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Asian Development Outlook 2003 : III. Competitiveness in Developing Asia
Institutions, The State, and The Market: A Partnership for Development
Firms do not operate in a vacuum; they cannot function successfully or be competitive in circumstances where appropriate institutions are lacking, where the role of government is not clearly defined, and where there is an inadequate investment environment. Figure 3.2 above showed that the general institutional infrastructure, largely provided by the government, affects how firms develop entrepreneurial and technological capabilities. Therefore, a development strategy requires a working partnership between the state and the market (Stern and Stiglitz 1997) as well as the building-up of institutions. The collaboration of the two parties, state and market, consists of a series of tasks and responsibilities assigned to each. This is particularly relevant in the context of developing countries, where markets and institutions are less developed. While the scope for government intervention may be greater in developing countries, government capacity to intervene may be more limited. Developing this partnership must be a synchronized process, since the tasks undertaken by the government and the market complement each other, and the smallest malfunction of one component puts the quality and efficiency of the entire system at risk. This is the essence of the "O-Ring Theory of economic development" (Box 3.4.).  The objective of this partnership is to create a well-functioning market economy. This is, in fact, what is meant by a "competitive economy," and what the above definitions of national competitiveness amount to. Therefore, although "national competitiveness" remains a very elusive concept, in particular in the specific context of trade, it can be used as shorthand for well-functioning market economy, and this makes it a useful concept in the policy debate and for development purposes. The definition of a competitive economy as a well-functioning market economy is not readily amenable to empirical analyses, and to being expressed in terms of measurable indicators or a composite index. And it has nothing to do with rivalry and competition inherent in the definition of competitiveness at the firm level. However, the idea of a well-functioning market economy encapsulates nicely the objective of a nation, and the fact that being competitive is not a state but a process. It is the general framework of analysis used here. The question is, what is the appropriate mix between markets and state, and how does the partnership work? Figure 3.3 shows how the responsibilities of markets and state are linked so as to achieve the ultimate objective at the national level, namely, development. This consists not only of increasing GDP per capita, but also of improving the quality of life, i.e., reducing poverty, promoting health and education, maintaining a clean environment, creating an employable labor force, and so on. The key is to ensure fast long-run growth of output, the most important determinant of which is rapid productivity growth. (It should be noted that many Asian countries have specific programs and strategies to improve productivity (APO 2001.) Therefore, what needs to be understood are the determinants of productivity, and this is how international comparisons and rankings should be undertaken. An implication of this is that, as an economy develops, it will move further along the path toward catching up with the technological frontier.  Today there is widespread acceptance that private entrepreneurship and incentives do a better job than the government (Easterly 2001). Therefore, the initial premise is that the production and allocation of private goods and services should be left to the market, while the government performs the crucial role of providing the institutional infrastructure. Furthermore, markets on their own do not necessarily produce socially desirable outcomes (Stiglitz 2002). As market imperfections are more prevalent in developing countries than in industrial countries, developing-country governments have a critical role to play and can, potentially, improve the outcome by well-chosen interventions. Finally, a third party is necessary for a well-functioning market economy—appropriate institutions. As seen above, the development of a firm's capabilities is affected by the general institutional infrastructure (see the subsection Enhancing Entrepreneurial and Technological Capabilities, above). Likewise, a firm's performance contributes to the development of a well-functioning market economy since the development of entrepreneurial and technological capabilities is a source of firm-level productivity, and the latter feeds into national productivity and long-run growth. The specific roles of institutions and governments to achieve this are discussed below.
