International Case Studies: Chreod

Chreod
河北省发展战略研究 www.Chreod.com
Asian Development Bank

Hebei Provincial Finance Bureau
TA No. 3970-PRC
Hebei Provincial Development Strategy
May, 2004
相关国际经验报告
International Case Studies
亚洲发展银行
河北省财政厅
Chreod Ltd. Chreod Ltd.

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e-mail: info@chreod.com e-mail: zhang@chreod.com
International Case Study
CONTENTS
A1: Case of California

Water Markets as a Mechanism for Inter-sectoral
and Inter-jurisdictional Allocation
A2: Case of New York City

Inter-Jurisdictional Water Resources Co-operation
B1: Case of South Korea

South Korea’s Experience Upgrading its Heavy
and Chemical Industries in the 1970s & 1980s
B2: Case of Transitional Economies

Cluster-Based Regional Economic Development
in Transitional Economy Countries
C1: Case of Pittsburgh, Pennsylvania

Economic Transformation in the North American “Rust Belt”
C2: Case of Ireland, Portugal and Canada

Industrial Restructuring in Peripheral Regions to Major Markets
C3: Case of Pueblo, Colorado

Restructuring of an Isolated, Small Industrial City in Western USA
D1: Case of South Korea

Ports Development in South Korea
E1: Case of Paris

Paris Metropolitan Spillovers
E2: Case of Randstad, The Netherlands

Managing Regional Development
E3: Case of Rhein-Ruhr, Germany

Regional Urbanization
E4: Case of South Korea

F1: Case of South Korea and Canada

SME Financing in South Korea and Canada
G1: Case of Australia

Fiscal Case Study of AUSTRALIA
G2: Case of India

Fiscal Reform Case Study of INDIA
G3: Case of Korea

Fiscal Reform Case Study of KOREA
Chreod Ltd.
A1: Case of California, USA
Water Markets as a Mechanism for Inter-

Sectoral and Inter-jurisdictional Allocation
Prepared by Stephen Dolan
Chreod Ltd.
Hebei Provincial Development Strategy Chreod Ltd.
Case Study A1: California’s Water Markets 26 February 2004
California: Water Markets as a mechanism for inter-sectoral and

inter-jurisdictional allocation
1. Introduction
1. As in China, with a growing population and urbanization, water is undoubtedly
California’s most precious resource. In this context, there is a growing trend towards
reallocating water from agriculture to urban areas. If cities in California were to get 15
percent of what agriculture in California currently uses, urban water availability would rise by
more than half (Haddad, 2000). It is estimated that this water savings would be more than
enough to meet new urban demands well into this century. It is also increasingly clear that
markets will play an important role in this reallocation. There are a number of important
implications and parallels to Hebei’s situation.
2. Under these circumstances, dramatic gaps between the demand for and supply of
water, the resulting resource management debate is typically driven by a need to use water
more efficiently. Further, it is also usually driven by the necessity to anticipate and address
inter-sectoral conflicts over allocation and use of water. The standard approach in North
America so far has been to advocate reform of water pricing across sectors to reflect the
scarcity value of water. This advocacy is based on theoretical and empirical evidence on the
need and desirability of such reforms including willing-to-pay studies. Nevertheless, major
users of water, particularly of irrigation water have usually resisted these reforms given that
they will likely result in dramatic increases in their cost of water.
3. Economic theory indicates that markets increase economic efficiency by allocating

resources to their most valuable uses. In other words, if certain conditions are met, markets
provide the correct incentives (and disincentives) and lead to efficient resource use. One
way to change the incentives so that water users support the reallocation of water, and to
achieving a more efficient allocation of water is through water markets. Water markets allow
water users to buy and sell water, thus changing the whole incentive structure and breaking
the logjam of water pricing reforms – when water users can gain from reallocation, they
would be willing to sell water or pay a higher price for new supplies.
4. Water Markets: The “primary function of the market system is to allow supplies to
meet changing demands in a manner that reflects the economic priority of competing
demands.” 1 There are certain conditions or criteria that must exist to transfer the use of
water between sectors, jurisdictions, or users within a market framework:
1. There must be a definable product to trade in the market. The product (water)
must be capable of being measured, controlled, and traded as a commercial
good. A market in water use rights will only develop if ownership, quantity,
measurability, and reliability are defined so as to generate confidence that the
right is secure and viable.
2. Demand for water must exceed supply.
3. The supplies derived from water use rights must be transported to where water is
needed and to be available when needed. Water available at the right time and in
the right location has economic value. The infrastructure must be in place for
water to be stored and transported to areas of demand.
4. Buyers must feel confident that they will receive and be able to use the right
purchased. For water markets to exist there must be a system of allocation,
permits, licenses or property titling that is respected by the market. There needs
to also be an administrative system that registers ownership and title transfer.
5. The water rights system must also resolve conflicts, be it administrative
arbitration, peer group resolution or the justice system.
1
Simpson, L and Ringskog, K. “Water Markets in the Americas.” The World Bank, Washington D.C.1997.
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6. The system must also apportion supply during period of shortages and excess
7. Well-defined and enforced mechanisms and criteria must be in place to assure
that users are adequately compensated when their rights are confiscated or
transferred to higher societal preferences. Within the context of California, for
example, formal water trading occurs between government entities, the various
water districts.
8. It is crucial in gauging the potential acceptability of water markets that the cultural
and societal values of water resources be considered.
9. For any management program, including a market-based system, to succeed in
the long term, it must be financially sustainable.
2. California’s Water Market
5. The formal water market in California has developed only recently in response to major
water shortages precipitated by expanding demand, a lack of conservation practices, and a
major drought. The transfer of water rights in this context went from being prohibited by law
to being advocated as a principal means for bridging the gap between demand and supply.
Reflecting this change in the regulatory environment, California has seen, especially during
the past two decades, the development of a number of both formal and informal water
transfer mechanisms. This flowering of innovation reflects the large gaps that exist between
the supply of and demand for water.
6. Historically the transfer of water between users was precluded under state law. The
owner of a water right did not originally have the freedom of transfer because, until recently,
the law was interpreted to mean that a water user who attempted to sell or transfer a right
had demonstrated that they no longer had a beneficial use for the water and, consequently,
had technically abandoned the right and were forced to relinquish it. In 1914 the State Water
Resources Control Board was formed with the authority to issue permits for the use of water
supplies. Historically, the state board held that water rights could be transferred but that the
state board would decide whether a transfer right could affect all other uses. Because the
state water board was responsible for maintaining return flows, its actions tended to
discourage transfers.
7. This situation continued until specific legislation in 1980 clarified that sale of a right did
not indicate abandonment or non-beneficial use of the water. Throughout the 1980s, the
state legislature continued to pass additional bills in an attempt to create a water market.
This included establishment of a program to facilitate long-term water transfers by setting up
a data bank of entities interested in conducting water transfers. The new law also replaced
the state board with the Department of Water Resources and required that this agency and
all other public water agencies make available a portion of unused capacities in water
conveyance facilities to facilitate the mobility of water transfers. In 1991, in response to a
major drought, the state legislature passed emergency legislation creating a Drought Water
Bank within the Department of Water Resources. This Water Bank provided for the buyback
of water supplies from the holders of water use rights as a temporary measure to offset the
effect of the drought. The idea was to develop a permanent program for buying water use
rights and renting them on an annual basis to maintain a controlled Water Bank.
8. The idea of a Water Bank was not totally new. During the 1976 and 1977 drought, the
U.S. Bureau of Reclamation established a Water Bank in the Central Valley Project that
bought more than 57 million cubic meters of water within the system at an average value of
$40.00 per thousand cubic meters. It then sold this water to other users within the project
who had critical needs, for an average value of $41.00 per thousand cubic meters. This
water bank primarily provided emergency water supplies to maintain the viability of orchards
or perennial crops that might have been lost otherwise, with devastating economic effects.
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9. The state Water Bank was established primarily to meet the emergency conditions of
the 1987 to 1992 drought. The Department of Water Resources purchased more than 975
million cubic meters of water at an average price of $102.50 per thousand cubic meters.
Administrative rules established prices based on estimates of what the selling farmers could
have received if they had used that water to grow high-value crops, plus an incentive to
facilitate the trade. The Department of Water Resources expended approximately $100
million for this water bank. The water assembled in the bank was then sold for a value of
$144.00 per thousand cubic meters plus the cost of transportation, primarily to high-value
agricultural purposes and to critical urban needs. Of the water sold from the bank, 80
percent went to municipal users in Southern California and in the San Francisco Bay area.
10. In parallel with the development of the State Water Bank, another trading system has
developed through the 1980’s and 1900s between state agencies, in particular, between the
Southern California Metropolitan Water District (MWD) and the Imperial Irrigation District
(IID). Both entities are major users of Colorado River water and located in California’s semi-
arid region. According to the 1922 Colorado River Compact, allotments for use of the
Colorado River are divided among seven western states and Mexico. California currently
uses approximately 6.5 billion cubic meters per year, more than its 5.4 billion cubic meters
allotment. Most of California’s Colorado River allotment goes to the Imperial Irrigation District
(IID), with 3.4 billion cubic meters and the Metropolitan (Los Angeles) Water District (MWD,
with 616 million cubic meters).
11. The MWD has spent $2 billion over the past decade to increase efficient water use in
anticipation of rising demand. This has resulted in a high price for water with the MWD
currently selling water for approximately $431 per cubic meter. In comparison, agricultural
water is extremely cheap – IID sells water to farmers for $14 per cubic meter. Thus, there
are enormous potential gains from trade. Further, studies show that farmers are sensitive to
changes in water price – increasing the price of agricultural water by 10 percent decreases
demand by 20 percent. In other words, the demand is price elastic. Thus, a marginal
reduction in subsidies for agricultural water would reduce its use by this sector. It is not
necessary (as some have argued) that agricultural output would decline as a consequence.
Increasing the price of agricultural water would simply give agricultural communities an
incentive to use water more efficiently, e.g., by using new technologies and planting high
value crops such as nuts, fruits and vegetables that are less water intensive (Fowler 1999).
Further, even if water markets reduced agricultural production, it would probably be on
marginally productive lands and crops (where in the first instance cultivation took place
because of cheap water). In this context, it has been estimated that agricultural water use
could decline by as much as 15-20 percent through conservation without significant
decreases in production (Wahl 1989).
12. Under an agreement, the MWD is leasing 130 million cubic meters of water per year for
35 years from the Imperial Irrigation District (IID). The water comes entirely from increases in
water-use efficiency brought about through techniques such as lining irrigation canals or
replacing them with pipes to reduce waste. The MWD has paid for these improvements. As a
result, it has been able to acquire the conserved water without reducing the number of acres
irrigated within IID (Reisner and Bates 1990).
13. Further, a smaller, more localized intra-sectoral market has also developed during this
same timeframe. Irrigators in California have been trading water among themselves for
years, both formally and informally and trading even occurs in some districts supplied with
federal water. Members of the Westlands Water District (WWD), for example, negotiated
roughly 4,500 transfers during 1990-91 alone. In March 1996, WWD established an
electronic bulletin board system that enables farmers to buy and sell annual entitlements to
federal water over the internet (Anderson and Snyder 1997).
14. Crucial to the development of water market mechanisms in California is its extensive
network of canals and pipelines, which allow for the transport of bulk water within and
between watersheds. The Southern California Metropolitan Water District maintains a
massive pipeline that transports bulk water from the Colorado River across the Rocky
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Mountains to the urbanized coastal regions. This pipeline has been a lifeline supporting the
rapid urbanization along the coast. Given that California cannot take any more water from
the Colorado River, in the 1960-1970’s it began to build a massive internal pipeline system
that transports bulk water from the water rich north to the rapidly urbanizing central and
southern regions of the state.
15. There are also numerous examples of water trading between agricultural and urban
users in other western U.S. states – Utah, Arizona, Colorado and Nevada. For instance,
groundwater in Arizona was made freely transferable by law in 1980. Following this the cities
of Phoenix, Tucson, Mesa and Scottsdale acquired more than 50,000 acres of farmland in
order to retire the fields and to utilize the water. A study by researchers at the University of
Arizona found that during the late 1970s and during the 1980s there were about 6,000
transaction in Utah, 1,455 in New Mexico, and 1,500 in Colorado (Steinhart 1990).
16. With respect to legislation, the leading proposal for water markets in California is
embodied in the Model Water Transfer Act for California. It provides a detailed framework for
institutional reform of this sector. Though it did not go far when introduced in the state senate
in 1997, the Model Act remains influential since it still represents the best thinking on water
markets in the state (Haddad 2000). The Model Act endorses voluntary water transfers
because they provide flexibility in resource allocation and because they promote reallocation
based on the principle of economic efficiency. At the same time it also acknowledges the
importance of protecting other parties who might be adversely affected by water transfers.
One of the major aims of the Model Act is to streamline the cumbersome administrative
process of review and approval of long-term (market-like) water transfers. At present this
process severely limits the number of transfers that can take place. Among other key
provisions, the Model Act proposes to strengthen ownership rights to water. The objective is
to assure the rights owners that if they decide to part with water rights temporarily, their
doing so will not be viewed as an indication that they do not really need the water and
therefore should eventually give it up.
17. Conclusions: California illustrates the potential that exists for bartering or paying for
more-efficient agricultural systems in exchange for receiving a portion of the water saved. In
such instances, both the original agricultural user and the purchaser receive benefits as the
efficiency of the system improves.
18. Within California, the concept of water markets, water banks, and bartered
improvements in efficiency continues to be hotly debated. Some of the questions still facing
the legislature and regulators in California are the same as those facing politicians and
regulators in developing countries. Such questions include whether a water market should
be free or regulated, who should benefit from the sale and transfer of water supplies that
historically have been viewed as the property of the sovereign, where should environmental
and ecological uses and needs for water within river systems stand in comparison with other
priority uses of water, whether the market should be allowed to determine the distribution of
water within the economy, and whether less-advantaged water users will be able to compete
in a market environment. These questions are being considered and addressed in California,
just as they will have to be addressed in the developing world.
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A2: Case of New York City
Inter-jurisdictional
Water Resources Co-operation
Prepared by Stephen Dolan
Chreod Ltd.
Case Study A2: New York City, Inter-Jurisdictional Water Co-operation 25 February 2004
Case Study: New York City
1. Introduction: During the past decade New York City has undertaken a rather innovative
approach to the planning and management of its water supply system. In the early 1990’s
New York City’s Department of Environmental Protection (DEP) embarked on an aggressive
plan to enhance the quality of the City’s drinking water through improved protection of its raw
water supply. The DEP’s watershed management program is an explicit recognition that the
health, welfare and well-being of New York City residents was dependent of the quality of its
raw water drinking sources, the Croton, Catskill and Delaware watersheds, all three of which
lie outside of New York City’s administrative jurisdiction.
2. New York City’s water supply system: The water supply system consists of three
unfiltered surface water sources (Croton system, Catskill system, and the Delaware system)
that lie to the north of the metropolitan region (Figure 1.1) and a system of wells in Queens.1
The three upstate water collection systems consist of a system of 19 reservoirs and 3
controlled lakes with a total storage capacity of approximately 550 billion gallons. The
system of reservoirs are linked through various interconnections to increase flexibility in
managing both water quality and supply targets and to mitigate the potential impact of
localized droughts. The three systems cover 8 counties in northern New York State and one
county in the adjoining state of Connecticut. The system supplies drinking water to almost
half the population of New York State, including over eight million people in New York City.
In 2001 overall consumption averaged 1.3 billion gallons a day.
3. The New York City Department of Environmental Protection (DEP) is the agency
primarily responsible for overseeing the operation, maintenance and management of the
water supply infrastructure and the protection of the 5,100 square kilometer watershed.
Within the DEP, the Bureau of Water Supply manages the upstate watersheds and
infrastructure and all drinking water quality monitoring in-City and upstate. The Bureau of
Water and Sewer Operations operates the City’s drinking water distribution and sewage
system.
4. The Croton watershed is the oldest portion of the water supply system. In 1842 the City
financed a dam to impound the water of the Croton River, in what is now Westchester
County. An aqueduct, with a capacity of 90 million gallons a day, was constructed to carry
water from the Croton Reservoir to the City. The City was given the responsibility to manage
the reservoir. Presently, the Croton Reservoir accounts for 10% of New York City’s water
demand.
5. The Catskill watershed was identified in the early 1900s as a potential water source. The
Board of Water Supply, a state-level institution, planned and constructed the initial
components of the system – the Ashokan Reservoir and Catskill Aqueduct. Upon
completion of the construction, the Board of Water Supply turned over the operation and
maintenance of the system to New York City. Subsequently, New York City and the State
have invested expanding the Catskill system and it now accounts for approximately 40% of
New York City’s water demand.
1
The system of wells in Queens account for less than 5% of New York City’s water supply.
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Figure 1: Watershed Map for New York City’s Water Supply System
Source: Department of Environmental Protection (2001)
6. The final component of New York City’s water supply is the Delaware system.
Development of this system of reservoirs and aqueducts began in the 1920s and 1930s.
Currently, the Delaware system accounts for system accounts for approximately 50% of New
York City’s water demand.
7. The Problem: Declining Water Quality: Each of the three systems face continuing
threat from the cumulative and episodic impact of pollution sources generated by certain
land uses and activities in the watershed. Land use within the watersheds is diverse, with the
bulk of it being forested. Approximately 70% of the land is privately owned. There are over
500 farms and 60 towns in all three watersheds. Forestry and agricultural activities play a
significant role in the local economy.
8. The Croton system has experienced the most difficult water quality problems of the three
systems. This is partly the byproduct of it being both the smallest watershed, as well as the
most urbanized. The Croton currently meets all health-based regulatory standards (e.g. e-
coli) for a surface water supply, but through the late 1980s and 1990s it began to experience
periodic violations of the aesthetic standards for color, taste, and odor. In 1990 this decline
triggered the United States’ Environmental Protection Agency’s Surface Water Treatment
Rule (1989) (SWTR). The SWTR requires all public water supply systems supplied by
unfiltered surface water sources to either provide filtration or to meet a series of criteria
relating to – water quality and watershed control. The SWTR was promulgated pursuant to
requirements outlined in the Safe Drinking Water Act (1986). Triggering the SWTR forced
the City of New York to invest more than US$800 million in the construction of a water
filtration plant for the Croton system to satisfy the EPA’s regulatory requirements.
9. Though not as serious as the problems facing the Croton system, the Catskill and
Delaware systems have also experienced localized and seasonal water quality problems. To
avoid building filtration facilities for both the Catskills and Delaware systems, at an estimated
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cost of $6 billion dollars for construction and a further $300 million per year for O&M, New
York City decided to focus its investment in the development of watershed management
program. The development and implementation of an effective watershed management plan,
which would protect water quality in the Catskill and Delaware systems, was identified by the
EPA as a necessary prerequisite for granting a Waiver to the SWTR filtration requirement,
which would would allow the City to, at least temporarily, avoid building filtration facilities for
the Catskill and Delaware systems. Any evidence of declining water quality or other violation
of SWTR criteria would result in the EPA canceling the Waiver and requiring the construction
of filtration plants/capacity for the Delaware and Catskill systems. In short, the timing and
scope of the program, was largely determined by the regulatory environment and, by
extension, cost avoidance.
10. In 1997 New York City, communities of the Catskill/Delaware watershed, the US
Environmental Protection Agency (EPA), New York State signed a Memorandum of
Agreement (MOA), which defines the key parameters of the watershed plans for both
systems. The MOA establishes the institutional framework and relationships for
implementing a range of protection programs identified as necessary by New York City, New
York State, and the EPA, as necessary for protecting water quality. The fundamental goal of
the MOA is to protect water quality within the watershed while promoting the economic
viability of the local communities. The MOA sets mutually agreed upon parameters for
protection and compensation to watershed communities in exchange for an SWTR waiver
from EPA.
11. Building Inter-Jurisdictional co-operation: The program involves direct investment

and compensation by New York City in the cities, towns, villages, and farms of the Catskill
and Delaware systems. The investment program is based upon two planks. First, the
regulatory and administrative justification for New York financing investments and
programming initiatives outside of its administrative boundaries is partly premised on a
Supreme Court decision from the early-1930s. During the initial stages of the development of
the Delaware system, the State of New Jersey brought an action in the Supreme Court
against the State of New York to stop it from using the waters of any Delaware River
tributary. The State of New Jersey argued that the water development project would have a
deleterious impact on downstream states. In May 1931 the Supreme Court of the United
States upheld the right of the City to augment its water supply from the headwaters of the
Delaware River. As a consequence, the Supreme Court gave New York City the right to
undertake projects outside of its administrative boundary in support of the maintenance of its
water supply.
12. Further regulatory justification is found within the implementing rules and regulations for
the watershed management program, which are entitled ‘The Rules and Regulations for the
Protection from Contamination, Degradation, and Pollution of The New York City Water
Supply and its Sources.’ The implementing rules and regulations were promulgated by the
City pursuant to New York State laws and approved by the New York State Department of
Health.
13. Second, during the early stages of program development, the cities, towns, and villages
of the Delaware and Catskill watershed voiced their displeasure with what they perceived as
New York City municipal officials interfering in the development of their communities. In
response to this initial skepticism and periodic hostility, a participatory, multi-stakeholder
approach was adopted. Further, reflecting this participatory and multi-stakeholder approach,
the watershed program enshrines a commitment to promoting local ownership and
developing ‘win-win’ solutions. This approach is captured in the MOA wherein it states that:
“… the goals of the drinking water protection and economic vitality within Watershed
communities are not inconsistent and it is the intention of the parties that enter into a
new era of partnership to co-operate in the development and implementation of a
Watershed protection program that maintains and enhances the quality of the New
York City drinking water supply system and the economic vitality and social character
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of the Watershed communities.”
14. To enhance program delivery and promote local ownership, New York City typically
contracts local institutions for implementation. In some instances, New York City has
provided support to the development of local multi-stakeholder institutions, such as the
Watershed Agricultural Councils (WAC). The WACs are not-for-profit organizations formed
to contract with the City to encourage farmers to devise whole farm management plans and
install best management practices as opposed to regulating agriculture. Members of the
Board for the WACs are local farmers, with one vote being allocated to the DEP. The WACs
have proven to be particularly effective in integrating local stakeholders into the
implementation process. In other instances, it has employed established delivery agencies to
deliver program initiatives.
15. Catskill and Delaware Watershed Program: Based on the program outlined within the
MOA, New York City, with some co-financing from New York State, has invested
approximately $500 million in protection measures in the Catskill and Delaware systems,
which has provided a substantial savings compared to the cost of filtration. A further benefit
is that the two watersheds have gained long-term protection.
16. The Catskills/Delaware watershed management plan reflects an integrated approach to

water resources management. Fundamental to the watershed strategy is the recognition that
different surface water bodies (reservoirs, streams, rivers, etc.) face different threats and
management challenges. Consequently, the management program needs to be flexible to
respond to the unique challenges facing each water body in the area of concern. The
watershed management program is composed of range of sub-programs that reflect the
target priority issues in the watershed. Further, the identification of the priority issues in
each watershed is based on extensive analysis and ongoing evaluation and assessment.
17. New York City’s water resource management strategy is composed of seven major
initiatives, which are designed to target the principal sources of pollution within the
watershed:
1. Watershed Agricultural Program: The City teamed with upstate stakeholders to

develop this voluntary program. The implementing partner is a multi-stakeholder
institution – Watershed Agricultural Council (WAC). Through the WAC the City funds
the development of farm-level management plans and implementation of best
management practices (BMPs). BMPs such as buffers and setbacks, soil-conserving
tilling and grazing practices, streambank fencing to keep animals out of waterways,
and erosion-preventing forestry strategies help preserve the natural water filtering
capabilities of the land and prevent potential disease-causing contaminants from
entering waterways. As of 2001, more than 90% of the farms in the system had
signed up to the program, developed farm-level management and implemented
BMPs.
2. Conservation Reserve Enhancement Program: A City/federal cost-sharing

program that pays farmers to take sensitive riparian buffer lands, adjacent to water
bodies, out of active farm use and re-establish the vegetative buffer.
3. Land Acquisition: The City solicits owners of environmentally sensitive land within
the watershed. The environmentally sensitive land has previously been demarcated
by a comprehensive land-use planning exercise. The City’s has budgeted upwards of
US$300 million over the next 10 years. Many of the parcels are opened hiking, cross-
country skiing, and snowshoeing, which enhances the recreational values of the
landscape.
4. Environmental Infrastructure Programs: The City has funded a program that in

conjunction with local partners has implemented a range of programs, including:
remediating septic tanks, upgrading buildings and facilities, implementing stormwater
Best Management Practices in key areas, and addressing wastewater collection and
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treatment in un-serviced hamlets and communities. New York City has invested more
than $250 million in the program to date. The City has invested a further $70 million
in upgrading existing wastewater treatment plants. There are 34 non-City owned
surface-discharging WWTPs in the Delaware/Catskill systems, which account for
approximately 60% of total flows in the region. The WWTP owners have signed
Memorandums of Understanding to participate in the upgrade program and then the
City funds the planning and construction of the upgrades. Local residents and New
York City share the costs of operating and maintaining the plant upgrades.
5. Environment and Economic Partnerships Program: The program has allocated

resources to support economic development within the communities of the Delaware
and Catskill systems. Under the MOA New York City provided $59 million to
capitalize the “Catskill Fund for the Future” to finance economic development studies,
grants and loans in watershed communities. The program is a reflection of the
importance of linking economic development and environmental sustainability.
6. New Watershed Regulations: The 1997 watershed regulations replace outmoded,

44-year-old standards and will dramatically improve the protection of the City's water
supply while permitting responsible development and community revitalization in
existing population centers. The new regulations, among other things, establish
standards for the design, construction and operation of wastewater treatment plants;
set design standards and setback requirements for septic systems; and require the
implementation of stormwater control measures for a variety of commercial,
residential, institutional and industrial projects. The regulations also provide for City
review and approval of certain activities having a potentially adverse impact on water
quality, with strict time frames for review and decision-making, expedited procedures
in case of emergency and rights of appeal.
7. Environmental Monitoring System: The water management program is premised

on maintaining water quality in the Catskills and Delaware watersheds. To meet its
requirements, New York City has invested significant resources in the development
and maintenance of a comprehensive monitoring system. Each year the City collects
more than 35,000 samples, from 300 sites, and performs more than 300,000
laboratory analyses. The monitoring system has the following core tasks/objectives:
Compliance monitoring – to ensure compliance with the MOA

Surveillance monitoring – conduct surveillance monitoring to optimize
water quality and quantity and support efficient operations; support the
evaluation of long-term water quality trends; provide early indicators of water
quality problems
Research support – conduct monitoring to support targeted assessments
of watersheds processes affecting the source, pathways, fate, transport, and
effects of key constituents
Modeling support – provide critical data to support the calibration and
verification of New York’s integrated terrestrial and aquatic modeling
program.
18. Most of the sub-programs are designed so that the resulting interventions and initiatives
are tailored to suit the particular needs of the locality. The sub-programs are designed to
promote ‘peer-to-peer’ interaction, be it between farmers or municipalities, and the adoption
of multiple benefit solutions. The most recent reviews of the Catskill/Delaware watershed
program (2001) indicate that it has been a success with various water quality improvements
having been met and even surpassed. Key ingredients to its success have been: 1) its
flexible, iterative, participatory, multi-stakeholder structure; and 2) the comprehensive
environmental monitoring system that has been established.
19. The watershed program is designed to contain a number of planning and management
horizons – short term (5-7 years) and long-term (50 years). In the short-term, the watershed
A2_5
program outlines a comprehensive program of investments and budgeted. The investment

program is a multi-year and annual investment planning process based on the rolling plan
approach whereby the annual plan is updated each year based on progress during the
preceding year and changes in priorities and market demands. The broader strategic
framework for the program plans within a 25- and 50-year time-horizon. The watershed
program uses scenario-based forecasts that projects land-use and population trends out to
the year 2050. These estimates represent extrapolations based on historical trends and
represent likely future land-uses and population sizes, assuming that growth rates follow
historical trends. These population and land-use projections are then use to estimate
potential future pollution loadings.
20. Conclusions: The Catskill and Delaware watershed program has achieved its
objectives, water quality within the watersheds has stabilized and, in many instances,
improved. For a US$500 million investment the City has been able to avoid investment US$6
billion in construction of a filtration plant and year on year operation and maintenance costs
totaling US$300 million. The success of the program is based in large measure on a
collaborative model that explicitly integrates local communities and stakeholders into the
planning and management process.
21. The New York City case study involves investments directed towards improving water
quality by the City in the communities that populate the Catskill and Delaware watersheds.
The Catskill/Delaware model provides an illustration of the development of a multi-faceted
strategy to protect and improve water quality for a variety of stakeholders. It is also an
example of integrating downstream and upstream users. The program also underlines the
importance and benefits accruing to a comprehensive, long-range approaches to watershed
management.
22. Lessons learned: The keys to success of this program is stakeholder involvement in a
participatory process guided by local leadership. Other lessons that can be drawn from this
case and potentially applied elsewhere include:
Local Leadership is central to successful participatory programs

Early buy-in by local stakeholders (i.e. farmers, households, small business)
who are usually mistrustful of regulators is essential
Reduction of nutrient, pollutants, and pathogens in the management of
upland agricultural runoff is important. Efforts to control the source of pollutants (i.e.
barnyard areas, silage systems, stored manure), runoff from landscapes (via
stormwater control measures), and watercourse protection (such as stream bank
buffer strips) are all successful components in the city’s watershed program.
Whole farm management that integrates a variety of BMPs is an affordable
means of sustainable agriculture, in terms of conserving both farming resources and
water quality.
What happens upstream can have a profound impact on conditions
downstream. Links must be made between economic development policies and
sustainable management policies.
A2_6
B1: Case of South Korea
South Korea’s Experience Upgrading its Heavy

And Chemical Industries in the 1970s &1980s
Prepared by ECG
Chreod Ltd.
Case Study B1: South Korea Heavy Industry Restructuring 14 May 2004
Korea, Inc.: A Review of South Korea’s

Experience Upgrading its Heavy and Chemical
Industries in the 1970s and 1980s
Prepared for:
Chreod Ltd.
111 Sparks Street, Suite 200
Ottawa, Ontario
Canada K1P 5B5
Submitted by:
Economic Competitiveness Group

2236 Sixth Street, Suite B
Berkeley, CA 94710 USA
Tel (510) 849 8400 * Fax (510) 849 8406
Email: aboyd@ecgroup.com
www.ecgroup.com
© 2004 Economic Competitiveness Group, Inc. All Rights Reserved.

Table of Contents
1. INTRODUCTION............................................................................................................................... 1
2. HISTORICAL SETTING: UNDERLYING REASONS FOR UPGRADING .............................. 3
3. IMPLEMENTATION STRATEGY: HOW ACCELERATION IN SOUTH KOREAN
INVESTMENTS AND EXPORTS WAS ACTIVATED........................................................................... 4
TABLE 1: KOREA’S INDUSTRIAL VISION AND STRATEGY .......................................................................... 4
THE INTERVENTIONIST STATE .................................................................................................................... 5
Top-Down Policy-Making Process ....................................................................................................... 5
State as the primary driver of entrepreneurial activity for big businesses ........................................... 6
Protectionist Policies: Subsidies and Price Controls .......................................................................... 6
Incentive Packages................................................................................................................................ 6
Discipline the State Exercises over Private Firms................................................................................ 7
Knowledge Transfer and Development of R&D ................................................................................... 8
Importance of Foreign Direct Investment............................................................................................. 8
Debt Financing and Productivity.......................................................................................................... 9
SKILLED WORKFORCE ................................................................................................................................ 9
4. THE CHAEBOL: MAGNITUDE AND CAUSES OF CHAEBOL CONCENTRATION ........ 10
INTER-CHAEBOL OLIGARCHIC COMPETITION ........................................................................................... 11
CASE STUDY 1: THE ELECTRONICS INDUSTRY ......................................................................................... 12
Limits of Government Discipline: 1979-1982 Restructuring ............................................................. 13
5. SME SECTOR DEVELOPMENT .................................................................................................. 14
SME Support System Policy Chronology............................................................................................ 14
Subcontracting .................................................................................................................................... 14
Collective Support System................................................................................................................... 15
CASE STUDY 2: SMES-AUTOMOBILE PARTS AND COMPONENTS INDUSTRY ............................................ 16
6. SUSTAINABILITY OF OUTCOMES............................................................................................ 17
TABLE 2: RATES OF MANUFACTURING GROWTH IN ASIAN TIGERS (% PER ANNUM)................................ 17
THE 1997 ECONOMIC CRISIS .................................................................................................................... 17
CHANGING MARKETS AND COMPETITION FROM LOWER-COST PRODUCERS IN OTHER COUNTRIES:
MOVING UP THE VALUE CHAIN ................................................................................................................ 19
7. CONCLUSION ................................................................................................................................. 21

1. Introduction
South Korea’s evolution from a “backwards” country to an economic powerhouse offers
considerable insight for other transitional economies interested in making a similar transition.
Indeed, South Korea was one of the first countries to attempt to penetrate world export markets
with little more competitive advantage than low wages. South Korea’s economic policies
efficiently modernized its heavy and chemical industries (HCI) among others and the country’s
impressive recent economic record speaks for itself:
• Believing that the developed markets of western Europe and North America were open
enough to absorb labor-intensive manufactures in large quantities the government’s
central objective of export-led industrialization has resulted in the value of merchandise
exports growing from 10% of GDP in the early 1970s to nearly 40% in 2003;
• In 1973, the manufacturing industry accounted for a quarter share of the nation’s GDP.
This share grew to nearly one-third by 1988 and since then has stabilized around 30%;
• Manufacturing's real value added rose at an average rate of 16.9% per year between 1963
and 1978;
• The share of HCI products in total exports rose from 21.3 % in 1972 to 34.7 % in 1978.
• In the electronics industry, production of radios increased from 158,000 units in 1963 to
6.7m in 1976 and 9m in 1986. Production of color television receivers began in 1975 and
rose to 10m in 1988, before peaking at 21.5m in 1996. Electronic calculator production
also began in 1975. South Korea has been making refrigerators since 1968, cameras since
1980, and videocassette recorders and microwave ovens since 1982;
• In the steel industry, lead by the success of Pohang Iron and Steel (POSCO), one of the
world's largest and most efficient steel producers, South Korea now ranks alongside
Japan, China and the US as one of the world's largest steel producers;
• In the automotive industry, South Korean production grew from 935,271 cars and
225,328 trucks in 1990 to 2.7m passenger cars and 274,698 trucks in 2002;
• In terms of technological advancement, Samsung Electronics has become a world leader
in the export of memory chips, having closed the gap that separated it from Japanese and
US firms in this specialized field in a short period of time and the automotive industry
has moved beyond the utility stage to one in which, without competing head on with
Japanese technological excellence, it provides good value for money within the
technological niche that it has established. 1
The overriding salient features of South Korean economic growth have been: the immensely
active role the central government has taken in almost every facet of the economy; the
government’s “top-down” strategic planning process; and the emergence of large, diversified
business groups, or chaebol. Growth began to accelerate when the central authority, once too
weak to defend itself against foreign aggression, became strong enough to mediate market forces
to advantage.2 The government’s central strategy was to build up a strong indigenous industrial
1
The Economist Intelligence Unit. “South Korea: Country Profile 2004.”
2
Amsden, Alice H. Asia’s Next Giant: South Korea and Late Industrialization. Oxford University Press, New
York, 1989.
© 2004 Economic Competitiveness Group, Inc. All Rights Reserved. B1-1

and technological base by building up large private conglomerates. 3 And South Korea’s late
industrialization has been largely a process of the chaebol diversifying into new industries on the
basis of their technological capability rather than individual entrepreneurs acting as independent
agents of further industrial change on the basis of their personal experience and education.4
But potential enthusiasm pertaining to the incorporation of the South Korean model into
transitional economies’ current economic polices must be tempered by the facts that the
protectionist policies that in great part nurtured the South Korean economy to its position of
prominence occurred in a pre-WTO world, and there are numerous examples of other transitional
economies that employed similar economic policies that have not fared nearly as well. And as
the enormous financial crisis that struck Korea in 1997 clearly demonstrated, an unintended
consequence of the country’s economic growth strategy that seemingly could do no wrong, was
that it actually created pervasive structural problems that directly led to the financial meltdown.
These structural problems, coupled with the growing threat of low-cost competitors and the
restraints against protectionist policies membership in the WTO entails, compel many analysts to
question the long-term sustainability of South Korea’s state-driven economic model.
Many economic development professionals presently advocate a more “bottom-up” approach to

strategic economic planning where the private sector is the primary driver and economic
initiatives are formulated via a collaborative process involving the public and private sectors, the
non-profit/NGO community and other stakeholders. For transitional economies that are
governed by the rules and regulations embodied in the WTO, implementing this type of “bottom-
up” economic planning process increases the likelihood of consensus in regards to economic
initiatives across regions, industries, sectors and institutions.
3
Lall, Sanjaya. Competitiveness, Technology and Skills. Edward Elgar Publishing Limited, UK, 2001.
4
Amsden, Alice H. Asia’s Next Giant: South Korea and Late Industrialization. Oxford University Press, New
York, 1989.

