Incentives, Infrastructure and Institutions:
Perspectives on Industrialization
and Technical Change in
Late-Developing Nations
FRANCISCO VELOSO and JORGE MARIO SOTO
ABSTRACT
The current paper explores the role of incentives, infrastructure, and institutions in late-industrializing
countries. We argue that all three dimensions are critical to understand differences in technological development
and industrial trajectories across countries, because they shape government policies and firm strategies in terms
of exports, subcontracting, and technology acquisition, among others. Moreover, we explain how recent insights
in the theory of economic growth may be used to understand the incentive and infrastructure dimensions of
development, even at a very micro level, but fall short of addressing institutions, a dimension our research
has shown to be as critical. The paper analyzes these relationships through an in-depth analysis of the evolution
of the auto industry in Taiwan and Mexico, characterizing the three dimensions and associated policies as well
as market and technology outcomes. The key implication for research is that advancing growth theory, so that
we may have a better understanding of late industrialization, requires a deeper micro research on the development patterns of these countries.  2001 Elsevier Science Inc.
Introduction
The development of England during the first industrial revolution and of Germany
and the United States during the second was based on technological breakthroughs
that increased labor and capital productivity severalfold [1]. These new technological
capabilities, particularly those of the second revolution, required important physical
and intangible investments that were realized through the establishment of large firms
centered on core competences [2]. On the basis of these assets, first-mover firms established themselves as members of international oligopolies, creating important entry
barriers that made it difficult for new firms, national or foreign, to join them [3].
After World War II, a number of countries around the world entered a “catchup” process, as they strove to reduce their differences in level of income per capita
FRANCISCO VELOSO is a doctoral candidate in the Technology, Management and Policy Program
at the Massachusetts Institute of Technology, Cambridge, Massachusetts.
JORGE MARIO SOTO is a Master in City Planning and a doctoral candidate in Urban Studies and
Planning at the Massachusetts Institute of Technology, Cambridge, Massachusetts.
Address correspondence to F. Veloso, Massachusetts Institute of Technology, 77 Massachusetts Ave.,
Room E40-242A, Cambridge, MA 02139, USA.
Technological Forecasting and Social Change 66, 87–109 (2001)
 2001 Elsevier Science Inc. All rights reserved.
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F. VELOSO AND J. M. SOTO
with most of the North Atlantic nations [4, 5]. Firms and governments in these latedeveloping countries (LDC) were well aware of the limitations they faced trying to
access world markets. As a result, their move towards industrialization was confined
to a small-step improvement process in low and mid-technology sectors. Governments
closed their borders to imports and fostered local industrial development based on
borrowing technology from firms in the developed countries, combined with low wages
that offset productivity differences [3, 4]. In fact, as we look at latecomers across
the globe, we find industries like textiles, paper, refining, steel, and automotive being
developed in many of these countries. But we also find important differences in developmental outcomes among the latecomers. For example, Mexico and Brazil are now far
behind Korea and Taiwan in terms of GDP per capita, manufacturing competitiveness,
and technological capabilities, despite having started their industrialization drive before them.
Scholars have agreed that economic development is mainly about two things: increases in efficiency, that is, to achieve more output with the same level of inputs,
through some form of technical change; or increases in the level of inputs, that is,
accumulate more capital. Nevertheless, there is an on-going debate about what is driving
growth, much of which centered on the differences across countries in terms of initial
conditions (e.g., wealth distribution or education); macroeconomic environment (e.g.,
inflation or saving rates); and industrial policies (e.g., inward versus outward orientation)
[1, 3, 6–10]. An emerging perception, though, is that these discussions—mostly related
to macroeconomic issues—lack further insights related to microeconomic behavior [3,
6, 10]. This is exactly the path followed by our research.
This article uses the patterns of development of the auto industry in Mexico and
Taiwan to show that incentives, infrastructure, and institutions all play a critical role
in the development process. Moreover, we explain how recent theoretical insights may
be used to understand the incentive and infrastructure dimensions of development,
even at a very micro level, but fall short of addressing institutions, a dimension our
research has shown to be as critical. The paper is organized in four sections. First, we
present the theories of economic growth and set the stage for how to interpret incentives,
infrastructure, and institutions in their context. We also explain the context of our case
studies. Second, we detail the patterns of development of the auto sector in two regions:
Taiwan and Mexico. Third, we provide an interpretation of the industry development
and future outlook based on the proposed framework. Finally, we present some brief conclusions.
Industrial Development and Technical Change
THEORIES OF ECONOMIC GROWTH
In the original perspective of neoclassical economics, developed by Solow [11,
12], economic growth is mainly associated with capital accumulation (see Figure 1).
Development—measured as output (GDP) per capita—is low because productivity is
also low. Since, according to this model, output is a function of the stock of capital
per capita, increasing productivity requires accumulating capital at a pace faster than
population growth. Because diminishing returns to capital accumulation are assumed,
growth on the earlier stages is rapid, but it slows down at later stages, eventually
reaching zero. The consequence is a natural and inexorable convergence of growth and
productivity across countries. When the stage of zero growth by capital accumulation
is reached, further development is determined by a rate of technical change—increases
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89
Fig. 1. Perspectives on economic development.
in the efficiency of the use of capital—that the model considers exogenously determined
(i.e., independent of economic conditions).
Neoclassical policy prescriptions are as simple as the theory is elegant. To increase
competitiveness, national industries should be exposed to competition in world markets,
which will adjust relative factor prices and facilitate an international division of labor.
In latecomer countries, this will dampen wage rates until they offset differences in
productivity across nations and domestic costs of production match international prices
at the margin. Because this offsetting is naturally easier in more labor-intensive industries, latecomers are destined to specialize in those activities in their earlier stages of
industrialization. Over time, relative factor intensity use will push for price equalization
across countries and an associated drive of LDC towards capital accumulation, generating the desired growth. Neoclassical economics then advocates trade openness and little,
if any, intervention of the state in the economy—that is, no “distortions”—to promote
industrial growth.
There are two major problems with this neoclassical growth model. First, the
expected paths of capital accumulation (and associated growth) across countries are
not really happening, and the anticipated convergence in growth rates has not been
observed [13, 14]. In fact, most poor countries have remained as such for decades, while
others like Taiwan or Korea have kept a formidable record of growth. Second, most
of the growth observed in empirical studies could not be attributed to capital accumulation, the endogenous part of the model, but rather by technical change, the exogenous—
and therefore unexplained—component [14].
Endogenous growth theory explores some of the key limitations of the original
neoclassical model, in particular the assumptions related to technology (see Figure 1).