Role of InstitutionsFirms and governments operate in the context of an institutional setting, determined mostly by historical and cultural factors, and by the government itself. Institutions have been defined as a series of rules, norms, and organizations that coordinate human behavior (World Bank 2002), while their role is to enhance organizational incentives in situations where a monetary reward is not enough. According to Santonu Basu, the main task of institutions "is to provide support to firms in exchange-related activities, such as marketing, communications, transport, the transfer of technology, credit and insurance" (Basu 2002). Successful institutions lower transaction costs, provide incentives, avoid or resolve conflict, and create the environment in which firms compete. The biggest differences between countries are in their institutions, and these differences are probably the most important bottleneck for development (Rodrik et al. 2002). In this sense, it can be argued that the quality of institutions ultimately determines the level of competitiveness of a country, if the latter is understood as a well-functioning economy. The question arises as to what sorts of institutions are more conducive to achieving growth and enable firms to be more competitive. The answers are complicated, and can be considered under three areas. First, the term "institutions" refers to a large "black box" that encompasses such diverse factors as political stability; the level of informal economic activity; public trust in politicians and the police; the level of organized crime and corruption; "bandit capitalism"; judicial and central bank independence; capacity to collect taxes and enforce the law; soundness of accounting systems; litigation costs; and protection of human rights. Most economists acknowledge that a high degree of corruption constrains the development of a well-functioning market economy as it affects, for example, the credibility and integrity of the government both domestically and internationally (i.e., for potential investors). Letting markets work without excessive bureaucratic procedures and red tape is also a fundamental prerequisite for development. Second, institutions evolve. In the words of Stern and Stiglitz "Institutions shape change and are shaped by change" (Stern and Stiglitz 1997, p.13), and whereas successful institutional arrangements usually take into account a country's history, a particular institution that worked at a certain time might not work later, even in the same country. For example, Korea in the 1960s and 1970s extensively subsidized private investment by controlling bank credit and rewarding successful companies (and penalizing poor performers) as a vehicle for sustained growth. Yet by the 1990s, the channeling of credit to favored companies had caused significant damage to the country's financial system. Broadly, "there is no single mapping between the market and the set of non-market institutions required to sustain it" (Rodrik 1999, p.13). Third, institutions are, to a large extent, a very immobile factor of production, i.e., they are country specific. A country can import or copy a machine, imitate a production process, or attract skilled workers, but not the institutions that exist in a successful economy. All this implies that the development of the institutions that suit the characteristics of each country is an organic, historical, and lengthy process that is subject to trial and error (Hausmann and Rodrik 2002). This process involves an element of domestic adaptation in so far as—although other countries' experiences might serve as a reference point—what works in one country might not work in another. If one looks across a broad spectrum of industrial countries, their institutions are very different, despite having very general commonalities. Likewise, it is incorrect to infer that because there were some similarities in the stages of development of the NIEs, the institutions and government policies were the same in all of them. (These issues are considered further in Catch-Up Competitiveness: Some Lessons.)
Areas of State ResponsibilityThe key factor for developing countries is the creation of capability to specialize in those industries for which world demand is rapidly growing (in other words, for which there is a high income elasticity of demand for exports). This means developing high value-added goods, and government policy has a definite role in facilitating this. The idea that nations compete as if they were big corporations derives from the notion that governments can implement polices that affect the competitiveness of firms. In fact, most government policies affect, more or less directly, the competitiveness of all firms by, for example, increasing the provision of basic education, or fostering the institutional change that will encourage innovation and the development of modern industries. In fact, the way in which the role of the state is defined and in which its services are delivered is probably the most important determinant of the standard of living of the community over the long term (Stern and Stiglitz 1997, p.27). What is more controversial is how much further beyond these general responsibilities the state should go.6,7 Despite the plethora of empirical studies, there seems to be no consensus. According to Stern and Stiglitz: "Government has the central responsibility to provide an institutional infrastructure in which markets can function" (Stern and Stiglitz 1997, p.4; emphasis added). This definition may seem to assign a rather minimalist role to the government, but the opposite is true. Developing this institutional infrastructure represents a huge task for most developing countries. The objective is to level the playing field and provide the