Institutions, Innovation and Regional Economic Change 3515111204, 9783515111201

Citation preview

Malte Lech

Institutions, Innovation and Regional Economic Change

Geographie

Megacities and Global Change Megastädte und globaler Wandel

Franz Steiner Verlag

Band 18

Malte Lech Institutions, Innovation and Regional Economic Change

megacities and global change megastädte und globaler wandel herausgegeben von Frauke Kraas, Martin Coy, Peter Herrle und Volker Kreibich Band 18

Malte Lech

Institutions, Innovation and Regional Economic Change

Franz Steiner Verlag

Gedruckt mit freundlicher Unterstützung der Deutschen Forschungsgemeinschaft

Umschlagabbildung: Zhujiang New Town, Guangzhou © Malte Lech

Bibliografische Information der Deutschen Nationalbibliothek: Die Deutsche Nationalbibliothek verzeichnet diese Publikation in der Deutschen Nationalbibliografie; detaillierte bibliografische Daten sind im Internet über abrufbar. Dieses Werk einschließlich aller seiner Teile ist urheberrechtlich geschützt. Jede Verwertung außerhalb der engen Grenzen des Urheberrechtsgesetzes ist unzulässig und strafbar. © Franz Steiner Verlag, Stuttgart 2015 Druck: Hubert & Co, Göttingen Gedruckt auf säurefreiem, alterungsbeständigem Papier. Printed in Germany. ISBN 978-3-515-11120-1 (Print) ISBN 978-3-515-11121-8 (E-Book)

CONTENTS 1. INTRODUCTION ............................................................................................. 13 1.1 Institutions in a regional economic growth model ...................................... 14 1.2 A Chinese success story: the Greater Pearl River Delta ............................. 16 1.3 Toward a new economic growth model? .................................................... 19 1.4 Aim and scope ............................................................................................. 20 1.5 Acknowledgements ..................................................................................... 23 2. THEORETICAL AND CONCEPTUAL BACKGROUND.............................. 25 2.1 Institutional change and the regional economy ........................................... 25 2.1.1 Institutions in an interdisciplinary perspective ................................. 25 2.1.2 The process of institutional change................................................... 27 2.1.3 The role of informality in the process of institutional change .......... 31 2.1.4 The role of institutions during China’s economic reform ................. 32 2.1.5 Spatial perspective to institutional analysis and change ................... 36 2.1.6 Institutions and regional economic resilience ................................... 36 2.1.7 Interim conclusion............................................................................. 38 2.2 Innovation and industrial upgrading in China............................................. 38 2.2.1 Information, learning, and innovation in an organizational perspective....................................................................................... 39 2.2.2 Internal sources of knowledge .......................................................... 42 2.2.3 External sources of knowledge: The role of Global Value Chains and Foreign Direct Investment ........................................................ 43 2.2.4 The latecomer firm: Resource constraints and innovation strategies .......................................................................................... 49 2.2.5 Systems of innovation in China and the Pearl River Delta ............... 52 2.2.6 Interim conclusion............................................................................. 55 2.3 Developing an analytical framework .......................................................... 56 2.3.1 Case study selection: The electronic industry ................................... 57 2.3.2 Analytical structure ........................................................................... 59 2.3.3 The regulative dimension .................................................................. 60 2.3.4 The cultural-cognitive dimension ..................................................... 60 2.3.5 The institutional perspective on regional economic upgrading ........ 62 3. METHODOLOGY ............................................................................................ 63 3.1 Empirical research data ............................................................................... 63 3.1.1 Quantitative survey data (2011) ........................................................ 63 3.1.2 Quantitative survey data (2009) ........................................................ 66 3.1.3 Qualitative interviews ....................................................................... 67 3.1.4 Secondary statistics ........................................................................... 68 3.2 Measurement concepts ................................................................................ 68 3.2.1 Measuring institutions ....................................................................... 68

6

Contents

3.2.2 Measuring innovation ....................................................................... 75 3.3 Critical method evaluation and limitations ................................................. 76 4. INSTITUTIONAL CHANGE AND STRATEGIC ADAPTATION. A FIRM-LEVEL PERSPECTIVE ON THE POST-CRISIS ECONOMY OF THE CHINESE PRD ......................................................................................... 79 4.1 Introduction ................................................................................................. 79 4.2 Theoretical and conceptual background...................................................... 81 4.2.1 Institutional change and organizational adaptation ........................... 81 4.2.2 Strategic responses to changing institutional environment in the PRD ................................................................................................. 84 4.3 Data and methods ........................................................................................ 86 4.4 Empirical analysis of firm adaptation processes ......................................... 87 4.4.1 Changing environmental conditions in the PRD............................... 87 4.4.2 Firms’ strategic adaptation to changing environmental conditions ........................................................................................ 91 4.4.3 Compliance with institutional pressure – on-site adaptation ............ 92 4.4.4 Balancing diverging interests ............................................................ 93 4.4.5 Bargaining favorable environmental conditions ............................... 97 4.5 Conclusion and discussion ........................................................................ 100 5. THE IMPACT OF FINANCING CHANNELS ON FIRM INNOVATION – IS THERE AN ‘INFORMALITY TRAP?’ ..................................................... 103 5.1 Introduction ............................................................................................... 103 5.2 Theoretical and conceptual background.................................................... 105 5.2.1 Sources of formal financial capital ................................................. 105 5.2.2 Sources of informal financial capital .............................................. 107 5.2.3 Institutional change and firm performance ..................................... 109 5.2.4 Financial sources and firms’ innovation activities .......................... 110 5.3 Data and methods ...................................................................................... 112 5.4 Finance and innovation in the electronics industry of the PRD ................ 115 5.4.1 Utilization of financial capital......................................................... 115 5.4.2 Financing sources and firm innovation ........................................... 119 5.4.3 Informal financing in electronics manufacturing firms – are firms stuck in an ‘informality trap’? ............................................. 122 5.5 Conclusion ................................................................................................ 123 6. INTER-FIRM LEARNING IN THE ELECTRONICS SUPPLY CHAIN – PROSPECT FOR ENHANCING LOCAL FIRMS’ INNOVATION PERFORMANCE? .......................................................................................... 126 6.1 Introduction ............................................................................................... 126 6.2 The process of innovation from a supply-chain perspective..................... 129 6.2.1 Modes of learning and knowledge transfer ..................................... 129

Contents

7

6.2.2 Institutional and moderating factors in the innovation process ...... 130 6.3 Data and methods ...................................................................................... 133 6.4 Econometric analysis ................................................................................ 136 6.4.1 Measuring knowledge exchange and innovation ............................ 136 6.4.2 Independent variables ..................................................................... 138 6.4.3 Descriptive results ........................................................................... 140 Characteristics of key-supplier relations (upstream-side) ........................ 140 6.4.4 Econometric models ........................................................................ 141 6.5 Discussion ................................................................................................ 144 6.5.1 Information exchange.................................................................... 145 6.5.2 Innovation performance .................................................................. 146 6.5.3 Hypotheses and limitations ............................................................. 147 6.6 Conclusion ................................................................................................ 148 7. POLICIES OF RESTRUCTURING ECONOMIC GROWTH – TOWARDS A NEW GROWTH MODEL IN CHINA AND ITS PROVINCES? .............. 150 7.1 Introduction ............................................................................................... 150 7.2 An institutional perspective on the Chinese political system ................... 152 7.2.1 The Chinese development planning system in transition................ 152 7.2.2 Central-local relations and development planning.......................... 152 7.2.3 Personalized policy-making ............................................................ 154 7.2.4 Party bureaucracy, policy reform, and institutional change............ 155 7.3 Data and methods ...................................................................................... 157 7.4 The Chinese national growth model ......................................................... 158 7.4.1 Changes in the national economic policy orientation ..................... 159 7.4.2 Governmental redistribution: Revenue and expenditure perspective..................................................................................... 162 7.4.3 Regional economic development trends ......................................... 165 7.5 Political leadership and industrial development in Guangdong Province ............................................................................................... 168 7.5.1 Provincial economic policy orientation .......................................... 168 7.5.2 Provincial economic development trends ....................................... 171 7.5.3 Shift-share analysis ......................................................................... 172 7.6 Interim conclusion..................................................................................... 174 7.7 The future of economic growth in China .................................................. 176 7.7.1 Quo vadis China? ............................................................................ 176 7.7.2 Quo vadis Guangdong? ................................................................... 178 7.8 Conclusion ................................................................................................ 179 8. CONCLUSION ................................................................................................ 180 8.1 Answering the empirical research questions ............................................. 180 8.2 The role of institutional factors for a new regional economic growth model....................................................................................... 183 8.2.1 The firm dimension ......................................................................... 184

8

Contents

8.2.2 The policy dimension ...................................................................... 185 8.2.3 Regional (institutional) differences and future economic growth .. 186 8.3 Future research agenda.............................................................................. 187 LIST OF REFERENCES ..................................................................................... 189 APPENDIX A: METHODOLOGY..................................................................... 209 A1: Shift-share analysis .................................................................................. 209 A2: English translation of the questionnaire, 2011 ......................................... 210 A3: List of qualitative interviews, 2011.......................................................... 215 A4: Partial correlation-matrix of independent variables (chapter 5) .............. 216 A5: Classification of product technology ....................................................... 217 APPENDIX B: DATA SOURCES ...................................................................... 220 B1: Cartographic sources ................................................................................ 220

Contents

9

LIST OF FIGURES 1.1 1.2 1.3 2.1 2.2 2.3 2.4 2.5 2.6 2.7 3.1 3.2 3.3 3.4 3.5 3.6 3.7 4.1 4.2 4.3 5.1 5.2 5.3 6.1 6.2 7.1 7.2 7.3 7.4 7.5 7.6 7.7 7.8 8.1

The Greater Pearl River Delta mega-urban region in Guangdong ............... 15 Total Value of Imports and Exports in Guangdong Province (1987-2010) . 18 GDP-growth in China and Guangdong province (1998-2012) .................... 20 Levels of institutional analysis ..................................................................... 30 Stylized Responses of a Regional Economy to a Major Shock ................... 37 The process of organizational learning ........................................................ 41 The OEM to OBM cascade. Export-led learning in latecomer firms ........... 50 Paths of Technological Capability Development ......................................... 51 Industrial characteristics of the survey region .............................................. 58 Conceptual framework for the empirical investigation. ............................... 61 Structure of the utilized datasets for the emirical investigation ................... 63 Selected institutional measurement in China and Hong Kong .................... 69 Development of the CP index in China and Hong Kong ............................. 70 Quality of financial institutions in China and Hong Kong ........................... 70 Assessment of institutional quality in the PRD ............................................ 72 Assessment of the importance of management Guanxi and informality...... 73 Assessment of the importance of governmental Guanxi .............................. 74 Strategic responses and firms’adaptation mechanism .................................. 83 Spatial patterns of partial relocation and firm expansion ............................ 95 Analytical framework ................................................................................. 100 Overview of China’s financial system ....................................................... 106 Key interest rate and loan-provision of Chinese financial institutions ...... 108 Analytical framework ................................................................................. 111 Example of production arrangements in the electronics supply-chain....... 127 Potential paths for industrial upgrading ..................................................... 133 The administrative structure of the PRC .................................................... 154 Regional aggregates of China (left) and Guangdong province (right) ....... 158 Non-tax revenue in percent of total revenue .............................................. 162 Governmental expenditure by poliy field as share of total expenditure..... 163 Fixed-asset investment in percent as share of total expenditure ................ 164 Development of gross industrial output in China from 2002 to 2010 ........ 167 Development of gross industrial output in Guangdong Province .............. 170 Shift-Share analysis of gross industrial output in Guangdong ................... 173 Chinese Product Manufacturing Index 2005 to 2014 ................................. 186

10

Contents

LIST OF TABLES 2.1 3.1 3.2 3.3 4.1 4.2 4.3 5.1 5.2 5.3 5.4 5.5 5.6 6.1 6.2 6.3 6.4 6.5 6.6 7.1 7.2 7.3 7.4

Mechanisms of knowledge transfer .............................................................. 45 Response rate according to firm location and contact mode ........................ 65 General characteristics of the surveyed firms .............................................. 65 Comparison between sample and population based on firm size and ownership classification ............................................................................... 66 Strategic responses to institutional processes............................................... 82 Monthly minimum wage in Guangdong province, Yuan RMB ................... 88 Motivation for partial relocation and firm expansion .................................. 96 Central characteristics of company surveys in the PRD ............................ 113 Central characteristics of privately-owned firms by location .................... 114 Utilization of financial sources by ownership in SZ and DG..................... 116 Utilization of financial sources in Chinese domestic firms by location ..... 117 Descriptive statistics of independent variables .......................................... 119 OLS regression – Financing and innovation .............................................. 120 Central characteristics of firms in regional differentiation ........................ 134 Industrial value-added in the survey region (2010).................................... 135 Descriptive statistics of independent variables .......................................... 137 Characteristics of key-supplier and key-customer relations....................... 139 Ordered logistic regression – Exchange of upgrading-related information ................................................................................................. 141 Ordered logistic regression – Improvements to products and processes.... 143 Political leadership and policy orientation in the PRC............................... 159 Compound annual growth rate of GOV by region in the PRC .................. 165 Political leadership and policy orientation in Guangdong Province .......... 168 Compound annual growth rate of GOV by region in Guangdong ............. 172

ABBREVIATION ABC BOC CAGR CCB CCP CCYL CEO CEPA CM CMC CNY CPI DG EMS FDI FIE FS GCR GD GD PBS GDP GOV GPN GVC HK HKMT HRS ICBC ICT IPR ISIC IT IVS JV LED MFA MOFCOM MOHRSS MOLSS MOD NBS NDRC NIE

Agricultural Bank of China Bank of China Compound Annual Growth Rate China Construction Bank Chinese Communist Party China Communist Youth League Chief Executive Officer Mainland and Hong Kong Closer Economic Partnership Arrangment Contract Manufacturing Central Military Commission of the PRC Chinese Yuan Corruption Perception Index Dongguan Electronic Manufacturing Service Foreign Direct Investment Foreign Invested Enterprise Foshan Global Competitiveness Report Guangdong Province Guangdong Provincial Bureau of Statistics Gross Domestic Product Gross Industrial Output Value Global Production Network Global Value Chain Hong Kong Hong Kong/ Macau/ Taiwan Household Responsibility System Industrial and Commercial Bank of China Information and Communication Technology Intellectual Property Rights International Standard Industrial Classification Information Technology Individual Visit Scheme Joint Venture Light-emitting Diode Ministry of Foreign Affairs of the PRC Ministry of Commerce of the PRC Ministry of Human Resources and Social Security of the PRC Ministry of Labor and Social Security of the PRC Ministry of National Defense of the PRC National Bureau of Statistics China National Development and Reform Commission Newly Industrializing Economies

12 NIS NPC NPL OBM ODM OECD OEM OLS PBC PRC PRD R&D RIS SAR SARS SCM SEI SEZ SI SME SMT SOE SZ TAC TFP TI TNC TVE TW

Abbreviation

National Innovation System National People’s Congress Non-performing Loan Original Brand Manufacturer Original Design Manufacturer Organisation for Economic Co-operation and Development Original Equipment Manufacturer Ordinary least squares People’s Bank of China People’s Republic of China Pearl River Delta Research and Development Regional Innovation System Special Administrative Region Severe Acute Respiratory Syndrome Supply-Chain-Management Strategic Emerging Industries Special Economic Zone System of Innovation Small and Medium Enterprises Surface Mounted Technology State-Owned Enterprise Shenzhen Transaction Cost Total Factor Productivity Transparency International Transnational Corporation Township and Village Enterprises Taiwan (Republic of China)

1. INTRODUCTION China’s rise to become a new economic superpower spurred interest in the inner processes and developments taking place within the country. The driving forces behind the regional economic development within China are connected to the process of globalization, accompanied by changing regimes of production and international division of labor. The development of various forms of industrial districts (MARKUSEN 1996) and the massive trend toward urbanization and industrialization are some of the effects of these changes taking place on the local level. Thus, the future of many emerging economies such as China is a (mega-) urban future. It poses a host of challenges related to vulnerability, informality, as well as urban and regional governance (KRAAS & MERTINS 2008: 4ff.). In order to understand the ‘Chinese miracle’, it is crucial to understand the different and sometimes contradictory patterns of regional economic development taking place within the country. The Greater Pearl River Delta (PRD), commonly referred to as Hong Kong’s manufacturing hinterland, can be considered as one prominent example of the abovementioned interaction between economic and urban development, and represents one example of the regional driving forces of China’s economic rise. In order to investigate these regional economic hotspots, it is important to understand their inner functions and logic. While many geographers focus on questions of mega-urban livelihood (KRAAS & STERLY 2009), or risk and resilience (KECK & ETZOLD 2013), several economic and social geographers have shifted the lens to processes associated with the development of firms, production networks, inter-firm governance as well as processes of agility on various scales and to entities (MEYER 2011; FU 2011; HARTMANN 2013; SCHILLER 2013). One feature commonly identified for mega-urban regions is the existence of informal structures and arrangements (KRAAS 2007: 81) which exist encompass both the business and the interpersonal sphere. Despite the visible economic success of many mega-urban regions in China, it is important to remember that the strong embeddedness of these regions into global production and trade regimes exposes these regions to significant risks. For the PRD, the global economic crisis of 2008 demonstrated that the decline in external demand does exert a substantial backlash on the regional economy, thus negatively affecting the local population. The upgrading of industrial and economic structures to a higher degree of economic self-dependency, innovativeness and domestic market orientation can thus reduce the dangers of a predominantly exportdominated development model and enhance regional resilience. Local firms are the main driving force of this change. Besides, technological and industrial upgrading are necessary steps to be taken to ensure persistent economic growth rates which, in turn, allow larger parts of the population of developing economies to

14

1. Introduction

take part in the process of economic progress and the generation of wealth – a key promise for the population in developing economies. The risk of being stuck in the so-called ‘middle income trap’ (OHNO 2009), a developmental stage where the leap towards self-dependent innovation is not achieved, thus poses a threat to many developing economies and their future development trajectories at large. To gain a better understanding of the process of regional economic change, an analysis of the economic growth models of mega-urban regions is considered a successful approach. 1.1 INSTITUTIONS IN A REGIONAL ECONOMIC GROWTH MODEL What does the phrase ‘regional economic growth model’ imply? Unlike neoclassical growth economics, the term ‘growth model’ is not related to, nor it should be confused with, the mathematical formulations of functions to explain economic growth (growth accounting). It is a conceptual umbrella term to capture various economic processes on different analytical levels from a regional perspective. For this thesis, I propose the following working definition: ‘A growth model is the prevalent form of industrial organization and economic interaction in a specified regional context within institutional boundaries aimed at generating economic growth.’ A growth-model, thus, aims to describe the dominant agents and identify the driving forces and organization of economic growth in a particular region. By nature, a ‘growth model’ cannot be static but is constantly changing and developing over time. Institutions, understood as systems of rules and norms that structure individual behavior, are the core analytical concept to understand social interaction within a growth model, and have proven to be effective for understanding their inner structures and functions. Two main actors for a regional economic growth model can be identified – local firms, and local as well as regional policymakers. What role do institutions play in the debate over regional economic change? All social processes and interactions subsumed within the growth model are structured, organized, or guided by institutions or institutional arrangements which can be understood as the ‘rules of the game’ as Douglas NORTH (1990) emphasizes. The way people engage in economic exchange, and the rules and norms of behavior that guide or even enable their interaction influences how regional economies work. In turn, these patterns of interaction are shaped by cultural practices and differ depending on history, traditions, or the stage of development. The informal institutions in China influence almost all forms of economic exchange and interaction; however, their role in the processes of firm-based innovation and regional economic change remains unclear, or at least ambiguous. By taking a firm- as well as a policy-level perspective, this thesis contributes to a better understanding of the mutually dependent processes of institutional and regional economic change. Nevertheless, research on economic development has showed that economic and institutional developments do not necessarily keep

1. Introduction

15

pace. In contrast, institutional theory revealed that institutions can be slow- or fast-moving (ROLAND 2004), and that ‘obsolete’ (often informal) institutions might remain intact despite maturing as economic or governmental structures. The complex interaction between institutional and regional economic change thus raises further questions as to how individual economic actors can contribute to regional economic change. What are their incentive structures? What factors might limit the potential for regional economic change? The conceptual integration of institutional and economic change allows for a process-oriented perspective on the changing regional economic development model. The present thesis seeks to contribute to a better understanding of the mutual interaction of institutional and economic change in the Greater PRD in China by adopting a context and cultural sensitive theoretical approach as proposed by YEUNG & LIN 2003) or PECK & ZHANG (2013: 386) who claim that: ‘The Chinese model may indeed frustrate and exceed […] many ‘imported’ theories.’ In the following subsection, I will introduce the selected case-study region, sketch its regional economic development path, and demonstrate the limits of the current regional economic development model which provides the motive for this thesis.

Fig. 1.1: The Greater Pearl River Delta mega-urban region in Guangdong. Own draft.

16

1. Introduction

1.2 A CHINESE SUCCESS STORY: THE GREATER PEARL RIVER DELTA The PRD is the economic core of Guangdong Province located in southern China (see Fig. 1.1). Despite problematic economic conditions during the pre-reform period (prior to 1978) and serving largely as China’s ‘rice bowl’ and ‘orchard,’ the region developed a strong and competitive manufacturing base following Deng Xiaoping’s reform agenda (HERRLE et al. 2008: 39). Today, the GPRD consists of nine Chinese municipalities of different administrative power as well as the special administrative regions of Hong Kong and Macao. Guangdong is home to approximately 85 million people, let alone the 56 million living in the economic core of the GPRD (registered population 2010); out of these, 83% live in urban settlements (GD PBS 2012). Due to the large number of unregistered population living outside of the household registration system (hukou) and the dynamic migration regime, the actual population figures are most likely significantly higher. Governmental estimates (2009) report approximately 27 million rural migrant workers; out of these, 19 million are from outside of Guangdong and eight million from within provincial boundaries (OECD 2010: 50). But how could the province characterized as ‘different, often marginal to the interest of the Chinese state, and typically troublesome and unruly’ (JOHNSON 2002: 125) make so much progress as to become one of China’s most important economic centers? The answer lies specifically in the exemption of the province from large-scale regional development programs, such as the ‘Third-Front’1 as well as its geographical conditions – far away from the centers of political power and adjacent to Hong Kong and its potentially ‘corrupting’ foreign influence. Just before the beginning of the reform-period in Guangdong, the economic state of the province was rather problematic. This was not so much caused by material damage inflicted during the Cultural Revolution, but rather by the fact that built infrastructure remained neglected for a long time and there was virtually no long-term development planning (VOGEL 1989: 35). The relatively weak presence of state-owned and heavy industry in Guangdong Province proved to be advantageous as it lightened the burdens associated with industrial readjustments that many provinces experienced during this period. The ‘Post-Mao’ reform period led by Deng Xiaoping marked a break in economic policy, but it was not until the 6th Five-Year Plan (FYP), agreed upon in 1981, that the equity-based economic policy in China was officially abolished. This was a political reaction to the first promising results of deliberate policy ex1

The ‘Third-Front’ (San Xian) was a large-scale industrial policy aimed at developing heavyand defense-related industries in remote areas of China’s interior provinces making them potentially inaccessible for hostile powers. The policy was introduced as a reaction to the United States’ involvement in the Vietnam War (NAUGHTON 2006: 73f.). Coastal regions like Guangdong Province were considered vulnerable to hostile attacks and were thus largely exempt from national industrial allocation. Third-front projects in Guangdong were related to naval shipbuilding, uranium mining, and defense electronics. ‘Local third-front’ projects were established on the provincial periphery of coastal areas, aimed at providing industrial goods for local defense capabilities (BACHMAN 2001: 273ff.)

1. Introduction

17

perimentation in some of China’s coastal provinces such as Guangdong (GU et al. 2001: 102). Besides the traditional economic center in the province’s capital, Guangzhou, as well as the cities of Shaoguan in the mountainous north, and Shantou in the eastern and Zhanjiang in the western periphery, large areas of the province lagged behind in industrial development (GU et al. 2001: 99). Measures taken during the reform and opening-up period were the relaxation of the state’s influence on pricing, the introduction of the rural household responsibility system, and the program of rural industrialization through the introduction of township and village enterprises (TVE) (LIN 1997: 49ff.). The TVEs, commonly operated by local village committees, were the main engine of the first wave of urban and industrial growth in the previously agrarian economy of the PRD (HERRLE et al. 2008: 41). At the same time, policy changes such as the introduction of special economic zones2 and open cities3 as well as the development of the open-zone economy in the Zhujiang Delta (1985), allowed for the increasing inflow of foreign direct investment (FDI) through export processing agreements (san lai yi bu) (VOGEL 1989: 175, WENG 1998: 431, FAN 1995: 441). While many of these reform measures appear to be centrally established, XU (2011) emphasizes that many measures were actually enforced by local policy-makers owing to personal efforts in interregional competition. Higher-ranking officials often opposed the proposed policy measures and agreed only later as the success of policy measures became visible. The reform period thus did not follow a centrally planned script, but rather favored small-scale policy experimentation by individual actors. The first two decades of the ‘open-door policy’ led to growth in the special economic zones of Shenzhen and Zhuhai. Especially, the formally underdeveloped city of Shenzhen and adjacent city of Bao’an (later incorporated in Shenzhen) grew substantially with its beneficial location in direct proximity of Hong Kong (GU et al. 2001: 106). While Shenzhen listed approximately 300,000 inhabitants in 1979, a surge of population inflow, especially during the 1990s, caused the population to rise to approximately 10 million in 2010 (GD PBS 2011). However, the development in Shenzhen was not solely driven by geographic proximity, but also by kinship ties in the local Chinese population with Hong Kong and Taiwan, which helped to reduce institutional weaknesses present in the Chinese mainland and reduced the risk of foreign investment (FAN 1995: 442). PECK & ZHANG (2013: 381f.), thus, argue that: ‘the (re)formation of Chinese capitalism was a cross-border and in some senses extraterritorial phenomenon from the start, as diasporic capital exploited a range of localized (and liberalized) openings.’

