Upgrading Clusters and Small Enterprises in Developing Countries

Environmental, Labor, Innovation and Social Issues

Jose Antonio Puppim de Oliveira

• Publisher: Routledge
• Year: 2016
• Topic: Physical Sciences
• eBook ISBN:
  9781317004110
• Subtopic: Geography
• Index: Geography

SME's are acknowledged as effective sources of jobs and incomes, gaining an important position in the development agenda, subsequently 'cluster' policies were conceived as a framework to augment the effects of SMEs and to optimize resources used to support them. Based on case studies from Brazil, Vietnam, Indonesia and India, this volume examines SME clusters and argues that unless they counteract common problems such as very low wages, poor working conditions, poor quality products and lack or environmental regulation, they will be pushed out of the market and so become unsustainable. This book suggests that the SME clusters currently being stretched should react by 'socially upgrading' in order to improve their innovation capacity, as well as social, environmental and labour standards. It puts forward conceptual frameworks which explain the way firms can upgrade: through markets, interaction among cluster members, through Corporate Social Responsibility and other such public policy, and through the better enforcement of regulation.

Chapter 1
Introduction: Social Upgrading among Small Firms and Clusters

Jose Antonio Puppim de Oliveira1

1.1 Introduction: The Problems with Traditional Policies of Cluster Upgrading

In the last two decades, the cluster2 concept has become popular both in academia and in practice. The cluster literature has grown significantly, as well as policies and tools that focus on creating and developing clusters.3 As small and medium enterprises (SMEs) gained an important position in the development agenda as effective sources of jobs and income, policies to promote clusters came as a framework for augmenting the positive effects of small firms and optimizing resources to support them. Creating and supporting clusters would help small firms to overcome production and marketing obstacles they generally face, and allow them to compete with large firms and in sophisticated distant markets.

Thus, small firms, specially when agglomerated in clusters, could be important mechanisms for spurring innovation and dynamic economic development. Moreover, one of the main (and lovable) ideas behind those policies is that supporting small firms is also a good social policy, as they are weak but generate jobs and income, mainly for the poor. Many of the cluster policies in developing countries and literature have assumed that supporting any kind of cluster/small firm—formal and informal, legal and illegal—leads to both local economic and social development, which is good for local communities. One typical example of those policies is microcredit for small, informal firms, now popular worlwide.

It is true that some policies lead to economic and social development, generating jobs and bringing people out of poverty and the reliance on social safety nets (where they exist). However, this development may not be sustainable over the long term, as SME policies may generate low-skill/low-paid informal jobs often under poor working conditions in businesses that produce poor quality products, do not pay taxes and do not respect environmental regulations. Benefits of those cluster initiatives can be wiped out suddenly by political turmoil, macroeconomic changes (e.g., changes in the value of the local currency) or international financial crises (Mead and Liedholm, 1998). Moreover, under globalization, competition from elsewhere or a weak position in a value chain can exacerbate the already poor business conditions making SMEs lose the little profit they had or reducing the already low salaries, leading to a “race to the bottom”. They can still survive with subsidies, but as more price-competitive, high-quality imports begin to arrive, those limited economic and social benefits can disappear, sending petty entrepreneurs and their workers back into poverty or to reliance on social safety nets.

The policy studies and the literature on clusters have suggested that in order to avoid the fate described above (“race to the bottom”), clusters and their businesses should upgrade products, processes, functions and markets through continuous innovation (Humphrey and Schmitz, 2000). Upgrading would raise small businesses to another stage of economic dynamism, benefiting them and the broader dependent environment (workers, communities, local governments, etc.). However, there are two fundamental problems with the traditional idea of cluster upgrading which are analyzed in this book.