Its most relevant aspect is that technological change is no longer an exogenous factor
generated outside the economic process, but rather a result of the allocative choices of
economic agents, therefore affecting productivity and growth patterns from the inside
[15]. There are two core approaches to explain endogenous technical change. In the
first one, a new R&D sector is considered along with the traditional economic sectors—
manufacturing, primary, etc. This sector also requires the use of factor inputs and
responds to profit opportunities that arise from generating new or improved products
and processes. Returns to investment in R&D come in the form of monopoly rents
over the new technologies, which displace consumption from older vintages [16, 17].
Moreover, cumulative usage of a technology by its owners usually results in productivity
gains through learning [18].
In this approach, technology has special characteristics as an economic good. First,
it is non-rival; that is, the fact that one agent uses it does not decrease the capacity for
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F. VELOSO AND J. M. SOTO
others to use it. Second, it is partially non-excludable, that is, generators often have
difficulty preventing others from making unauthorized use of it, at least to a certain
extent. Because of these characteristics, technology generates spillovers and adds to a
pool of public knowledge, which has the potential to decrease the costs for later generations to achieve new technological breakthroughs [18]. This growing external effect
compensates for the fate of diminishing returns predicted by the original neoclassical
model, generating the possibility for continued endogenous growth. The rate of development is now set, not by an exogenous change, but rather by the intertemporal equilibrium
between (a) societal valuation of the accumulation of technology and capital that assure
future growth, and (b) the propensity of consume.
A second approach to explain endogenous technical change extends the notion of
capital, introducing also human capital as a factor of production [19]. While raw labor
and physical capital are the critical inputs for farming or manufacturing, skills and
knowledge arise as the key factors that have to be accumulated to insure continuous
innovation and enhance long term growth. The critical intuition associated with this
model, which parallels the one described above, is the existence of externalities associated with the accumulation of human capital that compensate for the diminishing returns
of physical capital. As before, long-term growth comes out of the trade-off between
investment in capital (physical and human) and propensity to consume.
Endogenous growth theories provide a new framework to understand industrial
development. In a context of international trade, the patterns of specialization among
nations will be determined by their productivity and factor endowments—the main
forces behind relative international prices. If a country has a disadvantage to do R&
D—for example, due to a lack of high-qualified labor—trade will induce it to specialize
in other—perhaps technologically less dynamic—activities. In fact, the logic of comparative
advantage applied to the new technology framework will lead us to the conclusion that
countries with initial conditions favorable to the practice of R&D will specialize in the
more technology-intensive sectors, while the others will be restricted to less intensive ones.
Specialization among nations causes some sectors to expand and others to contract.
In the expanding ones, critical inputs are used more intensively and their relative prices
increase. This means that marginal costs of research production will increase in countries
with R&D intensive sectors—due, for example, to the high cost of qualified labor. In
the country specializing in sectors with no R&D, factor prices in critical resources
for R&D will be reduced, eventually spurring innovative activities and reducing the
development gap. In the long run, one could think this new theory not to be so different
from the traditional neoclassical perspective—only with the trade-offs between human
capital or knowledge and raw labor, instead of between physical capital and labor.
Despite their intellectual appeal, these new theories have proven to be of limited
use in guiding development policy, mostly due to several empirical shortcomings: First,
research has shown that growth periods with constant returns may not need research or
human capital spillovers. Through clever industrial policies, countries can shift resources
from industries with less returns on capital to others with higher international returns,
avoiding for some time the fate of diminishing returns [20, 21]. Second, authors have
argued that the magnitude of the externalities needed to assure endogenous long term
growth is very implausible [10, 22]. Third, because key variables and indicators considered are highly aggregated (e.g., average level of education, relative weight of industrial
sectors, R&D expenditures as a percent of GDP), it becomes very difficult to infer
specific policies beyond the unsophisticated “more education and R&D are good.”
Fourth, economic organization needed to assure that the markets work (e.g., factors
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91
Fig. 2. A framework for policy analysis.
being paid their marginal product is a basic assumption) is assumed to be in place.
Nevertheless, given the examples of institutional failures that prevent markets from
functioning, the creation of an appropriate institutional setting has remained a key
policy discussion [4, 5, 10, 23].
Given this critique, our perception is that these macro perspectives need to have
deeper roots in the actual behavior of the economic agents. Therefore, this article will
focus on how growth theory policy prescriptions are articulated at a micro level. To
achieve this, we will explore how relevant factors—human capital, R&D, labor, physical
capital, etc.—are articulated in a particular industry—automotive. We will compare two
countries, Taiwan and Mexico, which in the past have used similar policies to foster
automotive manufacturing, but which now present different structures in the industry.
We think that an understanding of how these different structures evolved will provide
relevant insights about the process of industrial development in latecomer countries
and, more generally, about the nature of economic growth.
THE THREE I’S OF INDUSTRIAL DEVELOPMENT: INCENTIVES, INFRASTRUCTURE
AND INSTITUTIONS
Both the neoclassical and the endogenous growth theories elaborate on the generic
conditions under which expected returns determine investment patterns on scarce factors, ultimately generating long-term growth. Exploring the micro conditions behind
these macro models requires clarifying how to read variables, such as expected returns
or factor scarcity, in the context of a particular industry or firm. For this purpose, we
first consider two broader dimensions: incentives and infrastructure (see Figure 2).
Incentives guide the allocation of resources and the effort to develop new knowledge;
they are related to the overall market conditions and the structure of competition, as
well as government policies. Infrastructure is related to the potential to generate desired
capabilities, and arises from physical assets, human capital, and general technical struc-
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ture [23]. Incentives and infrastructure can be considered as an extension of how firms
see expected returns and relative factor scarcity.
Two major aspects determine the incentive structure of the market, competition
being the most important. Competition in product and factor markets provides signals
to investors about the potential returns among alternative options, thus determining
their investment patterns. Endogenous growth theories, because they are based in the
existence of dynamic externalities and imperfect markets, require a careful analysis of
the dynamics of competition. On the one hand, growth-generating investment decisions
depend on the existence of some degree of monopolistic rents over products. These
rents may not exist in LDCs that are completely exposed to international competition,
since they are adopting foreign technology. On the other hand, when private agents
make their investment decisions, they fail to acknowledge the spillover effects certain
technologies have. Moreover, they may not be able to anticipate the full extent to which
there is learning potential in a new technology.
As a result, in latecomer countries private investment levels in activities with
learning or spillover potential tend to be lower than the social optimum, and may
even create “low-level development equilibrium traps” [15, 24]. This happens when
private—but not social—returns from productivity-enhancing investments (i.e., accounting for spillovers), are below those of non-productivity enhancing investments, causing
a stagnation in countries’ growth. This situation may be overcome by including the
spillover effects in the firms’ decision-making process, or by creating monopolistic
markets that generate above-normal returns.
In principle, these shortcomings of the market mechanism call for some sort of
government intervention, a second major factor affecting the firms’ incentive structure.
