent Law in 1984. Since then the Zhejiang provincial government has been active in the establishment and improvement of an IPR protection system. In 1987 Zhejiang provincial government enacted The Interim Procedures for Patent Application and Grant in Zhejiang, which was the first regional regulatory development on patenting in China. Since then the Zhejiang provincial government set up increasingly more branch patent offices to provide better services for patenting. By 2005, there have been 310 offices dealing with patent related affairs. The Provincial IP Bureau in Zhejiang has, in corporation with other government agencies and business associations, taken particular actions in areas where infringement against IPR appeared most seriously. Recently, nationwide information systems and reporting schemes on patenting are in development aiming to improve management efficiency and law enforcement ability. Zhejiang, with the development, is making efforts for interprovincial management of patenting. To show some aspects of law enforcement 150

capacity on patent, the settlement ratio of patent related law-suits are in increase in recent year. The provincial courts have dealt with more than 2500 cases on patent dispute since 1985. In 2004 the courts accepted 404 cases on patent disputes. It is informed that penalties caused by IPR infringement are rising. And obviously in China and in Zhejiang as well, the accession to WTO of China has brought about a dramatic surge in patent-related lawsuits. 2002 saw an increase of patent lawsuits by almost half compared with the previous year. Since 1998 onwards, the Zhejiang government stipulated additional set of measures to encourage firms’ innovation and patenting. For example, the government enacted a series of regulations and policies including The Regulation for Patent Protection in Zhejiang, The Zhejiang Provision of Special Funds for Patenting, The Interim Procedures of Reward to Sample Enterprises on Patenting. To sum up, Zhejiang and more generally China, has experienced a transformation in IPR institutions. IPR based institutions for proprietary technology has been introduced and developed to possess certain level of enforcement capacity and managerial efficiency. The development and enhancement of legal system in IPR has been a factor complementary to the building of technological capability as above discussed, responsible for the increased patenting performance in Zhejiang. To use the scheme in Figure 2, tightened and relatively effective legal system shifts curve L3 upwards to L2; specific funds and incentives for patent applications, and other technological infrastructural supports as well, compress the curve L0, these are means that have the effect reducing the costs for generating innovations. However one should remember, both the legal system development and the innovative capability building in Zhejiang are thus far limited. China will have a long way to go in this direction.

CONCLUSIONS Firms in Zhejiang Province, which are mostly private in ownership and with small and medium

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Enterprise patenting in Zhejiang province

size, seem now turning to become active in patenting, after being rather dull and sluggish in this regard during about two decades. Characteristic latecomer firms learning and capability building explain partly the dullness in the past and the current appeared surge, in parenting behavior of Zhejiang firms. Firms in Zhejiang had to start their business as beginners when economic reforms opened the space for their entry. Statistical and case data show that after twenty years of learning and accumulation, a small number of learning Zhejiang enterprises are now in the process of moving into so-called creative imitation stage of learning, with the majority remain basically early imitators. External to the firms, institutional development for IPR has played a part as well. IPR-related institutional development includes the stipulation and implementation of patent law in the mid-1980s, the thereafter organizational, regulatory and managerial development of the provincial patent system to build legitimating and enforcement capacity in which Zhejiang firms operate in dealing IPR affairs. This process may have been involved much of training and familiarization of the IPR institutions by all the businessmen and legal officials who could not have any experience from their career under the planned economy. The external factor in legal institutional development has to be functioning in an interactive manner with the internal factor in technological capability building of firms. These should be understood as responsible for the recent change in patenting behavior of Zhejiang firms. The growth of innovative capability of Zhejiang firms is not satisfactory as has demonstrated in their patenting performance. The majority of the firms are faced with great challenges as the experience of Zhejiang firms proved that imitative strategy cannot last long not only because imitation entails higher cost now with the tightening of IPR regime, but more fundamentally because competition without innovation would eventually collapse the firms themselves [see Volume 8, Issue 1–2, July 2006

(2006) Bao, Xu and Gu (this issue), pp. 153– 159]. However, turning to be innovative is not easy. Engaging innovation is costly and takes higher risks. The managerial tasks with innovative activities are more complicated and require new knowledge and competence. How could policies give guidance and incentives to assist to the strategic change? One line of such policies might be continuously providing incentives and information and better services in patenting affairs, such as small award funds, legal consultation and technical assessment services, training and dissemination of patent information and good practices in patenting. These are policies for the improvement of operational efficiency of the legal system and firms capabilities in patenting management. Some of these the Zhejiang IP Bureau has done well. More broadly, policies for the development of ‘framework conditions’, ‘science and engineering base’ and ‘transfer factors’ (See Oslo Manual) of the national and provincial innovation systems are crucial. Firms cannot innovate in isolation. Latecomer forms are especially weak in technological and managerial terms; their growth to a large extent is a function of the innovation system that forms operate in it. Thinking about Zhejiang firms, these system’s conditions are particularly to be the purpose of relative policies: a better developed science and engineering base would offer easy accessible knowledge as inputs into firms innovative activities; better developed links between firms and universities enable knowledge flows faster and more relevant. And industrial structure and well-developed market conditions among the framework conditions are indispensable factors for the firms in making decision on their innovation.

Endnote 1 This model is developed from Yang (1999).

References Barzel Y (1989) Economic Analysis of Property Rights (2nd edn), Shanghai People’s Publishing House, Shanghai, p. 5.

INNOVATION: management, policy & practice

151

Minghua Xu, Jinqi Chen and Haibo Bao Bernstein JI (1989) The structure of Canadian interindustry R&D spillovers and the rates of return to R&D, Journal of Industrial Economics 21: 324–47. Cohen WM, Nelson RR and Walsh JP (2000) Protecting their intellectual assets: Appropriability conditions and why US manufacturing firms patent (or not), National Bureau of Economic Research, Working Paper No. 7552, Cambridge, Massachusetts. Griliches Z (1992) The search for R&D spillovers. Scandinavian Journal of Economics 94(Supplement): 29–47. Hall BH and Ziedonis RH (2001) The Patent Paradox Revisited: An Empirical Study of Patenting in the US Semiconductor Industry, 1979–95, RAND Journal of Economics 32(1): 101–128. Hiroshi Ota (1992) Policy Implications for the United States, in: Japan’s Growing Technological Capability: Implications for the U.S. Economy, Arrison TS, Bergsten CF, Graham EM and Harris MC (Eds) National Academies Press, Washington. Jones CI and Williams JC (1977) Measuring the social return to R&D, Finance and Economics Discussion Series Staff Working Paper 1977–12, Federal Reserve Board, Washington, DC, February. Kim L (1997) Imitation to Innovation: The Dynamics of Korea’s Technological Learning, Harvard Business School Press, Boston, Massachusetts. Kim L and Nelson RR (2000) Technology, Learning, and Innovation: Experiences of Newly Industrializing Economies. Columbia University Press, New York, p. 3. Lanjouw J and Lerner J (2001) Tilting the Table? The Use of Preliminary Injunctions, Journal of Law and Economics 44(2): 573–603. Lanjouw JO and Schankerman M (2001) Characteristics of Patent Litigation: A Window

on Competition, RAND Journal of Economics 32(1): 129–151. Levin RC, Klevorick AK, Nelson RR and Winter SG (1987) Appropriating the Returns from Industrial R&D. Brookings Papers on Economic Activity 3: 783–820. Mansfield E, Rapoport J, Romeo A, Wagner S and Beardsley G (1977) Social and private rates of return from industrial innovations. Quarterly Journal of Economics 91(2): 221–40. Mansfield E (1985) How Rapidly Does New Industrial Technology Leak Out? Journal of Industrial Economics 34(2): 217–223. Mansfield E (1986) Patents and Innovation: An Empirical Study, Management Science 32: 173–181. Nordhaus WD (1969) Invention, Growth, and Welfare: A Theoretical Treatment of Technological Change, MIT Press, Cambridge, Mass. Schankerman M (1998) How Valuable Is Patent Protection? Estimates by Technology Field. RAND Journal of Economics, 29: 77–107. Scherer FM, Herzstein S Jr., Dreyfoos A, Whitney W, Bachmann O, Pesek C, Scott C, Kelly T and Galvin J (1959) Patents and the Corporation: A Report on Industrial Technology Under Changing Public Policy. 2nd edn. Boston, MA: Harvard University, Graduate School of Business Administration. Taylor CT and Silberston ZA (1973) The Economic Impact of the Patent System: A Study of the British Experience, Cambridge: Cambridge University Press. Utterback JM and Abernathy (1976) The dynamic model of product and process innovation, Omega, 3: 639–655. Yang W (1999) The Property of Technology Innovation, Tsinghua University Press, Beijing, pp. 146–150. Zhao X and Xu Q (2002) The Path of Technological Capability Evolution, Science Research Management 23(1): 70–76.

Innovation: Management, Policy & Practice welcomes L I T E R AT U R E R E V I E W S If you have a recent review that fits the scope of the journal, please see the inside back cover of this issue for details of how to submit work on www.innovation-enterprise.com

152

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Copyright © eContent Management Pty Ltd. Innovation: management, policy & practice (2006) 8: 153–159.

’Patent pool’ initiatives in manufacturing clusters in Zhejiang SUMMARY

KEY WORDS patent pool; IPR pool; manufacturing clusters; Zhejiang; IPR protection

Based on a case study of the IPR (Intellectual Property Rights) pool in the lock industry, Wenzhou, Zhejiang Province, China, this paper examines the formation and operation in which producers collectively take action in regularization and management of innovative knowledge in small firmdominated manufacturing clusters there. The study compares this emerging collective IPR management with patent pools in advanced economies, especially the United States, and explores the characteristics of the IPR Pool in Zheijiang manufacturing clusters. First, the essential rationale for collective action lies with the need for the survival and further development of the emerging rudimentary industry, as compared to mature or well-developed industries. Second, innovative knowledge regulated to protect the IPR pool is substitutive rather than complementary, and informal rather than formally granted by the IP administration as in advanced economy counterparts. Third, the local producers association plays a major role in institutional development for IPR regulation, while patent pools in the United States are alliances of members with no geographical proximity ties. The Zhejiang IPR pools example provides the necessary steps for latecomer manufacturing clusters to learn about intellectual assets and fair competition. Received 9 June 2005

Accepted 17 January 2006

HAIBO BAO

MINGHUA XU

SHULIN GU

Associate Professor Zhejiang Administration School Hangzhou, China

Professor/Director Soft Science Institution Zhejiang Administration School Hangzhou, China

Professor School of Economics & Management Tsinghua University Beijing, China

Volume 8, Issue 1–2, July 2006

INNOVATION: management, policy & practice

153

Haibo Bao, Minghua Xu and Shulin Gu

P

atent pool is a collective institution for intellectual property rights (IPR) sharing and transaction. This paper aims to introduce the IP pooling phenomenon appearing in small firmsdominated manufacturing clusters in Zhejiang Province, China. The study is a sister piece to that reported in Xu, Chen and Bao [(2006) this issue, pp. 144–152]. While the work by Xu et al. focuses on formal patenting behavior of firms in Zhejiang, this work gives particular attention to informal, cluster or community-based knowledge sharing and protection initiatives; that is, firms in a cluster collectively take action in regularization and management of innovative knowledge and relative production and marketing. Zhejiang is on the southeast coast of China. With limited arable land, mineral deposits and industrial investment in the planned economy period, in the past twenty years Zhejiang has developed the most market-oriented private small firms in China, employing some 10 million workers. Most firms are engaged in labor-intensive ‘low-tech’ manufacturing and, often, similar businesses are clustered in a certain geographical area of ‘Town’ or ‘County’, the lowest levels of administrative unit in China, with varying degree of vertical disintegration in division of labor among firms. There are 500 or so such specialized clusters in Zhejiang, producing socks, cloths, footwear, carpentry, low-voltage apparatus, ties, water pipes and valves. This paper discusses the IP pooling phenomenon in Zhejiang with a detailed case study of the lock industry in Wenzhou, Zhejiang. Section 1 introduces patent pools in advanced economies, especially in the United States. Sections 2 presents and interprets patent pool practice in Zhejiang, using a detailed case study. Section 3 discusses findings and raises research questions for further study.

PATENT POOLS IN ADVANCED ECONOMIES A patent pool is often based on an arrangement among multiple patent holders to aggregate their 154

patents. A typical pool makes all pooled patents available to each member of the pool, and offers standard licensing terms to licensees who are not members of the pool. The pool then allocates a portion of the licensing fees to members according to a pre-set formula or procedure. Patent pools appeared in the second half of the 19th century and the first half of the 20th century especially in the United States. Due to antitrust regulatory intolerance the use of patent pools declined in the second half of the 20th century. However, the use patent pools began to surge again recently in response to the accelerating pace of technological change and to a changing legal system for IPR in which patenting costs and barriers to enter into patented technological areas increased. Carlson (2003) estimated that in 2001 sales of devices based in whole or in part on pooled patents were at least $100 billion. Now patent pools are playing an important role in some high-tech industries in the present competition arena. Following are some patent pool cases in early and present times.1 The first patent pool was formed in 1856 around intellectual property conflicts in the sewing machine industry. In 1908, Armat, Biograph, Edison and Vitagraph formed a patent pool that aggregated all of the important patents for the early motion picture industry. The pooling agreement specified that royalties were to be paid into the pool by licensees of the pool patents. An aircraft patent pool was founded in the United States by July 1917, urged by an advisory committee convened by the then Assistant Secretary of the Navy, Franklin D. Roosevelt. The aircraft pool, which encompassed practically all airplane manufacturers in the US, resolved all pending infringement claims and bound its members to give each other non-exclusive licenses of all airplane patents then or thereafter owned or controlled (with unimportant exceptions). The pool’s charter contemplated only 100 members; apparently more than adequate to accommodate the potential membership. Members promised

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

‘Patent pool’ initiatives in manufacturing clusters in Zhejiang

not to put relevant patents out of the pool’s reach, by taking an exclusive but non-sublicensable license. The MPEG-2 pool formed in 1994 began as an agreement among nine patent holders to meet an international standard known as MPEG-2 video compression technology. The pool was an outgrowth of the creation of the MPEG-2 standard established by the Moving Picture Experts Group of the International Standards Organisation (ISO) and the International Electrotechnical Commission. The MPEG-2 Standard patent pool comprises a number of essential patents put into the hands of a common licensing administrator empowered to grant licenses on a non-discriminating basis, collect royalties and distribute them on a pro-rata allocation based on each Licensor’s contribution. The terms of the arrangement were negotiated with and approved by the US Department of Justice. In 1998, Sony, Philips and Pioneer formed a patent pool for inventions that are essential to comply with certain DVD-Video and DVDROM standard specifications. In 1999, another patent pool was formed by Toshiba Corporation, Hitachi Ltd., Matsushita Electric Industrial Co. Ltd, Mitsubishi Electric Corporation, Time Warner Inc. and Victor Company of Japan Ltd for products manufactured in compliance with DVDROM and DVD-Video formats. Now companies that manufacture DVD discs or equipment have only to deal with these two pools, instead of the ten separate firms that formed them. These patent pools have been active in posing patent fee charges on China’s emerging DVD industry. The phenomenon of patent pools, resurging recently, has received inadequate attention. Nevertheless, the literature has been growing. Carlson (1999) and Gilbert (2002) provide a historical perspective to patent pools. Priest (1977) and Shapiro (2001) attempt to develop models on patent pool rationales. Bittlingmayer (1988) and Clark (2000) study single patent pools in the aircraft and biotechnology industries. Merges (1999) summarizes transaction characteristics of patent Volume 8, Issue 1–2, July 2006

pools. For the purpose of this paper, we briefly summarize the findings relevant to our study.

Relations of patents in a pool The relationships of patents in a pool can be divided as blocking, complementary or competing (or substitutable). Blocking patents are when one patent is necessary for the practice of other patents, while the others are not necessary for the former. The former patent hence is the dominant patent and the latter improvement patents. Complementary patents are those collectively necessary to practice a technology. And competing or substitutable patents are those with which associated technologies compete with each other. Shapiro (2000) points out that patent pools raise welfare when patents in a pool are complementary but cause harm when they are substitutes. From an antitrust perspective, combining blocking or complementary patents into patent pools can be tolerated, but not combining competing patents. Theoretically, a patent pool with competing patents tends more possibly to constitute monopolization of the technology than a patent pool in which patents are competing. Scholars who study in the context of advanced market economies often see that blocking or complementary patent pools have been used advantageously to overcome transaction cost problems within the patenting system. Interestingly, IPR pooling in Zhejiang small firm clusters, on which this paper reports, started with substitute technologies. The motivation was not to solve problems as blocking or complementary patent tools were faced, for there was not much blocking or complementary IPR in the clusters in the early stage of imitation. What, then, were the motivations of the pools that evolved in the Zhejiang, China cluster? We will argue that, based on observation, it comes initially from the need for survival of the primitive imitation-based manufacturing activities. It was an effort by a group of manufacturers to regulate competition behavior, associated with an emerging market.

INNOVATION: management, policy & practice

155

Haibo Bao, Minghua Xu and Shulin Gu

Roles of patent pool

Sponsorship and formation How do patent pools promote intra-industry of patent pools technology transfer and strengthen cooperation of firms so as to increase economic efficiency in innovation? According to the available literature, patent pools play a role in reduction of transaction and enforcement costs, and promotion of knowledge sharing. All patent pools observed commonly developed regularized mechanisms for patent transactions. With a simple, coherent menu of prices and other terms, the collective patent pool organizations reduce the high transaction costs of repeat contracting, both among members and between members and users. Combining rightholder property rights into useable bundles, along with the establishment of pool IP transaction rules are useful in overcoming the tragedy of ‘anticommons’ while still preserving the incentives that come with these rights. The collective enforcement of patent pool property rights lowers the cost for prevention of trespassers or infringers, which might otherwise be prohibitively high for small firms. In patent pools, all community members cede some of their property rights to the community, and commit to protect those collective property rights and police against trespassers. In some cases, this creates collective IP enforcement efficiencies. Today, firms increasingly frequently engage in negotiations on patenting issues. Patent pools, as collective institutions for regulation and management of IP transaction and enforcement, are helpful for the sharing and dissemination of patented technology. Moreover, patent poolbased collective action has a participatory and repeat-play nature of exchange. Through collective management of patent transaction and IPR enforcement – and through other activities such as clearing and evaluation of IPR, coordination over and the launch of new technology standards, and promotion of research and development (R&D) – patent pools are smoothing the way for knowledge flow and knowledge sharing. 156

In several reported cases, mostly in the United States, patent pools were formed at the initiative of related patent holders with various interests, from securing benefits from patented IP to the protection of patented technologies’ manufacturing, and augmenting potential product markets. In most cases, patent pools developed a self-organization process. The US government, through its judicial system, monitors pool formations from an antitrust perspective, with some exemptions. For example, the patent pool Aircraft Manufacturer Association was formed with the intervention of the US government to protect national defense interests when the United States entered WWI.

PATENT POOL PRACTICE IN ZHEJIANG: CASE STUDY: THE IPR POOL IN THE LOCK INDUSTRY, WENZHOU 2 The IPR pool, called IPR Protection Committee, of the Wenzhou lock industry was established on November 12, 2001. The principal sponsors were eight leading firms in the industry, with participation by more than 100 lock producers from a total of 400 firms in the region. The Committee is part of the Wenzhou Hardware Industry Association. The purpose for establishment of the IPR Protection Committee was to protect the IPR of member firms and to eliminate unfair competition.

Motivation to IPR pool Why did the lock producers initiate establishment of a costly IPR protection institution? A review of the background shows that the essential rationale for the collective action lay with the need for survival and further development of the industry. The industry had, by 2001, experienced several crises because of ruthless price competition and low quality production. The first industry crisis came at the end of the 1980s. More than 100 firms were producing padlocks imitating those manufactured by a successful, local private producer, Dongzhen. Com-

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

‘Patent pool’ initiatives in manufacturing clusters in Zhejiang

petition among firms was very fierce because they were crowded in an undifferentiated market. As a result, ‘jerrybuilt’ products made by Wenzhou producers were sanctioned in 1989 and ‘made-inWenzhou’ locks were banned at the annual national exhibition that year. Many shopping centers thereafter refused to sell their product, and the padlock industry in Wenzhou collapsed altogether. The second crisis came in the early 1990s, with locks for bikes. After the first crisis, Wenzhou firms turned to another product – bike locks. They imitated products produced in a large enterprise in Shanghai. At the peak, bike lock producers in Wenzhou had increased to 200 firms but a reputation for poor quality products soon almost destroyed the industry once again. Only about a dozen survived. Since 1995, from the ruins of the second crisis, firms switched to door locks for which the technologies came from imported products. They produced locks for both the external and internal market – the domestic market having grown with the housing construction boom in China from the mid-1990s. Massive entries with unqualified imitations occurred following the success of the pioneering door lock producers. By 2001, more than 400 firms had entered the business. Would the industry crises of the past repeat all over again? The door lock industry responded by creating the IPR Protection Committee.

Functionality of the IPR Committee The committee has authority to review and grant ‘Apparent Design’, ‘Structural Design’ and ‘Packing Features’ for locks. In 2002, the Committee received 400 applications for new lock design and features. Granted new techniques are issued a certificate, shown to member firms gathering regularly on the tenth of each month, and announcements are made in local newspapers. Member firms approached for collective IPR ownership sign an agreement stipulating that each new design or feature granted is to be owned exclusively by the inventor firm for one year. Volume 8, Issue 1–2, July 2006

After a year, it becomes a common right of the pool. The Committee also has the authority to execute penalties for illegal imitation. For example, in March 2003, when a local firm imitated a granted design developed by another lock producer, the Committee confiscated its counterfeit products and the dies used for counterfeit production. Thus far, a total of 30 cases of counterfeit production have been sanctioned. As a consequence, illegal imitation and destructive price competition has been effectively curtailed. The formation and operation of the industry’s IPR Committee is based on collective actions of the member firms. Central and local governments have encouraged the development of business associations, and the IRP Committee, in the case of Wenzhou lock industry, is an incorporated part of the respective Association. The Committee has authorization from the IP administrative body for review functions and granting of intellectual property rights. Nevertheless, the Committee’s legal role, in review, grant and sanction of IPR-related cases, is informal, regional and temporary. Compared with patent pools in the United States, this IPR pool is less concerned with the functions of patent transaction and licensing, and more with regulation of IPR-related behavior, and therefore with regulation of competition among member firms.