In the Western PRD during the 1990s, growth started to concentrate in the secondary cities of the PRD such as Shunde, Nanhai, Foshan, Zhogshan, while formerly important centers like Shaoguan, Shantou and Zhanjiang gradually lost importance, thereby leading to an increase in spatial inequality in the province (GU 2 3

Shenzen, Zhuhai, Shantou (1979) Guangzhou (1984)

18

1. Introduction

Fig. 1.2: Total Value of Imports and Exports in Guangdong Province (1987-2010). Own compilation based on GD PBS (2010)

et al. 2001: 109). The development in Foshan and Shunde are special, insofar as their development was not primarily driven by external economic assets, but also by a strong localized entrepreneurial culture and a relatively advantageous position of the local commune, as well as brigade production units and a strong subsequent development in a more diversified industrial structure. Today, Shunde is home to a competitive manufacturing base of the Chinese household appliance industry (LIU & YANG 2014: 448ff.). While Shenzhen was able to maintain its position as the new provincial growth pole, in the Eastern PRD, development impulses started spilling over to the adjacent cities of Dongguan and Huizhou, which established themselves as important manufacturing hubs of light industries throughout the 1990s. This process of transforming the increasingly uncompetitive TVE-based economy was driven by FDI largely from Hong Kong and increasingly from Taiwan. The cross-border production regime, as a new driving force of the region’s economic development, was conceptualized by SIT (2004: 820) as the so-called ‘front-shop-back-factory’ model, in which Hong Kong served as the headquarters (front shop) with international connectivity and the PRD as local branch plant (back factory). The late 1990s marked a beginning of a period of substantial institutional reform which contributed to a further intensification of economic and industrial growth. The economic integration between Hong Kong and the mainland intensified, and has become increasingly institutionalized since Hong Kong’s political return to China in 1997. The introduction of the ‘Closer Economic Partnership Arrangement’ (CEPA) until Supplement VIII, signed in 2011, increased the mobility of people and goods between the two regions (CHIU 2006: 294). In addition, China’s accession to the World Trade Organization (WTO) in 2001 contrib-

1. Introduction

19

uted significantly to additional economic development of the regional economy (OECD 2010: 126, ENRIGHT et al. 2005: 136ff.), which is visible in the provincial trade statistic (see Fig. 1.2). During this phase, first policy measures, aimed at upgrading the regional industrial base toward higher value-added activities, were formulated (HUANG & CHEN 2010: 76f.), as the first negative effects (e.g. increasing environmental pollution, rising wages, and prices, etc.) of the continuous regional polarization of economic activities became visible. 1.3 TOWARD A NEW ECONOMIC GROWTH MODEL? While the ‘old’ growth model of the PRD has indisputably contributed to impressive economic and urban expansion, the period of unbowed economic growth during the 2000s demonstrated the weaknesses of the front-shop-back-factory growth model that relied on a foreign-guided production regime and limited domestic value-added. During this period, the province experienced a slowdown in productivity growth (OECD 2010: 18). The double-digit gross domestic product (GDP) growth during the pre-crisis period, accompanied by a high rate of investment in the GDP ratio, created excess capacities in housing and manufacturing (DOLLAR 2014: 10). Land and labor shortages were among the first indications that the current economic growth model was reaching its sustainability threshold (HARTMANN 2013, OECD 2010: 107). Besides shortages of production staff, the region experiences a general lack of highly qualified human capital. In a comparison of the number of people with college or higher education, Guangdong ranks below the national average in China (OECD 2010: 104f.). Additionally, the environmental and living conditions of the local population were showing clear signs of degeneration. Between 1997 and 2007, the total energy consumption in the province almost tripled, and crude oil and coal accounted for approximately 76% of the main energy sources in 2007. Urban sprawl and industrial expansion caused a decrease in arable land, strongly contributing to the degeneration of water quality (OECD 2010: 20; ZHOU et al. 2012). The degeneration of air quality, as recent results presented by TAO et al. (2012: 395ff.) show, indicate high concentrations of ozone and nitrogen dioxide, originating from industrial and traffic exhaust, among PRD’s cities with a significant impact on the local mortality rate. These developments did not remain unnoticed by local policy-makers. Before the crisis, national and local government officials were engaged in the implementation of various policy measures aimed at upgrading the economic structure of the PRD toward higher value-added activities. Rising minimum-wage standards as well as the implementation of the new labor contract law in 2008 were supposed to ease labor-related problems and help to retain migrant workers within the province. In turn, they led to an increase in prices for local manufacturing firms (YANG 2012). Regional authorities attempted to encourage firm relocation, especially of polluting industries, to the provincial periphery. At the same time, high value-added

20

1. Introduction

manufacturing was supposed to be strengthened in the PRD by supporting their technological development. In this regard, the OECD (2010: 128ff.) stresses the importance of the development of technological capabilities to sustain future growth in Guangdong’s SME- and MNE-driven regional innovation system, and to emphasize the role of absorptive capacity among the region’s SMEs which even today largely operate on the competitive edge and low profit margins. The global economic crisis, starting in 2008, with massive lay-offs and firm closures in the province, served as a strong reminder of the previously mentioned upgrading efforts (OECD 2010: 18). The decline in economic dynamics is visible in the figures of provincial and national GDP growth (Fig. 1.3). While the economic decline caused by the global economic crisis was significant and steep, the region recovered fairly quickly from the crisis. This was caused, on the one hand, by an increasing demand in the export markets, which started to pick up in late 2009, as well as the strong governmental stimulus package of the Chinese national government (approximately 4 trillion RMB). While the post-crisis period in the PRD and China is characterized by slower growth, the implications of the crisis for the development of a more sustainable growth path remain questionable (SCHÜLLER & SCHÜLER-ZHOU 2009: 381ff.). The global economic crisis, thus, marks the starting point for this investigation into the post-crisis economy of the PRD and its potential changing development model. 1.4 AIM AND SCOPE This thesis aims to shed light on the qualitative and quantitative dimension of change of the regional economic growth model of the Greater PRD. In particular, I will try to elaborate on the effect and influence of (external) institutional factors on the changing production regime in the regional manufacturing base, especially

Fig. 1.3: GDP-growth in China and Guangdong province (1998-2012). Own compilation based on GD PBS (2014) and UN NSD (2014)

1. Introduction

21

toward the process of technological and industrial upgrading among local firms which has been identified as an important factor to sustain the region’s economic competitiveness (SCHILLER 2013; FU 2011). As a comprehensive account of institutional factors influencing the process of economic upgrading would overstretch the scale of this thesis, I will concentrate on selected economic fields and processes that are of central relevance to the abovementioned restructuring process. The global economic crisis marks the starting point for this investigation; however, as I seek to embrace a process-oriented understanding, I will also look back at the development taking place in the previous decade and will attempt to integrate my findings into a careful prognosis of potential future development. The empirical sections can be read as self-contained chapters, as they encompass brief theoretical and methodological remarks. Nevertheless, I would suggest reading this thesis in its entirety as the chapters on theory and concepts will help to clarify the adopted conceptual and methodological approach. In Chapter 2, I will give an overview of the two basic theoretical foundations of this thesis, namely the field of institutional analysis and innovation research. The chapter will deal with the following research questions: – – – –

How do formal and informal institutions develop and interact in the process of institutional change in China? How do firms in China engage in knowledge transfer and innovation and what strategic approaches exist for firms for the aforementioned processes? What potentials for technological upgrading exist, considering the stage of development of the regional innovation system in Guangdong? How can the process of industrial upgrading be conceptualized regarding the role of institutions?

In the following (Chapter 3), I will introduce the reader to the utilized data sources and the applied research design. By using a primarily quantitative approach supported by qualitative data and secondary statistics, I will present and discuss the critical strengths, weaknesses, and conceptual limitations of the available data and of the methodological approach. Later, I will present some preliminary survey results embedded in a discussion of measurements concepts of institutions and innovation. In the first empirical section (Chapter 4) the reader will be confronted with the question of how a changing institutional environment drives firms to adapt themselves to the new environmental conditions by means of strategic reorientation. The main research questions for this chapter are: – –

Does the pressure that forces firms to adapt to new environmental conditions derive from political sources, or is it based on the changing competitive situation? How can firms’ individual responses be differentiated and systematically conceptualized? What are the factors that influence firms’ strategic responses?

22 –

1. Introduction

Did the economic crisis of 2008 encourage a strategic reorientation toward innovation and upgrading?

Chapter 5 will be concerned with an analysis of a specific institutional field, namely the financial market and its influence on firms’ innovation efforts and performance. The chapter will conceptualize the interplay of formal and informal institutions in the process of institutional change, and question the sustainability of the existing structure of institutional arrangements governing firms’ financing in China. The main research questions are: – – –

What sources of firm financing can be accessed and utilized by local firms and what different functions do different sources have? Do formal or informal financial sources contribute to an increase in innovation activities among firms? Is the reliance on informal financial sources leading to a situation where short-term orientation prevails over a long-term structural readjustment towards innovation activities?

In Chapter 6, I will focus on the role of institutional arrangements in the process of knowledge exchange in supply-chain relations. The chapter challenges the contemporary view of a self-dependent regional innovation system in Guangdong Province, by exemplifying the continuous importance of external knowledge assets for the process of industrial upgrading. The specific research questions raised are: – – – –

Do formal or informal modes of inter-firm interaction contribute to the exchange of innovation-related information? What role do specific forms of proximity (spatial and institutional proximity) play in the process of knowledge exchange? What differences can be observed regarding up- and downstream supplychain partners? What effect do different modes of interaction have on the implementation of innovation-related knowledge in the supply-chain interaction?

Finally, in Chapter 7 I will try to scale up the analytical view into an industrylevel perspective on the political potential for the implementation of a new national and regional economic growth model. I will discuss the role and governance of Chinese party politics concerning the implementation of economic development policy. Using secondary statistical data, I will assess the large-scale trends of industrial development in the previous decade as well as future development potential under the new leadership regime. The main research questions that form part of this chapter are: –

Are political incentive structures aligned with the goal of a reorientation or rebalancing of the Chinese economic development model?

1. Introduction

– –

23

What spatial-industrial trends of governmental spending and industrial development are visible in China, and does Guangdong Province follow the Chinese example on a smaller scale? How does the high degree of personalization in policy-making influence the debate surrounding a reorientation of Chinese economic development policy?

This thesis will be concluded by a summary of the main findings made in Chapter 8 With regard to the growth-model debate, I will briefly discuss the implication of my empirical findings for the research region especially concerning potential spatial difference of growth paths within the PRD. 1.5 ACKNOWLEDGEMENTS I would like to express my gratitude to numerous colleagues, partners, and friends who provided unflinching support during the writing of this thesis: To begin with, I would like to thank Prof. Revilla Diez as my doctoral advisor for supporting me personally throughout my academic career, and putting his trust in my research and personal abilities. I thank him for his continuous encouragement while working on this thesis and for never losing faith in my qualities. I would also like to extend my gratitude to the whole `agile firms’ research team and partners in Cologne as well as in Gießen and Kiel, especially Prof. Frauke Kraas and her colleagues Harald Sterly, Dr. Pamela Hartmann, Birte Rafflenbeul, and Marie Pahl, for their tireless organizational efforts within the priority program, especially for the preparation of countless meetings, and for providing a vibrant and comfortable research environment. I am also indebted to Prof. Ingo Liefner for taking his time and providing his professional evaluation of this thesis and for his effort accompanying the PRD project, and to PD Dr. Stefan Hennemann for enjoyable cooperation in Germany and China. Special thanks go to Dr. Arman Peighambari for a memorable research trip to Guangzhou, endless hours of discussion in Germany and in China, and interesting travels across China and Hong Kong. I also thank the German Research Foundation (DFG) for their generous funding of this research project as part of the priority program 1233 ‘MegacitiesMegachallenge – Informal Dynamics of Global Change.’ Taking place in China, this research project would not have been possible without the support of our trusted research partners and friends in China. First and foremost, Prof. Li Xun of the School of Geography and Planning at the Sun Yatsen University in Guangzhou and his skilled research team as well as all supporting staff. All of them donated countless hours of work to the success of our company survey and helped to create the backbone of this research project. A special thank you goes to Dr. Wenying Fu for her skilled translation and bridging the intercultural gap between China and Germany during our project. I would also like to express my gratitude to our knowledgeable supporters in China and Hong Kong for taking their time and knowledge in support of this pro-

24

1. Introduction

ject, especially Jens Hildebrandt (Guangzhou), Matthias Küpper (Beijing), and Alex Chunn (Hong Kong), for providing us with indispensible contacts from their business networks. I am very grateful to the Norwegian researcher Cecilie Andersson for taking me on trips to Guangzhou’s urban villages and showing me a different face of the PRD. Many people in Germany supported me before and during the process of writing this thesis. I thank Dr. Hans-Joachim Heuer and Dr. Susann Prätor for their help in developing my thematic and methodological understanding during my studies in Hanover. They provided me with the necessary scientific toolkit and their influence and advice never failed to inspire my own work. Dr. Dariusz Wójcek deserves a special mention for his helpful critiques of and comments on individual paper drafts. I am deeply indebted to many of my close friends without whom this thesis would not have come into existence: First of all, PD Dr. Daniel Schiller, for not only spending countless hours discussing rough drafts and (sometimes more or less good) ideas and for being my academic mentor, but also for his continuous personal encouragement and being a trusted and good friend. A big thank you goes to Julika Talke, Antje Nagel, Berit Böckel, Jonas Labowski, Nicolas Reum, and Raik Berger for supporting me throughout the writing of my thesis, and for all the memorable moments during our studies in Hannover. I also thank Leonard Böhm, Michael Laumann, Felix Apel, Nils Christopher Brause, Dirk Karsten as well as Marion and Jochen Paukstadt for providing their essential technical expertise and personal support. Finally, I especially thank Jenny Hsu for her help with the translation. Every person needs a solid anchor that holds him in place. My family, especially my parents Sabine and Alfred Lech, as well as my brother Frederik Lech, who provided me with much-needed support and backing. It is primarily their achievement that made this thesis possible in the first place. Thank you!

2. THEORETICAL AND CONCEPTUAL BACKGROUND This chapter is concerned with laying the conceptual foundation for the following empirical analysis. This thesis touches on two main cross-disciplinary theoretical themes–first, the topic of institutional change grounded in institutional theory in economics and sociology; second, the topic of innovation and upgrading among firms in developing economies. Following this introductory remark, I will extend the theoretical foundation and conceptual ideas on the issue of institutions and institutional change, with particular attention to the differentiation between formal and informal institutions. I will then attempt to summarize the main findings and ideas on the topic of innovation and upgrading in the context of developing economies. To that end, I will refer to the main ideas of this topic from the field of development economics, innovation theory, and innovation management. The final section aims to develop a synthesis based on the identified research gaps. It tries to conceptualize the role of institutions and institutional change for upgrading and innovation in the context of the Chinese regional economy in the PRD. 2.1 INSTITUTIONAL CHANGE AND THE REGIONAL ECONOMY 2.1.1 INSTITUTIONS IN AN INTERDISCIPLINARY PERSPECTIVE The past 20 years witnessed a surge in academic research on the issue of institutions in economics, sociology, and neighboring disciplines. The increasing influence of institutional theory on the scientific debate is not only demonstrated by a number of recent Nobel laureates concerned with the development of institutional theory in economics4, but also by attempts to broaden the debate on institutions beyond the scientific sphere. Recent publications aim at a larger scientifically interested community, e.g. Daron ACEMOGLU and James A. ROBINSON’s approach to the question ‘Why Nations Fail’ (ACEMOGLU & ROBINSON 2012), or Niall FERGUSON’s rather pessimistic outlook on the so-called ‘The Great Degeneration’ (FERGUSON 2013). These works signal the growing interest in questions concerning the role of institutions and institutional arrangements, especially in their role for the development of economies. In the scientific debate, the concept of institutions is commonly approached in a broader understanding and has been applied to various empirical settings.

4

1991: Ronald G. Coase; 1993: Douglas C. North; 2001: George A. Akerlof & Joseph E. Stiglitz; 2009: Oliver E. Williamson & Elinor Ostrom.

26

2. Theoretical and conceptual background

The basis of interest of scholars of institutional analysis is to elaborate the role of rules, norms, and habits which structure, regulate, and order social and economic interactions. According to HODGSON (2006: 2), institutions are: ‘systems of established and prevalent rules that structure social interaction.’ In sociological and economic terminology, institutions are commonly associated with their function to regulate behavior (HASSE & KRÜCKEN 2005: 14f.). Institutional misbehavior can be sanctioned by formal legal mechanisms. When appearing in less formalized form, for instance, in norms of individual behavior, or patterns of expectations of appropriate behavior or action (HASSE & KRÜCKEN 2005: 15), misbehavior leads to irritation in social interaction. Institutions thus shape structures of collective expectations. However, institutions should not be confused with monolithic rules that predetermine the action of individual actors or patterns of their interaction. On the contrary, institutions can have an important enabling function because they create patterns of predictable behavior. For instance, traffic rules coordinate traffic and thus allow for a relatively safe participation in the first place (HASSE & KRÜCKEN 2005: 15). Behavior is structured or incentivized, but not predetermined by institutions. Different scientific disciplines have different approaches to the topic of institutions. For instance, scholars of institutional economics are concerned with economic interaction in an ‘imperfect economic landscape’ that differs drastically from the simplified assumptions that characterize neoclassical equilibrium economics. They embrace a broader understanding of a socially-situated economic agent that acts beyond the scope of utility maximization within known alternatives and beyond market-mediated transactions and equilibrium states (SCOTT 2008: 26f.). Here, institutional analysis is interested in the ‘role of […] rules, procedures, and conventions, both formal and informal nature’ (MARTIN 2000: 79) that shape incentive structures of economic and social actors. Early contributions to the emerging field of institutional economics by Ronald H. COASE on the problems of the boundary of the firm (‘The Nature of the Firm’ - 1937) or transaction costs (‘The Problem of Social Cost’ - 1960) mark a watershed for the development of the transaction-cost concept, an important theoretical strand within the field of institutional analysis in economics. Oliver E. WILLIAMSON further refined Coase’s argumentation and is today considered a main scholar in the refinement of rational-choice theory in economics (WILLIAMSON 1975). Other strands of institutional economics encompass, for instance, historical perspectives on economic development with important contributions by Douglas C. NORTH (‘Institutions, Institutional Change and Economic Performance’ - 1990), or the research into the governance of common goods, as elaborated by Elinor OSTROM (‘Governing the Commons’ - 1991). In sociology, neo-institutional approaches emerged and evolved mainly through organization studies and related disciplinary fields, developing as a concurring concept to other important theoretical bodies such as ‘structuration theory’ advanced by Anthony GIDDENS (1984) and Pierre BORDIEU (1979), or ‘system theory’, mainly elaborated by Niklas LUHMANN (1984). (HASSE & KRÜCKEN 2005: 20, SCOTT 1987).

2. Theoretical and conceptual background

27

Today, the interplay and development of institutions, organizations, and their environment is a core concern in the field of institutional sociology. This strand of research was opened with programmatic contributions by John W. MEYER & Brian ROWAN (1977), as well as Paul J. DIMAGGIO & Walter W. POWELL (1983). While MEYER & ROWAN (1977) focused on the role of institutional legitimacy, DIMAGGIO & POWELL (1983) conceptualized the idea of isomorphism and its effects on organizations. The experimental contribution by Lynne G. ZUCKER (1977) revealed different degrees of institutionalization, demonstrating that institutions can change in a timely perspective (HASSE & KRÜCKEN 2005: 22ff.). A second strand of sociological institutionalism stresses the systemic character of institutions. According to this understanding, social and economic interactions are `embedded’ in network structures that are governed by social institutions such as trust or authority (MARTIN 2000: 82). Mark GRANOVETTER strongly influenced modern network theory with his conception of the strengths of weak ties and consideration of over- and under-embeddedness of social actors (GRANOVETTER 1973; 1993; 2005). In economic geography, institutional approaches experienced a late adoption, in combination with the opening of the discipline to the neighboring fields. Especially the transaction cost (TAC) and network embeddedness approaches have been integrated into the growing body of geographic institutionalism. Ron MARTIN’s review of institutional approaches published in 2000 is a pioneering work that gives a comprehensive overview of institutional approaches and their potential relevance to economic geography (MARTIN 2000). Today, the concept exists in tension to neighboring concepts such as evolutionary economic geography (BOSCHMA & FRENKEN 2009). Hence, Pernilla RAFIQUI (2009) argues for reemphasizing the role of institutions within an evolutionary analysis of economic landscapes (RAFIQUI 2009). Despite its potential to enrich research in economic geography, institutional theory is still far from a coherent theoretical conceptualization (MARTIN 2000: 78). SCHILLER (2013: 14) assumes that the ‘shallow adoption’ of institutional approaches in economic geography is related to the ongoing theoretical and conceptual experimentation associated with multiple calls for a conceptual re-orientation of the discipline (a critical discussion can be found in RODRÌGUEZ-POSE 2001). Though ‘institutionalism’ has been simultaneously growing in similar disciplines, it has failed to create a unified theoretical concept. 2.1.2 The process of institutional change Institutional change is the process of development or change in institutional structures and patterns. A change in institutional structure or arrangements changes incentive structures of actors, probably leading to a change in individual behavior. The introduction of new laws that keep a regulative tab on people’s lives can be considered one simple example of the results of the process of institutional change.

28

2. Theoretical and conceptual background

In contrast to the analysis of equilibrium states in neoclassical economics, scholars of institutional analysis commonly embrace a process-oriented perspective, and are interested in the evolution and development of economic systems over time (RAFIQUI 2009: 329; SCOTT 2008: 27). Thus, it is not surprising that some of the core fields in institutional analysis are explicitly focused on the analysis of historical development. For instance, the economic historian Douglas C. NORTH was highly influential on the debate on institutional change (NORTH 1990). Despite numerous critical voices, for instance, concerning conceptual vagueness or intra-organizational processes (HODGSON 2006: 8ff.), his high level of analysis that traces the development of social frameworks in their impact on economic development remains undisputed in its scientific influence (SCOTT 2008: 29f.). The analysis of institutional change is not a phenomenon limited to neo-institutional research that has developed since the 1960s. Its origins reach back to research by classical national economists such as Karl Marx or Max Weber (SWEDBERG 2009: 42ff.; LEIPOLD 2006: 23ff.). Institutional patterns are not always the efficient outcome of the effort of organizations or individuals to minimize transaction costs, or smooth social interaction, but are largely the result of ‘unintended consequences’ in a constantly changing environment populated by social and economic actors with limited information (RAFIQUI 2009: 341). Institutional change is thus mostly unplanned and not deliberately aimed at effectively enhancing social interaction (NELSON 2008: 7). Development, change, and decay of institutions How are institutions created and how do they change? Institutions can be created by positive feedback, increasing commitment, or objectifications (SCOTT 2008: 122ff.). Legitimacy is a key variable of institutional survival and describes the degree of social acceptability and credibility. From a regulative perspective, legitimacy might encompass the legal status of institutions, while in normative understanding, it is more concerned with moral obligation (SCOTT 2008: 59ff.). Once legitimacy fades, institutions are weakened and might subsequently disappear. This process may be driven by function, external pressure, or be motivated by political or society-driven forces (SCOTT 2008: 196f.). Diverse interactions between social actors lead to changes in common interpretative patterns, thereby fueling the process of institutional change (HOLLIGSWORTH 2000: 625). According to Douglas North, the mechanism of institutional change is perceived to be driven by changes in opportunity sets. Exogenous sources of this change might be technological change or factor prices, while an endogenous source might be the competition between organizations during resource scarcity (RAFIQUI 2009: 341). OLIVER (1992: 567ff.) describes three distinctive types of pressures that lead to dissipation or rejection, and later to deinstitutionalization. These pressures are political pressure, functional pressure, and social pressure. Institutional change is path-dependent and mostly incremental in its nature (MARTIN 2000: 80). Path-

2. Theoretical and conceptual background

29

dependency refers to a ‘process or system […] whose outcome evolves as a consequence of the processes’ or systems’ own history’ (MARTIN & SUNLEY 2006a). This evolutionary understanding marks one of the most important thematic overlaps between the fields of institutional analysis and evolutionary economics, prominently conceptualized by Richard R. NELSON & Sidney G. WINTER. In their understanding, the persistence and evolutionary development of organizational routines is a key variable for understanding technological change (NELSON & WINTER 1982 / 2002). Nevertheless, outside of the organizational boundaries, radical institutional change is rarely taking place and path-dependent patterns prevail. HOLLIGSWORTH (2000: 624) points out that ‘social institutions are historically rooted […]’ and that ‘the shape of institutional configurations at any moment limits the type of options for change.’ Even in times of substantial economic or social disturbances, the radical abolishment of institutions is the exception rather than the rule. For example, driven by regulative forces, radical abolishment creates institutional voids that require ad hoc solutions, and are characterized by a rise in transaction costs, as guiding structures of behavior or expectations are not present. Examples of this process can be observed in political change following civil wars or riots. Once established, institutions possess a higher degree of persistency. This explains the existence of variations in institutional settings, but also redundancies or the persistence of inefficient institutions (RAFIQUI 2009: 341; ROLAND 2004: 114). In line with Anthony GIDDENS’ (1984) ‘structuration’ theory, which stresses the interrelated nature of freedom and constraint (SCOTT 2008: 77), it should be mentioned that institutional change never happens automatically but is always a result of collective, albeit mostly unintended, action. Neglected institutions decay not because of their inner logic, but because social actors question their legitimacy or utility to structure their social interaction. This emphasizes the roles of actors in institutional analysis. A ‘taken-for-granted’ perspective of passive actors reacting to institutional pressures underestimates the importance of deliberate action in the creation, change, and deconstruction of institutions (HASSE & KRÜCKEN 2005: 67). Christine OLIVER (1991) elaborated a set of strategic responses of organizations to institutional pressures (OLIVER 1991). In her programmatic study, she presents five strategies of actors and organizations to cope with institutional pressure. On the one hand, actors can submit to institutional pressures, or find ways to reach a compromise between external expectations and demands as well as internal requirements. On the other hand, actors can actively defy or manipulate external demand (OLIVER 1991: 151). In between, there are a variety of strategic responses that aim to reach a compromise between external demands and internal organizational requirements. In addition, it is important to consider a timely dimension and the factor persistency in the process of institutional change. In Oliver WILLIAMSON’s (2000: 596) analytical framework, one can identify different forms of social institutions and their approximated frequency of change. Among the most durable are informal institutions, customs, norms and traditions, which can last as long as 1,000

30

2. Theoretical and conceptual background

Fig. 2.1: Levels of institutional analysis. Owl draft based on WILLIAMSON (2000:597)

years. Below them, WILLIAMSON allocates elements of the institutional environment, namely bureaucracy, judiciary and polity, prone to a frequency of change in 10 to 100 years. Further below are elements of contractual governance and resource allocation that inhibit shortest persistency. The potential for institutional change will thus also be dependent on the degree of persistency of the institutional structures and arrangements. In line with WILLIAMSON, ROLAND (2004) proposes to differentiate between fast- and slow-moving institutions. Referring to contemporary sociological theory, ROSA (2014: 26) claims that the persistency of institutional structures generally decreases in late-modern societies. Lastly, the differentiation between ‘institutional environment’ and ‘institutional arrangements’ helps to clarify the different spheres of analysis. The institutional environment encompasses institutional structures on the macro-level. It can be understood as the sum of rules, regulations, norms, and traditions that structure social and economic interaction at large. In contrast, institutional arrangements have a micro-level focus. They explain interpersonal or inter-organizational relations and exchange as well as their patterns. As WILLIAMSON (2000) shows, both elements are mutually interdependent and change in a co-evolutionary manner (see Fig. 2.1).

2. Theoretical and conceptual background

31

2.1.3 The role of informality in the process of institutional change It is obvious that a society’s institutional structure is not only guided by regulative patterns, such as laws and official regulations, but also that an institutional perspective must embrace the larger social and interpersonal order. These systems are commonly structured by informal institutions that are not codified but transferred in the interaction and exchange of social actors. They often form a secondary rule system below the structure of regulative authority. The debate about informal institutions is closely related to the informality concept, which was advanced during the 1970s, to describe economic activity in non-formalized labor and management practices in developing economies, and was adopted for the German-speaking geographic community throughout the 1980s (SCHILLER 2013: 27f.; SCHAMP 1989; HART 1973). However, while the early use of the concept acknowledged the importance of the informal sector in the so-called ‘survival’ or ‘shadow economy,’ the term carried a connotation of inferiority, or even illegality. The contemporary debate on informality led to a modified understanding of the concept. In line with advancements in the new institutional economics (NORTH 1990), today’s understanding of informality detached itself from the connotation of inferiority and the regional stigma of developing countries. In contrast, modern approaches stress informality as an enabling governance mode that functions at the crossroads of formal institutional arrangements. From a legalist perspective, informal institutions refer to rule systems outside of the regulative body of codified law. In his compelling analysis, ‘Order without Law,’ published in 1994, Robert C. ELLICKSON shows how Californian cattle ranchers settled disputes and engaged in self-organized governance outside the body of formalized law (ELLICKSON 1994). ELLICKSON provides a compelling account of the enabling role of informal institutions. Besides the legalistic perspective, informal institutions have a strong normative dimension. The existences of secondary rule systems that are grounded in intangible qualities, such as trust or reputation, are an element of informal economic exchange (HARTMANN 2013: 38f.). Based on such an understanding, informality is commonly linked to the concept of social capital (BORDIEU 1983). While exchange in formalized rule systems is commonly impersonal, direct personal interaction is crucial to informal economic exchange (LI 2007: 229ff.). Informality and informal institutions play an important role in helping us to understand regional economic development in China. Commonly guanxi networks are found to be a crucial element for the economic success, especially in the development of the coastal provinces (WANG 2000). Recent contributions by LIU et al. (2014), SCHILLER (2013), FU (2011), and MEYER (2011) conceptualize informality as a governance mode in ‘agile’ cross-border production organization as well as a decisive element of regional economic upgrading in China. HARTMANN (2013) uses the informality concept to elaborate flexible labor markets in China’s production regime.