2. Historical Setting: Underlying Reasons for Upgrading

The following excerpt succinctly captures the underlying reasons behind South Korea’s late
industrialization push:
The journey to industrialization began in the early 1960s with the introduction of First
Five-Year Economic Development Plan. It was at this point the government made a
conscious policy shift from the inward-looking growth strategy of import substitution to
the outward-looking growth strategy of export promotion. The essence of export
promotion growth strategy was to promote exports of light manufactured goods in which
Korea possessed comparative advantage given its cheap labor cost. The government
utilized various macroeconomic mechanisms at its disposal in implementing this strategy,
such as maintaining high interest rates to mobilize domestic savings, and enacting the
Foreign Capital Promotion Act to encourage the inflow of foreign investment.
In order to promote exports, the government also devalued the currency by nearly 100 %
and replaced the previous multiple exchange rate system with a unified exchange rate. It
also provided short-term export financing, allowed tariff rebates on materials imported
for re-export use, and simplified customs procedures.
The worldwide commodity shortage of 1972-1973 and the oil shock of 1973-1974 merely
compounded the problem. Korea had to respond decisively to the deteriorating trade
balance by modifying its export promotion strategy. The measures undertaken by the
government were to restructure the composition of commodity exports in favor of a more
sophisticated, higher value-added products and to diversify its trade partners.
To upgrade the composition of its exports, Korea turned to HCI. With the announcement
of the Heavy and Chemical Industry Development Plan in 1973, the government set forth
an accelerated development schedule for technologically sophisticated industries.
Investment in new industries produced significant results, and the country soon
developed successful undertakings in electronics, shipbuilding, and other fields.5
5
http://www.asianinfo.org/asianinfo/korea/eco/start_of_growth_in_the_1960s.htm and
http://www.asianinfo.org/asianinfo/korea/eco/heavy_and_chemical_industry_prom.htm

3. Implementation Strategy: How Acceleration in South

Korean Investments and Exports was Activated
According to Alice Amsden, late industrialization is characterized by three facets of growth:6
1. Diversification, or entrepreneurial decisions concerning penetration of new industries-

which ones to penetrate, when, and with what size investment.
2. Stabilization, or short-run macroeconomic policies to maintain the level of economic
activity.
3. Growth momentum, growth gains a momentum whose properties are distinct, depending
on the presence or absence of new technological discoveries.
To incorporate these facets of growth into a comprehensive economic policy, South Korea’s
economic model focused on five key issues outlined in Table 1 below:
Table 1: Korea’s Industrial Vision and Strategy 7
Deepening Raising FDI Strategy Raising Promotion of

Industrial Local Technological Large Local
Structure Content Effort Enterprises
Strong trade and Stringent local FDI kept out Ambitious plans Sustained Drive to
credit interventions content rules, unless necessary for R&D in create giant private
to promote capital, creating support for technology advanced industry, conglomerates to
skill and industries, access or exports, heavy investment internalize
technology protection of local joint ventures and in technology markets, lead
intensive industry, suppliers, licensing infrastructure. heavy industry,
especially heavy subcontracting encouraged Targeting of create export
intermediates and promotion strategic brands
capital goods. technologies
Selective export
targeting and
promotion
6
Amsden.
7
Lall, Sanjaya. Competitiveness, Technology and Skills. Edward Elgar Publishing Limited, UK, 2001.

To pursue this industrial vision, South Korea leveraged several institutions that have accentuated
its success in becoming a late industrializing nation. These include:8
1. An interventionist state
2. Large diversified business groups
3. An abundant supply of competent salaried managers
4. An abundant supply of low-cost, well-educated labor.”
The Interventionist State

Top-Down Policy-Making Process
South Korea’s economic decision-making and planning is extremely “top-down” in nature.
When preparing five-year development plans, the Economic Planning Board (EPB) issued,
“preliminary guidelines in terms of major policy targets and directions, together with
macroeconomic projections for both the international and domestic environment of the economy
during the plan period and beyond….Individual ministries then formulate[d] their own sectoral
plans in accordance with the guidelines…It is noteworthy…that policy proposals prepared by the
ministries are seldom open to the public for discussion and popular reaction…The lack of
consensus-building in the policy-making process reflects a “top-down” approach to government
policy formulation.” 9
Given this “top-down” approach, every major shift in industrial diversification in the 1960s and
1970s was activated by the central government: 10
• The state masterminded the early import-substitution projects in cement, fertilizers, oil
refining, and synthetic fibers-the last greatly improving the profitability of the over-
expanded textiles industry;
• The government also kept alive some unprofitable factories inherited from the colonial
period, factories that eventually provided key personnel to the modern general machinery
and ship-building industries;
• The transformation from light to heavy industries came at the state’s behest…in the early
1960s;
• The government…was responsible for the Big Push into heavy machinery and chemicals
in the late 1970s;
• The government also laid the groundwork for the new wave of import substitution that
followed heavy industry and that carried the electronics and automobile industries
beyond the simple stage of assembly;
• The government enacted the automobile protection law [in] 1962 [and] promoted the oil-
refining industry.
8
Amsden.
9
Ibid.
10
Ibid.

State as the primary driver of entrepreneurial activity for big businesses

In the case of big business, the entrepreneurial function of planning was primarily left to the
state. Moreover, the state assumed primary control over the coordinating function as well,
considering that the state controlled all capital other that short- or medium-term credit.11 The
government’s decision to assume the role of “director” of entrepreneurial activities, is in line
with the “top-down” orientation towards decision-making and varies dramatically from the
recent economic evolutions of more entrepreneurial cultures such as the United States. Driving
home this theme, “the point, however, is not that the entrepreneur in [South] Korea must spend a
great deal of time “dealing” with the government…Rather, it is that almost all important tasks
are themselves transformed as a consequence of government intervention.”12
Protectionist Policies: Subsidies and Price Controls

During South Korea’s late industrialization, the foundation of economic policy was the subsidy –
which included both protection and financial incentives. In late-industrializing countries, the
state intervenes with subsidies deliberately to distort relative prices in order to stimulate
economic activity. In exchange for subsidies, the state imposed performance standards on
private firms. In addition, long term credit allocated to selected firms at negative real interest
rates in order to stimulate specific industries and increase exports and exporters were
compensated for having to export by being allowed to sell in the domestic market at inflated
prices. Thus, “instead of firms operating in a competitive market structure, they each operated
with an extraordinary degree of market control, protected from foreign competition.” 13
Incentive Packages
The initiative to diversify, particularly into more capital-intensive projects, tends to fall to the
state because these projects require more comprehensive incentive packages to make them
financially attractive to private firms. Though, under South Korean law, 30% of a plant’s total
costs had to be self-financed, in reality, between 1963 and 1973, internal financing only averaged
20% of total financing. In 1983, Korea’s manufacturing sector financed only 9.9% of its
business through retained earnings and capital increases. The remainder of capital was highly
subsidized. 14
In fact, these incentive packages had enormous effects on the subsequent growth of the
Chaebols:
The main stimulus to the tremendous growth of industrial R&D was less the specific
incentives to R&D than the overall incentive regime. This created the chaebol, gave
them a protected market to master complex technologies, minimized reliance on FDI, and
forced them into international markets where competition ensured that they would have
to invest in their own research capabilities.15
11
Ibid.
12
Ibid.
13
Ibid.
14
Ibid.
15
Lall.

Discipline the State Exercises over Private Firms

An interesting characteristic of South Korea’s state intervention-oriented economic expansion
policy that strove to create price distortions that direct economic activity toward greater
investment was the degree South Korea of discipline the state exercised over private firms. The
chaebol, “consolidated [their] power in response to the government’s performance-based
incentives. In exchange for good performance in the areas of exports, R&D, or new product
introduction, leading firms were rewarded with further licenses to expand, thus enlarging the
scale of big business in general. In exchange for entering especially risky industries, the
government rewarded entrants with other industrial licenses in more lucrative sectors, thus
furthering the development of the diversified business group in particular.”16 The result of this
approach was that the government repeatedly supported a small set of big business groups in
exchange for good performance which was evaluated in terms of production and operations
management rather than financial indicators.
Given the export-orientation of the South Korean economy over the past half century, it is not
surprising that the strictest disciplinary measure imposed by the government related to export
targets. Additionally, firms have been subject to five general controls in exchange for
government support:
1. The government has owned and controlled all commercial banks….Government control
of the purse has helped orient the chaebol toward accumulating capital rather than toward
seeking rents.
2. In luring firms to enter new industries with the plums of protection an subsidies, the
government has imposed discipline by limiting the number it has allowed to enter
(although usually to not fewer than two firms per industry). This has ensured the
realization of scale economies.
3. Discipline has been imposed by on “market-dominating enterprises” through yearly
negotiated price controls, in the name of curbing monopoly power.
4. Investors have been subject to controls on capital flight, or the remittance of liquid capital
overseas. [This measure is] believed to have been a credible deterrent to private investors
who otherwise might have used public subsidies to build personal fortunes abroad.
5. The middle classes have been taxed, and the lower classes have received almost nothing
in the way of social services. This has enabled a persistent deficit in the government
account to reflect long-term investments. 17
The importance of the government’s central disciplinary role cannot be overstated:
These interventions shaped the nature of industrial development at a very detailed-often

product and technology-level. There was also the technological effort needed to compete
in world markets, with export orientation providing the discipline on firms and
bureaucrats. Entire sets of industries were promoted together to exploit linkages and
16
Amsden.
17
Amsden.

externalities, with changes being made as events unfolded and some activities proved
unviable.18
Knowledge Transfer and Development of R&D

A key element of South Korea’s economic development strategy was to develop indigenous
knowledge and technological capacities and established creative knowledge transfer mechanisms
to do so. The strategy emphasized utilizing foreign licenses and technical assistance to develop
these capacities:
[South] Korea…lacked theoretical knowledge at the world frontier, not only in the
machinery-building sector…but also in the continuous-process industries and, to an acute
degree, in electronics….[this] made it more difficult for [South] Korea to solve…the
most intransigent problem of technology transfer: the detailed working out of
technological applications of theory.
The central tendency has shifted from the absorption of foreign technology through
copying and self-teaching to the adoption of foreign technology through investing in
foreign licenses and technical assistance.
In [South] Korea, massive imports of foreign licenses and assistance have been viewed as
a means to attain technological independence, and thus, as part of a larger effort, in both
the public and private spheres, to avoid foreign control. Industrialization has occurred
almost exclusively on the basis of nationally owned rather than foreign-owned enterprise.
The industrial community in [South] Korea…became…drawn in under the rule…of the

technological trainee. Once the entrepreneurs recognized that government subsidies
could make manufacturing profitable…they increasingly turned their attention away from
speculating toward accumulating capital. 19
Importance of Foreign Direct Investment

In order to further the development of indigenous knowledge and technological capacities South
Korea’s economic policies restricted access to technologies via Foreign Direct Investment (FDI).
By encouraging externalized technology transfers and encouraging their local absorption in a
strongly export-oriented setting, they forced local firms to develop and deepen their own
technological capabilities. 20
Korean industry built up an impressive R&D capability by drawing extensively on

foreign technology in forms that promoted local control. Thus, it was one of the largest
importers of capital goods in the developing world, and encouraged its firms to obtain the
latest equipment (except when it was promoting particular domestic products) and
technology. It encouraged the hiring of foreign experts…to help resolve technical
problems.
18
Lall,.
19
Amsden.
20
Lall.

The government permitted FDI only when other means of accessing technology were not
available; it consistently sought to keep control firmly in local hands. Foreign majority
ownership was not permitted unless it was a condition of having access to closely-help
technologies, or to promote exports in internationally integrated activities. Some MNC’s
were induced to sell their equity to local partners once the technology transfer was
complete….the government pushed local firms to acquire independent capabilities [such
as] the mastery and improvement of imported technologies to the absorption of foreign
management practices and, later, to innovative R&D.
The government also intervened in major technology contracts to strengthen domestic

buyers. It sought to maximize the participation of local consultants in engineering
contracts to develop basic process capabilities. The 1973 Engineering Service Promotion
Law protected and strengthened domestic engineering services. The Law for the
Development of Specially Designated Research Institutes provided legal, financial and
tax incentives for private and public institutes in selected activities. (emphasis added) 21
Debt Financing and Productivity

Rising productivity was also a critical factor in South Korea’s rapid return to growth. A
noteworthy detail concerning South Korean industrialization is that at the beginning and end of
the period of massive foreign borrowing to finance heavy industry, the debt/GNP ratio remained
more or less constant, falling slightly from 34% in 1972 to 32% in 1979. 22
Rather than utilizing austerity measures to minimize external shocks, the South Korean
government has been reluctant to adopt expansionary policies and borrow its way out of balance-
of-payments difficulties. This has been possible because heavy foreign borrowing has been
balanced by large productivity increases. In general, and dependent on institutional constraints:
High growth rates of output generate high growth rates of productivity, and vice versa.
There is circular and cumulative causality. Once started, a momentum builds between
growth and productivity that drives industrialization forward…On the one hand, this
cumulative relationship between productivity and growth underscores the importance of
government intervention to keep momentum going. On the other hand, the fact that
productivity has little to do with imminent events at the world technologic frontier and
much more to do with production capability-investing in foreign designs, producing at
the appropriate scale, and learning-by-doing-highlights the importance of firm-level
management practices.23
Skilled Workforce
Another important component of South Korea’s policy to expand its indigenous capacity was the
government-driven initiative to develop a native force of engineers and technicians. The
development of engineering-oriented and technically-experienced workforce was deemed
21
Lall.
22
Amsden.
23
Amsden.

important because, “salaried engineers are a key figure in late industrialization because they are
the gatekeepers of foreign technology transfers.” 24
In addition, key features of South Korea’s towards workforce developing program include:
1. Korean firms have shown a preference for hiring engineers over administrators.
2. Even as managerial capitalism in Korea has spread, overhead has been kept in
check….They have appointed mangers to production positions on the shop floor, which is
where the competitive advantage of late-industrializing countries lies.
3. The number of layers of management has been kept quite small in Korea.
4. The Chaebol: Magnitude and causes of Chaebol

Concentration
As Alice Amsden notes:
Below the level of the state, the agent of expansion in all late-industrializing countries is
the modern industrial enterprise…described as large in scale, multidivisional in scope and
administered by hierarchies of salaried managers…In Korea, the modern industrial
enterprise takes the form of the diversified business groups, or chaebol.
In addition to the economies of scale that the chaebol developed as a result of the government’s
economic policies, they also developed important economies of scope that arose in the form of
their capability to diversify. In the United States, the tendency has been for firms to build and
diversify on areas of expertise and specialization. In late-industrializing countries, with little
expertise, the tendency has been to diversify into unrelated areas. For example, the Hyundai
group branched out vertically from construction to cement manufacture and shipbuilding, and
from shipbuilding to shipping and steel structures. The Samsung Group diversified horizontally
in entertainment with a broadcasting company, a daily newspaper and a hotel. Before 1980, the
chaebol grew primarily by internal investment. Subsequently, acquisition was their primary
vehicle of growth. Moreover, the chaebol’s increased productivity allowed the government to
use borrowing as a tool to nullify balance-of-payment difficulties and sustain fast growth,
“aggressive borrowing coupled with bailouts of financially troubled firms created a supportive
environment for big business.”
Additionally, import-substitution played a great role in the consolidation of the chaebol involved
in heavy industries:
The chaebol have their antecedents not in the cotton spinning and weaving but in the
simpler import-substitution heavy industries that the government encouraged on the
periphery of [light manufacturing]…the importance of [import-substitution activity]
stems from the fact that even the simple heavy industries like cement have qualitatively
different technologies-and hence, modes of competition-from those of the labor-intensive
pursuits like cotton spinning and weaving. The heavy industries expand by capital
deepening, or a rise in the capital/labor ratio, rather than capital widening, or a
multiplication of production units with the same ratio of capital to labor.
24
Amsden.

These policies had reinforcing effects as the chaebol developed their own internal capacities
which strengthened the willingness and ability of chaebol to be a more active partner in the state
diversification effort. Two factors propelling this willingness on the part of the chaebol to align
their interests with the central government’s overall diversification effort include:
1. The modern industrial enterprises acquired more technical and business experience.
Their opinions then gained more respect in terms of decisions about which industries,
when, and on what scale.
2. The modern industrial enterprises came to appreciate not just the high risks of entering
the heavy industries but also the high rewards.
The chaebol were able to grow quickly and prosper due to a variety of reasons:
1. Bought industry-specific technical expertise;

2. Borrowed abroad with credit guarantees and subsidies from the government;
3. After growth, were able to hire experienced, salaried managers;
4. Transferred qualified managers from established groups to new subsidiaries;
a. Business groups were multi-product yet still governed by overall group
management and strategy;
5. Korean management accumulated experience in the areas of feasibility studies, task force
formation, purchase of foreign technical assistance, training, equipment purchase, new
plant design and construction and operation start-up. This experience became an
invaluable competitive asset in the absence of proprietary technology because it allowed
the chaebol to be Korea’s first movers in many industries.
6. Risk diffusion – shifted people and money around the group to increase the probability
that risk-diffusing projects would earn profits.
Inter-Chaebol Oligarchic Competition

Another noteworthy fact concerning the development of the chaebol is that because the EPB
controls most prices, the chaebol mainly compete on non-price factors. These include:
1. Competition for industrial licenses and other favors from government;

2. Competition for foreign technical licenses;
3. Competition for labor;
4. Competition in the marketplace on the basis of quality and delivery.
Thus, the centrally-planned approach to economic development that characterizes the South
Korean model still allowed for a high degree of competition between the various chaebol which
allowed them to develop specific areas of expertise and in-house capabilities relative to one
another.

Case Study 1: The Electronics Industry 25
• In 1969 the Electronics Industry Promotion Law was enacted to stimulate

investments in assembly operations of black-and-white televisions in order to:
o Change the electronics industry structurally from assembly-type
production to one which produced mainly basic components and parts.
o Promote the electronics industry as a major export industry through the
development of new technology products and the expansion of overseas
activities.
o On the basis of product life cycles and comparative advantage, 57 items
including semiconductors, computers and related items selected as
strategic products.
• To promote higher value-added products, the government took steps which also
included $221.6 million in foreign loans:
o Established an industrial estate for the production of semiconductors and
computers.
o Established the Electronics and Telecommunication Research Institute
(ETRI) for product development, and allocated it a $60 million fund.
o Protected the domestic market from international competition by passing
legislation in 1983 restricting imports of computers and peripherals in the
low and medium market segments.
o Restricted direct foreign investment in electronics, however the
government encouraged joint ventures.
• In semiconductors, implemented the VLSI project which involved collaboration
between private sector R&D labs and public sector institutes.
In 1983:
o The government contributed $28 million to 182 research projects of 131
firms.
o The government contributed $40 million to 7 semiconductor and
bioengineering projects.
The government also:
o Set aside a lower tariff rate on equipment imported for R&D.
o Allowed firms to tax-exempt a percentage of profits for a fixed period for
investment in R&D.
25
Amsden.

Limits of Government Discipline: 1979-1982 Restructuring

By the late 1970s however, the government began to see the advantage in curbing the chaebol’s
monopolistic power by encouraging the development of the SME sector. The government was
interested in stimulating SME productivity through state-led coordination and management so
that the income ratio of SMEs would not be less than that of the bigger enterprises.
In pursuit of diversification into the SME sector, instead of regulation, the government chose
liberalization, “as the means…to discipline big business and reverse the institutional legacy of
two decades of state controls.”26 The government implemented a structural adjustment package
in 1980 that:
In effect…liberalized [South Korea’s] imports slowly, though on paper the number of

quantitative restrictions and tariff rates came down rather rapidly….the government
retained strong elements of industrial policy while withdrawing from some of the more
pervasive and detailed interventions it had undertaken in the 1970s under the HCI drive.
The liberalization itself was carefully formulated so as not to damage existing industries,
pre-announced to give enterprises time to adjust, variegated to suit industrial needs and
accompanied by large sprinklings of infant industry promotion. As a result, [South]
Korean industry continued to grow with no noticeable loss of production, exports or
employment; perhaps more importantly, he process of technological deepening continued
apace, with the heavy industries launched in the previous decade taking over the bulk of
manufacturing and export activity.27
Thus, the government liberalized imports (to a degree) and to compensate the chaebol, the
government rewarded big business with freer financial markets.
1. Government reduced regulation of nonblank financial intermediaries (NBFIs), many of

which had long been controlled by the chaebol;
2. Denationalized commercial banks.
However, these measures in general did little to minimize the monopolistic power of the chaebol
as they were able to successfully gain control of individual banks. In the new regulatory
environment, they used their new financial resources to:
1. Buy state enterprises that were being privatized;

2. Buy financially troubled firms, sometimes at the government’s instigation.28
Thus consolidation actually increased as a result of these liberalization policies. The increase in
concentration was especially sharp at the aggregate level where the share of manufacturing
output of the largest business groups rose from 32.8% in 1979, to 67.4% in 1984. As the World
26
Amsden.
27
Lall.
28
Amsden.

Bank observed, “it is clear from these cases that the [South Korean] government has bypassed
competitive solutions in most of its restructuring operations.” 29
5. SME Sector Development

As discussed earlier, to mitigate the chaebol’s growing consolidation movement the government
implemented a parallel set of policies to stimulate the SME sector in order to widen the breadth
of the country’s economic base.
SME Support System Policy Chronology30
1. Enactment of the Small and Medium Industry Basic Law in 1966.

2. In 1970s, government policy focused mainly on helping SMEs maintain operating
stability and penetrate new markets.
a. In 1975, government enacted the SME Gyeyul-hwa Promotion Act to strengthen
and stabilize vertical relations between the country’s large assembly firms and
smaller, independent parts/components suppliers.
3. In the 1980s, emphasis shifted towards expansion of SME business boundaries,
modernization of production processes and start-up enterprise support.
4. In the late 1980s and early 1990s, government policy shifted toward helping SMEs
achieve product innovation, factory automation and computerization, and to promoting
the development of rural SMEs.
5. In 1982, the government enacted the Small and Medium Industry Systemization Law
which reserved certain industrial spheres for small- and medium-size subcontractors. The
law:
a. Forbade prime contractors from swallowing up subcontractors through stock
ownership
b. Provided financial and tax incentives for SMEs to modernize
c. Introduced a scheme for reducing the risk they faced in commercializing new
technologies
d. Provided guidelines on fair trade policies
Subcontracting
Nevertheless, South Korean economic policies generally left subcontractors at a disadvantage
relative to prime contractors eg. chaebol, “in terms of equality between big and small business,
[South] Korea’s subcontracting system…has left much to be desired….As a consequence of
prime contractors’ market power, the profit margins of subcontractors are squeezed.”31
However, “in terms of growth and efficiency, [South] Korea’s subcontracting system has been an
ideal vehicle by which to spread the progressive practices of the modern industrial enterprise to
29
Amsden.
30
Kim, Linsu. Nugent, Jeffrey B. “The Republic of Korea’s Small and Medium-Size Enterprises and Their Support
Systems.” The World Bank – Policy Research Department – Finance and Private Sector Development Division,
December 1994 and Amsden.
31
Amsden.

the remainder of the productive economy.” 32 Subcontracting has served as a transfer

mechanism in three manners:
1. Prime contractors impose on-time, on-spec delivery conditions on subcontractors;

2. Subcontractor production systems have become extensions of those prime contractors
3. Salaried managers have been transferred to supplier firms.33
South Korea’s efforts in the area of SME subcontracting have had positive effects. In 1968 only
18.6% of Korea’s SMEs received revenue from subcontracting, which grew to 70% by 1990.
This development is important because, “subcontracting can act as a substitute for experience or
educational background.” 34
Collective Support System

In addition a comprehensive collect support system has developed in South Korea to sustain the
SME sector’s development:
The collective support system for small and medium-size enterprises (SMEs) is more
important in [South] Korea than in other countries, but is less important than private
support mechanisms. The success of [South] Korea's collective support lies in well-
functioning governance structures, in which hierarchical controls and human resource
policies are especially important.
Although [South] Korea has a dense network of public technology-support institutions,

[South] Korean SMEs tend to turn to private sources of technical support (especially
from buyers, suppliers, and moonlighting engineers) more often than to public
institutions. Even so, some collective support was used often and valued highly,
especially in technologically dynamic sectors.
For technical assistance to be timely and relevant, its delivery must increasingly be
decentralized-to industry-specific institutes and to geographic clusters of SMEs in the
same industry. Generally, networks of local agents and foreign traders developed as
firms gained in export experience.35
32
Amsden.
33
Amsden.
34
Kim & Nugent.
35
Kim & Nugent.

Case Study 2: SMEs-Automobile Parts and Components Industry 36
• Before 1960, South Korea’s auto parts sector existed only to meet replacement
demand for imported military vehicles and to rebuild civilian vehicles from
military equipment.
• In the 1960s, the government designated the auto industry as a “strategic sector.”
• In 1962, South Korea began assembling Japanese Nissan cars.
• In 1979, government designated automobiles one of the nation’s ten strategic
exports and began to set progressively higher local content requirements.
o Auto parts of SMEs began to qualify for targeted export finance.
• The government provided guidelines for linkages between chaebol auto
assemblers and smaller automobile parts firms, specifying which items were
reserved for SME subcontractors.
• South Korea’s automobile production rose from 28,000 in 1970 to 123,000 in
1980 to 1.5 million in 1991.
• South Korea’s automobile parts exports grew from 37.1 million in 1983 to 417.2
million in 1991 while the SME share of automobile parts exports rose from 9.6%
to 44.1% in the same period.
• A lack of in-house technological expertise exists among automobile parts SMEs.
o Stimulus for SMEs in the automobile parts sector to meet the demands of
assemblers comes largely from the auto assembly firms that place orders
within the SMEs, rather than from within the firm itself.
o Since technical specifications are determined by the final assemblers,
international exhibitions and other imitative forms of technical assistance
are of little value to South Korean automobile parts makers.
• However, South Korean automobile parts SMEs are upgrading their technological
capabilities.
o SMEs are using various sources of support for product and process
improvements including the The Small and Medium Industry Promotion
Corporation (SMIPC) and the Industrial Advancement Administration
(IAA) for most technical assistance and the Korea Productivity Center
and the Korea Standards Association for most training.
• Nevertheless, car assemblers’ demand for increasingly sophisticated parts has
motivated SMEs to seek further product innovations.
o The industry specific trade association, Korea Academy of Industrial
Technology (KAITECH) is assuming a role to improve collective support
systems in the automobile sector.
36
Kim & Nugent.

6. Sustainability of Outcomes
As the economic indicators on Page 1 and Table 2 demonstrate, South Korea’s policies resulted
in remarkably robust manufacturing growth relative to three other Asian Tigers that were
themselves, concurrently experiencing unprecedented, prolonged periods of economic growth.
Table 2: Rates of Manufacturing Growth in Asian Tigers (% per

annum) 37
1980-85 1985-90 1990-93

Korea 9.3 10.3 4.6
Hong Kong 3.0 2.9 -1.1
Singapore 1.3 10.3 4.4
Taiwan 6.5 5.8 3.4
Moreover:
Over the past four decades, South Korea has enjoyed an average economic growth rate of
8.6% per year and has emerged as the world’s 11th largest trading nation, establishing
itself as one of the world’s leading shipbuilders, and a leading manufacturer of
electronics, semiconductors and automobiles. These achievements enabled the country to
join the Organization for Economic Cooperation and Development in 1996.38
The 1997 Economic Crisis

Though South Korea’s economy has obviously witnessed impressive growth over the past few
decades, competitive pressures from low-cost producers and the financial crisis the country
experienced in 1997 illustrate that these same economic policies have also left the economy
rather vulnerable in some respects. This has forced some analysts to question the merit of the
South Korean economic model. :
On October 1997, the Korean Stock Exchange began to plunge followed by a sharp fall
of the Korean Won against dollar. Economies in Southeast Asia such as Thailand and
Indonesia have already developed instabilities in their markets, to termed "crises", and
the changes occurring in Korea was seen as a part of a regional contagion effect deriving
from the Southeast Asian crisis. However, by November 21, Korea's foreign reserves
were nearly depleted, and to prevent the total collapse of the economy, the government
announced that it would seek emergency loan from the International Monetary Fund
(IMF) to overcome the difficulties in the financial and currency markets.39
One of the primary causes of the economic crisis directly related to the chaebol and their
extraordinary influence on the South Korean economy.
37
Lall.
38
http://www.kieff.com/gary/StudentExamples/South%20Korea/SK_econ_labor.htm
39
http://www.asianinfo.org/asianinfo/korea/eco/economic_crisis_of_1997.htm

[A] factor behind [South] Korea's economic vulnerability was the highly leveraged
corporate financial structure. The corporate debt relative to nominal GDP ratio was
lowest in 1987-1988 when [South] Korea enjoyed current account surpluses. However,
since then, the ratio increased substantially to reach over 1.6 in 1996. Due to the highly
leveraged financial structure, largely driven by the over-investments of [South] Korean
conglomerates, chaebol, the corporate sector has become increasingly vulnerable to
unfavorable shocks.
Such deficiencies in [South] Korea's economic structure were the legacies of its past
development process. The 30 years of government-led growth process created a close and
collusive relationship between the government and chaebol. Chaebol often engaged in
projects at the government's bidding and the government, in turn, implicitly provided
insurance against project failures. The society as a whole came to accept the so-called
"too-big-to-fail" expectation. Under such a belief, the business firm's main concern
became expansion in size rather than to earn profits. To finance the expansion of
businesses, firms chose the option of debt-financed growth rather than equity-financed
growth. The high debt-equity ratio that resulted from such strategy exceeded 400 % by
the end of 1997, and the average ratio for the 30 largest chaebol reached 518 %.
Unfavorable terms of trade shocks in 1996 severely damaged profits of Korean

corporations in 1997. Series of corporate bankruptcies, even among the major chaebols,
including Hanbo, Kia and Yuwon, increased the size of outstanding non-performing bank
loans at an astounding speed. The deterioration of the corporate sector translated into the
weakening of the financial sector. The stringent lending policies adopted by financial
institutions in an attempt to minimize the effects of a worsening economic situation,
resulted in the shortage of capital which further increased the number of bankruptcies.
In other words, insolvent corporations and financial institutions damaged Korea's

credibility abroad, leading to foreign capital flight. The vicious cycle of foreign exchange
shortage and deterioration of Korea's credibility developed into a full-fledged foreign
exchange crisis at the end of 1997. 40
In sum, by taking the “top-down” economic policy approach that effectively facilitated the
consolidation of the chaebol, the South Korean government unintentionally instituted numerous
structural problems into the economic system that have come back to haunt it. Many of these
problems were rooted in a, “distorted incentive structure which encouraged overexpansion of
corporate investment and misaligned relative prices, especially the overvalued exchange rate
which distorted resource allocation and reduced export competitiveness.”41
40
http://www.asianinfo.org/asianinfo/korea/eco/economic_crisis_of_1997.htm
41
Cho, Yoon Je. “The Financial Crisis in Korea: Causes and Challenges.” Professor, Graduate School of
International Studies, Sogang University, Seoul, Korea, 1998.

Changing Markets and Competition from Lower-cost Producers in

Other Countries: Moving up the Value Chain
And even though South Korea has rebounded well from the 1997 economic crisis, the country’s
continued economic growth is by no means assured. The country faces the same competitive
pressures that all members of the WTO presently do. And as South Korea has moved into the
realm of “developed” countries, it is beginning to be confronted by the competitive threat posed
by low-cost economic rivals, namely China:
Even the Asian financial crisis, severe as it was, may prove to have less of an impact on
Korea's future than China will have. China last year overtook the U.S. as the top
destination for Korean exports. This year, the gap will widen, as exports to China jump
35%, to $47.5 billion, compared with a 7% rise, to $36.7 billion, in exports to the U.S.
Some 25,000 Korean companies -- many small or midsize -- manufacture in China, and a
dozen or so new ones make deals everyday. Korea's leading zipper maker, YBS, last year
made $20 million worth of zippers in China. JS International Co. closed its factory in
Korea last year and now makes some $8 million worth of shirts every year in China for
Japanese brands. "Dyeing and sewing are simply too expensive in Korea," says JS
President Park Chang Ik.
If Seoul gets too dependent on China, the thinking goes, it could end up as a satellite, with
little competitive advantage intact to keep South Korea growing. An early warning sign:
Korea's National Science & Technology Council in December reported that Korea is only
1.7 years ahead of China in the sophistication of its technology, and that the gap could
shrink to zero within five years. In the crucial cell-phone market, Korean companies today
only have a two-year lead over their Chinese rivals in terms of new products and
technologies. By 2007, Chinese companies will have caught up, Korea's Commerce
Ministry says.
Unless something is done to increase Korea's competitiveness, its current $13 billion trade
surplus with China will become a deficit by 2011, cautions the Korea International Trade
Assn. "China has been a goose laying golden eggs," says Jeon Byeong Seo, head of
research at Daewoo Securities Co. in Seoul. So golden, in fact, that last year he required
all his analysts to include some discussion of the "China effect" in every report. Jeon
warns, however, that "Korea's prosperity will depend largely on how long companies can
keep this goose alive."
So far, the benefits have largely flowed to Korean corporations, not their workers. And
Korea's labor laws and union contracts may not be flexible enough to adapt to the
changes. Since 1992, 770,000 manufacturing positions have disappeared from Korea. In
the same period, Korean companies have created well over 1 million jobs in China. "A
reckless corporate exodus has accelerated since last year," says Lee Jung Sik, a senior
director at the Federation of Korean Trade Unions, whose membership has fallen by
110,000, to 890,000, in the past six years.
For decades, the Korean economy depended on low-cost manufacturing. But the
manufacturing arms of the country's textile and shoe makers have largely been relocated

to China. Petrochemical, steel, lower-end shipbuilding, white goods, and even electronics
-- except for a handful of leading-edge products -- will likely face a similar fate within
five years. These industries employ about half of South Korea's workforce, so it is vital
for Korea to create more jobs in services and high-end manufacturing, says Woo Cheon
Sik, senior economist at think tank Korea Development Institute. "Demand from China
will benefit only a small number of leading companies," Woo says. "For the rest, China is
more of a threat." That threat is starkly revealed in rising corporate defaults in Korea,
which hit an all-time monthly high of 133,195 in January, up 14% from 116,707 a year
earlier, according to the Korea Federation of Banks.
Auto parts are another example of the phenomenon. Korean companies last year sold
$944 million worth of mufflers, door handles, windshield wipers, clutches, and headlights,
more than five times the $169 million recorded in 2002. But Chinese companies are
coming on strong. They are already competitive with the Koreans in making bearings,
seats and seat belts, air-conditioners, and bumpers.
And the problem goes beyond autos. Parts and intermediary goods account for nearly 70%
of Korea's exports to China. But the local content in China's manufactured goods
increased to 49.9% in 2001 from 34.8% in 1999, according to the Export-Import Bank of
Korea. One victim: Kohap Ltd., a Seoul-based textile firm that once employed 2,000
workers in Korea and had revenues of more than $1 billion. Rapid development of
synthetic fibers in China helped push Kohap into bankruptcy in 1998.
If Korea had a flexible economy like the U.S. that generated jobs as fast as it lost them,
China would not pose as much of a threat. But Korea built its postwar model on one big
idea -- to use local cheap labor to undersell the Japanese in the world markets for
manufactured goods. Since the Asian financial crisis, that model has changed somewhat,
with foreign companies taking over some Korean factories and banks and companies like
Samsung competing more on innovation and quality than price.
But Korea still has a long way to go before it becomes a flexible, job-generating, fully
modern economy. Laborious work rules and highly militant unions still discourage hiring.
Korea is trying to get around this by forming three special economic zones where the
usual work rules will be suspended. But why not just change the rules in the whole
country? At this point, that's a choice the political leadership isn't willing to contemplate.
"Special economic zones are terms heard only in communist countries," laments Bahk
Byong Won, Deputy Finance & Economy Minister. "We are taking a detour by allowing
these exceptions." 42
42
Ihlwan, Moon. “Korea's China Play: They're partners now. But in the future, China will dominate this powerful
relationship.” BusinessWeek, March 29, 2004

7. Conclusion
Korea’s impressive growth rates, and the overall success of its policies in promoting these two
traditional industries, belie a wider issue in selecting policies similar to those chosen by Korea:
many other countries have tried to adopt similar policies, with far less success. Indonesia
(aircraft) and Malaysia (automobiles) are two such examples.
While it is vital in Hebei to adopt policies that can help revitalize the traditional industries,
simply applying the Korean approach is not likely to yield a positive result per se. Those
policies were adapted to a specific time, to specific markets, and to specific governmental and
private sector structures.
That being said, many of the specific lessons from Korea are extremely useful in crafting a
policy for the Hebei region. Moving forward using a collaborative approach, involving key
stakeholders in each step, and adopting specific policies after careful analysis and buy-in, is
much more likely to ensure the outcomes desired for Hebei’s economy.