Growth of the lock industry since 2001 The IPR Committee’s services gained credit within the industry. Gradually, almost every firm of the total of 400 became participants. In cases of IPR dispute, the firms involved were able to make judgments following established transparent rules, and themselves submitted counterfeits and dies to the Committee. Even more impressive is the industry’s acceleration towards innovation-based competition, in contrast to the inferior imitation approach previously prevailing. One member firm, it is reported, altered its development trajectory immediately after an IPR dispute and law suit over their

INNOVATION: management, policy & practice

157

Haibo Bao, Minghua Xu and Shulin Gu

infringement of a protected design. The firm confessed its mistake and accepted the penalty. It then concentrated on developing new designs and, in the following months, submitted five new lock designs for approval to the Committee. The industry grew in both size and structure. Innovative activities – although modest as protected by IPR terms stipulated by the Committee – brought about product and market differentiation. With differentiated and quality products, prices are now set at a reasonable level and harmful price competition has ended. Firms, with certain profitability, have acquired the flexibility to reinvest in technology. Not only did the crises not recur but the cluster firms grew well. In 2002, Wenzhou producers won 5out of a total of 10 ‘Chinese King Producers’ for locks chosen by public appraisal. In 2003, Wenzhou earned the title ‘City of Lock Production’ in China. By 2004, Wenzhou lock cluster firms had increased to more than 500, producing 65 percent of the total outputs of the country, of which one-third were exported. The year 2003 was remarkable. Eight influential producers, including four of the 2002 ‘King Producers’, decided to merge into a limited liability company, the Qiang-Qiang Corporation Ltd. Their aim was to integrate resources to compete with both domestic and foreign competitors, such as Korea. Competition pressure was so strong that the presidents of the 8 firms accepted less powerful positions (than held earlier) in the newly merged corporation for the sake of business development – often a tricky obstacle with such mergers. The new corporation is operating well. In its first two years, it has managed to invest considerably in renewal of production lines, including its electroplating line. It has developed new products, such as fingerprint- and voice-controlled locks. It is strengthening its international marketing, having opened three overseas offices. As well, the merger may act as a prelude to transformation of corporate governance structure. Whereas firms in this and other industries in Zhejiang began principally under family ownership, the establishment of QiangQiang means, for the first time, a break158

up of those family firms. QiangQiang intends to bring in professional managers, although at this stage the presidents of the eight family firms manage the corporation themselves. Although the IPR pool in the lock industry is well known, it is by no means idiosyncratic or alone. The pen-making industry in Fenshui 3 and the electro-bike industry in Yongkang 4 – both in Zhejiang Province – established respectively the Pen-makers Association in 1998 and IPR Committee of the Electro-bike Industry in 2005. The Association and Committee have been assigned, and are exercising, similar functions in IPR regulation and industry completion. According to a 2004 document prepared by the Zhejiang Provincial Patent Bureau5, one of the stipulated tasks of the provincial patent administration is to ‘assist various industrial producers associations in the establishment and development of IPR protection institutions’, so that industries grow with shared knowledge and disciplined competition. It is reasonable to estimate that small-firm clusterbased IP pools, as illustrated, are or will be prevalent in Zhejiang and other provinces, although they may differ unavoidably in terms of success, effectiveness, difficulties and operational details.

DISCUSSION This paper has reported the patent pool-like phenomenon emerging in small firm clusters in Zhejiang Province. It has analyzed the motivations, the institutions and their functions, and some outcomes from institutional innovation, based on case studies. In comparison to patent pools in the United States, the cluster community-based IPR protection and shared institutions in Zhejiang have several characteristics: either Chinese or ‘developing’ or combined. The intellectual property rights of Chinese institutions are not officially ‘patented’ but cover minor, incremental innovations; some are not even taken into consideration at all by the formal patent system. The inventions and small changes in IPR are more substitutive than blocking or

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

‘Patent pool’ initiatives in manufacturing clusters in Zhejiang

complementary to each other. IPR communities in China exercise more of a police role against inferior imitation than collectively handling patent transactions and licensing. Nevertheless, the IPR protection committees and associations in Zhejiang play an important role, as illustrated, in the development and spread of intellectual assets and for fair competition, through broadly participatory practices. Mere inferior imitation, often the first step of latecomer firms, cannot lead to real market development; the essence of competition is to make something new, namely, innovation. Latecomers have to learn these lessons from experience. When firms alter their notions of competition and innovation, the industry and markets have tended to grow, based on increasing differentiation (specialization). In this regard, substitutive IP pools did no harm to industries. Rather, they took a healthier and more sustainable development direction. This paper reported only preliminary fruit of the research. Further study needs to broaden the scope of investigation, identify possibly different modes of IPR cluster pools, and factors that attribute to success or failure. The relationship between the cluster community based IPR institution and the formal patent administrative system is to be carefully explored, provided that the current practice of the cluster community to some extent overlaps with the formal patent administration.

Acknowledgement This project 70373008 was supported by National Natural Science Foundation of China.

Endnotes 1 See the following literature for details: Thompson (1987), Bittlingmayer (1988), Clarkson, Gavin(2003), Merges (1999), Gilbert (2002) and CPTech’s Page on Collective Management of IP Rights: Patent Pool. 2 Sources for the case analysis: 1) Bao haibo, Zhang jinrong: field work notes; 2) http://www.qiangqiang .cn/Release/list.asp?id=5; 3) http://www.wenzhoujian shi.com/Chinese/Default.asp; 4) http://www.baodeli .com/chinese/index.asp. 3 Bao Haibo, Zhang jinrong: filed work notes.

Volume 8, Issue 1–2, July 2006

4 Refer to http://www.sipo.gov.cn/sipo/dfzscqdt/ dfzscqdt_zhejian/zscqdt/t20051104_58260.htm. 5 See http://www.sipo.gov.cn/sipo/dfzscqdt/dfzscqdt_ zhejian/zscqdt/2004/t20040310_58537.htm.

References Bao Haibo (2003) A Strategic Study on Zhejiang Patenting, Soft Science in China 11. Bittlingmayer GL (1988) Property Rights, Progress, and the Aircraft Patent Agreement, Journal of Law and Economics 31( April): 227–248. Carlson SC (1999) Patent Pools and the Antitrust Dilemma, Yale Journal on Regulation 16(2): 359–399. Cassady R Jnr (1959) Monopoly in Motion Picture Production and Distribution: 1908–1915 Southern California Law Review 32: 325. Clark J, Piccolo J, Stanton B and Tyson K with assistance from Critharis M and Kunin S (2000) Patent Pools: A Solution to the Problem of Access in Biotechnology Patents?, United States Patent and Tradework Office (USPTO). Available at: http://www.uspto.gov/web /offices/pac/dapp/opla/patentpool.pdf. Clarkson G (2003) Patent Network Density: The Quest for Patent Thickets, Unpublished working paper, Harvard University. CPTech (2005) Collective Management of IP Rights: Patent Pool, CPTech. Available at: http://www.cptech .org/cm/patentpool.html. Gilbert RJ (2002) Antitrust for Patent Pools: A Century of Policy Evolution, unpublished working paper, University of California, Berkeley. Lerner J and Tirole J (2004) Efficient Patent Pools, American Economic Review 94(3): 691–711. Lerner J, Strojwas M and Tirole J (2003) Cooperative Marketing Agreements between Competitors: Evidence from Patent Pool, working paper, Institut d’Economie Industrielle (UDEI), Universitie des Sciences Sociales, Toulouse. Merges RP (1998) Institutions for Intellectual Property Transactions: The Case of Patent Pools (Revised 1999). Available at: http://www.law.berkeley.edu/institutes /bclt/pubs/merges/pools.pdf. Ministry of Information Industry, China: Brief Introduction to Electronic Standard Workgroups, under lead of Ministry of Information Industry, China. Available at: http://www.cesa.cn/art.php?newsid=105. Priest G L (1977) Cartels and Patent Licensing Arrangements, Journal of Law and Economics (October) 20: 309–377. Shapiro C (2001) Navigating the Patent Thicket: Cross Licenses, Patent Pools, and Standard Setting, Innovation Policy and the Economy 1: 119–150. Thomson R (1987) Learning by Selling and Invention: The Case of the Sewing Machine, Journal of Economic History 47(2): 433–445. Xu M, Chen J and Bo H (2006) Enterprise patenting in Zhejiang, Innovation: Management, Policy & Practice 8(1–2): 144–152.

INNOVATION: management, policy & practice

159

Copyright © eContent Management Pty Ltd. Innovation: management, policy & practice (2006) 8: 160–170.

China’s consumer-goods manufacturing clusters, with reference to Wenzhou footwear cluster SUMMARY KEY WORDS China manufacturing; agglomeration theory; consumer goods; footwear cluster; proximity; Wenzhou case; original equipment manufacturing; original design manufacturing; own brand manufacturing

This paper provides a pilot study of the development of consumer-goods manufacturing cluster in China and is divided into five sections. The first section introduces the contribution of ‘made-in-China’ to the global economy. In the second the context of the theory of agglomeration and cluster are briefly reviewed. Subsequently the paper draws a general picture of the development of China's consumer-goods manufacturing clusters and illustrates these in two representative provinces – Zhejiang and Guangdong – in the third section. The fourth section analyses the case of Wenzhou footwear industrial cluster in detail. Finally the paper discusses some problems facing Chinese consumer-goods manufacturing clusters and calls attention to their need for innovation and upgrade. Received 9 June 2005

JICI WANG Department of Urban and Regional Planning Peking University Beijing, China

INTRODUCTION: CONTRIBUTION OF ‘MADE-IN-CHINA’ TO THE

Accepted 17 January 2006

well as an important partner in their global strategy. Now China is known as a promising supplier to demanding customers and as an intimidating manufacturer to competing producers. China’s entry into the World Trade Organization brought its industry into global prominence. Many estimate that China will become a sophisticated manufacturing centre, and no longer just a lowcost source of cheap goods, in the near future. China’s local clusters of consumer-good manufacturers contribute greatly to bringing China’s industry to global prominence, as the following news items show:

GLOBAL ECONOMY

S

ince China opened to the outside world in the 1980s foreign companies have worked closely and actively with Chinese consumer-goods makers to promote original equipment manufacturing (OEM). They consider China a big market as

160

INNOVATION: management, policy & practice

China’s advantages in the global marketplace are moving well beyond cheap equipment material and labour. The country exploits clustering in a way that some countries just can’t match. … Drawing on its vast population and Volume 8, Issue 1–2, July 2006

China’s consumer-goods manufacturing clusters

mix of free-market and central-command economic policies China has created giant industrial districts in distinctive entrepreneurial enclaves such as Datang. Each was built to specialize in making just one thing including some of the most pedestrian of goods: cigarette lighters badges neckties fasteners. … The clusters are one reason China’s shipments of socks to the U.S. have soared from 6 million pairs in 2000 to 670 million pairs last year. Meanwhile American producers pummelled by imports from China and elsewhere saw their share of the U.S. hosiery market fall from 69% in 2000 to 44% in 2003 according to the latest industry data. (Los Angeles Times, 10 April 2005) Buyers from New York to Tokyo want to be able to buy 500,000 pairs of socks all at once or 300,000 neckties 100,000 children’s jackets or 50,000 size 36B bras. … Increasingly the places that best accommodate orders are China’s giant new specialty cities. … The niche cities reflect China’s ability to form ‘lump’ economies where clusters or networks of businesses feed off each other building technologies and enjoying the benefits of concentrated support centres. (New York Times, 24 December 2004) Since multifaceted reform began in the 1980s China’s clusters of consumer-goods manufacturers have emerged and developed rapidly in the coastal area especially in backward rural areas. The trajectory and specialization of those clusters is attributable at least in part to networked industrial systems based on the Italian model. At first the concept of cluster in China was politically delicate. Until the end of the 1990s Chinese policy makers neglected those clusters which were inconsistent with the rapidly growing non-locally embedded high-tech branch plants. Since the economic performance of those clusters became more and more obvious the concept of industrial cluster has appeared on the policy-making stage and been adopted. Volume 8, Issue 1–2, July 2006

Cluster development in China has passed three decades already. How good is its performance? What problems might arise from their continuing development? How do these problems manifest themselves in China? What lessons are there for developing countries? The purpose of this paper is twofold: firstly, to contribute to the understanding of local clustering of consumergoods manufacturers in China with particular reference to the Wenzhou footwear cluster; secondly, it discusses problems with their upgrade and innovation processes.

THEORETICAL CONTEXT Agglomeration and cluster phenomenon Over the last two decades there has been increasing evidence in developed countries that clustering and networking helps small and medium-sized enterprises (SMEs) to raise their competitiveness. The most studied contemporary examples of industrial clusters – the small-firm industrial districts of Italy (roughly corresponding to north-east and central Italy) – specialize in traditional industries such as shoes textiles leather goods furniture and ceramic tiles (Brusco 1982; Sforzi 1989). Germany’s Baden-Wurttemberg is known for its mix of small and medium-sized makers of machine tools and textile equipment. Other prominent examples of clusters studied early in developed countries include watches in Switzerland film production in Hollywood machine tools in Sakaki Township in Japan and the aerospace electronics complex in Southern California. Since the mid-1990s literature has emerged relating to policies for industrial clusters in developing countries. Examples include the Indian clusters – the metalworking and textile cluster of Ludhiana the cotton-knitwear cluster of Tiruppur the diamond cluster of Surat the engineering and electronics cluster of Bangalore and the footwear clusters of Agra. Other cases are: the footwear clusters of the Sinos Valley in Brazil Trujillo in Peru and Leon and Guadalajara in Mexico; the

INNOVATION: management, policy & practice

161

Jici Wang

Korean textile cluster in Daegu; and Pakistan’s sports goods and surgical equipment in Sialkot cutlery in Wazirabad and electrical fans in Gujrat. In Africa there are the metalworking furniture making garment and other clusters in Kenya Zimbabwe and Tanzania. Case studies suggest that the inter-firm division of labour and institutional support tends to be more developed in Latin America and Asia and less developed in Africa. There were only a few regions in Asia able to shift into relatively high-value-added activities by means of product differentiation and technological upgrading to become part of the newly ‘organized’ matrix of industrial space (Storper & Scott 1992). A big difference between clusters in developed and developing countries appears to be the market niches on which they focus. Developed countries specialize in higher-value niches so those clusters are dynamic and require high levels of innovation and functional flexibility. Clusters in developing countries on the other hand appear largely (one may even say entirely) at the lower end of the market where there are less dynamics and where competitiveness is determined by price. Buyer pressure to move up the value-chain is all but non-existent. There are two main paths of insertion in the global economy. The high road is one of increasing and improving participation in the global economy realizing sustained income growth. Producers in the low road are engaged in a ‘race to the bottom’ where increased exports can be paid for only by lower wages (Humphrey & Schmitz 1995; Lagendijk 1997).

Why industrial clusters? It has been widely recognized that the successful localization of flexible production found in both Western Europe and the United States is central to contemporary global economic development. The global economy then may be seen as consisting of a mosaic of interdependent specialized industrial clusters. Industrial clusters characterize today’s economic world map: critical masses in one place of linked industries and institutions – 162

from suppliers to universities to government agencies – that enjoy unusual competitive success in a particular field. In theory open global markets rapid transportation and high-speed communications should allow any company to source any thing from any place at any time. But in practice location remains central to competition (Porter 1998). The literature on local production systems stems initially from analysis of successful industrial districts in developed countries in the 1970s and ‘80s. Industrial districts are defined as essentially territorial systems of small and mediumsized firms with spatially concentrated networks, often using flexible production technology and characterized by extensive local inter-firm linkages (Bellandi 1989; Harrison 1992). In other words industrial districts are local systems with an active co-location of people and of independent firms specializing in different phases of a single production process. This literature has repeatedly suggested that selected regions are capable of exerting powerful push effects on national economic development. The most influential exponent of specialized industrial localization is Porter (1990; 1998) whose notion of industrial cluster has rapidly become the analytical concept and policy tool. Porter (1998) defines an industrial cluster as ‘a geographically proximate group of interconnected companies and associated institutions in a particular field linked by commonalties and complementarities’. Porter also points out that geographic cultural and institutional proximity provides companies with special access closer relationships better information powerful incentives and other advantages that are difficult to tap from a distance. The more complex knowledgebased and dynamic the world economy becomes the more this is true. Competitive advantage lies increasingly in local aspects – knowledge relationships and motivation – that distant rivals cannot replicate. Industrial clusters foster high levels of productivity and innovation with implications for

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

China’s consumer-goods manufacturing clusters

competitive strategy and economic policy. The clusters affect competition in three broad ways: first by increasing the productivity of companies based in the area; second by driving the direction and pace of innovation; and third by stimulating the formation of new businesses within the cluster (Porter 1998). Research on clustering in China has been inspired by the competitiveness of industrial districts in Italy. The industrial districts of Italy have established a strong position in world markets in a number of so-called traditional products – shoes leather handbags knitwear furniture tiles musical instruments food processing – and also in the industries which supply machinery to these sectors. From international debate the following have emerged as the main attributes of Italian industrial districts: • geographical proximity; • sectoral specialization; • predominance of small- and medium-sized firms; • close inter-firm collaboration; • inter-firm competition based on innovation; • a socio-cultural identity which facilitates trust; • active self-help organizations; and • supportive regional and municipal government. As for business know-how a vital role is played in industrial districts by tacit rather than codified knowledge. While the latter is tied in with technical progress and transferability mechanisms that perform through the market tacit knowledge is a form of knowledge that depends on the specific socio-cultural environment where production takes place and which is rooted in the actions of economic agents belonging to that environment. It spreads throughout the local production community mainly by means of personal direct contact and is based on untraded interdependencies associated with daily business routine rather than on traded interdependencies involving input and output relationships. Volume 8, Issue 1–2, July 2006

Agglomeration and geographical proximity Agglomeration and proximity are two related concepts in regional studies. However to differentiate them is not easy. In order to evaluate policy decisions, it is essential to make clear which concept is being used. International experiences show that agglomeration economies are attractive to innovative firms because of the effect on competitive advantage. The basic idea of agglomeration economies is that links between firms institutions and other economic agents located in geographical proximity tend to generate advantages of scale and scope; e.g., development of general labor markets and specialized skills and enhanced linkages between suppliers and customers (Lloyd & Dicken 1990). A further idea is that geographical proximity and regional agglomeration may greatly facilitate the ‘learning economy’. New views related to this idea are on industrialization as a territorial process and on innovation as a social process (Asheim & Cooke 1999). Boschma (2005) claimed that geographical proximity per se is neither a necessary nor sufficient condition for learning to take place. Proximity may facilitate interactive learning by strengthening other dimensions of proximity but also have negative impacts on innovation due to the problem of lock-in. Accordingly not only too little but also too much proximity may be detrimental to interactive learning and innovation. Boschma (2005) discussed five dimensions of proximity: cognitive, organizational, social, institutional, and geographical. In fact the agglomeration which facilitates the ‘learning economy’ has all five dimensions of proximity defined by Boschma. Therefore, agglomeration refers to geographical proximity plus local organizational proximity. The non-local linkage may happen in the spatial association because there is non-local organizational proximity.

INNOVATION: management, policy & practice

163

Jici Wang

DEVELOPMENT OF CONSUMER-GOODS MANUFACTURING CLUSTERS IN CHINA Background Thousands of industrial clusters dot the Chinese landscape. It is estimated that there are about 740 industrial clusters which have developed respective industrial associations in China.1 The coastal area which includes six provinces (Guangdong Fujian Zhejiang Jiangsu Shandong Liaoning) and two cities (Beijing and Shanghai) has nearly 498 industrial clusters about 67% of the total. The inland area has about 250 industrial clusters counting for 34% of the total. If calculated only on cluster quantity the coastal/inland ratio would be 7/3. Considering the revenues and number of employees the ratio would be even higher say 8/2. That is to say industrial clusters in coastal areas have a much more significant role than those in inland areas. Industrial clusters consisting of small and medium enterprises (SMEs) have been proliferating in areas where private sectors have successfully developed. Since 1978 when China’s economic reforms began rural entrepreneurs of several provinces have succeeded in penetrating light industry. While the top-down public strategy in China stakes its future on a small number of big firms increasing in size and strength and on planned technology parks with special treatments for foreign direct investment (FDI) people from below grasp the market niches in traditional industries; niches left by the structural defects of a command economy. Set up by rural households and starting with simple products like food clothes and ball-pen small manufacturing firms clustered in neighborhoods usually around a marketplace for their products. The local marketplace where enterprise managers can easily purchase materials from and sell products to local traders plays a critical role in stimulating the entry of new firms to the early stage of cluster development (Sonobe, Hu & Otsuka 2002). As a cluster develops, however, entrepreneurial ability for high-quality products 164

and marketing plays a more significant role. After more than 10 years some of the rural grass roots firms began to establish brand-name at home and abroad. This process of spontaneous bottom-up industrialization in rural areas was usually referred to as job generator for surplus rural labor and as an engine to raise the income of local residents. The inherent competitive advantages of such clusters were not recognized until very recent years because they are inconsistent with nonlocally embedded high-tech sectors in China. These clusters have been anchored to a network of small and medium-sized towns somewhere between the large cities and the deep countryside. With the expansion of cluster-based ‘industrial parks’ usually set up by local governments the urbanization process has accelerated. Rapid development of modern retail outlets – internationally such as Wal-Mart and Carrefour and domestically as well – has been a strong driver for those consumer-goods industrial clusters.

Representative provinces: Zhejiang and Guangdong Zhejiang and Guangdong provinces are the most prominent in China’s cluster development. Both provincial governments have pioneered promotion of this development. In 1999 the Department of Science and Technology of Guangdong Provincial government decided to encourage the establishment of ‘Common Technology Platforms’ for industrial clusters.2 In 2000 the Office of System Reform Zhejiang Provincial Province publicized 11 industrial clusters3 in Zhejiang Trade Fairs held at Ningbo city. In Zhejiang more than 800 industrial clusters accounted for about half of the province’s total industrial output producing output of 600 billion Yuan (US$72.6 billion) in 2001 and this share has been increased in following years. According to information provided by Zhejiang province a ‘clump economy’ is emerging in 85 of the 88 cities attributed at least in part to the numerous localized industrial clusters. A massive inflow of skilled labors from Shanghai and other industrial

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

China’s consumer-goods manufacturing clusters

FIGURE 1: CLUSTERS

DISTRIBUTION IN

centres has enhanced the strengths of household manufacturing based clusters and the ease of subcontracting with state-owned firms in the surrounding areas facilitated their integration with the economy and reforms of China. Hundreds of clusters specializing in various segments of light industry – textiles garments shoes socks/stockings badges neckties fasteners slide fasteners furniture and pens – have proliferated and fuelled the growth of the province’s economy. Clusters in consumer goods manufacturers in Guangdong Province developed differently to some extent to Zhejiang. Guangdong’s cluster development can be traced back to Hong Kong investment. Hong Kong has been well known as ‘a low-tech but high-IQ’ regional center and earlier in the reforms many international firms allied with Hong Kong companies to gain access to the China market. Hong Kong was and still is the largest ‘foreign’ investor in Guangdong province as well as in Mainland China. By means of ‘export processing trade,’4 or Sanlaiyibu promoted by the Chinese government a large number of Hong Kong firms clustered in areas of GuangVolume 8, Issue 1–2, July 2006

CHINA

dong to continue their export-oriented production. The huge output value coming from these production bases has contributed partly to China’s becoming one of the world’s largest manufacturing countries. It was via Hong Kong that Peal River Delta (PRD) from this province and surrounding areas accelerated integration into global production chains. By 2001 export in this area was valued at 50 billion dollars or 45% of national exports. Among 404 towns of the Pearl River Delta5 one fourth are characterized by clusters most of which have developed on traditional industry. Like in Zhejiang province and other areas the rapid industrialization of PRD has been based on exploiting low costs of land and labor. It is imperative that these clusters increase their higher value activities and intensify local forward and backward linkages if the region is to maintain its development momentum. Nevertheless the landscape of Guandong province is impressive: it has undergone quick industrialization and urbanization largely based upon clustered consumer goods manufacturing in the past twenty years.