enabling conditions for all firms to operate efficiently. What constitutes this institutional infrastructure? The left-hand side of Figure 3.3 shows that the areas are, namely (i) the provision of a basic legal framework, (ii) the attainment of macroeconomic stability, and (iii) the correction of market failures. The first two areas encompass a series of major preconditions for a well-functioning market economy, and constitute a state's general responsibilities. Economists have come to a consensus over the importance of these policies at least and agree that, if governments perform these tasks well, they will be laying the foundations for rapid development. In terms of the third area, when markets are imperfect due to the existence of noncompetitive market structures, public goods, or externalities, they tend to underprovide the goods and services that are desired by societies (or not provide them at all), or overprovide other goods and services that might not be desired by society (pollution). Governments should intervene to prevent both the formation of monopolies and, in general, any form of collusion, as well as stop consumer rights violations. States' General Responsibilities A general area of responsibility for the state is to establish a basic legal framework, which can be taken to encompass the following (Stern 1997, Stern and Stiglitz 1997): (i) rule of law, (ii) public administration, (iii) laws regarding contracts and the regulatory structure affecting key sectors such as telecommunications and financial services, (iv) intellectual property rights, and (v) competition laws and policies. Klapper and Claessens (2002) have found a positive relationship between per capita GDP and judicial efficiency, and Klapper and Love (2002) find that firm-level governance is lower in countries with weaker legal systems. The strength of firm-level governance is also inversely correlated with the extent of asymmetric information and contracting imperfections that firms face. A particularly important issue with regard to the basic legal framework is that of competition law. There are two key issues. One is the prevention of the formation of monopolistic forms and collusion in general (e.g., antitrust laws and protection of consumer rights) since these reduce efficiency and consumer welfare. Many developing countries have a legal framework for competition policy, but the problem is that there is no real enforcement of competition law. The second is that competition at the firm level requires a framework that allows easy and quick entry and exit of firms. Competitive pressure is important for productivity growth and innovation. Empirical evidence suggests that the degree of product market competition may have significant effects on growth, and that barriers to entry and exit are positively correlated with lower productivity, greater corruption, and a larger informal economy (World Bank 2003b, pp.91-92). Thus, reducing policy-related barriers to competition is essential to raise the productivity of domestic firms. The legal system should facilitate the entry of firms by, for example, reducing the number of applications and permits required to start a business.8 Djankov et al. (2002) collected data on the regulation of entry of firms in 85 countries. Table 3.6 provides the data on the number of procedures and the cost of entry for the Asian countries included in their sample. It also includes, for reference, Canada (with the lowest number of procedures) and the Dominican Republic (with the highest). The authors concluded that official costs of entry are very high in most countries, and that, indeed, stricter regulation of entry is correlated with more corruption and a larger informal economy.  The legal system should also facilitate the exit of firms via well-defined bankruptcy and insolvency laws, as they are a fundamental part of a well-functioning market economy. For example, it would be contradictory to deregulate a sector so as to make it more competitive, but then bail out struggling firms. Exit is important because it releases resources that can be used in more productive activities. Often, unviable firms can stay in business by entering lengthy and costly rehabilitation periods. Governments tend not to recognize that firms' failures are an inescapable consequence of entrepreneurial risk taking, and often create a labyrinth of administrative obstacles to starting, operating, and shutting down businesses (Box 3.5).  Finally, the importance of a stable macroeconomic environment for economic growth, i.e., sound monetary, fiscal, and balance-of-payments policies, is very well understood. Macroeconomic stability, in particular the control of inflationary pressures, is essential for an effective working of the price mechanism, efficient firm-level decision making, investment, and growth. In addition to making general interventions, governments can intervene in other, specific, situations to correct market imperfections resulting from inefficiencies in the market for information (e.g., asymmetric information problems). It may well be that a location is very attractive but prospective investors are unaware of it. A review of the literature indicates that governments tend to be very active in three areas related to the investment environment. The government objective is to use a series of targeted