B2: Case Study

Prepared by ECG
Chreod Ltd.
Case Study B2: Cluster Based Development in Transitional Economies 14 May 2004

Prepared for:
Chreod Ltd.
111 Sparks Street, Suite 200
Ottawa, Ontario
Canada K1P 5B5
Submitted by:
Economic Competitiveness Group

2236 Sixth Street, Suite B
Berkeley, CA 94710 USA
Tel (510) 849 8400 * Fax (510) 849 8406
Email: aboyd@ecgroup.com
www.ecgroup.com

Table of Contents
1. Background 1
2. Introduction to Clusters & Competitiveness 1
What is a cluster? 4
Clusters and Geographic Proximity 4
Regionalism and the Evolution of Clusters 5
Institutions for Collaboration (IFCs) 7
Role of Government in Developing Innovation Systems 7
The Pay-off from Clustering 11
3. Cluster Processes in the Transitional Economy Context 11
Cluster development is often hardest in traditional industries 11
It may be more challenging to implement cluster-based competitiveness initiatives in
transitional economies 11
4. Case Study: Chihuahua Century 21 Project 12
Problems encountered in Chihuahua “Century 21” Project 13
5. Case Study: Hungarian Automotive Cluster 14
6. Conclusion 19

1. Background
Cluster-based approaches to industry development represents an evolution in thinking on
how to approach regional strategic planning. It is emerging as a workable compromise
between top-down, government-driven industrial development, and more laissez-faire
approaches that concentrate solely on improving the business climate and infrastructure.
The biggest advantage of the cluster approach is that it allows planners to assist selected
industries with a dramatically lower risk of making big mistakes (e.g. building ‘white
elephants’). This is due to a number of factors:
increased emphasis on exhaustive analysis – of local capacities and market and
technology trends;
the focus on private sector leadership and extensive stakeholder involvement;
the tendency to improve public/private dialogue; and
the use of competitiveness as the litmus test for all efforts.
To explore more fully how these factors impact the effectiveness and efficiency of
government interventions using the cluster approach, it will be useful to introduce the
concept more fully, and present a few case studies.
2. Introduction to Clusters & Competitiveness

One of the central tenets of cluster-based model of economic development is that the
most economically successful regions have managed to knit together companies, teaching
and research institutions, and government at multiple levels to create a uniquely
competitive industry. Prof. Michael Porter has essentially introduced the concept of
“institutions for collaboration” – or IFC’s, to represent the myriad of public, private, and
quasi-public entities that are the glue that effectively binds the cluster together.1
Competitive advantage is not created within a single firm alone. Efficiency in internal
operations is a necessary – but not sufficient – condition to compete globally. Factors
external to the business, but internal to the regional economic foundation, are
increasingly important for the creation of competitive advantage. Each firm is part of a
“cluster” of interrelated firms, suppliers, customers, and service providers, as well as
supporting organizations (human resources, R&D, finance, infrastructure, and regulatory
environment). 2
1
Porter, Michael E. “The Economic Performance of Regions: Measuring the Role of Clusters.”
Presentation at the Competitiveness Institute’s Annual Meeting – Gothenburg, Sweden – September 19,
2003.
2
Stanford Research Institute, “Clustering as a Tool for Regional Economic Competitiveness.”
© 2004 Economic Competitiveness Group, Inc. All Rights Reserved. B2_1

Clusters are geographically concentrated co-operation networks of interdependent firms,

research and development institutions, other intermediary actors (like universities,
economic or regional development agencies, chambers etc.), where the close contacts of
the members and the continuous, fast knowledge exchange between them contribute to
the increase of the competitiveness of both the members and the whole region.3 Industry
clustering is a powerful framework for regional economic development because it
captures economic relationships among specific industry sub-sectors, and it provides a set
of tools to help define economic development strategies. 4
Every location, whether a nation, state, or region has a set of unique local conditions that
underpin the ability of companies based there to compete in an industry. The competitive
advantage of a location does not normally arise in isolated companies but in clusters of
companies. These firms are in the same – or related – field, or are linked by buyer-seller
relationships, common customers, or other relationships. An industry cluster is a group
of companies that rely on an active set of relationships among themselves for individual
efficiency and competitiveness. These relationships have four prominent characteristics:
• Buyer-Supplier Relationships. Core companies (see Figure 1 below) that

produce goods and services that are sold to final consumers, generally exported
outside the region.
• Competitor and Collaborator Relationships. Companies that produce the same
or similar goods and services at a specific level in the value chain.
• Shared-Resource Relationships. These relationships exist when firms rely on the
same sources of raw materials, technology, human resources, and information
even though they may use these resources to produce goods and services for very
different markets.5
• Critical Mass of Competitiveness Factors. Critical masses of information, skills,
relationships, and infrastructure in a particular field.
3
Grosz, Andras, “Cluster Initiatives in Hungary as New Forms of Economic and Regional Development –
The Case Study of the Pannon Motor Industrial Cluster (PANAC)” Regional Transitions – International
Conference, Gdansk – September 15-18, 2001.
4
5

Figure 1: The Structure of a Cluster
CLUSTER STRUCTURE
Export-based
industries
Supplier Industries
Input materials, distribution, trade and other

supporting services
Economic Foundation
Capital
Human and Regulatory Physical
resources Technology finance environment infrastructure
INTEGRATED
CLUSTERS
Source: Stanford Research Institute

According to Michael Porter,6 clusters increase productivity and efficiency by providing:
• efficient access to specialized inputs, services, employees, information,
institutions and “public goods” (e.g. training programs)
• ease of coordination and transactions across firms
• rapid diffusion of best practices
• ongoing, visible performance comparisons and strong incentives to improve vs.
rivals
Clusters stimulate and enable innovations by:
• enhancing ability to perceive innovation opportunities
• presence of multiple suppliers and institutions to assist knowledge creation
• easing experimentation given locally available resources
Clusters facilitate commercialization:
• opportunities for new companies and new lines of established business are more
apparent
• commercialization of new products and starting new companies is easier because
of available skills, suppliers etc.
6
2003.

What is a cluster?
In a cluster, firms and others within a concentrated geographical area are co-operating
towards common goals, and establishing close linkages and working alliances to improve
their collective competitiveness. 7 An active clustering agenda facilitates the integration
of a clump of co-located firms and organizations into a high performance system.
Optimization is at a system, rather than individual organization, level. An active local
cluster includes firms and support organizations working together to achieve results that
would not be possible individually.
A key component of any high performance cluster is extensive informal and formal
networking between firms - even competitors - right across the cluster, and between firms
and their supporting infrastructure. Soft networks (such as local professional and trade
associations) and hard networks (strategic alliances between firms) are both important,
and the development of such networks is supported by a local culture that enables both
competition and cooperation to thrive. Active clustering is co-opetition, a combination of
competition and cooperation that is more sophisticated than most notions of rivalry
within an industry, and which more appropriately captures the nuances of company
interactions within a region. Companies in cluster working groups often begin to see that
firms that they once considered direct competitors are actually in slightly different market
niches, and that many opportunities for joint work exist, even while there will continue to
be rivalry in some dimensions.
Clustering is not…
…strategic plans and yet more meetings, but more importantly a means of quickly
identifying a development route for the cluster as a whole, and then moving forward in a
collaborative way. Clustering is not a few deciding for many; it is an inclusive,
collaborative process. Clustering benefits from a community wide momentum.
Clustering is more than lobbying government under a new name, though a clustering
approach certainly can provide a very effective means of accessing government agencies
and making development priorities clear. Of more importance than lobbying is the
creation of a mechanism for a wide scope of improvements in areas of common concern;
creating a self-help system.
Clusters and Geographic Proximity

One might assume that globalization would minimize the importance of geographic
proximity; however, Porter and Enright8 argue to the contrary. With increasing
7
This definition is based on ‘Clusters as a Vehicle for Small Medium Enterprise Development: an
alternative perspective’ Small Business Project, Johannesberg,1999
8
Michael J. Enright, "The Globalization of Competition and the Localization of Competitive Advantage:
Policies Toward Regional Clustering" in N. Hood and S. Young, editors, The Globalization of
Multinational Enterprise Activity and Economic Development, (London: Macmillan, 1999)

globalization, the inputs to production flow more freely around the world; hence, they
also become more readily available to any producer and less of a differentiating factor.
Paradoxically, as the world becomes increasingly interconnected, building competitive
advantage has more to do with things that are fundamentally local: relationships and
interactions (which are easier to build when people are in close proximity and share a
common language and culture) and information sharing (which is far more effective in
face-to-face situations than through even the most sophisticated communication system).9
The common assumption underpinning these cluster relationships is the premise that such
relationships benefit from geographic proximity. The premise is that such relationships
will be stronger if the distances separating participants in the cluster are as short as
possible. Physical movement of goods is obviously important. In an era where just-in-
time inventory management and time-to-market responsiveness are standard elements of
competitiveness and productivity, the shorter the distance from loading dock to loading
dock or from desk to desk, the better. Similarly, the flow of information that directs the
flow of goods and services improves as distance decreases. Although information
technologies have reduced the impact of physical distances, many activities, ranging from
product design to contract negotiations, can best be accomplished by face-to-face
exchanges. 10 A rule of thumb is that a cluster is most effective if members can easily
meet each other in person within two hours.
It is increasingly clear that due to benefits of globalization we are seeing a number of
localities around the world, often small, develop a particularly innovative environment in
a specialized area, and through extreme competitiveness establish a global reach. As a
direct result these communities have wealth generating capabilities well beyond many
other localities in their country.
Research highlights that the process of creativity is the result of people talking,
communicating face-to-face in teams. Place is becoming more important, not less
important, especially for knowledge-intensive activities. New economy business practices
are collaborative, built on trust, dialogue and alignment.
Regionalism and the Evolution of Clusters

Considering the growing consensus around the importance of regionalism, many
competitiveness initiatives are focusing, “on ‘economic regions’ as the engine of growth.
Such regions have little to do with political or administrative boundaries and more to do
with the clustering of firms and institutions that are interconnected ... or, in the case of
many developing economies, should be interconnected.”11
9
The Mitchell Group, “Promoting Competitiveness in Practice: An Assessment of Cluster-Based
Approaches.” Prepared for the U.S. Agency for International Development – November 17, 2003
10
11
Approaches.” Prepared for the U.S. Agency for International Development – November 17, 2003

That said, there are often arrays of clusters at different locations in a given field, each
with different levels of specialization and sophistication and often focus on different
market segments.12
Every region has a unique set of local conditions that provide the “economic foundation”
or “competitive platform” upon which companies contend in a region. The ability of
regional companies to compete in the “new economy” effectively depends on how
effectively their region provides them with the resources that they need to excel.
These economic foundations of the new economy provide:
• Skilled and adaptable human resources;
• Access to the technologies on which new products and processes are
based;
• Availability of financial capital to support new ventures and expansion of
existing companies, and re-investment in transition industries;
• Support of advanced physical infrastructure for transportation,
communication, energy and water, and waste-handling; and
• A responsive regulatory and taxation structure that balances business
competitiveness with community concerns.
Clusters continuously evolve as new companies emerge or decline, or as local institutions
develop and change. They can maintain vibrancy as competitive locations for as long as
centuries (e.g., German printing, Swiss chocolate, Italian leather). Most successful
clusters prosper for at least decades.13 The challenge for a regional economy is to move
from isolated firms to an array of clusters and then to upgrade the breadth and
sophistication of clusters to more advanced activities (see Figure 2).14
12
2003.
13
14
2003.

Figure 2: Stages in the Evolution of Clusters
Precluster Emerging Expanding Transforming

Clusters Cluster Cluster
Institutions for Collaboration (IFCs)

One of the most important ideas to emerge from cluster methodology is Michael Porter’s
assertion of the importance of the presence of Institutions for Collaboration (IFCs) to
enhance cluster-based economic development activities. These are formal and informal
organizations that facilitate the exchange of information and technology, conduct joint
activities and foster coordination among firms.
IFCs can improve business environments by: creating relationships and level of trust that
make them more effective, defining common standards, conducting or facilitating the
organization of collective action, defining a communicating common beliefs and attitudes
and providing mechanisms to develop a common economic or cluster agenda. Examples
of IFCs include chambers of commerce, professional associations, university partner
groups and competitiveness councils.15
Role of Government in Developing Innovation Systems

There are a number of levers governments at different levels can apply in increasing a
country’s innovation capacity. While implementation of some aspects identified here can
be more effectively undertaken at a local level, this can in most cases be supported by
initiatives at a higher level of government.
At the National level

• Creating a legal, regulatory and financial framework that is conducive to
innovation;
• Addressing through incentives the systemic failures that block the functioning of
innovation systems, thus hindering the flow of knowledge and technology, and as
a result reducing the overall efficiency of R&D efforts;
15
2003.

• Building a genuine innovation culture, encompassing all aspects of the wealth

creation system including primary schools, tertiary institutions, government
funded R&D laboratories, and local government development agencies. A sub set
of this is a culture of collaboration at a multiplicity of levels.
• For technology developers and lead technology users (probably making up less
than 15% of a country’s SME population) the most important goal is to promote
the development of the private venture capital industry, giving the flexibility to
then adjust down the granting programmes that currently support them.16
• For the vast majority of SMEs - the technology followers - innovation policy
should more closely address their needs, especially in regards to: non-financial
innovation advice such as consulting services; recruitment of university graduates
and skilled personnel; awareness of new ideas and technologies; and incentives
and institutional frameworks for improving collaboration within networks and
clusters, including local technical centres/polytechnics.17
• Moving the emphasis to enable SMEs to find their preferred technology partners,
rather than technology suppliers seeking industry partners to support their research
interests. Providing incentives for the technology supplier to act as knowledge
brokers to their respective industries. Removing institutional rigidities, particularly
within technology providers, based on narrow specialisation.
• Need to target sub-populations of companies, rather than technology domains or
sectors, and to accept that innovation is important in all industries, from high tech
to low tech.
• Break down the barrier between science at a university and entrepreneurship.
• Steering larger grant applicants towards venture capital, thus freeing up funds to
support a larger number of SMEs. Build collaboration between (publicly funded)
granting institutes and (private sector) venture capitalists.
• Ensuring greater mobility of knowledge workers due to the importance of tacit and
specialised knowledge.
• SME participation in networks/alliances, both domestically and internationally,
should be encouraged to facilitate the mobility of knowledge. Encourage
networking of firms with local and international centres of excellence;
encouraging SMEs to form alliances with (larger) international firms.
• Leveraging R&D, eg through public/private research partnerships, and an
emphasis on pre-competitive research for groups of SMEs. Gearing research more
closely to innovation at the national and community levels.
16
OECD (2000) Enhancing the Competitiveness of SMEs through Innovation Proceedings of the Bologna
SME conference, 2000
17
OECD (2000) Enhancing the Competitiveness of SMEs through Innovation Proceedings of the Bologna
SME conference, 2000

• Extending (or relocating) specialised infrastructure to be closer to local clusters.

• Improving the access of SMEs to government support, eg a single application
form for all support agencies.
At the Local Level

It is the local, community level that is increasingly the functional unit for economic
activity and therefore economic development. It is here that the SME in particular
benefits from close physical proximity to related firms, and benefits from the local
availability of a specialized, supporting public infrastructure. It is primarily within a
local (not virtual) community that social capital and trust develop, facilitating the all-
important movement of tacit information.
Addressing the activities that follow will in many cases require a close partnership
between National /State and regional/local governments. Further, the delivery will be
enhanced in many locations through collaborative partnerships between local government
agencies.
• Providing a neutral corner that facilitates the development of local clusters,
addressing the lack of social capital/networking, creating a more open
environment for the flow of tacit information, and building increased
connectivity between knowledge agents and SMEs. Networking firms and
technology providers, and so enabling different ideas and approaches to be
available to the SME as inputs to innovation and learning;
• Facilitating the movement of knowledge amongst firms, for example stimulating
co-operation amongst firms in their knowledge activities, and facilitating senior
knowledge workers visiting other firms and research institutions.
• Developing local incubation centres, in part in response to the importance of
tacit knowledge. These incubation centres need to offer more than subsidised
real estate for the selected SMEs. A successful incubation centre is able to build
the necessary networking, trust and social capital, providing a mix-and-mingle
environment for the businesses under its roof. Location on a university campus
can facilitate the bringing together of firms, students and their supervisors, but
still needs government funding as an inducement to remove isolation;
• Developing the informal venture capital market through enhancing Business
Angel schemes - placing high growth companies in contact with high net worth
individuals, particularly from within the local community. Extending further
public investments in specialist skills development, education, and technology
support, with priorities being determined in partnership with local clusters.
Stages in the Cluster Development Process

The following section lays out a framework for launching a cluster development process.

Figure 3: Cluster Development Process

Institution-
Institution-
8 alise
alise the
the
Cluster
Cluster
Upgrading
Upgrading
7 Strategic
Strategic
Agenda
Agenda
Immediate
Immediate
6 Action
Action
Agenda
Agenda
Identify
Identify
5 Stepping
Stepping
Stones
Stones
Develop
Develop
4 Cluster
Cluster
Vision
Vision
Establish
Establish
3 Leadership
Leadership
Team
Team
Initial
Initial
2 Cluster
Cluster
Stocktake
Stocktake
Analyse
Analyse
1 Local
Local
Economy
Economy
Step 1. Analyze Local Economy

Identifying the embryonic and the more developed local clusters and
prioritizing the initial clusters for active development.
Step 2. Initial Cluster Stock-take

Gathering information about the cluster in the local economy.
Step 3. Establish the Leadership Team

Carefully choosing the appropriate people to participate in the leadership
group
Step 4. Develop Cluster Vision

Establishing the preferred future for the cluster.
Step 5. Identify Stepping Stones

Identifying the key steps to the preferred future.
Step 6. Immediate Action Agenda

Highlighting the short-term projects.
Step 7. Institutionalize the Cluster

Setting up an institution/organization that will sustain the clustering
process into the future.
Step 8. Upgrading the Strategic Agenda

Moving to longer-term, more substantive projects.

The Pay-off from Clustering

Whilst clustering is not in itself a panacea, a successful clustering approach can offer
benefits at multiple levels: to individual businesses, to support agencies such as tertiary
institutions, and in particular to the economic growth of a region. There is an important
relationship between innovation, upgrading competitiveness and clusters.
At the firm level, as firms become more specialized, the impediments to growth often lie
outside the boundaries of the firm. A clustering initiative focuses on developing the
whole system to the benefit of all firms across the cluster. Clustering helps align private
and public investments, such as local firms and a university, so the cluster is better able to
fulfill the promise of job creation.
Active clustering increases the wealth creating capability of a community, facilitates the
participation of the disadvantaged in economic development, builds the competitive
advantage and the reach of local firms, resulting in more income and more jobs for the
community.
3. Cluster Processes in the Transitional Economy Context

This section draws heavily on a review of clustering of transitional economies preparted
for USAID.18
Cluster development is often hardest in traditional industries

Participants in such sectors have “histories” with each other; memories of “glory days”
tend to produce backward- rather than forward-thinking; and new ideas or participants
can threaten older leaders, who may think only they know the sector. From cashmere in
Mongolia to shrimp in Campeche to coffee in El Salvador, traditional sectors
demonstrated their reluctance to embrace the new ways of doing business embodied in
cluster development.
Operationally, this implies that cluster selection must rely on cluster members’ interest
and enthusiasm. To demonstrate the benefits of working together, cluster-based
competitiveness funds must go where movement, however small, is happening ... not
where the economy “used to be.”
It may be more challenging to implement cluster-based

competitiveness initiatives in transitional economies
Transitional economies often are characterized by contextual obstacles which, though
present in other countries, seem more pronounced or entrenched in nations that have
experienced many years of central planning. These features include, for example: a weak
civil society in which there is little or no trust between the public and private sector; a
18
Approaches.” Prepared for the U.S. Agency for International Development – November 17, 2003.

lack of tradition of taking joint action on a voluntary basis; a production rather than
market or customer mindset; and weak understanding of international markets and basic
business skills. From the experience in Mongolia, in particular, we learn that:
• Initial efforts to generate understanding of broad competitiveness principles (i.e.,
Step 1) may need to be hands-on, interactive and tangible, rather than academic
and theoretical.
Most notably, firms are making changes that bring them closer to their customers and the
market – and that bodes well for increased competitiveness over the long term.
• The most important determinant of success is the “sweat-equity” investment of the cluster.
• Successful cluster-based initiatives are private sector driven – with links to the public
sector. They are not public-sector driven – with links to the private sector.
• Cluster-based competitiveness initiatives are not a “quick fix” solution. They involve major
shifts in thinking and practice and, hence, results take time.
The USAID report highlighted the importance of the “commitment to process”, private
sector driven The private sector must own and drive the process of cluster
development and not a quick fix…
4. Case Study: Chihuahua Century 21 Project

The Chihuahua “Century 21” Project was a comprehensive initiative launched by the
private sector of the border state of Chihuahua, Mexico, in 1990. Historically, Chihuahua
had an primary-sector-oriented economy, and it took “the recommendation of a large
consulting firm…to convince the federal authorities of the advantages of allowing the
installation of foreign firms along the Mexico-US border [leading to] the birth of the
maquiladora model.” 19 This maquiladora model endured until the early 90s.
However, by the early 90s it was clear that the regional economy needed further
restructuring. The “Century 21” Project sprung from this notion, with the project,
“funded equally by the private sector and the State government.” The study focused on 9
clusters grouped in 3 areas: light manufacturing, automotive, electronics and textiles and
apparel; natural resources, agriculture, cattle, forestry and materials; and services,
transportation and distribution, tourism and business services.” 20
19
Avila, Salvador H. “Chihuahua Siglo XXI: Lessons Learned in a Decade of Cluster-Formation
Processes in Latin America.” TCI Conference – Innovative Clusters: A New Challenge, Gothenberg,
Sweden, September 17-19, 2003.
20
Ibid.

Figure 4: Economic Clusters in Chihuahua
Light Natural Resources Services

Manufacturing
Agriculture,
Automotive Transport
Textiles Beef & Food Forestry & &
Furniture Business
Electronics Services
Industrial
Materials Advanced
Machines Materials Tourism
FINANCIAL INFORMATION
HUMAN INFRAESTRUCTURE BUSINESS RESOURCES
RESOUCES TECHNOLOGY TECHNOLOGIES
CLIMATE
Source: Avila
Problems encountered in Chihuahua “Century 21” Project

The following section outlines some of the specific obstacles to implementation that were
encountered in the Chihuahua project, along with suggested solutions.
Resistance from branch plant managers – some of the key economic actors in
Chihuahua were the managers of the maquiladora plants, owned by
multinationals. Managers were hard to recruit for a process that seemed only to
benefit the local economy.
Solution: engage with branch plant managers to show them how the operations of
their plants will benefit from involvement in the cluster. Even if they don’t participate
in the strategy development part of the process, they often do get involved in the
action/implementation stage – they are more often “do-ers” than thinkers.
Government wants to lead process – government officials argued that private
sector leaders were not qualified to make strategic decisions about the clusters.
Solution: It was necessary to convince the government that without strong private
sector leaders highly visible in the process, the project would be labeled as a ‘typical
government initiative” and genuine private sector involvement would disappear.
Government officials needed to be convinced that even though the preliminary

strategies were somewhat piecemeal, by letting the business leaders ‘flex their muscles’
and feel that they were truly a significant part of the process, they would eventually
commit more time to the process, and more comprehensive approaches would emerge.
Business leaders who were initially skeptical increased their level of commitment when
they saw some of the concrete results from the early action agenda – the ‘early wins’
from the project.
Government offers to “house” and staff project – when an early institutional
home was being sought for the project, the private sector did not have enough
funding to provide large, nicely furnished space for the project, and significant
administrative and technical staff. Government offered to provide in exchange
for putting the project in a government-owned building with government-
provided staff.
Solution: Against the advice of the consultants, project leaders accepted this offer and
the increased resources helped accelerate the process of clustering in Chihuahua. For
six years the Chihuahua project was clearly the most dynamic and substantive
clustering project in the world. However, in 2000, a new government was elected in
Chihuahua, and despite the broad-based nature of the project’s accomplishments, the
project office was shut down. All of the achievements are still there, and many study
groups come to Chihuahua to observe what was accomplished, but the cluster groups
and the Chihuahua Siglo XXI staff are no longer operating. The lesson for
sustainability is to find an institutional home for the project that is independent of any
one funder, even if this means that the overall funding will be lower.
Rivalry between sub-regions – the region’s two major cities, Juarez and
Chihuahua City, had some friction. One is the state capital, with stronger
administrative control, the other has a larger population and more concentration
in manufacturing. They are about 5 hour’s drive apart.
Solution: It makes more sense to define each region as a separate ‘cluster catchment
area’ if the natural geographic, social, economic and cultural linkages indicate that
frequent interactions take place in separate regions. Our rule of thumb is that if
participants can ‘meet for lunch’ occasionally without excessive effort, the regional
clustering is feasible – this often translates in practice to a 2-hour radius around the
cluster’s central point. To capture the true dynamics of a cluster, it may make sense to
form separate cluster working groups in each sub-region (not every sub-region will
have every cluster represented), and then link them via a Competitiveness Council or
specific “cluster coordinating committees” that operate in the provincial capital.
5. Case Study: Hungarian Automotive Cluster

The Hungarian automotive cluster case features several characteristics that are relevant to
Hebei:
• Centrally planned economy that shifted to a market economy and adopted a
cluster-based approach to economic development.

• Presence of relatively large levels of FDI which spurned dynamism within the
sector, but required region to incorporate innovative technologies in order to
capture more value-added activities.
• The cluster initiative focused on a traditional industry in which Hungarians had
developed technical expertise and specific areas of specialization.
• Cluster concentrations of various specializations are distributed over a wide
geographical area.
• Presence of strong and capable IFCs have enabled efficient coordination and
collaboration.
Following Hungary’s switch to a market economy in the early 90s, the country’s
favorable disposition towards the west and privatization made it a natural target for
foreign direct investment, garnering 21.5 billion euro from 1991-2001, much of it in the
automotive sector. 21
However, by the late 1990s, “the growth that [had been] mainly fueled by the investments
of foreign companies started to slow down. The traditional Hungarian economy could
not respond quick[ly] enough to the new requirements conveyed be the newly settled
companies, mainly in the form of contractual requirements for supplying.” 22 Moreover:
“The foreign owned companies were mainly operating like islands within
Hungary…They brought new technologies but they hardly integrated to the local,
regional economy. They kept working together with their existing supplier
network, considering their Hungarian companies only as relocated manufacturing
sites…In this context, clusters and the idea of cluster based economic
development was introduced as a possible method for vitalizing these business
and scientific connections and to assist in fuelling an innovation based, intensive
development phase of the Hungarian economy, thus helping the spreading
benefits of the economic growth.
“In order to decrease the vulnerability stemming from the high mobility of foreign
capital, it is essential that a transition takes place from the existing economic
development model. The current model relies on the attraction of foreign capital
involved in low complexity production using low-cost labor performing simple
tasks. The new innovation-driven economic model should be based on
competitively priced skilled labor force that is involved in the development and
production of complex products, continuous innovation and further attracting as
well as internally develop R&D and innovation-oriented companies. ” 23
21
Grosz.
22
Szilasi, Peter Tamas. “Cases of Hungarian Cluster Development: Duality of the Hungarian Economy –
Barrier for Sustaining the Economic Growth in Hungary.” August 15, 2003.
23
Szilasi.

The Hungarian Automotive Cluster case study demonstrates the importance of different
layers of well-coordinated IFCs to the long-term success of cluster initiatives. In October
2001, the Western-Transddanubian Regional Development Council, the Regional
Tourism Committee and the West-Pannon Regional Development Company singed a
cooperation agreement called the Pannon Business Initiative (PBI) to operate the overall
Hungarian cluster initiative. 24 In the automotive sector in particular, the Pannon Motor
Industry Cluster (PANAC) was founded in December 2000 in the West Transdanubian
region by five of Hungary’s biggest automotive companies. PANAC was established to
promote small and medium sized companies of automotive industry to join directly with
the leading car manufacturers and/or each other throughout the entire Transdanubian
region. 25
Thus, on a macro level, participating firms in the automotive cluster were able to draw on
the resources of the umbrella-like PBI organization in the context of being part of a
nation-wide competitiveness program encompassing a variety of sectors and industries.
And on a more micro-level, PANAC also served these firms as a resource for fine-tuning
action initiatives and other strategies specifically related to the automotive sector.
Moreover, the automotive cluster initiative received important support from other IFC-
type organization such as the Association of Hungarian Vehicle Component
Manufacturer (MAJOSZ), the Hungarian Foundation for Enterprise Promotion (MVA)
and the Hungarian Investment and the Trade Development Agency (ITDH).
The locations of automotive sector firms and other related industries are shown below in
Figure 4. Although PANAC was established as a regional initiative, it has outgrown
West Transdanubia and currently operates with a national agenda with 67 member
companies, “aiming to be a coordinating power for the Hungarian automotive industry.”26
24
Szilasi.
25
Conference, Gdansk.
26
Szilasi.

Figure 5: Automotive Sector Firms and Related Industries in North Transdanubia
Source: Grosz.
Clearly, the automotive cluster is distributed over a wide geographical area. Moreover,
certain sub-regions have developed unique specialization capacities. For example,
companies located in West Transdanubia are strongly specialized in automotive
components (engine, gearbox, cylinder head, exhaust etc.) or parts (cable-strand, seating,
lock, wheel-disc etc.). Whereas, companies located In North Transdanubia there is a very
strong specialization in production (decentralized production eg. most companies supply
only a few components or parts for the higher level of production). 27
The reality of Hungary’s widely dispersed automotive cluster highlights a point that is
entirely relevant to Hebei given its unique geographical disposition: region-wide clusters
can be comprised of several sub-regional mini-clusters with specific specializations.
27
Conference, Gdansk.

Members of sub-regional mini-clusters can collaborate with each other on a more

frequent basis while continuing to operate within the framework of the more
comprehensive region-wide cluster initiative.
A survey distributed to automotive cluster members prior to the establishment of PANAC
to determine the services in highest demand from a PANAC-type organization is also
very representative of the organizational needs in a variety of transitional economy
cluster initiatives. The survey results included the need for:
• financial assistance operating in a competitive system and special credits for
current assets;
• continuous information (about business, markets, investments, co-operations,
tenders or legal information etc.);
• co-operation partner search;
• technology center services for supporting production, developing quality
(gauging, calibration, special laboratory analysis);
• co-operation projects for increasing the efficiency of production (common
production projects). 28
To meet the automotive cluster’s needs PANAC became involved in the following
activities (among others):
• Assess and continuously monitor automotive requirements of suppliers;
• Develop an evaluation tool to assess firms’ abilities to meet those requirements;
• Monitoring global trends and their effects on local industry;
• Communicating the requirements and trends among network-members

o e.g. conferences, newsletters, website;
• Developing SME’s by providing specialized trainings and introducing
management and production techniques;
• Work with educational institutions and R&D organizations to foster interaction
with industrial partners;
• Assisting companies to enter cooperation projects/joint business activities with
other firms and to become involved in European-wide cooperation projects.
Initially, results of the cluster based approach are generally realized in more qualitative
areas such as increased interaction, linkages and dialogue etc, rather than in tangible,
quantitative ones such as increased employment, market share etc. These quantitative
28
Conference, Gdansk.

outcomes are more likely to occur after the collaborative process has become embedded
in regional economic development policy and has an opportunity to bear fruit. Because
of PANAC’s considerable organizational and coordination capacity, the Hungarian
automotive cluster initiative has been rather successful:
• In addition to PANAC’s 67 official members, roughly 100 other companies have
also become involved in the network;
• 800 employees of member-companies have participated in trainings;
• Five automotive conferences and technology forums have been held involving
150 companies;
• Three international business forums have been held involving 47 Hungarian and
35 German and Austrian companies;
• PANAC represented its members in four international subcontracting fairs.
The relative success of the Hungarian automotive cluster initiative illustrates how the
presence of capable IFCs, sustained government support and strong private sector
involvement can help overcome some of the coordination problems caused both, by
geography and lack of previous exposure to cluster-based economic principles. This
cluster initiative also offers several best practices for making the transition from a
centrally planned to a market-based economy and demonstrates that traditional industries
can be leveraged through the cluster process to establish competitive advantage, even in
the current hyper-competitive and globalized business environment.
6. Conclusion
In the introduction, four elements of cluster approaches were identified as keys to better
outcomes to invigorate a traditional industry in the developing country context:
increased emphasis on exhaustive analysis – of local capacities and market and
technology trends;
the focus on private sector leadership and extensive stakeholder involvement;
the tendency to improve public/private dialogue; and
the use of competitiveness as the litmus test for all efforts.
These elements have been important in two senses:
a) by reducing the number of mistakes that are typically made when government
lays out a “grand plan” for a sector with insufficient gound-truthing (analysis)
and buy-in with the private sector; and
b) by harnessing the entrepreneurial drive of private sector leaders in directions that
are consistent with regional industrial growth.

This latter effect should not be underestimated. The outpouring of innovative ideas, large
and small, that flow from a well-conceived cluster initiative can be astonishing. Business
owners and managers who had good ideas previously would simply hold on to them,
often lacking resources to implement them alone, and seeing no chance of getting the
support needed to implement them by reaching out to others. When they see the regional
decision-making framework being erected around them in a cluster approach, they begin
to feel that some of their best ideas about training, infrastructure, marketing & branding,
and new technological innovations can be implemented, and they begin to develop a trust
that, by and large, their efforts will benefit their own businesses just as much as other
cluster participants.
Once this shift in mind-set is accomplished, and both private and public sector leaders are
genuinely “working from the same blueprint,” one begins to believe that the region’s true
economic potential can be realized.