32

2. Theoretical and conceptual background

The aforementioned findings have to be reflected on the process of economic opening in China. The process of political opening and economic liberalization changed the socialist economic structure, leading to the development of inconsistencies in the formal institutional sphere and to the emergence of institutional voids that had to be filled with the development of new (informal) institutional arrangements (PUFFER et al. 2010). China’s economic and institutional sphere is constantly maturing, coupled with the process of institutional renegotiation. Political reform process introduced new formalized regulative patterns. This means that the necessity to rely on informality in the process of economic interaction is steadily reducing, as the formalized institutional sphere is growing and reaching maturity. Consequently, ‘necessity informality’ is transformed into ‘opportunity informality’ in China’s maturing economy. 2.1.4 The role of institutions during China’s economic reform How do the abovementioned ideas help to understand the process of economic and industrial development in the Chinese reform process? A closer look reveals that the beginning of the reform politics by Deng Xiaoping did not only trigger rapid economic growth, but was also accompanied by substantial institutional change. Examples of institutional change can be found in the changing price mechanisms, or the reorganization of the socialist into a hybrid plan and market industry. The transition debate With regard to the national economy, the change from plan to market involved transformation from fixed prices and production quotas to supply- and demanddriven economic organization (MEYER 2011: 39), as well as a reduction in state subsidies (DEHEJIA 2003: 35). In the debate on economic liberalization in transition economies, two major approaches to economic reform are discussed (POPOV 2007 / 2000). The ‘Shock Therapy’ refers to the quick and comprehensive reform of economic institutions and large-scale privatization of the state-controlled economy (POPOV 2000: 9). While this reform initiative theoretically allows a country’s faster participation in global production and trade regimes, countries following this approach have often slipped into a phase transformational recession, caused by structural challenges of economic transformation (e.g. overdependence on industry versus service leading to structural unemployment) and the emergence of institutional voids. In the ‘Gradualism’ approach, certain parts of the economic system are transformed first to market mechanism, while others remain under the state planning authority. This approach, as adopted in China, is characterized by a gradual withdrawal of state intervention in selected reform regions. These specific ‘laboratories’ of economic reform are thus subject to policy experimentation in market re-

2. Theoretical and conceptual background

33

forms. This stepwise implementation led to the preservation of legitimacy for the authority of the state at large. However, as SACHS et al. (1994) argue, the differences in economic outcome of the reform between China and many Eastern European economies is not so much caused by the difference in approach to economic reform, but rather by the structural differences and the time of reform in these countries. In their view, Russia’s position during the reform period was much more challenging as the country was suffering from a large percentage of population employed in the state-owned economy and the dismantling of the planning system. In contrast, the Chinese society was rather agriculture-focused, with relatively less dominance of state enterprises in workforce retention and the continuation of the state planning system. Changes in regulative patterns by national authorities in China did not lead to the disappearing of the existing cultural patters that structure economic interaction in China. On the contrary, the political and institutional void that followed the period of reform in many fields was filled by the return to culturally embedded and often informal institutions. In the following, I will present several institutional elements that structure economic interactions in China and discuss their importance for the process of economic opening. Changing institutional patterns in post-reform China China under Communist leadership established a political and bureaucratic system that fundamentally changed the social incentive structures. Collectivization of the economic system and the introduction of the commune and brigade system created a new form of social order. In spite of this fundamental change, historic institutions did not cease to exist but were forced into a system of informal social order. According to BOISOT & CHILD (1996: 604), the preference of interpersonal and relational governance hindered attempts at transforming the country into an entity of impersonal, rule-based governance. Thus, in the relative absence of legal institutions, ‘fieflike traditional mode of social organization’ prevailed (BOISOT & CHILD 1996: 604). This demonstrates the parallel existence of potentially contradicting patterns of expectations. Starting in 1978, economic reform and modernization marked another period of substantial institutional change in individual interaction, and a renegotiation of social patterns and economic practices. A good example of this is the entrepreneurial culture nurtured by early reform attempts in agriculture and rural industries (PUFFER et al. 2010: 451ff.; NEE & SIJN 1990). Before the reform, China’s economic system was dominated by stateowned enterprises (SOE) which were dictated by bureaucratic planning (CHILD & TSE 2001: 8f.). After the reform, the power of the state-owned enterprises diminished with the emergence of other forms of economic organization in individual as well as collective organizations.

34

2. Theoretical and conceptual background

Change took place with the introduction of the ‘household responsibility system’ (HRS) in the agricultural sector5 and the allowance of commune enterprises to partly engage in self-dependent business. These reforms marked the starting point for bottom-up institutional response and spurred economic growth in China, despite fundamental shortcomings in the legal status of many businesses (SACHS et al. 1994: 114f.). PUFFER et al. (2010: 460) thus argue that the rise of institutional voids increases the demand to rely on informal institutions. NEE & SIJN (1990: 21) conclude that the institutional reform in the agriculture sector in post-reform China changed the incentive structure of local farmers to engage more efficient economic activities. This process led to a significant rise in productivity (NEE & MATTHEWS 1996: 409). The case of rural industrialization, i.e. the development of so-called townshipvillage enterprises (TVE), marks an intermediary organizational form which became a main engine of economic growth in the post-reform period. According to BOISOT & CHILD (1996: 616), their emergence is mainly bottom-up-driven, as new regulations allowed for larger freedom to engage in self-organized production. TVEs are community-owned enterprises, and often originated from industrial communes in the pre-reform period. In the post-reform period, participation in TVE is based on residency and governed by the community government (BOISOT & CHILD 1996: 616). According to LI (2005), the success of TVEs is also linked to the interaction of local political administration that serves as a ‘quasi-formal parent company’ (LI 2005: 203). With increasing reliance on formal institutions of property rights and enforcement, as well as further reform steps toward the allowance of private enterprises, many TVEs were subsequently reformed into private enterprises. The TVE is thus an institutional and organizational artifact in a changing regulative landscape. Historical institutional patterns in China Many social institutions possess a long tradition and are part of a country’s history or heritage. Taking a historic perspective, LEIPOLD (2006: 164ff.) provides insights into the cultural and ideological history of China, and specifying relatively stable institutional structures that are characteristic even of contemporary Chinese economy. LEIPOLD emphasizes the role of Confucian-based institutional patterns, for instance, the traditionally important role of the patriarchic family structures in China and larger clan-like family structures that experienced a superelevation in all Chinese philosophical schools. Confucianism and its morally-ideologically bound institutions (dao – the morally right way) largely prevailed over formalized 5

The HRS allowed farm households to engage in dual-track agricultural production with production for the state quota at fixed prices and surplus production for market prices. This system generated economic surplus and changed the incentive structure of production in farm households.

2. Theoretical and conceptual background

35

law-based governance that can be found in many Western nations (LEIPOLD 2006: 167). While modernization weakened the philosophical foundations and gradually strengthened a formalization of governance structures, artifacts of traditional philosophical norms are still visible today – for instance, in the prevalent models of Chinese firm organization. Many small and medium-sized enterprises (SME) in China are family-owned and show a distinctive pattern of patriarchal management routines. These influence the mode of information processing and inter-firm relations by means of relational governance. Shortcomings in vertical integration are commonly substituted by extensive and mutually trust-based external networks centered on the institutional structure of guanxi (LEIPOLD 2006: 172ff.). The guanxi system is another example of the longevity of informal social institutions. With the low degree of institutionalized trust in China, the guanxi system helps to establish social interaction based on interpersonal trust (CHILD & MÖLLERING 2003: 72). Guanxi, a system of relational governance, is grounded in the mutual exchange of favors, goods, or information based on Confucian philosophy of ‘harmony and orderly world’ (FU 2011: 83). It is preferably used in family or kinship relations, but is open to persons in relative proximity based on criteria of emotional trust (LEIPOLD 2006: 173; PARK & LUO 2001: 456). The system of guanxi is transferable to persons outside of the network by means of brokers, and the extent of transferability depends on the relational strength of core participants (PARK & LUO 2001: 457). While these networks are generally considered intangible and participation is voluntary, the social obligation to mutual commitment is ensured by informal sanction mechanisms such as the dangers of losing face (Miànzi). Guanxi becomes an organizational asset when introduced into economic interaction. ZHANG & ZHANG (2006) stress the importance of guanxi to reduce transaction and search costs, and the threat of opportunism in inter-firm interactions. RAMASAMY et al. (2006) find the use of guanxi to be beneficial in the exchange of technological information among business partners in China. It reduces complexity and enables the handling of uncertainty (BOISOT & CHILD 1996: 625). The role of these Confucian traditions in business organization and relational governance exemplifies the prevalence of historical institutional structures and their persistence in the process of institutional change and formalization. Other examples of the role of persistent institutional patterns can be found in China’s education system, which is also based on Confucian traditions (MARGINSON 2011). I have shown that potentially concurring institutional structures (e.g. rulebased governance versus informal interpersonal governance) may exist at the same time, as institutional structures and arrangements possess a different persistency. The case of China demonstrates that political change and reform might trigger substantial institutional change, and may also lead to the emergence of institutional voids that need to be filled in order to allow smooth interaction of social actors. Different organizational forms may be the result of institutional change. Formal and informal institutions are thus never mutually exclusive, but often co-exist, creating a dense system of first- and second-tier social order.

36

2. Theoretical and conceptual background

2.1.5 Spatial perspective to institutional analysis and change Local and regional differences in institutional practices and their impact on economic interaction form the key interest of institutional scholars in geography. Two main concepts have emerged for the treatment of institutions in economic geography, namely ‘institutional spaces’ and ‘institutional thickness.’ Institutional spaces refer to geographical areas within the reach of distinctive institutional practices. These spaces can be limited to the national state or certain provinces that are under distinctive coordinative authority – for instance, the areas falling within the competitive or welfare regulations of state authorities (MARTIN 2000: 87). Institutional differences, on the national level, have been elaborated within the ‘varieties of capitalism’ (VOC) approach (HALL & SOSKICE 2001), and have recently been picked up by ACEMOGLU & ROBINSON’s (2012) to explain economic prosperity and poverty from a historic-economic perspective. Institutional thickness conceptualizes regionally- or locally-embedded regimes of coherent institutional rules focused on some sort of common agenda or purpose. Institutional thickness is characterized by strong and vibrant institutional arrangements between spatially-concentrated actors (e.g. firms, authorities, chambers, unions, or chambers of commerce) and their systems of cooperation, competition, and collective representation (MARTIN 2000: 88). Empirical evidence of these specific regional-institutional entities has been presented for production locations working in specialized niches and ‘post-Fordist’ production regimes such as flexible specialization (AMIN 1999; PIORE & SABEL 1984). However, despite the lack of a coherent theoretical foundation and anecdotal empirical evidence, this did not stop the introduction of institutional thickness into the concept of economic clusters, which suffers, despite unbroken popularity, from the same shortcomings of a ‘chaotic conceptualization’ (MARTIN & SUNLEY 2006b). Localized production regimes are commonly linked to the discussion of local learning, innovation and regional economic competitiveness (‘learning regions’). However, it is especially the `fuzziness’ of the concepts and the uncritical use of the notion that harm its usefulness in the theoretical debate (MARKUSEN 1999). Especially, the focus on co-location instead of local interaction and the institutional patterns governing those interactions have proven to be major theoretical weaknesses. 2.1.6 Institutions and regional economic resilience Among the latest theoretical innovations in economic geography is the concept of regional economic resilience which is engaged in questioning stability and adaptability of regional- and social-economic systems to major shocks or disturbances (SIMMIE & MARTIN 2010: 28ff.). The resilience literature is systemic and encompasses a meso- to macro-level focus of analysis. Scholars of regional resilience are still discussing ideas from various disciplines such as evolutionary biology (Generalized Darwinism), or complexity theory. Besides, established (evolution-

2. Theoretical and conceptual background

37

Fig. 2.2: Stylized Responses of a Regional Economy to a Major Shock. Own draft based on SIMMIE & MARTIN (2010: 29)

ary) concepts in geography, such as path-dependency and regional lock-ins (GRABHER 1993), have been implemented in this systemic approach to regional economies (HASSINK 2010: 48). Due to its relative novelty, a common definition of regional resilience has not been found yet, as resilience can be a reference both to a region’s ability to recover from shock or disturbance, and to its persistency to withstand economic crisis. SIMMIE & MARTIN (2010), however, propose a definition of resilience that looks at a region’s ability to continuously adapt to constantly changing economic conditions, hence moving beyond an ‘equibrist’ approach (SCHILLER 2013: 57). For the question of regional economic recovery, SIMMIE & MARTIN (2010: 29) present a four-stage concept of responses of regions to major shocks. In (a), a region recovers to its established growth path after a crisis. In (b) and (c), the regional economy recovers; however, its growth path is inferior to the pre-crisis development. This can be caused, for instance, by inadequate structural policy. Lastly, in (d), the regional economy has recovered and surpasses the pre-crisis path in the recovery phase (Fig. 2.2). Resilience also encompasses the ability of a regional economy to withstand economic disturbances (SIMMIE & MARTIN 2010: 29f.). The role of institutions in regional resilience is of central importance to understand the internal dynamics and processes between the various actors in the system.

38

2. Theoretical and conceptual background

For the case of China, it is important to understand the inner mechanisms of governance between state-owned enterprises and private enterprises with localand regional governmental authorities, in order to be able to understand the different outcomes of regional economic resilience. It is crucial to understand the role and interaction between local and foreign firms, especially because of the impact on capability formation in local firms. A crisis, such as the global economic crisis of 2008, can thus be interpreted as a starting point for analyzing the changing patterns of institutions in their effects on economic governance of actors which shape the future development path of the regional economy. Special importance needs to be paid to the process of innovation and the effect of informal institutions on innovation, both in a firm- and regional-level analysis, as it can be regarded as a major driver of regional economic change and modernization. Lastly, the role of path dependency connected with an analysis of the Chinese administrative system needs to be taken into consideration with regard to potentials for regional economic renewal and the dangers associated with political lock-ins (HASSINK 2010: 48). 2.1.7 Interim conclusion In this section, I elaborated the general concept of institutional theory in sociology and economics, and put specific weight on the importance of the process of institutional change. I have shown that persistency, time, and the role of actors are important for understanding institutional change. I have also demonstrated how the scientific understanding of the informality concept developed from an inferior residual category in development studies into an alternative mode of economic and social governance. I have elaborated the process of institutional transformation in China that led to a rise in the number of different organizational as well as institutional arrangements. Institutional voids in the reform process were filled by informal institutions based on Confucian traditions that co-exist in the maturing institutional sphere in China. Lastly, I have shown the role of the spatial economy, mainly through the concepts of institutional thickness and regional economic resilience. In both concepts, institutions remain a key variable to understand intra-regional interaction as well as regional ability to adapt economic disturbances. 2.2 INNOVATION AND INDUSTRIAL UPGRADING IN CHINA To assess the potential for change in the regional economic growth model in the Chinese PRD, it is crucial to understand the mechanism of innovation in local firms as well as industrial upgrading in the regional economic system. Technological advancement is considered a key determinant for industrial upgrading toward high value-added economic activities and the creation of wealth (LIEFNER & HENNEMANN 2006: 111). This section thus lays the conceptual foundation of the

2. Theoretical and conceptual background

39

analysis of the abovementioned processes. I will start by some general insights into innovation theory-related concepts such as knowledge generation, learning, and the adoption of knowledge. 2.2.1 Information, learning, and innovation in an organizational perspective While the concepts of information, knowledge, and learning seem to be intuitive to a wide audience, it is important to use them precisely and integrate them systematically into the understanding of the process of innovation. The foundation of an understanding of innovation rests with information that is passed on from one actor to another. This flow of information might be unspecific to a single person (KOSCHATZKY 2001: 49). Information is turned into knowledge when persons absorb it, interpret it cognitively, and merge it with the already existing knowledge base. This process alters the existing knowledge base and makes it ‘anchored on the commitment and beliefs of its holder’ (NONAKA 1994: 15). The systematic accumulation, reprocessing, and interpretation of information, based on existing knowledge as well as subjective beliefs, mark the process of learning in persons. Learning is usually a process bound to individual persons. Nonetheless, the process of organizational learning has received growing academic interest from organizational scholars (NONAKA & VON KROGH 2009). While information can be accumulated without systematic reinterpretation and remains highly subjective depending on the cognitive and mental structures of the holder, learning systematically integrates information into a stock of existing knowledge; hence, its structure is altered by comparison, re-evaluation, and validation. Therefore, knowledge carries some attribute of inter-subjective validation with has taken place during the learning process (KOSCHATZKY 2001: 49). According to POLANYI’s (1966: 4) notion that ‘we can know more than we can tell,’ knowledge can be separated into an implicit and explicit category. Implicit knowledge (or tacit knowledge) in this dichotomy can be understood as knowledge bound in persons, actions, or procedures. It can resist codifications, documentation, or even articulation (KOSCHATZKY 2001: 49). In contrast, explicit knowledge (codified knowledge) is bound in publications, blueprint machines or equipment, thereby making it easy to replicate and transfer if the recipient is in possession of the understanding of the codification (KOSCHATZKY 2001: 49). However, the process of transfer does not work without individual effort, as JENSEN et al. (2007: 681) point out. According to ALDRICH & RUEF (2006: 4), organizations are ‘goal-directed, boundary maintaining, and socially constructed systems of human activity.’ Their purpose is to carry our purposeful, collective action ‘towards an apparent common purpose’ (ALDRICH & RUEF 2006: 5). To achieve their goals, organizations or rather individual members within organizations follow certain organizational routines and techniques (NELSON & WINTER 1982). They cumulatively form a set of organizational processes. This means that decisions taken and structures established in the past will constrain the possibilities for decisions and its outcomes

40

2. Theoretical and conceptual background

taken today. As a result, organizational structures evolve in an evolutionary manner. This understanding of organization as well as of innovation has been influential in contemporary innovation research. The evolutionary approach in innovation research has been widely adopted. Its foundation was laid by the early works of Joseph Schumpeter6 (KOSCHATZKY 2001: 33). The process of organizational learning Before focusing on the process of innovation in firms, it is important to understand the mechanisms by which organizations learn. Organizations, in the form of firms, usually consist of several employees who are assigned various tasks within the organizational boundaries. Complex organizations usually consist of several levels of internal sub-structures (divisions or departments) which correspond to each other depending on hierarchy established within the organization. Learning nonetheless takes places within each individual member of the organization in a social and interactive process (NONAKA et al. 2000: 3). In order to let the organization benefit from individual learning effort, learned content needs either to be systematically codified in order to be passed along the members of the organization, or can be shared through socialization among individual members. In the process of lifting individual knowledge to the organizational level, ideas are exchanged and common meanings are developed (CROSSAN et al. 1999: 524). However, this interaction must not automatically associate with a positive outcome, as the interaction of individuals might end up negatively (NONAKA et al. 2000: 3). CROSSAN et al. (1999) have proposed a framework to study institutional learning by integrating four sub-processes of ‘Intuiting,’ ‘Interpreting,’ ‘Integrating’ and ‘Institutionalizing,’ with different levels of organizational hierarchy, namely ‘individual,’ ‘group’ and ‘organization’ levels (CROSSAN et al. 1999: 524ff.; cf. Fig. 2.3). Individual members generate ideas based on their previous experience and cognitive structure. Once verbalized and shared with other members, the interpretation leads to the development of a common understanding. The knowledge is then integrated into the existing knowledge stock of the organization. Institutionalization takes place when the common understanding of that knowledge is transformed into organizational routines and hence actions (CROSSAN et al. 1999: 525). Organizational knowledge, embedded in the organizational structure, can comprise various forms of routines and techniques or artifacts, such as rules of operation, manufacturing technologies or, for instance, customer data banks (KOGUT & ZANDER 1992: 384). Knowledge flows from the individual member to the group until it is grounded (and institutionalized) within the organizational structure.

6

cf. SCHUMPETER, J.A. 1911 (reprint: 1993): Theorie der wirtschaftlichen Entwicklung. Eine Untersuchung über Unternehmensgewinn, Kapital, Kredit, Zins und dem Konjunkturzyklus (8th ed.). Berlin: Duncker & Humblot

2. Theoretical and conceptual background

41

Fig. 2.3: The process of organizational learning. Own draft based on CROSSAN et al. (1999: 532)

The authors point out that organizational learning needs to be differentiated from the individual perspective learning of its members. While the staff of the organization might be subject to fluctuation when the organization matures, the knowledge they contributed to the organization must not necessarily leave with them, but rather become embedded in the routines, structures, and practices (CROSSAN et al. 1999: 529, DOSI et al. 2008: 1171). Based on this view, the sum of organizational knowledge is thus more than the whole of its parts – the knowledge embodied in individual organizational members. In a broad definition, which forms the basis of this study, the process of innovation is considered according to the OECD (2005: 46) as: ‘[…] the implementation of a new or significantly improved product (good or service), or process, a new marketing method, or a new organizational method in business practices, workplace organization or external relations.’

In contrast to an invention, which must be new to the world in a specific sense, innovations only require to be ‘new (or significantly improved) to the firm’ to be introduced (OECD 2005: 46). Innovation can be understood as the positive outcome of organizational learning and requires substantial commitment by individuals and the organization. As I will show, the potential of firms to access highly qualified human capital is crucial to the positive outcome of innovation; however, even under good conditions, the process of innovation is always associated with a high degree of uncertainty and risk.

42

2. Theoretical and conceptual background

Determinants of knowledge absorption The processes of learning and information processing in organizations are related to the existing knowledge base of persons and organizational routines. Therefore, the success and ease of learning something new will be influenced by the knowledge that has already been internalized. This concept has been formulated by scholars belonging to the organizational sciences under the notion of absorptive capacity. Two of such prominent scholars are COHEN & LEVINTHAL (1990). According to them, absorptive capacity is the ‘ability to recognize the value of new information, assimilate it, and apply it to commercial ends’ (COHEN & LEVINTHAL 1990: 128). In their view, learning is a cumulative process in which the outcome is the greatest when the new content is related to the existing knowledge. Similar to learning process in the organizational perspective, the development of absorptive capacity at an organizational level is dependent on the absorptive capacity of its members (COHEN & LEVINTHAL 1990: 131). However, the individual ability to absorb new knowledge will not yield in the best absorptive performance at the organizational level. Rather, it is a question of how individual members of the organization will be able to communicate the absorbed knowledge within the organizational structure in order for the organization to reap benefits from the abilities of its individual members. Specific forms of knowledge (for example technical details) will depend on the gatekeepers that are able to turn the special external knowledge into a form useable for the organization (COHEN & LEVINTHAL 1990: 131f.). The concept of path-dependence is again related to the evolutionary perspective of a firm’s innovation and organizational development. Firms need to continuously invest in absorptive capacity so that they do not fall behind in developing technologies. Once they have lagged behind the technological frontier, a catch-up act might not be easy to achieve, and the firms are threatened to be ‘locked out’ of further technological development (COHEN & LEVINTHAL 1990: 136). 2.2.2 Internal sources of knowledge As I have demonstrated, the potential sources for knowledge and organizational learning are manifold. Given a sufficiently qualified technical workforce as well as strategic and market competences, firms are able to create new knowledge within its organizational boundaries, mainly by means of systematic research and development (R&D). Internal R&D efforts positively influence creativity and help firms to understand modern technologies (LIEFNER & HENNEMANN 2006: 117). The success of internal knowledge creation is highly dependent on the availability of skilled personnel. LAURSEN & FOSS (2003) show that certain techniques of human resource management positively influence firms’ innovation performance. However, internal capabilities and technological knowledge will often not be sufficient to carry out substantial innovation activities.

2. Theoretical and conceptual background

43

This problem is observed in small- and medium-sized firms in China. Shortterm-oriented business models, or reactive strategies, as well as disadvantages in the institutional environment in China, come in the way of their innovation performance. The general degree of innovativeness in Chinese firms is considered to be relatively low, especially in the state-owned economy (SUN & DU 2010: 548f.). Analyzing the innovation behavior of manufacturing firms in Jiangsu Province, ALCORTA et al. (2008) show that a lack of information regarding technologies, coupled with a lack of opportunities for innovation co-operation, is among the most important problems hindering local manufacturing firms from carrying out innovation activities. These findings are supported by XIE et al. (2010). This emphasizes the importance of accessing external sources of knowledge, especially for manufacturing firms in China. 2.2.3 External sources of knowledge: The role of Global Value Chains and Foreign Direct Investment In order to access knowledge external to the firms, firms can engage in production relations with other firms. As carries of sophisticated technologies and products, foreign firms are often considered valuable partners for knowledge transfer. Spillovers, occurring between domestic and foreign firms, have to be considered as information about technical content that is, at least, partly a pubic good and therefore cannot be bound to a single economic actor. The transfer of this information can take place un- as well as intentionally through various codified and personal channels (KOSCHATZKY 2001: 96). External channels for the exchange of information are also bound to new modes of production arrangements of global production which developed as an organizational response the so-called ‘crisis of Fordism’ and the first industrial division of labor (PIORE & SABEL 1984). The decline of industrial mass production in the developed countries caused a fundamental restructuring of global industries, and led to an increasing international division of labor, also referred to as the second industrial divide (FRÖBEL et al. 1980; SCHÄTZL 2003: 224f.). Today, outsourcing has become a standard operational principle in the international organization of industrial production. Many host countries have reacted by increasing efforts at market liberalization since the early 1980s, or even started an active promotion of inward foreign direct investment into their countries (BLOMSTRÖM & KOKKO 2002). This process of the allowance of inward FDI started in China in 1979 and grew substantially during the first wave of inward FDI during the 1980s with the setup of new regulatory permits (LIN et al. 2009: 680). SACHS et al. (1994: 111f.) point out the importance of ethnic Chinese population in Hong Kong and their FDI in China in discussing their role in stimulating economic performance in China during the reform period. In addition, Chinese officials and national innovation policy have largely focused on the absorption of foreign technological assets, and traditionally considered the role of external knowledge sources very important.