interventions that aim to improve the investment environment and to support innovation and learning by firms. These areas are: (i) provision of tax incentives to encourage foreign direct investment (FDI); (ii) creation of export processing zones (EPZs); and (iii) promotion of industrial clusters. Government intervention in these areas is a controversial issue and there is less agreement among economists about the validity of this type of measure because they are often not time-bound with sunset clauses. Also, some of these measures are no more than old-style industrial policies offering favorable treatment of some selected industries, though dressed up as "new competitiveness policies." The underlying argument for intervention is that public policy in these areas can help overcome information failures that MNCs face in deciding where to locate, or in searching for a firm with which to link in a GVC (Moran 1998; UNCTAD 2001, 2002; OECD 2002). These interventions raise questions such as: Is host-country intervention needed to ensure the success of FDI? And, Would FDI flow to a given developing country without active government intervention? Four reasons may justify government intervention. First, the potential investor has a problem in acquiring relevant information about the host country, such as the legal institutions and tax regime; thus there is a rationale for host governments to provide and subsidize information networks. Second, there are market failures in terms of the credibility and willingness of host countries to fulfill the terms of long-term contracts; thus efforts to strengthen the credibility of the initial investment agreements are needed. Third, with FDI comes a know-how package that includes production methods, quality control techniques, and general management expertise. Host-country governments usually expect MNC investments to lead to an increase in employment and exports, as well as to knowledge spillovers—that is, to some externalities beyond the direct benefits reflected in market pricing, as technology is, to some extent, a public good. The MNC, however, does not include these benefits in its evaluation of the returns to foreign investment with the result that it tends to invest less than what is socially optimal. The role of policies to attract FDI is to bridge the gap between the private return (to the MNC) and the social return (to the host country). Fourth, developing countries face the problem that national and regional authorities in industrial countries are also targeting some of the same MNCs for FDI. The three areas related to the investment environment in which governments are frequently very active are discussed in the following paragraphs. Encouragement of FDI. FDI supplies a know-how package. Under appropriate conditions, this package can be a source for upgrading and learning in an effort at catching up with the frontier. When do these appropriate conditions contribute the most to the growth and development of the host country? According to Moran (2002, p.4) this will occur "when the parent has made the affiliate an integral part of the firm's strategy to maximize its corporate position in world markets. To accomplish this, the parent corporation almost always insists upon wholly owned status for the affiliate, combined with freedom to use inputs from wherever price, quality, and reliability are most favorable." Empirical evidence shows that arrangements such as mandatory joint ventures, export performance, or technology transfer mandates are not as beneficial as the host country might have hoped, to the extent that technology transferred in these cases tends to be older than that transferred to wholly owned affiliates. UNCTAD (2001, p.178) concurs that policies aimed only at inducing or encouraging foreign affiliates to transfer technology have generally not been very effective. For example, Korea used technology transfer requirements in the 1960s, but discontinued their application in 1989, as the measure began to produce disappointing results. The PRC has also stipulated technology transfer agreements in the automobile and automobile parts industry, though these arrangements will be phased out as part of its WTO commitments. Wholly owned affiliates that are free to source from wherever is most advantageous have the incentive to develop a supplier base that gives the parent an edge. "The incentive of the foreign affiliates to invest in the performance of suppliers, moreover, turned out to be quite weak in comparison with the intense motivation to ensure low price, timely delivery, and high quality control when the parent investors used local firms as an extension of their international supplier networks" (Moran 2002, p.13). FDI projects with high domestic-content mandates have high costs, show a lag in both technology and management practices, and offer little hope of maturing from infant-industry status to internationally competitive operations. They generally operate within a protectionist environment, a fact that tends to retard hosts' efforts at liberalizing trade and investment. Likewise, FDI projects launched with joint-venture requirements show a high degree of conflict among the partners, suffer from instability, and exhibit older technology and slower rates of technology transfer, than FDI projects without the mandate for joint ownership (Moran 