C1: Case of Pittsburgh, Pennsylvania
Economic Transformation
in the North American “Rust Belt”
Prepared by Derek Ireland
Chreod Ltd.
Case Study C1: Pittsburgh PA 12 February 2004
Economic Transformation In The North American “Rust Belt”

The Case of Pittsburgh PA
1. Introduction: Over the past 40 years, several cities in the North American industrial
heartland – or rust belt – have undergone with varying degrees of success substantial
economic restructuring and transformation in response to:
the forces of globalization, freer international trade, the newly industrializing

countries in Asia, and rapid technological change,
the resulting need for structural adjustment and modernization, and
losses in American comparative advantage in many traditional heavier and related

industries including iron and steel, non-ferrous metals, industrial chemicals and
more recently motor vehicle assembly and parts and consumer appliances.
2. Cities that have been negatively affected by these trends include Hamilton Ont., Gary
Indiana, Cleveland Ohio, Detroit Michigan and Pittsburgh Pa.
3. Many PRC cities will be facing similar challenges from market opening, technological
change, and losses in productive efficiency and comparative advantage in traditional heavier
and related industries that until very recently often were dominated by SOEs. These include
several cities in Hebei province such as Tangshan in the northern part of the province with
an industrial base that is dominated by metallurgy/iron and steel, paper production, ceramics
and textiles, and Handan in southern Hebei near Henan and Shanxi Provinces, with an
industrial base that is dominated by metallurgy, coal mining, and textiles.
4. In assessing and comparing the challenges and prospects of these Hebei cities with the
cities in the North American rust belt, it was concluded that the economic history,
transformation and prospects of Pittsburgh may provide some useful insights for Hebei.
Similar to Tangshan and to a lesser degree Handan, Pittsburgh is a medium-sized city on
the periphery of a major regional market – the Northeastern US urban region stretching from
Boston through New York to Philadelphia, Washington and Baltimore – that in the past
depended on metallurgy and especially iron and steel. Just as Pittsburgh is on the periphery
of the northeastern US urban region, Tangshan and Handan are on the periphery of the
emerging eastern and southern PRC regional and urban market, which starts in Beijing,
Tianjin and Shandong but is now concentrated in the Yangtze Delta centered on Shanghai
and the Pearl River Delta with its links to Hong Kong1.
5. Traditional Economic Base of Pittsburgh: The city of Pittsburgh, which is the county
seat of Allegheny County in southwest Pennsylvania, is located at the confluence of the
Allegheny and Monongahela rivers that come together to form the Ohio River. Pittsburgh is
a major inland port of entry, and is located at the junction of many major east to west
transportation arteries. The city was established on the site of the Native American town of
Shannopin, which was a late 17th century fur trading post. On this site, Fort Duquesne was
built by the French in the middle of the 18th century and when the fort fell to the English in
1
In 2001, the eight provinces and independent municipalities that comprise this eastern and southern market
along the PRC coast accounted for 30% of the PRC population, 42% of the country’s urban population (based
on the Chreod method), 46% of household bank deposits (a proxy for personal savings), 47% of gross
investment, 47% of national GDP, 50% of tertiary GDP, 55% of PRC retail sales, 62% of industrial output, 63%
of the patents granted, 78% of gross fixed investment, and 85% of national exports and imports. Hebei is
geographically on the periphery of this dominant PRC region but in terms of industrial and urban structure,
productivity, prosperity, and its stage in the development process, Hebei is closer to the middle region provinces
(such as Henan, Hubei and Hunan) than to the eastern and southern coastal provinces that now dominate the
PRC economy in virtually all indicators.
C1_1
1758, it was renamed Fort Pitt. The village surrounding the fort was first settled in 1760.
6. The glass, iron and coal industries were first established in the Pittsburgh region at the
start of the 19th century and Pittsburgh’s industrial growth was stimulated by important
transportation developments, such as the first steamboat in 1811, the canal system in 1834
and the first railroad in 1851.
7. Because of its access to large reserves of raw materials especially coal 2 , Pittsburgh
emerged as a major industrial centre called the “Steel City” in the late 19th century. The
establishment of the Carnegie Steel Company in 1889 consolidated the city’s leadership
position in the US steel industry. By the 1920s, Pittsburgh produced one-third of the
American output of finished and rolled steel. The city as well had the world’s larges tube and
pipe mill, structural steel plant, rail mill, wire manufacturing plant, bridge plant, and
construction fabricating plant. At that time, its major industrial sectors included
transportation equipment; metal, wood, plastics, paper and glass products; printing and
publishing; oil refining, textiles; chemicals; and household appliances. In the past, in
addition to many large steel companies, Pittsburgh was as well the headquarters for
Westinghouse and Heinz.
8. Restructuring and Transformation Over the Past 40 Years: The fortunes of the
Pittsburgh economy after WWII were closely tied to the global competitiveness of the
American steel industry. With rising imports from lower cost offshore suppliers including
many developing countries, the increasing cost of US labour, the failure of the steel industry
to modernize Pittsburgh’s steel making processes because of the high costs of these
investments, and greater use of alternative materials such as plastic, fiberglass, and
aluminum instead of steel, the US steel industry lost its leadership position 3 and the
economic base of Pittsburgh underwent a dramatic transformation starting in the late 1960s,
from heavy industry manufacturing to higher technology manufacturing, service industries
and commercial enterprises.
9. Pittsburgh’s economic transformation began in the 1970s, but the transformation was far
from easy. Between 1978 and 1983, 100,000 steel and related jobs in Pittsburgh
disappeared. By the mid-1990s, Pittsburgh, which had been the world’s greatest steel
producer, had been reduced to a single integrated steel mill, one specialty steel plant, and
one strip mill. It is reported that over the 1978-1983 period industrial employment in
Pittsburgh decreased by 44%. Unemployment during the 1978 to 1983 period averaged
about 10% and reached a peak of 14.7% in January 1983. With the declines in industrial
employment, Pittsburgh’s population also decreased as residents left the city in search of
work in other communities.
10. At this point in time, the Pittsburgh economy began to be transformed towards an
2
Forty percent of American produced coal came from within 100 miles of Pittsburgh.
3
In 1900, the United States produced 37% of the world’s steel, but Asia now accounts for 40% of global steel
production, China produces more steel than any other country, and steel imports into the United States have
risen sharply in recent years.
4
Pittsburgh is the hub for US Airways but this airline just recently emerged from bankruptcy and thus some
uncertainty remains regarding its medium to longer-term prospects and the jobs provided by the airline in the
Pittsburgh area. At the very least, the number of jobs provided by the airline in Pittsburgh will likely be reduced
considerably.
5
See Richard Florida, Competing in the Age of Talent: Environment, Amenities and the New Economy,
January 2000.
6
For example, the current urban development promotional program of Pittsburgh is called “Three Rivers: One
Future”. This program is focused on improving the Pittsburgh region’s business climate, which means
marketing the region, and making policy recommendations to improve Pittsburgh’s tax competitiveness and its
sewer and water infrastructure. A news report from the Pittsburgh Tribune Review dated February 23, 2003
sated that achieving the campaign’s goal of 50,000 new jobs over a three-year period will require significant
investment from the private sector, since the fiscal resources of the state, county and local governments are very
limited. Other news reports indicated that in particular the City of Pittsburgh is facing a budget crisis. This is
consistent with the view expressed in the text that restructuring of the Pittsburgh economy was essentially
market driven and based on private investment.
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economy based on information technology and other more advanced technologies.

Economic growth accelerated in particular in the 1990s. Businesses in communications, the
Internet, software development, and robotics began to appear, and more recently
biotechnology companies were established.
11. Downtown redevelopment played a major role in this transformation. The downtown
area is called the Golden Triangle, which includes the Gateway centre, a landscaped hub of
office and hotel space. Another contributor to the transition to higher value manufacturing
and service industries was the city’s many universities, including the University of Pittsburgh,
the Carnegie-Mellon U., Chatham College, and Carlow College. In particular, the University
of Pittsburgh’s biomedical research department and the Carnegie Mellon University’s
Engineering and Robotic Institutes made significant contributions to the city’s shift from
heavy industry to information technology.
12. While the number of jobs in these high technology industries is less than the number
employed in the distant past by the steel industry, information and other advanced
technologies provide a sounder foundation for expansion and growth in the future, and pay
much higher wages than traditional jobs in heavy industry and services. The Pittsburgh
economy is as well more diversified, which in turn provides greater economic stability
compared to the city’s heavy industry era.
13. Pittsburgh as well has an excellent symphony orchestra as well as art libraries, galleries,
and natural history museums. In the recent past, Pittsburgh was the headquarters for some
of the largest American corporations including U.S. Steel, Gulf Oil, Westinghouse Electric,
Rockwell International, Alcoa, National Steel, PPG Industries, and H.J. Heinz. Within the
United States, Pittsburgh placed third to New York and Chicago in terms of the number of
corporate headquarters. However, in recent years, some of these companies such as
Westinghouse and Heinz have been acquired by or merged with other companies that have
their headquarters in other cities and at times in other countries.
14. Another contributor to economic restructuring was the attraction of national and
international companies that have their headquarters in other parts of the US and in other
countries. It is estimated that as of April 2003, there were 324 business operations in the
Pittsburgh area that are owned by companies that are based in other countries. By country,
there are 88 German companies, followed by the UK with 63 companies, Canada 37, Japan
33, and France with 23 companies. Compared with locally owned companies, the Pittsburgh
operations of foreign companies are much larger in terms of employment and pay higher
wages.
15. Current Structure of the Pittsburgh Economy: In US census and other data, the
Pittsburgh Metropolitan Statistical Area (MSA) is defined to include the six counties of
Allegheny, Beaver, Butler, Fayette, Washington and Westmoreland. The population of the
metropolitan area in 2002 was 2.4 million, of which over one half or 1.3 million live in
Allegheny County where the city of Pittsburgh is located. In 2001, total employment in the
MSA was 1.04 million, and employment in the MSA expanded at the annual average rate of
1.0% per year compared with 1.9% per annum for the total American economy.
16. Despite the major transformation described above, Pittsburgh remains one of the slower
growing cities in the United States, and the unemployment rate of the Pittsburgh MSA is
typically above the national average by about one percentage point. In January 2003, the
Pittsburgh MSA unemployment rate was 6.8% while the national rate in the same period was
5.8%. Unemployment rates tend to be higher in the outlying counties than in Allegheny
County where the city of Pittsburgh is located. As well, it is reported that Pittsburgh has one
of the highest net corporate income tax rates in the country.
17. Based on the Census 2000 data, the largest sectors in terms of employment in the
Pittsburgh MSA were educational, health and social services which accounted for 22.8% of
employment, followed by retail trade at 12.6%, manufacturing 12.3%, professional, scientific,
management, administrative and waste management services at 9.3% and arts,
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entertainment, recreation, accommodation, and food services at 8.1 %. The following graph
indicates the more detailed employment breakdown for the Pittsburgh MSA for 2001. As the
summary data illustrated, most of the major sectors in terms of employment are in services.
The most important manufacturing industries are metal manufacturing (ranked 4th), plastics
(9th), and processed food (11th). (PLACE CHART HERE)
18. The four largest individual employers in the Pittsburgh MSA as of January 2002 were the
UPMC Health System (24,500 employees), the U.S. federal government (20,400), the
Commonwealth of Pennsylvania (15,900), and the US Airways Group (12,194)4, while the
remainder of the top ten were another health care provider, the U. of Pittsburgh, two financial
service firms, Allegheny County, and the USX Corporation, which is in the steel, oil and gas
industries and ranked tenth with 6,300 employees. This therefore was the only manufacturer
in the top ten employers in the Pittsburgh MSA.
19. Therefore, manufacturing, with employment of about 132,000 as of 2000, is now a

relatively small contributor to the economic and employment base of the Pittsburgh area,
suggesting that the city’s transition to a post-industrial economy is now more or les
completed.
20. As the MSA’s most important location for jobs, Allegheny County has a larger number of
employees in skilled positions such as management, sales and service, and fewer
employees in less skilled positions in transportation, construction, extraction, farming,
fishing, and forestry. Important generators of new jobs during the last half of the 1990s
included the hospitality industry, and the technology and biomedical industries.
21. In 2001, the mean annual per capita personal income for the Pittsburgh region was $US
33,000, and family incomes in the MSA at the time of the Census were slightly above the
national average. Pittsburgh in 2000 placed in the middle of the 25 largest metropolitan
areas in the United States in terms of per capita and family income. For example in that
year, the mean family income in the Pittsburgh MSA was $41,000 compared with about
$50,000 for the Philadelphia and Boston and $57,000 for New York.
22. Future Prospects: In the future, Pittsburgh hopes to continue to generate high
technology jobs in manufacturing and services, building on its strengths in medical research
and health facilities. Promotional efforts are focusing on biotechnology and information
technology industries. However, comparative analysis conducted by Richard Florida on the
Pittsburgh economy in January 2000 indicated that, compared to many competing cities,
Pittsburgh has some important weaknesses in attracting and retaining new economy
investors, companies and jobs5. These include its small population base, slow population
growth, small immigrant population, lagging labour force growth, limited entrepreneurial
capacity, limited cultural and ethnic diversity, urban sprawl, and limited lifestyle and
recreational amenities.
23. In many of the key indicators on amenities and environmental quality, Pittsburgh placed
closer to the traditional American industrial regions such as Baltimore, Cleveland and
Detroit, and placed well behind leading high technology regions such as Austin Texas,
Seattle Washington and Denver Colorado. Areas of relative strength include overall
environmental quality, arts and culture, professional sports, computer use in schools,
innovation capacity, degrees granted in science and engineering, academic R&D, and the
number of high-tech jobs now in the Pittsburgh area.
24. When these indicators were combined together, Pittsburgh ranked 31st out of the 35
cities used for this benchmark analysis. The study concluded that the greater Pittsburgh
region should give priority to improving its outdoor, recreational and lifestyle amenities that
are important to the new economy, in its ongoing strategy to attract knowledge workers and
build a high technology economy.
25. Possible Implications and Lessons for Hebei Cities: Transformation to a post-
industrial economy can take a long time, and does not guarantee high and sustained
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economic growth. While the Pittsburgh economy has expanded quite significantly in recent
years, its growth performance and standard of living are below the levels of many other
major urban centres in the United States. More sluggish growth in Pittsburgh is explained in
part by its traditional image as a blue-collar area based on heavy industry. People and
companies do not think of Pittsburgh as a high technology city. Changing a city’s image
takes time and considerable effort.
26. It is also important that Pittsburgh is on the periphery of the northeastern urban region.
Like all parts of the old industrial heartland of the United States in the Northeast and Midwest
states (as well as the Province of Quebec in Canada), Pittsburgh’s growth performance and
prospects have been negatively affected by the spatial movement of the American economy
towards the south, southwest and western regions of the United States.
27. The available information appears to suggest that Pittsburgh used its locational and
related advantages to help to restructure its economy, and to place the city on a more
sustainable growth path. For Pittsburgh, its strategic locational advantage was its location in
the State (Commonwealth) of Pennsylvania and on the periphery of the northeastern urban
region from Boston through New York to Baltimore-Washington. Economic links to Detroit,
Cleveland, Columbus Ohio, and other Midwest cities are also likely important – since these
cities are in fact closer to Pittsburgh than Philadelphia is. However, over the past 30 years,
a number of these Midwest cities were undergoing the same structural adjustments and
consequent slower growth as Pittsburgh.
28. Turning to Hebei Province, for Tangshan, its locational advantages could be its location
close to the two independent municipalities of Beijing and Tianjin, its leading role in the
northern Hebei economy and at least potentially its proximity to the quite highly developed
urban corridor in Liaoning from Dalian to Shenyang. For Handan in southern Hebei, its
locational advantages could be associated at least potentially with its proximity to and
crossroads location with southern Shanxi, northern Henan and the growing urban region
centered on Zhengzhou, and the rapidly expanding Shandong economy.
29. The information reviewed for this case study suggests that government played more of a
guidance, promotional 6 and information role, rather than a proactive role, in the
transformation of the Pittsburgh Economy. The evidence for this is provided by the current
structure of the Pittsburgh economy described above which includes large institutional
employers and many much smaller employers in manufacturing and services. There is no
indication that the City used subsidies and other financial incentives to attract a major
industrial or service sector employer. As well, the Pittsburgh area’s local governments
appear to have a limited fiscal capacity. Finally, the neo-liberalism ethic dominated
American governments during the 30-year transformation period for the Pittsburgh economy.
This ethic calls for less rather than more government intervention in the economy.
30. It appears therefore that restructuring was the result not of government financial
incentives used to attract one or two large industrial employers to replace the steel
companies, but rather was the consequence of the location and investment decisions made
by a large number of smaller companies, entrepreneurs and investors who decided that
Pittsburgh was a good place in which to locate, invest and expand.
31. The recent analysis conducted in Pittsburgh in evaluating in an objective and

comparative manner its strengths and weaknesses for attracting knowledge workers and
expanding its high technology industry represents good international practice since the
research provides a local government and enterprise sector with useful benchmark and
comparative data to guide the preparation and implementation of longer term economic
development strategies.
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C2: Case of Ireland, Portugal and Canada
Industrial Restructuring
in Peripheral Regions to Major Markets
Chreod Ltd.
Case Study C2: Ireland, Portugal and Canada 19 January 2004
The Challenge of Industrial Restructuring in

Peripheral Regions to Major Markets
The Cases of Ireland, Portugal and Canada
1. Introduction: Hebei could perhaps learn a great deal from the industrial restructuring
efforts of other countries and regions that are located on the peripheries of major markets,
that are less advanced in the development process than these major markets, and that have
faced and/or are facing restructuring challenges in large part because of the reduction in
trade barriers between the country or region and the major market. For Hebei, the province
is on the periphery of the more advanced East Asian market, which includes Japan, South
Korea, and the province of Taiwan, and the most highly developed regional market in China
largely to the south and east of Hebei. This eastern and coastal market in the PRC
encompasses Beijing, Tianjin and Shandong (three provinces that share borders with Hebei)
but is dominated by the Yangtze Delta (Shanghai, Jiangsu, and Zhejiang), Fujian and the
province of Guangdong centered on the Pearl River Delta1.
2. The reduction in trade barriers, the improvement in market access, and increased
competition in traditional markets now being encountered by Hebei manufacturers and
service providers result from the reductions in international trade barriers through the PRC’s
WTO accession and the reductions in inter-provincial and inter-city trade barriers that should
result either directly or indirectly from China’s WTO accession and from related domestic
economic reforms. In both cases, Hebei’s manufacturers will be facing heightened
competition in the provincial market from often more advanced suppliers in more highly
developed PRC coastal provinces and in highly developed East Asian countries. Hebei
enterprises as well will benefit (potentially and hopefully) from improved market access to
these much more prosperous PRC and East Asian markets.
3. Chreod has selected three countries that in the past 20 years appeared to face similar
1
This eastern and coastal market in the PRC currently dominates the Chinese economy and in many respects
now has characteristics that have more in common with other East Asian countries than with the middle and
western PRC provinces.
In 2001, the eight provinces and independent municipalities that comprise this eastern and southern market
along the PRC coast accounted for 30% of the PRC population, 42% of the country’s urban population (based
on the Chreod method), 46% of household bank deposits (a proxy for personal savings), 47% of gross
investment, 47% of national GDP and gross investment in fixed assets, 50% of tertiary GDP, 55% of PRC retail
sales, 62% of industrial output, 63% of the patents granted, 78% of actual direct foreign investment, and 85% of
national exports and imports. In 2001, GDP/capita in this region was 58% above the national average – which
in terms of 2001 purchasing power parity provided GDP/capita of nearly $6,800 in this coastal region. Splitting
the population between urban and rural residents, the per capita annual income of rural residents in the eight
provinces is 52% above the national figure, and for urban residents the eight provinces are 36% above the
national average. In virtually every other indicator of development, prosperity, and productivity, the eight
coastal provinces aggregated together are at least 50% above the national average therefore more than double
the corresponding figures for the other PRC provinces aggregated together when per capita indicators are
employed. The strength of this eastern region in foreign and domestic investment, innovation, and human
capital suggests that its dominant position within the PRC economy will be even greater in the years ahead.
Hebei is geographically on the periphery of this dominant PRC region (and typically is included with the other
more advanced eastern provinces in the three-part regional breakdowns used in the PRC). However, in terms of
industrial and urban structure, productivity, prosperity, market opening and participation in international trade
and investment, and its stage in the development process, Hebei is closer to the middle region provinces to the
south and west (such as Henan, Hubei, Hunan and Anhui) than to the eastern and southern coastal provinces that
now dominate the PRC economy in virtually all indicators, and in many cases is not too far above the western
provinces.
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challenges in relation to:
operating on the periphery of a more advanced market,
market opening,
closing developmental gaps with a larger and more prosperous market, and
structural adjustment from agriculture and other primary commodities, resource-
2
All of the national data for 2002 are taken from Table I (Size of the Economy) of the World Bank’s World
Development Report 2004: Making Services Work for Poor People, The World Bank, 2003, pages 252-253.
Hebei estimates are based on applying its 2001 share of PRC GDP (which was 5.22%) to the China figures in
Table I of the World Bank Report.
3
See Pierre Fortin, The Irish Economic Boom: Facts, Causes and Lessons, Industry Canada Research
Publications Program, Discussion Paper Number 12, May 2002.
4
See for example Paul P. Tallon and Kenneth L. Kraemer, “The Impact of Technology on Ireland’s Economic
Growth and Development: Lessons for Developing Countries”, Center for Research on Information Technology
and Organization, Graduate School of Management, University of California, Irvine CA, 1999.
5
This essentially means invitation to foreign investors and companies to participate in the Irish economic
success story.
6
In this literature, IT capital is defined to include the nation’s stock of computer hardware, software, and data
communications and services.
7
See Manuel Mara and Ricardo Pays, Critical Factors in the Catching Up of European LFRs: Evidence from the
Portuguese Case, 2000.
8
See: Frank Barry, Nuno Crespo, and M. Paula Fontoura, EU Enlargement and the Portuguese Economy, 2002
(Available on the Internet), page 3.
9
In 2002, primary products, oil and gas and resource-based manufactured goods accounted for 44% of Canadian
merchandise exports, while automotive contributed 22% and other non-resource based manufactured goods
contributed 33%. The ratios in 1992 were 49% for primary products, oil and gas and resource-based
manufactured goods, 24% for automotive, and 27% for other non-resource based manufactured goods
contributed. Therefore, despite high levels of development and prosperity, the structure of Canadian exports has
more in common with many developing countries than other industrialized countries.
10
The growth rate of 12.2% per annum which is based on current Canadian dollars is exaggerated by two factors
– domestic inflation which was quite low, typically between one and two percent per year, for nearly all of the
1990s, and the devaluation of the Canadian dollar particularly in relation to the US dollar Canada’s major
trading partner. Having said that, the World Bank in its World Development Report 2000/2001 indicated that
Canadian exports increased at an annual average rate of 8.8% from 1990 to 1999, which is still quite an
impressive growth performance given that the World Bank figures would be in US dollars. Chreod estimates
that for the full ten-year period to 2000 Canadian exports recorded annual average growth of 8.2% per year
based on US dollar figures. Regardless of the measure used, Canada’s export growth was impressive during the
1990s particularly when compared with growth in Canadian GDP which based on World Bank data averaged in
real terms 2.9% per year from 1990 to 2000.
11
This analysis is based to an important degree on the March 2000 Report of the Industry Sector, Manufacturing
and Processing Technologies Branch: “Performance of Canada’s Manufacturing Sector; Summary Report”. By
definition, the more mature industries exclude those industries and products that are termed high technology in
Canadian and OECD documents. The OECD definition of high-technology industries (called the sectoral
approach) encompasses aircraft and parts, computers, office, store and business machinery, communications and
pharmaceuticals. These high-technology industries when combined together account in Canada for about 10%
of manufacturing employment, manufacturing GDP, and manufacturing value added, about 10% of total
Canadian merchandise exports, and over 70% of total R&D expenditures in manufacturing. This sectoral
approach to assessing high technology has its merits, but it must be recognized as well that every industry
contains some “high technology” companies and product lines and that to be competitive all industries and
companies need to become “high-tech”. In addition, as noted below, it is possible that industries like industrial
machinery that are “high-technology” under the OECD definition and in other countries are “medium-
technology” within Canada in terms of productivity, innovation, and R&D intensity.
12
As noted in an earlier footnote, industrial machinery is typically considered to be a high technology industry
but in Canada it appears to operate more as a medium technology performer.
13
The first paragraphs in this sub-section are largely derived from two existing documents: “The Role of
Services in the Knowledge-Based Economy: A Conceptual Framework”, prepared by Dennis DeMelto (Industry
Canada, October 2000); and “ ‘Canada a Smart Country’ The Role of Services”, Presentation to DMDB,
February 12, 2001.
14
See for example: Roger Martin and Michael Porter, Canadian Competitiveness: A Decade After the
Crossroads, 2001.
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based manufacturing and heavy industry to a more diversified higher value added
economy.
4. These three countries are Ireland and Portugal (in relation to the much larger and more
highly developed European Union market) and Canada (in relation to the much larger and
more productive, innovative and prosperous American economy).
5. It can be argued that while Ireland and Portugal have some things in common with
Hebei, these countries are much smaller than Hebei Province. In terms of population size,
this is certainly correct. In 2002, the population of Hebei was estimated by Chreod to be
about 68 million compared to four million for Ireland and 10 million for Portugal.
6. However, the sizes of the three economies are more comparable when we compare
levels of output. Based on actual exchange rates, GDP in Hebei in 2002 was about $63
billion (5.2% of the PRC total) whereas the Ireland figure was $93 billion and the Portugal
figure was $109 billion. Using purchasing power parity changes these relationships to some
degree but broad comparability across the three economies remains. In terms of 2002 PPP,
the Hebei GDP in 2002 was $294 billion compared with $109 billion for Ireland and $ 174
billion for Portugal.
7. Canada’s output of course is much higher that Hebei’ production. The corresponding
figures for Canada are 2002 population of 31 million, GDP of $701 billion in terms of actual
exchange rates and GDP of $ 882 billion in terms of 2002 PPP2.
8. The following three sections will discuss industrial restructuring over the past 20 years in
each of the three countries. The final section will discuss the possible implications for Hebei.
9. Ireland: The emergence of Ireland as the Celtic Tiger on the fringe of Europe may
provide some useful insights and models for Hebei in the PRC – which arguably is on the
fringe of the more dynamic parts of the East Asian economy including the coastal PRC,
Japan, South Korea and Taiwan.
10. Ireland has been one of the more remarkable success stories of the industrialized
economies for well over a decade. From 1990 to 2002, the GDP growth rate of Ireland
averaged 7.3% per annum compared with less than three percent per annum for the total
global economy and the industrialized countries combined together. Over the eleven-year
period from 1989 to 2000, real GDP per capita in Ireland nearly doubled. Therefore, per
capita income between Ireland and the larger and more important EU members converged
considerably over this period.
11. To provide only a few comparisons, in 1992, Ireland’s GNP per capita based on actual
exchange rates was 69% of the UK figure, 55% of the French figure, and 53% of the
German figure. The corresponding ratios for 2002 were 95% for the UK, 105% for Germany,
and 108% for France. In short, Ireland passed two of these countries and is within 5% of per
capita GNP in the UK. The studies reviewed for this case indicated that better than one-half
of Ireland’s growth rate is accounted for by gains in productivity, while the rest is the result of
gains in employment. As a consequence, Ireland’s unemployment rate fell markedly from
nearly 16% in 1993 to 9% just four years later.)
12. Strong growth and higher living standards in Ireland are the result of long-term
improvements in productivity that began more than 25 years ago and more recently since
1994 strong growth in employment in the Ireland economy3. Over the period from 1976 to
2000, the growth in labour productivity in Ireland averaged 3.3% per annum. Over this 25-
year period, only South Korea among the OECD member countries achieved faster
productivity growth than Ireland.
13. Worker productivity in Ireland is now above the Canadian average and is approaching
the US figure. Worker productivity based on GDP per employee in Ireland was 93% of the
US figure in 2000, but when worker productivity was based on GDP per hours worked, the
Irish figure rises to 103% of the US average. The comparable Canada/US ratios are 83% for
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output per worker and 92% for output per hour worked.
14. High productivity growth is strongly associated with major structural change in the Irish
economy. The economy of Ireland has gone through a dramatic transformation in the past
50 years from a small largely agricultural economy on the fringe of Europe to a modern
highly industrialized trade-dependent economy that has enjoyed the most robust growth of
any European country over the past decade. When Ireland became independent from the
United Kingdom in 1922, the country had virtually no industry and more than 50% of the
work force was in agriculture. Agriculture’s share of the Ireland work force is now less that
10%.
15. The major factor in this transformation was the decision to join the European Union in
1973, but other factors as well made important contributions. These other factors included:
strong macroeconomic policies designed to control inflation, reduce government

spending, and lower interest rates (in recent years, inflation rates in Ireland have
been in the 2-3% range),
strong microeconomic policies that provided a good investment climate, established

the transparency and certainty offered by the rule of law, protected property rights,
ensured moderate growth in wages, and promoted competition in the domestic
market,
educations policies that provided free secondary education, encouraged low-cost

post-secondary education and promoted post-graduation training programs to
increase worker skills and human capital,
preferential tax policies that were strongly supportive of business investment,
very successful programs for attracting higher quality foreign direct investment,
promoting strong export growth (Ireland’s exports expanded at the annual average
rate of 14.5% per year from 1993 to 2002), and in recent years encouraged the
development of a quite strong information and communications technology sector
(further discussed below).
16. Many of these factors and favorable policies to investment and growth have been in
place for several decades. These factors and in particular the long–term upward trend in
productivity have combined together to greatly improve the international cost
competitiveness of the Irish economy over the past 15 years.
17. One lesson from Ireland’s strong productivity and competitiveness performance is that
government policy should not focus solely on productivity and innovation in specific sectors
(the picking winners approach). Rather, policy should give priority to more general
economy-wide policies, namely trade, industrial, investment, tax, and education policies, that
provide a strong policy framework and investment climate for all sectors -- and then allow
market forces and corporate decisions to do the rest. As described below, these policies,
which have been in place for an extended period, have established a very attractive
environment for highly productive multinational corporations to locate and grow in Ireland,
and have also supported strong economy-wide advances in Irish productivity for many
decades.
18. Ireland’s success therefore was the combined result of macroeconomic stability, skills
development, structural adjustment, product upgrading, and strong outward orientation in
terms of trade and investment based on policies of free trade and foreign investment
attraction. Investment attraction policies since the 1960s focused on attracting overseas
investment through a system of financial and tax-based incentives. These included non-
repayable grants to cover the costs of land and buildings, and export promotion through
declaring profits from export sales exempt from corporation taxation. (It is questionable
whether these policies today would be consistent with the current WTO obligations of
Ireland, China and other countries. In recent years, Ireland had to modify these policies to
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be consistent with EU rules that in many cases are based on WTO rules).
19. Investment aid from the EU under the Common Support Framework and the Common
Agricultural Policy also played some role in Ireland’s strong growth performance. Total net
transfers from the EU under these two programs were between 5 and 7% of Ireland’s GDP
from 1986 to 1995. However, the impact of these EU transfers should not be exaggerated.
The literature suggests that the other factors noted above had a much greater affect on
Ireland’s long-term growth performance and structural adjustment towards a highly
advanced economy.
20. As of 2001, exports accounted for 95% of the country’s GDP, 48% of its export sales
were considered to be of high technology products, and only 9% of exports were primary
products. Major export markets were the EU at 63% -- with the UK accounting for 20%,
Germany for 11%, France for 8%, the Netherlands for 6%, and Belgium for 5% -- and the
United States which accounted for 17% of Irelands total export sales. Therefore, while
Ireland is quite highly dependent on the EU market, the country’s exports are fairly
diversified within that market – and strong sales to the highly competitive US market further
illustrates its significant economic progress over the past decade and a half.
21. Further highlighting its dramatic transformation, agriculture which once dominated
Ireland’s output and exports now account for only 4% of GDP, while manufacturing now
contributes 36% and services the remaining 50% of GDP. In addition to computer software
and other goods and services in information and communications technologies, other major
industries include food products, brewing, textiles, clothing, chemicals, pharmaceuticals,
machinery, transportation equipment, glass and crystal. It is reported that foreign firms
generate over one-half of Ireland’s exports. In 2002, the unemployment rate in Ireland
averaged 4.7% of the labour force.
22. Much of the literature on Ireland’s success story has focused on the emergence of its
information technology (IT) sector4. The study cited below concluded that Ireland succeeded
in creating a world-class industry in computer hardware, software and services through what
the authors call “industrialization by invitation5” – despite having a generally weak indigenous
IT sector. In looking at the Ireland experience, the two authors stated that the country’s IT
success was not based on market forces alone. It was the consequence as well of
sustained policy interventions by the Ireland government since the 1970s to selectively
target foreign investment in high-technology growth industries, first in computer production
but subsequently expanding to include software and services.
23. There are questions however regarding whether the country’s continuing focus on IT
production can ensure sustainable economic growth over the longer term. There are also
questions regarding whether IT investments 6 can contribute to stronger industrial and
economic growth in both developed and developing countries. Econometric research
reviewed by both authors provided evidence of positive and significant returns to IT capital in
developed but not in developing countries. In developing countries, returns were much
higher from investments in non-IT capital defined to include investments in plant, machinery
and equipment. The authors concluded that developing countries needed complementary
investments particularly in telecommunications and education, as well as supportive
government policies, in order to achieve high returns from IT investments.
24. Ireland first began targeting multinational corporations in the high growth computer and
electronics industries in the 1970s. This involved policy makers identifying specific overseas
firms with access to emerging technologies and world-class manufacturing practices. The
Irish operations established by the MNCs in the 1970s were almost exclusively sub-
assembly operations. As well, many of foreign enterprises that located in Ireland at that time
left the country once their grant allocation had expired and because Ireland lacked a strong
indigenous IT sector.
25. Computer hardware producers dominated the first phase of IT investment up to 1985 but
after that overseas investment in software and services became more important, culminating
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in the decision by Intel to select Ireland as the site for its European manufacturing center in
1990. Intel stated that the selection of Ireland was because the country was a member of
the European Union (secure access to a large continental market was critical), the quality of
Ireland’s physical infrastructure, the overall balance of costs, the financial incentives
provided by the Government of Ireland, and the quality and number of highly qualified
personnel graduating from Ireland’s educational system.
26. As a consequence of these MNC investments, as of the end of the 1990s, the Ireland
operations of these MNCs accounted for over one-third of all PCs sold in Europe, and
Ireland became the eighth largest exporter of computer equipment in the world ahead of
many Asian newly industrializing economies. Ireland as well in the late 1990s was the fifth
largest producer in the world of computer software, and was the second largest exporter of
packaged software in the world after the United States.
27. By the end of 1997, the Irish software sector was comprised of 679 firms, employing
about 18,000 people. In 1995, the employment of hardware producers was 14,000.
Foreign-owned companies account for most computer software revenues, and these
companies export most of their output. Expanding exports are also contributing to the
growth of indigenous software firms. Compared to the mass markets in business software
that are stressed by the foreign owned software firms, Ireland’s indigenous software firms
are instead giving priority to niche markets. Exports also account for most revenues of
computer hardware producers.
28. In 1995, hardware and software exports accounted for one-fifth of Ireland’s total exports.
Despite recent growth in the indigenous IT sector, overseas firms in 1995 still dominated
Ireland’s computer hardware industry, accounting for 97% of industry revenues and 86% of
employment. Compared to indigenous firms, overseas hardware firms have larger scale, are
more capital intensive, and have much higher productivity. Therefore, while Ireland has
been successful in attracting overseas investment, indigenous firms in IT and other
industries remain marginalized and underdeveloped – suggesting that the positive spillovers
from foreign owned to domestic firms have been less than expected and desired. One factor
is that despite the country’s success in IT production, corporate use of IT among Ireland’s
indigenous firms is still quite low.
29. Conventional wisdom in the past was that Ireland’s growth miracle was largely based on
low corporate and other taxes, low wages and low production costs. Whether or not low
wages were a major factor in the past, low wages appear less relevant to the continuing
success of the Ireland economy. Ireland is no longer a low wage and low-income country.
World Bank data based on PPP indicate that in 2002 GDP/capita in Ireland of $ US 28,040
was higher than the figures for the United Kingdom, Germany, France, the Netherlands,
Sweden, Austria, Japan, and Australia, were just about even with the Canadian PPP figure,
and was about 20% below the U.S. GDP/capita standard. This points out that convergence
can take place in a matter of a few decades when the right policy framework and incentives
are in place. Moreover, with income and wage convergence, competition based on low
wages and other costs is no longer viable and a country or region must find new sources of
competitive advantage – in particular innovation, productivity and technological change.
30. Accordingly, as indicated in recent research on the Ireland success story, productivity
growth, innovation and technological change made significant contributions to Ireland’s high
GDP growth rate of 7.3% per year from 1990 to 2002. For example, one recent article
written by Paul P. Tallon and Kenneth L. Kraemer in 1999 titled “Impact of Technology on
Ireland’s Growth and Development: Lessons for Developing Countries”, argues that, despite
a weak indigenous IT sector and low corporate use of IT among indigenous companies,
Ireland has successfully created a world-class industry in computer hardware, software and
services, through as noted above policies that encouraged multinational corporations to
invest in Ireland. These industrial and investment policies were supported by a range of
financial and tax-based incentives and an education policy that was directed towards the
creation of a multi-lingual work force with technical expertise in occupational areas that
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would be important to MNCs.
31. The authors concluded that while IT production can generate significant economic
benefits, such benefits when based on cost-competitiveness are not sustainable and must
be complemented over time by greater IT use and production close to use – which in many
respects is consistent with the cluster approach being explored under the Hebei
Development Strategy.
32. The literature reviewed for this case indicated that Ireland is no longer trying to attract
simple manufacturing assembly operations. Instead, investment attraction and business
development are focused on more advanced products and processes. One example is that
Digital Compact now has 2,000 people working in Galway, but none of these people are
working in assembling and manufacturing. All of them are in software, customer service,
and value-added services. As well, Ericsson has changed their operations from assembling
circuit boards to the work done by 2,000 computer software engineers.
33. Future investment attraction will focus on the country’s strategic location with strong
education, skills and research capabilities in a cost-competitive environment, with highly
integrated infrastructure and a growing financial services sector based in Dublin. Tourism
development will also play a prominent role. Tourism visitations have doubled in the last
decade.
34. To review, despite the success of IT in Ireland, there are as well major lessons for
developing countries from the Ireland experience with IT and other higher technology
industries. First, reliance on overseas investment and MNCs has made Ireland vulnerable to
shifts in global demand for IT. Similar conclusions have been made regarding Singapore
and Taiwan. Second, there is the danger that MNCs attracted by generous financial
incentives will leave when market conditions change and the incentives are no longer having
an impact on corporate profits. Third, high IT production does not automatically lead to high
IT use among local firms and governments in a specific country. Complementary policies
are needed to promote greater internal growth through greater indigenous use of information
technology.
35. Fourth, despite these reservations, the Ireland experience indicates that overseas
investments in IT and other high technology industry can provide job creation in the short
term and in the long-term can help in the development of key technical and managerial
expertise that leads to the establishment of indigenous firms in niche areas, and can build
capabilities which result in indigenous firms that supply MNCs.
36. Finally, the Ireland experience indicates the need for development and investment
attraction strategies to evolve through time as labour and other costs rise and capabilities
expand. Because many developing countries can now compete with Ireland in cost-based
advantages, current strategies are moving beyond pure factor-based approaches to
encourage MNCs to establish multi-functional operations in Ireland in order to achieve
differentiation through managerial and technical expertise in non-manufacturing areas. For
example, in recent years, companies like Apple and Microsoft have relocated some aspects
of their R&D, logistics and marketing functions to Ireland. This change in strategy has been
needed after only a few decades of development success. The greater the development
success, the greater the need for strategies to be flexible to changes in opportunities,
constraints and competitive advantage.
37. Portugal: Portugal is a second country on the periphery of Europe that has experienced
quite strong economic growth over the past decade and a half – after Portugal joined the
European Community (now Union) in 1986. From 1990 to 2002, the Portuguese economy
expanded at the annual average rate of 2.5%. This is well behind the Ireland economic
boom described above but compares favorably with many other EU economies including
Germany (with annual average growth in GDP of 1.4% per year over the same period),
France (at 1.7%), and Italy (at 1.5%). Portugal as well kept pace with growth in the UK
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economy, which also was at 2.5% per year from 1990 to 2002.
38. Therefore, per capita incomes in Portugal experienced some convergence with EU
norms. In 1992, using actual exchange rates, per capita income in Portugal was 32% of the
German figure but by 2002 this ratio had increased to 48%. Compared to France, Portugal
went from 33% of the French figure in 1992 to 49% in 2002. Compared to Italy, Portugal
went from 36% of the Italian figure in 1992 to 57% in 2002.
39. Over the longer term, in 1986 when Portugal joined the European Union, Portuguese per
capita income amounted to 55% of the EU average; in 2000, that ratio had increased to
75%. EU analysis indicates that another 20-30 years may be needed to achieve full
convergence with the EU average. As well, income disparities within Portugal increased a
little rather than decreasing from 1986 to 2000. Therefore, convergence towards the more
prosperous EU economies is also taking place in Portugal but at a much more leisurely pace
compared to Ireland, which achieved virtually complete convergence in a fifteen- to twenty
year period.
40. A recent paper analyzed in some detail the role of structural change in Portugal’s modest
convergence towards EU averages in prosperity and productivity7 since it joined the EU in
1986. The service sector played the major role in the dynamics of convergence. Higher
productivity in services may be the consequence of EU membership, where demonstration
effects from other EU members have led both firms and consumers to place greater
demands on service firms. These demands in turn stimulated higher productivity and
product quality from financial institutions, businesses services, and household and public
services. Inflows of EU aid may as well have expanded aggregate demand, which had
upward effects on tradable services and in tourism.
41. Within manufacturing, low technology industries contributed the most to productivity
improvements, as their share of manufacturing value added increased from 52% in 1984 to
61% in 1994. This suggests that improving product quality, productivity, innovation, and the
use of advanced technology in more traditional industries can be just as important as
attracting foreign and domestic investment into so-called higher technology industries. The
medium to high technology group experienced a decline in their contribution to
manufacturing value added – this particularly reflects a relative decline in the chemicals
industries from 20% to 10% of manufacturing value added from 1986 to 1996.
42. In contrast, the manufacturing sectors that showed stronger export performance were in
the medium to high technology group of industries. This likely is the result of foreign
investments into this group of industries that mainly focused on assembling and other more
labour intensive operations. Foreign investment after EU membership therefore resulted in
greater product specialization and concentration in the lower value added aspects of high
technology industry. As a consequence, productivity improvements in this group of
industries were minimal compared to more traditional industry and services.
43. The paper found as well that R&D and innovation in the business sector are
concentrated in manufacturing and in particular in the high technology group of industries.
Therefore, the number of R&D performing firms in Portugal is quite low. Innovation surveys
indicate that, for most Portuguese firms, R&D has not been used as a strategic instrument to
promoted international competitiveness. Rather, the major reason why firms implement
R&D projects is to acquire technical competencies and to introduce incremental
improvements in their products and processes.
44. The main sources of innovation for Portuguese firms are not internal R&D sources but
rather equipment suppliers and business partners. Therefore, R&D takes place more as a
response to market conditions and pressures and less as a strategic mechanism to gain
competitive advantage. The authors note that innovation surveys do not address such
factors as design, marketing and other competencies that could be important to enhanced
productivity and product quality among clothing, textile, footwear and other lower technology
manufacturers. Canadian innovation surveys have displayed similar results, and similar
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limitations to capturing innovation initiatives and impacts in more traditional manufacturing

