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 trough 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.
Francisco Veloso is a Ph.D. Candidate in the Technology, Management and Policy Program at the Massachusetts
Institute of Technology, Cambridge, MA, USA. His research interests are Economics of Manufacturing and
Industrial Development. During the past years he has been studying the patterns of development of the autoparts
industry around the world, with a particular focus in late industrializing nations. He holds an M.Sc. in Management
of Technology and a B.Sc. in Physics Engineering.
Jorge Mario Soto is a Master in City Planning and Ph.D. Candidate in Urban Studies and Planning at the
Massachusetts Institute of Technology, Cambridge, MA, USA. His research focuses on industrial policy and poverty
alleviation in developing countries, and his doctoral dissertation studies the role of development banking in
Mexico’s industrial growth.
Correspondence should be addressed to F. Veloso, Massachusetts Institute of Technology, 77 Massachusetts Av.,
Room E40-242A, Cambridge, MA 02139, USA.
Running Title is: Three Iis for Industrial Development
FORTHCOMING IN TECHNOLOGICAL FORECASTING AND SOCIAL CHANGE
INTRODUCTION
The development of England during the first industrial revolution and of Germany and the US 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 across the world entered a 'catch-up' process, as they strove to reduce
their differences in level of income per capita with most of the North Atlantic nations [4, 5]. Firms and Governments
in these late developing 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 the developmental outcomes across 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, i.e. to achieve
more output with the same level of inputs, through some form of technical change; or increases in the level of
inputs, i.e. accumulate more capital. Nevertheless, there is still 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 vs.
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.
The current paper 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 in the efficiency of the use of capital— that the
model considers exogenously determined (i.e. independent of economic conditions).
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Neoclassical policy prescriptions are as simple as the theory is elegant. To increase competitiveness, national
industries should be exposed to competition in world markets, that 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—i.e., 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 —therefore unexplained— component [14].
Figure 1: Perspectives on Economic Development
Endogenous growth theory explores some of the key limitations of 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, that displace consumption from
older vintages [16, 17]. Moreover, cumulative usage of a technology by their 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; i.e. the fact that
one agent uses it, does not decrease the capacity for others to use it. Second, it is partially non-excludable, i.e. its
generators often have difficulties to prevent 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, that 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 to 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 continuos
innovation and enhance long term growth. The critical intuition associated to this model, that parallels the one
described above, is the existence of externalities associated to the accumulation of human capital that compensate
for the diminishing returns of physical capital. As before, long terms 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 international relative 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 less
technologically less dynamic— activities. In fact, the logic of comparative advantage applied to the new technology
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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. On 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 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 to function, 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 paper 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 that now present different
structures in the industry. We think that an understanding 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, the structure of competition, as well as
government policies. Infrastructure is related with the potential to generate desired capabilities, and arises from
physical assets, human capital and general technical structure [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 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 spill-over 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.
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As a result, in latecomer countries private investment levels in activities with learning or spill-over 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 investment—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 spill-over 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].
Figure 2: A Framework for Policy Analysis
In the neoclassical view, infrastructure is related with 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 new
factors are difficult to measure or account for [28]. Nevertheless, considering a distinction between labor and capital
on one hand, and technostructure on the other, 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 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 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. After 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, by
triggering the domestic production and technological advance of industries such as steel, machine tools, electrical
and rubber, among others. Likewise, the spill-over and dynamic learning effects in the auto industry facilitates the
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move up in the quality ladder over the 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 US, 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, autoparts
firms are considered the key vehicle for knowledge dissemination and industrial up-grade, and local content
incorporation is usually a good measure of the country industry capabilities.
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 thousand direct jobs, employing
about 15% of the labor force in manufacturing. It is the leading importing and the second 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 anywhere between
600 and 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 US, European and
Japanese manufacturers [35]. The vertical structure of the industry, and the strong ties to the US 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
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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
spill-over effects to the rest of the economy.
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, twenty years after the first decree, vehicle production had gone from
60 to 600 thousand units per year [33].
In the early 1980’s, the drop in oil prices and the debt crisis hit strongly the Mexican economy, 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 thousand 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 1990’s. From 1989 to 1994, the industry invested about
5.9 billion dollars, 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 1st, 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 thousand vehicles in 1994 to 783 thousand 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.
The downturn in auto sales ended in 1996, with a record production of 1.2 million units and exports of 970
thousand. For the coming years, with resumed economic growth and favorable export markets, assemblers seem to
keep a high profile investment outlook. New players are coming into the market and established ones are
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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 coincide 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 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 more than double exports, and there are no
signs that the trade deficit in going to recede in the future.2 To 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.