44

2. Theoretical and conceptual background

Technology transfer and learning in value chains The value chain, defined as the different steps necessary in the manufacturing of a product, is divided into different actors in a production network. In the example of the electronic industry, it usually spans between a lead firm (often the owner of developer of core technology), intermediary suppliers, or OEM/EMS7 providers, capable of organizing the full scale of production, as well as local suppliers engaged in the assembly or production of components. The variety and complexity of the chain’s organization depends on the complexity of the manufactured product and the technology involved. To understand this ‘new’ mode of international production organization and its impact on participating firms, the concept of global value chain (GVC) emerged during the mid 1990s among scholars of the Sussex school. Their main concern is how different settings of actors (lead firms, suppliers, etc.) as well as their capabilities and the kind of transferred information through the chain result in different modes of governance among the actors (STURGEON 2002 / 2003, GEREFFI et al. 2005: 82ff.). The two main areas of research within the conceptual boundaries are the analysis of governance structures within GVCs and the topic of industrial upgrading (GEREFFI 2014: 17). The later developments in the global production network (GPN) paradigm by scholars of the Manchester school (HENDERSON et al. 2002) tries to enrich the insights gained from previous research by incorporating it into a broader and less linear and multi-scalar view. In contrast to the global value chain perspective, it takes a larger set of actors and their interactions as well as the role institutions into account (COE et al. 2008a: 267, COE et al. 2008b: 272). The global production network perspective tries to elaborate the impact of the diverse structures mechanisms associated with global consumptions and production on upgrading and development efforts of local firms (HENDERSON et al. 2002: 457f.). The core mechanism they identify is ‘strategic coupling’ (COE et al. 2004: 469) – a process in which regions and global production networks are ‘mediated through specific action and practices of key actors and institutions’ (COE et al. 2004: 482). Recent contributions to the GPN framework raised questions of the potential concurent goals between external and local firms, where external firms in the GPN reap the benefits of production arrangements at the expense of local producers (COE & HESS 2011: 134). The GPN framework experiences unbowed popularity among economic geographers studying the effects of globalization and globalized production on local production regimes. While much empirical work has been devoted to the role of power and governance structures in global production networks, their implications for knowledge transfer and supply chain-induced learning received considerably less empirical attention. According to ERNST (2002: 508), global production networks can be considered as an ‘organizational innovation.’ They consist of an extensive network of agents (e.g. suppliers, affiliates, etc.) centered on a network flagship, as well as their interactions (distribution, cooperative agreements). The flagship will break 7

OEM = Original equipment manufacturing; EMS = Electronics manufacturing services

2. Theoretical and conceptual background

45

up the product value chain into separate steps and locate them accordingly to specific requirements (ERNST 2002: 508). With this approach, the authors tried to gain a better understanding of the processes of capability formation of local supplier networks, especially beyond the lead-firm-key supplier dyad. Tab. 2.1: Mechanisms of knowledge transfer Active

Passive

MarketMediated

(1) Formal mechanisms: (2) Commodity trade: FDI, FL, turnkey plants, Standard machinery transfer technical consultancies

Non-MarketMediated

(3) Informal mechanisms: (4) Informal mechanisms: Flagship provides technical Reverse engineering, obassistance to local supplier servation, literature

Source: Own compilation based on Ernst & Kim (2002: 1424)

By referring to the global production network paradigm, ERNST & KIM (2002) have developed a conceptual framework to analyze the impact of global lead firms on the development of technical capabilities among local suppliers (Tab. 2.1). Their analysis draws largely on the theory of knowledge and organizational learning. According to their framework, lead firms can exert considerable pressure on their local supplier networks to develop production capabilities according to the lead firms’ requirements. Hence, knowledge can be transferred through active commitments (FDI, technical consultancy), or passive forms (machinery requirements or reverse engineering by local supplier) (ERNST & KIM 2002: 1424). The success of local adaption of knowledge is in turn dependent on the forms of the transferred knowledge (tacit or codified) as well as the ability of the local firms to adapt and integrate the new knowledge into the existing knowledge base (ERNST & KIM 2002: 1426). They conclude that upgrading of local firms integrated into global production networks is by no means an automatic process, but demands considerable efforts of local firms (ERNST & KIM 2002: 1427f.). In contrast, MORRISON et al. (2011) have proposed a framework to study governance in the global value chain by considering the contributions made by the technological capabilities literature. According to this perspective, local firms need to invest in the development of competences (managerial, technical, and organizational) in order to be able to utilize their existing assets in an efficient manner. The developed competences (routines) are unique to the firm and accumulated over time, and result in learning. Hence, the development of technical capabilities in a firm is neither an external process nor happening automatically. In addition, the success of learning is dependent on the channels and forms of knowledge transfer, the complexity of the transferred knowledge, as well as the ability of local agents to integrate new knowledge into their existing stock of knowledge and

46

2. Theoretical and conceptual background

organizational routines (MORRISON et al. 2008: 41f.). Combined with the consideration of governance, the authors argue that power asymmetries in the global value chain between the buyer and producer will be a crucial determinant for the possibility of knowledge transfer (MORRISON et al. 2008: 46). In a recent contribution, PIETROBELLI & RABELLOTTI (2011) propose an integration of global value chain governance and innovation system literature. In their view, the global value chain and the host country’s innovation system will benefit mutually. On the one hand, the global value chain will help to improve capabilities of the innovation systems which, on the other hand, will lead to better opportunities for global sourcing, and thus better chances for learning and innovation within local firms. They contend that the development of efficient institutions, namely technology policies and technology organizations, will reduce transaction costs for lead firms in the global value chain, thus leading to a stronger reliance on market-based governance forms and opening up opportunities of learning and innovation for chain partners (PIETROBELLI & RABELLOTTI 2011: 1264f.). Modes and determinants of knowledge transfer To assess the effect of technological spillover on local firms, it is useful to distinguish between the forward and backward linkages of a firm. In forward linkages, effects are related to the interaction between the firms and their buyers. These can be, for instance, links between a global lead firms and international buyers (e.g. buyer links or effects on home countries’ labor markets). In contrast, backward linkages are the connections that lead in upstream direction of the supply chain, mostly between foreign-invested enterprise and their domestic suppliers. For the sake of foreign direct investment (FDI) and local capability formation, the analysis of backward linkages is more important as these effects are expected to have immediate effects on the participating local firm. Modes of knowledge transfer between firms can differ substantially. LAURIDSEN (2004: 564) distinguishes several means of knowledge transfer between multinational companies and their local business partners. The first channel, demonstration, happens when local firms start to copy some parts of the technology brought in by the foreign firms (CRESPO & FONTOURA 2007: 411). Reverse engineering of products produced by the multinational company is a common way for local firms to develop skills and technical understanding (BLOMSTRÖM & KOKKO 2002: 3f.). Technology embodied in products, components, and processes might not yet be available on the local market, so offering it to domestic or other international customers might lead to possible better market position for local firms. Another channel or mechanism of transfer is competition (LAURIDSEN 2004: 564). Increasing competition for local firms created through the existence of a foreign enterprise might lead to stronger incentives and efforts with local firms, thus boosting their products/processes and overall efficiency. This effect might not only be limited to the initial industry the foreign firm is engaged in, but also in the wider supplier network (BLOMSTRÖM & KOKKO 2002: 3). Hence, the possible

2. Theoretical and conceptual background

47

effects of this channel might be widespread in the host countries’ economy. However, it might be considered critical that fierce competition imposed by foreign firms might out-compete or crowd-out their local counterparts (BLOMSTRÖM & KOKKO 2002: 5). Other channels and measures draw on the human capital perspective. In this view, local firms can benefit from training measures received from multinational companies. While this deliberate process will require the willingness of the foreign partner to invest in their local suppliers, ‘poaching’ of staff that previously worked for multinational firms might be an option to strengthen the human capital base in local firms (LAURIDSEN 2004: 564). Forms of training measures might vary across companies. Possible forms are simple on-the-job training for manufacturing personnel to more formalized training programs such as seminars or formal schooling (BLOMSTRÖM & KOKKO 2002: 13f.). Deliberate efforts, such training and other supportive measures (enhancement in quality control, or assistance in the procurement of raw materials) of foreign firms to develop their local suppliers will also be dependent on the amount of local sourcing in the host economy. This, in turn, might be especially important if the quality and time requirements of the international firms are crucial (CRESPO & FONTOURA 2007: 412; LAURIDSEN 2004: 565). On the whole, the possible channels and measures to benefit from the interaction with (foreign invested) enterprises are numerous and might enhance local firms’ performance in various ways. Nonetheless, a certain level of capabilities in the local supply base is a necessary precondition to benefit from interaction with foreign firms. Moderating factors for the success of FDI spillovers might be related to institutional differences. Factors such as language and culture might influence the possibility of mutual learning and interaction between partners. This will also depend on the sourcing patterns that can be associated with the foreign investor. Besides, the degree of foreign ownership is another variable to influence the degree of knowledge exchange, especially if FDI takes place through joint venture agreements. Hence, minority foreign ownership might exert a negative impact on the willingness to share and exchange crucial knowledge to local partners. In contrast, JAVORCIK (2004: 622) found that stronger domestic ownership in FDI (joint venture agreements) would lead to stronger local sourcing, thereby contributing to better backward linkages and possibilities for spillovers. In addition, the intellectual property rights (IPR) regime of the host country might influence the sourcing patterns of foreign companies. A weak protection of IPR will reduce incentives for foreign firms to engage in strong cooperative relations with local partners due to the danger of knowledge leakage (CRESPO & FONTOURA 2007: 414f.). Empirical examples of FDI-induced learning Despite the promising theoretical perspective, empirical results for the effectiveness of FDI for the development of technological capabilities among local firms are ambiguous. Their difference from various research regions indicates the im-

48

2. Theoretical and conceptual background

portance of considering institutional factors moderating the potential for knowledge transfer. In her study of the Thai manufacturing industry, LAURIDSEN (2004) supports the thesis of the possibility for local firms to benefit from interaction with multinational enterprises. She stresses the importance of the supporting institutional structure in the form of state policies. KIYOTA et al. (2008) explored vertical linkages of Japanese multinational enterprises. Based on their results, the length of operation abroad influences the amount of local sourcing; hence, linkages develop gradually over time. Their results are coherent with previous studies: Local firms are able to improve their quality through the interaction with Japanese firms (KIYOTA et al. 2008: 1408). For China, THOMSON (2002) studied the effects of local clustering on the efficiency of knowledge transfer through FDI. His results suggest that geographically clustered, Hong Kong-based garments firms operating in the PRD are more strongly integrated into knowledge transfer (backward linkages as well as horizontal linkages) than their unclustered counterparts. Using provincial-level panel data, CHEUNG & LIN (2004) estimate the effect of FDI on domestic innovation activity in China. They find positive evidence for innovationrelated spillover effects in minor innovations measured by domestic patent application for utility model and design patents. LIN et al. (2009) evaluate the effect of inward FDI on domestic manufacturing firms in China using a panel data and total factor productivity approach. Their findings corroborate the position of a positive effect of FDI productivity spillovers on local manufacturing firms. Horizontal spillovers (effects of demonstration or competition) are observed for all forms of FDI regardless of motivation, original, or ownership pattern. Vertical spillovers (through the value chain; backward linkages) were measured for non-Hong Kong, Macau and Taiwan (HKMT) firms, mostly from OECD countries (LIN et al. 2009: 688f.). Using a similar methodological approach, ABRAHAM et al. (2010: 170) find export-processing FDI to be less effective in the generation of domestic productivity spillovers due to increasing competition, especially from HKMT firms. Their results indicate that joint venture agreements have a more positive impact on local manufacturing firms compared to investment from foreign-owned firms. Recent results, such as that presented by FU & GONG (2011), try to distinguish the effects of domestic and foreign effects on technological upgrading in Chinese firms. Using panel data for the period from 2001–2005, they conclude that neither Chinese nor foreign firms ‘dominate the technology frontier in China’ (FU & Gong 2001: 1222). Their results concerning the effect of FDI on local firms are mixed, and they conclude that the benefits of FDI for local firms might be limited. While technology transfer might facilitate technological development, according to the authors, this effect is limited to an early stage of development and to the second-tier technologies (FU & GONG 2011: 1222). In order to catch up with the world technology frontier, considerable domestic innovation effort is necessary (FU & GONG 2011: 1222). The discussion on potential sources for knowledge to carry out innovation activities shows that it is crucial to invest both in firms’ internal and in absorptive

2. Theoretical and conceptual background

49

capabilities, and to strengthen ties with foreign firms to gain access to relevant knowledge (LI et al. 2010: 262f.). Factors such as ownership type and investment motivation moderate the effect of foreign direct investment. 2.2.4 The latecomer firm: Resource constraints and innovation strategies Firms in developing economies are in a disadvantaged position in resource endowment to engage in innovation activities. In contrast to established firms, their position as late-entrants into markets leads to disadvantages associated with established consumer preferences, as well as their distance from lead markets, technology sources, and relative scarcity of innovation-related resources in their economies (WONG 1999: 5). This general observation marks the starting point for the so-called LLL approach proposed by MATHEWS (2002). Arguing from a resourcebased view (WERNERFELD 1984), MATHEWS claims that the so-called latecomer firms need the process of ‘linking-leveraging and learning’ (MATHEWS 2002: 467) in order to overcome their resource-constrained position and upgrade their technological capabilities. Since their initial resource endowment is inferior in comparison with multinational firms and therefore insufficient to innovate at the technological frontier (HOBDAY 2000: 131), these firms need to make strategic investments in developing linkages with international partners and leverage their existing resources in order to learn from their partners. When doing so, latecomer firms will try to access resources that are least rare, most imitable, and most transferable (MATHEWS 2002: 481). The two dimensions of technological capabilities can be conceptualized as product and process technological capabilities (WONG 1999: 6). MATHEWS’s (2002) most compelling argument is that it links the spillover argument (BLOMSTRÖM & KOKKO 2002), proposed by GVC and FDI scholars, with processes at the firm level, thus opening the black-box of the firm. Most importantly, it puts local learning in the context of strategic decision-making, detaching it from any kind of automatism that might be perceived in local capability formation (MATHEWS 2002: 485). WONG (1999: 5f.), however, shows that the position of late-entrants is not only associated with the abovementioned disadvantages. For instance, latecomer firms possess relative flexibility or agility to technological shifts and changes in technical regimes, and usually do not exhibit the same degree of organizational inertia than their established counterparts. In addition, they are able to gain from ‘free-riding’ on information, which is established at a cost by early entrants, and can potentially gain from observing firms and industrial development trends. In his research on Asian latecomer firms and their technological development, HOBDAY emphasized the importance of the original equipment manufacturing (OEM) sector (HOBDAY 1995 / 1998):

50

2. Theoretical and conceptual background

Fig. 2.4: The OEM to OBM cascade. Export-led learning in latecomer firms. Own draft based on HOBDAY (1995: 1184)

’OEM is a specific form of subcontracting that evolved out of the joint operations of TNC buyers and suppliers in new industrializing economies (NIE). Under OEM, the finished product is made to precise specifications of a particular buyer […] who then markets the product under its own brand name, through its own distribution channels’ (HOBDAY 2000: 133).

The rise of the OEM development model (Fig. 2.4) is a common form of production organization in the electronic industry, where it originated with US-based companies using East Asian suppliers for equipment production. The system consequently developed through the 1960s to the 1980s, evolving into a more sophisticated system of contract production. Long-term OEM agreements led to the development of technological relationships between trans-national companies (TNC) and local OEM providers. High quality requirements, coupled with training, technological exchange, and the development of production capabilities, led to the accumulation of knowledge and skills in local OEM providers (HOBDAY 2000: 134ff.). This approach to developing technological capabilities among latecomer firms has been conceptualized as the ‘Reverse Value Chain’ Strategy (WONG 1999: 8). Once technological capabilities start to grow stronger, some local providers may advance into the so-called original design manufacturing (ODM) stage, providing design services for larger TNCs. The final stage of the OEM cascade is the development of products under their own brand name, the socalled original brand manufacturing (OBM). In this stage, local firms are able to capture the most post-production value-added. The development trajectory de-

2. Theoretical and conceptual background

51

Fig. 2.5: Paths of Technological Capability Development. Own draft based on WONG (1999:30)

scribes the continuous accumulation of skills and routines and their subsequent internalization into technological knowledge, leading to a path away from dependent assembly and manufacturing activities into a full-scale self-reliant production. The development of process capabilities is followed by the development of product capabilities (WONG 1999: 10). The gap in technological capabilities thus subsequently narrows between TNCs and local manufacturing firms (HOBDAY 2000: 134). However, as TNCs are not altruistic development agencies, not all OEM relations develop into self-dependent innovations. The dependency on TNC’s willingness to share technologies and expertise as well as the subordinate position of local suppliers might remain throughout the production arrangement (HOBDAY 1995: 1178). In addition to the OEM to OBM development trajectory, WONG (1999) was able to identify four other generic routes for technological development for latecomer firms by focusing on the role of strategic decision making in latecomer firms (Fig. 2.5). In the so-called ‘Reverse Product Life Cycle’ strategy, latecomer firms start by manufacturing relatively mature and established products by licensing core technologies or by means of `imitative learning’ (WONG 1999: 9). In this approach, firms can benefit from their latecomer status by utilizing their relative cost-competitiveness but have to engage in continuous learning of product, and process, and R&D technology. Incremental innovation is the key driving force of technological change in firms. One of the biggest challenges of the ‘Reverse

52

2. Theoretical and conceptual background

product Life Cycle Strategy’ is the demand for the latecomer firms to simultaneously enhance product and process capabilities. The development of process capabilities is the ‘Process Capability Specialist’ Strategy which is linked to the systematic enhancement of process technologies and sophisticated production routines, and avoids the risks associated with product commercialization (WONG 1999: 10f.). The development trajectory is aimed at advanced manufacturing solutions under high operational flexibility, short lead times, and a quick ramp-up of production lines – capabilities commonly found in many contract manufacturing firms or electronic manufacturing service providers (HÜRTGEN et al. 2009 / LÜTHJE et al. 2002). When engaging in the ‘Product Technology Pioneering Strategy,’ latecomer firms need to rapidly catch up with the technological frontier by engaging in radical product innovation. This difficult strategy can be carried out by several approaches. First, it requires firms to invest substantially into international presence in lead-user markets and the development of marketing channels, while engaging in an aggressive pursuit of required product technology. In another way, latecomer firms can acquire the needed sophisticated technologies by acquiring foreign firms or poach highly qualified staff from leading international competitors and use knowledge embodied in technical staff. Lastly, the strategy can be pursued by substantial home R&D efforts. All forms of aggressive outward orientation or strong home-based R&D need to be backed by substation resources from the firms’ home country (WONG 1999: 11). One can imagine that resources provided by home countries’ national authorities by means of progressive innovation policies. The last strategy of ‘Application Pioneering’ aims to find new solutions for the application of existing technologies (WONG 1999: 13f.). In particular, service providers can benefit from this strategic approach to latecomer innovation. 2.2.5 Systems of innovation in China and the Pearl River Delta The previous sections showed that firms in developing economies can potentially access a broad array of external knowledge sources. If their strategic orientation and other constraints allow them to do so, they can subsequently carry out innovation activities and upgrade their technological capabilities. In order to systematize the process of industrial upgrading, namely the process of the development of technological capabilities in an industry, and integrate it into the larger perspective of an economic (sub-) system, the innovation system approach offers a useful conceptual approach. The concept of innovation system was developed in the late 1980s and emerged as a dominant research concept throughout the 1990s (SCHILLER 2006: 7). It aims at a systematic evaluation of all economic, social, political, organizational, and institutional factors in their impact on the creation and diffusion of knowledge in a national perspective (SCHILLER 2006: 7, EDQUIST 1997). According to LUNDVALL (1992: 10), the combination of the production organization as well as the institutional governance structure are the main determinant of the innovation system. More recent contributions, such as by BRACZYK et al. (1998),

2. Theoretical and conceptual background

53

shift the focus of analysis to the sub-national, namely the regional level, which is linked to global and national systems (BERGER & REVILLA DIEZ 2006: 115). Scholars of the RIS approach believe that region-specific conditions and the interaction of relevant actors and organizations determine the outcome of regional innovation performance (SCHILLER 2006: 28). While the system of innovation (SI) literature has largely focused on developed economies, there have been first attempts at adapting the concept for developing economies, such as China (YANG 2014; FU 2011). Nascent innovation systems in developing economies such as China are characterized by the scarcity of innovation-related resources and obstacles in the interaction between the relevant actors. The institutional structures that govern the interaction in the system are commonly not mature and reliable. The relative scarcity of innovation-related resources within the system boundaries hints at the importance of external knowledge sources, for instance by embodying product or resources of foreign firms (SCHILLER 2006: 9; LALL 2000: 15ff.). Besides, the internal capacity to be able to benefit from imported knowledge needs to be enhanced. This requires substantial investment in human capital development by means of investment in efficient education infrastructure as well as technical training for the local workforce (SCHILLER 2006: 9). However, HENNEMANN & KROLL (2008: 16) point out that China faced with a severe backlog with regard to the availability of highly qualified human capital and BAARK (2007: 353) emphasizes the role of strong state planning in the relative weakness in the Chinese RIS – especially with regard to education. In China, the state and provincial political authorities play a leading role in formulating national and regional innovation policy. The enhancement of technological capabilities in local firms as well as the provision of higher education has been among their core policy goals and was implemented in large-scale innovation-related programs such as ‘Torch’ (1988) and ‘Spark’ (1986) (HUANG et al. 2004: 373). However, China’s current political approach to innovation policy might conflict with the actual demand in innovative firms (KROLL & SCHILLER 2010: 125). China’s approach to absorbing technology has largely relied on the potential of spillovers by foreign firms operating in China. While the ‘market for technology’ (YANG 2014) did not yield the expected technological advancements, the Chinese administration initiated a shift in priorities toward the development and promotion of indigenous innovation (YANG 2014). Domestic enterprises are encouraged to upgrade technological capabilities to be able decrease their reliance on foreign technological assets. To achieve these goals, the government indentified several ‘strategic emerging industries’ (SEI) that are supposed to spearhead the new national innovation policy (LIU & CHENG 2011: 11f.). According to LIU & CHENG (2011: 45), this marks a major break with old innovation policies, as private enterprise were usually except of the formulation of innovation policy while SOEs as well as the complex of universities and governmentally-run research institutions were considered the engines of the above-mentioned policies.

54

2. Theoretical and conceptual background

The implementation of regional innovation policy and the creation of innovation systems in China follow a regionalized pattern. For instance, Beijing hosts the highest density of national research institutions as well as Tier-I universities; the regional innovation landscape has a stronger focus on government-funded innovation activities. The industrial focus is set on high-tech industries which are nourished in specialized science parks such as Zhongguancun in Beijing (LIEFNER & HENNEMANN 2006). In the PRD, the regional innovation system is largely concentrated around a large number of foreign enterprises and their interaction with the local supply base of predominantly SMEs. Historically, the region not been a main destination for national public R&D investment (OECD 2010: 132ff.). In quantitative terms, innovation activities play a major role in the province, as the region is one of China’s leading regions in terms of patent application. However, a closer look reveals that a few large and dominant enterprises in the telecommunication sector, such as Huawei Technologies and ZTE, are the main engines of quantitative innovation growth and patent output in the province (OECD 2010: 134; KROLL & TAGSCHERER 2009, ALTENBURG et al. 2008: 333). Their success in patenting and innovation is also closely related to the process of R&D internationalization and does not solely depend on leveraging domestic innovation resources (CHEN et al. 2011). In contrast, large parts of the regional manufacturing base demonstrate only limited innovation efforts and performance. KROLL & SCHILLER (2010: 122f.) conclude that the PRD still lag behind Beijing and Shanghai in terms of regional innovation performance. The OECD (2010: 134) thus recommends strengthening innovation cooperation between public research organizations, universities, large firms, and SMEs in the province. While the provincial government has invested heavily in the regional innovation infrastructure, with such large-scale projects as the ‘Higher Education Mega Center’ located in the provincial capital of Guangzhou, the regional innovation system remains fragmented and weak. The region faces problems related to qualified personnel. Besides, many small and medium-sized firms, which are the backbone of the provincial economy, are reluctant to carry out innovation activities. Despite insights presented by LU & WEI (2007), who argue that the regional innovation system of the PRD is continuously maturing into a self-dependent innovation system independent of foreign economic guidance, it is obvious that foreign knowledge sources are still an important pillar of innovation in the PRD. Analysis of industry-level data for the PRD shows that domestic firms are performing significantly worse than their foreign counterparts; however, their innovation performance is still higher compared to state- or community-owned firms. Among foreign-owned firms, HKMT-based firms show lesser tendency to innovation than other foreign firms (SCHILLER 2011b: 32). LIN et al. (2011: 3016) conclude that internal R&D activities are considered the most important source for technological innovation among ICT firms in Shenzhen and Dongguan. FU et al. (2012) trace the origins of the regional innovation system in Shenzhen and Dongguan by embracing an evolutionary approach. They find that both Shenzhen and Dongguan demonstrate quite different evolutionary development paths with re-

2. Theoretical and conceptual background

55

gard to their regional innovation systems. While Shenzhen follows a ‘dirigist’ approach featuring a strong involvement of governmental authorities, and thus host a more mature RIS structure nowadays, Dongguan’s RIS developed from grassroots base of self-organized growth surrounding trade arrangements of Hong Kong- and Taiwan-invested firms (FU et al. 2012: 548ff., YANG 2009: 398ff.). It is thus not surprising that Shenzhen was termed as ‘innovation city’ by the State Council in 2011 and the municipal government embarked on the development of a master plan for its subsequent implementation (YANG 2014). The distinctive development paths led to more efficient innovation patterns and governance structures in Shenzhen compared to Dongguan. Studying the backward linkages among Taiwanese firms operating in Dongguan, YANG & LIAO (2010a) point out that the degree of integration between Taiwan-based firms and local suppliers is weak. These ‘exclusive networks’ (YANG & LIAO 2010a: 213) further decrease the potential for inter-firm interaction, upgrading, and innovation. In her recent contribution, YANG (2014) traces the development of Shenzhen’s light-emitting diode (LED) industry under the policy shift of strategic new industries and the governmental attempt to boost domestic innovation capacity. She finds that while FIEs, operating in the LED industry, have been incentivized by increasing domestic demand for LED products, domestic firms were driven by governmental subsidies. The subsequent results were overcapacities in domestic LED production and a quickly following abolishment of the LED promotion policy in Shenzhen. This case also reflects the influence of changing national policy and national economic planning as put forward by HEILMANN & MELTON (2013). The energy efficiency goals formulated in the 11th Five-Year Plan were broken down for provinciallevel implementation. The initiative to foster energy-efficient LED technologies can thus be understood as a response to national policy-making and the subsequent abolishment also as a reaction to changing planning goals. I have shown that the RIS in the PRD depicts a specific case of regional innovation dynamics within the Chinese NIS. Its specific structure of innovationrelated actors and governing institutions can be seen as an obstacle to the transformation of the RIS into a self-dependent innovation system. 2.2.6 Interim conclusion In this section, I laid out the conceptual foundation for the understanding of the process of learning and innovation in firms in developing economies, and presented relevant theoretical contributions of the field of innovation theory and development economics. I started by clarifying core concepts of innovation theory – namely the processes of learning, innovation, and knowledge absorption. I showed that the process of organizational learning is dependent on the capability of identifying and absorbing relevant information and transform it into useable knowledge, which then needs to be integrated into a company’s stock of operational routines. I then discussed different sources of knowledge useable for firms by differentiating be-

56

2. Theoretical and conceptual background

tween internal and external sources. I showed that especially external resources are crucial for firms in developing economies, as these firms are commonly disadvantaged in their initial resource endowment concerning innovation-related resources. The concepts of value chains and global production networks are heuristic concepts to understand the processes of the reorganization of international production and the integration of firms in developing economies into the process of global production regimes. I discussed modes and possibilities of knowledge transfer in the abovementioned concepts, such as the potential for local learning through foreign direct investment (FDI). Regarding the example of China, I demonstrated that the empirical evidence of FDI-induced learning and capability formation remains ambiguous and depends greatly on moderating and institutional factors that influence the process of knowledge transfer. Next, I shifted the focus to the strategic perspective of latecomer firms that can embark on diverse sets of strategies to engage in the process of capability formation and industrial upgrading. The discussion of the relevant literature showed that there is no universal path for latecomer firms to engage in industrial upgrading, but the outcome of the process will depend on strategic investment in specific firms’ capabilities, such as product- and process-related capabilities. Lastly, I demonstrated the perspective of the innovation system literature, by scaling up the previous insights to a regional perspective. I pointed out the differences and similarities between China’s national and Guangdong’s provincial innovation system. I showed that even on the sub-regional level, there are distinct differences in regional innovation systems, such as between different cities in the PRD. The review of literature showed that Guangdong’s regional innovation system remains fragmented and that internal innovation capability, especially in domestic firms, is low. However, the review showed that domestic innovation capabilities are considered increasingly important for the development of the RIS which is also encouraged by regional policy-makers. The influence and importance of foreign firms in the RIS and their impact on local capability formation remain disputed. 2.3 DEVELOPING AN ANALYTICAL FRAMEWORK In this section, I will develop the analytical framework for the following empirical investigation into the role of institutional factors influencing firms’ innovation activities as well as the region’s potentials for industrial upgrading. Before conceptualizing the different approaches and fields of the empirical investigation, I will give some brief explanations of the chosen empirical case study.

2. Theoretical and conceptual background

57

2.3.1 Case study selection: The electronic industry My main objects of analysis are electronic manufacturing firms in the PRD. The larger electronic industry serves as the industrial-level case study. The definition of the electronic industry is derived from HOBDAY (2001: 14), and can be separated into six major building blocks, namely: Consumer Electronics, Telecommunications, Defense, Computing, Industrial, and Semiconductors and other components. Companies solely operating in the development of software are not included in this working definition of the electronic industry as it explicitly focuses on the manufacturing parts of the industry. The statistic classification is derived from the ISIC8 Rev. 4, Division 27 ‘Manufacture of electrical equipment’ (except manufacturing of cables and wires) as well as Division 28, Class 2817, ‘Manufacture of office machinery and equipment’ (UN 2008). For the analysis of secondary statistical data, I referred to the definition provided by the Chinese National Bureau of Statistics9 which categorizes the electronic industry by: 39: ‘Manufacture of Electrical Machinery and Equipment,’ 40: ‘Manufacture of Communication Equipment, Computers and Other Electronic Equipment’ as well as 41: ‘Manufacture of Measuring Instruments and Machinery for Cultural Activity and Office Work’ (NBS 2012). The reliance on an industrial case study reflects both pragmatic considerations and specific regional as well as industrial conditions in the research region: The pragmatic reasons for referring to an industrial case study are grounded in the conflict between the scale and scope of the analysis. If I referred to a larger scale that would encompass regional economic change of the region as a whole or several industries, the analysis could not pay specific attention to processes at the firm level. The research team thus decided to continue the existing strand of research based on firm-level investigations as these have proven to be the most insightful for the analysis of processes within as well as outside of the firm. The electronic industry has an important position within the region. Contributing to approximately 32% to the total provincial value-added in 2010, the electronic industry is by far the leading industrial sector in the province. A look at the research region reveals that in the city of Shenzhen, the electronic industry even accounts for 60% of total industrial value-added, 30% in Foshan, 36% in Dongguan, and 32% in Zhongshan10 (cf. Fig. 2.6). The PRD is one of the three main regional hubs for the production of electronic products in China besides the Shanghai and Beijing region. Due to its function as a testing ground in the opening and reform policy, the PRD was exposed to foreign direct investment from Hong Kong and Taiwan at a very early stage of the development process.