industries.
45. A major conclusion is that at least up to the mid-1990s favorable productivity and income
trends in the Portuguese economy were not based on major structural changes but rather
through existing industries improving their productivity and product quality. This result
suggests that S&T and innovation policies should focus on not only structural change in
favor of higher technology industries but as well on improving productivity, product quality
and innovation in more traditional manufacturing industries as well as in service industries.
Government policies and programs should as well support business R&D programs by a
larger number of companies in all sectors of the economy. Programs in support of business
R&D should as well stimulate the development of strategic innovation directed towards
better serving demanding customers and market niches in the global economy.
46. Programs in addition should be directed towards more rapid development of e-business
and Internet communications more generally as well as towards the acquisition of
complementary business capabilities in management, marketing, design and logistics. The
promotion of these capabilities across all sectors, and in particular, low and medium
technology manufacturing that still accounts for 80% of manufacturing value added in
Portugal, is needed in order to bring productivity levels in these industries closer to the levels
now recorded in the more advanced industrialized economies. Canadian innovation
research has provided similar conclusions. These conclusions as well could be relevant to a
province like Hebei on the periphery of the much more advanced East Asian economies
along the PRC coast and in Japan, South Korea and Taiwan.
47. Since Portugal joined the EU, its export structure changed in favour of more capital and
technology intensive products. In particular, the export shares of the more labour intensive
traditional sectors (textiles, clothing and footwear) declined, while the shares of machinery,
equipment, vehicles and other transportation equipment, the industrial sectors that
experienced the greatest inflows of FDI in terms of foreign equity, increased from 1986 to
2000. It appears therefore that, given the slow growth and heightened competition in the EU
markets for more labour intensive products, sharp productivity improvements in these
Portuguese sectors were needed to allow Portugal to maintain its market share.
48. However, at the end of the 1990s, the traditional industries still accounted for a higher
share of exports in Portugal than was the EU average. The Portuguese share was 30%
whereas the EU average for these traditional sectors was only 6%. The most important
export sectors in Portuguese manufacturing in 2000 were: machinery and equipment (20%
of total exports), vehicles and other transport equipment (15%), clothing (12%), textiles (7%),
and footwear (6%) 8 . Portugal is now a very open economy, with exports and imports
accounting for 75% of the country’s GDP; 80% of Portugal’s export trade is with the EU,
while the EU accounts for 75% of the country’s imports.
49. Peripheral countries and region such as Portugal and Hebei can benefit greatly from
inward foreign direct investment (FDI). FDI has direct impacts on capital formation,
employment, tax generation and exports as well as indirect impacts or spillovers on the
accumulation of technology, knowledge, skills and other resources that represent the
intangible assets of multinational firms. The competitive pressures from FDI as well can
stimulate domestic firms to become more efficient, productive and competitive.
50. After Portugal joined the EU, FDI inflows increased greatly to reach nearly 5% of GDP in
1991. However, since then, divestment flows have increased and manufacturing has
received a declining share of FDI into Portugal. In recent years, most FDI into the country
has gone into the property sector and other services, and foreign investment into Portuguese
manufacturing on a net basis has been minimal. This could be related to EU enlargement,
which is explored in the following paragraphs.
51. Portugal as well as other countries on the periphery of Europe will be affected both
positively and negatively by the enlargement of Europe from 15 to 25 member states in 2004
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– including eight states in central and eastern Europe (the so-called CEEC8) that only 14
years ago were members of the Warsaw Bloc. These states are the Czech Republic,
Hungary, Poland, Slovenia, Estonia, Latvia, Lithuania, and Slovakia. Positive impacts for
Portugal will arise from an expanded EU market by about 100 million people, which will
benefit current Portuguese producers and as well could make Portugal a more attractive
location for some foreign investors.
52. The negative impacts from EU enlargement will result from increased competition from
the CEEC8 countries in both the Portuguese market and in third country EU markets such as
Germany, where in many cases producers in the CEEC8 have shorter distances to ship their
exports compared to Portuguese manufacturers. In many cases, wages in the CEEC8
countries are lower than Portuguese wages. Hebei will be facing many of the same positive
and negative impacts and challenges from the enlargement of its market. In particular,
Hebei manufacturers could be facing new competition from PRC and other Asian producers
in their traditional markets in Hebei and other PRC provinces. In the case of Hebei,
competing producers may have higher wage rates, but labour productivity is likely higher,
their work force in many cases is better trained, and the products of competitors could be of
higher quality.
53. In the case of Portugal, a recent study (footnoted earlier) reviewed some of the
challenges from EU enlargement to be faced by Portuguese companies. These include the
following. Exports from Portugal are quite similar to the exports from central and eastern
Europe in terms of product mix, and Portugal is already starting to lose market share to the
CEEC8 countries in EU markets in their traditional product and geographic markets. EU
market share data indicates that in the last half of the 1990s the CEEC countries were
becoming more competitive in the most important EU markets in these traditional export
sectors of Portugal.
54. At the same time, the Portuguese economy is becoming increasingly concentrated in low
technology and low value-added sectors where European demand is declining. Portugal has
comparative advantage in these lower technology sectors, but continuing concentration on
these sectors will not help to upgrade the country’s production and exports.
55. Moreover, Portugal’s capabilities in more technology intensive sectors may continue to
decline, as the CEEC is experiencing strong FDI inflows into these more dynamic sectors
that involve higher technology and more rapidly expanding EU demand. Portugal therefore
needs to respond through attracting more FDI and through reallocations of capital and labour
into the more dynamic industrial sectors. However, these sectors require more highly
educated and skilled employees, an indicator where Portugal ranks quite poorly compared to
most other European countries including some of the CEEC countries.
56. As well, labour costs in several CEEC countries are lower than in Portugal and some are
geographically closer to the more advanced markets particularly Germany, Austria and Italy.
Portugal as well has some deficiencies in their macroeconomic policies and in the efficiency
of the country’ government sector. Partially as a result, there is some evidence in recent
years of the diversion of FDI flows from Southern Europe including Portugal to the CEEC
countries.
57. Therefore, Portugal will need to respond to EU enlargement and globalization more
generally through improving their micro- and macro-economic policies, through improving
the efficiency of government and industry, and through upgrading their products, production
and work force. Hebei is likely to face similar challenges as the markets available to their
producers increase together with competition from producers in other parts of East Asia.
58. Canada: Canada began to industrialize and urbanize much later than the United States,
the UK and the major countries of continental Europe in particular Germany and France, and
despite significant progress during the 20th century remains well behind the United States in
many key indicators of industrialization, innovation, productivity and prosperity. Full
convergence with the US remains a long-term goal but in many indicators related to
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productivity and innovation Canada has been losing ground to the US over the past decade.
59. Canada historically was an exporter of primary commodities (e.g. wheat, iron ore, oil and
gas) and semi-finished goods (e.g. aluminum zinc, and copper ingot, pulp and paper,
synthetic rubber and other primary chemicals) and an importer of machinery and equipment,
consumer products and other finished goods. For example, Canada would and continues to
export iron ore, coal and timber to Japan and imports motor vehicles, consumer electronics
and other final products from Japanese manufacturers.
60. During the period from 1960 to 1985, Canada did increase its export sales of motor
vehicles and parts as a consequence of the auto pact with the United States, as well as it
exports of telecommunication equipment (mainly Nortel) and aerospace products and other
transportation products (largely from Bombardier). Export advances in motor vehicles,
aerospace and telecommunications to the present day are the result of strategic
partnerships between government and industry that involve strategic trade initiatives, and
major investments in basic research, innovation, and machinery and equipment by Canadian
governments.
61. Despite these advances and strategic investments in more advanced technology,
Canadian export sales remained dominated by resource based commodities and semi-
manufactured goods through the 1980s. Even up to the present day, resource based
exports remain very important to the Canadian economy9, and Canadian exports continue to
be dominated by a relatively few major companies in the automotive, telecommunications,
aerospace, and resource sectors.
62. By the mid-1980s, there was growing recognition among Canadian governments and
businesses that significant industrial restructuring and economic modernization was needed
to upgrade Canadian production and exports, and to reduce Canadian dependence on
resource based commodities and semi-manufactured goods. More specifically, industrial
restructuring in Canada over the past 15 years was in response to:
globalization and international economic integration,
significant reductions in Canadian trade barriers through the Canada-US Trade

Agreement (CUSTA), its replacement the North American Free Trade Agreement
(or NAFTA) which came into force in 1994, the Uruguay Round of the GATT (now
WTO), and other bilateral trade agreements signed over the last decade,
and to a lesser degree, the adoption of more market friendly neoliberal government
policies, privatization, regulatory reform, and the downsizing of federal and
provincial governments in order to reduce government deficits, balance government
budgets, and reduce government debt.
63. Compared to previous Canadian trade policy positions, Canadian negotiators in

multilateral trade negotiations over the past 15 years have adopted a less defensive posture
(that was designed in the past to protect Canadian “infant industries”) and have played a
more proactive role in improving access to foreign markets especially the US market, and
using lower trade barriers in Canada and other countries to increase the efficiency of
Canadian industry, encourage industrial restructuring and upgrading, and promote
competition in Canadian markets. It was hoped that greater competition in Canadian
markets and greater access to foreign markets would help to achieve higher productivity, job
creation and prosperity, greater industry and product specialization, greater economies of
scale and scope, and higher levels of product and process innovation in Canadian industry.
64. To date, the goals of Canadian governments have been realized to some degree.
Canadian export sales to the American market increased greatly over the past decade, and
Canada’s growth performance compares quite favorably with most other industrialized
economies except for the United States. From 1990 to 2002, Canada achieved an annual
average growth rate of 3.0 % per year, compared with 2.6% for the global economy and
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2.4% for the high-income industrialized economies combined together.
65. However, the major interest of Canadian policy makers was to achieve some
convergence with the United States in terms of economic growth performance, productivity,
innovation and prosperity. This goal was not achieved. During the same period, the US
economy expanded at the annual average rate of 3.3% and based on actual exchange rates
per capita income in Canada fell from 91% of the US figure in 1989 and 89% in 1992 to 64%
in 2002. Much of this decline in relative position is associated with the decline in value of the
Canadian dollar compared to the US dollar from between 75 and 80 cents in the late 1980s
to 63 to 65 cents in the early years of the 20th century. Since then, the Canadian dollar has
recovered to around the 75-cent level as of the first weeks of 2004. Therefore, in terms of
purchasing power parity, the differences between Canadian and US per capita incomes in
2002 was only 20 % not 36%.
66. Still, despite fairly strong growth in GDP through the 1990s, the conventional wisdom in
Canada is that the Canadian economy lost ground to the American economy in global
competitiveness, productivity, innovation, research and development, the commercialization
of R&D, and economic modernization and restructuring. For example, from 1980 to 1998,
labour productivity growth in the United States averaged 1.29 percent per year, compared to
average annual productivity growth of 1.03% for Canada. Canada as well ranks behind the
US and many other G-7 countries in many innovation indicators such as human capital
devoted to R&D, R&D intensity, external patent applications, the technology balance of
payments, and business and government funded expenditures on R&D.
67. Some economic analysts argue that comparatively poor performance on these indicators
was largely the result of the falling value of the Canadian dollar. This downward trend
allowed Canadian exporters to profitably expand their sales of goods and services in the US
market -- without improving their production processes, product quality, marketing, and their
structure of production towards higher value added products. Now that the Canadian dollar
has returned to what many consider as a more normal level (in the 75 to 80 cent range),
there is considerable concern regarding whether Canadian industry will be able to make the
required adjustments in productivity, efficiency, product quality, and product mix in order to
remain competitive in American and global markets.
68. Canadian industrial restructuring and competitiveness can be illustrated through changes
in Canada’s export performance. When measured in current Canadian dollars, Canada’s
exports expanded quite strongly through the 1990s10 and Canada’s positive trade balance
(exports minus imports) rose from $Can 10.5 billion in 1991 to $Can 55.5 billion in 2000.
69. Most of the strength in Canada’s export sector results from sales to the US market, in
response to Canada’s preferred position in the American market because of the CUSTA and
then NAFTA, the devaluation of the Canadian dollar compared to the American dollar, and
the strong and continuous growth in the US economy up to 2001. During the period from
1991 to 2000, Canada’s positive trade balance with the United States expanded from $Can
23.3 billion to $Can 129.7 billion, and the absolute increase in Canada’s exports to the
United States which amounted to nearly $Can. 250 billion accounted for 94% of the increase
in Canada’s export sales to all countries from 1991 to 2000.
70. While Canada’s positive trade balance with the United States expanded dramatically
during the 1990s, Canada has an increasingly negative trade balance with the rest of the
world. In the case of Asia and Oceania combined, Canada’s negative trade balance
increased from a fairly modest $Can 4.9 billion in 1991 to $29.6 billion in 2000 as in the latter
year imports exceeded imports by more than two to one. By country, Canada’s trade deficits
are particularly noteworthy with respect to China, Japan, South Korea, Taipei China, and
Malaysia. In fact Canada in 2000 showed a trade deficit with every major country market in
Asia. Canada’s trade deficits with other major regional markets also displayed major
increases during the 1990s, while in the case of the Middle East a surplus changed into a
deficit.
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71. These trade data would suggest that Canadian exporters benefited from Canadian dollar
devaluation only in the US market. In fact, the devaluation relative to other currencies was
much less compared with the loss in value in relation to the US dollar. In a few of these
other markets as well, slower growth in the import market compared to the Canadian and
North American economies also dampened Canadian exports to these markets and would
tend to increase the trade deficit. This is particularly true of the Japanese market through
the entire decade and of some of the Newly Industrializing Economies (the so-called Asian
Tigers) since 1996.
72. Over this nine-year period, the proportion of Canadian exports destined for the American
market rose from 75% in 1991 to about 87% from 1999 on. Not surprisingly, the proportion
of Canadian exports shipped to other major regional markets declined in every case. The
sharpest declines took place in Asian markets, where Canada’s exports registered an
absolute decline from 1996 through to 2000, apparently in response to the Asian economic
crisis and the continuing problems in the Japanese economy. Serious declines in share also
took place in Western Europe where it is assumed the completion of European economic
integration had a dampening effect on Canadian sales, and Other Europe where the
dislocations following the break-up of the Soviet Union had a major impact on Canadian
exports.
73. There are very few countries where Canadian export growth approached the growth rate
of 14.1% experienced by Canada’s sales to the U.S. market. Other countries where
Canadian exports expanded by more than 10% per year included Mexico (in response to
NAFTA), Viet Nam, Sri Lanka, Turkey, Chile (with whom Canada recently signed a Free
Trade Agreement), Argentina (where the recent economic meltdown is likely reversing the
1990s growth trend for Canada exports), and Cuba. For many of these countries,
impressive Canadian gains started from a low base and Canada’s share of the total import
market is still quite small.
74. What is perhaps most remarkable is that, except for the US market where Canada’s
import market share was about 19% over the past decade, Canada’s share of the total
import purchases of most other major trading nations is very small, typically below 2%. This
is true of both larger and smaller Asian markets, where Canada’s market share ranges from
modest highs of 1.7% in China, 1.6% in Japan, 1.4% in Indonesia, and 1.1% in Australia, to
market shares of 1.0% or less in all other countries including 0.7% in India, 0.7% in the
Philippines, 0.4% in Thailand, and 0.3% in Malaysia.
75. To place these numbers in perspective, Canada in 2000 accounted for 1.9% of global
Gross National Income based on PPP (Canada placed 12th in this indicator in the World
Bank’s tables), and in the same year Canada accounted for 3.8% of the world’s exports.
Canada’s large share of the world’s export trade is the result almost totally of Canada’s close
trading and commercial relationships with the US – in this regard, it is important to note that
a significant proportion of Canada’s two-way trade with the United States is in fact intra-firm
trade between companies that are strongly related usually through ownership and less often
through strategic alliances.
76. When Canada’s trade with the United States is removed from both the numerator and
the denominator, exports as a proportion of Canada’s total GDP falls from 33% to 6%. It is
often said that Canada is a trading nation but perhaps not a nation of traders. This is
because of the dominance of the United States in Canada’s total exports, Canada’s limited
participation in major European and Asian markets, and because Canada appears to be
globally competitive in a comparatively narrow range of industries and products, including
automotive, aerospace, telecommunications and related electronics and information
technologies, and of course the Canadian staples – the resource commodities such as
wheat, lumber, other forest products, ferrous and non-ferrous metals and potash.
77. Once US trade is removed from the equation, it is questionable whether Canada can
even be ranked among the major trading nations. When exports to the US market are
eliminated from both the numerator and denominator, Canadian exports as a proportion of
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Gross National Income falls to levels that are well below those found in most of the countries
listed in Table B2, and starts to approach the figures found in Indonesia, India, Pakistan and
Bangladesh, countries that are not known as major trading nations.
78. Accordingly, during the past 15 years, Canada has become increasingly reliant on the
US market that now absorbs more than 85% of Canadian exports and therefore better than
one-third of Canada’s production of goods and services. As well, outside of the American
market, Canada is a relatively minor player in other major international markets in Europe
and Asia and in these offshore markets Canadian exports in many cases are still dominated
by the country’s traditional resource-based commodities and semi-finished goods. In short,
industrial restructuring, economic modernization and improving Canadian competitiveness
continue to be works in progress.
79. Differences in social policy may be one factor in assessing Canadian and US
performance. Canada compared to the United States has adopted a more European-style
social welfare system, particularly in the areas of health care, unemployment insurance, and
up to the early 1980s regional development programs and incentives. This has resulted in a
more egalitarian society in Canada and lower disparities in income across regions and
socioeconomic groups.
80. At the same time, this arguably has resulted in reduced work incentives, innovation and
entrepreneurship, and has perhaps slowed down the reallocations of investment, capital and
employees across enterprises, industries and regions that are needed for industrial
adjustment and upgrading. At the time of the Canada-US Trade Agreement (CUSTA) in
1988 and of NAFTA in 1994, there were concerns that Canada would be forced to adopt a
less comprehensive social safety net along the lines of the American model. While some
cutbacks in federal and provincial social welfare spending have taken place over the past ten
years, these appear to be more related to pressures for deficit reduction than from forces
related to CUSTA and NAFTA.
81. The following paragraphs expand on these issues and challenges and the policy
responses of Canadian governments.
82. Research conducted by Industry Canada a few years ago focused on the country’s more
traditional and mature manufacturing industries. The research and policy analysis
recognized that Canadian industry includes not only the strong high technology performers
such as computer hardware and software, telecommunications equipment, other electrical
and electronic products, pharmaceuticals and scientific equipment and other industries
where research intensity is high and innovation and continuous improvement to products
and processes are essential to competitiveness. The industrial sector also includes the
more mature industries that have been important to Canadian manufacturing for a long time
and will continue to be important to Canadian industrial and economic performance for the
foreseeable future11.
83. This industry grouping covers a wide range of industries:
from the automotive sector which is highly integrated with the global industry and
economy,
to clothing, textiles and footwear that are very labour intensive and are not major
users of advanced technology,
to forest products, minerals and other the resource sectors with their high capital
intensity, mature technologies and strong dependence on international markets,
to a number of industries such as printing and publishing and non-metallic mineral

products that are strongly oriented towards local and regional markets within
Canada and export relatively small portions of their output.
84. Some of the major characteristics of these industries, based on past research conducted
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by Industry Canada and other groups in and outside government are as follows:
i. In many of these more mature industries, smaller firms that are closely held and/or
family owned account for significant portions of shipments. Demographic change
and population aging are particularly important to these industries. Industry
performance and even survival in some product lines in the future will depend on
company success in attracting younger owners and managers. Companies and
industries with below average productivity and profits and weak balance sheets,
may encounter significant difficulties in attracting new owners and managers.
ii. Many of these industries such as plastics, the rubber industry, fabricated metals and
intermediate chemicals sell most of their production to other industries and therefore
significantly influence the competitiveness of their major customers.
iii. Many of the more mature industries place in the lower rank of Canadian industries
in terms of productivity levels, productivity growth and innovation. These industries,
and most companies within these industries, are characterized by:
− high labour intensity,
− lower work force skills,
− smaller company size,
− weak technology adoption and receptor capacity,
− weak links with universities, research institutes and training institutes,
− limited involvement in the global economy,
− limited access to foreign direct investment (FDI) and foreign technologies,
− below average investment in machinery and equipment,
− limited ability to control production and administrative costs as markets

become more competitive, and below average shipments growth.
These poorly performing industries continue to account for significant portions of

Canadian manufacturing and therefore depress the overall performance of the
sector and Canadian economy.
iv. Some of these industries, such as wood products, chemicals and textiles,
experienced large gains in shipments and exports during the 1990s. However,
these gains appear to be more related to the low value of the Canadian dollar and
cost reduction during the recession, than in product and process improvements that
would lead to lasting improvements in competitiveness.
v. The overall perspective from the available data is that productivity gaps between
industry groups are increasing. Therefore, many industries that now have below
average levels of labour and total factor productivity are falling further behind other
manufacturing industries, their US counterparts, and the total Canadian economy in
terms of productivity performance.
vi. This could be a particular concern for the future performance and competitiveness
of food products, plastics, leather and allied products, wood products, furniture and
fixtures, printing and publishing, fabricated metals and other manufacturing.
Industrial machinery12 and refined petroleum and coal products may also warrant
special attention, particularly when their modest productivity levels and advances
are compared with the dramatically better performance of the same industries in the
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United States.
vii. Combined together, these ten industry groups, which could be considered to be
　at risk　 based on productivity and innovation performance, accounted in 1997 for
nearly 40% of total manufacturing shipments, and for 957,000 jobs or 52% of total
manufacturing employment of 1.84 million in the same year. These industry groups
combined to account for close to 7% of total (manufacturing and non-manufacturing)
employment in Canada in 1997.
viii. Many of the companies in these “at risk” industry groups supply equipment,
components and other production inputs to other manufacturers. Over time, weak
productivity performance in supplier industries will dampen productivity, sales and
profits in their customer industries.
ix. Many of these industries as well are concentrated in the slower growing regions of
Canada, and therefore their comparatively sluggish performance impedes
government efforts to reduce regional disparities in this country.
85. While the overall performance of these “at risk” industries is below average, there are
likely high company performers within each of the “at risk” industries and some of the more
mature industries have performed quite well in past years. For example, primary textiles and
clothing experienced above average gains in productivity from 1983 to 1997, associated with
measures to control costs (including decreases in employment) and major advances in
export sales as a proportion of total shipments. These two sectors place near the bottom of
the industry ranking in nearly all of the technology adoption indicators, and thus
improvements in productivity and export sales appear to be based on other considerations
not covered among the typical technologies used by manufacturing industries. Greater
research on the high performing companies in low performing industries and on the mature
industries that performed better than average in recent years would benefit both company
strategy and government policy.
86. The challenge for Canada is that while the high technology industries such as electrical
and electronic products and telecommunications equipment performed much better than
other Canadian manufacturing industries in productivity, innovation, and investment, the
Canadian performance in the high technology sectors was well below the US performance in
the same sectors. The implication is that for Canada to perform as well as or better than the
US in productivity and innovation, the more mature industries in Canada must make a
stronger contribution to Canada’s overall industrial and economic performance in the key
indicators of investment, productivity and innovation.
87. More needs to be known about the major performance characteristics and challenges
faced by these more mature industries, particularly those that are in the “at risk” category
indicated in previous Industry Canada research. Some of the information and analysis that
could be helpful would include the following:
benchmarking the performances of foreign and domestically controlled firms in

selected mature industries to identify why the former typically out perform
domestically controlled companies;
more detailed industry group studies to learn why many Canadian “mature”
industries performed below their US counterparts;
case studies of high company performers in low performing industries in order to

identify experiences, lessons and achievements that could be applied more widely
throughout the industry group;
analysis of whether and how first tier companies (i.e. major customers) in supply
chains are assisting their suppliers in more mature industries to upgrade their
products, processes and management in order to continue to be a preferred
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supplier;
research on the reasons for low technology adoption and lengthy technology
adoption lags in industries that are under performing in innovation and productivity
growth;
the importance of human resources, management and organizational structure in

determining the receptor capacity of SMEs in selected industries;
impacts of population ageing on ownership and management in various mature

industries in transition; and
the possible conflicts between investment and innovation strategies and cost
reduction strategies in selected industries and manufacturing more generally.
88. One major lesson from this research is that restructuring and innovation strategies
should focus not only on the higher technology industries; but in addition should be relevant
to all manufacturing and service industries and should be designed to capitalize on
innovation strengths within industries, sub-industries, product lines and industries regardless
of the industry, location, stage of industry development, and type of enterprise. One major
argument in favor of economy-wide innovation strategies is that in most economies including
the United States high technology industry contributes only a small portion to GDP and
employment. This is certainly true for Canada and even more so for Hebei.
89. Expanding on the economy-wide approach discussed in the previous paragraph, Canada
and other OECD countries are as well giving greater attention to innovation and
competitiveness in the service, particularly for producer and other innovative and exportable
services.
90. The service sector, and in particular producer services, are making a growing
contribution to output and employment in all OECD countries and many emerging market
economies, and as well is becoming increasingly important to international trade13. Services
account for over 65% of GDP and total employment in most OECD countries. The
percentages for Canada are 67% for GDP and 74% of the work force. The most rapid
growth has been in producer services, which encompass business services,
communications, finance, insurance and real estate, and trade, transportation, logistics and
storage.
91. The transition to a services based economy in OECD countries and more advanced
emerging market economies parallels to a significant degree the transition to a more
knowledge-based economy. The major sources of service sector growth include:
the emergence of new technologies particularly information and communications

technologies,
out-sourcing of services by the business sector and government,
increasing business demand,
trade liberalization where services are now addressed at the WTO and in many
regional trade agreements, and
higher prosperity, the aging of the population and related changes in lifestyle, which
are resulting in strong growth in tourism, the restaurant sector, and many other
personal services.
92. The distinction between goods and services are now becoming blurred as successful
companies bundle together goods and services into a single product in order to increase
market share and meet customer needs. In many sales, markets and companies, the
service component is more important than the goods component to the actual sale. This is
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found in a wide range of industries such as the computer industry, copiers, as well as aircraft
and motor vehicles where financial services, warranties, after-sales service and in some
cases training are critical to company success and sustainable competitive advantage.
93. Key factors and trends in the Canadian service sector and in other OECD countries that
may be relevant to structural adjustment in Hebei Province include the following.
The size, quality and depth of the Canadian service sector, particularly producer
and other innovative and exportable services, will be increasingly important to
Canadian productivity, innovation, the country’s ability to compete in international
markets and Canadian efforts to diversify Canadian export sales in terms of both
products and geographic markets.
While there are large variances between industries, the productivity performance of
the services sector in Canada has generally been weaker than in manufacturing.
Major investments made in recent years in information, internet-based and related
technologies have not yet been captured in major productivity advances by
producer services and other service firms. One consideration is that the receptor
capacity, innovation strategies and ability to assimilate and make effective use of
new technologies, could be limited in many service firms particularly smaller
companies.
Analysis of innovation strategies and the commercialization of research should give

major attention to the challenges faced by producer service firms in benefiting from
technological change and new product and process innovations, and to the
strategies adopted by more successful service firms and industries to use
technology to improve profits and shareholder value. There is the danger that
innovative service firms and industries are enhancing the productivity of
manufacturers and other service firms but capturing little of the benefit for
themselves and their shareholders.
Barriers to entry into service markets are often lower than the barriers faced by
manufacturers, the copyrights, proprietary information, and other intellectual
property and soft assets of service firms can be easily copied by competitors (either
legally or illegally), and like manufactured goods new services can readily become
commodities and then become obsolete very quickly because of rapid technological
change.
Service firms can be more flexible and footloose than manufacturers, and as the
experience of Bangalore India underlines, emerging market economies can quickly
become major players in global markets for services. Continuous upgrading of
products, processes, skills, marketing programs and other core competencies, as
part of a long-term strategy for sustainable competitive advantage, is probably more
important for many service providers and services exporters than for typical
manufacturers.
Exports of service providers are closely linked to broader developments in foreign

direct investment, the emergence of international (or stateless) corporations, and
the restructuring now taking place in major international firms. The following
explores some of these inter-relationships in greater depth.
Global out-sourcing provides both challenges and opportunities for Canadian

providers of financial, engineering, architectural, accounting, management
consulting, planning, transportation, computer, IT and other producer services to
businesses. Canadian service providers that in the past provided their services to
domestic firms behind high non-tariff barriers are now very much a part of the global
marketplace.
Producer services are particularly affected by trade barriers inside the border and by
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inter-provincial/inter-state trade barriers in federated nation states. Barriers within

Canada as well as within other countries negatively affect the performance of
Canadian based producer service firms. Trade barriers inside the borders of large
emerging market economies can be expected to be particularly important to
Canadian providers of producer services in the future.
As noted above, a company’s ability to develop and assimilate information

technologies and other more advanced technologies now plays a major role in the
competitive position of producer service firms.
Company capacity to benefit from technology could be enhanced if it is located

within a cluster. Successful clusters are likely to include producer and other service
providers that both support the manufacturers and research facilities in the cluster
and are important drivers of the cluster in their own right.
94. In response to Canadian economic developments over the 1990s, over the past three
years, the policy and program initiatives of Canadian governments have shifted from the
macroeconomic issues of inflation, deficit reduction and trade policy, to the more
microeconomic issues of innovation and learning. Working closely with the private sector,
universities, research institutes and other non-government groups, Canadian governments
are attempting to accelerate the creation and adoption of new process and product
innovations by industry, government, households and other groups, and to ensure that
Canadian businesses, workers, households and governments have the information, skills,
and expertise needed to identify and successfully assimilate more advanced technologies
into their operations. As stressed earlier, a major goal of Canadian governments and
businesses is to close the innovation, productivity, investment, R&D commercialization,
standard of living, and other gaps between Canada and the United States and other major
OECD countries.
95. Closing these gaps requires that a number of microeconomic challenges be addressed.
These include:
the slow adoption of new technology by most Canadian industries;
corporate strategies that emphasized cutting wages and other production costs
rather than improving product quality;
limited investment in specialized human resources to support innovation and

upgrading;
falling public investment in post-secondary education;
commercializing university research and product and process innovations within