Governments are concerned with making sure that societal costs and benefits are endogenized in the decisions of private firms. In a learning environment this may mean
subsidizing research activities, investing in education, protecting infant industries, promoting exports, or even disciplining firms [2, 25]. But government intervention has to
be wise: artificial restraints on competition can also divert profits to activities other than
building technological capabilities. In relatively closed regimes with strong pressure to
substitute imported for local goods, there may be little incentive for firms to improve,
since they can capture the local market regardless of their own productivity [26].
In the neoclassical view, infrastructure is related to the existing amount of labor,
capital, and natural resources. The new theories bring to stage other important factor
inputs, in particular human capital, R&D expertise, and the public stock of knowledge.
Thus, hereafter infrastructure will encompass—in addition to labor and capital—what
we will call technology infrastructure, or technostructure. Tassey [27] has proposed a
definition that suits our discussion: technostructure consists of science, engineering, and
technical knowledge available to industry. It is embodied in human, institutional, and
industrial forms. The reason for such generic consideration is that this set of new factors
is difficult to measure or account for [28]. Nevertheless, making a distinction between
labor and capital on one hand, and technostructure on the other hand, enables a separate
analysis of the roles played by each of these aspects in the development path of a
particular industry.
Although incentives and infrastructure greatly inform our understanding of the
behavior of firms, government policies, and industrial trajectories, they do not tell the
whole story about the differences across countries. That is because both incentives
and infrastructure do not operate in a vacuum, being shaped and shaping institutions.
Therefore, we argue that part of the development story relates to the institutional
THREE I’S FOR INDUSTRIAL DEVELOPMENT
93
setting of specific industries and sectors in each country, an aspect that has not been
considered in mainstream growth theory.
Our analysis builds on a body of literature developed by scholars such as North
[29, 30] and Williamson [31], although we do not subscribe to the perspective of treating
institutions strictly as instruments to minimize transaction costs. Our perspective on
institutions is closer to Zysman [32] and Stiglitz [10]. Zysman argues that the “institutional structure of the economy, combined with its industrial structure in a more classic
industrial organization sense, creates a distinct pattern of constraints and incentives.”
By shaping the interaction among firms—both national and multinational—and between
firms and the government, institutions affect the choice of policies and the strategies
of firms, and thus affect the technological development and trajectories of entire sectors
and nations. In this paper, we make a particular assessment of how the institutional
setting has conditioned the development of the auto industry in the two regions considered: Mexico and Taiwan.
AUTOS AND INDUSTRIAL DEVELOPMENT
The automotive industry provides an excellent case to assess the role and interaction
between incentives, infrastructure, and institutions in late industrialization. Since World
War II, countries like Brazil, Mexico, India, Taiwan, and South Korea have recognized
and exploited its potential to forward industrial development. Besides employment and
trade issues, the auto industry demands a significant amount of intermediate inputs,
creating a pressure to develop other industries. For these countries, it could be the hub of
an integrated industrial structure, triggering the domestic production and technological
advance of industries such as steel, machine tools, electrical, and rubber, among others.
Likewise, the spillover and dynamic learning effects in the auto industry facilitate the
move up the quality ladder over a range of products, from the manufacturing of simple
parts to the assembly of complex modules.
In the postwar period, a major problem these countries faced was that the industry
required very specific technologies and was dominated by a few oligopolistic firms in
the United States, Germany, and later Japan. The solution for latecomer countries was
to adopt trade protection mechanisms—quotas and tariffs—forcing firms to produce
locally if they wanted to access domestic demand. Simultaneously, the enactment of
policies to stimulate foreign direct investment (FDI), and the establishment of local
content requirements (LCR), facilitated the participation of indigenous firms and fostered the desired linkages within the national economies. These policies evolved over
time and the initial schemes were complemented later with measures devoted to export
promotion, finance, quality, R&D, etc.
The environment described above can be found in most late-developing countries
with a sizable population and manufacturing experience previous to World War II.
Still, while the general policy framework is quite similar, the outcomes have varied
significantly across countries. We have chosen to study Mexico and Taiwan because
both countries have successfully developed the auto industry, but under different conditions and along different paths, as we show below. The analysis will cover both the
assemblers and suppliers, but we will be particularly concerned with the latter. Assemblers are known to replicate manufacturing and organizational structures (including key
people) from their original bases, with limited concern for the role of local people
and firms. Therefore, auto parts firms are considered the key vehicle for knowledge
dissemination and industrial upgrade, and local content incorporation is usually a good
measure of the country’s industrial capabilities.
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State-led Growth of the Auto Industry in Mexico and Taiwan1
THE AUTO INDUSTRY IN MEXICO
Automotive production is Mexico’s most important manufacturing activity. The
auto industry—comprising automobile and engine assemblers and parts manufacturers—
generates over 400,000 direct jobs, employing about 15% of the labor force in manufacturing. It is the leading importing, and the second-largest exporting, industry of the
country. It has one the highest rates of investment and productivity growth, and is
indeed the spearhead of modernization and industrial restructuring in Mexico [34, 35].
In 1997 there were 19 assembly companies operating in the country, most of them
multi-national corporations (MNC) and a few Mexican-controlled firms in trucks and
buses. The auto parts industry includes between 600 to 800 firms, grouped in three basic
categories according to ownership structure, market orientation, and policy regulation:
first, the National Auto Parts Industry (NAPI), companies controlled by Mexicans
capitalists; second, the so-called National Suppliers (NS), firms that can have up to
100% foreign ownership and supply mainly for the assemblers established in the country;
third, in-bond plants or maquiladoras, foreign-owned firms that import almost all their
inputs other than labor, and export most of their products directly. About 110 to 150
auto parts firms are first-tier Original Equipment Manufacturers (OEM) delivering
directly to assemblers, while the rest are second- and third-tier suppliers, or spare parts
producers [36].
First-tier NAPI firms tend to be vertically integrated and import most components
they do not manufacture themselves—even if second- and third-tier Mexican suppliers
could produce some. These firms are also highly concentrated. At least 50 of the OEMs
are linked to 18 grupos—large and diversified Mexican conglomerates—such as Desk,
Condumex, and Vitro. Most of them have joint-ventures (JV) and technological ties
with U.S., European, and Japanese manufacturers [35]. The vertical structure of the
industry, and its strong ties to the United States, have created a strong dependency of
assemblers and first-tier suppliers on imported parts. As a result, only 36% of the vehicle
parts and materials are sourced in Mexico, the value which is mandated by Government
LCR [36].
The contemporary profile of the auto industry derives from the interaction between
the government, assemblers, and parts producers. This interaction has been formalized
in the five successive “Automotive Decrees,” which contain the most important policies
for the protection and promotion of the industry. The decrees reflect the changes of
ideas, interests, and relative power of the players involved, as well as the shifts in the
overall developmental approaches of the government over time (see Figure 3). They have
provided the policy framework within which firms have set investment and production
strategies, and thus have been the main instruments for the state to influence the
development of the industry.