8 International Standard Industrial Classification of All Economic Activities 9 China Statistical Yearbook (2011) 10 All calculations are based on the Statistical Yearbook of Guangdong Province (2011)

58

2. Theoretical and conceptual background

Fig. 2.6: Industrial characteristics of the survey region. Own draft, based on GD PBS (2011).

2. Theoretical and conceptual background

59

The industrial structures in the electronic industry are thus very mature and show a high degree of regional differentiation. These region differentiations pose interesting opportunities for an analysis of specific sub-regional institutional structures. While the generalization of results obtained from the case studies is subject to debate, the interpretation of results of a province’s largest industry at least allows for the best plausible projection of the obtained results. Lastly, industrial considerations also made me refer to the case study of the electronic industry: (1) The electronic industry is highly segmented and shows a strong international division of labor. Production regimes are globally spread and locally embedded. This allows for a specific analysis of the role of foreign firms in the process of knowledge transfer. (2) The industry is very diverse and covers all kinds of products at different levels of technological sophistication. It thus allows for an analysis of different stages of firm innovation at different points of time. The industry features relatively mature products, such as household appliances surrounding open technological standards, as well as highly sophisticated semiconductors or close standard products (BORRUS & ZYSMAN 1997, STURGEON & KAWAKAMI 2010: 257). (3) In comparison with other industries, the electronic industry is one with a rapid speed of innovation and product renewal. The speed and dynamics of development have contributed to a strong internal separation of the industry into various sub-industries and product categories that show distinctive development trajectories. The Information technology (IT) industry, one important pillar of the electronic industry, is among the fastest developing industries in the field of electronics as demonstrated by the development of semiconductor sizes as well as the continuously growing hard-drive capacity (POON 2004: 135f.). This is especially important as I try to assess the role of innovation for the process of regional economic change. (4) Product demand for electronic products is both driven by international buyers and a drastically increasing number of customers in China. The industry is largely consumer-driven (despite certain exceptions), and shows both international volatility and domestic growth potentials. Today, domestic brands and a dense network of SMEs in China have led to the development of a multifaceted landscape of production (FU 2011: 3; PEIGHAMBARI 2013: 15f.). 2.3.2 Analytical structure For conceptual reasons, I will refer to SCOTT’s (2008: 51) approach of the institutional pillars. As it is not possible to engage in a comprehensive evaluation of all institutional patterns among electronic firms in the PRD, I will concentrate on specific institutional fields that I identified as important for the process of innovation and industrial upgrading. The following differentiation between regulative and cultural-cognitive institutions is purely for conceptual purpose, and does not present the analytical structure followed in the empirical chapters. Due to the overlap between the two institutional pillars, I will concentrate on the description and analysis of the underlying institutional structures and arrangements without placing them within the conceptual boundary of the institutional pillar.

60

2. Theoretical and conceptual background

The structure of the following empirical investigation is twofold: Chapters 4– 6 are dedicated to the processes taking place with the PRD. This firm-level perspective seeks to elaborate strategies of adaption to institutional pressure, and address specific institutional structures and the governance of institutional arrangements. In the second part (Chapter 7) I will scale up the previous results and enhance the firm-level perspective by a region-level evaluation that pays specific attention to the role played by national and provincial policy in the debate surrounding the process of industrial and upgrading in Guangdong and the PRD. 2.3.3 The regulative dimension The regulative dimension encompasses institutional structures that mainly constrain firm in their pursuit of individual agenda. For instance, the role of intellectual proper rights (IRP) protection in discouraging firms to carry out substantial innovation activities is strongly debated (HU & JEFFERSON 2009; MASSEY 2006; LIU & JIANG 2001). Contrary to existing empirical studies, I will focus on other institutional factors influencing firms’ innovation performance that did not receive sufficient empirical attention. Firstly, I want to elaborate the role of innovation and upgradingrelated policy as well as the regulative role of market pressure (Chapter 4). Especially, in the aftermath of the global economic crisis, regional policy-makers have increasingly showed their willingness to transform the PRD into an advanced manufacturing region based on high-value added manufacturing (WANG 2010). Besides the firm-level perspective, I want to extend the investigation to the role of regulative policy from a regional perspective that compares Guangdong’s industrial development path with China’s more general growth path, reflecting recent industrial changes in light of changing policy regimes (Chapter 7). Besides the regulative role played by political bodies, I will try to evaluate the effect of the financial market on firms’ innovation performance (Chapter 5). While the topic of financial reform has received considerable theoretical and empirical attention, little research has been conducted into the role of financial institutions in firms’ innovation performance. By doing so, I will try to contribute to the closure of the research gap identified in this intersection of institution- and innovation-related analysis. 2.3.4 The cultural-cognitive dimension It is not surprising that an analysis of the role of financial institutions cannot be imagined without the consideration of the role of cultural-cognitive institutional structures. As I have already elaborated the concepts of guanxi for the economic sphere in China, I will now integrate the observation made into the empirical investigation. I have shown that informality plays a key role in providing Chinese firms with necessary flexibility and agility to operate in highly volatile environ-

2. Theoretical and conceptual background

61

ments. Additionally, I will try to evaluate the double-edged role of informal institutions, as it remains questionable if the reliance on informality is truly beneficial in the firms’ individual pursuit of innovation-related business models. Lastly, we have seen that the electronic manufacturing industry is highly segmented and characterized by a strong division of labor between individual steps of production. So far, scholars have emphasized the analysis of these value chains with regard to governance patterns and the question of power and control. While there is extensive research on the patterns and modes of knowledge transfer in developing economies, a systematic investigation into the role of supply-chain interaction in firms’ innovation performance is still missing. I will try to fill this gap in my investigation into the role of institutional governance of supply-chain interaction in the electronic manufacturing industry (Chapter 6). Specific attention will be paid to the role of cognitive proximity in its effect on knowledge transfer. Given the skepticism regarding the efficiency of knowledge transfer in FDIinduced modes of interaction between lead firms and local suppliers, one can assume that interaction in value chain, which is characterized by a higher degree of institutional proximity (stronger cultural proximity), might demonstrate the higher propensity to effective transfer of information and knowledge.

Fig. 2.7: Conceptual framework for the empirical investigation. Own draft.

62

2. Theoretical and conceptual background

2.3.5 The institutional perspective on regional economic upgrading While my analysis of institutional structures and arrangements will remain only a fragment of a comprehensive investigation into the role of institutions in the pursuit of a new regional economic development mode, the aim of my empirical investigation is twofold. Firstly, I want to contribute to stronger empirics in institutional analysis regarding the role of firm-based innovation, leaving behind the predominant, shallow conceptualization, and treatment of institutions in economic geography. Secondly, I would like to raise awareness about a more systematic treatment of the role of regulative policy concerning regional economic research in China. Economic geography needs to overcome the ill-nourished treatment of policy that perceives China as a monolithic political structure or a simplified receiving end in the process of `strategic coupling’. The acknowledgement of this research by the fields of political science and political sociology can greatly benefit research in economic geography of China and Asia. Fig. 2.7 presents the conceptual framework of this thesis.

3. METHODOLOGY In this chapter, I am going to discuss the applied research design and briefly the utilized methods used in the empirical investigation. I applied a mixed-methods research design (JICK 1979) with a focus on quantitative research by means of survey-data and the analysis of secondary statistics, as well as supporting semistandardized qualitative interviews. This approach helped to clarify the obtained survey results and thus supported the process of interpretation (JICK 1979: 608f.). The three separate datasets create the following structure of empirical material, presented in Fig. 3.1. 3.1 EMPIRICAL RESEARCH DATA 3.1.1 QUANTITATIVE SURVEY DATA (2011) The latest phase of field data collection in the PRD started in September 2011 and data collection was concluded in January 2012. The process of questionnaire preparation and development took place in Germany and China, and was carried out jointly with colleagues of the University of Giessen and our Chinese research team comprising Prof. Li Xun from the School for Geography and Planning at the Sun Yat-sen University in Guangzhou. The questionnaire covers five thematic fields: (1) Strategy, (2) Innovation activities, (3) Management & Human resources, (4) Suppliers/Customer relations, and (5) Business environment (details can be found in the methodological appendix). Our regional focus encompasses a comparative perspective as this research project aimed at identifying differences in the regional economic growth models between the East and the West parts of

Fig. 3.1: Structure of the utilized datasets for the emirical investigation. Own draft.

64

3. Methodology

the PRD. Sampling was carried out in the cities of Shenzhen and Dongguan in the eastern, and Foshan and Zhongshan in the western delta. During the process of questionnaire development, the research team continuously engaged in discussions with researchers experienced in firm-level research in the PRD and China, to avoid common pitfalls in cross-cultural research and in the development and formulation of questionnaire items (ROY et al. 2001: 206f.). Their bilingual language training and knowledge in economics and geography, as well as proficiency in economy-related vocabulary, ensured the consistent back translation of the developed survey items (BRISLIN 1970). We were ready to face increasingly problematic research conditions as the region was hosting numerous international research teams and local firms were increasingly reluctant to participate in the numerous state and private surveys. Regarding the complicated research environment, YANG (2009: 394) points out that qualitative research should be the mode of choice for firm-based research in the PRD. However, due to previous experience with quantitative research in the PRD (2007 and 2009) and our capable local research partner, we decided to embark on using primary quantitative methods. The pre-test of the questionnaire was carried out in 10 selected firms identified at the Shunde Consumer Electronics Fair (August 19–22, 2011), as well as during expert interviews with participation of the research team. Participating managers were asked to point out questions they found confusing or ambiguous. During this iterative process, the quality and consistency of the questionnaire was enhanced, and the wording converged toward the understanding of business owners and entrepreneurs. Twenty student-assistants were trained to distribute the questionnaire via mail, telephone, or on fairs. The interviewers, all of them being at least bachelor-level students from local universities in Guangzhou, were informed about the goal of the research project and received training in the structured application of the designed questionnaire. Key concepts and vocabulary were explained in detail to make sure all interviewers were familiar with the concepts applied in the research project. For the sampling process, we utilized two different sources, as there is no central database of electronic manufacturing firms in the PRD (MEYER 2011: 93). First, the Guangdong Electronic Company Catalogue, provided by the Statistical Bureau of Guangdong Province, was used to identify potential electronic manufacturing firms. Randomly selected companies were contacted by phone and asked for their willingness to participate. Upon positive feedback, the questionnaire was distributed by mail. In case of returned questionnaires showing missing or ambiguous information, our interview team engaged in a follow-up telephone interview to obtain the missing information. Following this process, we were able to gain a high level of internal consistency. Secondly, visits at local trade and industry fairs were organized where questionnaires were distributed after getting permission of the managing staff. The fairs took place in Dongguan (September, 3C Electronic Expo), Shunde (October, China Shunde International Exposition for Household Electrical Appliances), and in Shenzhen (November, China High-Tech Fair). Follow-up telephone calls were again used to ensure the quality and con-

65

3. Methodology

sistency of the information provided. In total, 1,200 firms were contacted and 900 questionnaires distributed by mail or at trade and industry fairs. 295 questionnaires were returned completely. The response rate reached approximately 32% (cf. Tab. 3.1) which can be considered successful regarding the problematic research environment and macroeconomic situation during the research period. Five cases had to be excluded as they represented firms not located in our geographic focus. Looking at the regional distribution of the 290 successfully returned questionnaires, 84 cases (29%) were located in Shenzhen and 116 (40%) in Dongguan. Tab. 3.1: Response rate according to firm location and contact mode

Postal contact and telephone follow-up

Fair visits and telephone follow-up (or on-site collection)

Distributed*

900

Firms in survey

104

Response rate

10%

Distributed*

900

Firms in survey

190

Response rate

21%

* Distributed refers to firms that permitted the questionaire to be send to them or agree to participate on the fair Source: Own calculation based on survey conducted in DFG SPP 1233 [2011]

Tab. 3.2: General characteristics of the surveyed firms n

Mean

Min

Median

Max

Std. Dev.

Firm size, no. of employees

287

561

10

200

10,000

1,185.16

Firm age

290

10.14

1

9

31

5.87

Total Sales, Mil. CNY

269

250

0

30

24,000

1,583.44

Sales distribution, Mainland China, %

286

63.27

0

78

100

37.77

Sales distribution, Hong Kong, Macao, %

282

5.49

0

.25

70

8.67

Sales distribution, Japan, Korea, Taiwan, %

282

9.77

0

3.5

100

16.04

Sales distribution, Europe, North America, %

283

13.89

0

5

90

20.57

Sales distribution, Rest of the world, %

283

7.83

0

0

90

14.91

Share of Contract Manufacturing, %

284

57.36

0

60

100

35.72

Share of Own Brand Manufacturing, %

284

42.56

0

40

100

35.72

R&D spending as share of total spending, %

244

18.73

0

12

100

17.35

R&D employees as share of all employees, %

250

13.16

0

10

90

13.82

Sales in new or sig. improved products, %

239

41.63

0

40

100

25.01

Average salary, shop-floor worker, CNY

261

2,312

0

2,200

5,000

690.52

Average salary, engineer & tecnician, CNY

254

4,457

1,500

4,000

10,000

1,584.14

Source: Own calculation based on survey conducted in DFG SPP 1233 [2011]

66

3. Methodology

The Western PRD is significantly less covered with 48 cases in Foshan (17%) and 42 (14%) in Zhongshan. Tab. 3.2 summarizes some general characteristics of the company survey. The research process revealed that the global economic crisis of 2008 had a severe impact on the firm population in the PRD; thus, it was impossible to assess the actual size and structure of the electronic industry in our research region at large, as many local firms shut down or relocated to other areas. As existing catalogues of electronic firms are commonly not exhausting, I utilized data provided by the Guangdong Provincial Bureau of Statistics of Electronic Firms above designated size for the preliminary testing for representativeness. This approach is the closest approximation of the company population; however, as the phrase ‘above designated size’ indicates, many of the small firms are not represented in this grouping. The results (Tab. 3.3) show that our sample differs significantly from the firm population, as assessed by official statistics, as small firms and domestic firms are significantly overrepresented in our sample. The results obtained thus cannot be generalized for the larger population of the electronic industry in total and thus possess exploratory character. Tab. 3.3: Comparison between sample and population based on firm size and ownership classification

Small firms Firms size [2] Large and medium sized firms [3] Chi-Squared Domestic Firms Ownership structure Foreign invested firms [4] Chi-Squared *=sig. p > .05

Sample (n=290) Population (N=10,941) [1] 192 (67%) 8,286 (76%) 93 (33%) 2,655 (24%) χ² = 10.85* 225 (78%) 6,065 (55%) 65 (22%) 4,876 (45%) χ² = 51.61*

1. According to statistical classification of Guangdong PBS the population consits of "Manufacture of Communication equipment, Computer and Other Electronics Equipment, Manufacture of Instruments, Meters and Machinery for Cultural and Office Use". 2. Large and medium sized firms are all state- and non-state-owned enterprises with sales valume exceeding 5 Million CNY, more than 300 employees and more than 40 Million CNY fixed assets. In the survey, 5 cases could nither be classified as small or large- and medium sized due to missing information. 3. In the sample, firms are classified as large- and medium sized if their sales valume exceeds 30 Million CNY and if they hold more than 300 employees. 4. Foreign firms refers tofirms being fully owned by foreign investors and those with minority or majority foreign share (Chinese-foreign equity and Chinese.foreign cooperative) Source: Own calculation based on survey conducted in DFG SPP 1233 [2011]

3.1.2 Quantitative survey data (2009) Prior to the 2011 survey, the research team carried out a survey of electronic manufacturing firms in the PRD. I utilized the dataset for several comparative anal-

3. Methodology

67

yses of the pre- and post-crisis situation of electronic manufacturing firms, as the sampling frame and research design are similar to the 2011 survey. Led by Dr. Wenying Fu, our local research partners collected a sample of 422 electronic manufacturing firms in the cities if Shenzhen, Dongguan, Huizhou, and Heyuan. In spite of differences in research focus, several items, especially surrounding the ‘fact sheet’11, which collects various concrete company data, remained almost identical to the 2011 survey. While both surveys cannot and must not be treated as ‘panel-like’ data, certain analysis for the regions of Shenzhen and Dongguan could be carried out. More details regarding the sampling technique and data collection as well as representativeness can be found in FU (2011: 12ff.). 3.1.3 Qualitative interviews To support, inspect, and further qualify the quantitative data obtained in the company survey, the research team carried out 15 semi-structured qualitative interviews with companies and industry experts in China and in Hong Kong. Two additional interviews with scientists engaged in research on the cross-border production between mainland China and Hong Kong further helped the team to gain a more profound understanding of the economic dynamics of the region. An overview of the interviews with firms and supporting governmental and nongovernmental institutions can be found in the appendix. Many of the abovementioned interviews with the managing staff included company visits and helped us to gain insights into the production conditions in the PRD. Interview partners were commonly approached at trade fairs or through recommendations by supporting institutions. Our semi-standardized interview guidelines resembled the quantitative questionnaire prepared for the survey and covered its main thematic blocks. This allows for a comparison of the interview results with the results obtained from the quantitative survey. However, the scope of the interviews was adjusted depending on the interview partners’ knowledge of the mentioned topic. Generally, managers were well informed about all aspects of the production process and innovation activities, and were willing to share their knowledge also about potentially confidential details. Limitations exist in information related to guanxi-related topics. Especially Chinese managers were reluctant to share information about their personal guanxi networks. However, this behavior is not surprising as the line between corruption and informality remains blurred despite the widespread use of guanxi in China’s business environment. To ensure anonymity, names and company information are not disclosed. The interviews lasted between 45 minutes and 2 hours, and were partly transcribed. In case of language barriers, trained translators accompanied the interviews. In these cases, a detailed protocol

11 The ‘fact sheet’ collects standardized quantitative information about central firm characteristics

68

3. Methodology

of the key findings replaced the transcript which was discussed in the research group after each interview 3.1.4 Secondary statistics Secondary statistical data was used to assess macro-level (provincial and national level) industrial development trends, as well as policy-focused spending and revenue. Since most data is available for several years, the data was mainly used for analysis in a timely perspective and to uncover macro-level development trends. The data was collected from various issues of the Guangdong Statistical Yearbook, provided by the Guangdong Provincial Bureau of Statistics (GD PBS) and China’s Statistical Yearbook, provided by the National Bureau of Statistics (NBS). For the industry-level assessment ‘Gross output value’ data of industry above designated size12 in 100 million Yuan is utilized because this data was supplied by the Statistical Bureau of Guangdong Province since 2002 as well as in a sufficient regional differentiation. It is utilized as a proxy indicator for economic activity on city a as well as provincial level. Industrial value added date would possess a higher explanatory clarity; however, this data was provided on a few years back, making it insufficient for temporal analysis. However, as the correlation between ‘gross industrial output value’ and ‘gross industrial value added’ reveals, both indices show strong and highly significant correlation (r=.98, for 2010 data). To measure governmental spending and revenue, I refer to national spending accounts in various policy fields. This data, supplied by the NBS, is available at the provincial level with a sufficient degree of disaggregation into thematic fields. 3.2 MEASUREMENT CONCEPTS Since institutions and innovation are the main concepts guiding this thesis, it is necessary to discuss potentials and limitations in their measurements. Both concepts share the similarity that there is no single comprehensive approach for their measurement. 3.2.1 Measuring institutions The quality of the institutional environment Empirical measurements of the institutional environment are numerous and range from publicly available measurement of competitiveness indicators, such as the ‘Global Competitiveness Report’ (GCR) (WEF 2013) and the ‘Corruption Percep12 Designated size refers to sales volume exceeding 5 million Yuan RMB.

3. Methodology

69

tion Index’ by Transparency International (TI) (TI 2014), to commercially available products such as the ‘Strategic Risk Index’ (AEGIS ADVISORY & INTEGRO 2013) aimed at providing investment risk assessment. While the former two provide extensive information regarding the process of data gathering and processing, the latter covers the process of data processing due to its commercial nature, thereby making it significantly less usable for scientific purposes. Despite their different foci, they share the common methodological base of using secondary statistical and primary survey data, integrating it into a comprehensive index score used for comparative analysis. In the GCR, institutions form one pillar that is used as the measurement of global competitiveness. Their main advantage is their continuous data gathering which allows for time-series analysis, thus helping to map the process of institutional change. In the following section, I will provide some insights into the observations of the mentioned reports, presenting China and Hong Kong for comparative reasons. Fig. 3.2 shows differences and changes among selected institutional indicators of governmental quality of the GCR in a timely comparison. Small wonder, the general assessment of institutional quality is ranked higher in Hong Kong than in China. However, since the beginning of the observation period in 2006, China demonstrated a slight increase in institutional quality, especially between 2008 and 2010. With the exception of ‘public trust in governmental officials’, all indicators rank at a middle quality level. For Hong Kong, the spread between individual indicators is higher. Especially, the indicator ‘favoritism in decision of governmental officials’ as well as ‘public trust in politicians’ decreased to middle quality levels. This is somewhat surprising regarding the commonly cited high perception of institutional quality in Hong Kong, which are supported by indicators such as ‘judicial independence’ and ‘transparency of government policymaking.’ The results become understandable considering the recent disturbances as a reaction to negotiations between Hong Kong SAR government and Beijing centering on Hong Kong’s future under the ‘One Country Two Systems’ approach (AEGIS ADVISORY 2014).

Fig. 3.2: Selected institutional measurement in China and Hong Kong. Own calculation based on WEF (2013)

70

3. Methodology

Fig. 3.3: Development of the corruption perception index in China and Hong Kong. Own calculation based on TI (2014).

Another indicator of governmental quality is the measurement of corruption and bribery. It is commonly used to describe the development state of many economies. Fig. 3.3 demonstrates the development of TI’s ‘corruption perception index.’ Based on different secondary survey data, this measurement of institutional quality shows the strongest divergence between mainland China and Hong Kong. While Hong Kong shows a stable development trend on a high level of institutional quality (e.g. low level of governmental and corporate corruption and bribery), mainland China remains on a low level. Both indicators show a stable development trend at the either low- or high-end of the scale, indicating a persistent development trend. According to TI, corruption and bribery is highly prevalent in business and governmental relations in China, influencing the quality (and way) of governance and running business. Given the financial system as part of the institutional sphere (Fig. 3.4), I find a similar distinction between mainland China and Hong Kong. However, as the previous observation showed, mainland China demonstrates an increase in institutional quality. In mainland China, especially the ‘soundness of banks’ significantly increased in recent years. The fields that are commonly identified as problematic are venture capital availability and accessibility of bank loans. These indicators

Fig. 3.4: Quality of financial institutions in China and Hong Kong. Own calculation based on WEF (2013).

3. Methodology

71

also remain below average in the GCR measurement. Compared to China, Hong Kong shows a mature structure of financial institutions. ‘Soundness of banks’ ranks high across the observation period. The availability of venture capital and accessibility of bank loans deceased in recent years but experienced a slight rebound in the post-crisis period. A sharp decline can be observed in financial mechanisms through local equity markets; however, this mechanism showed a stronger trend of rebound compared to the former two. It becomes obvious that the results vary depending on the utilized secondary data and the methodological approach. While China shows some extent of institutional maturity, it remains immature in other dimensions. It shows a distinctive development trend between maturing market institutions and the prevalence of informality. In contrast, Hong Kong fluctuates at a high level of development. While many elements of the institutional environment can be considered very mature and reliable, there are certain indications of institutional decay that need to be observed carefully to assess the future development of the special administrative region. How do the survey results of the company survey in the PRD reflect this assessment of the institutional environment based on secondary sources? To facilitate a comparison, I asked firms about their perception of several dimensions of the institutional environment. Owing to limitations in research design, it is not possible to provide a time-series institutional evaluation and I have to rely on cross-section data which demonstrates the managers’ assessments at the point of the survey. Managers were asked to provide their assessment of institutional quality on a variety of indicators on a 5-point Likert scale (strongly disagree – to strongly agree). I separated between domestic and foreign enterprises to assess differences between the two important sub-groups of enterprises in the PRD.

72

3. Methodology

Fig. 3.5: Assessment of institutional quality in the PRD by domestic and foreign firms. Own calculation based on DFG SPP 1233.