INNOVATION: management, policy & practice

165

Jici Wang

CASE STUDY: WENZHOU FOOTWEAR INDUSTRY

Footwear industry: Change in global production and China’s opportunity The footwear industry, one of China’s traditional low technology sectors, has been viewed as a ‘sunset activity’. Compared to other sectors its technological change has been slow. For a long time the sector has been exposed to severe international cost competition that has led to a decline in production sites at ‘old’ locations and migration of the industry to ‘young’ locations in low wage regions (Shamp & Main 2003). Labour costs continue to be a dominant factor in competitiveness. Entrepreneurs are induced to search for countries and regions with lower wages. More efficient use of labour is required even in regions/countries usually considered as sources of unlimited cheap wages. Assembly of shoes began shifting from developed countries in the 1960s first to Japan; then to Korea and Taiwan; and in the early 1980s to Southern China. In the mid-1980s when Taiwan and Korea supplied 45 percent of world footwear exports 80% of Hong Kong manufacturers shifted a significant part of their shoe production to mainland China especially Guangdong Province. By 1994 the world exports share of Taiwan and Korea had dropped to 7 percent while Mainland China’s share grew to 50 percent from 8 percent in 1986. With the support of a strong plastic industry and technology research on footwearmanufacturing at home Taiwan is in a strong position for production of rubber and man-made leather shoes. Over 90% of Taiwan’s footwear factories (more than 1,000 companies) have set up plants in the mainland China especially Fujian Province and Guangdong Province. Now China has become the world’s largest exporter and consumer of footwear. In 2003 more than 20,000 companies produced more than 6 billion pairs of shoes of all kinds of which over 3.87 billion are for export. Footwear earns foreign exchange of 9.47 billion dollars. Sixty 166

percent of the shoes made in China enter the international market accounting for 25% of the total turnover of the world’s shoe industry. China accounts for about 68.3 percent of all footwear imports into the U.S a staggering increase of 2,700 percent since 1986. The low cost of labor in China makes it a very attractive place for foreign shoe manufacturers to build factories. However the shoe-making industry in China has been at the low end of the value chain. The industry is faced with challenges from both low cost production in Indonesia, Thailand, Mexico and India and high quality products from Italy, Spain and Portugal. Additionally some foreign factories in China pose extra pressures on local producers. As in Italy and India, where footwear industries are clustered in certain locations, most of the shoe-related enterprises in China are also clustered mainly in the east coastal provinces – Guangdong Fujian Zhejiang and Shandong (from south to north) with a few scattered in the west. The volume of leather sport and cloth shoes from the eastern region accounts for as much as 80 to 90 percent of overall output. Most shoemakers are subcontracted to world brand names such as Reebok, Nike, Riddell, Wilson and WalMart and employ modern machinery and technology with technical assistance provided by the hiring company or machinery supplier to produce shoes of a quality acceptable to the world market. Most of them also engage in tanning, shoe mould making and shoe parts with the aim of cost reduction, production, flexibility and quality control.

Wenzhou footwear industrial cluster and its influential factors The city of Wenzhou in Zhejiang province has a long history of shoe production. The first pigskin shoes in China, the first vulcanized shoes, the first press molding shoes and the first galoshes were all created in Wenzhou, one of the seedbeds of the Chinese shoe industry. In the 1930s Wenzhou shoes had sold all over China. Since China’s economic reforms, Wenzhou has gained even

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

China’s consumer-goods manufacturing clusters

greater momentum. Now it is the ‘Footwear Capital’ of China in terms of industry capacity, number of enterprises (the city has about ten thousand footwear enterprises), output and quality of shoe, and completeness of related or supportive industries. About 500,000 employees work in the shoe and leather-related industries, in firms equipped with more than 1000 imported advanced production lines, which in 2002 produced 1000 million pairs of shoes worth 30 billion Yuan ($4 billion equivalent) distributed to 100,000 stores in China and abroad. The shoe industry in Wenzhou began in family firms. Today some are modern enterprises, the leaders of which have developed their own brands. Recently, increasingly more firms are connecting to the Internet supported by local specialized Internet services. Three factors influencing development of the Wenzhou footwear cluster are: • the local production network; • the roles of local industrial associations; and • the attitude of the local government.

Production network Each independent small or medium-sized company in Wenzhou tends to cover an individual phase of production connected by specialized transaction networks and co-ordinated by more or less explicit forms of co-operation. This division of labour is made possibly by a production process that is technically divisible. In fact the economy of Wenzhou is better called the ‘swarm effect’. Wenzhou’s shoe industry has grown significantly. Geographically it is concentrated in Lucheng District center of Wenzhou city territory: 905 shoe firms with 550 advanced production lines for shoe-making are gathered there producing more than 300 million pairs of shoe annually. They are sold to more than 20 countries and regions in North America, Europe, South America and the Middle East as well as to the domestic market. This geographical concentration aided the division of labour among shoe makers as well as Volume 8, Issue 1–2, July 2006

between producers and input suppliers and related services: around Lucheng Baishi of Yueqing town also specializes in shoe production; Yongjia of Huangtian town produces shoe adornments; Hetongqiao distributes shoe materials; and Shuitou town has a raw leather market leather machine market and leather chemicals market with sales of 2000 million RMB and growing.

Role of local industrial associations Economies of agglomeration are an important but not sufficient condition for industrial growth and economic development. The footwear industry in Wenzhou developed from family workshops. Its folk character prevented heavy intervention by government administration forces in the early years when the government gave little help but posed no hurdles. The people of Wenzhou ran their businesses with wisdom, diligence, bravery and great creativity. They created various pretty low-price commodities that attracted consumers. In the 1980s when shoes were in short supply in China the major problems encountered by Wenzhou producers were related to credibility and reputation. The quality of product was sometimes poor; in addition inferior counterfeit products often appeared in the marketplace from black factories. In 1987 angry costumers burned down Wenzhou shoes at the City Gate of Hangzhou the provincial capital. The Wenzhou shoe industry was almost beaten until the Wenzhou Lucheng Association of Shoes Industry was organized in 1991. The Association first concentrated on enhancing the reputation of Wenzhou shoe products. Now the Association has 1138 member enterprises and 26 association branches. Since its establishment the Association has made great efforts to improve shoe quality by training on production and design and introduction of advanced equipment. It organized local managers to visit their counterparts in the US Italy and Korea and has also helped member enterprises to expand sales channels – with annual shoe exhibitions in cities around China since 1996 and by contact with

INNOVATION: management, policy & practice

167

Jici Wang

foreign customers such as the trade association of Italy. Its International Shoe Equipment Material and Technology Exhibition has become one of the most professional exhibitions in Asia. Recently the Association organized development of an electronic information network. The Association also works as a bridge agency between the shoe industry and the government passing policy to enterprises and transmitting the requirements of enterprises to the government.

Attitude of local government The local governments of Wenzhou did nothing when its shoemakers began business. This was unusual in the 1980s as at that time the political atmosphere tended to be hostile to private initiatives. The Wenzhou government took such a non-interventionist attitude because with meager land and natural resources and no modern industrial basis its people were poor and had little other chance to improve themselves. Privatelyowned firms created by rural residents therefore boomed initially taking the then policy-favored title of ‘township or village enterprise’. Wenzhou government was however responsive to the shoe-burning accident and called on local shoemakers to improve quality. This encouraged not only better quality management but also newcomers into shoemaking. Thereafter Wenzhou government actively supported service activities; for example it was involved in the establishment of a footwear design centre set up in cooperation with an Italian business entity. Colleges and schools in Wenzhou have added professional majors of shoe leather under the coordination of government. Recently the Wenzhou government began construction of a shoe industry park called ‘Chinese Shoes Metropolis’ in Shuangyu Town with functional areas planned for shoe-making machinery services and shoes-culture including a shoes-cultural museum an exhibition hall for shoe transactions and a shoes-cultural park. The Metropolis will enable visitors to enjoy both new techniques of shoe-making and the traditional culture of Wenzhou as well as shopping and relax168

ation. The investment in this industrial park is estimated at 500 million Yuan largely from the city budget which signals that shoemaking is centrally integrated in the regional development strategy of Wenzhou.

DISCUSSION/CONCLUSION Geographically agglomerated traditional manufacturing which produces mainly consumer goods has contributed greatly to China’s export growth. It has been an important driver to regional industrialization of coastal areas and offers ordinary rural residents the opportunity to learn modern production and distribution techniques. Hundreds of millions of people have been integrated into global production and have thereby improved their lives. Today after two decades of development China is faced with challenges in the labor-intensive export-oriented manufacture of consumer goods. Firstly, as China has entered widely into international markets, and with accession to the WTO, the number of trade disputes involving China has increased dramatically. It is reported that in 2003 of the overall 194 anti-dumping lawsuits launched by WTO members 54 were against China. The Spanish burning of Chinamade shoes is a warning and has indeed made China policy makers seriously consider international reactions. China’s economy is huge and its impact on the global economy is a factor which has to be taken into account in China’s development policy formation. However, China’s policymakers are still inexperienced in this regard. As far as further development of traditional manufacturing is concerned there are several problems to address. One relates to the erosion of low cost advantages. Labor costs are increasing following the decision made by the central government of China in 2005 that farmers are to be freed from agricultural taxes and to enjoy subsidies for infrastructure and food crops planting. This elevates the threshold of the minimal acceptable wage for immigrant farmers an important labor force for manufacturing. Labor short-

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

China’s consumer-goods manufacturing clusters

ages have occurred since 2004 in Guangdong and Zhejiang provinces, the most important homes of labor-intensive manufacturing. In addition costs of land and raw materials are rising. Pollution caused by industrial production and the resultant environmental degradation is another problem. The footwear industry produces millions of tons of wastewater from leather and paper-making and is one of the most contaminative sources of industrial pollution. Waste residue from the shoe and other industries is also huge. One can see waste residue piled up like skyscrapers around shoe industry towns. Construction of treatment facilities for wastewater and residue has begun but capacity and efficiency is still far from adequate. Additional investment is required to remedy environmental degradation which further wears away the low cost advantage. Some of the trade-related lawsuits against China point out that goods manufactured in China have problems in areas of environmental protection or labor welfare. These problems must be dealt with carefully on every count. There are surely other censures against China mainly related to its industrial and trade policies and over which there are debates among development policy analysts but these are issues issue beyond the scope of this paper. It is however certain that China needs continuing production in its traditional industries and that continuation is only possible by means of improved manufacturing quality and efficiency. To cope with the cost proliferation it must climb up the value chain from OEM to ODM (original design manufacturing) and OBM (own brand manufacturing). Investment in environmental protection can no longer be delayed. There is as well great room for improvement in learning and cluster efficiency. All these concern technical organizational and managerial advancement requiring higher levels of human and physical capital. China is at a major developmental crossroad.

Endnotes 1 This is only an incomplete estimation counted Volume 8, Issue 1–2, July 2006

2 3 4

5

from various publications and media reports and from empirical case studies of our research group. The cluster mapping project of China is about to start now. The industrial clusters in Guangdong were called Specialized town (Zhuanye zhen) in the end of 1990s. The industrial clusters in Zhejiang were called Specialized industrial district (Zhuanyehua chanye qu) in 2000. The ‘export processing trade’ refers to certain government-approved transactions where a foreign party purchases Chinese manufactured goods or has raw materials and components processed on a consignment basis in China in both cases with the inputs imported free of duties and value-added tax. The Pearl River Delta counts for 80% of GDP of Guangdong province and 26% of foreign direct investment. of the nation.

References Asheim B and Cooke P (1997) Localized Innovation Networks in Global Economy. Paper presented at the IGU Commission on the Organization of Industrial Space residential conference, August, Gothenburg, Sweden. Barboza D (2004) Textile Enclaves: In Roaring China Sweaters Are West of Socks City. New York Times Dec. 24. Bellandi M (1989) The industrial district in Marshall, in: Goodman E and Bamford J (eds) Small Firms and Industrial Districts in Italy, pp 136–52, London: Routledge. Asheim BT and Cooke P (1999) Local learning and interactive innovation networks in a global economy, in: Malecki E and Oinäs P (eds) Making Connections, pp 145–78, Aldershot: Ashgate. Boschma RA (2005) Proximity and innovation: A critical assessment. Regional Studies 39: 61–74. Brusco S (1982) The Emilian model: Productive decentralisation and social integration. Cambridge Journal of Economics 6: 167–84. Harrison B (1992) Industrial districts: old wine in new bottles? Regional Studies 26: 469–84. Humphrey J and Schmitz H (1995) Principles for promoting clusters & networks of SMEs. Paper commissioned by the Small and Medium Enterprises Branch UNIDO. Lagendijk A (1997) From new industrial spaces to regional innovation systems and beyond: How

INNOVATION: management, policy & practice

169

Jici Wang and from whom should industrial geography learn? EUNIT Discussion Paper 10, Centre for Urban and Regional Development Studies (CURDS) Newcastle upon Tyne: University of Newcastle. Lee D (2005) China’s Strategy Gives It the Edge in the Battle of Two Sock Capitals. Los Angeles Times April 10. Lloyd P and Dicken P (1990) Location in Space: A Theoretical Approach to Economic Geography, 3rd edn, New York: Harper and Row. Marshall A (1920) Principles of Economics, 8th edn, London: Macmillan. Porter M (1990) The competitive advantage of nations, New York: Free Press. Porter M (1998) Clusters and the new economics of competition. Harvard Business Review 76(6): 77. Schamp EW and Main F (2003) Decline of the District Renewal of Firms: The Case of Footwear Production in a German Border Area. Paper presented at the Restructuring of old industrial

areas in Europe and Asia conference, Department of Geography, University of Bonn, Germany. Storper M and Scott AJ (eds) (1992) Pathways to Industrialization and Regional Development, London: Routledge. Sforzi F (1989) The geography of industrial district in Italy, in: Goodman E and Bamford J (eds) Small firms and industrial districts in Italy, pp 153–73. London: Routledge. SMEs (Small and Medium Enterprises) Branch, University of Sussex, UK. Sonobe T, Hu D and Otsuka K (2002) Process of Cluster Formation in China: A Case Study of a Garment Town. Journal of Development Studies October 39(1): 118–139(22). Sforzi F (1999) The districts in the Italian Economy: Features and Trends. Paper presented at the ASEM Conference on Industrial Districts Industrial Districts and International Transfer of Technology as Means to Promote Trade in Goods and Services, Bari, Italy.

N E W T I T L E AVA I L A B I L I T Y O R G A N I Z AT I O N A L J A Z Z E XTRAORDINARY P ERFORMANCE

THROUGH

E XTRAORDINARY L EADERSHIP

by David Napoli, Alma M. Whiteley and Kathrine S. Johansen ISBN 0-97557710-6-X; xiii + 252 pages; softcover; October 2005 Myths that we operate in certain and predictable worlds, and that mankind can control its environment, do not help us to build productive, satisfying and sustainable organizations. Constant, rapid and unpredictable changes, both internal and external, are challenging the time-honoured business models we are taught to follow – as we strive to manage our complex, evolving organizations. Placing people at the centre of the organization, Organizational Jazz shows how and why complex adaptive systems work to create wealth and dignity – creating a work environment for innovation and performance by joining the certain with the uncertain. Drawing on the science of complex adaptive systems, numerous original case studies and a hands-on workshop, this book offers a lens through which we search for new ways of thinking about, and working with, the unpredictability of our dynamic complex world. eContent Management Pty Ltd, PO Box 1027, Maleny QLD 4552, Australia Tel.: +61-7-5435-2900; Fax. +61-7-5435-2911; [email protected] www.e-contentmanagement.com

170

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Copyright © eContent Management Pty Ltd. Innovation: management, policy & practice (2006) 8: 171–192.

Regional innovation performance: Evidence from domestic patenting in China SUMMARY

KEY WORDS patent; Regional Innovation System; Regional Innovation Capacity; innovation efficiency; idea production function; Stochastic Frontier Model

This paper empirically studies the determinants of domestic patenting at a regional level in China. Applying a stochastic frontier approach to a panel of data published by China government for 30 provinces from 1998 to 2004, I explore the relationship between domestic patent grants and variables associated with R&D inputs and time-varying nuanced factors. Results imply that region-specific factors affect the efficiency in the production of three types of patents (namely, invention, utility model, design) quite differently. Industrial structure is one influential factor which determines the efficiency levels of all three types of patenting. High technology industries are not as efficient and innovative as expected. Although the role of educational institution and government support is important in patenting inventions and utility models, it is not significant in patenting designs. Firms’ commitment in innovation helps promote the efficiency in patenting utility models and designs only. It does not significantly affect the efficiency in patenting inventions. It is found that the estimated mean efficiency level is higher in the case of utility model patenting than in other two cases, while the production of design patents is found the most inefficient. Ranking regions by an order of estimated mean efficiency levels, I find that a pattern of center–periphery in innovation efficiency is only observed in the case of invention and utility model patenting, not in the case of design patenting. Received 9 June 2005

Accepted 1 March 2006

XIBAO LI Key Research Base in Humanities and Social Sciences The Ministry of Education, China, and Research Center for Technological Innovation School of Economics and Management Tsinghua University, Beijing, China

Volume 8, Issue 1–2, July 2006

INNOVATION: management, policy & practice

171

Xibao Li

INTRODUCTION

I

t is a stylized fact that different innovation systems have quite different ability to innovate at the global technology frontier. The efficiency or productivity is heterogeneous among innovation systems. In spite of the fact that much attention has been paid to identify sources of these differences and roles of innovative settings in innovation literature (Nelson 1993; Niosi 2002; Freeman 2002) only few studies empirically explored these issues. One recent work by Furman et al. (2002) put forth a novel framework and empirically examined the relationship between innovation intensity and variables associated with national innovation systems. Drawing upon Romer’s endogenous growth theory (Romer 1990), Porter’s theory of industrial competitive advantage (Porter 1990) and theory of national innovation system (Nelson 1993), this approach incorporates both economy-wide input factors and environment related nuanced factors. Differences in innovation performance are attributed to differences in national innovation capacity, which in turn depends on the level of a nation’s common innovation infrastructure, the environment for innovation and the linkage between these two. Based on a similar framework, this paper extends Furman et al.’s study in three aspects. First, it extends the concept of national innovation capacity to regional levels. As some researchers pointed out (for example, Cooke et al. 1997; Tödtling & Kaufmann 1999; Doloreux 2002), innovation systems have a regional dimension. It is reasonable to argue that the concept of innovation capacity can be extended to regional innovation systems. The difference in innovation intensity varies not only across countries, but also across sub-national regions, like states or provinces (Evangelista et al. 2001; Acs et al. 2002; Fritsch 2002) It is interesting to see how differences in innovation performance across regions can be attributed to differences in regional innovation capacity. However, previous exploration of the regional comparison is mainly based on case studies (see, for example: Asheim & Isaksen 1996;

172

Héraud 2003; Asheim & Coenen 2005) The purpose of this research is to compare regional productivity based on evidence from an econometric perspective. Secondly, this paper investigates the regional differences in China. China is not only a less developed country (LDC), but also one of the transformation economies such as Central and Eastern Europe as well as one of Asian Developing Countries. Many researchers have noticed that innovation systems in developing or transitional countries are quite different from those in developed countries (Nelson 1993; Liu & White 2001; Radosevic 2002). In most LDCs and transformation economies, there exist serious inequalities in both economic development and innovation capacity across regions. For example, among 30 provinces in China, in terms of domestic patenting, five developed provinces (Guangdong, Shanghai, Zhejiang, JiangSu and Shandong) accounted for 53% of total patent grants in 2003. Fifteen regions below the median level accounted for less than 11% in total. Taking into consideration the peculiar characteristics of these economies properly and using a panel data on domestic patenting, this research will present empirical evidence from China. Thirdly, this analysis takes a different approach methodologically. In their work, Furman et al. (2002) used ordinary linear regressions to explore the relationship between international patents, which are taken to reflect the innovation intensity, and R&D inputs and other nuanced factors. With knowledge production function approach, Fritsch (2002) compared the quality of regional innovation systems based on negative binomial estimations. However, both studies shed little light on the separate effects of input factors and efficiency factors. Using domestic patenting information, I assume that input factors determine the production frontier of patents, and nuanced factors affect the efficiency in patent production. Thus, the effect and the role of various factors should be identified separately. In this sense, innovation systems are regarded as ‘X-

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Regional innovation performance

efficient’ (Niosi 2002). Their level of efficiency is variable depending on some region-specific and time-varying variables (Fritsch 2002). Drawing on literature in productivity and efficiency studies, I use a stochastic frontier model in this study. This paper is organized as follows. Section 2 briefly introduces the theoretical literature on regional innovation system, and describes the unit of analysis. Section 3 discusses the theory of idea production function and a stochastic frontier model. Data are summarized in Section 4. In Section 5, findings and results are discussed in details. Finally, Section 6 concludes.