1998). It should be added that local content requirements, together with other trade-related investment measures (TRIMs) are now being phased out as a result of the 1995 TRIMs agreement that emerged from the Uruguay Round.9 The TRIMs agreement commits all countries to eliminate local content requirements, trade-balancing requirements, foreign-exchange balancing requirements, and restrictions on exporting.10 In view of the empirical results summarized, "the more beneficial option might be to expand the TRIMs agreement to include a prohibition on joint venture and technology sharing requirements" (Moran 2002, p.24). In this context, should governments compete for FDI? Governments often try to "lure" MNCs by offering them fiscal and financial incentives (e.g., tax breaks, loss writeoffs, accelerated depreciation, capital subsidies, subsidized loans) and business facilitations so that they set up operations in their country (UNCTAD 2001, p.171). The problem with these strategies is that, as various national and regional governments try to attract FDI with the same types of incentives, their effects tend to cancel each other out. This can lead to a race as countries each try to give the biggest incentives to investors, which merely ends up as a policy of beggar-thy-neighbor (World Bank 2003b, p.80; OECD 2002, p.177). Moreover, while these strategies may lead to higher investment levels, there is little evidence that such initiatives can be systematically successful. Investment incentives do not generally make up for deficiencies in the investment environment. Furthermore, within countries, these proactive policies discriminate against those sectors and projects not targeted by incentives. In deciding whether to build a factory, MNCs use a variety of indicators and variables such as labor costs, productivity, and distance to suppliers and end markets. The host country's financial incentives tend not to be particularly important (Villela and Barreix 2002). UNCTAD (1996) and OECD (2002) conclude that fiscal and financial incentives can have an incentive on attracting FDI, but only at the margin. Thus, when a firm has two approximately similar location alternatives for its investment, then incentives can tilt the decision. The problem is that many government officials seem to believe that these incentives work, because the benefits, such as jobs created or a new plant, are visible, while the wider costs are not obvious and hence overlooked. Often, the financial costs of the incentives far outweigh the benefits from faster growth and from increased employment and tax revenues (World Bank 2003b, p.82; OECD 2002, p.169).11 The worst case is, perhaps, when the MNC beneficiary of the subsidy does not differ in any fundamental way from domestic firms. The subsidies simply distort competition. Under some circumstances, though, targeted FDI incentives may have beneficial effects. Indeed, the case for public policy in attracting FDI rests on the argument that MNCs produce positive externalities derived from their specific knowledge about production or management. Knowledge has the nature of a public good, and therefore can spill over to local firms. OECD (2002) summarizes the empirical evidence based on case studies and statistical analysis as follows: "There is strong evidence pointing to the potential for significant spillover benefits for FDI, but also ample evidence indicating that spillovers do not occur automatically. Whether these potential spillovers will be realized or not depends on the ability and motivation of local firms to engage in investment and learning to absorb foreign knowledge and skills" (OECD 2002, p.176; emphasis added). Despite the potential benefits derived from the presence of externalities (and hence a possible case for investment incentives), the recent consensus is, however, that a government's efforts should be directed at convincing investors that the country is implementing sound economic policies. Policy makers should therefore remain cautious about the positive effect of granting incentives exclusively to foreign investors. Policy measures that focus on general forms of support available to all firms, foreign and domestic, tend to reduce rent seeking and corruption. Evidence shows that the effective enforcement of contracts, absence of red tape, adequate infrastructure, and the presence of trained and trainable workers act as a powerful force to attract FDI in sectors such as electronics, automobile parts, chemicals, industrial and medical equipment, and business services (Moran 2002). To sum up, public policy to attract FDI to the Asia-Pacific region should aim at improving the macro- and microeconomic fundamentals of the economy, including infrastructure and education, and at strengthening institutions, such as the legal system. Attempts at incorporating domestic-content and joint-venture requirements into FDI agreements will have negative effects (see also Moran 1998, p.166). From a microeconomic point of view, governments must tackle the impediments to competition and entrepreneurship if they are to encourage FDI, and should direct efforts to reduce any excessively complex administrative procedures (e.g., business and tax registration, land access, site development, import procedures, and inspections) required to establish and operate a business. These discourage