Ever since the first decree in 1962, automotive policy has aimed to promote the
growth of the industry and its integration with the local economy. On the whole, policy
has tended to reserve assembly for MNC and parts production for domestic capitalists,
shielding the former from international competition and securing a minimum business
for the latter. The policy rationale has been twofold: on the assembly side, to insure
economies of scale and allow for monopolistic rents; on the parts side, to promote
infant industries and generate backward linkages and spillover effects to the rest of
the economy.
1
This section relies extensively on [33].
THREE I’S FOR INDUSTRIAL DEVELOPMENT
95
The initial policy mechanisms included import restrictions and tariffs, local content
requirements, price controls and production quotas on vehicles, restrictions to the
vertical integration of assemblers, and limitations to foreign ownership in parts firms.
These policies had some positive effects during the sixties, but the strong expansion of
the domestic market during the seventies increased trade deficits in the auto industry.
This situation contributed to a shift of the policy focus towards exports. The 1972 and
1977 decrees adjusted most restrictions and included others, such as import compensation
and foreign exchange balancing, but did not have the desired effect of boosting exports.
In spite of these limitations, by 1981—20 years after the first decree—vehicle production
had gone from 60,000 to 600,000 units per year [33].
In the early 1980s, the drop in oil prices and the debt crisis hit the Mexican economy
strongly, contributing to a sharp contraction in vehicle sales. This situation called for
further change in automotive policy. The 1983 decree intended to rationalize domestic
production, resume growth and reverse the trade deficit, by means of increasing local
content requirements and reducing the number of models and product lines to achieve
larger scale economies. The new measures had the anticipated effects: the automotive
industry achieved trade surpluses in the mid-1980’s, with vehicle production at 640,000
units by 1989 [33].
In 1986, Mexico joined the General Agreement on Tariffs and Trade (GATT) and
overnight opened almost all industrial sectors to international competition. In line with
the opening, a fifth decree in 1989 relaxed import restrictions of finished vehicles,
lowered compensatory obligations in foreign trade, exempted assemblers from buying
parts locally for their export lines, and lowered tariffs and local content requirements
for both assemblers and parts producers. These changes and the promising perspectives
of the North American Free Trade Agreement (NAFTA) gave a big boost to the auto
industry in the early 1990s. From 1989 to 1994, the industry invested about $5.9 billion,
geared towards plant and product modernization, quality and productivity gains, and
integration within MNC’s global plans. In 1992, vehicle production reached about 1.1
million units, and direct exports of parts were at 11–12% of output—excluding maquiladoras. (However, the industry had again a negative trade balance, due to the sudden
surge in imports of parts and luxury cars made possible by the new legislation.) By the
time NAFTA entered into effect—January 1, 1994—the industry was already fairly
open: what NAFTA essentially did was to set the times and forms for the remaining
restrictions to be phased out; in particular, it established the 2004 deadline for the
elimination of LCR [33].
The financial crisis initiated on December 1994 brought about an abrupt contraction
of the domestic market for automobiles , with a 70% drop in sales from 1994 to 1995.
Most assemblers adjusted by shifting production towards exports, which grew from
about 568,000 vehicles in 1994 to 783,000 in 1995—a 38% increase. Obviously, the
roughly 50% devaluation of the peso favored exports. This major shift towards exports
not only kept the industry afloat, but also generated its first trade surplus of the decade
[34]. NAPI firms found it harder to adjust to the crisis. Because of local content regulations, they had traditionally sold to vehicle lines for the domestic market. But assemblers
were not required to incorporate products of the NAPI in their export lines, and thus
the export shift largely bypassed these suppliers. To a certain extent, the currency
devaluation may have given them some protection from imports, but the drop in domestic
sales overshadowed this effect. As for NS and maquiladoras, although they had been
increasingly supplying for domestic lines, the bulk of their production was and still is
for exports, giving them more room to adjust.
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The downturn in auto sales ended in 1996, with a record production of 1.2 million
units and exports of 970,000. For future years, with resumed economic growth and
favorable export markets, assemblers seem to hold a high-profile investment outlook.
New players are coming into the market and established ones are rationalizing their
product lines, with a strong trend to specialize in small passenger cars and light commercial vehicles. Government, private sector organizations, assembly firms, and experts
concur that prospects for the assembly industry in general are quite favorable, with
annual growth rates between 7.5% and 10%. By the year 2000, vehicle production is
expected to be anywhere between 1.9 and 2 million units, with a share of exports
between 53% and 75% [34].
This new environment has generated opportunities and challenges that are changing
the outlook of the supplier structure as well. While the favorable prospects for the
assemblers will likely trickle down for NS and maquiladoras, the future looks more
uncertain for the NAPI. Gradual trade liberalization and regional integration under
NAFTA was deemed to force NAPI firms to improve their production technologies
and standards to compete in international markets, but it seems that only a group of
the largest firms has been able to pursue this upgrade. Although direct and indirect
exports have increased as share of total sales, going from about 26% in 1989 to 67%
in 1996, imports of components by both the assemblers and parts producers are more
than double exports, and there are no signs that the trade deficit is going to recede in
the future.2 On the contrary, it could very well grow when the remaining restrictions
in national value-added and trade balancing disappear in the year 2004, threatening to
reverse the current surplus of the industry as a whole.
THE AUTO INDUSTRY IN TAIWAN
As in Mexico, the auto sector is among the most important industrial activities in
Taiwan. In 1996, it represented 5% of the industrial output and generated 100,000 direct
jobs. Additionally, it provides crucial links to the rest of the economy, since about 45%
of all materials and parts included in the cars assembled in Taiwan are sourced locally.
The export figures are also important in an international context, since Taiwan is Asia’s
second largest exporter of parts, with US$2.5 billion—after Japan, but ahead of Korea,
all of ASEAN, and India [33].
In 1996, as a result of joint ventures and technical cooperation agreements with
local firms, 11 assemblers were operating in Taiwan. All the production was destined
for local sales, since existing technology transfer agreements do not allow the companies
established on the island to export. About 300 companies capable of supplying directly
to assemblers exist on the island, with about 60 of them playing a systems integrator
role. Moreover, the first-tier firms now have important design capabilities that they
have developed over time, backed by an expenditure in R&D that amounted to 2.7%
of the 1995 sales. At the second and third levels, over 1500 firms supplying particular
parts can be found. These are mostly family owned and managed businesses often
dedicated to one or two first-tier clients [37, 38].
Due to the strict restriction on foreign equity control, the majority of the firms are
owned by Taiwanese, although joint ventures are also common. In general, there is not
a captive relationship between the assembler and the supplier, and companies supply
three or four assemblers. In late 1980s, when their positioning in the national market
was solid but opportunities for growth were scarce, the stronger firms expanded into
2
Authors’ estimations based on data from [34, 36].