UNIT OF ANALYSIS Since the 1990s, the approach of innovation system has gained popularity in the analysis of innovation activities in both national and regional contexts. It emphasizes on process, learning, and interaction among innovative actors, and is wellsuited to the analysis of innovation practices and interdependencies in the innovation process. In an innovation system, the main groups of actors that have an impact on innovation output include firms, universities, research institutions, government agencies and supporting services. They are connected by various linkages ranging from informal to formal network relationship, and interact in the production, diffusion and the use of economically useful knowledge. Besides this network, an innovation system also includes such institutional factors as a nation’s system of schooling, training and financial institutions as common infrastructure. The way innovation actors in a system interact depends on the nationor region-specific institutional setting. The concept of innovation system was first proposed at and applied to the national level (Lundvall 1992; Nelson 1993) More recently this approach has been extended to the regional level. The underlying arguments are based on the recent findings on regional studies. Studies on regional innovation show that innovation activities are not equally distributed in space and production of new technological knowledge tends to Volume 8, Issue 1–2, July 2006

cluster spatially. The uncertainty, complexity and tacit form of new knowledge make it transferable only through personal interaction. Spatial proximity could be instrumental in facilitating interactive learning and knowledge flow. As Fritsch (2002) pointed out, if spatial proximity and regional boundary matters, regional system of innovation would be an adequate approach to analyze innovation activities. In this article, I choose 30 administrative units1 in China as units of analysis based on the following arguments (see also Tödtling & Kaufmann 1999): 1. First of all, each province in China is an administratively and economically independent geographical region. Although subject to the same legal and political institution, each has its own governance rule and innovation support infrastructure. Each can set its own technology policy and innovation plan. In this sense, they are independent of each other in innovation activity. 2. People living within one province usually share the same local spoken language (dialect) and local culture. Since a large proportion of Chinese people are still living in the countryside region and seldom move in their whole life, the demarcation of these regions was formed long time ago. From the map of China, it is not difficult to find that these regions are quite different in shape and area. Hence, the dialect, custom, convention and culture in each province have been cultivated for quite a long time. Each has its distinctive historical, cultural and social setting. Arguably, this ‘social capital’ influences the direction of evolutionary processes of the region. 3. Because of the limitation on residence in China, it is not easy for labor force to move across regions freely for quite a long time. The mobilization of labor forces, the availability of educational institutions and of research organizations are usually tied to specific regions. Most innovation activities are carried out within regions. ‘Tacit knowledge’

INNOVATION: management, policy & practice

173

Xibao Li

is more likely tied to regions, and can only be accessed within a particular region. 4. Industry clusters are localized and hence supporting networks between firms are usually at the regional level. In China, there is a large share of heavy industries in northeastern areas than in any other areas. Light industries are mainly located in eastern and southern China. For instance, many electric appliance firms have headquarters in southern area. Hence, the dispersion of industry clusters provides us a possibility to examine various influences on the pace of technological changes. Thus, the administrative unit ‘province’ is taken as a lens through which the sources of differences in innovation activities are analyzed. Each unit constitutes a regional innovation system, which, in turn, is an important part of national innovation system in China (Chung 2002) There are another two advantages in adopting this approach. On the one hand, information about innovation and related factors are available from official statistics. On the other hand, these data are comparable and can be used to empirically investigate the effect of various region-specific factors.

MODEL To empirically model the characteristics of regional innovation system and investigate their influence on regional innovation intensity, I draw on the work by Furman et al. (2002) and use the idea production function in ideas-driven growth theory (Romer 1990) as a framework. Focusing on an aggregate level, the idea-driven growth model was proposed to treat endogenously the role of technological change in economic growth. In this model, an idea sector for the economy produces new ideas according to a Cobb-Douglas function: (New Ideas)t ∝ (Labor)t λ (Accumulated Ideas)t ø

(1)

According to this theory, the production of new 174

ideas in period t is determined by the number of idea workers (Labor)t and the stock of ideas up to time t (Accumulated Ideas)t . Here ø denotes the effect of the stock of ideas produced in the past on the rate of new idea production. If ø > 0, then prior research helps the current idea generation, and the so-called ‘standing on shoulders’ effect exists. On the contrary, if ø < 0, ‘fishing-out’ hypothesis holds. In other words, the ideas which are easiest to find have been discovered before and prior research makes the production of new ideas in current period difficult. Although this model is widely accepted and useful in explaining the level of economy-wide innovation, its power in the analysis of innovation intensity and performance is limited by its small set of factors. In effect, this production function only provides a frontier value. The observed output is also dependent upon the level of production efficiency. As Furman et al. (2002) mentioned: ‘A strong cluster innovation environment can amplify the strengths of the common innovation infrastructure, and a weak one can stifle them.’ Drawing upon Porter’s theory on national competitive advantage and industrial clusters and national innovation system literature, they encapsulated nation-specific nuanced factors (including microeconomic environmental, institutional, and policy factors) in the model by expanding the set of explanatory variables in (1) In empirical practice, a linear econometric equation can be obtained by taking the logarithm of both side of (1) and considering measurement errors. Furman et al.’s extension amounts to add nuanced factors into the right hand side of the linear equation. Hence, they treated the effect of nuanced factors as the same as that of input factors (labor and previous knowledge stock) Instead of thinking of nuanced variables as distinctive input-like factors, I treat them as factors affecting only the idea-production efficiency. Drawing on the literature on productivity analysis, I propose a stochastic frontier specification to analyze the effect of region-specific factors on the efficiency of innovation systems in this study.

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Regional innovation performance

The stochastic frontier model was first proposed by Aigner et al. (1977) and Meeusen and van den Broeck (1977) In this specification, the measurement error is assumed to consist of both a random term and an inefficiency term. The random term reflects the analyst’s observation error. The inefficiency term represents the extent to which the actual output deviates from the production frontier. The real production frontier is determined by both input factors and a random observation error, and thus is stochastic. As its name indicates, the inefficiency error is assumed to take negative values only. This specification identifies and estimates both input factors and inefficiency factors separately. It is well suited to analyze and evaluate the inefficiency of a production process. Recently, considerable researches have extended and enriched this model in various contexts both with cross-section data and with panel data (see, for example, Kumbhakar et al. 1991; Battese & Coelli 1995; Knittel 2002) Both time-variant and time-invariant factors can be encapsulated to investigate their effect on efficiency. Given the new idea production function as specified in (1), a stochastic frontier model specification takes the following linear form, shown in (2), (3), below. Here εit is assumed to be an i.i.d. normally distributed measurement error and µit is a nonnegative inefficiency error which is assumed to follow a one-sided normal distribution truncated at 0. Yit is the logarithm of the measurement of new ideas for region i in year t, and Xj,it is the jth input factor in new idea production function, which determines the deterministic production frontier. The mean of inefficiency error µit is

Volume 8, Issue 1–2, July 2006

determined by time-variant inefficiency factors Zk,it (k =1,…,K ), which may or may not include variables in Xj,it (j =1,…, J ). With regard to the sources of error, εit arises from the idiosyncratic region/year-specific technology shock unrelated to both the efficiency in innovation activity and the fundamental determinants of production frontiers. µi reflects the inefficiency associated region i in a particular year t. The analysis uses a log–log specification. Variables are expressed either in a logarithm form or as a ratio. Consistent with the majority of prior works, this treatment makes the estimation less sensitive to outliers and estimates have a nature interpretation in terms of elasticities. In this specification, the effect of both input factors and inefficiency factors can be identified and estimated. The specification in (2) and (3) is different from that in Furman et al. (2002) in that nuanced factors do not enter the econometric equation in a linear form. Rather I assume that they affect the realization of potential innovative potential indirectly in a non-linear way, i.e., they determine the conditional mean µit of truncated normal distributed term µit . By interpreting the effect of nuanced factors this way, this specification is linked to the argument that innovation systems are ‘X-efficient’ (Niosi 2002) Primary innovation actors in a system are not operating optimally but ‘X-efficiently’. They are not totally rational, but bounded rational. They satisfy, not maximize. With a stochastic frontier specification, I can highlight the importance of nuanced factors in innovation efficiency and empirically examine the extent to which ‘X-efficiency’ affects the innovation output.

INNOVATION: management, policy & practice

175

Xibao Li

Moreover, in an OLS specification, if inefficiency exists, the intercept would be biased, whereas estimated of other parameters are still consistent. Hence, as far as efficiency level is concerned, OLS cannot provide a correct estimate present in the data. In his empirical investigation of interregional difference of knowledge functions, Fritsch (2002) interpreted the estimated coefficients of R&D inputs as reflecting the efficiency of regional innovation productivity. The differences across regions are tested by comparing the estimated slopes. However, with this approach, he was not able to check the effect of efficiency factors and the efficiency is left as a black box. The stochastic frontier model can not only give an unbiased estimate of inefficiency level, but also allow analysts to investigate nuanced inefficiency factors and to examine the extent to which efficiency levels varies across regions.

DATA AND SUMMARIES Empirically investigating the sources of differences in innovation intensity and performance requires that each included factor be tied to observable measures. The data used in this study come from official statistics published by Chinese government. China Statistical Yearbooks and China Science and Technology Statistical Yearbooks provide all the data in this analysis. Table 1 lists definitions and sources of all variables and Table 2 summarizes these variables.

Patent information in China This paper uses domestic patent grant data as a visible measure of new ideas or innovation output. Because domestic patents in China are granted only for those innovations that represent something new-to-the-world or new-to-thenation, they are a measure of high-quality of R&D activity in China. In literature, the use of patent statistics brings about important measurement issues (Pavitt 1988; Griliches 1990; Archambault 2002) It is widely recognized that patent information could neither include all important 176

technological innovations nor reflect the importance of different innovations. There are pitfalls associated with equating patenting with the level of innovative activity in both ‘quantity’ and ‘quality’ perspectives. Besides the patent information, a few other indicators of R&D outputs have appeared in literature, for example, the new product sales (Liu and White 1997), changes in firmlevel stock market value (Pakes 1985), literature based innovation counts (Acs et al. 2002), the number of new products (Fritsch 2002) and the number of patent citations (Trajtenberg 1990a,b) Unfortunately, there are even more serious caveats associated with these indicators. The new product sales are related to the local market prices and vary between industries. Changes in firmlevel stock market value are not appropriate for regional level analysis. Although good indicators of innovation output, the number of literature or survey based new products and that of patent citations are usually not available and not easily accessible. In comparative studies, the use of patenting information is worth special attention. When units of analysis under study are from different countries or institutional settings, since patent laws and patenting processes may differ across regions, usually it is not directly comparable to use the number of patents registered or granted locally as a measure of innovation activity. In their international comparison among OECD nations, Furman et al. (2002) addressed this limitation by including only the number of ‘international patents’, defined as the number of patents granted by USPTO. In regional comparison within one country, however, this is not a big issue. In practice, the patent information has already been extensively employed in regional studies. For example, Evangelista et al. (2001) used regional level patent data to analyze the regional innovation systems in Italian. In an analysis of regional production of new knowledge in the US, Acs et al. (2002) provided empirical evidences that patent information is a reliable measure of innovative activity.

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Regional innovation performance TABLE 1: VARIABLES

AND DEFINITIONS

Variable DEPENDENT VARIABLE Scenario 1 (Short Lag) LogINV3it

LogUM1it

Definition

Source

The number of invention patents granted in year t +3 in logarithm scale

Chinese Statistical Yearbook (CSY) and State Intellectual Right Office of China (SIPO) Period: 1998-2004 CSY & SIPO: 1998-2004

The number of utility model patents granted in year t +1 in logarithm scale The number of design patents granted in year t +1 in logarithm scale

LogDE1it Scenario 2 (Long Lag) LogINV4it LogUM2it LogDE2it INPUT FACTORS LogRNDPit

LogGDPPCit

The number of invention patents granted in year t +4 in logarithm scale The number of utility model patents granted in year t +2 in logarithm scale The number of design patents granted in year t +2 in logarithm scale

CSY & SIPO: 1998-2004

Total R&D FTE Personnel in logarithm scale

China Science & Technology Statistical Yearbooks (CSTSY) Period: 1998-2002 CSTSY: 1998-2002

GDP per capita at regional level in logarithm scale, and adjusted by the real growth rate to 1998 level Proportion of Scientists and Engineers among Science & Technology personnel (%) Share of R&D Expenditure devoted to basic research (%)

SNEPit BASICREit INEFFICIENCY FACTORS LIGHTHEAVYit

Ratio of gross industrial output from light industries to that from heavy industries

HITECHit

Percentage of gross industrial output from high technology industries (%)

EDUit

Ratio of local educational expenditure to regional GDP (%) Share of regional financial revenue spent on local Science & Technology activities (%) Percentage of Science & Technology funding contributed by business firms (%) Percentage of Science & Technology funds contributed by financial institutions (%) Trade Specialization Index (between -1 and 1) Total value of technology contracts in logarithm scale, and CPI-adjusted to 1998 constant value

GOVit BUSit BANKit TSIit LogCONTRACTit

CSY & SIPO: 1998-2004

Volume 8, Issue 1–2, July 2006

CSY & SIPO: 1998-2004 CSY & SIPO: 1998-2004

CSTSY: 1998-2002 CSTSY: 1998-2002

China Statistical Yearbook on Industrial Economy. Period: 1998-2002 Chinese Statistical Yearbook on High Technology Industry. Period: 1998-2002 CSTSY: 1998-2002 CSTSY: 1998-2002 CSTSY: 1998-2002 CSTSY: 1998-2002 CSTSY: 1998-2002 CSTSY: 1998-2002

INNOVATION: management, policy & practice

177

Xibao Li TABLE 2: SUMMARY

STATISTICS OF ALL VARIABLES

Number

Periods (t)

Median

Mean

Std. Dev.

DEPENDENT VARIABLES Scenario 1 LogINV4 LogUM2 LogDE2

90 150 150

2002~2004 2000~2004 2000~2004

5.1703 7.0496 6.2226

5.2244 6.9352 6.3951

1.1696 1.1949 1.3625

Scenario 2 LogINV3 LogUM1 LogDE1

120 150 150

2001~2004 1999~2003 1999~2003

5.0783 7.0003 6.1643

5.0941 6.9205 6.3082

1.1397 1.1514 1.3235

INPUT FACTORS LogRNDP LogGDPPC SNEP BASICRE

150 150 150 150

1998~2002 1998~2002 1998~2002 1998~2002

0.7753 -0.4520 61.5830 4.1063

0.6186 -0.3187 61.5447 5.1627

1.1043 0.5243 8.0945 3.9430

INEFFICIENCY FACTORS LIGHTHEAVY HITECH EDU GOV BUS BANK TSI LogCONTRACT

150 150 150 150 150 150 150 150

1998~2002 1998~2002 1998~2002 1998~2002 1998~2002 1998~2002 1998~2002 1998~2002

0.5450 6.7899 4.3131 0.8723 51.8990 8.3299 0.2200 2.5388

0.6039 6.7815 4.5680 0.9788 49.9940 8.7821 0.1756 2.2136

0.3744 8.1037 1.4327 0.4948 13.0490 4.1204 0.2473 1.6400

Variables

In China, there are three types of patents, namely, inventions, utility models and designs. Figure 1 reports numbers and proportions of three types of patent grants in 30 regions in year 2003. Regions are arranged from left to right by a descending order of numbers of total patent grants. Three facts stand out immediately. First, regions differ markedly in patenting. Guangdong, occupying the first rank in terms of total patents, has more than twice as many patent grants as does Zhejiang, which is in the third place. Second, inventions, as the most important and technologically intensive patents, only account for a very small proportion (less than 8%) Most of domestic patents in China belong to two less innovative categories: utility models and designs. Utility models account for more than half of total patents for most of regions. Third, 178

difference varies greatly across regions. For instance, in Guangdong the percentage of invention grants is less than 3.3%. But in one of the least developed west regions, Shangxi2,2 this percentage is 23.5%. Since three types of patent grants are very different in economic value, technological importance and requirement for R&D inputs, the extent to which patent statistics represents true innovation intensity depends on which type of patenting information is used. In other words, the difference of quality across patents of different types cannot be ignored. Hence, it is not wise or appropriate to compare regional innovation intensity in terms of combined patent numbers. In this study, I employ three variables to measure the innovation output of each region. They are defined as numbers of respective type of patents granted to appli-

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Regional innovation performance

Patent Number

Total Patent Grants: 3572 to 41799

Total Patent Grants: 1331 to 3374

Total Patent Grants: 90 to 1285

Invention

30000

1200

3000

Utility Model

Design

20000

10000

2000

800

1000

400

0

Percentage

0

0

90

60

30

FIGURE 1: NUMBERS

ia ng zh ou G an su N in gx ia H ai na Q n in gh ai

nj

ui

Xi

G

2

u

xi

gg

an

en

AND PERCENTAGES OF THREE TYPES OF PATENT GRANTS IN

cants from a particular region in a given year. Three types of patent information are analyzed separately. More importantly, unlike in most developed countries, in China a large number of patents are granted to independent applicants. Table 3 shows the breakdown of each type of patent grants.3 Non-institutional patenting represents the innovation capacity contributed by residents living in a region, however, since the R&D input statistics is usually calculated for institutions, problems can occur when one tries to study R&D productivity or investigate innovation efficiency with combined statistics. Considering data availability and possible pitfalls and caveats, I justify the use of combined patent information based on the following arguments. First, this analysis is about a comparison of regional innovation efficiency. Non-institutional patenting is an important part Volume 8, Issue 1–2, July 2006

Region

N

ei

m

i

an Sh

gx an Ji

Yu

ng ua

nn

xi

i

1 xi an

Sh

G

lin

hu

Ji

An

H H u ei lo bei ng jia ng Ti an jin

an qi ng ng

an

H en

C ho

H un

ai ej ia n Ji g an Sh gsu an do ng Be ijin g Li ao ni ng Fu jia n Si ch ua n H eb ei Zh

gh

do ng

Sh

ua G

an

ng

0

2003

of regional innovation performance. Second, as will be discussed shortly, I use GDP per capita as a proxy of knowledge stock in an innovation system. It could encapsulate part of the effect of regional innovation capacity on non-institutional patenting. Finally, given the logarithm specification in (2), the extent to which inconsistency exists depends on the extent to which regions are different in proportions of non-institute patent grants. If there is no big difference in shares of non-institutional patent grants across regions, the use of combined statistics affects only the coefficient of constant term in the right hand side of (2) Coefficients of all other factors can be correctly and consistently estimated. Hence, this study is subject to the caveat that difference in share of non-institution patenting across regions is, if not negligible, small.4 It should be noted here that there exists the

INNOVATION: management, policy & practice

179

Xibao Li TABLE 3: PATENTS

GRANTED TO INSTITUTIONAL AND NON - INSTITUTIONAL APPLICANTS

Inventions Total Non-Institution Institution % Universities and Research Institutes % Business Firms % Institution Utility Models Total Non-Institution Institution % Universities and Research Institutes % Business Firms % Institution Designs Total Non-Institution Institution % Universities and Research Institutes % Business Firms % Institution

1998

1999

2000

2001

2002

2003

1655 701 954

3097 1412 1685

6177 3353 2824

5395 2781 2614

5868 2724 3144

11404 4509 6895

60.8 19.1 57.6

57.4 27.4 54.4

55.3 36.0 45.7

52.8 41.7 48.5

51.0 46.5 53.6

49.4 49.1 60.5

33717 25225 8492

56094 41491 14603

54407 38888 15519

54018 37474 16544

57092 38723 18369

68291 44283 24008

22.1 74.2 25.2

18.5 78.9 26.0

15.4 82.6 28.5

14.6 83.3 30.6

12.2 85.8 32.3

12.8 85.3 35.2

26006 11006 15000

32910 15283 17627

34652 16863 17789

39865 20645 19220

49143 29123 20020

69893 38428 31465

1.6 98.3 57.7

1.1 98.5 53.6

1.6 98.3 51.3

0.9 98.9 48.2

0.9 98.9 40.7

1.2 98.5 45.0

Source: (1) China’s Statistical Yearbooks 1999-2004. (2) Stratified data on domestic patents in 2004 are not available yet when the study is done. Some institutional patents are granted to applicants from governmental sectors, which is not included here.

problem of quality across patents of the same type too. As is well recognized, granted patents differ greatly in the magnitude of economic value and technological importance associated with them. In terms of domestic patents, this ‘quality’ issue might be more severe in developing countries like China than in other developed countries, since its innovation system is still in transition and not yet settled. Despite of these problems, since patent approvals in each region are subject to the same patenting laws and procedures, variables based on Chinese domestic patent information are consistent across 30 regions. For the purpose of regional comparison, they constitute consistent measures of technologically and economically significant innovations 180

and hence it is justifiable to use the domestic patent information in this study. Since it takes time to process and approve patent applications, Furman (2002) used a threeyear lag between R&D inputs and patent grants in their international comparison without giving any justification. In China, it usually takes about three years for an invention patent application to get approved, and utility model and design patent applications can be approved within one year. Considering that there exist a lag between R&D input and patent applications too, I consider two scenarios in this analysis. In the short-lag case (Scenario 1), I use a 3-year lag for invention case and 1-year lag for both utility model and design cases. In the long-lag case (Scenario 2), a 4-year

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Regional innovation performance

lag is applied to invention patents and 2-year lag to both utility model and design patents.