inflows of FDI (Morisset and Lumenga Neso 2002).12 Creation of Export Processing Zones. Countries have also tried to encourage industrial development by establishing EPZs (UNIDO 2002, pp.117-132). The argument for setting up EPZs is that they can be useful for countries that are trying to establish an export-oriented manufacturing sector but that lack the technical and/or administrative capacity to develop a countrywide system to allow exporters duty-free access to imported equipment and materials. However, the empirical evidence for or against the benefits of EPZs is inconclusive. While their immediate benefits—job creation, greater foreign exchange earnings, and higher real wages in the EPZ itself—have been documented, it is less clear whether EPZs simply cause firms that already export to relocate into the EPZ to benefit from the financial incentives, and whether they produce spillover effects to the rest of the economy and improve competitiveness (Schrank 2001). For example, Taipei,China's early EPZs in the 1960s provided basic infrastructure and freedom from red tape for firms in textiles and apparel, plastic products, and electrical appliances, and EPZs were very important initially since they helped in placing Taipei,China on the path toward export-led industrialization. However, as infrastructure facilities improved generally and as regulatory procedures were rationalized, the importance of EPZs diminished. Since the 1980s, little new investment has taken place in the EPZs, reflecting both their redundancy as infrastructure and the fact that duty-free procedures have improved outside these zones (UNIDO 2002, p.122). Some authors argue that MNCs have used EPZs mainly for assembly operations, with the result that the envisaged backward and forward linkages with the rest of the economy tend to be minimal. For example, Noland (1990, p.61) indicates that in the 1980s, only around 3% of the material inputs used in the Penang free-trade zone in Malaysia were acquired domestically. The question is how to transform low-skill export enclaves, which is what EPZs tend to start from, into higher-skill and higher-productivity areas that are better linked to the rest of the economy, so triggering a sequence of beneficial changes throughout the economy. Promotion of Industrial Clusters. An industrial cluster is a regional agglomeration of firms in related industries offering complementary infrastructure (e.g., roads, transport, and public utilities). The idea has been around for many decades, but it appeared again with strength in Michael Porter's (1990) work. More than a decade later, efforts to promote competitive clusters at both the national and regional levels represent an important component of development and investment policies in many countries. The objective of a cluster is to create a virtuous circle to attract new firms and help existing ones grow. Industrial parks are a particular type of cluster, which often go beyond physical infrastructure by providing a variety of common facilities and support services (e.g., finance, law, information, joint research facilities, and hotels). Their overall objective is to reduce costs and risks. Science and technology parks are intended for technologically advanced industries—Suzhou Technology Park in the PRC, for example, is made up of three institutions: Suzhou New and High-Technology Service Centre, Suzhou International Business Incubator, and China Suzhou Pioneering Park for Overseas Chinese Scholars. The park now accommodates 300 firms, 90% of which were set up by overseas Chinese and 10% by R&D institutes and universities. Twenty percent are high-technology enterprises. UNIDO (2002) argues that the success of the park is due to the wide array of services it provides: banks, Internet access every 10 square meters, conference rooms, accounting and legal services, human resources support, and import-export services (UNIDO 2002, p.122). By far the best-known cluster is Silicon Valley, in California. Every government wants to build a Silicon Valley without, however, realizing that it was not planned. Scientists and engineers moved there because the right conditions existed, e.g., patent laws, financial system, and an "informal creative culture" of inventing (Box 3.6). However, there is little evidence that efforts to create clusters are successful, especially when they are policy driven or little more than efforts to force the creation of a particular industry.13 The reason is that it is difficult for governments to pick the winners (Hausmann and Rodrik 2002). The problem is that while it is easy to see the industrial parks and clusters that have succeeded, there is little understanding about how to create them, and it is unlikely that governments have any great expertise in selecting the areas where clustering may be successful. In general, the effectiveness of these measures is largely context specific, predicated on the economic environment and institutional setting. If local firms operate in a well-functioning market environment, it is more likely that they will actively engage in some sort of linkage or cluster program anyway. Governments that have succeeded in supporting the emergence of competitive clusters have acted as mere catalysts or initiators in support of cluster development initiatives, and have sought to complement, rather than replace, private sector efforts to improve conditions for competitive performance. The government, in these cases, has set priorities, which involved making choices (e.g., budget allocation). But this was different from picking the winners.  