Figure 3: Policy Stages of the Auto Industry in Mexico and Taiwan
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. In addition, 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 is 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
have now 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 business, often working dedicated to one or two first tier
clients [37, 38].
Due to the strict restrictions 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 1980's, when their positioning in the national market was
solid enough but the opportunities for growth were scarce, the stronger firms expanded into foreign markets, either
through exports, or by setting their own plants abroad, particularly in main land China. Today, more that half of the
auto parts production in Taiwan are exported, mostly to the US 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 in 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].
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During the first half of the decade of the seventies, the government experimented with a number of contradictory
measures in the industry, liberalizing imports one year, only to bring tariffs protecting local firms up 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 US 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 enacts
a new decree, where a clear export promotion strategy framework emerges. In this new policy, the development of
the parts industry appears 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 is explicitly considered, although no specific regulations
were included [33, 39].
With the 1985 "Automobile Industry Development Act" the industry enters 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 autoparts 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. 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 value-added 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 that was 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 licenses agreements with multinational OEMs. They are aware that a liberalization of the
market for imports will reduce the share of 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 a 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 to all 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
by Taiwanese firms as a prime business opportunity, 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 been largely 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 MLC, recreating the same supply relationships existing in the island.
-8-
With these strategies, Taiwan aims at having two or three conglomerates with international positioning in the
industry, fifty companies with capability to produce advanced parts, 7% of all industrial production in Taiwan and 4
billion dollars 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 use
to assess industry competitiveness: exports, a reflection of existing capabilities; and R&D expenditures, a degree
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 autoparts 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
requirements, local content may go down to 30% in Taiwan [37] and to 20-30% in Mexico [41].
Loosing 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 by imports instead of local production, or if assemblers and
the surviving parts firms find it increasingly more efficient importing parts and sub-components than producing
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 just harm the balance of trade, but also curtail the learning
capabilities of local firms as well as the knowledge spill-over effects to the rest of the economy. In a world
increasingly dependent on technological development and knowledge-based competitive assets, this may an
important handicap for the Mexican auto industry and its related activities.
Figure 4: Auto Industry Supply Structures
On the other hand, Taiwan does not seems 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 her firms to other sectors and 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 about government intervention and trade policy, among other things discussing how
the distortion of real prices affects the incentives firms face [26]. Even when intervention is justified by the
existence of learning or spill-over 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 do not continue this discussion here. We 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
-9-
content requirements, import tariffs and quotas, restrictions to foreign ownership, tax subsidies, financing, 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 1980’s, 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 both Mexico and Taiwan, the oldest
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 in the nineties, both industries exported parts, and Mexico was becoming a major assembler of cars for the
US market. At this stage, important differences in the firm’s incentive structure of both countries started to come out
more clearly. The liberalization drive—i.e., the reduction or lifting of tariffs, local content requirements, limits to
vertical integration and restrictions to 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 one 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—i.e., among the
small and medium parts producers. Most of the sector’s development since the second half of the eighties is due to
car exports for the US 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, assemblers 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 shutdown operations, moved to the part 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). Mexico
presents an umbrella structure where downstream are weak. Assemblers import a substantial amount of parts,
particularly for their export lines. Not surprisingly, NS also import 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 based is further eroded.
In contrast, Taiwan’s liberalization is only expected to go forward when the country joins the WTO in 1999 or later.
Then LCR will be gradually 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 very 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. An important share has no size that enables them to attain minimum efficient production scales and some
lack capabilities in terms of quality and responsiveness.
Despite the protective measures, the auto parts industry exports US$ 2.4 billion, half of its turnover, an exposure
similar to Mexico, which has the additional advantage of being close to the US market3. Moreover, as pointed
before, the shrinkage in the supply structure that is predicted to happen 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
- 10 -
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 and little on promotion.
The Taiwanese government allocated support according to the principle of reciprocity, whereby assistance is only
given in exchange for performance standards. One of these standards took the form of exports requirements, so that
a firm would have to export so much over a certain time period in exchange for, say, tax breaks. More important,
sometimes standards also took the form of requiring firms to invest in intangible investment, namely worker training
or R&D. Moreover, these incentives were gradually increased over time. Since the end of the eighties, 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 a '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
go through a period of learning. It was able to do it because its discount rate and its social investment portfolio
enables 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 intangible assets. Throughout
the whole process it is considering the spill-overs arising from developing an industry with high learning potential
and important linkages and externalities.