Fig. 3.5 shows that managers in the PRD assess the quality of the legal system in China and the PRD as relatively reliable. While significantly more domestic firms (20% compared to 9%) found the legal system to be unreliable, more than half of the surveyed firms expressed their trust in the legal system. In addition, only a limited number of foreign and domestic managers expressed their concerns regarding the ability to foresee changes in the business environment and showed concerns over the safety of their investment decisions. On the contrary, managers were less confident about the system of property rights protection and enforcement, as well as the burden of governmental regulations, which 42% respectively 44%, considered as often changing. What is most problematic, according to the view of the surveyed managers, is the problem associated with unfair business practices in the PRD, which almost half of the firms considered prevalent. The findings of the company survey regarding the quality of the institutional environment are therefore comparable to the assessment of institutional quality based on secondary sources. Measuring institutional arrangements While the abovementioned measurements of institutional environments are commonly observed, investigations into institutional arrangements remain rare. Surveys suffer from nondisclosure of information and ambiguities in terms of measurement concepts. In the previous phases of this research project, several approaches have been used to measure individual use of (informal) institutions. SCHILLER (2013: 71ff.) used composite indicators of several survey items to assess the utilization of in-

3. Methodology

73

Fig. 3.6: Assessment of the importance of management Guanxi and informality by domestic and foreign firms. Own calculation based on DFG SPP 1233.

formal business practices among Hong Kong and Chinese managers. He separated between the dimension of a personalized and a business sphere. MEYER (2011: 89f.) utilized an assessment of different contractual regimes to approach the degree of formality and informality in customer-producer interactions. Using the empirical dataset, I experimented with different approaches to institutional measurement. For the analysis of China’s financial market and firms’ financing patterns, I relied on an approach similar to MEYER’s (2011). Different patterns of firm financing were assessed and ordered according to their degree of informality. While I considered financing by banks or the equity market as means of formal financing, as they are publicly available and (should) not be dependent on relational networks, financing by parent or affiliate firms, as well as through networks of extended families, or friends are considered modes of informal financing. For the assessment of informal channels of knowledge transfer, which are utilized in the analysis of the patterns of supply-chain interaction, I experimented with different approaches to institutional measurement. While the development of composite indicators of informal business practices failed due to insufficient construct validity (SCHNELL et al. 2005: 154), I relied on single-item measurement of institutional practices based on the utilization of guanxi in different business relations. Additionally, the construct of institutional proximity was operationalized using the nationality of the main foreign investor which served as a proxy for similarities in institutional practices. More detailed information on the utilized measurements and variables can be found in the following empirical chapters. In the following section, I will provide some descriptive results regarding the perceived importance of guanxi in both business and governmental relations

74

3. Methodology

Fig. 3.7: Assessment of the importance of governmental Guanxi by domestic and foreign firms. Own calculation based on DFG SPP 1233.

gained from the company survey. As in the previous section, I separated between domestic and foreign enterprises. Fig. 3.6 shows that the assessment of the importance of management guanxi and informality does not differ significantly among domestic and foreign firms. Most managers attributed management guanxi with the possibility to access latest business information and to find suitable business partners. Interestingly, managers also mentioned the potential of management guanxi to engage in the exchange of technology-related knowledge. This hints at a practical dimension of guanxi beyond the mere informatory dimension. Asked for the importance of trust in agreements, most managers considered this point highly important for doing business in China. Given the low level of structural trust in China and the potential existence of a ‘crisis of trust’ (LINGGI 2011: 145f.), this is somewhat surprising. Nevertheless, it might underline the importance of trust (Xing) in the already mentioned guanxi relations instead of generalized trust (CHEN & CHEN 2004: 313). Least approval was given to the question of whether personal agreements in China are more important than written contracts indicating a prevalence of formal over informal business practices. Regarding the importance of guanxi in governmental relations (Fig. 3.7) the majority of managers consider this mode of guanxi most helpful to accelerate bureaucracy and to gain access to necessary business licenses (significantly more positive assessment by managers of foreign firms). It is considered less important in considering ‘hard’ concessions such as access to land, or in gaining access to universities or governmental research institutions. The descriptive results as well as the insights gained from secondary surveys hint a slow and gradual process of institutional maturity in China. However, the current state of development cannot be compared to developed and matured mar-

3. Methodology

75

ket economies with sufficiently reliable institutional structure and rule. In addition, there are indications that certain institutional arrangements in the informal sphere continue to structure economic and political interactions in China. This dualist rule system might promise short-term opportunities; its long-term implications for economic growth and economic restructuring cannot be predicted. 3.2.2 Measuring innovation Quite in contrast to the measurement institutional structures and arrangements, the measurement of innovation, as conducted in recent decades, developed certain empirical standards that are nowadays being employed in empirical research (for instance collected in the OECD’s Oslo Manual). For macro-level investigations, scholars commonly refer to standard measurement of R&D intensity or effort (SMITH 2005: 153ff.). Patent statistics pose another approach to grasp the extent of innovation performance (SMITH 2005: 158). However, all of these indicators come with specific shortcomings. While R&D expenditure is considered a relatively precise mechanism of estimate innovation efforts, it can easily be inflated by the inclusion of non-R&D tasks which are often hard to distinguish. Patent application, as a hard measurement of innovation, provides a stable and countable measurement of new product ideas and modes of technical application; however, they measure rather invention than innovation itself, and ‘mark the emergence of a new technical principle, not a commercial innovation’ (SMITH 2005: 160). More recent approaches related to the OECD’s (2005) Oslo Manual embrace a more comprehensive understanding of innovation processes involving innovation-related activities beyond R&D such as training, industrial design, and technological acquisition (SMITH 2005: 160). Conducting empirical research on innovation-related topics in developing economies such as China creates certain obstacles to the utilization of standard operational procedures in innovation research. As I have shown, innovation systems in developing economies are generally not mature and are characterized by structural holes in the patterns of interaction between relevant actors. Within firms and organizations, innovation usually takes place behind the technological frontier in forms of catching-up development. These structural differences create the distinct challenges in measuring innovation. For the company survey, the research team referred to the OECD’s (2005) definition of innovation activities of the introduction of a new or significantly improved product, process, or operational or marketing procedure. Innovation is considered as ‘new to the firm’ instead of ‘new to the market,’ paying attention to the catching up nature of innovation in China. Specific attention was paid to channels of knowledge and information transfer between different actors in the regional innovation systems and the firms’ internal development of innovation capacities. I asked for the number of patent applications in different categories in recent years but refrained from using the data as the information provided seemed to be inflated and showed general concerns regarding the use of patent data in

76

3. Methodology

China. Recent publications by LI (2012) and HU & JEFFERSON (2009) discuss how the effects of legislature greatly influenced the quantitative dimension of patenting in China in recent years. This quantitative observation, in addition to concerns regarding the qualitative dimension of patenting in China, justified my avoidance. Within the empirical investigation, I utilized different measurements of innovation and innovation-related behavior that consider the problems associated with innovation research in China. For the investigation into the effects of financial institutions on firms’ innovation activity, I relied on comparably ‘solid’ measurement of innovation efforts and outcome. To begin with, I referred to expenditures for R&D activities as provided by firms. Secondly, I tried to approximate the innovation outcome by measuring sales in new or significantly improved products. As the control variables of various financial sources proved to be quite robust, I decided to couple them with solid innovation indicators. In contrast, for the investigation into information exchange and knowledge transfer within the electronic industry value chain, I relied on softer measurements and self-assessment, aiming for insights into the tacit and informal dimensions of the process of innovation. Information exchange in different thematic fields was measured using a 3-point Likert scale. Innovation performance, as measured by self-reported product and process improvements, was measured on a 5-point Likert scale. Different scale ranges resulted from different precisions in the measured concepts. Firms were significantly more precise in answering questions regarding the results of innovation in contrast to the process of information exchange, thereby making it necessary to simplify the constructs for the empirical investigation. The observations and close inspection of the data revealed another problem commonly associated with innovation research in developing economies, namely the exaggeration of innovation efforts and results. As managers know, it is economically and socially ‘desirable’ to be an innovative firm, there is a tendency of exaggeration of innovation performance. Hence, results need to be treated carefully and with a certain degree of skepticism about the reported innovation efforts and outcomes. This effect of common method variance is, however, not limited to our dataset, but a general problem associated with research based on self-reported survey data (DONALDSON & GRANT-VALLONE 2002: 247f.). In brief, the goal was to create a working compromise between ‘hard’ and ‘soft’ measurements of innovation activities and learning among electronic manufacturing firms. In addition, I compared the survey results with information provided by managers during the qualitative interviews, in order to approach the process of data triangulation, as proposed by JICK (1979). 3.3 CRITICAL METHOD EVALUATION AND LIMITATIONS The research team was able to obtain an extensive set of different qualitative and quantitative data, which allowed for in-depth analysis of the research topics. The tailor-made design of the survey and careful research procedure allows for detailed firm-level analysis. However, as this research project was carried out in

3. Methodology

77

China, the data and the methodological approach is subject to certain limitations that need to be discussed. The first issue surrounds the quantitative questionnaire: I have to acknowledge that the sampling technique used poses limitations regarding the representativeness of results, as the preliminary testing revealed. The absence of a reliable source of information about the firm population in the electronic industry makes it difficult to assess how precisely all elements of this heterogeneous industry are covered in the survey. First insights hint at an overrepresentation of Chinese domestic over foreign firms, as well as large and medium-sized firms over small firms. This sample bias might be caused by the applied sampling methods (PEIGHAMBARI 2013: 101) and also by non-response bias among contacted firms as already discussed by SCHILLER (2013: 77). In addition, the distortion caused by the global economic crisis led to an overall high fluctuation of firms in the industry. Not surprisingly, many firms were facing a period of economic rebound after the crisis, and as such were more interested in their business than in academic surveys. Secondly, the measurement of implicit or culturally embedded concepts, such as guanxi, always creates the danger of non-responses or vague answering. However, patience and pragmatism among the research team, especially during the telephone follow-up interviews, compensated for these problems. While I do acknowledge that the abovementioned challenges reduce the potential for representative results, this trade-off is necessary and is compensated by the detail and scope of information I was able to gain from the survey data. The reliance on existing secondary data, such as firm-level questionnaires carried out by national or provincial level statistical authorities, would have reduced the potential sampling bias; however, the specific and detailed information I obtained during my research would not have been possible using other sources. In brief, the tailor-made approach to questionnaire development, despite its limitations, made it possible for me to conduct an in-detail analysis which would not have been possible using different research instruments. A second issue is related to the use of Chinese national and provincial statistics. While this data allows for comprehensive timely analysis, Chinese official statistics are subject to intensive debate regarding the quality of the data provided. A central element of criticism concerns the questionable reporting standards of the provincial and national statistical authorities, as well as the potential conflict of interests between ‘accurate’ and ‘politically-desirable’ growth figures. Regarding the debate about statistical (in-) accuracy, RAWSKI (2001) concludes that GDP growth figures between 1997 and 2001 are significantly inflated. HOLZ (2003: 162) contradicts claims of purposeful falsification of statistical data by the NBS; however, he admits that output and growth statistics show a certain degree of imprecision as the system of statistical accounting is still catching up with international measurement standards. In a more recent contribution, LI & GIBSON (2013) exemplify the problems associated with population figures in China regarding the issues of ‘hukou’ and ‘non-hukou’ populations. KOCH-WESER (2013) discusses the ongoing inconsistencies in China’s economic output data. Hence, the results derived from official Chinese secondary statistics need to be interpreted and treat-

78

3. Methodology

ed carefully. Despite the weaknesses, official statistical data of Chinese authorities is widely used in the scientific community. Interpreted carefully, they still provide an important source of information about macro-level development trends. Lastly, problems arise regarding the possibility to generalize the results. As this study focused on one industrial case study, it will not be possible to assess the regional-industrial development among different industries. A broad research design, encompassing various industries in the PRD, despite its alluring thought, would have overstretched the boundaries of this research project in financial and personnel terms. Moreover, while the electronic industry is by far the most important in the research region, it is not homogeneous and ranges from relatively low-tech components or appliances to high-tech products. My research thus covers firms from various levels of technological sophistication following diverse business models, thereby rendering generalized propositions about the electronic industry problematic. Despite the abovementioned challenges and problems, I am convinced that the careful and pragmatic approach to the collection of research data and the cautious methodological approach provide interesting and detailed insights into the industrial development of the PRD during the pre- and post-crisis periods.

4. INSTITUTIONAL CHANGE AND STRATEGIC ADAPTATION. A FIRM-LEVEL PERSPECTIVE ON THE POST-CRISIS ECONOMY OF THE CHINESE PRD 4.1 INTRODUCTION The period in the Chinese Pearl River Delta (PRD) following the financial crisis of 2008 is marked by a growing tension in the local firms’ business and competitive environment. Local firms in China’s center of export production increasingly felt the pressure by other economic centers in China (e.g. the Yangtze River Delta, Beijing, and the emerging cities in the Central and Western regions) and by political initiatives to transform the regional economic growth model (HUANG & CHEN 2010: 73). Ongoing spatial agglomeration of economic activities for more than 25 years led not only to the development of a competitive economic development model based on mostly low value-added manufacturing, but also proved to be a weakness for the regional industry in times of crisis and disturbances. The turbulent position between volatile markets and fierce competition as well as the increasing density of regulatory policy proved to be demanding for local manufacturing firms. While the immediate effects of the financial crisis led to numerous firm closures, the Chinese economy stabilized rather quickly – not least due to enormous stimulus packages to cushion the threats of recession (OHM & LIEFNER 2011: 402; NAUGHTON 2009: 10f.). Nonetheless, the period of double-digit GDP growth and ever-increasing export volumes seemed to be coming to an end, as the target markets of China’s export industry were struggling with recession and structural readjustments. Firms in the PRD, exposed to these changing environmental conditions, were forced to alter their individual business models and strategies, as the existing principles of business organization were thrown into question (HAYTER 2004: 97). The adaptation of organizations and firms to the changing environmental situations (internal and external) has traditionally formed an area of research interest in organizational sociology as well as management and operations research (WARD et al. 1995: 99). Changing environmental conditions pose opportunities and risks, and need to be accounted for in strategic decision-making (BOURGEOIS 1980: 36; DUNCAN 1972: 313). However, the perception of environmental conditions differs among agents in the same environment due to its highly subjective nature (JURKOVICH 1974: 382f.). Typologies of environments can be created, for instance, along the dimensions of simplicity to complexity, static to dynamic, or objective to perceptive (DUNCAN 1972; JURKOVICH 1974; BOURGEOIS 1980).

80

4. Institutional change and strategic adaptation

The geographical perspective on a firm’s environment offers an empirical view of environmental conditions on different spatial levels, ranging from the global to the local context. In this account, I understand a firm’s environment as the economic and market conditions that influence its decision-making and strategy depending on individual resource endowment. In order to understand a firm’s adaptation to changing environmental conditions, one need also to consider the local institutional environment of the firm. Contributions of institutional economists and sociologists have greatly enriched the understanding of, what Douglas North calls, the ‘rules of the game in society’ (NORTH 1990: 4). In recent years, institutional approaches have also gained popularity within the research field of economic geography (RAFIQUI 2009; MARTIN 2000). Firms are thus not only embedded into a business environment comprising market and political conditions, but also into an institutional environment that is constructed of social relations, norms, and values as well as their respective governance. Both are interrelated and are subject to mutual change. And both are, to different degrees, contingent to specific spatial contexts. Changes in the business and competitive environment will thus also exert influence on institutional conditions and governance processes. Applying a theoretical approach grounded in institutional sociology, I develop a conceptual framework to analyze 14 in-depth interviews conducted in 2011 with firms in the electronic manufacturing industry of the Chinese PRD. The results suggest that the modes of strategic adaptation applied by firms differ depending on the degree of institutional embeddedness and institutional bargaining power. I find that firms that are strongly embedded in their institutional setting and possess institutional bargaining power are able to alter environmental conditions to their favor. While these forms of proactive adaptation are suitable for firms in favorable institutional settings, I also find that firms operating in less favorable conditions will have to rely on more reactive modes of strategic adaptation such as on-site rationalization. Strategies that are aimed at industrial upgrading and innovation are considered the ‘high-road’ (MALECKI 2004: 1108) of firm adaptation, and are important to maintain the long-term competitiveness of firms in developing economies (FU et al. 2012; SCHILLER 2013; LU & WEI 2007). However, I do not find evidence that the financial crisis of 2008 triggered a specific mode of strategic adaptation deliberately aimed at enhancing technological capabilities among the interviewed firms. Rather, the aim of upgrading and innovation can be found among firms pursuing different modes of adaptation and depends on the firms’ individual resource endowments. The chapter aims to broaden the understanding of regional economic development trends in the post-crisis economy of the PRD, and contributes to the discussion on potential changes in the existing regional economic development model. By providing qualitative evidence and deducting hypotheses, the chapter tries to develop a research agenda for future quantitative analysis in the interplay between changing institutional environments and firms’ modes of strategic adaptation.

4. Institutional change and strategic adaptation

81

4.2 THEORETICAL AND CONCEPTUAL BACKGROUND 4.2.1 INSTITUTIONAL CHANGE AND ORGANIZATIONAL ADAPTATION Institutions can be understood as ‘[…] a web of interrelated norms - formal and informal - governing social relationships’ (NEE & INGRAM 1998: 19). GIDDENS (1984) sees them as ‘more strongly held rules supported by stronger relations and more entrenched resources’ (SCOTT 2008: 77). Institutions are a form of rule systems with the goal to structure, constrain, and enable actors’ social behavior and routines. Social interaction is embedded in a complex environment of institutional rule. The institutional environment is therefore the sum of various institutional arrangements on different levels of social interaction and with distinctive characteristics depending on social and cultural contexts. The institutional environment makes up the ‘rules of the game in a society’ (NORTH 1990: 4, HELMKE & LEVITSKY 2004: 727) and ‘provides stability and meaning to social life’ (SCOTT 2008: 46). However, institutions and the institutional environment are constantly changing and being altered by social actors. HAYTER (2004: 706) points out that: ‘impacts of crisis […] are significant turning points in development trajectories in the short- and long-term,’ and as such they might trigger changes in a firm’s strategic orientation. Modes of organizational adaptation to changing institutional conditions have been a core interest in the field of organization sociology and strategic management. Within this field, several strands of theoretical reasoning can be identified. Early neo-institutional theory in sociology emphasized the constraining effects of institutions on actors’ behavior and development (SCOTT 2008: 76). For instance, MEYER & ROWAN (1977) stress the interplay between institutional isomorphism of organizations in order to gain legitimacy and resources. DIMAGGIO & POWELL (1983) present mechanisms of the mentioned isomorphic change in which competitive and institutional processes drive organizational structure to resemble each other. Structural similarity is thus an important consequence of the abovementioned pressures (SCOTT 2008: 43). While these approaches emphasize the influence of institutional forces on individual actors, they embrace a ‘takenfor-granted character’ of institutions, and passivity of organizations and of agents in the process of institutional change (OLIVER 1991: 145ff.). Anthony GIDDENS’s (1984) ‘structuration’ theory contributed to the understanding of the interrelation between freedom and constraint in actors’ behavior. According to this view, social structure is ‘both product and platform of social action’ (SCOTT 2008: 77) and actors possess ‘agency’ to have an individual impact on the social world. Individuals are thus simultaneously following existing social structures while being involved in the process of production and reproduction of the latter (WHITTINGTON 1992: 695). Based on this understanding, individual behavior cannot solely be determined by institutions.

82

4. Institutional change and strategic adaptation

Tab. 4.1: Strategic responses to institutional processes Strategies

Acquiesce

Compromise

Avoid

Defy

Manipulate

Tactics

Examples

Habit

Following invisible, taken-for-granted norms

Imitate

Mimicking institutional models

Comply

Obeying rules and accepting norms

Balance

Balancing the expectations of multiple constituents

Pacify

Placating and accomodatinginstitutional elements

Bargain

Negotiating with institutinal stakeholders

Conceal

Disguising nonconformity

Buffer

Looseing institutional attachements

Escape

Changing goals, activities or domains

Dismiss

Ignoring explicit norms and values

Challenge

Contesting rules and requirements

Attack

Assaulting the source of institutional pressure

Co-opts

Importing influential constituents

Influence

Shaping values and criteria

Control

Dominating institutional constituents and processes

Source: Own compilation based on Oliver (1991: 152)

A second field is concerned with the co-evolution of institutions and actors. LEWIN et al. (1999) proposed a model of organizational adaptation that considers the co-evolution of firms, industries, and the institutional environment and external elements. Their respective focus of analysis on the institutional environment is the national level. In addition to LEWIN et al. (1999), KRUG & HENDRISCHKE (2008) proposed to study the process of co-evolution and institutional change of business systems in China at a regional level to account for regional and local specifics (MEYER 2011). Both approaches share the common goal to link macroenvironmental development with organizational change and adaptation at the micro-level. They are less deterministic but favor an understanding of mutual influence between the environment and the actor. In this perspective, MEYER (2011: 21) states that strategic measures at the organizational level are not solely determined by their institutional environment, but that organizational action and development mutually influence institutional structures and arrangements. Besides institutional isomorphism and co-evolution, a third approach to study the interplay between institutions and organizations can be found in the research concerned with the (deliberate) alteration of institutional structures and environments by social actors. LAWRENCE (1999) put forward the notion of ‘institutional strategy’ to describe ‘patterns of organizational action concerned with the formation and transformation of institutions, fields and the rules and standards that

4. Institutional change and strategic adaptation

83

Fig. 4.1: Strategic responses and firms’adaptation mechanism. Own draft, based on OLIVER (1991)

control those structures’ (LAWRENCE 1999: 167f.). From the strategic perspective of the firm, scholars of business studies emphasized the notion of ‘adaptive specialization’ as the ‘[…] choice of strategy appropriate to the environment and resources of the firm, and the design of matching structure’ (CHAKRAVARTHY 1982: 42). By drawing on arguments of resource dependency, OLIVER (1991) developed a set of strategic responses that organizations refer to when exposed to environmental pressure. The strategic choices presented in Table 4.1 range from complying to institutional pressures to actively defying or manipulating them. The typology takes into account the varying degrees of influence or bargaining power organizations are equipped with to proactively engage in the process of institutional change. The concept of institutional strategy has been adapted by scholars of management sciences, and has been addressed in studies of organizational legitimacy (SUCHMAN 1995; KOSTOVA & ZAHEER 1999), organizational flexibility (SOPLENA et al. 2014), and in questions of institutional change and company strategy in developing economies (HOSKISSON et al. 2000; PENG 2003). The typology of strategic responses to institutional pressure thus offers a flexible toolset to analyze the process of firm adaptation to changing environmental conditions at the micro-level. For the conceptual framework, I will utilize OLIVER’s (1991) strategy portfolio to gain a systematic insight into the adaptation strategies applied by electronic manufacturing firms in the PRD in order to maintain their competitive position in a changing environment after the global economic crisis of 2008.

84

4. Institutional change and strategic adaptation

4.2.2 Strategic responses to changing institutional environment in the PRD How do electronic manufacturing firms in the PRD adapt to changing conditions in their business and institutional environment? I will try to answer this question by drawing on the theoretical insights from the previous section and develop a conceptual framework for the following empirical work. I also refer to YANG’s (2012: 149) typology of restructuring strategies of manufacturing firms in the PRD. Based on OLIVER’s (1991: 152) typology of strategic responses to institutional pressure, I develop a two-dimensional scale matrix of firms’ strategic adaptation to changing environmental conditions (Fig. 4.1). The x-axis estimates the degree of institutional embeddedness. Following BAUM & OLIVER (1992), I see institutional embeddedness as the ‘relational density’ (BAUM & OLIVER 1992: 540) of a firm with other agents in its environment. Relational processes might be of social, political, or economic nature, and can potentially take place on various geographic or organizational scales (HAYTER 2004: 99). Strongly embedded firms share more (local) linkages with other firms in the population or with political or industrial stakeholders. A high degree of institutional embeddedness can also result from strong supply-chain links and from interaction or customer relations, as well as strong market potentials at their current location. Firms that possess a stronger institutional embeddedness at their current location and within their operational environment in the PRD are thus expected to be less prone to complete relocation than to on-site adjustment (Quadrants II and IV). The y-axis describes the degree of institutional bargaining power. While authors of the international relations literature define ‘institutional bargaining’ as ‘efforts on the part of autonomous actors to reach agreement among themselves on the term of institutional contracts or interlocking sets of rights and rules’ (YOUNG 1991: 282), I utilize a broader socio-economic understanding of this bargaining process. In my understanding, `institutional bargaining’ refers to the process of actively influencing and improving a surrounding institutional environment. Bargaining power thus describes the ability of firms to take part in or initiate the abovementioned processes. Firms in possession of neither strong institutional embeddedness nor sufficient institutional bargaining power (Quadrant I) are expected to favor the strategic response of `avoidance’. In this strategy, institutional pressures are avoided by escaping the institutional and business environment in the PRD by means of complete relocation or firm closure. Several authors have observed this form of adaptation by analyzing Hong Kong-based companies’ FDI in the PRD. Many of the mentioned firms are not integrated into close-knit supply chains or business groups, or do not possess reliable and influential policy-business relations. Numerous lower value-added manufacturers or firms with environmentally hazardous production processes have thus chosen to leave the PRD due to the increasing labor costs and tightened environmental regulations (XU & YEH 2013: 9, LIAO & CHAN 2011: 628). This process is difficult to observe empirically in a crosssectional study, since relocated firms are not present in the study region at the

4. Institutional change and strategic adaptation

85

time of the study. Hence, I will not further analyze this adaptation strategy in my empirical investigation. In Quadrant II, I find firms with a low degree of institutional bargaining power as well as a high degree of institutional embeddedness. This setting can be observed among many second- and third-tier suppliers in the PRD’s production network. Firms in this category are usually strongly embedded in the local production environment but lack the size or influence to actively alter or influence their surrounding business environments. They will thus rely on a `compliancestrategy’ that is aimed at enhancing their current business situation by means of ‘on-site adaptation’ such as rationalization, automation, or innovation activities. Quadrant III describes the ‘balancing-strategy’ found among firms that possess a low degree of institutional embeddedness but a higher degree of institutional bargaining power. Hence, firms in this quadrant have substantially greater number of resources to react to external and internal demands. A common form of adaptation is to engage in partial-relocation activities, where higher value-added parts of the production process remain in the PRD and lower value-added and labor-intensive activities are relocated. Due to the strong policy initiatives aimed at industrial upgrading in the PRD and Guangdong Province as well as the provincial relocation regime, I expect firms engaged in these processes to favor locations within the provincial boundaries of Guangdong, specifically the more peripheral areas which are politically designated as potential relocation sites. In Quadrant IV, there are firms that are both equipped with strong institutional embeddedness and significant institutional bargaining power. These firms are strongly integrated into the local and regional production regime and commonly inherit some sort of hub function in a production network. At the same time, they possess the size and power to influence their local business environment by adapting operational routines as well as bargain for preferential political treatment. The mode of strategic adaptation for firms in this category will thus be called `bargaining strategy’. While the investment in innovation and upgrading is considered the ‘highroad’ of a firm’s development trajectory, I do not expect these processes to be directly related to immediate adaptation requirements. As such, I expect these activities to be observable in most modes of strategic adaptation; however, they depend on the different degrees of the firms’ internal characteristics and resource endowments. Nonetheless, I believe that the disruption caused by the financial crisis of 2008 encouraged local electronic manufacturing firms in their individual attempts to enhance technological capabilities and engage in higher value-added manufacturing. It is important to mention that the developed typology of modes of strategic adaptation processes should not be understood as ‘all-embracing’, but rather as ideal types. During the empirical investigation, I found that the developed categories are not mutually exclusive, but boundaries between the adaptation strategies are fragile and some firms also employ strategic adaptation mechanisms of different categories. Based on the conceptual consideration, I develop a set of research questions to be answered in the following empirical investigation:

86 – – – – –

4. Institutional change and strategic adaptation

RQ1: Does increasing market or policy pressure influence strategic adaptation within local electronic manufacturing firms? RQ2: Does institutional embeddedness discourage local electronic firms from relocating and encourage favoring on-site adaptation? RQ3: What spatial patterns of firm expansion and partial relocation can be observed among spatially mobile firms? RQ4: To what extent does institutional bargaining power enable firms to influence their institutional and business environment? RQ5: Did the economic crisis of 2008 encourage a strategic reorientation toward innovation and upgrading among local electronic firms?

4.3 DATA AND METHODS For answering the aforementioned research questions, I draw on two empirical datasets, obtained in late 2011, of electronic manufacturing firms in the PRD. Since the opening and the reform period, the electronic industry has been playing a role as one of the leading industrial sectors in Guangdong Province, and has contributed approximately 32% to the total industrial value added in 2010 (GD PBS 2012). Early exposure to foreign direct investment due to the geographic proximity to Hong Kong and the early establishment of special economic zones in Zhuhai and Shenzhen created a mature and well-established production regime for export production (VOGEL 1989). Since the global economic crisis hit the region in late 2008, the established development model and future prospects of predominantly low value-added manufacturing and export-production has been increasingly questioned in scientific and political debates (MEYER et al. 2009, LU & WEI 2007). The high degree of international connectedness of the regional electronic industry as well as the diverse levels of technological sophistication in the firm population makes the region and its industry an intriguing research setting for the analysis of firm adaptation processes in changing environmental conditions. During the phase of data collection, finished in early 2012, I conducted 14 indepth interviews with senior representatives of domestic Chinese and foreign firms in the PRD as well as in Hong Kong. I chose a semi-standardized interview method to account for the broad thematic focus of the research. The thematic focus of the company interviews covered (1) the perception of environmental conditions, (2) strategic orientation, (3) human resource situation, (4) innovation activities, (5) supply chain interaction, and (6) potential for firm relocation. The interviewed companies ranged from small and medium-sized enterprises of Chinese origin to large subsidiaries of multinational companies. In addition, five interviews were carried out with senior members of industry and trade associations as well as supporting governmental institutions in Hong Kong and the PRD. These interviews thematically focused on the changing environmental conditions in the PRD and development trajectories for local firms. The mix of firms, industry, and trade representatives helped to enhance and validate

4. Institutional change and strategic adaptation

87

the quality of the obtained data, as well as the statements obtained from individual perception of the interviewed person. The individual interviews lasted from 1 to 2 hours, and were partly transcribed. In order to maintain the anonymity of the interviewed organizations and individuals, their names are not disclosed. Furthermore, I make use of a quantitative dataset of manufacturing firms in the cities of Shenzhen and Dongguan in the Eastern PRD, and Foshan and Zhongshan in the Western PRD for the assessment of partial relocation as well as firm expansion processes. The thematic focus of the quantitative survey covered the topics of (1) Company strategy, (2) Innovation activities, (3) Management & human resources, (4) Supplier-customer relations, and (5) Business environment. For the sampling for the quantitative data, the Guangdong Electronic Company Catalogue, provided by the Statistical Bureau of Guangdong Province, was used and the questionnaire was distributed by mail as well as at important regional industrial fairs. Follow-up telephone calls ensured the quality and consistency of returned questionnaires. In all, 290 valid questionnaires were returned, leading to a response rate of approximately 32%, of which 84 came from Shenzhen, 116 from Dongguan, 48 from Foshan, and 42 from Zhongshan. 4.4 EMPIRICAL ANALYSIS OF FIRM ADAPTATION PROCESSES 4.4.1 CHANGING ENVIRONMENTAL CONDITIONS IN THE PRD In order to learn more about the drivers of firm adaptation processes, I asked my interview partners about their perception of the global economic crisis in late 2008 and business development in the restructuring phase following it. During the crisis, the unemployment rate of factory workers increased significantly (FAN et al. 2011: 5; YANG & LIM 2010: 36, LI & FUNG RESEARCH 2008: 2). According to CHAN (2010: 665), the crisis led to 62,000 firm closures in 2008 resulting in massive lay-offs and work-related disputes13. Former provincial party secretary Wang Yang only showed limited concerns with the increasingly problematic business situation of local firms and criticized them as ‘[…] obsolete productivity forces […] discarded by the cycling fluctuation of the market’ (HUANG & CHEN 2010: 77); a byproduct in the process toward a region driven by ‘advanced manufacturing and modern services’ (WANG 2010). Firms asked for their assessment of the crisis period itself; however, they did not describe it as an overly dramatic break in their business routine. This perception was commonly mentioned among larger and predominantly foreign-owned enterprises, which were better prepared for periods of economic downturn. A manager of a Hong Kong-based electronic manufacturing firm with production facilities in Dongguan described the situation of his company as follows:

13 Figures vary depending on the source: YANG & LIM (2010: 27) mention 67,000 by drawing on information from the New York Times (November 13, 2008).