THREE I’S FOR INDUSTRIAL DEVELOPMENT
97
foreign markets, either through exports or by setting their own plants abroad, particularly
in mainland China. Today, more than half of the auto parts production in Taiwan is
exported, mostly to the U.S. parts replacement market.
The structure for the auto industry is the product of forty years of development,
through several main periods that follow the pattern described for Mexico, but with a
stronger drive from the local government (see Figure 3). Until 1967, due to government
regulation, all the cars sold in Taiwan were to be produced by Yulon Motor Company
(through a technical assistance contract with Nissan) and subject to a 20% local content
requirement. In 1967, as demand grew to 15,000 units per year, the Ministry of Economic
Affairs (MOEA) approved the establishment of three new assembly plants on the island.
Nevertheless, like Yulon, these were to be created through technology transfer to local
firms, and not by direct investment. During the same period, the government also
enacted its first decrees promoting the development of the auto industry. As in Mexico, it
consisted of a bundle of local content requirements, tariffs, and investment controls [33].
During the first half of the seventies, the government experimented with a number
of contradictory measures in the industry, liberalizing imports one year, only to bring
up tariffs protecting local firms the next. Nevertheless, by 1976—despite these measures
and a market of only 50,000 cars per year—there were six auto manufacturers operating
in Taiwan, in partnership with firms from Japan, the United States, and Europe. Simultaneously, strict local content regulations and a non-captive relationship between assemblers and suppliers had generated a number of supplier firms that were actively working
with local assemblers and foreign firms to upgrade their manufacturing capabilities. In
1977, encouraged by the results the supplier firms were having on the island, the
government enacted a new decree, whereby a clear export promotion strategy framework
emerged. In this new policy, the development of the parts industry appeared for the
first time as a policy goal, and the need to strengthen R&D and human resources
training to build up manufacturing and design capabilities was explicitly considered,
although no specific regulations were included [33, 39].
With the 1985 Automobile Industry Development Act, the industry entered a
period of government-institutionalized promotion. While emphasizing a reduction of
parts tariff protection to reinforce competition among companies, the new decree also
strengthened the drive to promote exports, increase R&D, and absorb foreign technology. The specific measures included partial deregulation of foreign investment in local
firms, tax incentives for research and design, as well as reductions in local content requirements.
The novelty was the active role played by several government sponsored organizations. CETRA, the China External Trade Development Council, was created and started
an aggressive campaign to promote local manufacturing capabilities abroad, leading
groups of parts entrepreneurs to international fairs and attracting foreign firms to
look at Taiwan as a possible investment opportunity. CSD, the Corporate Synergy
Development center, implemented a wide cooperation and learning program, disseminating information on advanced production techniques among assemblers and suppliers.
ITRI, the national research institute started research programs directed to the industry.
These policies, helped by a growing auto assembly on the island (as a consequence of
a local demand increase from 150,000 in 1985 to 450,000 in 1992), had very positive
results in the auto parts industry. During this period, exports alone grew by 50%,
reaching US$1.5 billion in 1992 [33, 39].
The most recent decree dates from 1992, when the government set the goals of
the industry for the year 2000 and established a number of programs to assure them.
Fig. 3. Policy stages of the auto industry in Mexico and Taiwan.
THREE I’S FOR INDUSTRIAL DEVELOPMENT
99
It included a reduction of all protection schemes, in accordance with GATT agreements,
and the enactment of further incentives for investment in R&D and increase of exports.
In particular, the government started an ambitious program to develop high valueadded components locally. National firms, financially backed by the government and
ITRI, would acquire the capability to design and manufacture components such as the
engine, the gearbox, the ABS, etc. The initial component targeted was the engine,
through a technology transfer contract with Lotus plc, which is expected to enter
production during 1999. Power steering and ABS are among the next possible targets.
Currently, the major problem local assembly firms are facing is the small scale
of the market and the barriers to exports imposed by their license agreements with
multinational assemblers. They are aware that a liberalization of the market for imports
will reduce the share of the sales for national assembler firms. The concern is that an
anticipated shrinkage of the overall market might drive some of the producers below
the minimum viable production scale, and eventually force them to close. Therefore,
there is ferocious competition between brands in Taiwan to increase market share. The
perception is that assemblers better positioned in the local market will not only avoid
closing down, but may eventually convince their licensers to concentrate production of
some models in Taiwan, exporting them all to the Asian region. Another development
route the local assemblers are pursuing to counter stagnation and recession of sales in
the local market is the establishment of partnerships to enter China. This market is
considered as a prime business opportunity by Taiwanese firms, not only because of its
size and growth, but also due to their cultural ties and geographical proximity.
The suppliers, like the assemblers, also have a scale problem. So far, this has largely
been overcome by a growing export of replacement equipment. More recently, these
firms have been using the reputation acquired in export markets to try to gain entry
into the web of global sourcing of some of the world assembly firms, as OEMs strive
to concentrate manufacturing of certain parts in some countries. Another strategy has
been to join the assemblers in their move towards mainland China, recreating the same
supply relationships existing in the island.
With these strategies, Taiwan aims at having two or three conglomerates with
international positioning in the auto industry, 50 companies with capability to produce
advanced parts, 7% of all industrial production in Taiwan and $4 billion of exports.
Nevertheless, studies have demonstrated that if the requirements for local content were
suddenly removed, a significant number of second- and third-tier firms might go out of
business [40].
The Drivers of Industrial Development and Policy Analysis
From a development perspective, it is important to assess, after a long trajectory
of state-oriented growth, the capacity of the auto industries of Mexico and Taiwan to
compete in open markets. Two critical benchmarks will be used to assess industry
competitiveness: exports—a reflection of existing capabilities; and R&D expenditures—a degree of local knowledge incorporation, as well as a measure of investment
in future capabilities. Moreover, as explained before, we will be particularly concerned
with the capabilities of the auto parts industry, rather than the assemblers. Our research
seems to indicate that—in both countries—assemblers and a number of first-tier suppliers
will be able to survive and develop further. Second and third tiers, however, already
face a very difficult situation, which will likely worsen once liberalization happens
to its full extent. Industry analysts speculate that, in the absence of state-imposed
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requirements, local content may go down to 30% in Taiwan [37] and 20–30% in Mexico [41].
Losing auto parts firms and decreasing local content may not be bad per se, insofar
as more efficient firms replace inefficient ones, and export growth compensates for
imports. However, in the Mexican case in particular, important problems may arise if
the outgoing firms are substituted for by imports instead of by local production, or if
assemblers and the surviving parts firms find it increasingly more efficient to import parts
and sub-components than to produce them (i.e., a sort of “maquilization”). Becoming a
huge assembly operation with little local content and value-added is not a far-off
possibility [42]. It may not only harm the balance of trade, but also curtail the learning
capabilities of local firms as well as the knowledge spillover effects to the rest of
the economy. In a world increasingly dependent on technological development and
knowledge-based competitive assets, this may be an important handicap for the Mexican
auto industry and its related activities.