Explanatory variables Besides a measure of innovation output, we should have measures of a region’s input and nuanced factors as specified in (2) and (3) too. In the framework proposed by Furman et al. (2002), determinants of innovative capacity are divided into three categories: the common innovation infrastructure, cluster-specific innovation environment, and the linkage between them. It is easy to consider all these variables in an OLS specification. However, to include them in a stochastic frontier model, explanatory variables have to be re-classified into two groups: X ’s and Z’s. Conditional on the data availability, this research draws upon Furman et al.’s work to select explanatory variables, and categorizes them into input factors and efficiency factors on the basis of their relationship with knowledge production process. Specifically speaking, in a regional innovation system, firms, universities, research institutes and government organizations are the primary actors. Resources commitments are regarded as direct input factors to the process of knowledge production. The nature of linkage between innovation actors, industrial clusters, local support from financial and educational institutions, and the openness to outside world constitute region-specific innovation setting, which determines the efficiency of innovation activity. Since direct measures of innovation environment and the nature of linkage are not available, to address these challenges, this study employs intermediate measures or proxies to capture important economic outcomes associated with strength in these areas. In this analysis, total FTE R&D Personnel (LogRNDP ) and GDP per capita (LogGDPPC ) in the regional level are used to represent two main determinants of new idea production frontier: the overall level of human capital devoted to innovative activity and a region’s knowledge stock, respectively. In classical Cobb-Douglas production functions, R&D expenditure would Volume 8, Issue 1–2, July 2006

be a second input factor. However, FTE R&D personnel and R&D expenditure are highly correlated even after taking a logarithm (r 2 = 0.953) In view of the correlation with other explanatory variables, only the information on FTE R&D personnel is used in this model. With regard to knowledge stock, in Furman et al. (2002), they also considered patent stock, which is defined as the sum of patents from the start of sample until the year of observation. Since the data in this study cover a rather short period, the possibility of using patent stock is not explored here. Only regional GDP per capita is used as a proxy of regional knowledge stock. In the new idea production function, another two input-related factors are included in Xj,it too. The first one measures the ‘quality’ of human capital in R&D input, and is expressed as the faction of scientists and engineers among science and technology personnel, denoted by SNEP. In innovation activity, the ‘quantity’ and the ‘quality’ of R&D personnel both matter a lot. Since people are different in creativity and productivity, the quality of R&D personnel undoubtedly influences the frontier of innovation production. Unfortunately, there is no information on educational background for R&D personnel. The data on the share of scientists and engineers among FTE R&D personnel is not available either. Hence, the proportion of scientists and engineers among personnel engaging in scientific and technological activities is used as only a rough proxy. The second one is the percentage of R&D expenditure devoted to Basic Research (denoted by BASICRE ) and reflects the use of R&D expenditure in innovation activity. In practice, the allocation of research fund varies across regions. Since patents are more likely produced from applied research than from basic research, it is reasonable to assume that the allocation of research fund affects the possible patent output frontier. The more money is spent to applied research, the more patents will be developed and granted. To examine determinants of inefficiency in patenting, measures of region-specific nuanced

INNOVATION: management, policy & practice

181

Xibao Li

Percentages

(or environmental) factors Zk,it ought to be included in (3) Although input factors are quite amenable to measurement, the environment for innovation is difficult to measure, because of the subtlety of concepts and the lack of data. Hence we consider intermediate measures consistent with the outcomes of innovation-oriented environmental factors. First, information on local industrial structure is incorporated. Ideally it would be favorable to include a variable representing the distribution of regional industrial clusters. Since the detailed information on industry clusters is not available, I considered using the ratio of gross product from light industries to that from heavy industries (denoted by LIGHTHEAVY ) to capture the possible effect of industry structure. In addition, a variable denoted by HITECH is included to represent the importance of high technology industries in regional innovative activity. It is defined as the ratio of gross industrial output from high technology industries to total local gross industrial output. The ratio of local educational expenditure to local GDP (denoted by EDU) measures the intensity of human capital investment. The more money is spent on education, the more highly skilled R&D personnel are available for firms and

Total Patents: 3,353 to 35,043

research institutions to draw upon. Both institutional and non-institutional innovation activities will benefit from a pool of qualified labor forces. In fact, a more relevant measure would be the share of GDP spent on secondary and tertiary education. However, in China’s Statistical Yearbooks, only the information of total local education expenditure is available. Financial support from government reflects the innovative atmosphere in a region and affects innovation incentive and efficiency. I include the share of financial revenue spent on science and technology (S&T) activities by local government as a measure of the strength of government’s resource commitment, denoted by GOV. It measures the relative importance of S&T in government’s allocation of financial sources. Also, R&D activities funded by government may have a distinct feature, which may affect both the quality and quality of innovation output. The percentage of funds for S&T raised from firms in business sector (denoted by BUS) reflects the innovation propensity by one of the main actors in an innovation system. It represents the initiative taken by business firms in innovation. It is also a useful indicator of the vitality of regional innovation environment and is comparable across regions. The efficiency and productivity of inno-

Total Patents: 1,128 to 2,972

Total Patents: 85 to 1,091 Government Firms Banks

90

60

30

182

ua ng xi an gx Sh i N anx ei m i2 en gg Xi u nj ia G ng ui zh ou G an s N u in gx i H a ai na Q n in gh ai Ji

G

Ji lin An hu Yu i nn an

un an H Hu ei b lo e ng i jia ng T C ianj ho in ng qi n Sh g an xi 1

en an

FIGURE 2: PERCENTAGES

H

H

G

ua ng do Zh ng ej ia n Ji g an Sh gs an u d Sh ong an gh a Be i iji Li ng ao ni ng Fu jia Si n ch ua n H eb ei

0

OF SCIENCE AND TECHNOLOGY FUNDS FROM THREE SOURCES

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Region

Regional innovation performance

vation depend largely on whether and to what extent firms within an economy direct financial resource toward those ends. The share of total S&T funds loaned from banks or other financial institutes (denoted by BANK ) is included as a measure of the extent to which the financial institutions support creative technological activities or the role of financial institutions in an innovation system. Figure 2 gives a comparison of shares of S&T funds raised from three different organizations: governments, firms and banks. It is very clear that funds for S&T from banks only account for a very small proportion. Firms and government organizations contribute most of S&T funds. It is worth noting that the S&T funds from government only measures the contribution of government compared with those from firms and banks. This is different from the financial support from government (GOV ) discussed above. Since it is highly negatively correlated with the share of firms, it is not included in this analysis. The openness of a region to international trade is one of important policy or external factors that affect the efficiency level of innovation production, and it is particularly important in LDC and transition economies like China. It is expected that a region can have access to sophisticated technological information and knowledge from international trade (especially from technology import) Liu and White (1997) found out that technology import expenditure is an important variable in explaining the innovation output in some Chinese firms. To incorporate its effect, I use the regional Trade Specialization Index (TSI ) to represent the extent to which a region makes use of external technology information and knowledge. This index is defined as: TSI =

Total amount of export – Total amount of import Total amount of Export + Total amound of import

When TSI is positive (or negative), a trade surplus (or deficit) occurs. The smaller its value is, the more likely a region draws upon advanced technological knowledge from external economy. Volume 8, Issue 1–2, July 2006

In reality, what products have been imported is also important. Whether they are high-technology equipments or raw materials could make a big difference. Given that this measure does not consider this information, it represents the underlying concept with inevitable noise. Finally, the strength of linkage between innovation actors is considered in the model. The mechanisms for S&T transfer varies both across regions and over times. This study uses an intermediate measure which is consistent with the strength of S&T transfer: the amount of contractual value in technology market (denoted by LogCONTRACT) It reflects the intensity of transaction or collaboration between primary actors in an innovation network. As discussed before, all variables included are either in a logarithm form or expressed as a dimensionless ratio (see Table 1 for the details). When monetary values are involved, they are deflated by consumer price indices (CPI), except for GDP per capital which is adjusted by the real growth rate, to the 1998 constant value. In addition, considering that Chinese patenting law underwent an important change in 2000, year dummy variables are included in frontier equation (1), and a time variable is included in mean inefficiency equation (2) to capture the trend of change in efficiency during the study period. In empirical studies where so many independent variables are included, it is better to discuss the issue of multi-colinearity. In this study, separate diagnostic tests based on variance inflation factors and condition numbers show that multicolinearity is not a big problem among explanatory variables X ’s and Z’s as defined in (2) and (3).5 Table A.1 in Appendix gives the pair-wise correlation coefficients among included variables. The lower part in Table 2 summarizes all explanatory variables (both Xj,it’s and Zk,it’s) From this table, we can obtain a general idea of China’s regional innovation capacity. On the average, about 60% S&T personnel are scientists and engineers. A very small faction (about 5%) of total R&D expenditure is directed to basic

INNOVATION: management, policy & practice

183

Xibao Li

research. R&D expenditure is mainly spent in the field of applied research and experimental development. The share of local GDP spent in education is less than 5% and the fraction of local financial revenue used for S&T is less than 1%. Firms contribute about half of S&T funds.

FINDINGS AND RESULTS Results from the stochastic frontier model for three types of patents in two scenarios are reported in Table 4 and presented in three parts below. I will first evaluate the determinants of the patent production frontier and then explore the impact of environmental factors on innovation inefficiency. Finally, based on estimated mean values of inefficiency, I examine the distribution pattern of inefficiency present among regions.

Determinants of patent production frontier The upper part of Table 4 provides findings regarding the relationship between three types of patent grants and innovation inputs. The results imply that there exist a robust and relative precise relationship between three types of patent grants and FTE R&D personnel in both scenarios. These estimates have a nature interpretation of elasticities. Suppose that Scenario 2 is the case, i.e., a lag of 4 years between R&D inputs and inventions granted are appropriate. A 1% increase in FTE R&D Personnel would lead to about 0.8% increase in invention patent grants. In terms of utility model and design patenting, these estimates are consistent and similar in two scenarios. That is, a 1% increase in R&D input would lead to about 0.9% increase in both utility model and design grants. The effect of GDP per capita depends on the type of patents. In all three types of patent production, φˆ > 0, which implies that there exist ‘standing on shoulder’ effects in patenting. That is, knowledge stock helps the creation of new knowledge. However, the extent to which it influences patenting varies across patent types. In Scenario 1, if real GDP per capita increases by 184

1%, invention, utility model and design grants will increase by about 0.53%, 0.45% and 0.68% respectively. In Scenario 2, these estimated elasticities would be 0.45, 0.49, and 0.99, respectively. In either case, the impact of GDP per capita on design grants is greater than that on invention and utility model grants. It seems that the role of local economic development is more conspicuous in design patenting. With regard to the quality of R&D personnel, positive signs of estimated parameters suggest that the higher quality of R&D personnel (roughly measured by SNEP ) lead to more innovation outputs. However, this effect is not statistically significant in all types of domestic patenting. About the allocation of R&D resource, negative signs of parameters indicate that the effort devoted to basic research will depress the potential of patenting. Probably it is because most patents are byproducts of applied research and experimental development. That more resources are directed to basic research means less input into patent production. However, this negative effect is quite limited. Roughly speaking, given a certain amount of total R&D expenditure, a 1% increase in basic research leads to about 0.02% decrease in patent grants.

Determinants of innovation inefficiency Findings for inefficiency factors are reported in the lower part of Table 4. Except for the case of invention in Scenario 2, year-specific dummies are not significant statistically, implying that differences in efficiency can be attributed to factors related to regional innovation environment. Comparing parameter estimates for different types of patent grants, it is found that determinants of inefficiency vary from type to type, indicating that incentives to developing inventions, utility models and designs might be quite different. In both scenarios and across all patent types, the influence of industrial structure on patenting efficiency seems to be significant. A negative sign of LIGHTHEAVY means that a larger proportion

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

RESULTS

Volume 8, Issue 1–2, July 2006

INNOVATION: management, policy & practice *

** ** ** ** **

**

** ** * ** **

0.1282 (0.0314) ** 0.5063 (0.1303) ** 0.7764

2.2404 (0.5607) 0.1316 (0.0880) -1.7327 (0.2760) 0.0696 (0.0159) -0.2205 (0.0739) -0.6463 (0.1704) -0.0184 (0.0087) 0.0197 (0.0220) 0.5238 (0.3922) -0.0416 (0.0611)

7.3766 (0.3572) -0.0328 (0.1138) -0.3545 (0.1220) -0.3707 (0.1398) -0.2812 (0.1617) 0.8862 (0.0393) 0.4464 (0.0917) -0.0035 (0.0062) -0.0320 (0.0091)

150

LogUM1

** **

**

**

**

** **

** **

0.1550 (0.0197) ** 1.0000 (0.0000) ** 0.2337

3.8385 (0.4063) -0.0182 (0.0501) -2.3175 (0.1557) 0.0060 (0.0071) -0.0473 (0.0405) 0.0463 (0.0916) -0.0183 (0.0046) -0.0086 (0.0122) 0.4741 (0.1908) 0.1879 (0.0355)

7.4081 (0.2887) -0.0356 (0.0904) -0.3359 (0.0704) -0.3190 (0.1064) -0.1352 (0.1210) 0.8705 (0.0283) 0.6834 (0.1234) 0.0106 (0.0066) -0.0187 (0.0074)

150

LogDE1

** * * ** **

0.2281 (0.0473) ** 1.0000 (0.0000) 0.5816

2.6253 (0.9149) 0.3696 (0.1543) -0.4631 (0.2559) 0.0298 (0.0181) -0.4576 (0.1112) -0.5896 (0.1845) -0.0021 (0.0115) -0.0148 (0.0262) -0.5373 (0.3774) -0.0514 (0.0630)

0.7913 (0.0356) ** 0.4504 (0.1662) ** 0.0102 (0.0089) -0.0243 (0.0155)

4.5590 (0.6971) 0.6789 (0.0129) ** 0.9942 (0.2029) **

90

LogINV4

** ** ** ** *

**

** ** **

**

0.1359 (0.0284) ** 0.5586 (0.1151) ** 0.7506

2.0815 (0.5573) 0.1077 (0.0809) -1.8821 (0.3083) 0.0617 (0.0153) -0.1859 (0.0710) -0.5912 (0.1746) -0.0131 (0.0074) 0.0230 (0.0228) 0.1554 (0.3458) -0.0320 (0.0606)

7.0969 (0.3911) -0.0509 (0.1060) -0.3902 (0.1201) -0.1926 (0.1342) -0.3068 (0.1556) 0.9157 (0.0403) 0.4877 (0.1036) 0.0013 (0.0065) -0.0286 (0.0099)

150

LogUM2

Scenario 2 (Long Lag)

Asymptotic standard errors are in parentheses. ** and * denote significance at the 95% and 90% confidence levels, respectively.

2

0.1117 (0.0263) ** 1.0000 (0.0000) 0.4801

2

σ (= σ µ + σ ν ) γ (= σ 2µ /σ 2) Mean efficiency

2

1.4088 (0.4830) 0.1755 (0.1104) -0.3508 (0.1503) 0.0322 (0.0102) -0.2473 (0.0763) -0.2532 (0.1463) -0.0042 (0.0061) 0.0288 (0.0156) 0.0223 (0.3247) 0.0503 (0.0625)

Constant Time Trend LIGHTHEAVY HITECH EDU GOV BUS BANK TSI LOGCONTRACT ** ** ** *

0.9076 (0.0804) ** 0.5322 (0.1251) ** 0.0023 (0.0052) -0.0224 (0.0118) *

120

LogINV3

Scenario 1 (Short Lag)

STOCHASTIC FRONTIER MODELS

5.2829 (0.4506) -0.0561 (0.1192) 0.3512 (0.1873) * 0.7749 (0.2344) **

FROM

Constant T1 (1999) T2 (2000) T3 (2001) T4 (2002) LogRNDP LogGDPPC SNEP BASICRE

Sample Size

TABLE 4:

**

* *

**

**

** **

**

0.2960 (0.0391) ** 1.0000 (0.0000) 0.2294

2.7465 (0.6419) 0.1012 (0.0840) -1.8398 (0.1531) 0.0154 (0.0120) -0.0340 (0.0684) 0.0153 (0.2080) -0.0145 (0.0087) 0.0286 (0.0150) -0.2761 (0.3641) 0.1844 (0.0697)

7.4682 (0.7559) 0.1195 (0.0248) 0.0063 (0.1534) 0.2765 (0.1916) 0.1753 (0.2024) 0.8778 (0.0395) 0.9913 (0.1537) 0.0108 (0.0128) -0.0438 (0.0146)

150

LogDE2

Regional innovation performance

185

Xibao Li

of light industries in a region reduces the inefficiency level, or equivalently, increases the efficiency level. It implies that domestic patenting is more intensive within light industries than within heavy industries. This might be due to the fact that it is easier to innovate and patent new knowledge in technological fields related to light industries than those fields related to heavy industries. Or firms in light industries are more active in innovation activities. Comparing estimated coefficients of LIGHTHEAVY for three types of patents suggests that the effect of a lightindustry oriented industrial structure is more evident in the case of utility model and design than in the case of invention. Strangely enough, estimated coefficients of HITECH are positive in all 6 cases, although they are not significant in the case of design patenting. This suggests that a region with more intensive high technology industries is less efficient in regional domestic patenting. This seems contradictory to the common sense that a region with more high-tech industries should be more active in technological innovation and more efficient in patenting. However, a rough comparison of ratios of R&D input to output between high technology industries and manufacturing validates the finding from this stochastic frontier estimation. In terms of five innovation measures, namely, R&D FTE personnel, R&D expenditure, sales revenue from new products for export, patent applications and patents granted, Table 5 gives ratios of each measure in high-tech industries to TABLE 5: COMPARISON

that in manufacturing from 1999 to 2003. It is evident that ratios in terms of two R&D input factors (i.e., R&D personnel and expenditure) are significantly higher than ratios in terms of two R & D output measures (i.e., patent applications and patents granted), which means that high tech industries as a whole are not as productive in patenting as the manufacturing. Why is it the case? Does it mean that high tech industries are less innovative in China? Although a further study is definitely needed to answer these questions, tentative explanations might be suggestive. If, in high-tech industries in China, granted patents are of higher quality, and firms are more likely to keep technical secrecy than patenting, then the problems of patent quality and patenting propensity have to been taken into account seriously before properly interpreting of the findings above. As high ratios of revenue from new product for export indicate (row 3 in Table 5), it is also possible that enterprises in high-tech industries devote more R&D resource to innovative activities such as developing new products and exploring new markets. Thus, the measure of patents granted does not capture the whole effect of innovation performance in high tech sectors. However, if those new products in high tech industries are developed from available technology, one may argue whether so-called high tech industries in China are really ‘high’ or ‘new’ from a technology perspective. Checking out the role played by innovation actors shows that a large resource commitment to

BETWEEN HIGH TECHNOLOGY INDUSTRIES AND MANUFACTURING IN

CHINA

ITEM

1996

1997

1998

1999

2000

2001

2002

2003

R&D FTE Personnel R&D Expenditure Revenue from New Products for Export Patent Applicationa Patent Granted a b

24.2 21.7

25.0 24.6

22.2 33.4

25.7 30.4

30.9 34.4

32.9 38.1

31.2 35.5

29.7 32.8

34.5 12.4 11.5

30.6 13.6 12.9

43.4 18.6 20.0

44.6 20.4 15.5

53.5 20.2 23.8

50.9 23.1 20.1

50.6 27.3 20.9

55.2 27.7 22.9

Note: Numbers in the table are ratios of respective items in high technology industry to those in manufacturing. Source: China Statistics Yearbook on High Technology Industry 2004. aOnly inventions and utility models are included. bData used in calculating ratios after 2000 are referring to the owned patents.

186

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Regional innovation performance

educational expenditure and a strong support from government organizations increase the efficiency in both invention and utility model patenting. Both EDU and GOV have negative estimated coefficients and they are statistically significant. However, their influence on design patenting is not so significant. For business firms, their innovation initiative (BUS ) does not help to increase the efficiency in invention patenting significantly, although it is favorable to patent utility models and designs. At first sight, it might sound surprising. However, this is probably true in China. Actually, these findings are consistent with our observation from Table 3, where it is found that universities and research institutes are major innovation actors in invention patenting, and business enterprises are dominant in patenting utility models and designs. Since expenditures on higher education accounts for a large proportion of total regional educational expenditure, a higher value of EDU can be approximately though of as representing a stronger role of universities. Similarly, a higher value of GOV is indicative of a stronger financial support to regional research institutions. Hence, results from stochastic frontier models implies that universities and research institutions are inclined to engage in more technologically intensive innovative activities, and not very efficient at marginal innovative activities – patenting designs. Efforts made by business enterprises are mainly on patenting utility models and designs. Since utility models and designs only represent marginal technological improvement and modification, and do not represent important innovations, business firms, being the most important innovators in advanced economies, are only marginal innovators in China. As Liu and White (2001) pointed out, the innovation efficiency of Chinese firms is relatively lower than that of other innovation actors. With respect to the role of financial institutions (BANK ) in regional innovation system, the estimated results are inconclusive. In the case of both utility model and design patenting, support from financial institutions is not a statistically signifiVolume 8, Issue 1–2, July 2006

cant determinant of innovation efficiency. In the case of invention patenting, two scenarios give very different results. Similarly, it is not very clear whether and how foreign trade factor influences regional innovation performance. Although estimated TSI coefficients are not significant statistically in both scenarios, positive signs seem to indicate that a region with a lower TSI is be more efficient in patenting utility models. Or equivalently, foreign importation might be favorable to patent utility models. Evidences on linkage between innovation actors are unclear in the case of invention and utility model either. However, positive estimated LogCONTRACT coefficients suggest that a strong linkage between innovation actors have a negative impact on the efficiency of design patenting. This is probably because regions with active and prosperous technology markets do not show much interest in marginal modification of products. For utility model patenting, estimated LogCONTRACT coefficients have negative signs in both scenarios, indicating that an active technology market and strong linkage among innovation actors could be conducive to patent utility models. However, its influence is not significant statistically. From the estimated γ it can be concluded that, in both invention and design cases, variance can be explained almost totally by the factors included in the inefficiency equation (γ is very close to 1). In the case of utility models, determinants of inefficiency level could explain more than 50% of total variance. The high values of estimated γ imply that the use of stochastic frontier models is justified in this analysis.

Patterns of innovation inefficiencies Based upon estimated stochastic frontiers, it is easy to calculate technical efficiency estimates for 30 regions in each period (Coelli 1996) They are a measure of technical efficiency relative to production frontier (1). The last line in Table 4 reports means of technical efficiency estimates for each patent type in two scenarios. The results suggest that on average regional innovation sys-

INNOVATION: management, policy & practice

187

(b)

25 20

30

Design (S2)

(a)

30

Utility Model (S2)

Invention (S2)

Xibao Li

25

20

15

15

15

10

10

10

5

5

5

0

10

20

0

30

0

10

20

0

30

20

30

25 20

25 20

15

15

10

10

10

5

5

5

20

30

0

30

(f)

30

15

10

20

Design (S1)

Design (S1)

Utility Model (S1)

25

0

10

(e)

(d) 30

0

0

Utility Model (S1)

Invention (S1)

Invention (S1)

25

20

0

(c)

30

0

10

20

GDP Per Capita

FIGURE 3: RANK ORDERS

30

0

0

10

GDP Per Capita BY

EFFICIENCY ESTIMATES

20

30

GDP Per Capita IN

2000

Note: (1) Three panels in the upper part compare rank orders by efficiency estimates between two scenarios. For each panel, the horizontal axis and the vertical axis show rank orders based on estimated efficiency values from Scenario 1 and 2, respectively. (2) Three panels in the lower part demonstrate rank orders by efficiency estimates from Scenario 1 in vertical axes and those by GDP per capita in horizontal axes.

tems in China are the most efficient in utility patenting and the least efficient in design patenting. Despite of the fact that several regions (Guangdong, Zhejiang and Shanghai) have experienced a boom in design grants recently, most other regions still lag behind and are very inefficient in design patenting, which could have seriously reduced the mean efficiency level on a whole. Estimated efficiency values for each region can also be used to sort 30 regions according to various efficiency criteria. Based on efficiency esti188

mates for the year 2000 data6 in two scenarios, I am able to check whether the rankings from two scenarios are consistent. More specifically, 30 regions are first ordered by estimated efficiency values in two scenarios. Two groups of obtained rank orders are next displayed in a scatter plot to see whether they fall on the straight line with slope 1. In the upper panel (a), (b) and (c) of Figure 3, the horizontal axis demonstrates the rank order of each region based on estimated efficiency values from Scenario 1. Rank orders obtained from Scenario 2 are indicated on the vertical axis.

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Regional innovation performance

For all three patent types, two sets of rank orders lie closely around the straight line with slope 1, which means that rank orders from two sets of estimated values are consistent. To see whether there is any systematic relationship between local economic development and efficiency level, I plot the order of each region by estimated efficiency values against that by regional GDP per capita in the lower part of Figure 3. Vertical axes in panel (d), (e) and (f ) show the rank order of each region based on efficiency estimates in patenting inventions, utility models and designs in Scenario 1, respectively. From panel (d) and (e), it is easy to see that regions with higher GDP per capita are usually more efficient in patenting inventions and utility models, except for several richest and poorest regions. There seems to be a center– periphery pattern of R&D efficiency for most other regions (Fritsch 2002) In other words, estimated efficiency values are higher in more developed areas than in less developed areas. Quite strangely, however, several poorest regions falling around the lower-right corner of panel (d) and (e) are the most efficient in patenting invention and utility models. On the contrary, several richest regions located in the upper-left corner of panel (d) and (e) are the least efficient. This indicates that the innovation is a nonlinear process and there might be a diminishing return to scale in innovation production. Hence, given a certain amount of R&D resources, it would be more effective and efficient to allocate it to those poor areas than to those rich areas. Checking out the panel (f ), I do not find any noticeable pattern in the case of design patenting. Again, it implies that process of patenting designs is quite different from that of patenting inventions and utility models in China.