The first problem is that upgrading traditionally means improvements in the production or economic sphere of the clustered businesses. Upgrading would allow small firms to have better products or processes, reach better markets or reap more gains from their economic activity. However, this kind of upgrading pays little attention to the labor, social and environmental spheres. It assumes that by upgrading firms economically, their workers and the locality where they are based would benefit automatically (trickle-down effects). Economic upgrading would also mean more continuous innovation capacity or jobs for more qualified professionals. Indeed, many small firms in LDCs are able to learn, innovate, and employ qualified professionals, even in cutting-edge sectors (see Okada, 2004 and Okada chapter in this book). But this may not be true in all cases, as economically upgraded firms can also fire workers or squeeze their salaries and pollute more (see the chapter by Almeida in this book). Thus, traditional upgrading overlooks the social and environmental dimensions of the complete process of upgrading. A better upgrade would be what I call the ”Social Upgrading”: an upgrade that would aim at a long-term development strategy based on formalized firms paying taxes; following environmental, labor, health and safety regulations and spurring social local development. There are many points in common between traditional upgrading and social upgrading4, and sometimes they come together, but my point is that they are not the same thing.

The second fundamental problem of upgrading is the full understanding of how firms upgrade. It is not clear in the literature how and why firms would upgrade. The traditional cluster literature relies on the internal dynamics of the clusters for upgrading.5 Through interaction among cluster members (firms, supporting organizations, etc.), firms would learn from each other. This would help them to innovate and develop new products, processes, functions and markets. However, many cases of upgrading include the interference of external actors, like actual or potential clients. Moreover, the literature does not distinguish the process of economic upgrading from social upgrading. It assumes that they are the same process, but they are actually different in many cases, as in the examples of this book (e.g., the important role of law enforcement officials).

Alongside the traditional cluster literature, the chapters in this book empirically examine three other basic frameworks which have been developed recently in the literature to explain ways that firms can socially upgrade: upgrading through markets, through ethical concerns (Corporate Social Responsibility—CSR) and through regulation. Although certain limitations remain, those frameworks can bring new insights to understand social upgrading.

First, upgrading through markets: some authors suggest that linking with global chains and markets—both generally more demanding in terms of quality— would bring the motivations and resources (technical and financial) to make firms choose to upgrade (Humphrey and Schmitz, 2002). There are also many cases of social upgrading through global chains, especially exporting markets in developed countries, which demand certain social and environmental standards. Many times those standards are regulations (like the directives of the European Union). However, the reality for most of the small firm clusters in developing countries gives little prospect for socially upgrading through global chains, as most of the firms are not linked to more demanding international or even national markets.

Second is upgrading through ethical and social principles. This is the basis of the framework of Corporate Social Responsibility (CSR). CSR involves the voluntary ethical actions to improve labor, environmental and social standards of firm stakeholders (internal and external). Small firms have implemented some CSR activities traditionally or through new approaches designed specifically for small enterprises (Vives, 2006). Nevertheless, even though CSR has the potential to improve social and environmental standards, especially for large firms and their chains, CSR has limited effects because it is still new and voluntary.

Third is upgrading through regulation. Social upgrading could be achieved by simply complying with the economic, labor or environmental laws, which are strict in many developing countries. However, regulatory compliance and enforcement are major problems in developing countries. There are political obstacles to making local governments support upgrading, and this may require further changes and even sacrifices on the part of the businesses. Many local firms prefer to make deals with local governments to extend subsidies and a lack of law enforcement, alleging they cannot compete and may close down if certain laws are applied. As cluster and SME policies in developing countries are a mix of social and economic development policy, many local politicians tend to accept this as a kind of social policy and a political token to keep the support of important constituencies, what is called the “devil’s deal”.6

The book explores the idea of social upgrading and the conditions under which it tends to take place. This chapter further discusses the idea of social upgrading and the ways to achieve it as well as how the other chapters contribute to that discussion. First, I will introduce the main debates on clusters. Second, I will explain the concept of social upgrading. Third, I will analyze the three main frameworks for social upgrading mentioned above. Finally, I will present a framework to advance the agenda of cluster social upgrading and the advantages of working with clusters for social upgrading in SMEs.