Canada (related in part to weaknesses in the Canadian venture financing industry;
lower government financing of university research compared to the US and some

other OECD countries;
low government and business investments in research and development as a

proportion of GDP;
the limited ability of many Canadian firms to participate in global supply chains;
and,
the failure of many Canadian companies to prepare and implement distinctive

corporate strategies that set these companies apart from their competitors and
establish sustainable competitive advantage in terms of branding, building strong
relationships with customers and suppliers, upgrading human capital among
management and labour, process innovations, the quality of their products and
services and creating customer value, in ways that are distinct from their
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competitors.
96. The conclusion was therefore that Canadian governments have had much greater
success in addressing the country’s macroeconomic issues than in confronting its
microeconomic challenges14.
97. These goals, policies and challenges were captured in two discussion papers on the
Canadian Innovation Strategy published by the Government of Canada in February 2002.
Major aspects of the strategy as outlined in the two documents include the following:
i. Renew the Government of Canada’s science and technology capacity to respond to

emerging public policy, regulatory/stewardship and economic challenges and
opportunities.
ii. Address potential public and business confidence challenges before they develop
and ensure that Canada’s regulatory/stewardship regimes and marketplace
framework policies are world class, through e.g. completing systematic expert
reviews of Canada’s most important business and regulatory regimes.
iii. Encourage innovation and the commercialization of knowledge in the private sector,
through providing greater incentives for the commercialization of world-first
innovations; providing more incentives to small and medium-sized enterprises
(SMEs) to adopt and develop leading-edge technologies; rewarding Canada’s
innovators; and increasing the supply of venture capital in Canada.
iv. Support the development of globally competitive industrial/technology clusters. The

target is to develop by 2010 at least 10 internationally recognized technology
clusters.
v. Strengthen the innovation performance of communities throughout Canada. More

specifically, the Government of Canada will consider providing funding to smaller
communities to enable them to develop innovation strategies tailored to their unique
characteristics. Communities would be expected to engage local leaders from the
academic, private and public sectors in formulating their innovation strategies.
Additional resources, drawing on existing and new programs, could be provided to
implement successful community innovation strategies.
vi. Ensuring that Canada receives the skilled immigrants it needs and helps immigrants
to achieve their full potential in the Canadian labour market and society. This is to
be accomplished by 2004 through significantly improving Canada’s performance in
the recruitment of foreign talent, including foreign students, by means of both the
permanent migrant and temporary foreign workers programs.
vii. More generally, the strategy highlights the strong links between innovation and
human resource development as set out in the discussion paper “Knowledge
Matters: Executive Summary,” which states as the first of three key imperative that
“the knowledge-based economy means an ever-increasing demand for a well
educated and skilled workforce in all parts of the economy and in all parts of the
country.”
98. Some of these policy initiatives, such as support to the basic science, establishing the
appropriate policy and regulatory framework, cluster development, innovation and
commercialization of research in the private sector, innovation at the local community level,
and linking innovation with learning and human capital development, could be relevant to the
Hebei strategy. Possible lessons for Hebei from all three countries are discussed in the
following final section.
99. Final Comments and Possible Lessons for Hebei: This document outlines the recent
experiences, success and challenges of three countries that like Hebei were late-starters in
industrial restructuring and economic modernization and are on the peripheries of major
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markets. There are a number of possible lessons that could be important to Hebei’s policies.
All three countries have had some success in the past 15 or so years, but only Ireland could
be called a total success in terms of achieving their convergence and restructuring goals.
Successful industrial restructuring takes decades not years and requires that
essentially the same policies be in place for an extended period. Policy certainty is
just as if not more important than policy perfection.
Government policies and partnerships with enterprises should be designed to

promote productivity, innovation, modernization, restructuring and enterprise reform
across all industries – including traditional manufacturing, higher technology
products, and higher order and more traditional services.
Given the growing importance of services to all developed and developing

economies including the PRC and Hebei Province, government initiatives to
improve productivity and innovation in service activities could be particularly
beneficial to job creation, raising productivity and living standards, and enhancing
competitiveness.
Restructuring therefore takes place through adjustments, improvements and greater

innovation in traditional industries, where the country or region has traditionally held
a comparative advantage, as well as in the introduction of new more knowledge
based economic activities. A phased approach that first emphasizes upgrading and
innovation in traditional industries and then focuses on more advanced technology
and the introduction of new higher technology sectors may be the appropriate policy
stance.
Structural adjustment and job creation based on low-cost labour, resources, and
other industrial inputs, can be an effective strategy for a while. However, a new
lower cost producer is always on the horizon. Over the longer term, structural
adjustment and economic development more generally must be based on product
and process innovation and upgrading, strategic investments in more modern
physical plant and equipment and in human capital, and government policies and
enterprise strategies designed to establish sustainable competitive advantage over
an extended period.
Successful structural adjustment requires both effective macroeconomic policies –

focused on reducing inflation and government deficits -- as well as effective
microeconomic policies that are focused on innovation, learning, and productivity
improvement.
Micro-economic policies that are more industry- and economy-wide in terms of their
scope and impact are more effective than more targeted policies that attempt to pick
industry, product, company and technology winners and losers. This is particularly
true for jurisdictions such as Hebei that lack the required information and
experience, the fiscal resources to provide very generous financial incentives to
companies and technologies and that cannot afford to make the mistake of picking
the wrong companies, products and technologies. Governments in these situations
should provide the right policy environment and then let the market and enterprise
and investment decisions do the rest. This approach has the added advantage of
being consistent with China’s WTO obligations and with the PRC’s economic reform
policies.
Programs to attract high quality outside investment need the support of

complementary policies in such areas as education and training,
telecommunications, transportation, other physical infrastructure, environmental
improvement and urban management.
Goals, policies and strategies should be based on a realistic assessment of the
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strengths and weaknesses of a particular economy and on the reality that not all
provinces and regions within a country or a multi-country market can grow faster
than the national or multi-country average.
Realistic objectives are particularly important for economies like Hebei on the fringe
of major markets that are well behind other provinces and countries in terms of
market opening, industrial structure and economic modernization. As the
Portuguese experience indicates, convergence to national and market norms can
take many decades even with a generally appropriate policy framework.
More specifically, market enlargement through WTO entry, domestic market reforms
and other trade measures provides both opportunities and threats to industrial and
service firms on the fringe of larger, more highly developed, markets. Improved
market access can lead to higher sales and profits for existing enterprises.
At the same time, the threats posed by more advanced outside competitors to the
sales of existing enterprises in local and external markets – and to the attraction of
high quality outside investment to the fringe region – should not be under-estimated.
As illustrated in the Portuguese case study, detailed analysis is needed of both the
threats and the opportunities. In many products and markets, Hebei enterprises
could be facing more advanced competing firms that produce higher quality
products at lower cost and have more experience in supplying, marketing and
distributing their products in intensely competitive global markets.
The Irish and Canadian experience indicates that government policies and
programs need to be based on a sound understanding of corporate strategies,
interests and resources. Irish success in attracting high quality foreign direct
investment was based in part on the government’s extensive knowledge of the
requirements of foreign investors and of how those requirements are changing over
time.
On a less positive note, the Canadian experience points out the disconnects
between government policy, policy implementation and policy effectiveness on
improving industrial structure when (i) government policy stresses R&D, product and
process innovations, R&D commercialization and human resource development to
bring about structural change; and (ii) corporate strategy is emphasizing cost
reduction and capitalizing on the low-value of the Canadian dollar, and was giving
less priority to innovation because of limited internal corporate fiancnial resources,
limited access to venture capital and bank financing in many cases, and limited
capacity in many firms to successfully assimilate advanced technology into their
operations.
C2_22
C3: Case of Pueblo, Colorado
Restructuring of an Isolated, Small

Industrial City in Western USA
Prepared by Chreod
Chreod Ltd.
Case Study C3: Pueblo, Colorado 16 February 2004
Pueblo, Colorado: Restructuring of an Isolated, Small Industrial

City in Western USA
1. Introduction
1. Pueblo, Colorado is the only medium-sized industrial city in the Rocky Mountain West
of the United States and is the largest regional trade, service, and health care centre in
southeastern Colorado. The city survived the deep manufacturing recession of the late
1970s and early 1980s that brought devastating reductions in production and employment to
most industrial cities of the region. Pueblo met the economic crisis head-on by diversifying
its economy, mobilizing public resources, and engaging its leaders and citizenry in a
community-wide process to reposition Pueblo as a fully diversified community with a mixed
industrial base.
2. Pueblo is the southern-most sizable city of Colorado’s Rocky Mountain Front Range.
Situated within an urban corridor containing four-fifths of all Colorado residents, Pueblo is
linked to the metropolitan areas of Fort Collins, Denver, and Colorado Springs. Due to its
location within the northern apex of the Old Southwest, the city has a demographic mix of
Hispanic (of Spanish ancestry, rather than Mexican) and non-Hispanic populations relative to
more northern cities of the prairie. Historically, this ethnically diverse community has
consisted of active and loyal neighbourhoods and barrios supported by a proliferation of
ethnic social clubs, neighbourhood associations, and service organizations – while also
maintaining one of the lowest indexes of Anglo-Hispanic residential segregation of cities
located in the greater Southwest from California to Texas.
3. Such conditions made Pueblo fertile ground for the development of a strong civic
culture – in a context where distrust of citywide institutions and leaders (except for the
Democratic party) was widespread. Low taxes and charter constraints that reduced the
scope and range of city government, combined with Pueblo’s political culture, meant that
even such basic public services like street paving were provided by special improvement
districts rather by city or county government.
4. Pueblo quickly developed from a supply town on the rural frontier to the steel mill
centre for the region, with secondary functions in retail trade and mental health services.
From 1892 to 1982, the Colorado Fuel and Iron Company (renamed the CF&I Steel
Corporation in 1966) was the city’s largest employer, and instrumental in shaping Pueblo’s
economic fortunes and political character. Traditionally, over 50% of local government
revenue has been generated because of CF&I – derived from the manufacturing sales tax
and the use tax (of materials and machinery used in manufacturing processes).
2. A community in crisis
5. With the national recession in 1982, CF& I experienced a full-year loss of $23.5 million
– its first since 1962. In 1982-83, it closed its four Pueblo blast furnaces and eliminated
about 3,000 jobs, while retaining about 2,200 workers and shifting its emphasis to speciality
products manufactured by modernized mills using scrap-fed electric furnaces. The plant
closings had a major impact on every sector of Pueblo’s economy and for every segment
within its society. Massive lay-offs led to chronic out-migration of the working age population
(1,500 persons annually between 1980 and 1984). Demands on local government for
expanded social services and public safety increased at a time when revenues from
manufacturing sales and use taxes were being eroded.
3. Modernizing Civic Institutions
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6. By the early 1950s, the proliferation of city districts (at one time there were 28 such
districts in a city approaching a population of 100,000) had reached crisis proportions as
Pueblo grappled with longstanding conflicts over how best to organize local government. In
1954, Pueblo’s political leaders and citizenry adopted a compromise charter for a city
manager form of government that called for a strong council with powers to levy citywide
taxes for special improvements – a process that would continue well into the 1970s as
community leaders gradually modernized Pueblos’ civic infrastructure.
7. In 1971, an intergovernmental system, the Pueblo Area Council of Governments

(PACOG), was created by the newly-elected city council. COG established three key
institutions to modernize Pueblo’s civic infrastructure: the Pueblo Regional Planning
Commission (absorbing the city’s commission), the Pueblo Human Resources Commission,
and the Pueblo Industrial and Economic Development Commission (known as the Pueblo
Development Commission).
8. The COG framework attracted reform-minded community leaders committed to

implementing a comprehensive plan for physical development based on a strategy of
‘orderly growth’ that propelled modernization efforts in the 1960s and 1970s. Hence, such
efforts functioned more as an extension of regional planning in preparation for future growth
than the basis for an economic development strategy – with the Pueblo Regional Planning
Commission, not the Pueblo Development Commission, at the centre of initiatives.
9. The plan included physical infrastructure projects, downtown revitalization,

neighbourhood development, cultural initiatives, and sub-urbanization. Central to the
process was consensus-building and leadership. For example, voters approved a bond for
the development of a downtown mall, and local banks in Minnequa and the courthouse area
threw their support behind neighbourhood development. Hence, physical resources such as
water supply, industrial land, a transportation network, and a solid waster facility were well
established prior to the depression of 1982-83, and therefore could be rapidly mobilized to
respond to the crisis.
10. Pueblos’s new generation of civic-minded community leaders of the early 1960s, who
viewed service to their community as a moral obligation, fervently believed in an improved
Pueblo rather than a fundamentally different Pueblo. They communicated to Pueblo’s
citizens the message that Pueblo could remain an ethnically diverse industrial city, while also
“discovering” and developing its potential – and that individual self-interests and the
collective good were not mutually exclusive.
11. Hence, over the course of thirty to forty years, Pueblo’s leadership enabled its citizens
to educate and habituate themselves about their city’s physical, economic, and cultural
improvements – on a project by project basis. The electorate made the final decision, usually
over funding, on most major projects through referenda on tax increases and bond issues.
4. Economic Development Planning: PEDCo

12. During the 1960s and 1970s, relatively few businesses were attracted to Pueblo and
there was no unified program capable of retaining or expanding businesses. However, in
1981 the Pueblo Economic Development Corporation (known as PEDCo) was formed,
uniting public and private sectors, with a starting budget of $315,000 that came from city,
county, COG, and private sector funds.
13. PEDCo’s organization is premised on a strategy of inclusiveness; its board of directors

consist of twelve elected directors, including a member each from the city, county, and the
COG. Additionally, there are five ex-officio non-voting directors representing Pueblo West
Metro District, the Chamber of Commerce, the city manager’s office, the Pueblo Latino
Chamber of Commerce, and Pueblo Community College. Most of PEDCo’s leadership has
consisted of CEOs of private corporations located in Pueblo, as well as business executives
C3_2
employed by companies outside Pueblo, who were interested to locate in Pueblo.
14. By the time the recession hit Pueblo, PEDCo was operational. In 1983, it established
the Pueblo Business Technology Center (BTC) in partnership with the Control Data Corp. of
St. Paul, Minnesota, to provide a host of services, including Control Data’s PLATO
computer-based education courses, management consulting, financial assistance, business
planning, and marketing. Funding for the project came from private and public sources at the
local, state, and federal levels. Twenty-eight companies were nurtured within a two- year
period.
15. PEDCo adopted an entrepreneurial approach, focussing on the creation of ‘primary

jobs’ producing goods and services for export out of the region – a philosophy reflective of
national trends in economic development encouraged by the Reagan administration
(including the use of revolving loan funds, below market loans, and generation of revenue
streams independent of federal programs and tax revenues). In 1986, the state of Colorado
awarded the urban enterprise zone status to five economically depressed areas in the city
and county of Pueblo – to attract new firms to the community while also assisting the
development of local firms located in the designated areas. Approved firms received tax
credits for such activities as reinvestment, job creation, health insurance, research and
development, building development, and child care.
16. A significant portion of PEDCo’s annual budget supports national and state marketing
and advertising campaigns (especially in professional publications) to enhance Pueblo’s
image and to aggressively target industries and regions of the country. PEDCo also visits
and hosts potential companies, and coordinates development plans and information
assistance to companies investigating location to Pueblo. In January 1985, the American
Chamber of Commerce Researchers Association designated Pueblo as the cheapest place
to live in the United States – a marketing asset used to attract outside firms with jobs at low
to moderate wages (such as low-tech assembly, telemarketing, and distribution).
17. The first major ‘coup’ of PEDCo’s marketing strategy occurred in 1984 with Sperry
Corporation’s decision to construct a $10-million computer design and manufacturing plant
at Pueblo’s under-utilized airport industrial park. Sperry’s Defence Systems Division (with
headquarters outside St. Paul, Minnesota) oversaw the construction of the new 150,000-
square-foot facility and its subsequent operations designed to produce navigational
computers for military ships and planes under long-term contracts with the U.S. Department
of Defence.
18. While the Sperry plant was expected to employ 700 to 1,000 workers, its workforce
doubled due to the building of an automated Materials Management Center adjacent to the
manufacturing plant. The plant created the momentum required to fuel Pueblo’s economic
turn-around, to retain and expand existing firms, and to attract new ones. Yet the public
investment required to attract Sperry had depleted the city’s treasury. Despite this, Pueblo’s
residents, believing the investment had more than paid off, approved in 1984 an increase in
the sales tax for economic development purposes, increasing the city sales tax from 3% to
3.5% and generating about $2.5 million a year. For more than a decade, the tax was
renewed by voters, and by 1991, the revenue was being used to support any economic
development activity approved by city council.
19. When Sperry (then LORAL) closed down its facilities and left town in 1996, fifteen
years after the establishment of PEDCo, Pueblo was relatively unscarred by the loss. By
then it had in place a viable economic development infrastructure and a diverse, multi-
centred economy of small and medium-size export-oriented firms. It had also attracted
nearly 35 firms to Pueblo, at least one every year, with only seven firms employing over 250
workers. As of February 1997, over one-third of these firms had expanded their operations at
least once during this period.
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5. Downtown Revitalization
20. During the period 1981 to 1997, Pueblo pursued a program of downtown revitalization
concurrent with its industrially based developments. Under the Economic Recovery Tax Act
of 1981, a 25% tax credit for restoration of historic structures was established. Such an
incentive prompted the creation of the Union Avenue Historic District – with Energy
Conservation Systems, an Atlanta-based developer, investing $1 million to buy and $1
million to renovate eleven buildings in the historic district. Similar ventures followed, such as
the late nineteenth century Pueblo Union Depot that was architecturally restored and
transformed into a thriving social and commercial centre of the district.
21. In 1995, voters approved bond funding of $12.85 million for the Historic Arkansas
Riverwalk Project (HARP), a 26-acre San Antonio-style walk along a reopened river channel
of the downtown core that would link business districts in the city’s historic core with
pedestrian and bike pathways, a waterway, a lake, and a series of bridges. HARP is
administered by an intergovernmental authority comprised of representatives from the city,
the county, the water board, the power authority, and other governmental entities.
6. Conclusions
22. The story of Pueblo clearly demonstrates how institutional modernization -- with
attendant mobilization of public resources -- is key to successful local development:
Institutional reforms require strong local leadership and a civic-minded citizenry educated
about the issues that affect their city and engaged in the planning and decision making
process. Furthermore, the experience of Pueblo suggests that economic development must
be pursued as part of an integrated approach to community development that is fostered
from within rather than imposed from outside. Seen in this light, the pursuit of economic
development is not an end itself, or an emergency response to an impending or actual
economic crisis. Pueblo began reforming its institutions and leadership because it had a
clearly defined vision of Pueblo as a culturally and economically diversified industrial centre
long before the crisis occurred. This was possible because of Pueblo’s strong civic
leadership and civic culture – the driving force and legitimate author of any community’s
economic development plan to secure prosperity and quality of life for its citizens.
C3_4
D1: Case of South Korea
Ports Development in South Korea

Prepared by Chreod
Chreod Ltd.
Case Study D1: Ports Development in South Korea 23 April 2004
1. Introduction
1. While rich in human capital, South Korea is resource-poor in terms of coal, petroleum
and raw resources. Rather than rely on primary resources, the country has been able to
effectively exploit the international trade approach to development by tapping into the skills and
work ethic of its population. South Korea has been able to capitalize in the manufacturing of
important consumer niches like cars (e.g., Hyundai, KIA) and electronic goods (e.g.,
Samsung). The country is largely mountainous, and the shortage of flat land has led to port
development as a strategic means of regional development (Lee, 2003). Since factories tend to
be sited on flat land, manufacturing activity in South Korea is crowded on the gentler valley
floors.
2. After the Korean War (1950 to 1953), the Korean peninsula remained partitioned
indefinitely along the 38th parallel. The sudden division of Korea into two created a living
drama cum experiment in the social sciences: a command regime to the north with its own
agenda, and a capitalistic, pro-Western south with an eye to material wealth and infrastructural
development. Essentially, a low-income population with a single ethnicity, language and
heritage was divided into two and placed under governments expressing radically different
political, economic and social philosophies (Eberstadt and Banister, n.d.). The outcome, with
South Korean standards of living and quality of life indicators far surpassing that of its only
immediate neighbour, can be explained in terms of the dramatic economic development
associated with manufacturing, and the infrastructure developed to support the international
trade approach to development. Ports represent an important component of the Korean
infrastructural miracle. The period of aggressive port building begins in South Korea after 1961,
the advent of the Park Jung-Hee Era or the Third Republic.
2. PORTS IN SOUTH KOREA

3. South Korea’s massive investment in infrastructure has both a unique history and
important implications for the country’s phenomenal economic growth. First of all, the division
of Korea into North and South Korea effectively blocks South Korea from the continent of Asia.
Cut-off from mainland Asia, South Korea was virtually forced to become a seafaring nation. It
has an extensive port system and one of the largest ship-building industries in the world.
4. Between 1982 and 2002, Korea experienced remarkable economic growth. In fact, the
Korean economy grew at an average annual rate of 7-8% (Lee, 2003). Accompanying this
rapid economic growth during this period, the overall volume of port traffic also grew at an
average annual rate of 10.2 percent (Kim, 2003). While there was a dramatic blip with respect
to shipping volumes associated with the Asian financial crisis of 1997, Korean port cargo
surpassed previous levels by 2002.
5. To accommodate growing trade volumes since the 1960s, the Korean government was
forced to undertake aggressive port building strategies. The position of the central government
was this: they saw port bottlenecks (e.g., Glasgow after World War II) as impediments to
economic growth (Konvitz, 1992). In fact, the South Korean economy is now so highly
dependent on port infrastructure that port building is a national priority. The country’s major
exports are cars, electronic products, machinery, steel, ships, textiles, clothing, footwear, and
fish. Major imports to South Korea include crude oil, coal, iron ore, grains, machinery, transport
equipment, organic chemicals, and forestry products. Intra-Korean shipping includes cargo, oil
and steel products, plus sand and cement (Lee, 2003).
D1-1
3. The Geographic Context of South Korean Ports

6. All South Korean ports benefit from being on the dominant trading routes that link both
the nations of the Pacific Rim, and the coastal cities along the Atlantic Seaboard of North
America and Europe. International shipping patterns currently reflect ‘a hub and spoke
pattern’, where international cargo converges on major airports and seaports, and is then
transported into the local regions. South Korea is consistent with the hub and spoke trade
pattern, and maintains a formalized 3-category hierarchy of ports: hub ports, feeder ports and
multi-purpose ports. As shown in Figure 1 below, there are two hub ports in South Korea—
Busan and Gwangyang—both along the south coast. Because of the increasingly large size of
container ships, hub ports must employ deep water berths and channels.
7. With the hub port, trade is international and highly containerized. South Korea, after
1961, has tried to keep pace with state-of-the-art developments in containerization
technologies.
Figure 1: Hub and Regional Ports of South Korea.

Source: Government of the Republic of Korea, 2000.
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8. The second category of port is the feeder port that serves the large regions, which
includes the ports of Incheon and Pyungtaek that serve Seoul, and Masan, Ulsan and Pohang
(which ring the south coast). The feeder ports serve the hub ports by providing short sea
routes to the hinterlands. The third category is the multi-purpose port, which services the less
populous regions (and includes Mokpo, Donghae, and Gunsan). It fulfills the major functions of
ports (berthing, on-loading and off-loading, storage), but at a smaller scale. In other words, the
multi-purpose ports support both the hub and feeder ports. With the smaller ports servicing
intra-Korean shipping, more and more of a ship’s operational time may be spent in port (i.e., in
a berth). For this to be accommodated, the smaller ports need either extensive berthing or the
logistical ability to handle ships that are continually kept in motion: 24/7 (Lee, 2003).
9. Starting with the country’s two hubs, South Korea’s ports have followed different
development patterns and are highly individual.
4. SOUTH KOREA’S TWO HUB PORTS: BUSAN AND GWANGYANG

A. Busan (Pusan)
10. The port of Busan is the largest in South Korea and sits at the centre of the country’s
second largest city, Busan, which has a population of approximately 3,750,000 (City
Population, 2004). Since Japan is East Asia’s largest economy by value traded, it is no
surprise that the country’s largest port takes advantage of the shortest distance between Korea
(Busan) and Japan (Shimonoseki). The port of Shimonoseki itself benefits from a strategic
position as it is located at the junction of Honshu and Kyushu islands. The Kanmon Strait
(between the islands of Honshu and Kyushu) represents the shortest sea route between
northeast Asia and North America. Goods from South Korea headed to Japan are
disembarked at Shimonoseki and then re-assigned to ships going to the Kansai or Kanto
(Tokyo) regions.
11. Busan itself is considered a container port. It is the sister port of Shanghai, Rotterdam,
New York and Seattle (the world’s most important ports). In fact, Busan sees itself as a top 5
port in the world, and has extensive plans in place to ensure that it stays there (Shin, n.d.). Yet,
despite its plans, it is hampered by its location at the centre of a large city, and therefore
experiences congestion and clogging (Containerisation International, 2002). In fact, congestion
for container ships is sometimes so high that a large proportion of containers must be handled
at conventional piers using traditional methods (rather than the new Super-Post Panamax
Container Cranes).
12. The international port of Busan was opened in 1876, and pier construction began in
1906. Between 1974 and 1982, 4 new container terminals and international passenger
terminals were constructed. In 1974, the construction of Jasungdae Container Terminal began
on Piers 5 and 6, and ushered Busan into the era of container shipping. The port is currently
classified into 4 primary sectors: the North harbour, the South harbour, Gamcheon harbour
and Dadaepo harbour (see Figure 2 below). In 1991, the construction of the Gamman
Container Terminal addressed container cargo needs, and the Sin Gamman Container
Terminal was added nearby within the North Harbour in 2002 (Korean Marine Institute, 2004).
The Busan New Port area of Gadeok Island began its first phase of development in 1997 and
will open in 2006. CSX World Terminals is the major private investor for Phase I and used a
Buy Transfer Operate scheme. It is expected that private capital will run 3 of the new berths in
2006, and that another 8 berths will be run by the government. Busan New Port’s second
phase is scheduled to begin in 2007.
13. With the promotion of the Busan New Port, South Korea is expected to be able to
maintain its reputation as ‘a hub port in the era of the Pacific Rim.’ Busan continues to be
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suitable for aggressive expansion because its tidal markers are not as severe as those
experienced at Incheon or elsewhere. As well, Busan continues to enjoy its shortest route to
Shimonoseki status.
Figure 2: The Major Components of the Port of Busan

Source: BRMAFO, 2004)
14. Most importantly, Busan has received the on-going political and (to a lesser degree)
financial support of the central government in Seoul. In fact, the central government has seen
Busan as a competing pole with Seoul at the other end of the country and encourages this
relationship (Shin, n.d.). The central government continues to invest heavily in infrastructure
that supports Busan, such as the new rapid railway using French TGV technologies. Use of the
bullet trains will take passenger traffic off the axis rail and free up rail time for cargo. The
national government also sees important linkages between port functions and information
networks.
15. Building on its strategic location, the port of Busan has demonstrated a number of
initiatives that have led to its dominance in Korean and international shipping: continual growth
and renewal of both the host city and the port; building of seawalls; diligent reconstruction;
harbour construction; and privatization of container terminals. Ultimately, low costs, efficiency
of handling and a strategic location continues to keep Busan competitive for now. Not
surprisingly, the population of Busan continues to grow. Between 2001 and 2011, the
metropolitan population is expected to increase by approximately 50,000 people per year
(Shin, n.d.). Nevertheless, with the dramatic interruption of Busan’s cargo handling role
following Typhoon Maemi in 2003, it is not clear whether this may impact on the overall viability
of the port in the same way that the Kobe earthquake did to Kobe (Digital Chosunilbo, 2003).
16. Finally, as first envisioned in the Fourth National Territorial Plan (Government of the
Republic of Korea, 2000), Busan is now one of four duty-free areas in South Korea (along with
Gwangyang, Incheon, and the Incheon International Airport). This means that all products and
cargo shipped through Busan are exempt from tariffs. Registered companies, meanwhile, are
also free from value-added taxes (VAT) and excise duties. With its duty-free area, Busan has
experienced boosts in both container throughput and income from storage. More jobs in the
goods processing, wrapping, labeling and related activities accompany designation as a duty-
free area (Korea Today, 2001).
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B. Gwangyang (Kwangyang)
17. Gwangyang Port is the second largest in South Korea after Busan. It is also a deep-water
port, which partially explains why Gwangyang and Busan were designated as the hub ports
rather than Incheon. In addition to its competitive location (more protected from typhoons and
tidal waves than Busan) along the south coast of the country, Gwangyang offers competitive
stevedoring fees plus competitive or reduced port fees (tonnage dues, dockage, anchorage,
towage and pilotage). Container taxes are also exempted. Finally, and importantly,
Gwangyang Port and its hinterland are designated as a Special Economic Zone, which means
that the area will provide an enhanced business environment for foreign firms and the
foreigners living in the area. More specifically, foreign firms are granted various privileges like
tax incentives, financial incentives and exemption from many local laws (including
environmental ones). In the Special Economic Zone, English is used as one of the two official
languages.
18. Construction of the Gwangyang Port began in 1987, and terminal operations only began
in 1998. However, since then, growth in cargo and TEUs has been phenomenal. Major
corporate users of the port include Hyundai Merchant Marine and Maersk Sealand
(Containerisation International, 2002). Regarding growth, Gwangyang has the unique attribute
of not being surrounded by a large city. Consequently, it has extensive room for expansion. It
currently is the gateway to the Yeocheon-Yulchon Industrial Complex with its large oil refinery,
petrochemical factories, the Gwangyang steel mill (POSCO) and many related industries
(Government of the Republic of Korea, 2000). As demonstrated in the figure below, the
POSCO presence in the Gwangyang port is dominant.
Figure 3: Major Components of the Port of Gwangyang.

Source: Samsung, 2004
D1-5
19. The development of Gwangyang has followed three well-planned phases. In Phase 1, the
container port was built and opened in 1998. In Phase II, a new terminal began operation in
2002. In Phase III, the largest component of the port (21 berths along a 5.6 km. quay) is to be
completed by 2011. With Gwangyang’s Phase III development, the port’s container facilities
will be as large as those found or planned for Busan. In 2000, Gwangyang was listed as the
10th largest port in the world according to total cargo volume (AAPA, 2004). Ulsan ranked 9th,
Incheon ranked 13th and Pusan ranked 14th on the same index (AAPA, 2004). Another
interesting design element is that the port’s highway system connects with the Korean highway
network without going through any heavily urbanized area like a downtown. This minimizes
congestion in urbanizing areas nearby and leads to speedier delivery of inputs and outputs
from the port facilities.
20. The latest innovation at Gwangyang is the port’s assertion that it will be Asia’s first fully
automated port by 2008. The fully automated addition will boost Gwangyang’s container
capacity by 22%, while cutting labour costs by 44% and berth operating costs by 17%
(Maritime Press, 2003). Increasing automation represents the status quo of the future. By
2011, the capacity of Gwangyang at 4.82 million TEUs will rival Busan’s capacity at 5.03
million TEUs (Yoo, 2001).
21. Finally, Gwangyang, in combination with Busan and Incheon, are also designated tariff-
free areas, which means custom free zones or CFZs. This is considered another marketing
and branding technique generated by the central government to allocate foreign interest to
targeted areas. Meanwhile, advantages of Gwangyang over Busan are myriad, and include the
following: less congested, less expensive, room to grow, capacity will equal Busan by 2011,
closer to Hong Kong (100 km. or 3 hours closer by ship), lower port and cargo discharge fees,
no container tax, rarely affected by poor weather due to natural breakwater, and averaging 20
days of weather-related port bottlenecks per year compared to Busan’s 35 days (Yoo, 2001).
5. THE REGIONAL PORTS OF SOUTH KOREA

22. The regional ports of South Korea fulfill a number of functions. They are feeder ports to
the two hub ports, as well as multi-purpose ports servicing smaller and less populous areas.
Important exceptions include Incheon, which has a number of international functions related to
its proximity to the capital city, Seoul. Returning to Figure 1 above and moving from Incheon
southwards, the regional ports of South Korea include the following:
23. Incheon (Incho’on, Inchon). The port of Incheon is South Korea’s third largest port
(after Busan and Gwangyang) and is considered the gateway to Seoul, which lies 35 km. to the
east. Incheon’s location as a coastal city has provided it with many advantages, including its
ability to be a conduit for trade between Korea’s largest city and capital—Seoul—and China
and the world. In 1883, the population of Incheon was only 4,700 people. By 2001, Incheon
was considered part of the urban agglomeration of Seoul, with a population 21,700,000 that
includes Bucheon, Goyang, Seongnam and Suweon (in addition to Seoul proper and Incheon).
24. Overall, the historical growth and success of Incheon is attributable to its proximity to the
capital and to the industrial areas of the capital, rather than to any natural advantage that the
site has as a port. In fact, Incheon is a disadvantageous site for a large port due to its tidal
difference and the overwhelming requirement for on-going dredging. Incheon is an artificial port
with lock gate facilities that overcome the tidal difference of 10 metres. It currently has no deep
sea channels and much of its traffic is from South Korean shipping companies. However, a
new phase involves plans for deep sea berths and international container shipping.
25. In fact, following World War II, Incheon had experienced a decline due to its large tidal
range, and the port’s relative distance from the main shipping routes. Fortunately, these
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problems were addressed by the central government in 1966, when the closed harbour basin
entered into by locks was installed. A second tidal basin was constructed in May, 1974. Now,
the port city is fully integrated with Seoul through the metropolitan subway system and the
major international airport servicing Seoul, which is Incheon International Airport. Gimpo
Airport, Seoul’s original airport, now primarily services domestic air travel.
26. Pyeongtaek. Pyeongtaek is a newly developed port that will also service Seoul and
remove some of the congestion from Incheon. Pyeongtaek experiences a large tidal difference
like Incheon, although slightly less at 9.5 metres (Seaplus, 2004). The port is not as deep as
Gwangyang or Busan. Pilotage of all ocean-going vessels using this port is compulsary.
27. Gunsan/Jangshang. Gunsan Port is ancient, but officially opened in 1899. Its original
impetus was as the location for the export of rice to Japan. Now, it is envisaged as having
considerable trade opportunities with China. With the construction of the Gunsan Coastal
Industrial Complex in the 1970s, a new outer port was built. Now, with its linkage to the
Seohaean Expressway, Gunsan Port will be better integrated with both its hinterland and
Seoul. Jangshang is on the opposite side of the inlet.
28. Mokpo (Mokp’o). Mokpo is fully integrated with train service to Seoul, and is the ferry
terminus serving the many adjacent islands in the Yellow Sea. The port currently has a Foreign
Investment Zone related to the Daebul National Industrial Complex. In this sense, Mokpo
hopes to tap into globalization trends and become an international city.
29. Jeju. As a port on an island, Jeju faces many strategic limitations. It has attempted to
overcome these issues by aggressively providing an international city with duty-free shopping
for native Koreans, an international zone with advantages for foreigners and incentives to
foreign investment. The island has been duty-free and visa-free since 2001. The port itself
primarily services ships coming from either Incheon or Busan. A port expansion plan is in place
and will be fully realized by 2011. Interestingly, English is being made one of the two Official
Languages of Jeju Island, along with Korean—to the criticism of Korean language scholars and
the Ministry of Culture and Tourism.
30. Yeosu (Yosu). Yeosu was the headquarters for the Korean navy for over 400 years and,
as such, has a strong naval history. It has traditionally represented Korea’s strategic location
for defence against the Japanese since the Joseon Dynasty. Yeosu’s sister cities in China are
Hangzhou (Zhejiang Province) and Weihai (Shandong Province). Currently, there are two ports
in Yeosu: the old port and the new port. The old port occupies the northern part of Yeosu
Strait, while the new port is located on Yeosu Bay. The new port is deeper and larger. Tidal
ebb in the new port is also considered minimal.
31. Masan. The original port of Masan opened in 1899. The port now maintains a Free Trade
Zone, and supports the Changwon Industrial Complex. A newer large scale portion of the
Sachun Industrial Complex is now under construction.
32. The Namhae Expressway and Kuma Expressway connect Masan to the cities of Taejon,
Kumi, Taegu and Chinju and can compete effectively as lower cost and greater speed than
Busan Port. Like other port cities in South Korea, Masan is attempting to cluster high
technology companies in its Special Economic Zone and in the Masan Valley (artificial
intelligence companies are being targeted to the Naeseo-eup and Usan-dong areas). The
Jinbuk Local Industrial Complex is also attempting to make clustering possible for small to
medium-sized businesses, a target often overlooked in the planning by the central government
(which seems singularly oriented to Multinational firms).
33. Ulsan. Ulsan enjoys its near-adjacency to Busan, and creates an alternative shipping
route that can also exploit its proximity to Japan. The port of Ulsan self-differentiates itself in
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two ways: as Korea’s largest industrial port and as Korea’s largest harbour dealing with liquid
(related to the fact that the country’s largest petrochemical complex is located nearby). Ulsan is
part of the country’s industrial heart (the Ulsan Industrial District) and is home to one of Korea’s
most important multinational corporations: Hyundai. Until 1962, Ulsan was merely a fishing port
and regional market centre. Then, following South Korea’s first five-year economic plan, Ulsan
became an open (international) port. Major industrial plants and factories located there
soonafter. An oil refinery, fertilizer plants, automobile production and heavy industry followed.
Overall, the port of Ulsan makes itself competitive with Busan through the following techniques
or advantages: lower inland transportation fees, no container tax, lower cargo fees, shorter
transportation distances to Seoul, and lower entering, berthing and anchorage fees. The
nearby port of Pangojin, where shipbuilding is done, was integrated with Ulsan in 1962. Ulsan’s
sister city in the US is Portland, and Changchun in China. Importantly, the port has access to
large industrial water sources (which are important to port functions like cleaning and cooling).
34. Pohang (P’ohang). The port of Pohang is the gateway to Kyungsang-bukdo Province.
As shown in Figure 4 below, the port complex itself is located in a classic C-shaped harbour
and consists of Pohangsinhang port (piers 1-8) which supports the area’s industrial complex,
Pohangguhang port (which is the Songdo pier, the Ferry terminal, and Dongbin pier), and
Yeongilmansinhang port, which is scheduled to open in 2011 (KMI, 2004). Pohang is well-
served by trains to Seoul several times per day, and acts as the terminus for the ferry routes to
the adjacent islands in the Sea of Japan (also known as the East Sea). Pohang’s industrial
development is based on POSCO, one of the largest steel producers in the world. To service
the steel trade as a transshipment point, the port of Pohang is particularly good at handling the
industrial inputs to the steel making process: coal, iron and limestone.
Figure 4: Pohang Harbour.