88

4. Institutional change and strategic adaptation “[…] we were lucky in an unlucky situation […] a lot of the smaller manufacturers fell by the wayside, especially in industries like toys. Luckily we reached a certain size and influence.” (HK-C3)

Another manager of a Hong Kong-headquartered firm described the crisis as even helpful for his business in terms of consolidating his firm’s supply chain: “[…] that actually helped our business […] it helped to consolidate it and the manufacturers and suppliers that were not strong enough fell by the wayside and we gained significant market-share.“ (HK-C2)

The interviews revealed that while the crisis certainly affected firms in the regional manufacturing industry, the overall impact was not considered as severe as in other industrial branches operating on lower profit margins and on a lower technological level. The crisis itself seemed to be perceived as a strong but limited downturn in business, and firms were returning quickly to their previous routine. Labor costs and labor shortages For the post-crisis recovery period, the perception of the business environment shows a strong trend of homogeneity. Not surprisingly, increasing labor costs and the problem of labor shortages and labor turnover are considered the most problematic for the electronic manufacturing industry. Tab. 4.2: Monthly minimum wage in Guangdong province, Yuan RMB Winter 2006

Winter 2009

Spring 2011

Special Economic Zone (SEZ): Shenzhen

810

1,000

1,320

Tier 1: Guangzhou

780

860

1,300

Tier 2: Dongguan, Foshan, Zhongshan, Zuhai

690

670

1,100

Tier 3: Huizhou, Jiangmen, Shantou

600

580

950

Tier 4: Other cities

500

530

850

Compiled after: MOLSS 2009 & MOHRSS 2010 / 2011

Owing to a lack of work opportunities, unfavorable working conditions in local factories, deficits in the social security system, and improved working opportunities in many Western cities of China, a section of the migrant population decided against returning to Guangdong in the aftermath of the crisis (LI & JINGHONG 2010: 628ff.; XUE 2008: 99). The dissatisfaction caused by unpaid wages and benefits raised the fear among municipal and provincial policy-makers about social unrest and growing disorder. These developments caused growing labor shortages in the still rather labor-intensive manufacturing industry in the region, which were reported before the crisis (HARTMANN 2013: 18). Higher wages and the wish for a better working environment further intensified the problems associated with high labor turnover in many manufacturing firms (HARTMANN 2013;

4. Institutional change and strategic adaptation

89

HARTMANN KILIAN et al. 2012: 58f.; HUANG & CHEN 2010: 80f., HE et al. 2011: 1288, CAI & WANG 2012: 11f.). According to JIANG et al. (2009: 170), high labor turnover is associated with operational risk such as organizational friction, instability of skills in the workforce, and increased necessity for training of new employees. Rising minimum wage standards as well as the implementation of the new labor contract law in 2008 (Tab. 4.2) were supposed to retain qualified personnel in the PRD. In turn, they led to a significant rise in labor costs for local manufacturing firms (YANG 2012: 147). Not surprisingly, among the issues mentioned most frequently in my interviews were topics concerned with the development of the regional labor market – more specifically the problems associated with increasing labor shortage and labor turnover. All of the interviewed firms described labor-related problems among the most challenging issues for their business. Findings by HARTMANN (2013) and HARTMANN KILIAN et al. (2012: 76) showed that production workers in the electronic industry of the PRD were aware of even minor wage differences among employers and mentioned these differences as their main criteria for changing employers. These results are supported by findings of XUE (2008) of migrant workers in electronic firms in Dongguan. The problem of labor turnover is specifically mentioned for the production branches of the interviewed firms. One manager of a Hong Kong firm mentioned an annual labor turnover in manufacturing of around 100%. This estimation is supported by other observations and not only limited to FIE. A Chinese manager of an SME in Shunde (Foshan) estimated the monthly labor turnover in his production site at around 10%. A technology manager of a foreign-invested electronic firm in Foshan, however, considered the labor turnover also to be a result of labor recruitment practices: “On the issue of labor fluctuation […]. You need to consider where the people come from. If I am going to recruit staff from Beijing and bring them down to Foshan, then I need to assume that 80% will be gone in a short period of time. They will complain that their family is not here. […]. Workers who used to come here from the Western provinces in the past do not move here, because they ask themselves: ‘Why should I leave my family only for earning 100 Yuan RMB more a month? I better stay at home with my family where the cost of living is lower and I do not have the effort of moving.’” (FS-C2)

While the labor-related issues were mentioned almost constantly during the interviews, not all firms considered it a thread to their manufacturing operations in the PRD. The actual perception of the problem was dependent on the degree of labor being an integral production resource. A supply-chain manager of a Shenzhenbased manufacturing firm for computer peripherals mentioned that rising labor costs are indeed a factor to be taken into account for the operation in the PRD; however, the predictability of labor price changes makes the problem measurable: “What I can see is that in the past five years, the labor-costs for China are still very competitive. So we will stay here… at least for the next five years. […] about the raw-materials, it is really something out of control because copper and the other major commodities are affected by so many factors like the currency policy, some regional issues that cannot be predicted and also disasters like last-year’s earthquake […] It can increase from 100% - 500% in a one year or two year. For the rare earths the increase is like 10 times. I could never imagine and that is

90

4. Institutional change and strategic adaptation something I can never predict. It had really given us a lot of cost-pressure but fortunately, we can offset most of that.” (SZ-C1)

Other factors affecting the business environment in the post-crisis period mentioned in the interviews were issues of rising land prices and unstable power supply. Energy-intensive manufacturing and growing energy requirements of the local population led to frequent power outages due to limited energy capacity during peak times. Municipal governments reacted to this situation by assigning periods of energy-saving during certain times of the week, leading to production downtimes in local firms (HE et al. 2011: 1289). Changes in the monetary policy were also described as problematic in the scientific debate. National policy-makers initiated the appreciation of the national currency in order to settle trade disputes with important international trade partners (YANG 2012: 147; SUN 2009: 31; XUN et al. 2009). While these structural adjustments helped to reduce tensions in international trade and politics, the increasing costs of production and materials have increased the pressure on many export-oriented businesses in the region that operate traditionally on thin profit margins (YUAN & ZHOU 2009: 86, SHARIF 2011: 3). During the interviews, certain concerns were expressed over rising costs of operation, but they were not explicitly blamed on structural adjustments of monetary policy. Not surprisingly, concerns were commonly more generally expressed over the threat of ‘surging prices’ and firms’ profitability. Policy pressure Policy programs that aim at upgrading the industrial structure in the PRD as well as at fostering innovation activities in local firms are numerous, and can be found on all levels of political decision-making. I thus expect policy programs to be exerting increasing pressure on local firms in the wake of the crisis. The goal of policy-makers at the national level is the reduction of spatialeconomic disparities between the highly developed coastal areas and the relatively underdeveloped inner provinces of the PRC. For instance, the Ministry of Commerce (MOFCOM) has been encouraging relocation of lower-value-added manufacturing firms to central and western provinces since 2007 through state loans, tax incentives, and infrastructure investments (XUN et al. 2009: 29; LI & FUNG RESEARCH 2008: 7). At the same time, industrial upgrading in the PRD was encouraged by the ‘National Development and Reform Commission’ (NDRC) in the ‘The Outline of the Plan for the Reform and Development of the Pearl River Delta (2008–2020).’ Provincial and local policy initiatives aimed at developing the provincial economic structure into more innovative and higher value-added activities. For example, the ‘double restructuring of industry and labor force’ program, initiated by former provincial party secretary Wang Yang in 2008, aimed at relocating polluting and low-value-added industries from the provincial core to the relatively underdeveloped periphery, was implemented in Guangdong Province (YANG 2012:

4. Institutional change and strategic adaptation

91

152; LIAO & CHAN 2011: 630f.; YU 2010: 104; LI & FUNG RESEARCH 2008: 10ff.). Local ministerial departments have been engaged in different policy initiatives to strengthen firms’ innovation capabilities, or to facilitate interactive learning through cluster promotions (OHM 2011: 145ff.; BARBIERI et al. 2012: 616f.; BARBIERI et al. 2010). Results of these policy initiatives are inconsistent and have not yet undergone systematic scientific evaluation. While relocation for manufacturing firms has become an increasingly popular option and a part of the local firms’ population have begun relocating labor-intensive steps of the production process to locations with a better availability of lower-wage employment, most firms still adapt a ‘wait-and-see attitude’ (YANG 2012: 154; LI & FUNG RESEARCH 2010: 2ff.; LI & FUNG RESEARCH 2008: 3). In a general account, OHM (2011: 140f.) states that about one-third of electronic manufacturing firms in the PRD experience political pressure on their business model. In contrast to my expectations, none of the interviewed firms mentioned policy programs to be responsible for changes in their operational routine, or as the source of increasing competitive pressure. This is surprising because the initiatives aimed at enhancing and upgrading the regional economic base were numerous even before the global economic crisis hit the region. One can suspect that the mentioned programs are not explicitly aimed at the majority of the local electronic firms since the electronic industry is considered a relatively high value-added industry in the PRD despite its internal heterogeneity. To answer Research Question 1, I can state that market, and not deliberate policy-programs, affected local electronic manufacturing firms in the aftermath of the global financial crisis and encouraged changes in their strategic orientation. Pressure to change existing business models did predominantly work through the price mechanism. This is important, since part of the local firm population, which could already have been reached by policy programs, left the region and reduced the overall upgrading potential in the industrial base. However, policy pressure does indeed exert a certain influence ‘through the backdoor’, as the rise in the minimum wage and the induced price mechanism is policy-driven. 4.4.2 Firms’ strategic adaptation to changing environmental conditions In the following section, I will present three modes of strategic adaptation of firms in the electronic manufacturing industry. A case-study method is applied to exemplify two of the abovementioned strategies in detail, while one strategy is elaborated using gathered survey data. The following two firms were identified because they represent good examples of two modes of strategic adaptation: – –

COMPANY A, is a medium-sized component supplier of Taiwanese origin with its production site in Dongguan. COMPANY B: is a large lighting products manufacturer of European origin with production sites in Foshan, as well as R\&D facilities in Foshan and Shenzhen.

92

4. Institutional change and strategic adaptation

4.4.3 Compliance with institutional pressure – on-site adaptation The adaptation strategy of ‘compliance’ describes the process of ‘conscious obedience’ (OLIVER 1991: 152f.) of an organization to institutional pressure exerted on it. In this understanding, firms in the electronic manufacturing industry, following this adaptation path, are aware of the institutional changes and pressures in their business environment. They will deliberately try to adapt their business model or operational routines to the changing environmental conditions. In the conceptual model, firms choosing this adaptation strategy possess a high degree of institutional embeddedness but a low level of institutional bargaining power. Their production is strongly embedded into local value chains, often as component suppliers to larger manufacturing firms or dependant on specific local conditions in the PRD, such as proximity to Hong Kong. Simultaneously, their relative size, age, and technological level do not equip them with necessary institutional bargaining power to proactively engage in the changing environmental conditions. Changes in the PRD’s business environment in the aftermath of the global economic crisis are characterized by rising cost competition and increasing scarcity of production factors such as labor and land. Firms operating under these conditions will thus try to comply with or pacify external pressures through cost reduction. A good example for this mode of strategic adaptation could be observed in COMPANY A, a Taiwanese component-manufacturing firm located in Qiaotou, Dongguan. The family business was founded in 1989 in Taiwan and the company expanded its production into mainland China in 1996. Today, the company possesses production sites not only in Dongguan, but also in Suzhou in the Shanghai metropolitan region. The company produces various kinds of resistors and serves as a component supplier for larger electronic firms and contract manufacturing firms. According to the managing staff, the firm is mostly experiencing rising costs in wages, energy, and raw materials. To deal with this pressure, the firm is relying on a strategy of cost reduction by means of automation of production and reduction in the number of employees. The introduction of surface mount technology (SMT)14 significantly reduced the labor input, allowing for the more sophisticated production of chip resistors. This strategy made it possible for the firm to cut labor costs despite rising wages, and increase productivity and output significantly. According to the manager, labor turnover at the production site can hardly be controlled. One approach to retain trained personnel is to pay a bonus upon the employees return from the Chinese New Year. This method counters the ‘New Year fluctuation’ many local firms suffer from. While the factory management can partly influence labor-related issues, the problem of energy scarcity cannot be managed adequately. The firm reacts by complying with local political requirements to shut down the operation for two days each week. The more energy intensive parts of production, such the SMT operations are carried out during the night when energy prices are lower and electrical grid stability is higher. 14 `Surface mount technology’ is an industrial process of automated chip assembly.

4. Institutional change and strategic adaptation

93

Carrying out innovation activities to partly escape the institutional pressures is not an option for the local management, as the PRD production site is only considered a manufacturing plant and R&D activities are carried out at the parent company in Taiwan. The firm is strongly embedded into local production networks and the importance of the PRD location is further strengthened by the proximity to Hong Kong as an important trade hub for the export production. To answer Research Question 2, I find that the institutional embeddedness of the firm in our case study did indeed discourage the management from considering relocation activities. Location-specific advantages, such as the geographic proximity of Hong-Kong as well as the organizational embeddedness in the Taiwanese-Chinese production nexus, did discourage relocation and favored strategic adaptation by on-site measures. 4.4.4 Balancing diverging interests The strategic adaptation process of ‘balancing’ is applied by firms reacting to varying institutional demands in the process of strategic adaptation. It is understood as an attempt to reach a state of equilibrium between external, environmental requirements and internal organizational demands (OLIVER 1991: 153). In my model, I found this strategic adaptation to be pursued by firms with a higher degree of institutional bargaining power, and hence more possibilities of actively altering their surrounding environmental conditions but with a lower degree of institutional embeddedness. Lesser institutional embeddedness, as well as reduced dependency on the local or regional production regime or embedded actors, gives firms a higher degree of spatial flexibility. Not surprisingly, I identified partial relocation or other forms of firm expansion beyond their initial production site to be a common mode of organizational adaptation. Commonly, firms are affected by the various forms of environmental pressures present in the region. Contrary to the ‘avoidance’ strategy, which considers plant closure or complete relocation, in the ‘balancing’ strategy, firms usually maintain their PRD production location. Examples of this mode of adaptation of firms in the PRD are various and have been studied intensively in the scientific literature. YANG (2009: 392ff.) discussed the ‘northern expansion’ of the Taiwanese IT industry from the PRD’s IT clusters in Dongguan to the Greater Shanghai area. She finds that total relocation is an uncommon practice among Taiwanese investors who rather prefer partial relocation and firm expansion. XUN et al. (2009: 28f.) report on the first waves of industrial relocation from Dongguan and Shenzhen starting as early as 2005. In their recent study of a lower value-added industry in China, ZHU & HE (2013) examine spatial relocation strategies of textile firms in Ningbo. LIAO & CHAN (2011: 634) presented examples of ‘stratified’ and ‘pseudo relocation’ strategies adopted by Hong Kong-based firms which include partial relocation in the former, and acquisition and outsourcing activities in the latter case. Similar to YANG’s (2009) example of the Taiwanese IT industry, they also find that maintaining the PRD production site for higher value-added

94

4. Institutional change and strategic adaptation

activities or firm coordination is a common phenomenon among Hong Kongbased investors. Improvements in public infrastructure in the more remote (western) provinces further incentivized (partial) relocation of industries (FAN et al. 2011: 55). In her recent analysis, YANG (2013: 1058) shows that the increasing reliance on key suppliers strengthens relocation tendencies within China and puts emphasis on the subsequent reliance on domestic production networks. In the interviews, I found that a number of firms already embraced the mentioned partial relocation approach. The mentioned PRD-YRD (Yangtze River Delta) location duality was predominantly visible among foreign-invested firms, especially among those from Taiwan and Hong Kong. However, some larger contract manufacturers also pointed out the disadvantages associated with the tremendous growth in some parts of the Greater Shanghai area. The increasing economic growth in manufacturing in parts of the region led to an escalation of prices and put increasing pressure on local factory managers to run their factories in cost–efficient manner. Thus, price considerations do not seem to be the only motivation to relocate to the Yangtze River Delta area, as the cost advantage in the PRD appears to be marginal. Several of the interviewed firms, especially those with larger production capacities, were considering establishing ‘satellite factories’ for the upcoming years. But they also mentioned the costs associated with relocation. The senior technology manager of the Foshan-based multinational firm stated: “The problem is the huge effort associated with the relocation. And the difference from here to Sichuan is not yet as big. I need to build up the new factory, I need new `overheads’, then I need to consider transport costs that I have to add upon the product price until I have the goods here… in the end, the location advantage is gone. […] But if it was for me to set up a whole new factory, then I would go to the Western provinces.” (FS-C2)

According to trade experts in Hong Kong, partial relocation is a strategy to be applied for firms that are able to compensate for the disadvantages associated with relocation into more remote and less developed areas. The development of a working supply chain, the integration of suppliers, and the development of the logistics chain require a substantial amount of investment. This is especially true for firms moving into the more remote, but cheaper Western provinces. The relocation into the YRD is thus potentially more a market seeking or ‘consolidating relocation or expansion’. Working supply-chains and proximity to parent companies or better access to other knowledge sources might compensate for the higher prices associated with this geographic location.

4. Institutional change and strategic adaptation

Fig. 4.2: Spatial patterns of partial relocation and firm expansion. Own draft based on DFG SPP 1233

95

96

4. Institutional change and strategic adaptation

While relocation is becoming an option for an increasing number of local firms due to abundant supply of labor and land mostly in the Chinese interior, the consideration of relocation of activities to locations outside of mainland China, remains vague. By now, the advantages of China’s manufacturing base seem to be more important than future production opportunities in South-East Asia. Asked for the consideration of relocation activities to locations such as Vietnam and Thailand, a manager of a Hong Kong-based manufacturing firm mentioned problems associated with finding skilled employees and organizing the production backend in terms of logistics and supply networks. In line with previous results, the interviews showed that (partial) relocation of manufacturing firms in the electronic manufacturing industry is not so much driven by policy or environmental concerns as in other industrial branches. Policy programs aimed at increasing relocation and ‘harmonious development’ (FAN et al. 2011: 47) do not seem to motivate relocation activities. Most firms mentioned the cost and resource considerations (labor costs and labor supply), or market seeking motivations when embarking on production for the domestic Chinese market. I find that firms engaged in this mode of strategic adaptation seem to be searching for a balance between rising costs and environmental pressure, such as bottlenecks in resource availability in the PRD as well as the existing location advantages of the region. The disintegration of production steps and sites lets firms tap into various factor markets. To validate the qualitative findings, I compare the results with findings from our quantitative firm survey. Tab. 4.3: Motivation for partial relocation and firm expansion

Reasons for partial relocation of firm expansion in the past 3 years (important / very important) Rising costs of production

76% (n=25)

Access to production workers

62% (n=23)

Access to sales market

62% (n=23)

Governmental regulations

48% (n=24)

Access to engineers & technicians

39% (n=24)

Access to suppliers

26% (n=23)

Access to knowledge sources

22% (n=23)

Source: Own calculation based on survey conducted in DFG SPP 1233 [2011]

Surprisingly, only approximately 10% of the 290 survey firms mentioned that they were engaged in partial relocation and firm expansion activities in the past three years. This proves the low quantitative importance of relocation strategies among firms. Those 10% were asked to provide information about location, motives, as well as firm functions of partial relocation and firm expansion activities within the past three years (Tab. 4.3). The majority of firms mentioned rising production costs, access to production workers, and access to sales market as the most important motives for partial relocation and firm expansion. Environmental

4. Institutional change and strategic adaptation

97

regulations, supply-chain integration, or innovation-related motivations were perceived to be considerably less important. Looking at the spatial pattern of partial firm relocation and expansion in line with Research Question 3 (Fig. 4.2) I find that there is no clear trend in location choice visibly favoring more peripheral regions of Guangdong Province of the PRD. Within China, one can observe that a larger number of firms are moving manufacturing activities into Jiangsu province. This is not surprising considering the previous observations made by YANG (2009) with regard to the relocation of IT manufacturing from Dongguan to Suzhou in Jiangsu province. Other locations are the adjacent Northern provinces of Guangdong, Hunan, Jiangxi, and Hubei. Those locations share the advantages of rather lower costs with ‘relative’ proximity to the PRD. The potential trend of `going West’ in relocation to Sichuan or Chongqing is not yet visible as a clear trend in our data. In terms of relocation of R&D activities, I observed that only a minority of firms did relocate R\&D facilities from their PRD site. In the exceptional cases where R\&D relocation occurred, the destinations were cities in the Greater Shanghai region and the Beijing metropolitan region. Owing to the relative small sample size, the observations made within the company survey should be handled carefully. Further empirical evidence is needed to validate the observations made. 4.4.5 Bargaining favorable environmental conditions The strategic response of ‘bargaining’ can be observed among firms that do possess a high degree of institutional embeddedness as well as a higher degree of institutional bargaining power. According to OLIVER (1991: 154), bargaining can be understood as a more actively pursued mode of adaptation with the goal of gaining some concession from external agents. In our model, firms pursuing this strategic mode are aware of their more powerful negotiating position and will try to actively influence environmental pressures to their favor. I observed this mode of adaptation among firms that usually possess a longer history of operation in the PRD, and have developed stronger a supply chain or political linkages within the region. Their size or level of technological sophistication equips them with more favorable power conditions to negotiate their operational requirements with local cadres. Not surprisingly, I identified this mode of strategic adaptation predominantly in foreign-invested enterprises or among important Chinese domestic firms operating on a higher level of technological or organizational sophistication. A good example of this means of adaptation could be observed in COMPANY B, a large foreign-invested multinational enterprise operating in the field of lighting production. The company entered the Chinese market in 1995 and opened its production site in Foshan in 1997. Today, approximately 3,600 employees are engaged in full-scale production of various lighting products. When asked about the perception of environmental challenges, the firm’s senior technology manager reported mostly about problems associated with labor

98

4. Institutional change and strategic adaptation

scarcity while labor turnover is not among the most pressing issues. In contrast to other interviewed firms, the approaches to overcome the mentioned problems are of a rather proactive nature: “We have an apprentice training program like in our home country. 3 years, two-track system and we train around 75 apprentices each year and will raise this to 100 per year in future […] Compared to other Chinese firms we have a low rate of labor turnover. From that perspective, we have many employees with our company for more than 10 years who accumulated a lot of knowledge during their career with us. We tell our future employees beforehand that we pay ‘market-median’ or a little above that, so that they will not expect to earn exorbitant salary. […] On the other hand, employees can rely on the company. Every employee receives his wage each month. We pay the insurances as promised and cover other expenses as well, that are being promised in other firms, but that are commonly not paid in the end. […] In addition, we pay performance-related bonuses. Like if an engineer develops a patent, they will receive a bonus or if production lines run over the production quote. This goes down all the way to the operator working on the production line.” (FS-C2)

The company’s approach to labor-related problems is closely related to its experience in the home country. Instead of relying passively on the local labor market, employees are intensively trained and bound to the firm. This is also achieved through means of cooperation with institutions of the higher education such as technical colleges and universities when recruiting higher skilled employees, which is also proposed by LI & JINGHONG (2010: 630f.). Preparatory classes equip the staff with the necessary knowledge before they start working with the company. For production workers who are mostly migrant workers, on-the-job training programs are established to provide them with basic knowledge about technical working routines. Besides providing workplace stability and offering training, a third mechanism to cope with labor-related problems lies in the company’s recruitment practice. According to the senior technology manager, local recruiting is an important method to decrease labor turnover rates: “I like recruiting staff locally. I tell the HR [human resource] personnel to try recruiting people from Guangzhou… preferably even Foshan. […] As for the normal engineers, I like to recruit them from universities that are not top-notch. People from Beijing University or Fudan University who come here have extremely high expectations towards career and salary. This is problematic as many university graduates would like to be manager within half a year and that is hard to realize for us. We invest quite a lot to train them for the job and keep them learning while they start working. We have made the experience that many who came here told us: ‘Well, I am still not manager… then I will go somewhere else.’” (FS-C2)

This focus on local recruiting and close-knit cooperation has a bonding effect of the firm to its current location in Foshan. Consequently, a stronger degree of cooperation has developed between the company and local politicians. Institutional embeddedness is thus also related to institutional bargaining power. Institutional bargaining power is an important mechanism to tackle immediate environmental constraints and problems faced by the company. For problems related to energy scarcity and grid stability, our interview partner mentioned that they make certain concessions to the local government, such as reducing energy consumption by turning off certain energy-intensive production steps (product testing). However, due to their important position for generating business tax for the local govern-

4. Institutional change and strategic adaptation

99

ment, they do not have to follow the requirement to stop production for three days per week. With regard IPR protection (intellectual property rights), the company also closely cooperates with the local government: “We have our own company division that is engaged in identification of ‘underground factories’. […] We have good contact to the local government that works through cooperation with the local police. Our staff identifies ‘underground factories’, the police closes them down.” (FS-C2)

In brief, cooperation with local governments to bargain favorable environmental conditions has strengthened the companies’ competitive situation in the PRD. Asked for the importance of innovation activities in the aftermath of the global financial crisis, our interview partner pointed out that his company was carrying out intensive innovation activities before the crisis affected the business environment and the crisis itself did not trigger a change in the company’s innovation orientation. Engineers based in Shenzhen carried out R&D activities for more sophisticated product fields like automotive and medical. The Foshan engineering department carries out R&D for the traditional product lineup. According to our interview partner, there was no significant change in R&D strategy and activities in the aftermath of the global financial crisis. R&D in China is part of the companies’ global R&D network operating in various locations in South and East Asia, as well as in cooperation with engineers in the home country and as such less affected by local changes. I find that a higher degree of institutional bargaining power will indeed give firms more possibilities to influence their institutional and business environment. Firms possessing this resource will be able to alter various elements of their surrounding environment. In answering Research Question 4, I find that institutional bargaining power allowed the firms to negotiate preferential political treatment to overcome institutional and operational constraints at their current location. The proactive approach to tackle the labor-related obstacles proved to be a successful strategy; however, it was only possible due to the firms’ significant size and influence. Research Question 5, which asked for strategic reorientation of local electronic manufacturing firms toward innovation- and upgrading-related strategies in the aftermath of the global financial crisis, can be declined, by comparing the selected case-studies. Among the interviewed firms, the perception of the crisis as a trigger for more innovation-related strategies remained weak. In many cases, predominantly among FIE (foreign-invested enterprises), innovation was carried out before the crisis and the firms incrementally adjusted their innovation strategies during the period. However, none of the managers reported about a fundamental change caused by the disruptions of the crisis itself.

100

4. Institutional change and strategic adaptation

4.5 CONCLUSION AND DISCUSSION Changing environmental and competitive conditions in the PRD, which were accelerated not only by the financial crisis in 2008, but also by deliberate policy changes, require local electronic manufacturing firms to adapt their business models. Increasing labor and land scarcity, electricity shortages, and generally rising costs of doing business put local managers under increasing pressure. How do firms cope with these changing environmental and institutional conditions? I try to answer this question by drawing on an extensive set of data, including 14 in-depth qualitative interviews with firms and business representatives in the PRD and Hong Kong, as well as quantitative firm data of a large-scale quantitative survey obtained between late 2011 and early 2012. The analysis contributes to a more systematic understanding of the firms’ behavior and strategy under changing institutional conditions, and in the interplay of firms and their regional environment, thus calling for further research to question the firms’ development trajectories in the changing production regime of the PRD. The elaboration of the concept of ‘institutional bargaining power’ proves to be a promising tool to analyze government-industry relations in China’s transitional context in order to contribute to a better understanding the mechanisms of governmental coordination in firm-government relations.Results indicate that market, rather than policy pressure, incentivize firm adaptation processes in the aftermath of the financial crisis. Policy-induced changes, e.g. by means of changes to the regional minimum wage standards, does exert a policy influence through the backdoor.