1.2 Debates on Clusters, Value Chains and the Social and Environmental Issues in SMEs

Even though there is no consensual definition of what a cluster is exactly (Martin and Sunley, 2003; Asheim et al., 2006), its principal idea is the agglomeration of firms in one sector of economic activity in a certain geographical space (Amorim, 1998; Cassiolato, et al., 2000; Schmitz, 1995). Besides the firms, clusters are also composed of other economic, social and political actors called supporting organizations, such as trade unions, distributors, export agents, governments and universities. Studies on clusters are currently in vogue and they are the object of study in several fields, such as development studies, business economics, regional sciences, political economy and geography (Porter, 1998; Markusen, 1996b; Piore and Sabel, 1984, Martin and Sunley, 2003).

The concept of the cluster was particularly important to giving conceptual support to SME policies. In clusters, SMEs are able to overcome some of the obstacles they usually face when operating in isolation such as a lack of specialized skills; difficulty in accessing new technologies, inputs and services; problems in reaching markets and distribution channels; information, credit.

In order to overcome those obstacles, practical experience has shown that clustering can lead to several effects over time: division and specialization of labor; the emergence of a wide network of suppliers; the appearance of agents who sell to distant national and international markets; the emergence of specialized producer services; the development of a pool of specialized and skilled workers; and the formation of business associations. Moreover, because of the concentration of firms in one sector, many clusters also include specialized universities, as well as consulting, researching and training organizations, which can interact with the firms and create an atmosphere of intense knowledge production.

In general, the actors in a cluster have a certain degree of interaction among them exchanging information, goods and services. The dynamics of these interactions can bring greater advantages for firms that become part of a cluster rather than remain isolated. Many of the economic and organizational effects of clusters are result of the proximity and interaction among the economic actors and supporting organizations. These effects could be divided into two kinds. First, there are the external economies documented by Alfred Marshall in the nineteenth century (Marshall, 1890). They are the positive or negative unpaid, out-of-market-rules side effects (externalities) of the activity of one economic agent on other agents. There is also a second effect, the collective efficiency, which is the advantage to be gained by local external economies and joint action (Schmitz, 1995). This is a deliberate conscious act resulting from the collective action of different actors in the cluster. Those effects are important to explain cluster upgrading as collective action are necessary to help firms to overcome certain obstacles to upgrade.

Even though Marshall (1890) and others mentioned the advantages of spatial concentration of economic activities a long time ago, much of the modern work to explain the concept of clusters of small firms was developed in the Third Italy in the 1980s (Piore and Sabel, 1984). The region had a concentration of small and medium firms specialized in one specific sector that could compete in the global market with the gigantic “fordist” multinationals. The explanation for the competitiveness of those firms was the intense interaction that existed among them, as well as their flexibility in production (flexible specialization). The results of those studies gave major conceptual support to justify the significance of small and medium enterprises not only for social purposes (job generation, income distribution, etc.) but also as viable economic agents to compete in the global economy. Later on, the concept of clusters was expanded to include clusters among large and multinational firms, which maintained an innovative environment due to the cooperation as well as the intense competition among them (Porter, 1998).

Clusters have also been the subject of public policies in support of their development. Since the 1990s, government policies for creating and expanding clusters have been widespread, as one Brazilian public official said: “every region wants to create its own Silicon Valley”. Many governments perceive the support for clusters as a way to generate dynamism in the economy and create foci of regional economic development. Thus, clusters have become both the unit of analysis and a framework for public action in economic development and industrial policies, especially in developing countries (Altemburg and Meyer-Stamer, 1999; Schmitz, 1995; Schmitz and Nadvi, 1999; Rabelotti and Schmitz, 1999; Meyer-Stamer, 1998). For example, the Brazilian Agency for the Support of Micro and Small Enterprises (SEBRAE) started to prioritize policies for supporting clusters instead of individual firms, which was the focus of SEBRAE’s actions until the beginning of the 2000s.