Source: Korean Maritime Institute, 2004
35. As part of South Korea’s eastern axis, Pohang looks forward to engaging in trade and
transshipments with Vladivostok, the terminus of the trans-Siberian railway in Russia to the
north. Tidal difference at Pohang is considered 30 cm or less. As an industrial port handling
petroleum products, the port of Pohang and its marine police have been particularly astute at
monitoring oil-related issues.
36. Donghae (Tonghae). Donghae is well connected to Seoul by rail, and enjoys the
distinction as South Korea’s most northeastern port. It is a new port, and opened in 1976.
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Although Donghae could be a dramatic gateway to the resources of northern China and
Siberian Russia, the port’s dominant commodity is cement for construction elsewhere. The city
itself is dominated by employment in agriculture and the fishery.
37. Depending on wind direction, the outer harbour may be subject to serious swells. The
inner harbour is protected by two breakwaters. Dense fog is also a safety consideration,
stressing the importance of climatic conditions to port location. To the port’s benefit, Donghae
has been designated duty free and will be seeking container traffic following renovation.
6. LESSONS LEARNED FROM THE SOUTH KOREAN PORT

EXPERIENCE
38. Lesson # 1. Target development to those port sites that capitalize on comparative
advantages based on geographic location. The Korean peninsula sits between two
economic giants—China and Japan—and has an enormous primate city as a capital (Seoul).
South Korea’s three largest ports—Busan, Gwangyang and Incheon—tap into their
comparative advantages regarding distance by exploiting their proximity to these economic
powerhouses. Since Japan is East Asia’s largest economy by value traded, it is no surprise
that Korea’s largest port takes advantage of the shortest distance between Korea (Busan) and
Japan (Shimonoseki). Gwangyang, as a competitor to Busan, has a 3 hour advantage in
sailing time to Hong Kong and can be used as the transshipment portal to the US for
Singapore and Malaysia as well. Meanwhile, the port of Incheon exploits its proximity to Seoul.
39. Lesson # 2. Capitalize on globalization. On-going improvements in

telecommunications and transportation technologies continue to induce growth in globalization.
Driving globalization are the following technology-based innovations: the Internet, e-mail,
container shipping, delivery companies like DHL or FedEx, and the New Economy. The rapid
development of the New Economy in the Core (of the Core-Periphery) is leading to on-going
wealth generation (see The Progressive Policy Institute, 2004). Containerization continues to
induce dramatic efficiencies and cost economies of scale in the liner shipping sector (i.e., ships
that took weeks to unload and load in the 1970s can now be in and out of port in hours). In the
bulk shipping sector, larger boats and better satellite communications are improving safety and
speed.
40. Lesson # 3. Employ the other shipping trends that support globalization. Key
trends in shipping include the following: ‘hub and spoke’ logistic scheduling for ships; larger
ships and larger terminals; deeper port channels and deeper berths to service the larger ships;
use of Super-Post Panamax Container Cranes, which are currently the largest shipping cranes
employed in the world; running of shipping schedules with better information technology (e.g.,
ship guidance by GPS); better inter-modal linkages (linkages between different transportation
modes like shipping to rail to truck); and, improved recognition of port-related environmental
issues.
41. Lesson # 4. Locate ports within easy access to major shipping routes. The closer a
new port is to a major shipping lane, the more likely that there is a built-in or accessible market
for the services of the port. Good access to shipping lanes suggests that the ability to optimize
shipping distances is possible.
42. Lesson # 5. Integrate ports to support ‘hub and spoke’ systems. For the ‘hub and
spoke’ pattern of international cargo shipment to be fully realized, hub ports must (A) be
strategically located and (B) have connected transportation nodes completely integrated for
container shipping. First of all, “economies of scale in cargo shipment have led to the
emergence of a few global players in shipping, [that are] able to control the allocation of
transshipment business to strategically located, well-equipped and efficiently managed hub
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ports” (Sommer, 1999). Second, this also means that seaport hubs must be completely
integrated with the existing feeder port, trunk rail, air, and highway systems. Containers must
be loadable and unloadable through complete automation, and be entirely synchronous with
peak land-shipping routes. As stated, the two South Korean hubs—Busan and Gwangyang—
are fully integrated. However, the port of Busan has excess capacity vis-à-vis the rail and road
infrastructure, which leads to dramatic bottlenecks and inefficiencies. Integrating airports with
the port nodes is also critical so that machinery parts or global staff required in emergencies
can be easily transported in, and injured nationals can be airlifted out. Korea’s largest seaports
are linked with the country’s two largest airports (Gimhae International Airport services Busan,
Gwangyang and Ulsan from the nearby city of Gimhae and Incheon International Airport
services Seoul, Incheon, and Pyeongtaek).
43. Lesson # 6. Improve port management. With containerization as the new standard
for shipping, ports are now processing many more ships than could traditionally be done. To
achieve optimal processing, the port must be managed like clockwork so that maximum
efficiency of machinery and human employment can be achieved. This means 24-hour service,
as well as micro-management of individual boats by the port authority. It is important to
recognize that ships are now maintained on tightly-controlled international shipping schedules
and interruptions to these shipping schedules are not well-tolerated by multinational shipping
corporations. Many South Korean ports are not currently run on a 24-hour basis (although
there are exceptions like Busan), and this could hamper their competitiveness in the future.
44. Lesson # 7. Nurture the emergence of mega hub ports. According to Kim (2003), “the
world's leading ports, Singapore, Hong Kong and Rotterdam, have been developing large-
scale ports in order to take the initiative to step up the level of competition among ports. They
are promoting the mega-hub port strategy with deep-sea ports and large scale berthing
facilities. Major world ports have a huge cargo distribution center near the port site where
integrated distribution services are provided, such as cargo handling, transportation, storage,
inventory control, quality control, distribution, processing, exhibitions, information services and
so on. In addition, they developed the free ports or free trade zones near the port in order to
increase welfare gains through the expansion of trade.” As stressed throughout this paper, the
current South Korean ports targeted as mega hubs are Busan and Gwangyang. There is room
to accommodate both mega hub ports along the southern coast because Busan is
experiencing serious congestion. Meanwhile, Gwangyang enjoys superior proximity to Hong
Kong and other Chinese ports, and can build on this advantage.
45. Lesson # 8. Make port specialization a part of a national strategy. By combining

local port development with national territorial plans and strategies, a higher level of integration
of funding sources can be achieved alongside superior implementation. According to Oh (n.d.)
and the Government of the Republic of Korea (2000), the central government divides South
Korea into 3 coastal axes for economic planning purposes:
• The East Coastal Axis. This axis is to focus on tourism and improving the industrial
relationship with northern China and Russia. This means supporting Pohang Steel, Ulsan auto
and heavy industries, and Donghae resource processing.
• The South Coastal Axis. This axis is to focus on international logistics, tourism and
industry. The ports of Busan and Gwangyang are to be nurtured, and specialized industrial
clusters are to be developed in Masan, Changwon, Jinju, Sachon, Suncheon and Mokpo.
• The West Coastal Axis. The third axis is envisioned as capitalizing on China’s
burgeoning economic growth. This means that a network of new industrial sites is being
targeted to Incheon, Asan Bay, Gunsan, Janghang, and Mokpo (the southernmost tip of the
axis).
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46. By recognizing the importance of port planning at both the national and regional levels,
South Korea has been effective in making its hub ports effective in the international arena.
Historically, the policy of port development in South Korea can be said to have begun in 1967,
when the first Port Act was introduced. In 1992, a systematic and integrated port development
plan was put in place, which involved long-term forecasts of port traffic and a strategic view of
well-balanced regional growth (Kim, 2003). Korea has always excelled at attempts at
redistributing production areas and economic growth—regardless of whether they have been
successful or not. However, due to a lack of funding sources, port development plans have
been implemented in a fragmentary manner (Kim, 2003). “The long-term national port master
plan...in 1999, is a systematic and integrated development plan. It includes a network system
for each port, a rationalized sharing role and function of each port and terminal” (Kim, 2003).
47. The 1999 plan also earmarks sufficient area for industrial complexes to continue to be
built. As stated earlier, one of the most interesting components of the new plan is its creation of
a hierarchy of hub, feeder and multi-purpose ports. With the smaller ports servicing intra-
Korean shipping, more and more of a ship’s operational time is typically spent in port.
Accommodation for this reality must be accounted for either by increasing berths or increasing
the 24-hour use of the ship (Lee, 2003).
48. Overall, both Busan and Gwangyang are experiencing high levels of investment, as are
the new port complexes targeted to the following ports: North Incheon Port, Mokpo New Outer
Port, Pohang New Port, Ulsan New Port, and Saemankum New Port. More interesting yet is
the fact that the national port strategy is being integrated with the national territorial
development plan. Incheon Port and Pyeongtaek Port are being developed to service the
capital region—Seoul. Gunsan Port is to service the central region, while Gwangyang and
Mokpo ports will service the southwest region. Busan Port, Pohang Port, and Ulsan Port are to
service the southeast region and Donghae Port will service the East Coastal Region. This
demonstrates complete synchronicity with the planning units of the national territory.
49. Lesson # 9. Create multiple-use ports nested in Network Cities. Network cities
evolve when two or more previously independent cities begin to function cooperatively, and are
aided by fast and reliable corridors of transport and communications infrastructure (Batten,
1995). Since the central government of South Korea is so pro-building regarding infrastructure,
new relationships are emerging. In particular, the new investment in TGV technologies to link
Busan to Seoul is a good example of improved networking. To build on the new bullet train
linkage with enhanced fibre optic cables, and improved satellite linkages represents the
gradual evolution towards fully integrated network cities.
50. New roles for ports include those as logistical centres, free trade zones, and teleports.
This means that their position within the global network is critical, as well as their relationship
to the network of the domestic market. The two hub ports function as portals to the global
network up and to the domestic network down. In other words, ports no longer merely fulfill
their original function: cargo shipment. As logistical centres, ports are expected to provide
storage, sorting, packaging, labeling, and service delivery. But, at the same time, they are
expected to participate at an advanced technological level with functions like the geo-
referencing of ships, coordinating ship movement into and out of port, video-conferencing,
teleporting and logistical planning (Kim, 2003).
51. Moreover, ports and port cities should be fully integrated multi-functional service centres
that also provide office, retail and financial functions. If the headquarters of a multinational
corporation selects a port city to be its home, it expects to have financial, marketing and legal
services at its disposal. As well, passenger travel can be advantageously integrated, as
demonstrated in Pohang. Teleports are also an important integrating function at terminals. The
overall integration of information technology (satellites, fibre optic cables, telephone lines and
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cellular networks) into an efficient network is critical to how well a port can perform.
52. Lesson # 10. Nest the port inside an industrial complex or create cost-effective
linkages between the port and the industrial complex. An important factor in the success of
the South Korean shipping industry is that port facilities and industrial development were
always regarded as mutually beneficial. Ports get the manufactured products out, and bring the
raw inputs in. Since even before the introduction of the Port Act in 1967, South Korean
planners have consistently created industrial areas to accompany any new developments in
port infrastructure. The point is this: provide port infrastructure and industrial zone development
simultaneously rather than counting on ports to generate industrial growth or vice-versa.
Secondarily, the industrial zones in the South Korean cases were not always immediately
adjacent to the port. Rather, they sometimes depended on superior rail and highway linkages
to generate the cost-effectiveness or viability of the port (e.g., the strong relationship between
manufacturing in Seoul and the port of Busan).
53. Lesson # 11. Pursue the planning and building of the ideal 3rd generation port.
Traditional or first generation ports were multi-purpose but dependent on human effort (e.g.,
stevedores, sailors, etc.). Second generation ports were container ports, where inputs and
outputs from the ships were handled in containers by cranes. These new ports were highly
efficient, and effective. However, the 3rd generation ports are equipped with integrated multi-
modal infrastructure, superstructure and info-structure, are fully automated, and perform all
port functions with a high level of technology and innovation. Characteristics of the 3rd
generation ports including the following: deep channels; super-cranes reaching over 60
metres; full automation of port functions; and full networking (Jung, 2003).
54. Lesson # 12. Support the economic and population decentralization policies of the
central government with port policies. By developing the port of Busan along with local
industry, some of the development pressure was taken off of Seoul. The Korean government,
meanwhile, saw the importance of the geographical proximity to Japan that Busan enjoyed.
Therefore, they wisely integrated Seoul and Busan with trunk highways and high-speed
railways, commuter railways and other transportation modes. At the same, Busan was able to
exploit its comparative advantage based on location (its proximity to Shimonoseki in Japan).
55. Lesson # 13. Employ Customs Free Zones (CFZs). A customs free zone is an area
that is legally and geographically independent. It offers clearance, tariff, and public tax
exemptions. Goods brought into a CFZ from a foreign country are not regarded as import
goods and are exempted from taxes and tariffs. However, if the goods are targeted for
domestic demand, then they are taxed. The primary goals of the CFZ include the following:
promoting national seaports or airports as logistical centres, attracting international container
ships, offering business affairs and development assistance, providing business education and
integration, plus international exchange facilities. There are over 800 CFZs throughout the
world. The challenge becomes creating one in geographical proximity to existing shipping
routes, and integrating it with other transportation modes.
56. Lesson # 14. Employ Special Economic Zones (SEZs)—sometimes translated as

Economic Free Zones (or EFZs). SEZs are distinct from CFZs (which are related only to
customs and tariffs). The port of Gwangyang and its hinterland are designated an Special
Economic Zone, which means that the area provides an enhanced business environment for
foreign firms and the foreigners living in the area. More specifically, foreign firms are granted
various privileges like tax incentives, financial incentives and exemption from many local laws
(including environmental ones). In Gwangyang’s Special Economic Zone, English is used as
an official language and all Korean laws and policies are made available in English. Foreign
experts are permitted to enter South Korea for short stays without visas if they are visiting
SEZs, and employees will be issued hassle-free long-term visas. Ombudsman’s Offices will be
set up to deal exclusively with foreign interests. For the workers, tax-free work allowances are
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permitted (Ministry of Finance and Economy, 2002).
57. Lesson # 15. Keep growing. All of the South Korean ports are in growth phases. And,
most of them have sophisticated growth plans extending over the next decade. For example, at
Pohang, the Yeongilmansinhang Port is scheduled to open in 2011. This growth trajectory in
port-building is supported by the on-going growth in seaborne trade (see Appendix 3) that
shows no sign of abating. Because transportation is said to be price elastic (demand can be
greatly affected by changes in price), ports must remain competitive in order to survive. If one
port charges more, this may be enough to induce a company to move its operations or change
its transshipment quotas.
58. Lesson # 16. Understand that intra-Asian cargo shipping is increasing. While the
traditional container shipping pathway has been between centres of consumption in North
America/Western Europe and centres of production in the Far East, intra-Asian shipping is
increasing. In particular, as China increasingly becomes ‘the world’s factory’, both production
and consumption levels there are anticipated to improve dramatically.
59. Lesson # 17. Improve port transparency and reduce ambiguous port handling
fees. The South Korean ports are attempting to improve transparency in line with efforts
regarding governments and corporations within the country. Seoul is one of world’s first cities
with entirely transparent municipal approval processes. Regarding ports, ambiguous handling
fees experienced around the world are being minimized.
60. Lesson # 18. Explore public-private partnerships. With falling levels of available
government funds to support infrastructure development, partnerships with private industry
were inevitable. In fact, East Asia and Latin America are leading in this increasingly worldwide
trend. Globally, “public port agencies have been moving away from the service port model,
under which the port authority provides all commercial services as well as regulatory functions,
and increasingly adopting the landlord model. Under this approach public port authorities retain
their regulatory functions and continue to own the land and basic infrastructure assets such as
berths and breakwater facilities. But they divest themselves of the managerial and financial
responsibility for commercial facilities such as terminals and equipment in the port area”
(Sommer, 1999).
61. The trend towards increased public-private partnerships in port development or

redevelopment is based on a number of factors, including the following:
1. the widespread lack of available funding for port development or

redevelopment;
2. the incredible growth in global trade that has forced users of port facilities to put
political pressure on authorities to improve services, bring down costs to users, and
enlarge existing facilities. So, facing limited possibilities for increasing port efficiency by
retraining staff, the next logical step forward was to focus on enlarging the existing port
facilities to cope with or accommodate larger trade volumes. And,
3. the emergence of only a few global shipping ‘players’ that can allocate shipping
to whichever hub ports give them the best deal. In order to stay in the market, ports
have had to ‘step up’ in order to meet the new envelope of needs demonstrated by
these global shipping companies. Public authorities simply do not have the resources to
financially cope, thereby making public-private partnerships the only way to proceed
(Sommer, 1999).
62. The 1999 national strategy for port development in South Korea specifically makes room
for the use of private capital. In fact, private capital is critical to the multi-billion dollar
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redevelopments of Busan New Port and Gwangyang (Kim, 2003). The South Korean
government is currently using a 50-50 ratio with respect to private development of ports.
However, the government sees this as evolving to even higher levels of private to public
investment: 60-40 (Kim, 2003). An individual piece of legislation called The Private Capital
Inducement Act for Expansion of Social Overhead Capital was introduced in August, 1994. So,
government has tended to fund the dredging and port-related activities while private industry
has focused, where it could, on the terminals and the technology.
63. Lesson # 19. Remain aware of a possible downside to public-private partnerships

regarding ports. On the one hand, the presence of private industry induces competition. This
means that entire ports may become pitted against each other at some future date as private
industry tries to undercut its competitors, leaving the larger and better- capitalized private
companies better able to withstand the competition over the long run. On the other hand,
private industry in high-investment infrastructure fields like ports may wish to extract higher
prices for port handling fees than a government seeking to protect its own investment would.
Higher prices would, if the market will bear them, lead to a less competitive position for the
port. China has recently experienced difficulties with privately-held port functions becoming
non-competitive due to price escalations (Containerisation International, 2002). As well, foreign
ownership of terminals and other port facilities means a loss of domestic wealth and control for
the host country (i.e., profits leave, and decisions are made offshore).
64. Lesson # 20. Realize that costs drive the port market. Much of South Korea’s
success in garnering port business has been to the detriment of Japanese ports. South Korea
did this by providing low cost services (including 24-hour port service in some places like
Busan) plus incentive zones enjoying privileges granted by the government. As stated,
transportation is a cost-dependent industry, and heavy goods in particular (e.g., coal,
petroleum) are considered price elastic (meaning that as transportation prices go up, the
demand for transportation services for heavy goods will fall—perhaps dramatically). Port prices
in Gwangyang and Busan are considered the lowest in the region, and are less than half of
those in either Hong Kong or Kobe (Containerisation International, 2002).
65. Lesson # 21. Keep abreast of capacity requirements. South Korea has continually
had greater demand for port facilities than could be provided. Furthermore, the proportion of
GNP allocated to port facility construction has actually fallen since 1976 (Kim, 2003). The
resulting inefficiency associated with port congestion is an on-going concern. In fact, recent
investment in ports as a portion of GNP in South Korea has been substantially less than in
Japan and Taiwan (Kim, 2003).
66. Lesson 22. Have competing ports nearby. Individual companies should have the
opportunity to benefit from a competitive use of more than one port. As such, they can have
their own corporate infrastructure in place if one of their ports is hit by a natural hazard or a
strike. The port of Busan is responsible for over 70% of Samsung’s electronic exports and the
implications of Typhoon Maemi were profound for Samsung (Kang, 2003). As well, the Seoul-
Busan axis is regarded as over-developed (Oh, n.d.). The axis, while handling over 70% of
South Korea’s freight traffic, simultaneously suffers from congestion, excessive density,
environmental pollution, high housing costs, and even housing shortages. Having access to
alternative ports can increase the flexibility of an individual corporation in getting its products to
market.
7. CONCLUSIONS
67. Among Asian nations, South Korea’s recovery from the Asian financial crisis of 1997 has
been strong. Despite the revelations that there were many weaknesses in the economy, the
international trade approach to development continues to be the primary way that the country
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will grow in this century. Of course, if South Korea and North Korea re-unite, then North Korea
will behave as a tax on the entire economy in the same way that the former East Germany did
and continues to do to Germany. Ignoring this possibility for a moment, the performance of the
South Korean economy continues to be strong, although muted below previous growth levels.
68. With economic growth comes economic competition, and the latest threat to the hub
status of the ports of Gwangyang and Busan is Shanghai. Shanghai, meanwhile, ranks high on
both container shipping and the total volume of cargo shipped. New port developments along
the South Korean coasts may not be able to keep pace. After all, there are limitations to the
size of the domestic market in South Korea that may play out in the ability of its ports to deliver
scale and cost efficiencies in transshipment services. Nevertheless, the future for South
Korean ports, each with advantages derivative of the axis that it lies on, looks good. In
particular, the ability of the central government to integrate territorial and land use planning
with port planning appears effective.
69. All planning should be geared towards optimizing geography, on-going containerization,
port deepening and enlargement, and public-private partnerships (with some caution
exercised). A point of view adopted by the Korean Maritime Institute regarding public-private
partnerships is the following: “Foreign participation with state-of-the-art technology will help
enhance the efficiency standard at South Korea’s container ports. It may help to attract further
transshipment cargo from Asia and it will partly solve the capital shortage. However, South
Korea shippers may start to worry about potentially higher handling charges like the foreign-
invested terminals in China. Domestic shipping lines are worried, because to be successful,
they cannot operate their business without a good terminal base” (Containerisation
International, 2002). Once again, geographic considerations along with economies of scale
and costs will continue to be the crux of port success.
D1-15
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Territorial Plan in Response to the Growth of China. Downloaded from:

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D1-17
E1: Case of Paris
Paris Metropolitan Spillovers

Prepared by Edward Leman
Chreod Ltd.
Case Study E1: Paris Metropolitan Spillovers 16 February 2004
1. Introduction
1. France is divided into 22 regions, each region into departments, and each department
into communes. The City of Paris is one of 8 departments in the Ile-de-France Region. Ile-
de-France covers 12,000 km2 with a population of about 11 million, and is considered
Metropolitan Paris. The City of Paris is 103 km2 with 2.1 million inhabitants, accommodated
at very high densities of 24,000 people per km2 (double the highest densities of London).
France’s second largest city is Marseille, with an agglomeration population of 1,425,000.
Consequently, Paris is a powerful primate city that strongly dominates France through
economics, governance, and culture.
2. The Île-de-France region has nearly 20% of France’s population in only 2% of its
geographic area. The region is responsible for 30% of France’s GDP, and accounts for 22%
of national employment. Stated differently, GDP per capita in Paris is 43% higher than the
national average. Importantly, the Île-de-France region employs almost half of France’s
managerial staff and is stronger than all other major European regions in terms of
professional qualifications and productivity. About 81% of employment is in the service
sector.
3. The spatial structure of Paris and the Île-de-France region has changed dramatically
over the past century. Historically, the population density inside the walls of Paris has been
high. However, from a peak of 2,906,000 in 1921, the Ville-de-Paris’ population has declined
27%. Mostly, the fall in population is accounted for by out-migration to outlying settlements,
new towns and other regions of France. This out-migration has been facilitated by
comprehensive transportation planning and direct intervention by the central government in
new town planning. In France’s most recent census (1999), 18 of 20 Parisian
arrondissements (districts) had lost population when compared to a previous peak.
4. Out-migration has not had the debilitating impact that might be anticipated. Business
demand for conversion of residential buildings into office buildings in central Paris remains
strong. This means that employment growth has to some degree taken up the slack provided
by out-migrants.
5. When considering the Île-de-France region as a whole, the redistribution of population

has followed strong interventions by the central government. Five new towns have been
built, and business investment by the central government has permitted dominant (La
Défense) and sub-dominant (Saclay and Roissy) employment nodes to emerge. Other
development areas have been designed to support transport axes or lagging sub-regions.
Cergy-Pontoise supports the development of the Paris-Le Havre corridor, while Évry, Melun-
Sénart and Saclay support southern Paris and the TGV corridor to Lyon. Marne-la-Vallée
and Saint-Quentin-en-Yvelines support the more depressed areas of eastern Île-de-France.
Airport-dependent business has developed in the Paris-Roissy corridor and is serviced by
Charles de Gaulle Airport.
2. Settlement Pattern
6. In the 1800s, travel across central Paris was difficult because the street pattern had
evolved during the Medieval period and was designed for use by pedestrians, or by people
riding on horseback. People with carriages often had to use the boulevards that circled the
city in order to traverse it. The maze-like street pattern, in combination with open sewers
and high population density, induced Napoleon III to hire Baron Haussman to change the
overall morphology of Paris. While Napoleon III wanted to improve Paris, he also wanted to
demonstrate the efficiency of his administration and employ the many young unemployed
Parisians to reduce social discontent.
7. Haussman had a dramatic impact on Paris. He changed the morphology and

functioning of the city in the following ways: (1) removal of many tenement areas that had a
E1_1
history of insurrection or could be barricaded, (2) the razing of much of Île de la Cité except
for a few key monumental buildings, (3) removal of the inner wall of Paris in order to extend
the city to the outer fortified wall, (4) creation of long straight boulevards to showcase military
strength and move artillery, (5) use of radial street design from certain foci (e.g., Arc de
Triomphe) in order to highlight key monuments, (6) provision for a new water supply system
and (7) construction of an enlarged sewer system. Later, the Boulevard Péripherique was
built on top of the outer set of Paris’ fortified walls, and fully encloses the central city.
8. In the 1950s, Paris experienced a boom in demand for office space. To meet demand,
a series of historic buildings were pulled down and the sites redeveloped. However, since
the 1960s, the core of Paris has had relatively strict preservation policies in place. The
Parisian government first identified La Défense, situated as a continuation of the Champs
Elysées, as the new target area for business development. This successfully dampened
some of the development pressure on downtown Paris. However, other solutions were
needed, including the designation of other business districts and the creation of the five new
towns (satellite cities ringing Paris). La Défense was considered a success because it
redeveloped brownfields with post-industrial activity. Because of its central location, La
Défense continues to reinforce central Paris as a business focus.
9. The Boulevard Péripherique is roughly circular (Fig. 1). As such, it permits enormous
volumes of traffic to be deflected around the central city rather than enter it. Outside the
Boulevard Péripherique, the urban landscape starts to loosely resemble the sprawl of North
American suburbs. Densities fall dramatically, and travel by automobile becomes more
important. The central city is the tourist area, but 80 percent of Parisians live outside the old
city and the same percentage works outside. Many tourists, in fact, never get outside the
Boulevard except when they land at one of Paris’ airports.
Figure 1: Boulevard Péripherique

10. Concerning spatial structure, perhaps the most important lesson learned concerns
Paris’ employment of new towns to redirect population growth out of the central city. The
development of new towns in the London area is recognized as a failure in post-World War II
England. While Paris’ 1956 plan was inspired by the Abercrombie plan for London, it was
improved with specifically French details that permitted it to work: in particular, the ability of
government and private industry to enter into partnerships. Nevertheless, aware of London’s
problems, the plan was overhauled in 1965 and a new corridor for development was
identified (Paris to Le Havre, to maximize the opportunity for container-ship trade).
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Figure 2: Population Densities in Ile de France (showing locations of New Towns in red),
1962
Source: calculated by Chreod Ltd. from data provided by IAURIF (2002)
Figure 3: Population Densities in Ile de France (showing locations of New Towns in red),
1999
E1_3
3. Strengths and Weaknesses

A. Economic Context
11. France is the world’s 4th largest economy after the US, Japan and Germany. Both
France and the UK have similar populations and similar GDP’s at around US$ 1.5 trillion per
year. Until 2002, when the global economy slowed, the French economy had experienced
four years of solid growth, which saw its unemployment rate fall from 12% to below 9%. The
French government continued to fund venture-capital projects by facilitating high-tech start-
ups, and the resulting job growth buffeted employment. However, national unemployment in
France is widely considered high for Western Europe, particularly for individuals under 25
years of age (over 20%).
12. Paris is the economic center of France, with an average salary 40% higher than the
rest of the country. The on-going investment in transportation linkages plus the city’s urban
planning orientation towards high density continue to provide Paris with a variety of
economies of scale. In-migration from the rural regions is on-going and the migrants need to
be housed, fed and employed.
13. Two fundamental economic trends have been dominant in Paris over the past few
decades: (1) the sectoral shift in employment away from manufacturing to services, and (2) a
decentralization of industrial and commercial functions to the periphery (although the
decentralized functions maintain their connections to the regional economy). Between 1964
and 1984, the Paris economy lost an estimated 200,000 manufacturing jobs.
14. After Tokyo, Île-de-France is the world’s second most concentrated location for the
globe’s 500 largest corporations. In other words, Paris is ahead of London, New York and
Chicago for transnational headquarters. La Défense, Paris’ central business district, is the
largest in Europe, and Paris ranks as the globe’s 4th largest hub for financial transactions.
15. Paris has 100 million consumers within a 500 km radius. It is an apex in Europe’s
Golden Triangle (London-Paris-Berlin). The city’s relationship with the rest of the Golden
Triangle is cemented by high-speed rail links and high-density communication corridors.
Paris is connected to London, Belgium, Amsterdam and southern France by high-speed rail
links called the TGV.
B. Population
16. Like London, young people tend to migrate to Paris and retired people tend to leave.
Population growth tends to be highest in the suburbs, as opposed to the central city which
consistently lost people in the 1990s.
17. Paris has the most highly educated workforce in France with 37% of the 20-59 year old
age bracket being university graduates, as compared to 26% for France as a whole. Overall,
France’s level of educational achievement at the baccalaureate level is comparable to the
US.
18. Immigrants to France comprise nearly 20% of Paris’ population. The largest
nationalities involved are North African (Algerian, Moroccan, and Tunisian), but there are as
well large groups of Indochinese communities from previous French colonies.
C. Environment
19. In theory, water provision (plus waste water and garbage collection) in France is the
responsibility of the mayors of the communes. In practice, the communes amalgamate to
form inter-communal bodies that deliver these services collectively. These services are
usually delivered by private companies, two of which supply more than 60% of France’s
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drinking water and 40% of water collection.
20. Regional and departmental councils are also involved in the delivery of water-related
services. Both levels subsidize inter-communal bodies in the delivery of expensive water and
wastewater treatment facilities, as well as implementing plans and infrastructure intended for
flood control and irrigation. The councils of the departments are also empowered to protect
wetlands by using special taxes to purchase sensitive areas. As well, they can provide
technical advice and financial means to support the inter-communal bodies to maintain
and/or improve river banks.
21. Paris has an extensive sewer system that achieves efficiencies by using a small
number of large wastewater treatment plants rather than a large number of smaller plants.
However, overflows after major storms continue to be a problem. Finally, low tide or low
surface levels during the dry season increase the offensiveness of poor water quality.
22. The Île-de-France region has preserved 75% of its area as woodland or rural areas,
and more than 50% of the region is maintained for agriculture. In fact, Parisian planning has
recognized the importance of a network of greenspaces since at least the 1970s. The 1976
regional plan for Île-de-France set out a hierarchical network of natural spaces that extended
from the centre of Paris to the outskirts. However, the 1973 goal that 10 m2 of local park per
person was to be provided has still not been achieved. As well, industrial contamination
remains an issue throughout Île-de-France, where 3000 to 6000 contaminated sites are
found in each of the departments.
D. Transportation
23. The transportation system of Île-de-France integrates air, water, road, rail and cycle
modes within a comprehensive framework. Futher, investment in the high-speed trains (the
TGV) has helped to integrate the French hinterland with Paris, and Paris with the Golden
Triangle.
24. Transportation is clearly a regional responsibility in France. In the Île-de-France region,

transportation is the responsibility of the Syndicat des Transports d’Île-de-France (or STIF).
STIF is a public body composed of representatives of the central government, the regional
council and the eight departments. STIF’s mandate is the entire Île-de-France region. It
plans and approves all regular routes, contracts with the operators, plans new services, sets
fares, coordinates all of the transport companies, and pays participants. Transportation
services are provided by 80 companies that are chosen and regulated by STIF. Two of the
companies are publicly-owned monopolies, and the rest are private companies. The most
significant operators are:
• RATP (Régie Autonome des Transports Parisiens). RATP looks after the
subway, some heavy rail lines, tramways, and over 310 bus lines. RATP’s
relationship with STIF is executed through service contracts;
• SNCF (Société Nationale des Chemins de Fer Français). SNCF is responsible
for the high-speed heavy rail links plus many suburban rail links tying into the TGV;
• OPTILE. OPTILE is the federation of nearly 80 private bus companies that
service the outer ring of Paris. The service contracts are awarded in
perpetuity, unless STIF decides otherwise and compensates the company for
any loss of revenue.
25. Growing patronage of STIF services since 1975 indicates that Ile-de-France has
largely met its transportation challenge. Its success has been the result of a number of
factors, including the following:
• giving STIF the legal authority to impose fares and schedules on its service
providers;
• financial independence via the Transport Tax (a tax paid by all employers with
more than 9 employees), subsidies from members, and revenues of road
E1_5
traffic fines paid by car drivers;