CONCLUDING REMARKS In terms of both the quantity and the quality of domestic patents, the performance of regional innovation systems varies largely among 30 regions in China. These differences are accounted for not only by the level of R&D inputs, but also Volume 8, Issue 1–2, July 2006

by the inefficiency in patent production. Based on a theory of new idea production function, this study tries to find determinants of innovative efficiency. In order to encapsulate the effect of environmental nuanced factors, this analysis uses a specification of stochastic frontier model to analyze three types of patent grants. Different from previous studies with OLS estimation, this approach enables us not only to identify and estimate the input and nuanced factors, but also to compare efficiency estimates among regions. Taking each region as an independent innovation system, this model explains differences in efficiency across regions in terms of the region-specific environmental factors. Since three types of domestic patents (namely, inventions, utility models, and designs) are very different in nature and represent different technological novelty, they are examined separately with a panel of official statistics published by Chinese government. Many findings stand out from the results. First, previous knowledge stock represented by GDP per capita is important in the production of all kinds of patents. Share of R&D resources directed to basic research influences the frontier of patenting. Second, with respect to efficiency factors, industrial structure is an important determinant of efficiency in all cases of patent production. A region with a larger proportion of light industries is more likely to innovate efficiently. High-tech industries are not as innovative as expected. Infrastructure variables like EDU and GOV have a larger positive impact on the efficiency of patenting inventions and utility models, and on the other side business firms influence the efficiency of patenting utility models and design patents more remarkably and positively. Educational institutions and financial support from government do not significantly affect design patenting, and firms’ initiative in funding S&T activities does not help much in invention production. Thus, innovation systems in China seem not yet well developed at a regional level. Firms’ contribution to the national and global technology frontier is only marginal and not very

INNOVATION: management, policy & practice

189

Xibao Li

important. Traditional knowledge providers (universities and research institutes) dominate the creation of most technologically intensive innovations in China. Given the estimated mean level of efficiency, this study also compares rank orders of 30 regions according to various criteria. Results show that there exist a weak center–periphery pattern with regard to the innovation efficiency in invention and utility model production. There is no such a geographical pattern present in the case of design patenting. Several caveats in this line of empirical study should be mentioned here. One limitation, which is common to the use of patent information, is that we have not really addressed the problem of patent ‘quality’. For example, the quality of granted patents might be very different across technology fields or sectors. In high-tech sectors, it is possible that patents are of higher quality than those in other sectors. Although variables based on domestic patent data are consistent across regions and can be used in interregional comparison, we should keep in mind that demerits of patent as imperfect proxy of innovation output, as thoroughly discussed in Furman et al. (2002), exist in this study too. Another limitation of this empirical analysis is associated with the selection and measurement of input and efficiency factors. In this analysis, LIGHTHEAVY and HITECH are used to represent the industrial structure in a region. However, some regions in China have the traditional industrial structures, large numbers of small township–village firms, and/or an absence of science-based industries and formal scientific institutions. These characteristics might be dominant over the industry structure variables.7 In this sense, the interpretation of our empirical findings should be very careful. Several extension of this research could be pursued in the future. It might be useful to try other measures of innovative output and include more efficiency factors. For instance, if the number of patent applications is used as an innovation indicator, there would be no need to determine the length of time lag between patenting application 190

and approval. In addition, it would be interesting to incorporate the effect of knowledge intensive business services (KIBS) on the innovative productivity. The role of foreign companies as one of the network organizers in regional innovation systems could be examined further in the future. Finally, further exploration of political and social characteristics of China may shed light on the difference of innovation efficiency across regions, too.

Acknowledgement This is a revised version of the manuscript prepared for the 2nd Globelics Conference, October 16–20, 2004, Beijing, China. I am grateful for financial support provided by School of Economics and Management at Tsinghua University. I also thank Bengt-Åke Lundvall, Shulin Gu, Xudong Gao and two anonymous referees for their helpful comments, and Jie Liu for providing part of data.

Endnotes 1 Here an administrative unit is either a province, or a municipality, or an autonomous region. Since Hong Kong, Macao, Taiwan and Tibet are quite different in their economic conditions from others, and information from these regions is not easily accessible due to the differences in statistical practice, we exclude them from our analysis and only 30 regions are included. In the following, I will refer to such a unit as a region and do not make distinctions between a province, a municipality, and an autonomous region. 2 Despite of different pronunciations in China, two provinces in China share one exact same English name: Shanxi. To distinct between them, I denote one with capital in Xi’An as Shanxi1 and the other with capital in Taiyuan as Shangxi2. 3 See Archambault (2002, Table II in page 28) for a list of U.S. patents granted to independent and institutional inventors in leading countries. 4 There might be another argument about China’s non-institutional patenting. Before July 2001, China’s patent law does not assign the right to institutional patents to inventors themselves. Given the characteristics of patenting, it is possible that some inventors apply for right to true institutional patents in the name of non-institu-

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Regional innovation performance tional patents. This is different from the practice in the US, Germany and Japan, where institutional patents account for a large percentage in patenting. 5 Interested readers may contact the author directly for these results. 6 That is, independent variables and environmental nuanced variables are from the year 2000. 7 The author is grateful to one anonymous referee for pointing this out.

References Acs ZJ, Anselin L and Varga A (2002) Patents and innovation counts as measures of regional production of new knowledge. Research Policy 31: 1069–1085. Archambault É (2002) Methods for using patents in cross-country comparisons. Scientometrics 54(1): 15–30. Archibugi D (1992) Patenting as an indicator of Technological Innovation: A Review, Science and Public Policy, No. 19: 357–368. Asheim BT and Isaksen A (1997) Location Agglomeration and Innovation: Towards Regional Innovation Systems in Norway? European Planning Studies, 5(3): 299–330. Asheim BT and Coenen L (2005) Knowledge Bases and Regional Innovation Systems: Comparing Nordic Clusters, Research Policy 34 (8): 1173–1190. Héraud J-A (2003) Regional Innovation Systems and European Research Policy: Convergence or Misunderstanding?, European Planning Studies, 11(1): 41–56. Battese G and Coelli T (1995) A model for technical inefficiency effects in a stochastic frontier production function for panel data. Empirical Economics 20: 325–332. Belsley DA, Kuh E and Welsch RE (1980) Regression diagnostics : Identifying influential data and sources of collinearity. New York: John Wiley & Sons. Carlsson B, Jacobsson S, Holmen M and Rickne A (2002) Innovation systems: Analytical and methodological issues. Research Policy 31: 233–245. Cefis E and Orsenigo L (2001) The persistence of innovative activities: A cross-countries and crosssectors comparative analysis. Research Policy 30: 1139–1158. Chung S (2002) Building a national innovation system through regional innovation systems. Technovation 22: 485–491. Cooke P, Uranga MG and Etexbarria G (1997) Regional innovation systems: Institutional and Volume 8, Issue 1–2, July 2006

organizational dimensions. Research Policy 26: 475–491. Doloreux D (2002) What we should know about regional systems of innovation. Technology in Society 24: 243–263. Edquist C, Eriksson M-L and Sjögren H (2002) Characteristics of collaboration in product innovation in the regional system of innovation of east Gothia. European Planning Studies 10(5): 563–581. Evangelista R, Iammarino S, Mastrostefano V and Silvani A (2001) Measuring the regional dimension of innovation: Lessons from the Italian innovation survey. Technovation 21: 733–745. Freeman C (2002) Continental, national and subnational innovation systems – complementarity and economic growth. Research Policy 31: 191–211. Fritsch M (2000) Interregional differences in R & D activities – an empirical investigation. European Planning Studies 8(4): 409–427. Fritsch M (2002) Measuring the quality of regional innovation systems: A knowledge production function approach. International Regional Science Review 25(1): 86–101. Furman JL, Porter ME and Stern S (2002) The determinants of national innovative capacity. Research Policy 31: 899–933. Griliches Z (1990) Patent statistics as economic indicators: A survey. Journal of Economic Literature 28(4): 1661–1707. Liu X and White SR (1997) The relative contributions of foreign technology and domestic inputs to innovation in Chinese manufacturing industries. Technovation 17(3): 119–125. Liu X and White S (2001) Comparing innovation systems: A framework and application to China’s transitional context. Research Policy 30: 1091–1114. Lundvall B-Å (Ed.) (1992) National Systems of Innovation: Towards A Theory of Innovation and Interactive Learning. Pinter, London. Lundvall B-Å, Johnson J, Anderson ES and Dalum B (2002) National systems of production, innovation and competence building. Research Policy 31: 213–231. Maddala GS (1986) Econometrics, 3rd edition, McGraw-Hill, Inc. Nelson RR (Ed.) (1993) National Innovation System: A Comparative Analysis. Oxford University Press, New York. Niosi J (2002) National systems of innovations are X-efficient (and X-effective): Why some are slow learners. Research Policy 31: 291–302. Pakes A (1985) On patents, R&D and the stock

INNOVATION: management, policy & practice

191

192

INNOVATION: management, policy & practice

TSI

0.1251 0.2230 0.1135

BANK

LogGDPPC SNEP BASICRE LIGHTHEAVY HITECH EDU GOV BUS BANK TSI LogCONTRACT

0.4758 0.2913 -0.1085 -0.0477 0.4849 -0.0409 0.4097 0.1401 0.0444 -0.2641 0.7375

0.5046 -0.1013 0.1784 0.5027 0.0029 0.3878 0.3121 -0.0444 -0.4583 0.6714

0.0517 -0.1507 0.2146 0.3744 0.2440 0.2473 -0.3076 -0.4593 0.3822

-0.0632 -0.0232 0.3533 -0.3374 -0.3539 -0.2241 -0.1557 -0.0690

0.1662 -0.3239 0.0755 0.0763 0.0473 0.0130 0.2162

0.3850 0.2342 -0.1619 -0.2193 -0.4709 0.4253

-0.2737 -0.3622 -0.4330 -0.3873 -0.0435

0.3509 0.1958 -0.0018 0.3721

BUS GOV EDU HITECH LIGHTHEAVY BASICRE SNEP LogGDPPC LogRNDP

COEFFICIENTS BETWEEN EXPLANATORY VARIABLES

APPENDIX TABLE A.1: CORRELATION

market rate of return. Journal of Political Economy 93: 390–409. Pavitt K (1988) Uses and abuses of patent statistics, in: Van Rann AFJ (Ed.), Handbook of Quantitative Studies of Science and Technology, Elsevier, Amsterdam. Porter ME (1990) The Competitive Advantage of Nation. New York: Free Press. Radosevic S (2002) Regional Innovation Systems in Central and Eastern Europe: Determinants, Organizers and Alignments. Journal of Technology Transfer, 27 (1): 87–96. Romer P (1990) Endogenous technological change. Journal of Political Economy 98: S71–102. Tödtling F (1999) Innovation networks, collective learning, and industrial policy in regions of Europe. European Planning Studies 7(6): 693–697. Tödtling F and Kaufmann A (1999) Innovation systems in regions of Europe – a comparative perspective. European Planning Review 7(6): 699–717. Trajtenberg M (1990a) A penny for your quotes: patent citations and the value of innovation. Rand Journal of Economics, 21(1): 172–187. Trajtenberg M (1990b) Economic Analysis of Product Innovation: The case of CT scanner. Cambridge, MA: Harvard University Press.

0.3817 -0.0323 -0.4386

Xibao Li

Volume 8, Issue 1–2, July 2006

Copyright © eContent Management Pty Ltd. Innovation: management, policy & practice (2006) 8: 193–209.

From trade hub to innovation hub: The role of Hong Kong’s innovation system in linking China to global markets SUMMARY

KEY WORDS Hong Kong; China; Pearl River Delta; innovation hub; innovation system

Hong Kong has achieved a remarkable rate of economic growth in the last half of the twentieth century, and is widely acknowledged as an important driver of development in South China. The territory occupies a unique position as an international trade and financial hub on the Chinese border, in which capacity it has been well served by the entrepreneurial drive and resilience of its population. Extensive exploitation of technology and innovation in the organization of international production networks have fueled Hong Kong’s economic success – but the risks associated with these features of the innovation system also threaten to undermine the territory’s future growth. This paper discusses the nature of the global and regional linkages characterizing Hong Kong’s innovation system – particularly its integration with a rapidly developing innovation system in China – and its move towards an innovation hub status. Received 9 June 2005

Accepted 19 October 2005

NAUBAHAR SHARIF ERIK BAARK

Research Assistant Professor Division of Social Science Hong Kong University of Science and Technology Hong Kong SAR, China

Associate Professor Division of Social Science Hong Kong University of Science and Technology Hong Kong SAR, China

INTRODUCTION

H

ong Kong has lately resumed its traditional position as the key transit point for the exchange of goods and services between China and the international economy. Sophisticated and reliable intermediary services occupy a key role in maintaining this status, but Hong Kong’s future depends on the capacity of its intermediaries to Volume 8, Issue 1–2, July 2006

retain and expand market share both within Asia and worldwide (Meyer 2000: 247). Hitherto, however, the question of technological innovation in Hong Kong’s developmental experience has gone largely ignored. The few studies that have addressed the issue have emphasized the laissez faire policies that have characterized the industrialization process in Hong Kong (e.g. Hob-

INNOVATION: management, policy & practice

193

Erik Baark and Naubahar Sharif

day 1995). To be sure, Hong Kong’s entrepreneurs have adroitly exploited available technology, but they have not generally carried out research and development (R&D) for the purposes of creating proprietary technology (Davies 1999; Yu & Robertson 2000). For this reason, technological innovation has only recently attracted serious attention in Hong Kong, where the government has launched a new strategy in pursuit of knowledge-intensive economic growth. R&D investment in industry has been gradually rising, however, and continuing public support of efforts to generate new technologies are transforming Hong Kong into an innovation hub with global links to and from China. Our point of departure in this paper is the proposition that a system of innovation has been emerging in Hong Kong during the past century, conditioned by major economic and political upheavals at the global level as well as by gradual institutional change at the local level. The maturation of the system of innovation has accelerated lately, as the influence of economic and political forces have re-asserted themselves through the return of Hong Kong to Chinese sovereignty and the Asian financial crisis of the late 1990s. It must be acknowledged that Hong Kong’s constantly shifting position in the global and regional political and economic landscape has been – and continues to be – a fundamental influence on its innovation system. Many critical factors are situated in political environments that reach beyond the local (or ‘national’) scale. For example, the influence of global networks has often directly affected regional economies, underscoring the need for local and regional development. Although Hong Kong’s government has enjoyed relative autonomy through British colonial rule and now the return to Chinese sovereignty – with a level of authority similar to that of a national government – the international context and indeed the ideology of the government itself (which has generally espoused a laissez-faire economic policy) have left the regulation of business in Hong Kong largely to market forces. Con194

sequently progress in the development of Hong Kong’s innovation system converges at three distinct spatial levels: local, regional, and global. In other words, what we observe in our analysis of the innovation system reflects causal relationships that transcend ‘national’ dimensions. Indeed, linkages with economic or innovative activities that occur outside the borders of the Hong Kong Special Administrative Region (HKSAR) – which have enjoyed increasing public policy support – have transformed the competitive strategies of business firms in the territory. In the remainder of this paper, we introduce the concept of an innovation hub and discuss how an innovation hub might develop on the foundation of a trade and financial hub; review the historical background from which current developments have emerged; examine the integration of Hong Kong’s economy with that of the Pearl River Delta Region; and assess Hong Kong’s prospects for finally emerging as a key innovation hub in China. In this respect we sketch both optimistic and pessimistic scenarios in the concluding section.

INNOVATION HUB: A CONCEPTUAL DISCUSSION From a literal viewpoint, the word ‘hub’ refers to the central part of a wheel from which spokes radiate. Common usage of the term extends to a ‘hub’ denoting a central point or main part of activity and interest. Qualifying adjectives can be added to the common definition of ‘hub’ to further narrow the usage of this term. Our concept of an innovation hub envisions a center of exchange that builds on the foundation of a ‘trade’ or ‘financial’ hub. Although the term ‘trade hub’ is a recent coinage, it can easily apply to a long history of precedents in the emergence and decline of commercial centers. Commercial cities such as Venice occupied important positions in the European economy of the Renaissance as it acted as the central node for trading activity that permeated much of continental Europe. Later, the key status of a world city shifted to Amster-

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

The role of Hong Kong’s innovation system in linking China to global markets

dam and London, and while these centers increasingly commanded the flow of goods in international trade, they also became important hubs of financial transactions (Braudel 1986). The ability to consolidate financial or trading activity is, therefore, a key characteristic in making a city or region a ‘hub’. When a city is termed a ‘world city,’ therefore, it is typically because of its ability to act as a hub for a certain activity (i.e. finance, trade or even tourism) or a number of activities, combined. Additionally, from within this city or region, the specified activity which has made it a hub usually extend beyond its immediate borders into neighboring cities, regions or countries. At the very least, the effect of its hub activity is felt beyond its borders. The term ‘innovation hub’ closely follows from the earlier usage of the hub phraseology – trade hub, financial hub and transportation hub. In particular, it refers to an area with two intertwined characteristics. First, innovative activity predominates within the region as compared particularly to neighboring regions and second, there are strong linkages and knowledge flows via the primary region into neighboring regions. The term of an ‘innovation hub’ is not completely new as it has been variously utilized to designate a science park initiative in South Africa and to advertise various Internet Websites promoting high technology business. In the case of the South African science park, the area in question is distinctly sub-national, and indeed smaller than the city-level (located in Gauteng province, South Africa). In the second example, the hub is virtual in nature, promoting businesses in cyberspace. Under the concept of an ‘innovation hub’ that we apply in the present paper, we conceptualize the innovation hub – Hong Kong – as a distinctly ‘physical’ city-space located at the mouth of the Pearl River Delta in Guangdong province, PRC. Furthermore, we consider that Hong Kong can perform the functions of an innovation hub by leveraging its facilitator capabilities in the domain of innovation. The functions served by an innovation hub entail not only spending increased Volume 8, Issue 1–2, July 2006

indigenous resources on innovative activities in a greater commitment to R&D but also and just as importantly, effectively applying new knowledge produced elsewhere to enhance value-added inputs to the production chain. We envisage an innovation hub to transcend the confines of a local cluster – as in a science park – and contribute with an extensive network of linkages and value-added activities to the generation and flow of knowledge. Given this point of departure, there are four concrete ways of demonstrating the existence of an innovation hub or the efficacy of government measures directed towards achieving such a status. First, we would expect an innovation hub to have a wide network of linkages facilitating the flow of knowledge and technology. In the case of Hong Kong, these linkages overlay those that have been developed through Hong Kong’s historical status as a trade and finance hub. Occupying this latter role, Hong Kong has traditionally been the throughput node for trading and financial activities between China (particularly in the Pearl River Delta region and Guangdong province) and the rest of the world. Additionally, over the last decade, Hong Kong has provided an increasingly attractive alternative to Western finance centers, allowing Chinese firms to access international sources of equity. In both cases, the key idea has been that the flow of goods, services and capital through Hong Kong is essential to the territory’s competitiveness. Hong Kong firms have facilitated this flow by capitalizing on their expertise in logistics, supply chain management, transportation and a favorable environment for the movement of capital. Secondly, we believe that actors in an innovation hub should devote substantial resources to innovative activities. That is, we expect to see major expenditure increases on R&D in public as well as private organizations. As firms are the locus of innovative activity within an innovation systems framework, they must be inculcated with an ‘innovation culture’ or ‘ethic’ if they are to upgrade their innovative and technological capa-

INNOVATION: management, policy & practice

195

Erik Baark and Naubahar Sharif

bilities and also recognize and seize opportunities arising from the effective implementation of innovation and technology produced elsewhere. In Hong Kong’s case, the government has implemented measures to increase the amount spent on R&D. The point is to leverage Hong Kong’s position as a gateway linking China and the world, which the government has recognized as its greatest historical and present-day competitive advantage. Most notable among these measures was the establishment of the ‘Innovation and Technology Fund’ (ITF), set up in 1999 with HK$5 billion (approximately 500 million Euros/US Dollars 650 million) earmarked to provide funding for projects that contribute to innovation and technology upgrading in both new and established industries. The Innovation and Technology Commission (ITC) was also set up to spearhead Hong Kong’s drive to become a worldclass knowledge-based society. As far as the private sector is concerned, innovative activity has mainly been increasing among large firms (defined as non-manufacturing enterprises with more than 50 employees and manufacturing enterprises with more than 100 employees). Thirdly, we assume that an innovation hub provides extensive services and an institutional framework that facilitate various forms of innovation. Key resources include financial institutions such as a venture capital and stock exchange for high technology firms and advanced legal, accounting and management services. An ideal institutional infrastructure would include protection of intellectual property rights. An example of this in Hong Kong was the setting up, in 1999 of the ‘Growth Enterprise Market’ (GEM), an alternative stock market on the Hong Kong Stock Exchange which provides ‘innovative’ firms relaxed regulations to tap into external (public) sources of funding. Finally, innovation hub status can be demonstrated through an analysis of ‘innovation-friendly’ government policies. Such policies can include loans, grants, subsidies, etc., for innovation-centered companies; the provision of incubation 196

services; and an emphasis on fostering university–industry relationships for the effective commercialization of new technologies.