Figure 5: Drivers for Development of the Industry in Mexico and Taiwan
Infrastructure
Despite sharing similar objectives, the policy schemes that Mexico and Taiwan enacted in the 1960’s differed much
at the level of the technostructure. 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
foreign direct investment. These local firms played the initial crucial role in 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—e.g. Sanyang Industries in Taiwan, that produces Honda cars,
would arrange for their local suppliers to visit the counterpart Honda suppliers in Japan.
The difference came on 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 been the differences in the technical ability of the labor population.
While Mexico was still fighting literacy in the seventies and eighties, Taiwan was already developing a sound
technological infrastructure. Research and development indicators are usually 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 happens at the level of human resources, where
Taiwan has 2.1 researchers per thousand people against 0.6 in Mexico [46, 47]. While the previous argument is
related with the overall population, the situation becomes more acute once we compare the set of technical
organizations supporting the industry in both regions.
- 11 -
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
much needed support to the smaller firms. Even among firms who do use the national institutions, they do it mostly
for inspection and testing purposes. Of 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].
By contrast, as described before, an important set of technical oriented organization in Taiwan has made an
important contribution to the development of the industry: CSD—Corporate Synergy Development Centre played a
major role in disseminating auto components manufacturing best practices; ITRI, the Industrial technology Research
Institute, has 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, they
provide the industry, in particular small firms, with an important knowledge base, that 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 US) should, and it has, attract investment. The
problem has been the ability to generate spillovers from this investment into the larger economy, a crucial aspect
pointed 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 framework established between the different players in Mexico and Taiwan. In fact, we would argue
that institutions were a major influence in the way government influenced both the incentive structure and the
technostructure, as well as in the way firms perceived them.
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, autoparts small and
medium companies 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, an 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 auto parts industry firms [36]. At one end are the large first-tier suppliers, both national and
international, that have a more systematic relation with a core assembly firm, 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, those that produce goods for the public, so that they do not need to be certified
by assemblers. In between we find no milieu of 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 to change aspects in the incentive
structure that provides the rules of the whole 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 would these policies be
- 12 -
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 Board (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 in a
regional one-stop shop for parts sourcing by large international corporations is highly based on CETRA's expertise
and capabilities. ITRI and CSD, as explained before have also played an important role.
The other important fact is that private companies have been very cooperative. Assemblers have extensively helped
suppliers to develop their capabilities, facilitating contacts, particular international, and establishing upgrading
programs. Assemblers and suppliers share the same industry association that is used as a focal point to discuss
policies with the government. Bargaining with the government has been done through this organization, that gains
therefore an important clout. Moreover, as some of the assemblers started to move abroad, they have invited their
suppliers to come together with them. Some suppliers have accepted the challenge, and we witness now replication
of the Taiwanese supply chains in Main Land 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 a milieu 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 out of the major models of economic development, that
make the simplifying assumption that they are in place. Our findings seem to indicate that further development in
these theories must take in consideration institutional patterns, and how they interact with policy. Recent
developments at the level of the economics of information, so far applied at the level of firm behavior [49], may
provide an interesting line of research to merge with traditional perspective on development, bringing new and more
complete perspectives to a field in a large 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, loosing 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. Besides, 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 seem not to be 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 substituted by imports instead of 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 spill-over 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 by analysts rather weak.
What made this difference between the Mexican 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 pattern of development of the auto industry in these two regions of the globe. We
can conclude that relation 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.
- 13 -
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 and little on promotion. The key aspect seems to be the fact 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 while 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.
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 US) attracted investment. The problem has been some inability to generate
spillovers from this investment into the larger economy. By 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 dimension. Moreover, the literature has focused on the concerns and realities of the developed world,
addressing incentives and decisions of innovators based on R&D. Therefore, it has 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 is affected by institutions. The examples explored in the paper have shown
that a cooperative environment and a milieu 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, that make the simplifying assumption that they are in
place. Our findings indicate that further advance in these theories must take in 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 the patterns of these
pure learners. Recent developments at the level of the economics of information, so far applied at the level of firm
behavior, may provide an interesting line of research to merge with traditional perspective on development, bringing
new and more complete perspectives to the field.
ACKNOWLEDGMENTS
We are greatly indebted to Alice Amsden for all her support, encouragement and insightful remarks. We would also
like to thank Pedro Conceição, Teresa Lynch, Sebastian Fixson, Ian Sue Wing, Brian Zuckerman and an anonymous
referee for extensive and constructive comments. Francisco Veloso acknowledges a PRAXIS XXI fellowship for his
research work in MIT and a grant from ITEC for his travel to Taiwan.
- 14 -
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Automobile Industry by Economic Liberalization, Joint Research Program Series No. 120, Institute of
Developing Economies, Tokyo, 1997.
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Characteristics, Taipe, 1996.