The general conclusion about these specific intervention policies is that they work best when they are implemented in conjunction with broad reform packages. In the final analysis: "Bigger payoffs are likely to come from interventions to improve the broader business environment" (World Bank 2003b, p.83) (Box 3.7 gives an example of this in the context of Ireland).  There is, finally, another raft of microeconomic interventions that, though difficult to evaluate, are less controversial than the above three (UNCTAD 2001, pp.173-193). Experience with some programs suggests that the returns to well-conceived initiatives can be high, otherwise, they can be a waste of resources. Public initiatives can play a role in enhancing the availability of information about the host country. The provision of information, a public good, through seminars, web sites, maintenance of databases, commercial missions, or trade fairs and exhibitions is certainly useful. Also, industry associations and chambers of commerce can be valuable sources of information. Evidence shows that a proactive approach in terms of marketing a country through customized packages of information for specifically targeted industries yields high returns (Moran 2002). These packages include host-country web sites, with access to relevant legal texts and regulations, links to relevant ministries, and direct contacts to existing investors and industrial-park developers. The objective is to help foreign firms reduce their search costs and overcome market failures due to asymmetric information to avoid bad location decisions. Areas of Shared Responsibility between the State and the MarketAs Figure 3.3 shows, the state and the market have three areas of shared responsibility toward creating a well-functioning market economy: education, physical infrastructure, and technology and innovation/R&D.Providing basic education (primary and secondary) is clearly the role of the state. Education plays the dual role of enhancing a person's quality of life as well as increasing his or her productivity. But beyond basic education, the question is how tertiary education should be supplied. (Education and science and technology policies are discussed further in the section Education and Skills.) For a long time many economists believed that the government alone should provide physical infrastructure, which includes bridges, roads, ports, railways, water, telephones, and electricity. Today, however, it is clear that this is an area of shared responsibility and that the private sector can also provide infrastructure. This eliminates the problems inherent with government monopolies, such as inefficiency and rent seeking, and increases competition among both domestic and foreign companies. Technology and innovation/R&D policies are key to successful development.14 A crucial point is that the government must put in place the institutional infrastructure necessary for an effective transfer of technology and for the development of indigenous technology (Chang 1996). This infrastructure refers to the bodies that support industrial technology, such as education and training, R&D, or export information. Successful innovation and building of technological capabilities cannot be undertaken without them. Some of these institutions, such as universities and public laboratories, may be funded by the government. Others are sponsored by the private sector, for example industry associations. In fact, most industrial countries have succeeded in developing cooperative interaction among them. Summing up, the role of public policy in enhancing firms' competitiveness is multifaceted. There is no doubt that governments can positively affect the environment in which all firms operate. Guaranteeing the legal system (and making sure that it is enforced through appropriate institutions), providing macroeconomic stability, and correcting market failures are fundamental government-supported pillars in ensuring a well-functioning or competitive economy. Education and infrastructure, also crucial to improving firms' competitiveness, are areas of responsibility that the government can share with the private sector. But beyond these areas, it is less clear what the role of public policy should be. The evidence at hand is inconclusive regarding governments' incentives to attract FDI, to create EPZs, and to promote clusters. Governments could, on the other hand, play an important role in providing information about their country. Two related dynamic competitive factors that are making developing Asia a formidable producer and exporter of technology-intensive goods are having important consequences and are inducing a shift in the location of the world's knowledge-based work. The first factor is the shifting investment strategies of MNCs and the importance of GVCs, which has been facilitated by faster and cheaper transport and communications15 (discussed further in the section Global Value Chains). The second factor is the availability of skilled labor (examined in the section Education and Skills).
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