TRADE AND INNOVATION IN HONG KONG: HISTORICAL OVERVIEW Hong Kong has evolved gradually from a colonial outpost on the coast of China into an important intermediary for the country’s overseas economic linkages. From 1847 to 1997, Hong Kong relied on its position as a Crown Colony of Great Britain to provide a safe haven for an expanding group of British trading houses – commonly known as Hongs – that organized the flow of commodities between China and the rest of the world. More recently, the five decades leading up to 1997 have seen Hong Kong emerge as a newly industrialized economy before evolving into an unrivalled trade hub between the People’s Republic of China and the rest of the world, in which capacity it has developed an extensive portfolio of business and financial services. Studies of Hong Kong’s economic development in the early part of the twentieth century have identified a variety of informal institutions and state initiatives supporting a regime of industrialization that relied primarily on small-scale manufacturers linked in familial or ethnic networks, connected with expanding markets for products in China, South East Asia, Europe and the U.S. (Clayton 2000). The recognition of this ‘undergrowth’ sector of small-scale industrial firms in Hong Kong was important, however, for two reasons: First, it provided opportunities for Chinese entrepreneurs to accumulate technical and managerial skills that could be successfully deployed in subsequent stages of development; second, it gave Chinese firms opportunities to practice organizational modes that supported networking, sub-contracting relationships and an international search for markets – elements that ‘rehearsed’ critical features of subsequent industrialization in Hong Kong prevalent to this day. With the overthrow of the Kuomintang (KMT) regime of General Chiang Kai Shek in

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

The role of Hong Kong’s innovation system in linking China to global markets

1949 and the establishment of the People’s Republic of China by the Chinese Communist Party, however, a new era was initiated in Hong Kong’s history. This event led to an exodus of about one million Mainland Chinese to Hong Kong. The people of Hong Kong, including its migrants, grew up and developed in a community that had Chinese roots but were under British administration. These migrants, in turn, brought about an escalation in the establishment and size of manufacturing industries that further expanded the role Hong Kong hitherto had played, mainly as an entrepôt. In the face of the declining power of the KMT in China, the Shanghai textile barons transferred enormous amounts of capital and managerial expertise in textile manufacturing to the colony (Wong 1988). Today, it is estimated that more than half of Hong Kong’s sevenmillion-plus citizens are descendents of post1949 migrants. Two events in the 1980s deeply affected Hong Kong’s people and thereby its innovation system. The first was the modernization program that the late Chinese leader Deng Xiaoping promulgated in 1978. The other was the opening in 1982 of discussions between the Chinese and British over the future of Hong Kong and its sovereignty. The latter negotiations ended in 1984 with the signing and ratification of the Sino-British Joint Declaration which stated that Hong Kong would become a Special Administrative Region (HKSAR) of the People’s Republic of China and that Hong Kong’s capitalist system and ‘way of life’ would be preserved for 50 years. The ‘one country-two systems’ framework under which Hong Kong is presently governed was enshrined in the ‘Basic Law’, the present constitution of the HKSAR. The modernization program acted as a catalyst in the transformation of Hong Kong’s innovation system. In many ways, the opening of China made Hong Kong’s learning curve shorter. This ultimately not only provided economic benefits but it also helped Hong Kong accept that its fate is inextricably bound to that of Mainland China. The most striking change observed in Hong Volume 8, Issue 1–2, July 2006

Kong’s innovation landscape following the opening of the Mainland in 1979 was the decreasing role of manufacturing and the simultaneous rise of the services sector. At its peak in the mid1980s, the manufacturing sector employed 41.7 percent of the active labor force but by 1995 this figure had dropped to only 15.3 percent (Berger and Lester 1997: 9). In contrast, the services sector grew from constituting 67 percent of Hong Kong’s GDP in 1980 to 87 percent by 2002. Yet far more critical than modernization to Hong Kong’s transformation was the return of the British Crown Colony of Hong Kong to the People’s Republic of China. Enright et al. (1997: 7) accurately describe how Hong Kong’s historical role as a city of departure from China laid the foundation for a reverse flow of business investments during the 1990s not only back to Hong Kong but also to Mainland China, through Hong Kong. They argue that this has: … helped Hong Kong become the de facto capital of the 50 million or more overseas Chinese who today play such an important role in the economic modernization of the Asian region and in the reconstruction of China’s market economy. The economic impact has been considerable, since overseas Chinese investors – often Hong Kong companies or investors operating out of Hong Kong – now employ 15 million or more people in China. Furthermore, the migration of production facilities to the PRD in many ways represented growth rather than decline in Hong Kong’s engagement in manufacturing; however, for political reasons such growth was categorized as outside the territory, even if it was, from a historical perspective, a re-integration into the Chinese economy. The result was also that the relocation of production facilities further spurred the growth and increased sophistication of producer business services (Tao & Wong 2002). Since the Asian Financial Crisis in 1998, how-

INNOVATION: management, policy & practice

197

Erik Baark and Naubahar Sharif

FIGURE 1: HONG KONG R&D

EXPENDITURES ,

1998–2002

Source: Leung (2005), p. 8.

ever, the Hong Kong government has launched major initiatives to improve innovation in the economy. The economic growth of previous decades had been achieved with very low levels of R&D investment in industry and with public investment being concentrated in support of research in the higher education sector. A key initiative has been raising the level of R&D investment. Countries with a comparable level of per capita GDP commit 1.5–3 percent of their GDP to R&D. Overall investment in R&D in Hong Kong is still a meager 0.60 percent of GDP and most of this continues to rely on public funding to universities, as shown in Figure 1. A report by the Chief Executive’s Commission on Innovation and Technology in 1998 inspired a new strategy on the part of the government for enhancing Hong Kong’s reliance on high technology in advanced sectors, leading to a range of new schemes to support R&D. Most notable among these measures was the establishment of the ‘Innovation and Technology Fund’ (ITF), set up with HK$5 billion (approximately US$625 million) earmarked to provide funding for projects that contribute to innovation and technology upgrading in both new and established indus198

tries. The Innovation and Technology Commission (ITC) was also set up to spearhead Hong Kong’s drive to become a world-class, knowledgebased society. The ITC manages the ITF and the Applied Research Fund (ARF) and supports such infrastructure projects as the Hong Kong Science Park. These initiatives in many ways reflect Hong Kong’s status as an entrepreneurial city, increasingly intent on participating in the ‘siliconization’ of Asian urban centers (Jessop & Sum 2000).

INTEGRATION WITH THE PEARL RIVER DELTA REGION AND BEYOND The Pearl River is one of China’s three main rivers. Formed at Guangzhou, it flows east and south to form a large estuary between Hong Kong and Macau. The river links Guangzhou to Hong Kong and the South China Sea and is one of China’s most important waterways for trade. The region known as the Pearl River Delta (PRD) is found along the estuary of the Pearl River. Although the territories of Hong Kong and Macau are geographically integrated parts of the PRD, the ‘special’ status of these two territories often sets them apart from the rest of the region; therefore, in the literature that has emerged in

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

The role of Hong Kong’s innovation system in linking China to global markets

recent years, the term ‘Pearl River Delta’ is often used as shorthand for the administrative zones, municipalities and districts of the PRD in Mainland China (excluding both the Hong Kong and Macau SARs). Some reports use the term ‘Greater PRD Economic Region’ when they include Hong Kong and Macau (e.g. Federation of Hong Kong Industries 2003). As part of the Open Door policy introduced during the 1980s, Guangdong Province was given greater political and economic autonomy than other jurisdictions in the Chinese Mainland. The main areas of greater autonomy were finance and fiscal matters, foreign trade and investment, commerce and distribution, allocation of materials and resources, the labor system and prices. Guangdong was allowed to keep a larger share of its output and foreign exchange than other provinces while being required to achieve self-sufficiency in capital investment. The province was given greater control over economic planning, the approval of foreign investments and foreign trade. Guangdong also assumed control of several stateowned enterprises located in the province. These measures fueled rapid economic development in Guangdong Province, with most of this development occurring in the Special Economic Zones established in the PRD. At this point deeper economic links began to emerge between Hong Kong and the PRD, as Hong Kong’s economy shifted from manufacturing to services and manufacturing concurrently shifted from Hong Kong to the PRD. The Open Door policy, coupled with economic reforms, not only provided an enormous production hinterland and market outlet for Hong Kong’s manufacturers but also generated abundant business opportunities for a wide range of its service activities. These include, in particular, freight transport, storage, telecommunications, banking, real estate development and professional services in such areas as law, insurance and accounting. This allowed Hong Kong businesses and its managers to build an unparalleled fund of knowledge about what it takes to operate production systems disVolume 8, Issue 1–2, July 2006

tributed across long distances and to turn out high quality goods in a wide range of industries in China. For this reason, Hong Kong’s experience in the PRD region stands as a benchmark for working in China (Sung 1998). Therefore, while ‘Made in Hong Kong’ manufacturing declined, ‘Made by Hong Kong’ manufacturing – that is, manufacturing in Hong Kong-owned and managed plants in the PRD region – flourished (Berger & Lester 1997: 5). By shifting parts of their operations to China, Hong Kong industrialists vastly increased the scope of their enterprises. By 1997, Hong Kong manufacturing companies were estimated to employ some five million people in their plants in Hong Kong and China (Berger & Lester 1997: 10) – over five times the workforce they had employed in Hong Kong at the peak of manufacturing in the territory in 1984. In 2003, the figure was estimated to be as much as 15 million. Over the period from 1980 to 2001, the PRD region was the fastest-growing portion of the fastestgrowing province in the fastest-growing large economy in the world (Enright et al. 2003: 21–25). Since 1997, Hong Kong has thus entered a period of warming economic, political, social and cultural ties with Mainland China, particularly with the PRD, which have become the focus of much explicit debate in Hong Kong political discourse. It is presently Hong Kong’s unequivocal objective to deepen the economic integration of Hong Kong with the PRD. This suggests that a regional innovation system that includes Hong Kong and the wider PRD region is emerging and this is indeed what recent reports sponsored by powerful business circles in Hong Kong have argued. For example, a study of economic interaction between Hong Kong and the PRD region sponsored by the Hong Kong-based ‘2022 Foundation’ outlined several clusters of service-enhanced industrial development which involved a division of labor between international services located in Hong Kong and production facilities located in the PRD (Enright et al. 2003). Another report sponsored by the

INNOVATION: management, policy & practice

199

Erik Baark and Naubahar Sharif

FIGURE 2: PATTERN

OF CONTRACTING OUT

R&D

BY

HONG KONG

FIRMS ,

2002

Source: Federation of Hong Kong Industries (2003), Made in PRD: The Changing Face of HK Manufacturers, p. 46.

Federation of Hong Kong Industries similarly underscored the close economic linkages in the region. It proposed the strengthening of the overall infrastructure to facilitate R&D activities among companies in Hong Kong and the PRD to take advantage of the various strengths in the region, such as the intellectual property rights protection framework in Hong Kong and the availability of affordable R&D staff in the PRD (Federation of Hong Kong Industries 2003). This report, using a survey, also showed that many firms in Hong Kong were carrying out R&D in both Hong Kong and the PRD. Based on information supplied by 229 such firms (49 percent of the sample of firms operating in both Hong Kong and the mainland), it was clear that the outsourcing of R&D and investments in R&D beyond the borders of Hong Kong was very significant (see Figure 2). Only 17 percent of the total R&D staff of these firms was located in Hong Kong, while 53 percent were located in Guangdong Province, 3 percent in the Yangtze River Delta, 19 percent in other Mainland provinces and 8 percent overseas (Federation of Hong Kong Industries 2003: 47–48). R&D was relocating to the Mainland primarily because of its supply of talent and research facilities, with lower research costs as a lesser factor. The majority of the firms with Mainland operations surveyed (78 percent) indicated that 200

they planned to continue or expand their R&D efforts and almost half (46 percent) planned to recruit more R&D staff in Guangdong. Only 13 percent had plans to recruit more R&D staff in Hong Kong (see Figure 3). It is evident from this survey that Hong Kong firms are exploiting the larger pool of R&D talent that has become available in the Mainland, and particularly in Guangdong province. It is also notable that Hong Kong firms planned to focus their R&D recruiting efforts more on Shanghai and other Mainland cities (albeit to a lesser extent than in the case of Guangdong) than on Hong Kong. Table 1 indicates comparative figures for R&D expenditures and personnel recruitment in Hong Kong, Guangdong and Beijing. The table illustrates that Guangdong has become a significant site for R&D, with considerable investments by large and medium-sized firms in the development of new technology. Hong Kong already benefits from being more closely associated with the high technology industries and services emerging there. In this sense, although Hong Kong still lags behind Guangdong and Beijing in terms of scientific and technological resources, its firms are actively reaching out to exploit available resources to upgrade its technology development capabilities. Among the initiatives aimed at promoting Hong Kong’s economic development is the Closer Economic Partnership Arrangement (CEPA).

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

The role of Hong Kong’s innovation system in linking China to global markets

FIGURE 3: R&D

MANPOWER PLANNING OVER THE NEXT

1–2

YEARS FOR

HONG KONG

FIRMS , AS OF

2002

Source: Federation of Hong Kong Industries (2003), Made in PRD: The Changing Face of HK Manufacturers, p. 51.

Under this arrangement which came into effect on 1 January 2004, 273 Hong Kong products qualify for zero-tariff status under rules governing origin of manufacture and will be issued a certificate of Hong Kong origin Hong Kong’s business

landscape is dominated by small and mediumsized enterprises (SMEs). It has been estimated that Hong Kong will save HK$750 million from zero-tariff exports. Eighteen service sectors are allowed easier access to Mainland markets,

TABLE 1: RESEARCH AND DEVELOPMENT (R&D) EXPENDITURES GUANGDONG AND BEIJING, 2001 Hong Kong (HK$100 million) Total R&D Expenditure • As % of GDP (in region) Expenditure by: • Scientific Research Institutions • Higher Education • Large & Medium Enterprises Total FTE of R&D Personnel FTE of R&D Personnel in: • Scientific Research Institutions • Higher Education • Large & Medium Enterprises

70.76 0.55%

AND

PERSONNEL

IN

Guangdong (RMB100 million) 137.43 1.29%

HONG KONG, Beijing (RMB100 million) 171.17 6.02%

1.47# 48.47 20.83* 7,365

5.18 4.65 89.60 79,052

91.04 20.86 21.10 96,255

280# 3,791 3,294

4,209 9.949 43,279

43,982 18,171 12,277

# Government * Business. Source: Based on Table 4.2 in Federation of Hong Kong Industries (2003), Made in PRD: The Changing Face of HK Manufacturers, p. 54.

Volume 8, Issue 1–2, July 2006

INNOVATION: management, policy & practice

201

Erik Baark and Naubahar Sharif

including telecoms, banking, accounting, logistics and tourism, and there is ‘enhanced cooperation’ in various areas of trade and investment. In essence, CEPA is designed to allow Hong Kong firms to benefit early from the liberalization of the Mainland’s restricted sectors, which will open up to all foreign companies from 2005 as a result of China’s accession to the World Trade Organization. For this reason, others have branded CEPA as more talk than action. To be sure, CEPA still includes limitations for the operation of Hong Kong firms in the Mainland market and all benefits accrue to goods made in Hong Kong (of which there are fewer as manufacturing moves to the mainland) or Hong Kong-based service firms providing a limited range of products in cooperation with Mainland partners. Nevertheless, CEPA will promote economic integration with the whole of the Mainland, including the PRD region (Hong Kong Trade Development Council 2003). Both CEPA and China’s WTO accession constitute important challenges for Hong Kong but they also represent opportunities for further development of its role as an intermediary for global commercial linkages. The next stage in Hong Kong’s cooperation with the PRD requires further investment and involvement in the upgrading of industrial production in China through the development of joint competitiveness, building on the past experience of out-processing (Sit 2004).

HONG KONG’S EMERGING ROLE: TOWARDS AN INNOVATION HUB? There is no doubt that Hong Kong is closely integrated with the international economic system and that globalization therefore has had a significant impact on the innovation system in Hong Kong. Because of its colonial status until 1997, Hong Kong’s development was linked to the policies of the United Kingdom and with an open economy, actors in Hong Kong sought opportunities in the international market. During the colonial regime, industrial and innovation polices 202

prior to 1997 were governed by a laissez-faire attitude. This attitude in theory opposed all government intervention in a free market economy and therefore also any attempt on the part of the state to engage in the formation of new markets. Nevertheless, the relationship of Hong Kong to the global economy in both the pre-1997 and post-1997 periods has not been that of a simple ‘globalization’ of its urban economy and governance but instead should be seen as an articulation at various levels of powerful economic and political actors, operating under the overreaching ideologies of ‘positive non-intervention’ and, more recently, of active ‘imagineering’ (Pun & Lee 2002). In particular, since the return to Chinese sovereignty, the Hong Kong government has been consistently supporting foreign investment in the territory and has made a key priority of creating a business environment that would encourage transnational corporations to set up regional headquarters in Hong Kong. The number of overseas firms that have established their regional headquarters in Hong Kong has grown from 602 in 1991 to 906 in 2003, while firms with regional offices in Hong Kong grew in number from 278 to 2,241 during the same period. Most of these firms exploit Hong Kong’s position in the growing Chinese market and their activities are concerned primarily with managing global production or supply chains. The rapidly expanding services located in Hong Kong also serve global networks of production or trade. Few transnational corporations have so far located significant R&D functions in Hong Kong, however, and instead appear to focus their overseas expansion of R&D on locations in the Chinese Mainland. Foreign investors had thus set up over 600 R&D centers in China as of June 2004, with a total investment of US$4 billion (‘Foreign R&D Centers ... 2004’). Many Hong Kong industries have developed technological capabilities that are significant assets in linking global markets with production bases in the Chinese Mainland. In the garment industry, for example, the technology that Hong

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

The role of Hong Kong’s innovation system in linking China to global markets

Kong firms has accumulated and developed over the years emphasizes capabilities in such areas as human resource management, operations and suppliers. These technologies are essential if Hong Kong firms are to succeed in selling to buyers in the demanding, fashion-oriented markets of advanced industrial economies. Such technologies, while not particularly R&D intensive, may indeed support the kind of soft managerial technology that is as urgently needed in the Chinese Mainland as any other forms of technology (Thompson 2003: 94–95). In fact, Thompson (2003: 107) argues that ‘the historical labordependence of the Hong Kong garment sector has resulted in the establishment of firms specialized in satisfying the demand of the highly sophisticated, wealthy fashion-dominated markets of North America, Europe and Japan. Focusing on these markets obviates many of the benefits of capital-intensive production because of the relatively small batch sizes required and the very short turnaround times imposed by rapidly shifting consumer sentiment. To successfully deal with such markets requires a high flexibility and very skillful value chain management and coordination – in short, managerial-intensive production. Hence, Hong Kong garment firm FDI in mainland China brings with it a high degree of cutting-edge, world-class, soft business knowhow that is as much required in China as any hard technology.’ That many of the skills and capabilities that Hong Kong garment firms have brought to China have spilled over into increasingly competitive Chinese firms indicates the actual innovative capabilities which such Hong Kong firms possessed when they moved production to the Chinese Mainland. Some of the most important industry clusters competing from a base in Hong Kong were created in the wave of expansion in the manufacturing and services sectors in the 1970s and 1980s. These clusters include light manufacturing, transportation, tourism, financial and business services, and communication and media industries (Enright 1997). Hong Kong-based industries Volume 8, Issue 1–2, July 2006

have remained strong in specialized niches of global product markets. Thus, in the late 1990s, Hong Kong remained among the world’s largest exporters of items such as watches and clocks, toys and games, imitation jewelry, travel goods and handbags, fur clothing and telephone sets (Enright 2000). It is interesting to observe that commodity flows from production for global markets orchestrated by Hong Kong firms increasingly bypass the territory. Figure 4 shows that Hong Kong firms once transshipped or re-exported almost 90 percent of goods via Hong Kong in 1994, but that 37.5 percent were shipped directly to markets overseas from the production site (usually PRD) in 2003. Due to textile import quotas and quality control, Hong Kong firms once re-exported most of their garments (Feenstra & Hanson 2004). The quota requirements are likely to become irrelevant when new WTO rules become effective and quality control and logistics services may shift to the Mainland. Following the removal of quotas during the early part of 2005, Hong Kong’s re-exporting of apparel has grown very rapidly, in spite of a spectacular rise in China’s direct exports and a decline in domestic apparel exports from Hong Kong (Hong Kong’s apparel 2005). The key point is that most textile and apparel exports from the PRD – whether passing through Hong Kong or not – are derived from production and marketing chains operated with Hong Kong capital. The relocation and expansion of producer networks from Hong Kong to the Pearl River Delta has supported the development of important producer services in Hong Kong in areas such as financial services, insurance, communications and logistics. The relationship between Hong Kong and southern China is often described as qian dian hou chang (Hong Kong as the shop in front and China as the factory to the rear). As a consequence, these transformations have resulted in an ever-growing, knowledge-based business sector whose primary activities are enhanced by innovation and research. The innovative character

INNOVATION: management, policy & practice

203

Erik Baark and Naubahar Sharif

FIGURE 4: SHIPMENT METHODS

FOR

EXPORTS

OF

GOODS MADE

IN

CHINA

BY

HONG KONG COMPANIES

Source: Hong Kong Trade Development Council (December 2004), Reaching Out, Not Hollowing Out: Hong Kong Industry and Trade Development Trends Under Globalization, p. 15.

of these Hong Kong-based services is not adequately reflected in the available R&D statistics. The producer services offered by Hong Kong firms have been constantly improved in terms of quality, reliability and the development of innovative solutions during the last two decades. Despite the relatively high cost of qualified labor, Hong Kong-based firms in logistics, telecommunications and finance have remained competitive in the region. Trans-national service firms make up a substantial portion of the services sector and these firms have often brought the latest technological advances to Hong Kong. But service firms increasingly originate in Hong Kong and such firms have been adopting IT-based systems aggressively as their products and service delivery have benefited from the resulting innovation. One firm that has gained considerable fame on the basis of its high level of competitiveness in innovative services is Li & Fung, a Hong Kong trading company established in Canton in 1906 with sales amounting to US$4.2 billion in 2001. Li & Fung was among the manufacturers that practiced organizational modes supporting networking, sub-contracting relationships and the international search for markets before World War II. Today, Li & Fung has developed a specialized 204

role as the orchestrator of loosely coupled supply chain processes for a range of consumer products requiring labor-intensive manufacturing. Supplying well-known clients like Levi Strauss, Reebok and Disney, the firm uses a broad network of more than 7,500 suppliers in Asia and other continents to meet specific product needs. This positions it to handle the total chain of production and delivery of products to end customers – often packaged and marked with a price to be put directly on the shelf. This efficiency is achieved with the assistance of a hybrid organization that includes a highly advanced and sophisticated electronic trading system linking 5,000 people supervising the manufacturing process and various clients globally. The firm has also developed a number of customized extranets for major clients such as Coca-Cola (Brown et al. 2002). At the same time, Li & Fung utilizes more traditional networks of personal contacts and supervision for ensuring quality assessment and on-time deliveries. This extensive network of human resources co-exists with its information technology infrastructure to handle detailed design, production scheduling, logistics, final assembly and customer relations. A dedicated team is engaged in extremely knowledge-inten-