The way governments promote clusters as a tool for industrial and regional development has been a source of debate in the literature. On the one hand, governments can be heavily interventionist to promote the development of clusters, such as providing incentives and market protection, together with infrastructure (Markusen, 1996a, 1996b). On the other hand, some authors argue that certain interventions can promote inefficiencies and hurt competitiveness in the long term (Porter, 1996). For them, governments should only provide infrastructure and support for education. The harsh competition among the firms in the same cluster (located next to each other) would be an incentive to innovate in order to make the clusters more economically efficient and competitive.

In the last years, the importance of the cluster concept has moved from the advantages of physical proximity, which generates collective benefits of the economies of scale and collective efficiency, to a more virtual proximity and interaction to generate knowledge and exchange of information (Nooteboom, 2006). Since the works of Marshall, economies of scale had been the main advantage for a firm being in a cluster. More recently, however, one of the main advantages has become the networking opportunities and knowledge generated among the different actors in a cluster. A firm in a cluster can take advantage of the immense opportunities for information exchange and knowledge generation through interaction with the different actors in the cluster. Over the years, the cluster concept has evolved beyond the physical geography of the economic agents and become more related to the social and economic interaction among the agents independently of their locations. There is no need for physical proximity among all actors in a cluster in a world with the Internet, cheap communications, easy capital flow, more efficient logistics and cheaper transport. Nowadays, suppliers, commercial agents, and supporting organizations can be far away from the firms without undermining the advantage of being close to each other.

The governance of clusters has been the subject of analyses in recent debates (Schmitz, 2004; Visser and Langen, 2006). Some of the inquiries examine what institutional and organizational mechanisms govern clusters and what are the roles of firms and supporting organizations, as well as external actors, in the governance of clusters. The concept of network (Powell, 1990) has been utilized as a framework of analysis to understand cluster governance (Atzema and Visser, 2007). Mechanisms of governance have been fundamental to spur innovation and upgrading in clusters (Schmitz, 2004; Nooteboom, 2006; see also the chapter by Ipiranga, Faria and Amorim in this book).

The literature on clusters had been characterized in the past as having a focus on the internal dynamics of the clusters to explain economic dynamics (Humphrey and Schmitz, 2002; Schmitz and Musyck, 1994; Rabellotti and Schmitz, 1999). Competitiveness, innovation and upgrading in a cluster were to be determined by the intensity of the relations among the different actors and their collective efficiency (Posthuma, 2004; Pyke et al., 1990). Also, there had been an emphasis on the need for intense cooperation among the different agents to lead to economic efficiency (Cassiolato and Szapiro, 2003). The cluster literature has given scarce attention to market relations (demand), and how markets influence changes in clusters (Tendler and Amorim, 1996), even though clusters are becoming more globalized as their economic relations expand to places far awa...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Table of Contents
• List of Figures
• List of Tables
• Preface and Acknowledgements
• 1 Introduction: Social Upgrading among Small Firms and Clusters
• 2 Seeking the High Road to Jepara: Challenges for Economic and Social Upgrading in Indonesian Wood Furniture Clusters
• 3 Environmental Upgrading of Industrial Clusters: Understanding their Connections with Global Chains in the Brazilian Furniture Sector
• 4 Social Upgrading in Agriculture-based Clusters: Common Lessons from Cases in Asia and Latin America
• 5 Small Firms in the Indian Software Clusters: Building Global Competitiveness
• 6 Understanding Incentives for Clustered Firms to Control Pollution: The Case of the Jeans Laundries in Toritama, Pernambuco, Brazil
• 7 Social Technology for Mobilization of Local Productive Arrangements: A Proposal for Applicability
• 8 Conclusions: Lessons from the Cases
• Index