On the other hand, Taiwan does not seem to be threatened by “maquilization”—or
least not as much. As we show in subsequent sections, one of the reasons is that, in
general, Taiwanese auto parts firms seem to have a better technological infrastructure
than Mexican firms have, particularly NAPI ones, and thus a higher potential to develop
technological capabilities. This may help explain Taiwan’s success at directly exporting
original equipment and spare parts, as well as the move of a number of firms to other
sectors further up the technological ladder, in contrast to Mexico’s accelerated increase
of net imports of parts and weakening of the automotive chain. What made this difference
between the Mexican and Taiwanese auto parts industries? How should we interpret
it in a theory of late industrialization? The framework presented in the first section will
guide us to explore these questions.
INCENTIVES
Economists have long debated government intervention and trade policy, discussing
among other things how the distortion of real prices affects the incentives firms face
[26]. Even when intervention is justified by the existence of learning or spillover effects,
many seem to prefer subsidies rather than trade barriers [43]. However, since trade
balance in the auto sector was a key concern for governments in industrializing nations,
trade restrictions have always played a role in the industry. Therefore, we will not
continue this discussion here. We would rather focus on trying to understand how trade
policies were designed and balanced with other measures, and how they affected the
pattern of incentives of the auto sector.
For the most part, Mexico and Taiwan have had similar patterns of government
intervention, and therefore auto firms have shared a somehow similar incentive structure
in both countries. Both governments have adopted local content requirements, import
tariffs and quotas, restrictions to foreign ownership, tax subsidies, financing, and matchmaking among others. These policies created an artificial market where national companies were able to compete while trying to promote the learning necessary to develop
an internationally competitive auto sector. Interestingly enough, the timing and objectives of policy reforms have been quite similar as well (see Figure 3).
Starting in the early 1980s, the auto sector and the auto parts industry in these
countries increasingly changed their orientation from domestic to foreign markets. The
parts industry had a major growth push when national companies started to be exposed
to international competition. It was forced to introduce the latest technologies and
managerial techniques in order to catch up with the requirements of assemblers. In
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101
Fig. 4. Auto industry supply structures.
both Mexico and Taiwan, the long-established firms were usually among those that
became internationally competitive, and also the most helped by government through
protective measures and subsidies [33]. For these firms, the learning premises for government intervention in the market were being fulfilled.
Entering into the nineties both industries exported parts, and Mexico was becoming
a major assembler of cars for the U.S. market. At this stage, important differences in the
incentive structure of both countries started to come out more clearly. The liberalization
drive—that it, the reduction or lifting of tariffs, local content requirements, limits to
vertical integration, and restrictions on foreign ownership—has been deeper and more
rapid in Mexico than in Taiwan. With GATT and NAFTA, Mexico’s imports of components soared and, despite an absolute growth of the auto sector and the establishment
of more internationally competitive firms, the supply base of the industry is shrinking.
In 1995, for a car assembly of 1 million vehicles, Mexico parts industry sales were
US$8.5 billion, compared with US$4.2 billion in Taiwan, for an assembly of 400,000
vehicles. This means that, adjusting for relative size, Taiwan’s auto parts industry was
already 25% larger than the Mexico’s [33].
For Mexico, the main problem seems to be in the second and third tiers of the
automotive sector—among the small and medium parts procedures. Most of the sector’s
development since the second half of the 80s is due to car exports for the U.S. market,
but existing LCR are only valid for assembly lines for the Mexican market. Therefore,
assemblers can import all the parts they need for their export lines. Moreover, the
development of this export market resulted essentially from domestic economic shocks
that cramped the local demand, and not from a purposefully articulate and gradual
government strategy. Therefore, assembler and first-tier parts firms, suddenly shifting
away from the less demanding Mexican customers and towards high-demanding American ones, increasingly relied on imports or on the more developed NS—which for the
most part are really foreign, but locally established. They had no incentive and no time
to help local firms achieve the necessary levels of performance that would allow them
to remain as their suppliers. As a result, many firms, particularly among the second
and third-tier suppliers, were not able to modernize. They shut down operations, moved
to the parts replacement market, or became distributors rather than producers.
This effect can be better understood by analyzing the Mexican auto industry supply
pyramid (see Figure 4). As can be seen, Mexico presents a weak pyramid base structure.
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Assemblers import a substantial amount of parts, particularly for their export lines. Not
surprisingly, NS also imports a very large proportion of the value of their sales. The
concern expressed by industry analysts is that as NAFTA forces national value-added
restrictions to disappear by the year 2004, this national supply base will be further eroded.
In contrast, Taiwan’s liberalization is expected to go forward when the country
joins the WTO in 1999 or later. At that point, LCR will gradually be reduced and
eventually disappear, but tariffs and imports quotas will likely remain for a few more
years. This protection is seen by critics of government intervention as excessive, enabling
a number of ineffective firms to stay in business. This situation is corroborated by the
existence of a wide supply base. In contrast to Mexico (see Figure 4), over 1500 firms
supplying particular parts can be found at a second and third-tier levels. A significant
number are not large enough to attain minimum efficient production scales, and some
lack capabilities in terms of quality and responsiveness.
Despite protective measures, the auto parts industry exports US$2.4 billion—half
of its production—a proportion similar to Mexico, which has the additional advantage
of being close to the U.S. market.3 Moreover, as noted earlier, the shrinkage in the
supply structure predicted when Taiwan opens its borders is still less than what may
happen in Mexico in 2004. In addition, studies have suggested that average part quality
levels in Taiwan may be two to three times higher than in Mexico [35, 44]. The key to
these positive results is a government policy scheme that planned the growth of the
industry and provided assistance for firms to upgrade. It is fair to say that automotive
policy in Taiwan provided both protection (e.g., local content requirements and tariffs)
and promotion (e.g., tax subsidies and technological assistance), while in Mexico the
policy relied mainly on protection (see Figure 5).
The Taiwanese government allocated support according to the principle of reciprocity, whereby assistance is given only in exchange for performance standards. One standard was in the form of export requirements, so that a firm would have to export a
certain amount over a given time period to receive, for instance, tax breaks. More
importantly, standards sometimes were in the form a requirement for a firm to invest
in intangible investment, namely, worker training or R&D. Moreover, these incentives
were gradually increased over time. Since the end of the 80s, an additional “hidden
incentive” has been in place. Every couple of years the MOEA gathers with the industry
association and announces that liberalization will occur. Firms ask the government for
a delay, to which it agrees, provided that firms meet additional performance criteria.
The 2.7% of sales expenditure in R&D that auto parts firms are now spending—high
by any standards—and the amount of exports leaving from the island are the best
examples of how these requirements have had a positive effect on the firms [40].