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

The role of Hong Kong’s innovation system in linking China to global markets

sive ‘disintegration’ and optimization of supply chains, carrying out the design and planning of distributed manufacturing and coordination of the vast network. But few of these activities require formal R&D and innovation is integrated into the development of new business processes and products. It is the specialized expertise in supply chain management that provides Li & Fung with its unique competitiveness in global markets. In addition to producer services and specialized support for global production chain management undertaken by Hong Kong-based firms, the territory has maintained and expanded its role as a regional financial centre. Notably, Hong Kong has become an important venue for raising financial resources such as venture capital or equity (Florida & Kenney 1988). Statistics released in 2002 reveal that Hong Kong had developed into the largest venture capital center in Asia, managing 30 percent of the total capital pool in the region. The industry had about US$50 billion in funds under management by Hong Kong venture capital firms, administered by over 660 professional venture capital managers across about 200 funds, the second highest number after Japan. Hong Kong’s venture capital industry is highly export oriented. In 2000, 91 percent of the funds under management by venture capital firms came from outside Hong Kong, the majority from outside Asia. Fully 87 percent of these funds were serving companies outside of Hong Kong, although the bulk went to companies in the region, particularly in China (Hong Kong Trade Development Council 2002). As a financial services hub, Hong Kong offers free-flowing capital and information, an independent judiciary system resting on the rule of law and backed by an uncorrupted government, a very simple and straightforward tax law, and world class transportation and information technology infrastructure (Carney & Gedajlovic 2000). The environment also benefits from an abundant supply of various professionals in the legal, accounting, finance and consultancy fields, Volume 8, Issue 1–2, July 2006

enabling venture capitalists to benefit from a clustering effect. Perhaps even more essential to venture capital firms and other actors involved in financing innovation is the possibility of utilizing the high liquidity of the Hong Kong Stock Exchange which has a market capitalization of US$470 billion. Profits can therefore be earned by sales of equity shares through initial public offerings (IPOs). In an attempt to further promote this aspect of Hong Kong’s status as a financial service hub, the Growth Enterprise Market (GEM), established in November 1999, provides a new fundraising channel for emerging growth companies backed by a mature market and regulatory infrastructure. Over 150 companies are listed on the GEM, making up a total market capitalization of about US$8 billion. Although R&D and innovation has been increasing over the past several years, innovative activities are undertaken least by small enterprises. Hong Kong small and medium sized enterprises (SME) are defined as non-manufacturing enterprises with fewer than 50 employees and manufacturing enterprises with fewer than 100 employees. In September 2004, there were about 282,000 SMEs in Hong Kong. They accounted for over 98 percent of the total number of enterprises. With the government’s effort to raise awareness of the importance of innovation among all Hong Kong firms as well as its recent innovation-promoting initiatives, the percentage of SMEs undertaking innovative activities in 2002 has increased as compared with 2001 (HKSAR 2002 ‘Report on 2002 Annual Survey of Innovation Activities in the Business Sector’: 38). This increase was a result of two features: less under-reporting of R&D and also an increase in actual R&D activity as a result of government assistance. As Hong Kong firms face limits to profit-maximization through costreduction, they increasingly view innovation and R&D as a driver of future profits. Combined with the government incentives, business R&D expenditures in Hong Kong’s SMEs have begun to rise over the past few years. While the number (and percentage) of large firms undertaking innovative

INNOVATION: management, policy & practice

205

Erik Baark and Naubahar Sharif TABLE 2: KEY STATISTICS Size of Establishment Large Medium Small Total

ON INNOVATION ACTIVITIES IN THE BUSINESS SECTOR

2001 & 2002

Year

Total number of establishments

Number of establishments having undertaken innovation activitiesa

2001 2002 2001 2002 2001 2002 2001 2002

5781 5083 32 591 28 040 234 315 232 325 272 688 265 449

771 (13.3%) 662 (13.0%) 2 647 (8.1%) 3 974 (14.2%) 7 448 (3.2%) 11 877 (5.1%) 10 866 (4.0%) 16 513 (6.2%)

Innovation expenditure (HK$ million)b 3602.8 (53.4%) 4858.1 (55.0%) 1987.2 (29.5%) 2562.1 (29.0%) 1156.4 (17.1%) 1415.1 (16.0%) 6746.4 (100.0%) 8853.3 (100.0%)

a Innovation activities include product innovation, process innovation, ongoing innovation activities and abandoned activities. Figures in brackets represent the per centages to total no. of establishments. b Figures in brackets represent the per centages to total innovation expenditure. Source: Adapted from Report on 2002 Annual Survey of Innovation Activities in the Business Sector, p. 38.

activities dropped in 2002, their innovation expenditure continued to constitute over half of all innovation expenditure among businesses in Hong Kong (see Table 2).1 The establishment of The Hong Kong Science and Technology Parks Corporation (HKSTPC) is an important expression of the ambition to increase R&D spending in small firms. The HKSTPC aims to establish a flagship technology infrastructure to provide a comprehensive range of services that cater to the needs of the high technology industry at various stages, ranging from nurturing technology start-ups through the incubation program to providing facilities and services in the Science Park for applied R&D activities to providing land in industrial estates for production. A noteworthy asset to Hong Kong’s innovation system is its relatively dynamic higher education sector related to innovation. University research in Hong Kong is higher in quality than that of its neighbors in the region (as indicated by research output) although recently proposed budget cuts have yet to affect this part of the system. Increasing interaction with industry (in terms of technology and research transfer) marks an important policy-initiated trend in this area. In this respect, the Applied Science and Technol206

ogy Research Institute (ASTRI) – established in 2000 to perform high quality R&D for transfer to industry and to act as a spawning ground for technology entrepreneurs – has begun to make inroads. As of the end March 2004, the ASTRI had carried out 22 R&D projects in four technology areas at a total cost of HK$179 million (HKSAR Innovation and Technology Commission 2004: 6).

CONCLUDING REMARKS In the ongoing transformation of Hong Kong’s innovation system, it is important to remember two easily overlooked points. First, China’s innovation system is also undergoing extensive changes with its de facto move from a socialist to a marketoriented economy. Therefore, while it is analytically justifiable for the purposes of scope and concentration to take as our departure Hong Kong’s innovation system, changes north of the border have recast the situation in new ways that require further assessment. The conjecture offered here is that Hong Kong’s innovation system is expanding in association with developments in China’s innovation system – particularly the emerging role of the PRD as a center of innovative developments in the region. In this respect, one possible fruitful avenue of analysis would

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

The role of Hong Kong’s innovation system in linking China to global markets

lie in studying the co-evolution of the two systems of innovation to examine how they complement one another. Leading on from this point is the second issue: that relating to the vastness of China and heterogeneity among regions. China’s population of 1.3 billion people is an often touted statistic to describe its enormity. However, in addition to the number of people is its land area, of roughly 9.5 million sq. km, just a shade less than the area of the United States. Finally, there is the disparity in incomes between the coastal regions and the hinterland. Each of these rudimentary measures provides a sense of the challenges of analyzing China as a single homogenous unit. A more fruitful avenue of analysis would be to conceptualize Hong Kong’s role, not in regard to China as a singular monolith, but rather in regard to Guangdong province in particular, and more specifically the Pearl River Delta region. Therefore, understanding Hong Kong’s emerging role in the region as an innovation hub, in which capacity it spearheads the development of new value-added services and provides technological and organizational support for innovation in Guangdong, will reveal important opportunities and challenges and encourage better-informed policy making. Furthermore, such a conceptualization would yield itself to fruitful analyses between the various regions in China such as Guangdong (including Hong Kong), Shanghai and Beijing. An optimistic viewpoint would see the innovation systems in Hong Kong and Guangdong as fundamentally complementary and thus project a process of co-evolution that would strengthen the specialized competencies in each system ultimately merging into an integrated and effective whole. In this scenario, Hong Kong would continue to provide a window to facilitate interrelationships between Guangdong province and the international economy while serving as a base for high value-added inputs in the design, production and distribution of products and services. At the same time, scientific and technological resources in Hong Kong – or those linked directly to Hong Volume 8, Issue 1–2, July 2006

Kong – would provide strategic advantages to local firms and transnational corporations entering the Chinese market, particularly the Southern China market. In other words, Hong Kong would become a successful innovation hub for and spearhead innovative and economic development in, Guangdong province. A more pessimistic scenario would envisage more direct competition between regions in Hong Kong and various regions in the Mainland, – each seeking to develop mutually independent systems of innovation and to attract transnational corporate R&D at each other’s expense. In that case, local governments on both sides would have far more to do, including establishing expensive, heavily subsidized infrastructure projects or organizations that served specifically to develop new industries without significant inter-linkages to other parts of the wider ‘national’ innovation system in China. This scenario could reduce the benefits of complementarities between Hong Kong and the Pearl River Delta but it could also undermine the potential cooperation between organizations in Hong Kong and those from Shanghai and the greater Yangtze River Delta region.

Endnote 1 Technological innovations include all products (goods and services) and processes (production, delivery) that are technologically new or significant technological improvements over older products and processes. The products or processes must have already been implemented (that is, introduced to the market or put in practice within a company). The innovation need not be new or significant to a firm’s market (merely new or significant within a firm is sufficient).

References Berger S and Lester RK (1997) Made by Hong Kong. Oxford University Press, Hong Kong. Braudel F (1986) Civilization and capitalism, 15th–18th Century. Harper & Row, New York. Brown JS, Durchslag S and Hagel III J (2002) Loosening Up: How Process Networks Unlock the Power of Specialization. The McKinsey Quarterly (Special Edition: Risk and Resiliance): 59–69. Carney M and Gedajlovic E (2000) East Asian

INNOVATION: management, policy & practice

207

Erik Baark and Naubahar Sharif Financial Systems and the Transition from Investment-driven to Innovation-driven Economic Development. International Journal of Innovation Management 4(3): 253–276. Chen E and Ng R (2001) Economic Restructuring of Hong Kong and the Basis of Innovation and Technology, in: Masuyama S, Vandenbrink D and Chia Siow Yue (eds) Industrial Restructuring in East Asia. Institute of Southeast Asian Studies, Singapore. Clayton DV (2000) Industrialization and institutional change in Hong Kong, in: Latham AJH and Kawakatsu H (eds) Asia Pacific Dynamism 1550–2000. Routledge, London and New York. Davies H (1999) The future shape of Hong Kong’s economy: Why high-technology manufacturing will prove to be a myth, in: Fosh P et al. (eds) Hong Kong Management and Labour. Routledge, London. Enright MJ (2000) Globalization, Regionalization, and the Knowledge-Based Economy in Hong Kong, in: Dunning JH (ed) Regions, Globalization, and the Knowledge-Based Economy. University Press, Oxford, pp 381–406. Enright ME Scott and Dodwell D (1997) The Hong Kong Advantage. Oxford University Press, Hong Kong. Enright MJ, Chang KM, Scott E, Zhu WH (2003) Hong Kong and the Pearl River Delta: The Economic Interaction. 2022 Foundation, Hong Kong, pp 6–11, 48–79, 106–130. Federation of Hong Kong Industries (2003) Made in PRD: The Changing Face of HK Manufacturers, Part II & Full Report, Hong Kong. Available online at http://www.hku.hk/hkcer/prd/full _report/English_Full_Report.pdf, accessed March 2004. Feenstra RC and Hanson GH (2004) Intermediaries in Entrepôt Trade: Hong Kong Re-Exports of Chinese Goods, Journal of Economics & Management Strategy 13(1) March: 3–35. Florida R and Kenney M (1988) Venture Capital and High Technology Entrepreneurship. Journal of Business Venturing (Fall 1988) 3(4): 301–319. HKSAR Government (1998) Commission on Innovation and Technology First Report, Hong Kong. HKSAR Government (1999) Commission on Innovation and Technology Second Report, Hong Kong. HKSAR (2002) Report on 2002 Annual Survey of Innovation Activities in the Business Sector, Hong Kong SAR. HKSAR, Innovation and Technology Commission 208

(2004) New Strategy of Innovation and Technology Development. Consultation Paper, Hong Kong. Hobday M (1995) Innovation in East Asia: The Challenge to Japan. Edward Elgar, Aldershot. Hong Kong Government Information Services. Hong Kong: Colonial Reports, Vol 1946–, Hong Kong. Hong Kong Trade Development Council (2002) Venture Capital (profiles of Hong Kong Major Service industries). Available online at http:// www.tdctrade.com/main/si/spvent.htm, accessed March 2004. Hong Kong Trade Development Council (2003) CEPA and Opportunities for Hong Kong, October. Hong Kong Trade Development Council (2004) Reaching Out, Not Hollowing Out: Hong Kong Industry and Trade Development Trends Under Globalization, December. Hong Kong (2002) Hong Kong: Venture Capital Centre of Asia. Available online at http://www.info.gov.hk/gia/general/brandhk/091 6001.htm, accessed December 2004. Emerging Textiles.com, Hong Kong’s apparel reexports up 58% in February, 12 April 2005. Available online at http://www.emergingtextiles .com/?q=art&s=050411Bmark&r=free&n=1,, accessed May 2005. Jessop B and Sum NL (2000) An Entrepreneurial City in Action: Hong Kong’s Emerging Strategies in and for (Inter)Urban Competition. Urban Studies 37(12): 2287–2313. Lall S (1996) Learning from the Asian tigers: Studies in technology and industrial policy. St Martin’s Press, New York. Leung SKC (2005) Measuring Innovation – The Experience of Hong Kong, China. Paper presented at the International Conference on Innovation Systems in Hong Kong and the Chinese Mainland, HKUST, January 7–8. Meyer DR (2000) Hong Kong as a Global Metropolis. Cambridge University Press, Cambridge. People’s Daily Online, Foreign R&D centers in China on the rise, 20 August 2004, Available online at http://english.people.com.cn/200 408/20/eng20040820_153974.html, accessed May 2005. Pun N and Lee KM (2002) Locating Globalization: The Changing Role of the City-State in PostHandover Hong Kong. The China Review 2: 1–28. Sit V S (2004) China’s WTO Accession and its Impact on Hong Kong – Guangdong Cooperation. Asian Survey 44(6): 815–835.

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

The role of Hong Kong’s innovation system in linking China to global markets Speech by Chief Executive at HK Science and Technology Parks, 2 February 2005. Available online at http://www.info.gov.hk/gia/general /200502/02/0202143.htm, accessed May 2005. Sung YW (1998) Hong Kong and South China: The Economic Synergy. City University of Hong Kong Press, Hong Kong. Tao Z and Wong YCR (2002) Hong Kong: From an Industrialized City to a Centre of Manufacturing-Related Services. Urban Studies 39(12): 2345–2358. Thompson ER (2003) Technology Transfer to

China by Hong Kong’s Cross-Border Garment Firms. The Developing Economies XLI-1 (March): 88–111. Wong SL (1988) Emigrant Entrepreneur: Shanghai Industrialists in Hong Kong. Oxford University Press, Hong Kong and New York. Yu TF and Robertson PL (2000) Technological capabilities and the strategies of small manufacturing firms: The case of Hong Kong, in: Foss NJ and Robertson PL (eds) Resources, Technology and Strategy. Routledge, London and New York.

N E W T I T L E AVA I L A B I L I T Y 3 D E T H I C S : I MPLEMENTING W ORKPLACE VALUES by Attracta Lagan and Brian Moran ISBN 0-9757422-3-X; viii + 184 pages; softcover; February 2006 Who governs corporate behaviour? Institutionalised greed has made corporate ethics everyone’s concern. Proliferating court cases indicate the potential of socially irresponsible corporations to cause physical, mental and financial injury to employees, customers, community, the national economy and natural environment. In this book, Attracta Lagan and Brian Moran show how personal, professional and societal dimensions of business ethics influence the implementation of workplace values by company directors, CEOs, CSR directors, HR managers, middle managers and OH&S officers. Systematic application of their 3D Ethics model leads to consistent and predictable behaviour, aligned to stated personal, workplace and democratic values – that are increasingly being sought by employees, business and society. Ethics is not just about morality; it is a challenging dimension of personal and corporate behaviour that, when consistently applied, results in higher performance.

You have in your hands an important tool for raising ethics awareness and new organisational standards to meet rapidly mutating social requirements. – John Elkington (Author: Cannibals with Forks: The Triple Bottom Line of 21st Century Business)

eContent Management Pty Ltd, PO Box 1027, Maleny QLD 4552, Australia Tel.: +61-7-5435-2900; Fax. +61-7-5435-2911; [email protected] www.e-contentmanagement.com

Volume 8, Issue 1–2, July 2006

INNOVATION: management, policy & practice

209

Copyright © eContent Management Pty Ltd. Innovation: management, policy & practice (2006) 8: 210–211.

APPENDIX Innovation with Chinese characteristics: Towards harmonious transformation REPORT ON SPEECH BY PRESIDENT HU JINTAO AT CHINA’S FOURTH NATIONAL CONFERENCE ON SCIENCE & TECHNOLOGY, BEIJING, 9 JANUARY 2006 Opening of China’s Fourth National Conference on Science and Technology at the Great Hall of the People in Beijing, 9 January 2006. [Xinhua Photo]

A

wealth of policy materials, case studies, press releases and research reports on the role of innovation in China’s social, scientific and economic development may be found on the English language version of the PRC website: http://english.gov.cn/ The following materials have been extracted from reports on that website and synthesised here into an overview of President Hu Jintao’s keynote speech at China’s Fourth National Conference on Science & Technology, Beijing on January 9, 2006. The speech, titled ‘adhere to a new path of innovation with Chinese characteristics and strive to build an innovation-oriented country’ was published by the People’s Publishing House and was distributed by Xinhua Book Stores January 10, 2006. Outling major strategic tasks for building an innovation-oriented country, President Hu Jintao said China will embark on a new path of innovation with Chinese characteristics, the core of which is to: • adhere to innovation; • seek leapfrog development in key areas; • make breakthroughs in key technologies and common technologies to meet urgent require210

ments in realizing sustained and coordinated economic and social development; and • make arrangements for frontier technologies and basic research with a long-term perspective. Hu said that China’s competitiveness should be enhanced by giving prominence to raising innovation capability. Raising the capability of innovation would focus on major issues in the field which hamper economic and social development such as: • technologies for water resources and environmental protection; • protecting intellectual property rights of key techniques in equipment manufacturing and information industries in raising competitiveness; • boosting manufacturing and information industries; • raising agricultural production capacity; • developing technologies in energy exploration, energy-saving and clean energy resources; • optimizing energy infrastructure. Goals also included developing a recycling economy, breakthroughs in pharmacy and key medical equipment, developing technologies for national defence, and building up advanced scientific groups, research institutions and enterprises, Hu said.

INNOVATION: management, policy & practice

Volume 8, Issue 1–2, July 2006

Appendix: Innovation with Chinese characteristics

Top Chinese leaders Hu Jintao (C), Wu Bangguo (4th R, Front), Wen Jiabao (4th L,Front), Jia Qinglin (3rd R, Front), Zeng Qinghong (3rd L, Front), Huang Ju (2nd R, Front), Wu Guanzheng (2nd L, Front), Li Changchun (R, Front) and Luo Gan (L, Front) attend the opening ceremony. [Xinhua Photo]

Outlining a medium–long-term program for science and technology development from 2006 to 2020, Hu said that China will spend 15 years to turn itself into a innovation-oriented country, which means broad and profound social reform. ‘A favorable mechanism should be established so that science and technology will accelerate social development, and in turn, society should increase investment in scientific and technological innovation,’ he added. Hu also called for the creation a favorable financial environment for local, national and international companies to conduct innovation. According to Hu, China will implement the strategy of rejuvenating the nation with science, education and human resources, giving further importance to science, technology and innovation to transform the country’s social and economic development in a coordinated sustainable system which places people first. China will train world first-class scientists, especially young and middle-aged scientists, based on national key scientific research projects and international scientific cooperation projects. An incentive mechanism will be formed to increase the efficiency of innovation and provide more chances for young talented people. China will introduce more overseas-trained people and attract overseas Chinese graduates back to start businesses in China, Hu said. Chinese research institutes and universities are encouraged to build joint laboratories and Volume 8, Issue 1–2, July 2006

Chinese President Hu Jintao (C) poses for a photo with Ye Duzheng (R) and Wu Mengchao, winners of China’s 2005 national science and technology awards. [Xinhua Photo]

research centers with overseas research organs. China will support enterprises to increase export of high-tech products and establish research and development (R&D) bases overseas. International enterprises are also encouraged to set up R&D organizations in China. Hu added that China should not only inherit and develop traditional culture but also absorb the advantages of the cultures of other countries. Important tasks in building an innovationoriented country include encouraging the innovation vitality of the entire society, turning scientific and technological achievements into productive forces. The government would play a leading role in scientific and technological achievements, while the basic role of the market will be given full play in the allocation of scientific and technological resources. Companies would play a principal part, while research institutes and universities across the country would assume a key role in the innovation process. Hu also stressed the combination of military and civil scientific and technological resources and the combination of central and local innovative forces as crucial to innovation and social and economic development in China. Adapted from: President Hu outlines tasks for building innovation-oriented country http://english.gov.cn/2006-01/09/ content_151696.htm Editor: Zhang Lihong; Source: Xinhua

INNOVATION: management, policy & practice

211

A N N O U N C I N G J OURNAL OF M ANAGEMENT & O RGANIZATION Journal of the Australian and New Zealand Academy of Management ISSN 1833-3772

www.jmanorg.com

The Journal of Management & Organization (ISSN 1833-3772) is now published by eContent Management P/L in association with ANZAM The Journal of Management & Organization is an international peer-reviewed journal for timely publication of research, scholarship, educational and practitioner perspectives on management-related themes and topics. Supported by a high calibre international editorial board, it provides global perspectives on management and organization of benefit to scholars, educators, students, practitioners, policy-makers and consultants. In one forum, the Journal of Management & Organization covers: Qualitative and quantitative empirical research articles Methodological advances, including those from theses Theoretical and conceptual articles Articles on management education and learning Literature reviews, including those from theses Practitioner perspectives and case studies A dynamic new voice in management and organization research, the Journal of Management & Organization addresses the interests of management academics, students and practitioners worldwide through: Global reach with Asia Pacific orientation Two special issues per annum High profile international editorial board Timely double blind peer review Management education and case studies Timely publication at a reasonable price Literature reviews and methodology articles PPV access to all backset articles Publishing in three issues in 2006 (volume 12/1–3) and four issues in 2007 (volumes 13/1–4), Journal of Management & Organization publishes alternate general and special issues. Print subscribers for 2006 may elect to receive volumes 10–12 online for a small surcharge. Volumes 1–9 will be uploaded progressively through 2007. SAMPLE COPIES OF VOLUME 12/1 (JUNE 2006) ARE NOW AVAILABLE Volume 12/2 (September 2006) comprises a special issue on: Managing Emotions and Conflict in the Workplace, edited by Peter Jordan and Ashlea Troth (Griffith University) Volume 12/3 (November 2006) includes feature articles, reviews and a section on Careers Special issues are assigned an ISBN to facilitate ordering for course adoptions and library collections.

Special issues for 2007 and 2008 include: Global Service Sector Management Edited by Nils Timo and Peter Haynes Australasian Entrepreneurship Edited by Trish Corner and Kathryn Pavlovich Work–Family Balance Edited by Thomas Kalliath and Paula Brough Corporate Governance Edited by Clive Smallman Linking the Employee–Customer Interface Edited by Sharyn Rundle-Thiele and Rebekah Bennett

Editor: Ken W Parry, Griffith University Associate Editor: Gael McDonald, UNITEC Associate Editor: Ray W Cooksey, University of New England Book Reviews Editor: Chrys Gunasekera, Queensland University of Technology Editorial Board and Author Guidelines: www.jmanorg.com Manuscript Submissions: [email protected]

eContent Management P/L journals and special issues are available through all recognised subscription agencies and library collections. eContent Management Pty Ltd PO Box 1027, Maleny QLD 4552, Australia Tel.: +61-7-5435-2900; Fax. +61-7-5435-2911 [email protected] www.e-contentmanagement.com