Fig. 4.3: Analytical framework. Own draft, based on OLIVER (1991)

4. Institutional change and strategic adaptation

101

Due to the exploratory nature of the study, I would like to encourage future research to validate the findings and thus present the following working hypothesis: –

H1: Increasing market pressure, rather than policy initiatives, affects local electronic manufacturing firms’ business models in the PRD

In order to facilitate a systematic assessment of strategies for firm adaptation in a case-study approach, I develop an analytical framework grounded in institutional sociology. I find that modes of strategic adaptation are dependent upon the degree of institutional embeddedness as well as institutional bargaining power. Firms’ institutional embeddedness describes the degree of relational-density in inter-firm networks and the local production regime, for instance by means of supply-chain integration. Institutional bargaining power, in contrast, describes the ability of firms to alter and influence competitive and other elements of the business environment on the back of relational assets (see Fig. 4.3). In this view, firms in possession of more institutional bargaining power will be able to negotiate favorable institutional and environmental conditions, while firms that are weak in bargaining power will have to rely on strategies of on-site adaptation, such as rationalization. I find that certain firms are indeed in possession of institutional bargaining power to influence their environmental and institutional conditions. Despite maturing institutional conditions, these findings indicate the continued existence of institutional loopholes. Hypothesis 2 can be deducted as follows: –

H2: A higher degree of institutional bargaining power will give firms greater possibilities to influence their institutional and business environment.

The degree of institutional embeddedness influences the firms’ ability to exit the institutional and business environment through (partial) relocation. Not-soembedded firms will engage in partial relocation in order to tap into cheaper or better accessible factor markets while reaping the benefits of their PRD site. Empirical results show that the spatial pattern and individual motivation of partial relocation do not represent the desired policy goals of strengthening the provincial periphery of Guangdong or the Chinese Western provinces. They rather follow existing patterns of spatial agglomeration and spatial proximity to the developed economic centers in China. Thus, Hypotheses 3 and 4 read as follows: – –

H3: (Partial) firm relocation and firm expansion will not favor locations in the periphery of Guangdong Province despite of provincial policy initiatives. H4: A higher degree of institutional embeddedness will favor on-site adaptation of processes and will discourage (partial) relocation processes.

Finally, I ask the question whether the global financial crisis encouraged firms to change their business models toward higher value-added activities or innovation.

102

4. Institutional change and strategic adaptation

The results indicate that the crisis of 2008 was perceived as a temporal interruption of business routine, and firms were quick to normalize operations in the postcrisis period. Firms engaged in systematic innovation and R&D activities were usually already carrying out those activities before the crisis affected the regional economy. Despite deteriorating competitive conditions for low-cost manufacturing, firms seemed to be able to sustain their individual business models, owing to strategic adaptation. A systematic trend toward upgrading among the interviewed firms is not visible. Hypothesis 5 thus claims: –

H5: The financial crisis of 2008 did not encourage change in the firms’ strategies and business models toward innovation and upgrading activities. From the current viewpoint, it seems difficult to assess the sustainability of the mentioned adaptation strategies; however, from the partial continuity of the lowcost manufacturing model, it remains questionable whether the region as a whole increases its resilience toward future crisis periods or economic disturbances. Similar research supports the observations made. For instance, BUTOLLO (2013: 166) summarizes that: ‘[…] the pressures on the labour-intensive, predominantly export-oriented growth pattern in Guangdong province have provoked changes in company strategies; however, the solutions that are being chosen mostly lie in a reconfiguration of production systems.’

Policy-makers should thus further strengthen their efforts in order to motivate firms to invest substantially in upgrading innovation activities.

5. THE IMPACT OF FINANCING CHANNELS ON FIRM INNOVATION – IS THERE AN ‘INFORMALITY TRAP?’ 5.1 INTRODUCTION Economic instability in the aftermath of the global financial crisis and ever increasing competition among China’s most prosperous economic centers in Shanghai and Beijing (LIN et al. 2011; CHEN 2007) have strengthened the political efforts towards industrial upgrading in China’s core region of export production (HUANG & CHEN 2010: 80f.; FU et al. 2012: 94). The established development model for the Greater Pearl River Delta (PRD), which is grounded in export production and fueled by the regional economic integration of Hong Kong and the mainland and its future prospects, is increasingly being questioned (MEYER et al. 2009; LU & WEI 2007). Recent studies emphasized the importance of domestic investment, innovation activities and linkages in the regional innovation system for this region (FU et al. 2012 / 2013; WEI et al. 2012; SUN 2002). However, despite recent efforts by policy-makers, the regional innovation system in the Greater Pearl River Delta remains fragmented, and firms’ innovation performance lags behind that in other Chinese regions (KROLL & SCHILLER 2012; SCHILLER 2011; YAM et al. 2011: 393). Innovation activities in developing countries are often distant from the current technological frontier and are commonly defined as being ‘new to the firm’ (AYYAGARI et al. 2011: 1549). This definition considers innovation to be: ‘the implementation of a new or significantly improved product (good or service), or process, a new marketing method, or a new organizational method in business practices, workplace organization, or external relations’ (AYYAGARI et al. 2011: 1549; SCHILLER 2011: 27).

Aside from the widely acknowledged importance of knowledge and technology transfer through FDI and technological upgrading by forging links with foreign multinationals (HOBDAY 2000: 133ff.; HOBDAY 1995: 1183), SUN & DU (2010: 543) as well as LIN et al. (2011) single out the importance of in-house R&D activities for firms in developing economies. The development of domestic industrial and technological capabilities is crucial to avoid the pitfalls of the middle-income trap – a situation where technology absorption and utilization as well economic advancement stagnates and the economy remains ‘trapped’ in a foreign guided export regime (OHNO 2009). The debate on industrial upgrading has generally acknowledged that financial constraints pose an obstacle to technological development in many developing economies (SCHILLER 2011: 27). However, only limited empirical attention has been devoted to this phenomenon. Aside from the importance of equity capital in firm financing and despite high savings rates, private capital seldom covers the

104

5. The impact of financing channels on firm innovation

firms’ total financing requirements (ALLAN et al. 2008: 518; HUSSAIN et al. 2006: 589). The importance of the financial system for the innovation process has been established by Schumpeter’s analysis of the economic system. Banks and venture capitalists supply ‘innovation entrepreneurs with the liquidity necessary to carry out their projects’ (BERTOCCO 2008: 1173). DOSI (1990: 316) emphasizes that the financial allocation system functions as the ‘crucial bridge between the present and the future, between what ‘has proved to work’ and the exploration of ‘what is possible’’. Small privately owned firms in China are particularly vulnerable to financial constraints and often rely on informal financing for their business operations and investments (CHAN et al. 2012; PONCET et al. 2010). This situation is caused by a changing institutional landscape and incremental developments in the Chinese financial markets, which partly inherited the institutional inertia of the pre-reform period. This interplay between financial markets and firms is, however, not just a Chinese phenomenon and can be observed among many transition economies such as in Central and Eastern European countries (KARREMAN 2009: 261). Only limited empirical evidence is available that links the observation of firm financing channels with an analysis of innovation activities in developing economies. The specific institutional structures of the Chinese financial system, with a state-dominated formal credit-lending sector and a multisided structure of informal arrangements in private lending create a distinctive environment for the interplay between financing channels and innovation activities. However, the effects of the relationship between informal financing and firms’ innovation activities remain largely unclear. The effects of the global financial crisis that shook the world’s economy in late 2008, with its indirect effects still being felt today, further complicates this setting. This chapter will fill this research gap by drawing on the institutional specifics present in the Chinese financing system and thereby contribute to a better understanding of the impact of different financial channels on the innovation performance of private electronic manufacturing firms in China. The utilization of two separate datasets obtained by surveys in the Pearl River Delta will allow for a better understanding of the temporal changes of firm financing during and after the global economic crisis. The empirical results indicate different functions for formal and informal financing channels. I find that informal financing complements imperfect lending mechanisms from the formal financial markets and serves an important supplement to cover firms’ overall financial requirements. Particularly during the crisis period, informal financing served as a crisis buffer when formal lenders were hesitant in their lending decisions due to the unclear economic outlook and market conditions. In the restructuring period after the financial crisis, I find that informal financial capital does not contribute to firms’ innovation efforts or performance but rather hinders them. In contrast, formal bank financing through Chinese banks tends to support innovation efforts. An `informality trap’ might arise through which firms are strongly reliant on informal financing to cover their overall busi-

5. The impact of financing channels on firm innovation

105

ness expenditures and might thereby be hindered from pursuing long-term oriented innovation and upgrading activities. 5.2 THEORETICAL AND CONCEPTUAL BACKGROUND 5.2.1 SOURCES OF FORMAL FINANCIAL CAPITAL The communist legacy in the Chinese banking system led to a largely inefficient and over-regulated state-controlled banking system (NAUGHTON 2006: 446). In the early reform period, the ‘monobank’ structure of the financial system was incrementally broken up into a two-tier system with the national bank PBC (People’s Bank of China) and four commercial state-run banks, the Industrial and Commercial Bank of China (ICBC), the Agricultural Bank of China (ABC), The Construction Bank (CCB) and the Bank of China (BOC) (LIU & WU 2008: 163). Aside from the ‘big four’ banks, which were commercialized in 1995, a variety of joint-stock commercial banks exist that were founded in the late 1980s. Other elements of the Chinese banking system comprise city banks, often controlled by local governments, urban and rural credit cooperatives, policy banks aimed at funding policy goals as well as stock and bond markets and venture capital providers (fig. 5.1) (HSU 2012: 31; NAUGHTON 2006: 454ff.; KARREMAN & VAN DER KNAAP 2012). Recent years were characterized by increasing efforts from local governments to establish own financial institutions in their respective jurisdictions (LIU & WU 2008: 165). Despite fundamental institutional changes in recent years, such as the partial opening of the Chinese financial system to foreign banks in 2006, the state-controlled banking system remains the most important pillar of China’s financial infrastructure and the system remains largely shielded from the international financial markets (PESSAROSSI et al. 2012: 432). The People’s Bank of China (PBC), China’s national bank, implements monetary policy and credit allocation to the lower-tier banks. The latter are responsible for individual credit provision to firms and individuals. Due to the strong political control and influence, the formal banking system largely served as the provider of low-cost capital for state-owned enterprises (SOE) in the form of policy lending and experienced a problematic accumulation of non-performing loans (NPL) (ESTRIN & PREVEZER 2011: 52; FIRTH et al. 2009: 1145f.). According to TSUI (2011: 695ff.) the close-knit ties between politics and the banking system still exist today and showed deficits in the recent surge of debt-financed infrastructure development. According to ZHANG (2008: 669ff.), political connections also enhance access to the formal bank financing of small and medium- sized enterprises (SME). The reduction of NPLs and the recapitalization of the national banks has thus become an important instrument to stabilize the banking system (ALLEN et al. 2008: 528f.; NAUGHTON 2006: 460ff.). Recent reform attempts aim to improve the quality of lending decisions based on credit and risk analysis along with the promotion of lending to SMEs and privately owned enterprises (JIANCHUN & DALY

106

5. The impact of financing channels on firm innovation

Fig. 5.1: Overview of China’s financial system. Own draft, based on ALLEN et al. (2008: 512) and TSAI (2002: 37).

2012: 35; FIRTH et al. 2009: 1146). However, privately operating SMEs in particular remain disadvantaged in bank lending decisions due to the information asymmetries caused by missing credit history records or missing tools for the evaluation of the former (YIU et al. 2012; CHOWN & FUNG 1998: 315; CHAN et al. 2012: 490). Intransparent accounting and financial reporting practices in many smaller firms further complicate the risk assessment process with formal lenders, a problem that is also commonly reported for the Chinese stock markets (SCHILLER 2013; BAILEY et al. 2009: 10). In turn, lenders might turn to the customers or suppliers of the potential borrower to gain information about the borrower’s business credibility. ZHU et al. (2012: 1138) note that only 10% of private entrepreneurs in China can obtain bank loans. Weak legal institutions and insufficient protection of creditors’ rights resulted in disputes between lenders and borrowers, leading lenders to more further hesitant to lend long-term oriented capital. Another reason for the reluctance of the state-banking system to become involved in private capital provision is fixed interest rates, which discourage riskier investments over guaranteed returns from investments in state-owned industries. Individual interest rates are tightly coupled to the key interest rate set by the PBC and range approximately 6% annually for one-year loans (WORLD BANK 2013). The relatively shielded position of the Chinese banking system proved to be advantageous during the global financial crisis. According to SUN (2009: 32)

5. The impact of financing channels on firm innovation

107

‘Chinese banks do not need to react to the crisis by cutting back lending […]’ but rather intensified their efforts to supply the economy with needed liquidity. Arguably, much of this additional liquidity has been channeled into state-owned enterprises. It remains an open question whether private SMEs benefit from the extra liquidity in a similar way. Nonetheless, the effect of the crisis on firm financing might also have been more indirect, for instance by more cautious investment practices for the individual case during the crisis period (OHM & LIEFNER 2011: 397). Because the Chinese National bank lowered the key interest rate (Fig. 5.2) to dampen the economic downturn during the crisis period and the bank’s function was to stabilize economic development during the recovery period, we expect stronger involvement from the Chinese banks during the post-crisis recovery period: –

H1: Chinese banks have increasingly contributed to overall firm financing volume in the aftermath of the global economic crisis.

Foreign banks play only a marginal role in firm financing in China, stemming from the unfavorable institutional conditions that are imposed upon international financial service providers, despite the opening of the Chinese service economy in the post-WTO period. High capital requirements for the initial investment as well as strictly limited potential for local bank acquisition or joint ventures prevented even Hong Kong based banks from starting larger operations in mainland China (CHAN & ZHAO 2012: 75f.). Because of these limitations, the extent of foreign bank financing for local Chinese firms is limited. 5.2.2 Sources of informal financial capital Financial constraints caused by the resistance to lend to privately owned firms and the general inability to access foreign capital have led to the development of a blooming landscape of informal financial institutions ‘outside the officially recognized financial sector and unregulated by the monetary authority’ (HSU 2012: 28f.). Despite their current function to fill the institutional voids caused by the institutional legacy of the national banking system, informal finance has a long tradition in Chinese culture in the form of private lending as well as rotating savings and credit associations (HSU 2012: 29; TSAI 2002: 39). It can be found not only in mainland China but also in Taiwan, with very similar characteristics (TANG 1995; TSAI 2002: 223). Aside from inter-personal lending, inter- and intrafirm lending, through trade-credits or business groups, plays an important role in many Asian economies (CARNEY et al. 2009: 171ff.). Figure 5.1 provides an overview of the formal and informal financial actors in China. Despite being an integral engine of firm performance for privately owned firms in the process of rural industrialization (TSAI 2002: 89ff.), ‘back alley banking’ was widely considered to be an illegal practice throughout the 1980s and 1990s. More recently, government officials have started to acknowledge the im-

108

5. The impact of financing channels on firm innovation

Fig. 5.2: Key interest rate and loan-provision of Chinese financial institutions. Own draft, based on PEOPLE’S BANK OF CHINA- STATISTICS DEPARTMENT (2013)

portance of these lending mechanisms and are starting processes to lead to their partial legalization (HSU 2012: 30). In contrast, some examples of private lending or trade credit among wholesalers are not considered to be illegal as long as they do not surpass the fixed national interest rate, and they are therefore considered to be a private instead of a formal business transaction (TSAI 2004: 1492). The most prominent example of the impact of informal finance on economic development is the discussion and turmoil around the Wenzhou development model, which gave birth to vibrant privately organized economic development in the south-eastern province of Zhejiang but was severely and repeatedly affected by large-scale credit defaults and cumulative firm closures (PARRIS 1993: 242; TSAI 2002: 122ff.); LI 2009: 143). A central element of informal finance in China is its embeddedness in traditional Chinese institutions such as the guanxi system (ALLEN et al. 2008: 507; TSAI 2002: 260f.). Repeated interactions and growing trust among borrowers and lenders act as a substitute for the formal safeguards present in the official financial system (ESTRIN & PREVEZER 2011: 55). Information asymmetry is reduced as lenders gain information about the credibility of the borrower through social networks (YIU et al. 2012). Repaying a loan becomes a social obligation consistent with the mutual character of the guanxi relationship. Misbehavior is sanctioned by the borrower losing his business credibility and thus being excluded from future transactions in the informal financial system. Potential negative elements of the informal finance sector are, for instance, higher interest rates due to the limited collateral of borrowers (HSU 2012: 31; ESTRIN & PREVEZER 2011: 55), a threat that became especially visible during the Wenzhou crisis in 2011 in Zhejiang province. Information about interest rates on the informal capital markets is scarce. In a recent report, WAHL & MAACK (2012:

5. The impact of financing channels on firm innovation

109

19) noted that the average lending interest rate on the Chinese grey capital markets averages approximately 24% annually. Examples from TSAI’s (2002) detailed case studies mention a 36% annual interest rate with a so-called ‘loan shark’ in Fujian province (TSAI 2002: 98). LI’s (2009: 146) example of Wenzhou city mentions a monthly interest rate for enterprises averaging approximately 20%. Interest rates on informal or grey capital markets are, despite regional differences, therefore usually higher than the formal capital markets but are, in turn, more accessible, especially for individuals or smaller firms (LI 2009: 146). In times of crisis, informal financing can function as a buffer to compensate for immediate financial constraints when the lending channels of the formal financial markets are inaccessible: –

H2: Informal finance functions as a crisis buffer and bridges short-term financial constraints. 5.2.3 Institutional change and firm performance

While the general influence of institutions is widely acknowledged (WÓJCIK 2009), the debate on the element of informality and informal institutions in the process of economic development recently distanced itself from the outdated understanding of informality ‘being an inferior residual category’ (SCHILLER 2012). Informal institutions comprise mostly unwritten, socially enforced rules of individual behavior that are rooted in culture and ideology and that exist outside of officially sanctioned channels (PENG 2002: 252; HELMKE & LEVITSKY 2004: 727). Today, informality is understood as an alternative and enabling governance mode that distances itself from the sole analysis of livelihood strategies by marginalized social actors (SCHILLER 2012; MEYER 2011). Informality fills institutional gaps, reduces transaction costs and enables social interaction in a changing and incomplete economic landscape. In the process of economic transition, reliance on informality is considered to be an institutional necessity, as instability and the limited predictability of future events often require different strategic responses (OLIVER 1991: 152). MEYER (2011) has shown the importance (and inertia) of informal arrangements among customer-producer relationships in electronics manufacturing firms in Southern China. She notes that even though the institutional environment has continuously matured, informal modes of business organization continue to exist, often side-by-side with formal arrangements. She thereby supports NELSON’s (2008: 7) observation that institutional change is not a planned process aimed at enhancing the efficiency of social interaction but works in a selective and partial form, leading to the existence of apparently inefficient or redundant social institutions (ROLAND 2004: 114). Thus, a continuously maturing institutional environment will not necessarily lead to the disappearance of informality but will rather weaken its overall importance as a governance mode (HELMKE & LEVITSKY 2004: 732). The resilience of informal institutions is partly

110

5. The impact of financing channels on firm innovation

caused by their deep roots in society’s normative and cultural understanding (MEYER 2012: 13). Financing among electronics firms in Southern China is a good example of the same trend. While the formal financial market in China has grown rapidly, and credit lending to private borrowers is expanding, informal lending practices remain an important mode of firm financing (YAO & YUEH 2009). This importance is maintained, as the next section will show, not only because informal financing has deep roots in the Chinese lending system but also because the maturing institutional environment of the formal financing markets still suffers from institutional inertia from its communist origin, leading to disadvantages for privately owned firms. We can thus state that reliance on informal institutions used to be an institutional necessity in China, and it has subsequently transformed into a modern form of opportunity informality. The previous examples have demonstrated the advantages of informal arrangements and governance modes for firm performance in China (SCHILLER 2012; MEYER 2011), but it is also important to understand the potential weaknesses of this reliance on informal institutions, especially in the field of firm financing. While informality was previously one key to the competitive advantage of Chinese firms, the changing economic landscape and increasing regional and global competition requires firms to substantially invest in upgrading products and production processes to stay competitive. These innovation processes pose a financial burden, and it remains questionable whether the reliance on informal business modes might hinder firms in their individual efforts, either in terms of technological learning or in obtaining the necessary financial assets to conduct innovation activities (ZHU et al. 2012: 1138). 5.2.4 Financial sources and firms’ innovation activities The complex institutional structure of the Chinese financial system and its ongoing changes led to the development of a multisided financial system. So far, only limited information is available on the different effects from the utilization of financing channels for firms’ innovation processes. The advocates of the formal financial markets stress the importance of banks, equity markets and venture capital providers as well as other types of formal credit lending institutions to firms’ innovation financing. Financing through these channels is characterized by a higher degree of formalization and predictability. This characteristic is often visible in lower interest rates for the capital provided (HSU 2012: 31). Lower interest rates and longer lending periods as well as continuous lending allows firms to better utilize capital in their implementation of R&D efforts or innovation-related projects; it also allows firms to structure their operational routines using a more long-term oriented development model. Empirical evidence on the link between firm financing and innovation is often limited to firms in developed economies. MINA et al. (2013: 894ff.) analyze the demand supply of external finance for innovation in SMEs in the United Kingdom and the USA. They find only limited

5. The impact of financing channels on firm innovation

111

Fig. 5.3: Analytical framework. Own draft.

evidence for financing constraints in the aforementioned firms, indicating the maturity of the capital markets. BENFRATELLO et al. (2008: 215) find a positive effect from bank branch expansion on process innovation in Italian firms. HYYTINEN & TOIVANEN (2005: 1387ff.) argue that financial constraints are a bottleneck to innovation and growth in Finnish SMEs. AYYAGARI et al. (2011: 1564) find that external financing is positively related to firm innovation in a large number of developing economies. Specifically, the use of local bank financing is helping local firms to upgrade existing product lines. LAZONICK (2007) as well as CARPENTER et al. (2003) analyze the interplay of the stock market and innovation among electronic firms in the United States. LIN et al. (2011) find a positive relationship between capital mobilization and innovation performance in Chinese ICT firms. We thus expect a positive impact from the utilization of formal financial channels on firms’ innovation and upgrading efforts: –

H3a: Formal financial channels contribute to innovation and upgrading activities in Chinese electronic manufacturing firms

Necessary preconditions for this type of innovation financing are a working and sufficiently mature capital market as well as a sufficient degree of political and economic stability. Informal financing fills these institutional voids by providing capital with more flexibility in the prerequisites for collateral and the conditions for the lending process. Thus, informal financing bridges financial constraints in less predictable environments, e.g., in developing economies, during economic crises or disturbances or during short-term liquidity constraints (TSAI 2004: 1492). YIU et al. (2012) find that informal financing channels might positively influence firms’ economic performance. However, AYYAGARI et al. (2010) note that formal bank financing exerts a more positive influence on firms’ productivity growth than reliance on informal financing channels.

112

5. The impact of financing channels on firm innovation

While firms conducting innovation activities might be easily supplied with the necessary funds from informal sources or equity financing, the often less systematic character of informal financing as well as the lower capital volume, shortterm orientation and significantly higher interest rates can be an obstacle for the financing of innovation activities (LI 2009: 144; ZHU et al. 2012: 1138): –

H3b: Informal financial channels do not contribute to innovation and upgrading activities in Chinese electronic manufacturing firms 5.3 DATA AND METHODS

The PRD and its leading industrial sector, the electronics industry, which contributes to approximately 30% of the provinces’ industrial value added, offer a unique research setting for the analysis of the interplay between firm financing and innovation activities. Due to the region’s early exposure to the Chinese opening and reform period in 1978, the early establishment of special economic zones in Shenzhen and Zhuhai as well as the continuous investment inflow induced by the region’s geographic proximity to Hong Kong, the PRD has a more mature and liberal financial system than many other Chinese regions (VOGEL 1989: 151ff.). Proximity to the finance and trade hub of Hong Kong allowed firms in this area easier access to foreign financial capital. The electronics manufacturing industry in the region is characterized by a high share of privately operating SMEs that are disadvantaged in the Chinese financial markets. Their strong embeddedness in global value chains and fragmented production processes have favored the development of flexible financial arrangements such as trade credits and other modes of inter-firm financing. Due to the limited number of state-owned enterprises in the electronics industry15 as well the distance from the state-controlled innovation infrastructure, the regions’ SMEs are one crucial pillar to the process of industrial upgrading in the regional economy. To obtain the most comparable results, we narrowed the regional focus of the empirical investigation down to the two important cities of Shenzhen and Dongguan on the eastern wing of the PRD. Both cities are major drivers of industrial development and core regions for the electronics manufacturing industry in Guangdong province. Often considered as ‘one step ahead in China’ (VOGEL 1989), the cities’ relatively mature institutional structure and market-oriented industrial systems makes them a suitable region for the following analysis. Shenzhen, due to its long exposure to Western FDI through Hong Kong, has developed a comparatively competitive IT electronics industry. Dongguan developed a large manufacturing base in computer processing and the manufacturing of 15 Notable exceptions can be found among large SOEs and JVs in Shenzhen such as TCL, ZTE and Huawei. However, despite their visibility, they cannot be taken as representative for the total electronic industry

5. The impact of financing channels on firm innovation

113

computer peripherals primarily through Hong Kong and Taiwanese invested enterprises (YANG 2007: 403ff.; LAI et al. 2005: 298f.). Both cities share different histories of institutional transition in their development process, as FU et al. (2012: 535ff.) discovered. While Shenzhen was subject to a higher degree of state involvement in shaping its economic and institutional structure, Dongguan developed a grassroots institutional structure that primarily focused on compensation trade for low cost manufacturing (FU et al. 2012: 548). While both cities prospered with their individual development models, today’s economic conditions and institutional structures are still largely different. To assess the potential impact of this situation on the firms’ financing and innovation patterns, we will also include a regional perspective for the empirical analysis. To assess the utilization of different financing sources and their impact on firms’ innovation activities, I draw upon two sets of primary survey data obtained from firms in the electronics manufacturing industry in the Chinese Pearl River Delta. The survey data were collected in the autumns of 2009 and 2011 by our experienced research partner Professor Li Xun and his research team at the School for Geography and Planning at Sun Yat-Sen University in Guangzhou, PRC. For the sampling process, the Guangdong Electronic Company Catalogue, provided by the Statistical Bureau of Guangdong province, was used and the questionnaire was distributed by mail. Follow-up telephone calls were conducted, which ensured a high level of quality and internal consistency for the returned questionnaires. In the 2009 survey period, a response rate of 58% was reached; in the 2011 period, the rate was 32%. However, it was impossible to test for the representativeness of the sample due to missing information for the total population or the sampling frame due to high fluctuation in the overall population of firms. Hence, the results of the empirical analysis are of an exploratory nature and do not claim representativeness for the total population. Tab. 5.1: Central characteristics of company surveys in the PRD

Survey 2009 Surveyed period

Sample distribution Response rate

Thematic focus

Survey 2011

2008 (crisis period)

2010 (recovery period)

Shenzhen (n=169)

Shenzhen

Dongguan (n=175)

Dongguan (n=116)

approx. 53%

approx. 32%

1) Market & Strategy

1) Strategy

(n=84)

2) Organization & Marketing

2) Innovation activities

3) Innovation activities

3) Management & human resources

4) Human resources

4) Supplier / customer relations

5) External relations

5) Business environment

Source: Own calculation based on survey conducted in DFG SPP 1233 [2011]

114

5. The impact of financing channels on firm innovation

The central characteristics of the surveys are listed in Table 5.1. Items covering the utilization of financial sources were included in the same way in both phases to ensure comparable results. State-owned owned enterprises were excluded from the following analysis because they do not form an important part of the electronics industry and act within a different financial regime. Unobserved factors of governmental-industrial relations, such as potential preferential lending or measures of policy-guided lending and their impact on innovation financing of SOE’s might bias the results obtained. I thus concentrate on privately owned firms that are perceived to be disadvantaged on the formal capital markets. An overview of general sample characteristics for the surveys in terms of regional differentiation is presented in Table 5.2. Regarding the ownership differentiation,16 the results show that Chinese-owned firms comprise the majority of the surveyed firms in both survey periods. Tab. 5.2: Central characteristics of privately-owned firms by location Shenzhen

Survey and location

Dongguan

Shenzhen

2008 Number of firms

Ownership, %

169

175

84

116

Chinese

68%

42%

81%

68%

HK

11%

18%

6%

7%

Taiwan

10%

24%

7%

14%

Other

11%

16%

6%

.000 ***

X²-test (sign.)

Foundation in PRD, %

2000 and earlier 2001-2010

62%

34%

48%

53%

38%

66%

52%

.008 ***

.047 **

1-99

32%

18%

26%

25%

100-499

38%

43%

43%

42%

500 and above

30%

39%

32%

.009 ***

X²-test (sign.)

Main final market, %

11% .206

47%

X²-test (sign.)

Employees in PRD, %

Dongguan 2010

33% .969

China

69%

53%

84%

70%

East Asia Western Countries X²-test (sign.)

7%

11%

4%

13%

23%

36%

12%

17%

.010 ***

.036 **

*** sig. p