This behavior by the Taiwanese industry and government fits with the perceptions
raised by the endogenous growth theories presented in the first section. Government
has been playing the role of “benevolent social planner.” It closed the borders because
it was aware of the inability of national firms to compete in the world market before
they went through a period of learning. It was able to do it because its discount rate
and its social investment portfolio enabled a longer investment period and payback
time than private agents. Nevertheless, the reciprocity principle it has pursued through
performance standards replaces the normal market mechanisms, reestablishing a correct
incentive framework for firms and assuring a better investment pattern, particularly in
3
Mainland China can’t play the role of the United States for Taiwan because political constraints do not
allow direct trade with MLC.
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Fig. 5. Drivers for development of the industry in Mexico and Taiwan.
intangible assets. Throughout the whole process, it considered the spillovers arising
from developing an industry with high learning potential and important linkages and externalities.
INFRASTRUCTURE
Despite sharing similar objectives, the policy schemes that Mexico and Taiwan
enacted in the 1960s differed greatly at the level of the technostructure (see Figure 5).
In their earlier stages of development, the auto sector in both countries relied solely
on foreign knowledge. In Mexico, a number of international assemblers were already
established, and a few more started operations when the government set restrictive
import schemes. Assemblers tended to be highly integrated vertically, and helped upgrade local suppliers insofar as regulations forced them to give a share of the business
to the latter. In Taiwan, because of restrictions on foreign ownership of assemblers,
assembly operations were established through technology transfers and license schemes
from foreign to local firms, rather than through direct foreign investment. These local
firms played the crucial role of initially disseminating technology to their suppliers.
They taught them the quality and logistics required for auto manufacturing, either
directly or by establishing transfers with their home base suppliers: for example, Sanyang
Industries in Taiwan, which produces Honda cars, arranged for their local suppliers to
visit their counterpart Honda suppliers in Japan.
The difference between Taiwan and Mexico came in the capacity to absorb and
develop the knowledge transfer that was taking place, particular at later stages of
development of the industry, when it became clear that local firms needed to go beyond
low-cost, low-quality production. One of the key issues has been the difference in the
technical abilities of the working population. In fact, while Mexico was still fighting
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literacy in the 70s and 80s, Taiwan was already developing a sound technological infrastructure. Research and development indicators are a good indicator of differences in
absorptive ability [45]. By 1995, aggregate R&D expenditures in Taiwan had reached
1.8% of GDP, while in Mexico they accounted only for 0.31% of GDP. A similar
situation happened at the level of human resources, where Taiwan had 2.1 researchers
per thousand people versus 0.6 in Mexico [46, 47]. While the previous argument is
related with the overall population, the situation becomes more acute when we compare
the set of technical organizations supporting the auto industry in both regions.
In Mexico there have been virtually no organizations which specialize in technical
services (testing, training, technical information and consultation, R&D, etc.) to small
and medium enterprises [35]. State-run and private technical support organizations have
overspecialized in large and medium enterprises, and have failed to provide a muchneeded support to the smaller firms. Even firms who do use the national institutions
do it mostly for inspection and testing purposes. In a 1995 survey conducted among
Mexican auto suppliers, only 17% of the firms used these organizations for other kinds
of technical support, including technical education and training. Moreover, research
and development in core auto technologies is considered rather weak [35].
In contrast (as described above) an important set of technically oriented organizations in Taiwan has made an important contribution to the development of the industry:
Corporate Synergy Development Centre (CSD) played a major role in disseminating
auto components manufacturing best practices; the Industrial Technology Research
Institute (ITRI) promoted the development of a number of research projects for the
industry, including large and small companies—in 1994 it filed more patents (368) than
the whole of Mexico in 1995 (348) [46, 48]; the Taiwanese Productivity Centre has
long been helping small firms in their quality certification process. All together, these
organizations provide the industry—in particular small firms—with an important knowledge base, which seems to be at the core of the competitiveness of the autoparts firms.
Another key innovative action promoted by the Taiwanese government has been
the development of key components for the car, which has started with a national
engine. Although this option has been criticized on the grounds that it is an investment
that will never be commercially viable, it has still enabled the generation of a knowledge
base that is regarded by many as beneficial [33]. R&D expenditures of 2.7% of sales
for the first tier suppliers is an excellent record by any standard (only the top 60
European suppliers spend a value above this level).
Overall, we could say that Mexico has relied more on classical competitive perceptions: abundant low wage labor and capital scarcity coupled with a potential large market
(the United States) has attracted investment. The problem has been the ability to
generate spillovers from this investment into the larger economy, a crucial aspect pointed
out by the new development theory. Taiwan has had an overarching focus on the
diffusion and further development of the knowledge base, whereby there is an endogenization of learning spillovers in the industry. Still, an overemphasis on protection may
have been causing some stifling of more rapid progression at this level.
INSTITUTIONS
In addition to differences in the incentives and in the infrastructure, very different
perspectives existed in the institutional frameworks established between the different
players in Mexico and Taiwan. In fact, we would argue that institutions were a major
influence on the way government affected both the incentive structure and the technostructure, as well as on the way firms perceived them.
THREE I’S FOR INDUSTRIAL DEVELOPMENT
105
Mexican subcontracting relations in the automotive industry have been, and still are,
predominantly adversarial. Assemblers and suppliers in Mexico participate in different
industry associations. Moreover, small and medium autoparts companies (SME) do not
have a voice in the industry. INA (the parts association) and the automotive chapter
of the National Chamber of the Manufacturing Industry are dominated by large firms,
and therefore cannot appropriately represent the interest of SME. As a result, the
learning process has been bounded in terms of the type of goods produced by national
auto parts firms [36]. At one end are the large first-tier suppliers, both national and
international, that have a more systematic relation with assembly firms, so that design
is discussed and parts are manufactured according to the specifications and standards
of the latter. At the other end are the smaller replacement market manufacturers that
produce goods for the public and thus do not need to be certified by assemblers. In
between we find no organizations promoting the relations between the several agents
of the industry. In this sense, information exchange, learning, and innovation take place
for the first group of auto parts industry firms but not for the second, which represents
the largest number of the auto parts firms in the chain. The alternative is to build a
more cooperative set of relationships, which requires a change in the aspects of the
incentive structure that provide the rules of the game. This calls for an intervention at
the institutional level, but it is far from clear how could this be advanced effectively in
the context of increasing liberalization and deregulation of the sector.