- 16 -
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- 17 -
Figure 1: Perspectives on Economic Development
Exogenous
Factors
Technology
Natural
Resources
Labor
Endogenous
Factors
Technology
Physical
Capital
Human
Capital
Figure 2: A Framework for Policy Analysis
Neoclassical
Endogenous
Determinants ➣ Returns to Capital
Incentives
➣ Returns to Capital
➣ Returns to R&D
➣ Returns to Innovation
➣ Competition
➣ Government Policy
➣ Competition
➣ Government Policy
Infrastructure ➣ Stock of Physical Capital
➣ Natural Resources
➣ Labor
➣
➣
➣
➣
➣
Institutions
➣ Assumed
➣ Assumed
- 18 -
Stock of Physical Capital
Natural Resources
Labor
Stock of Human Capital
Technostructure
Figure 4: Auto Industry Supply Structures
Tier 2
Suppliers
uct
ion
Taiwan
110-150
Companies
300
Companies
se
Pro
d
Imported
parts,
CKDs
hou
Tier 1
Mexico
55% VALUE*
In
In
hou
se
Pro
d
uct
ion
Vehicle
Assembly
Tools,
Dies
*Excludes
maquiladoras
Tier 2
Suppliers
Vehicle
Assembly
Tier 1
300
Companies
Imported
parts,
CKDs
45% VALUE
1500 Companies
Tools,
Dies
Tier 3,4 Raw Materials and Support Industries
Tier 3,4 Raw Materials and Support Industries
Figure 5: Drivers for Development of the Industry in Mexico and Taiwan
Mexico
Incentives
Taiwan
➣ Local Content Requirements
➣ Tariffs and Quotas
➣ Subsidies for Development
➣ Local Content Requirements
➣ Tariffs and Quotas
➣ Subsidies for Development
➣ Protective Environment Abruptly
➣ Reciprocity Principle: Protection
Changed with no Support for Local
Firms
➣ Adequate Capital-Labor Structure
➣ Initial Technological Structure
Infrastructure
based on Foreign OEMs where
Suppliers Source Knowledge
➣ Shortage of Human Capital
➣ No Technostructure Support
for Increasing Requirement of
Exports, Training and R&D
➣ Adequate Capital-Labor Structure
➣ Initial Technological Structure
Transferred from Foreign OEMs
to Local Owned Firms
➣ Adequate Human Capital
➣ Strong Technostructure Support
➣ Investment in National Technology
Driven R&D projects
➣ Adversarial Relation between
Institutions
OEMs and Suppliers
➣ Cooperative Relation between
OEMs and Suppliers
(Joint Investment in Main Land)
➣ No interaction between the
government and the SMEs
- 19 -
➣ Strong interaction between OEMs,
Suppliers and the Government
Through the National Association
Figure 3 : Policy Stages of the Auto Industry in Mexico and Taiwan
Year
1962
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
Taiw an
Periods
A ctive Protection
Inconsistent A ctions
LCR
20%
Policy
Initiatives
Start of D om estic A uto Progr
Installation of Tariff Protection
Ban autom obiles im ports
Establishm ent of LC Program
20%
20%
20%
60%
60%
Strategic Prom otion
60%
60%
Industry Prom otion A ct
M ore Tariffs
Selective Lift of im ports Ban
70%
70%
70%
Institut. Prom otion
70%
N ew Industry Prom otion A ct
Parts D evelopm ent
R& D Prom otion
Big Com pany establishm ent
70%
50%
Liberalization
30%
Industry D evelopm ent A ct
D rop Protection
Export Prom otion
30%
30%
30%
O bjective 2000 Policy A ct
Taiw an M N C Source base
D evelop Key Com ponents
M exico
Periods
InitialD evelopm ent
Policy
Initiatives
Im port Ban on Engines and som e Parts
Ban on parts Production by A ssem blers
Establish LocalContent Requirem ents
LCR
60%
60%
60%
60%
Export Prom otion
O ffset im ports by exports
Q uota for exceeding LCR
60%
60%
60%
60%
Trade D ef. Reduction
D ebt Fight
A sblers have to establish
foreign currency rule
Restricted M odels
A sbl. trade surplus rules
Low LCR for Exports
60%
60%
60%
80% for parts
60%
60%
60%
Low LCR for Exports
-1-
Liberalization
N A FTA
Im ports below 15% of sales
Export/Im port ratio rules
Rem ove ban parts im port
D osm estic added value:36%
1
This sections extensively relies on [33]
Authors’ estimations based on data from [34, 36]
3
Main Land China can’t play the role of the US for Taiwan because political constraints do not allow direct trade with MLC
2
-1-