The institutional context for Taiwan is almost the opposite. In fact, a sound institutional setting supporting the industry exists. The concern was not only with what policies
to have in place, but also how these policies would be enforced and how the firms could
be helped to pursue the development pattern envisaged. Four organizations put in place
by the government have played a critical role. The Industrial Development Bureau
(IDB) of the Ministry of Economic Affairs has played a coordinating role. Companies
and institutions are aware of the directives that are set by this bureau and recognize
its knowledge and concern with industry direction. The perception from companies is
that it is a working interface to government policy that can be reached and influenced
through organizations such as the Taiwanese Auto Manufacturers Association
(TTVMA). The China External Trade Development Council (CETRA) is also a powerful and respected organization. The recent government strategy to transform Taiwan
into a regional one-stop shop for parts sourcing by large international corporations is
based largely on CETRA’s expertise and capabilities. ITRI and CSD, as explained
above, have also played an important role.
The other important factor is that private companies have been very cooperative.
Assemblers have helped suppliers to develop their capabilities extensively, facilitating
contacts—particularly international—and establishing and upgrading programs. Assemblers and suppliers share the same industry association that is used as a focal point to
discuss policies and bargain with the government. Moreover, as some of the assemblers
started to move abroad, they invited their suppliers to come with them. Some suppliers
accepted the challenge, and we now witness replication of the Taiwanese supply chains
in mainland China or ASEAN countries.
Our argument is that industrial development patterns are conditioned by different
institutional settings that affect both incentives and infrastructure. In particular, the
examples explored above have shown that a cooperative environment and the presence
of support organizations enhance the dissemination of knowledge, induce long term
commitments to relevant technologies and export markets, and facilitate equalization
of bargaining power among economic agents. This key institutional dimension is left
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out of the major models of economic development, which make the simplifying assumption that they are in place. Our findings seem to indicate that further development in
these theories must take into consideration institutional patterns and how they interact
with policy. Recent developments in the economics of information, applied so far at
the level of firm behavior [49], may provide an interesting line of research to merge
with traditional views on development, bringing new and more complete perspectives
to a field in turmoil.
Conclusion
After a long trajectory of state-oriented growth, the auto industries of Mexico and
Taiwan are now going through a period of liberalization. Despite a general trend of
growth in total auto sector sales, the supply base in both countries (our relevant measure
of industry capabilities) is shrinking. Part of this trend is an expected rationalization of
the industry, purging the least efficient units out of the system. In fact, losing auto parts
firms and decreasing local content may not be bad per se, insofar as more efficient firms
replace inefficient ones, and export growth compensates for imports. Moreover, the
parts industry in both regions exports half of its turnover, which shows that many firms
have achieved a good level of competitiveness. Still, this problem seems to be not so
simple for Mexico.
In 1995, adjusting for relative size, Taiwan’s auto parts industry was already 25%
larger than Mexico’s, and the liberalization trend is expected to have a stronger negative
impact in Mexico. Important problems may arise if outgoing firms are replaced by
imports instead of by local production (i.e., a sort of “maquilization”) becoming a huge
assembly operation with little local content and value added. It may not just harm the
balance of trade, but also curtail the learning capabilities of local firms as well as the
knowledge spillover effects to the rest of the economy. These questions become even
more pressing once we look at quality and technology indicators. Studies have suggested
that average part quality levels in Taiwan may be two to three times higher than in
Mexico. Moreover, Taiwanese first-tier suppliers expend 2.7% of sales in R&D, high
by any standards. In Mexico, although no equivalent figures exist, research and development in core auto technologies is considered rather weak by analysts.
What made this difference between the Mexicans and Taiwanese auto parts industries? How should we interpret it in a theory of late industrialization? We have explored
the role of incentives, infrastructure, and institutions in late industrialization, looking
at the patterns of development of the auto industry in these two regions of the globe.
We can conclude that the relationship between behavior and outcomes in the industry
fits our perceptions and the intuition developed by the endogenous growth theories,
both at the level of incentives and infrastructure.
At the level of incentives, we find that automotive policy in Taiwan provided both
protection (e.g., local content requirements and tariffs) and promotion (e.g., tax subsidies
and technological assistance), while in Mexico the policy has relied mainly on protection.
The key aspect seems to be that government in Taiwan played the role of a “benevolent
social planner,” trying to generate a socially optimal incentive structure. While it closed
the borders to assure a stream of profits to national firms when they were unable to
compete in the world market, it also enacted strong reciprocity principles and performance standards to replace the normal market mechanisms. Through these policies, it
emulated market’s static competitive features, while also providing dynamic incentives
that assured a better investment pattern, particularly in intangible assets.
THREE I’S FOR INDUSTRIAL DEVELOPMENT
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Endogenous growth theories have also shown how a country’s technological infrastructure, in terms of human capital and R&D capabilities (expenditures), may make
a difference in its pattern of industrial development. Still, Mexico has relied more on
classical competitive perceptions. Abundant low wage labor and capital scarcity coupled
with a potential large market (the United States) attracted investment. The problem
has been the inability to generate spillovers from this investment into the larger economy.
In contrast, Taiwan has had an overarching focus on the diffusion and further development of the knowledge base, fostering an endogenization of learning spillovers in
the industry.
The crucial lesson is related to the level of analysis. Although endogenous growth
theory does predict the observed outcomes, given the behaviors described, most empirical research related to growth has avoided entering a micro-level discussion. Moreover,
the literature has focused on the concerns and realities of the developed world, addressing incentives and decisions of innovators based on R&D. It has therefore neglected
the situation of latecomer countries that are pure learners and adopters of technology.
Most of the analysis is done as way of side implication for having international trade, with
poor capacity to either explain or guide policy options in late-industrializing economies.
Given the pertinence of this micro research, we have tried to demonstrate how
developing technological capabilities and gearing up manufacturing industries are affected by institutions. The examples explored in the paper have shown that a cooperative
environment and the presence of support organizations enhance the dissemination of
knowledge, induce long term commitments to relevant technologies and export markets,
and facilitate equalization of bargaining power among economic agents. Therefore,
understanding the relationships between the key stakeholders and how they affect firm
strategies and industrial patterns is critical for a successful analysis. This key institutional
dimension is left out of the major models of economic development, which make the
simplifying assumption that they are in place. Our findings indicate that further advance
in these theories must take into consideration institutional patterns and how they interact
with policy.
We believe that institutions condition the development process in powerful ways,
so that a theory of industrialization will have to account for institutions as well. Advancing growth theory in terms of better formal (mathematically speaking) analysis of late
industrialization requires a deeper micro research and understanding of the patterns
of these pure learners. Recent developments in the economics of information, applied
so far at the level of firm behavior, may provide an interesting line of research to merge
with traditional views on development, bringing new and more complete perspectives
to the field.
We would like to acknowledge the encouragement and support of Alice Amsden.
We would also like to thank all the comments on previous versions of this article, in
particular those contributed by Ian Sue Wing, Brian Zuckerman, Teresa Lynch, and
Pedro Conceição. Francisco Veloso would also like to acknowledge a PRAXIS XXI
fellowship for his research work at MIT, and a grant from ITEC for his travel to Taiwan.
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Accepted 18 June 1999