• STIF has always compensated service providers for any schemes that
caused the loss of revenue, thereby creating goodwill and respect; and
• the fact that the two largest companies are state-owned, and subject to the
National Assembly.
E. Regional Governance
26. Originally created in 1955 to provide a framework for regional town and country
planning, regions later became local authorities in 1982.
27. Regional governments (and the Île-de-France government in particular) have wide-
ranging jurisdictions in town planning; economic development; vocational training; transport;
construction, funding and maintenance of secondary schools; environment; culture; and
international actions.
28. Some of the strongest lessons learned from the French governance experience are
demonstrated by new hybrid organizations created in 1963. DATAR (Délégation à
l'aménagement du territoire et à l'action régionale) is the region’s town and country planning
and regional development agency. They are the national government’s instrument at the
regional level. These agencies target development for tourism, and for industrial and urban
development. Simultaneously, the Interministerial Committee on Regional Development
(CIAT) decides on objectives and takes decisions concerning regional development while
the Regional Development Fund provides financing for development initiatives. Other
partners, including other local authorities and private industry also contribute to the process.
Partnerships are critical to the success of regional planning in France. After 1964, DATAR
played a pivotal role in reducing the dominance of Paris by encouraging the development of
new towns (not only in Paris, but also in Lille and Lyon). Businesses wanting to do business
in the central Île-de-France region require authorization from DATAR and face considerable
financial disincentives for doing so.
29. Decentralization legislation adopted in 1982 and 1983 ensured that regions became
fully-fledged local authorities. The regions now prepare detailed regional plans, partner with
the central government and ensure that their plans recognize the directives of national plans.
Planning ‘contracts’ that are derived from the implementation strategies of regional
government are co-financed by a variety of agencies other than the central government: the
regional authorities, the national regional development fund and, in some cases, even the
European Union.
4. Policy Lessons
A. Imposition of flat area-wide business taxes
30. In 2000, flat tax rates for businesses were imposed across entire metropolitan areas in
order to reduce local competition for businesses through tax cuts—and to increase
cooperation among sub-metropolitan entities. Leveling the playing field among municipalities
remains important in France.
B. La Défense and State Intervention in the Property Market
31. France has a long history of intervention in the property markets of Paris. La Défense,
being large (750 hectares), did not grow as predicted until the government began to severely
restrict redevelopment in inner Paris, impose differential taxing to dissuade businesses from
wanting to locate in the CBD, and provide financial incentives. Another part of La Défense’s
success relates to the creation of a solitary agency to manage the land. The EPAD agency
(l’Etablissement Public d’Amenagement de la region de La Défense) was a public body that
worked closely with private companies to develop La Défense. They owned the land and
were empowered to purchase more land, expropriate land, and bank it. They acted as
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intermediaries between companies and the banks, and controlled all urban design and site
planning decisions. The agency assembled the developers, the companies and the tenants.
Ultimately, EPAD is subservient to the French government and decisions affecting La
Défense were often made by France’s president. Other reasons for the success of La
Défense include: designation of a growth pole with special development laws different from
downtown, intensive transportation development, allocation of considerable resources for
purchase and expropriation of property, and retention of its historical basis (i.e., La Défense
is so called because of a memorial dedicated to the defense of Paris during the Franco-
Prussian War).
C. Development of New Towns
32. After World War II, France realized that there were serious regional imbalances in
wealth and development across the nation, and growing pressures on Paris. To address this
regional imbalance, the government set up the regional development agency - Direction de
l’aménagement du territorie - in 1949. One of the strongest lessons learned from Paris
concerns the success of their new towns program. Figure 3 illustrates the government’s plan
for establishment of the new towns, last updated in 1994.
Figure 4: Regional Development Strategy for Paris, 1994
33. In concept, 6 new towns for approximately 500,000 people each were to be built on the
edge of the built-up area of Paris. In reality, only five were implemented, although
development of business nodes at La Défense, Saclay and Roissy were also facilitated. The
new towns were to be constructed on existing transportation corridors and were to be served
with new high capacity road links and the TGV. Innovative techniques employed in the
implementation of the new town plan include the following:
1. Joint ventures between government and private industry. The government

would provide the secondary and tertiary systems in the new towns, but new
construction was to be the responsibility of the private sector.
2. A system of development fees and financial incentives to encourage
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decentralization of both existing and new economic activities. For example,

relocation bonuses were made available to firms moving out of the core and
higher exactions were imposed on new firms selecting a core location.
3. Industrial jobs were clearly favoured in the establishment of the new towns and
all outlying areas.
4. In order to stop the conversion of apartment buildings into offices in the core, La
Défense was conceptualized as the new commercial anchor for the downtown
and was located on top of the intersection of many of the commuter rail routes,
ensuring good accessibility for the new Central Business District.
5. Aggressive construction in La Défense more than doubled existing office space
in central Paris.
6. A centralized coordination agency, the Central Group for New Towns,
administered La Défense and the new towns, thereby providing an integrated
regional planning function. The Central Group answered directly to the Prime
Minister, and integrated the many disparate actors in France responsible for
new construction.
7. A Public Development Corporation (EPA or Établissement public
d’aménagement) was established for each project. The EPA purchased land,
constructed the infrastructure, and negotiated land sales to private developers.
8. The private construction of each new town was financed by six- to twenty-year
below market rate loans from the Central Bank.
9. National legislation permitted the EPAs to freeze land prices in each
development area and therefore phase land purchases to avoid a financial front
loading of the project. The area for the new town was mapped, and land prices were
frozen for eight years (extendable to 14 years) at a base value equal to fair
market prices one year prior to the designation of the New Town. The EPA then
purchased the land as it required it at the base price plus an increment to reflect
inflation. In order to introduce flexibility for new firms considering the area, the
designated New Town zone was three times the overall anticipated size of the
New Town.
10. During construction, the rights of the local governments involved were
suspended and overtaken by the EPA. Once completed, lands in the EPA were
returned to their jurisdiction and taxes could be collected (often after a tax holiday
for the new firms).
11. The integration of profitable higher-end uses like offices and market-rate
housing with social housing. Private investors were given many incentives to
include social housing in their plans, including the following: no permitting fees (e.g.,
no development fees, no permits to pay for); construction grants of up to 25%; five-
year exemptions from local property taxes; eligibility for other tax breaks like
accelerated depreciation; and extremely low public mortgages were made
available to encourage tenancy of the built projects (Vigier, 2001).
34. The new towns have been successful, judging by their growth over the last 40 years
(Fig. 4), and population pressure on central Paris has consequently been reduced. New
town populations have grown by factors of 6 to 10 over the period.
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300,000
252,532
250,000
200,000
179,346
population
150,000 142,737
107,405
100,000 93,069
79,726
69,928 69,366
49,777
50,000
36,237
29,289
22,498
15,032 12,317
6,007
-
Cergy-Pontoise St. Quentin-en- Evry Senart Marne-La-Vallee
Yvelines
1962 1975 1999
Figure 5: Change in New Town Populations, 1962-1999

5. Conclusions
35. The purpose of this case study was to explore how secondary cities and adjacent
regions have captured spillovers from a metropolitan region’s economic growth. Without
doubt, Paris has had an enormous economic influence on cities and regions on its periphery
and beyond. Part of this success is the result of the city’s demographic and economic
dominance, but strong government action to decentralize population and economic activity
has played a major role. The national government and the Ile-de-France regional
government have intervened massively to influence the settlement pattern. They have
constructed major transport axes based on road and rail, orchestrated development of large
employment nodes, and built new towns that succeeded in diverting some of the pressure
form central Paris. However, this development has occurred within a 50 km radius of central
Paris, notionally a one hour drive time. If similar, decisive actions were replicated by Beijing
and/or Tianjin (which current Master Plans do not call for), spillover benefits would likely
accrue only over a 10-20 year period, and would be limited to the administrative territories of
each provincial-level municipality. Spillovers to Hebei (Langfang, Zhuozhou, Gaobediean)
would likely be minimal, at best, since both Beijing and Tianjin have considerable
undeveloped territory which market forces would tend to first develop.
E1_9
REFERENCES/FURTHER READING
Arbonville, Denise, Elise Palomares and Patrick Simon. 2000. Comparative Statistical Analysis At the National, Metropolitan,
Local and Neighbourhood Level. URBEX Series, No. 3. Available from: http://www.frw.uva.nl/ame/urbex/.
Bergman, Barbara. 1996. "Saving Our Children from Poverty: What the United States Can Learn from France". New York:
Russell Sage. Available from:http://www.osservatorionazionale famiglie.it/documentazione/costodeifigli/bergmann.pdf.
Burgel, Guy. New towns. [Les villes nouvelles.] Espace, Populations, Societes, No. 2, 1986. 25, 377-84 pp. Villeneuve d'Ascq,
France.
Cohen, Jeanine, Elisabeth Decoster and Muriel Tabariés. 2001. Urban Area, Technopolitan Spaces and Innovative Firms: The
Dynamics of Innovation. In: Innovative Cities. James Simmie (ed.).
Gurfinkel, Michel. 2000. “Case Study: France and the New Economy” in Valeurs Actuelles, September 28, 2000. Downloaded
from www.oecdobserver.org on May 16, 2003.
IAURIF (Institut d’Amenagement et d’Urbanisme de la Region d’Île-de-France). 2002. Growth Sectors/Cluster in Dublin,
London, Paris and Rhine/Ruhr: Synthesis and Recommendations. DIT (Dublin Institute of Technology) and IAURIF, Paris.
Metropolis. 2003. Available from: http://www.metropolis.org/Metropolis%5Cgcities.nsf/
HeadingPagesDisplay/EuropeParisAbout+Paris?OpenDocument.
Ministère des Affaires Étrangères. (2003). The State and Political Life: The Institutions. Available from:
http://www.france.diplomatie.fr/france/gb/instit/instit05.html.
Petit, Thierry. 2003. The Socio-Economic Profile of Paris. Cahiers de L’IAURIF No. 135. IAURIF, Paris.
Savitch, H. 1988. Post Industrial Cities—Politics and Planning in New York, Paris and London.
STIF. 2003. Integration and Regulatory Structures in Public Transport: Case Study-Paris-Île-de-France. Available from:
www.emta.com/fichiers_divers/ Surveys_Paris_case_study.pdf.
TGV Web. 2003. From: http://mercurio.iet.unipi.it/tgv/jpg/tgvgeomap.jpg
Thibault, Christian. 2000. Paris/Ile-de-France—For a Sustainable Environment. IAURIF, Paris.
UN (United Nations). 2001. Cities in a Globalizing World: Global Report on Human Settlements. New York: United Nations
Centre for Human Settlements.
Vigier, Francois. “The Paris Regional Plan and the New Towns.” Executive Seminar on Urban Planning and Local Economic
Development. Iasi, Romania. March 20-23, 2001. From:
ttp://www.gsd.harvard.edu/research/research_centers/cuds/upled/11_2.pdf.
World Bank. 2003. Guangdong Pearl River Delta Urban Environment Project. Appendix 12: Wastewater Management—
Selected Case Studies.
E1_10
E2: Case of Randstad, The Netherlands
Managing Regional Development

Chreod Ltd.
Case Study E2: Randstad, The Netherlands 16 February 2004
1. Introduction
1. At the core of the Netherlands is the Randstad Region. The rest of the country is the
periphery. The Randstad consists of four urban areas - Utrecht, Amsterdam, The Hague,
and Rotterdam-Europoort - surrounding the so-called green heart of the Netherlands: While
sometimes referred to as a ring city or rim city (a direct translation of the Dutch word
randstad), the literature also calls the agglomeration a horseshoe—starting at Utrecht and
then circling through Amsterdam, The Hague, and ending at Rotterdam-Europoort. In the
middle of the horseshoe is a huge swath of protected green land. The Randstad Region
covers an area of approximately 6,000 km2.
2. Much of Holland lies below sea level, and reclaiming land from the sea has been an
on-going historical process. The two technologies that permit land reclamation are polders
and dikes. The polder is the piece of land created by draining water from an area. The
process is simple: a wall or dike is built to encircle an area, and trapped water is pumped
out. Windmills traditionally fulfilled this function in the Netherlands, but have been largely
replaced by modern engines. Once dry, the polder is prepared for human activities. To the
benefit of Dutch agriculture, the land in polders is often highly productive.
3. Dutch tradition asserts that these areas are relegated to agricultural uses, although
Schipol Airport is located in a polder. All of the Randstad cities are adjacent to enormous
tracts of reclaimed land. The Green Heart, as well, has land reclaimed between 1600 and
1900, particularly between Amsterdam and Rotterdam. The Green Heart emerged because
the horseshoe-cities were built on higher ground—along the dunes in the west; the
Pleistocene sands in the east, and along the banks of rivers. Dikes are walls that prevent
the entrance of the North Sea into the reclaimed land. In fact, dikes have been built
throughout the outer rim of the country facing the North Sea.
4. The horseshoe-shaped Randstad Region has four urban anchors.
5. Utrecht. Utrecht’s history is ancient, as the city was a fortified Roman settlement
around 48 BC. The city is located along branches of the lower Rhine River. While first settled
as a fortress, the city became an Episcopal See in the 690s A.D. The city was home to many
early Germanic emperors, and it was chartered in 1122. With the protection of the church
and the Holy Roman Empire, the city became the capital of an important principality and a
medieval ecclesiastical, cultural, commercial, and industrial center. However, it lost much of
its dominance as Amsterdam benefited from its coastal and port activities in the Middle Ages
and later.
6. Amsterdam. According to the Dutch Constitution, the King or Queen is to be crowned

in the capital of the Netherlands, Amsterdam. This constitutional fact recognizes the
importance of the largest city and historical economic engine of the country. However, The
Hague is the seat of government and the location of the residences of the Dutch Royal
family. So, in effect, the Netherlands is one of the world’s few countries with two capitals.
7. Amsterdam started as a tiny fishing village called Amsteldam, because it was located
at a dam built across the Amstel River before 1275 A.D. Amsterdam is known for its canal
system, and the fact that the city lies about 4 meters below sea level. The canal system was
initially dug as moats around historical city walls, and later developed as a system of
waterways that made it possible for people to travel by boat around the inner city. More than
one thousand bridges integrate the city.
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Figure 1: Randstad Functional Urban Region

Source: IAURIF 2003
8. The Hague. The Hague is the seat of government. The original Dutch name of the city
is s-Gravenhage, which means the count's private dominion. The counts of Holland had a
hunting preserve here in the 13th century, which is about 6 km inland from the North Sea.
The heart of the city is the quadrangle of government buildings known as the Binnenhof, or
Inner Court. The Hague is a service town, and industry is sparse—although several
headquarters for petroleum companies are located here. Like other Dutch cities, the fortunes
of The Hague rose and fell. The city was a focus for diplomatic relations in the 1600s, but its
importance declined under French rule. Then, after becoming the capital, its fortunes rose.
The headquarters of the multinational firm Dutch Royal Shell are located here. The city
currently has an international presence due to its capital functions, as the center for the
European Union Police (Europol), and home to the International Court of Justice.
9. Rotterdam-Europoort. The settlement of Rotterdam is medieval in origin (chartered in

1328). Currently, Rotterdam-Europoort is considered to be the world’s busiest port system
and the world’s largest dredged harbor. Rotterdam is the second largest city in the
Netherlands after Amsterdam and is located in the province of South Holland. The city’s
wealth is based in industry: petroleum, sugar refining, distilling, chemicals and shipbuilding,
in particular. Like The Hague, Rotterdam was badly damaged during World War II. Much of
the central city and more than a third of the port's equipment was destroyed by the Germans.
A totally new inner city was planned and rebuilt by the 1960s, and the port was expanded.
E2_2
Rotterdam had the first subway system in the Netherlands, built in 1968. Europoort is a large
supplementary harbour area constructed in the 1960s—primarily for the unloading and
storing of oil from large tankers.
10. Generally, the northern wing of the Randstad (Amsterdam and Utrecht) is service-
oriented—which is consistent with the historical profile of these cities over the centuries. The
southern wing (Rotterdam-Europoort) is characterized by its manufacturing and transport-
oriented economy. The presence of higher-level educational institutions in the northern wing
also propels it into the New Economy, while the southern wing (including The Hague) has
demonstrated a lack (although not absence) of these institutions.
11. The population of the Randstad was 7.2 million in 2003, representing about 46% of the
total Dutch population. Population density averages 1,143 people per km2, high even for
Holland, which is one of the densest countries in the world. GDP per capita in 2003 was
25,114 Euros. The Randstad ranks 5th in Europe as a centre for international organizations,
4th as a centre for headquarters of European organizations, and 3rd as a centre for
headquarters of Europe’s 500 largest corporations.
12. The Randstad Region is not a metropolis in the traditional sense. Rather, it is a
polycentric urban region involving four large cities: Utrecht, Amsterdam, The Hague, and
Rotterdam-Europoort. Each of the cities has its own strengths and comparative advantages,
and spatial planning has done much to improve the region’s functionality and integration
through transportation corridors and communications infrastructure.
13. Each city has specialized as follows:
• Utrecht is where the Dutch rail network converges, and is a major university town
and convention centre.
• Amsterdam is the centre for cultural production, banking, finance, commerce and
luxury trades like diamonds, clothing and art. It is the focus of air transport with
Schipol International Airport.
• The Hague is the centre of government, administration, international institutions and

the civil service.
• Rotterdam-Europoort is the centre of shipping, and oil production and refining. The
area also supports shipbuilding and manufacturing, including alcohol, glassware, and
chocolate.
14. The most interesting question with respect to the Randstad and similar polycentric
regions is: why did one city come to dominate England and France, while the Netherlands,
Belgium (e.g., the Flemish Diamond) and Germany (e.g., the Rhine-Ruhr) developed a
number of urban centers where no one city dominates? The answer is complex. When
compared to England and France, Germany and the Benelux countries are newer political
entities. This means that any consolidation of political power is, by definition, more recent.
As well, northwestern Europe “is home to an old urban culture with local patrician elites
reluctant to succumb to the centralized authority of the state” (Dieleman and Faludi, 1996:
325). Secondly, the entire area, when mapped at a continental scale, reveals uniformly high
densities of population. Polynucleation is the inevitable path barring dramatic growth in one
pole.
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A. Economic Context
15. The comparative advantages of the Netherlands in general and the Randstad in
particular are related to location, agricultural productivity and petroleum. As such, important
business sectors include the following: the cluster of transport and logistics; agriculture,
horticulture and related agro-industry; and petrochemicals. The Randstad Region has
proved to be very successful in attracting foreign businesses, particularly distribution centres
and European headquarters of foreign firms. The Netherlands ranks third in the world for
agricultural exports behind the US and France.
16. Like other urbanized areas across the globe, manufacturing contributions to
employment have consistently been falling. Services have picked up the slack, rising from
53% of employment in 1960 to 76% in 1990. Though agricultural employment is small,
agriculture remains important economically due largely to certain specialized Dutch
agricultural products.
17. The Randstad Region is home to 70 percent of the head offices of the 100 largest
Dutch companies, 65 percent of research and development activities and high-tech
companies, 93 percent of foreign services, and 80 percent of foreign enterprises. The
Randstad has 7 million inhabitants (approximately 45% of the Dutch population) and over
50% of the jobs, on only 20% of the land.
18. Though none of the four Randstad cities can compare in size, economic strength, or
political influence to world cities like London, New York, Tokyo and Paris, some analysts
suggest that the Randstad as a whole represents a new type of world city—the regional
world city. “None of the Dutch urban centres, despite their strong international orientation,
can meet alone the specifications of the world city concept” (Shachar, 1994). But, in
combination, there is little doubt that they function as a major node in the global economy.
19. Though Holland has an advanced and healthy economy, economic growth has slowed
in recent years. In 2003, Dutch economic growth was negative, even though the economy of
the European Union grew by 0.7 percent. This makes Dutch performance comparable to
such European countries as Germany and Portugal, and compares unfavourably to growth
rates in the U.S. and Japan.
B. Population
20. The population of the Randstad was 7.2 million in 2003, and the populations of the
component urban sub-regions were: Utrecht 558,031; Amsterdam 1,427,846; The Hague
883,857; and Rotterdam 1,192,886
21. Approximately 62% of the Dutch population is between 20 and 65 years old and only
25% are younger than 20. The birth rate has been dropping dramatically since 1970, but the
net gain through migration (the number of immigrants minus the number of emigrants) has
risen since the 1960s.
22. Until the 1960s, the Netherlands was a country that people tended to leave. However,
this situation has changed and in-migrants (including re-migrants) from former Dutch
colonies and protectorates account for much of this activity: Suriname, the Antilles,
Indonesia, and Aruba. Migration from the Mediterranean areas and asylum seekers also
constitute important cohorts. There are nearly a million foreign nationals living in the
Netherlands, and these are concentrated in the larger cities of the Randstad Region.
C. Education
23. The educational level of the Randstad population is higher than the national average,
with a greater proportion of higher education graduates (30%). The residents of the
Randstad Region are highly educated in a way that is not only disproportionate to the rest of
the Netherlands, but also to most of Europe. Since the educational level of the Randstad
E2_4
population is higher than the national average, and since universities are clustered within the
region, the Randstad is the obvious Dutch choice for concentrating investment in the high
technology industry and other quaternary services.
24. Another important characteristic of the Dutch educational profile is the stress placed on
language. Many Dutch people are bi- or tri-lingual. In a world where the global language of
commerce is English, this is an important consideration, particularly when recognizing that
the Randstad Region is the location of more business headquarters than any region in
Europe except London. Capabilities with language establish a foundation for comparative
advantage in a poly-lingual continent and participation in the global economy.
D. Transportation
25. Transportation networks are a key to the success of the Randstad Region. The figure
below reveals the highly integrated nature of the Randstad transportation infrastructure, both
road and rail. In particular, the preeminence of Utrecht as the core of the rail system and
Amsterdam as the core of the motorway system are evident. Schiphol Airport, one of
Europe’s largest, is found in Amsterdam and the world’s largest port is located in Rotterdam.
26. Until recently, the Dutch employed a funding formula with a modal split of 50-50
between road and rail infrastructure. This ratio led to the decline of rail, and the Dutch
responded by increasing the investment in rail, and the connections between rail and other
forms of public transit. Improved high-speed rail connections to Brussels, Germany and
Paris, sea connections to London, and other rail connections to Cologne, Maastricht and
Hamburg are underway.
27. Holland is almost unique in Europe in the importance of the bicycle as a means of
transport. In the Randstad, one out of four trips is taken by bicycle. In fact, bicycle use in the
Randstad increased between 1980 and 1990, and annual growth rates for car purchases are
actually falling in the Netherlands. The central government has recently put road pricing into
effect, which will charge commuters for using high-volume roads during rush hour. Plans to
extensively expand the road network in the Randstad Region have been abandoned.
Figure 2: Inter-city Transportation, Randstad 2000
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E. Environment
28. The delta of the Rhine near Rotterdam is a highly ecologically diverse area. The
Randstad is surrounded by lakes and wetlands that lie on the routes of many migrating bird
species. Enclosed within the large cities of the Randstad is the Green Heart of the
Netherlands, which is a thick, wet layer of peat developed over time in the many river deltas
of the area. Unlike other large metropolitan area where greenspace is at the outskirts of
town, the Green Heart is an interior enclave accessible to all residents of the Randstad
Region.
29. The need for ecological rehabilitation has become a priority for the Netherlands since
most of its hydrological resources are degraded. After all, since it is below sea level, much of
the country does not experience natural contaminant flushing.
30. The primary functions of the Rhine River provide some insight into its high levels of
pollution. First, the Rhine is Europe’s most densely traveled shipping route. Second,
enormous components of the European industrial complex are located along its route,
particularly in the Ruhr and Main areas. Third, major pharmaceutical companies are located
within the Swiss and Bavarian lengths of the rivers. And fourth, energy production in the form
of hydropower and nuclear power reside within the basin and tap into the river’s hydrological
resources. These realities impinge on the potential of returning the Rhine River to its original
integrity. Yet, there are river improvement programs in the works that address these issues.
31. Air pollution is important to the Randstad Region for a variety of reasons: it impacts
regional health, it affects regional productivity, it damages the natural ecosystems of the
Netherlands, it tarnishes the image of the region, and importantly, it seriously compromises
agricultural productivity. Of all of the European Union countries, the Netherlands has the
largest relative gap between current CO2 emissions and the Kyoto targets.
32. In the Netherlands, the main source of nitrogen dioxide is traffic. Consequently, most
measures taken by municipalities are related to transportation. Without exception, the
highest levels of ambient air contaminants experienced in the Netherlands are measured in
the Randstad Region.
F. Governance
33. Although not a federal state, the Netherlands gives a large amount of autonomy to its
12 provinces (each of which has an appointed governor and elected council). The Randstad
Region is not an autonomous region under the national government in The Hague. The
region has no official status, no mayor and no municipal council to direct its undertakings.
Four provinces are involved in governing the Randstad - Utrecht, Flevoland, North Holland,
and South Holland.
34. The central government plans for the Randstad Region, rather than any regional body.
Not surprisingly, it can be argued that any regional body covering the Randstad Region
would be so powerful that it could compete directly with national governmental functions.
The provinces do cooperate with respect to infrastructure and environmental protection, but
maintain their own autonomy. “To date, regional authority in the Randstad is elusive, and the
national government tends to take that role for the region, although it does so with
considerable input from provincial and municipal governments” (Smith, 1999).
35. The evolution of the Randstad Region is marginally weakened by a fragmented

governmental system. To some observers, it seems that the north and southern parts of the
Randstad are becoming increasingly separate subsystems of policy-making. New initiatives
like the Delta Metropolis Coalition and the Bureau Region Randstad still have to prove their
efficiency and effectiveness.
E2_6
4. Policy Responses
A. Regional Planning and Policymaking
36. Planning in the Netherlands is a central cultural institution. It is physical and spatial
planning that has been the most instrumental in shaping urban growth, development and
urban form. The need for industrial location policy in the immediate post-war period set the
stage for the centrality of planning in the Dutch model. The national planning system
involves all three levels of government. The national government sets policies and principles,
the provincial governments prepare statutory structure plans, and the local governments
prepare land use plans. Dutch governance has developed an extensive network of co-
ordination between physical planning at the various levels.
37. A number of national urban policies have shaped spatial structures in the Netherlands.
Following World War II, the priority policy concerned industrial location. Later, concern for
deconcentrating people from Western Holland became the priority, and still later, housing
policy came to dominate. “From the late-1960s until the end of the 1970s a concept of
‘deconcentrated concentration’, in which overspill from the largest cities was to be contained
within a city-region framework, was the overall strategy. Subsequently, national policy aimed
at controlled overspill dispersal through the designation of 15 growth centres, and although
that policy was very short-lived and replaced by a ‘compact cities’ policy in the 1980s, the
centres were given until 1990 to achieve their population targets” (Smith, 1999).
38. Growth since 1980 is taking place along 3 axes: between Amsterdam and the coastal
city of Haarlem; one involving Utrecht which will eventually connect with Amsterdam; and
one along the south which connects Leiden, The Hague, Rotterdam, and Barendsrecht. New
Town developments have tended to reinforce these connecting axes in order to capitalize on
existing infrastructure. This supports the policy of concentrated deconcentration. This spatial
planning policy has also been called urban containment, since its motive was to protect the
Green Heart from sprawl.
39. Housing development in the Netherlands involves government participation to an

unprecedented degree. As such, government subsidies are able to guide housing
development. Much of the land, having been reclaimed from the sea, is under government
rather than private jurisdiction. Nearly 95% of housing development in the Netherlands
proceeds with government subsidy and this often includes up to 50% of construction costs.
Its close involvement with land and housing provides the government with another policy
lever to affect urbanization patterns.
B. Delta Metropolis
40. Several initiatives to encourage stronger regional identity and better governance have
emerged. A bottom-up association of both public and private actors resulted in the
foundation of the Delta Metropolis Association in 1998. The Fifth National Memorandum on
Spatial Planning (2001) introduced the Delta Metropolis concept to the national government.
C. New Economic Activities
41. The Dutch population is characterized by a number of factors that have a direct impact
on the development of the New Economy. The proportion of companies offering their
employees training has grown considerably in the Netherlands, and the country ranks 3rd in
the European Union on spending on human capital development. Spending levels on
research and development are above the European average, but fall below the OECD
average. Education levels and language skills are high compared to most parts of Europe.
“The relatively good position of the Netherlands in the EU is mainly caused by the large
contribution of the government that extensively supports R&D expenditures in research
institutes and universities” (Lalta et al., 2002).
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D. Environmental Initiatives
42. A variety of Rhine-based strategies have been generated for the Netherlands to both
improve water quality and flood control. There has been a movement away from engineering
measures to those involving increased storage and discharge capacity by modifying the land
uses in flood plains. The Rhine 2020 program, for example, is based on the sustainable
development of the Rhine and involves strategies based on flood prevention and protection,
water quality improvement and groundwater protection.
43. In June 2001, the European air quality directive was implemented by the publication of
the Dutch Air Quality Decree. The European air quality directive sets strict limits for sulphur
dioxide, nitrogen dioxide and oxides, particulate matter and lead in ambient air. In the
Netherlands, the most important variables are nitrogen dioxide and particulate matter
because the exceeding of these annual limit values is considered particularly problematic.
44. The Dutch air quality decree is intended to have a large impact on decision-making at
the local, provincial and national levels in the Netherlands. The national government is
expected to formulate an Action Plan for the entire country that will demonstrate how the
country is implementing measures to reduce particulate matter and nitrogen dioxide. The
provincial government, meanwhile, is to act as the intermediary between the local and
national governments. As well, local air quality reports are to be collected and analyzed at
the provincial level. If measured concentrations of pollutants exceed levels specified in the
decree, then local air quality plans have to be generated and implemented.
E. Transportation
45. The Randstad Region has been particularly forward-looking in regard to transportation.
The need to provide high quality links between the component cities was recognized early
and an efficient pattern of roads and rail exists. Recently strong emphasis has been placed
on rail transit and facilitating the already heavy use of bicycles as a means of transportation.
46. Holland has also recognized the importance of connections to other European
countries. Schiphol Airport in Amsterdam is one of Europe’s major air transport hubs, and
links to the airport from other parts of Holland and nearby countries are constantly being
improved. Rail, road, and sea links to other parts of Europe are good.
47. Its focus on public transit and bicycle use has allowed the government to abandon or
defer virtually all new roadway projects within the Randstad Region, thus saving enormous
amounts of money and avoiding the social and environmental impacts that would result from
more roads in such a high-density area.
5. Conclusions
48. The Randstad appears to be a largely successful model for the management of a
polycentric area. Each of the four cities has specialized in its comparative advantages and
the whole is integrated through economic cooperation and strong transportation networks.
The comparative advantages of location, agricultural productivity, and petroleum-related
industries have helped the Dutch make of the Randstad a “regional world city”.
49. A dense and efficient network of roads and rail lines serves the Randstad and connects
its cities. A heavy emphasis on public transit and bicycle commuting has lessened the need
to build major new roadways in the region.
50. The Randstad, however, has serious pollution problems. Since much of the land is
below sea level, there is no natural contaminant flushing, and most of the region’s
hydrological resources are degraded. The Rhine River is severely polluted, but major
initiatives are underway to improve the situation. Air pollution is a serious problem and, faced
with environmental directives from the EU, Holland has recently put in place a much more
E2_8
rigorous program of monitoring and enforcement of regulations.
51. None of the individual cities in the Randstad is able to take the lead in regional
development, and there is no regional government. Planning for the Randstad is carried out
by the national government, with considerable input from the provinces and cities.
Nevertheless, the success of the Randstad is evidence that this governance system works.
Physical and spatial planning is a central cultural institution in Holland, and its importance is
rarely questioned. Planning is fully integrated into Dutch government, and national spatial
policies have been developed and largely implemented. This largely explains why the
Randstad functions so effectively.
REFERENCES/FURTHER READING
Bakker, Marien and Hans Schmitz. 2003. The European Air Quality Directive and New Chances for Mobility Management.
Available from: http://www.karlstad.se/ecomm/papers/ MarienBakker.pdf
Batten, David. 1995. Network Cities: Creative Urban Agglomerations for the 21st Century. Urban Studies. Volume 32. No. 2.
1995. Pages 313-327.
Dematteis, Giuseppe. 2000. “Spatial Images of European Urbanization” in Cities in Contemporary Europe. Arnaldo Bagnasco
and Patrick Le Galès (eds.). Cambridge: Cambridge University Press.
De Smidt, M. 1992. A World City Paradox—Firms and the Urban Fabric, in F.M. Dieleman and S. Musterd (eds). The Randstad:
A Research and Policy Laboratory. Kluwer: Dordrecht.
Dieleman, Frans and Andreas Faludi. 1996. Randstd, Rhine-Ruhr and Flemish Diamond as One Polynucleated Macro-Region?
In Tijdchrift voor Economische en Sociale Geografie. Vol. 89. No. 3. 320-327.
Duel, Harm et al. 2003. Habitat Modeling of Rivers and Lakes in the Netherlands: An Ecosystem Approach. Canadian Water
Resources Journal Volume 28 Number 2. Available at: http://www.cwra.org/8duelAbstract.pdf
European Conference of Ministers of Transport, 2001. Implementing Sustainable Urban Travel Policies. National Peer Review:
The Netherlands. Paris: OECD.
Friedmann, J. 1986. The world city hypothesis. Development and Change. Volume 17. Pages 69-84.
Friedmann, John. 1995. Where we stand: a decade of world city research, in P. Knox and P.Taylor (Eds) World Cities in a
World System, pp. 21– 47. New York: Cambridge University Press.
Frijters, Ine and Jan Leentvaar. 2003. The Rhine Case Study. Water Management Inspectorate, Ministry of Transport, Public
Works, and Water Management, the Netherlands. Available from:
http://www.ce.utexas.edu/prof/mckinney/ce397/Topics/Rhine/Rhine.htm
Hall, Peter. 1966. The World Cities. London: Weidenfeld and Nicholson.
Hall, Peter. 1984. The World Cities. 3rd Edition. London: Weidenfeld and Nicholson.
Ham, Maarten Van, Pieter Jooimeijer and Clara Mulder. 2001. Urban Form and Job Access: Disparate Realities in the
Randstad. Tijdschrift voor Economische en Sociale Geografie. Volume 92. No. 2. Pages 231-246.
Huis, Mila van, Han Nicolaas, and Michel Croes. 2000. Migration of the Four Largest Cities in the Netherlands. Amsterdam:
Statistics Netherlands, Department of Population.
IAURIF, 2003. The Metropolises of North-west Europe in Figures. Available at
http://www.iaurif.org/en/doc/studies/metropoles_en_chiffres/randstad.htm
IHE Delft. 2003. Water, Climate, Food and the Environment in the Rhine Basin. http://www.
wac.ihe.nl/dialogue/Adapt/documents/Adapt%20Rhine%20100203.pdf
KNAG. 2001. Royal Dutch Geographical Society. Available at www.
Knapp, Wolfgang and Peter Schmitt. 2003. European Journal of Spatial Development. October 2003. No. 6.
Kreukels, Anton. 2001. Growth Management in a Comparative Perspective: Europe—United States. Contribution to the
International Workshop on “New Approaches to Land Management for Sustainable Urban Regions” at the University of Tokyo.
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Ministry of National Lnad, Infrastructure and Transport, October 28-31, 2001.

Lalta, Vinodh et al. 2002. Knowledge-based Economy 2002: R&D and Innovation in the Netherlands. Amsterdam: Statistics
Netherlands.
Manshenden, J.J. and M. de Smidt. 1992. The Northern Wing of the Randstad: Suburbia Versus the City in the Netherlands.
Netherlands Journal of Housing and the Built Environment. Volume 7. Pages 179-92.
Musterd, Sako and Ingrid van Zelm. 2001. Polycentricity, Households and the Identity of Places. Urban Studies. Volume 38.
No. 4. Pages 679-696.
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Deceive?” Built Environment Volume 15, Number 1. Pages 11-16.
Petit, Thierry. N.d. The Socio-Economic Profile of the Randstad. Chaiers de L’Iaurif. No. 135.
Placido, Elaine. 2003. Urban Sprawl and Policy Tools: An inventory of tools used by four Midwestern Cities to manage growth.
Available from: http://www.unomaha.edu/ ~wwwpa/project/placido.html
Raadschelders, Jos and Theo Toonen. 1999. Modernity and the Challenge of Metropolitan Governance: Failure of Structural
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Sassen, S. (1991) The Global City: New York, London, Tokyo, Princeton, NJ: Princeton University Press.
Scott, Ralph. 1996. Introduction to Physical Geography. New York: West Publishing Company. 1996.
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River, NJ: Prentice-Hall.
Shachar, Arie. 1994. Randstad Holland: A ‘World City’? Urban Studies Volume 31. No. 3. Pages 381-400.
Shetter, W.Z. 1997. The Netherlands in Perspective: The Dutch Way of Organizing a Society and its Setting. Nederlands
Centrum Buitenlanders: Utrecht.
Simmonds, Roger and Gary Hack. 2000. Global City Regions: Their Emerging Forms. New York: Spon Press.
Smith, Adair. 1999. Atlas of Urban Regions: The Randstad. Available from: www.mit.edu/afs/
athena/course/11/11.hkstudio/www/hkrpt99sept.pdf
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Available from: http://www.cbs.nl/en/
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UN (United Nations). 2001b. Human Development Report 2001: Making New Technologies Work for Human Development.
New York: Oxford University Press.
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E3: Case of Rhein-Ruhr, Germany
Chreod Ltd.
Case Study E3: Rhein-Ruhr, Germany 16 February 2004
There are two significant urbanization issues in Hebei Province that impact on the Province’s development: 1) the dispersed
settlement pattern characteristic of much of the Province; and 2) the fact that the area of Hebei surrounding Beijing has failed
to capture spillovers from the Capital’s growing urban economy. The case studies are designed to illustrate how such issues
have been managed in other countries. These countries are very different from Hebei Province, and caution must be used in
trying to apply their practices directly to Hebei. Nevertheless, the case studies provide ideas that might be adapted to
conditions in Hebei and help the Province address these problems.
Case studies of the Rhine-Ruhr Region of Germany and the Randstad Region of Holland are used as examples of dispersed
settlement patterns and the types of policies and programs that have been used to attempt to overcome the constraints
imposed on development by such patterns. Capturing spillovers from a nearby major urban centre are studied in two other
case studies – the Paris and Seoul Metropolitan Regions.
1. Introduction and Context

1. Germany is Europe’s most populous country and its largest economy. It remains a key
player in the continent’s economic, political and defense goals. Following World War II, the
country was segmented into West and East Germany, with West Germany following the
western development model and East Germany becoming a satellite of the Soviet Union.
East Germany did not prosper, and after the decline of the USSR in the 1980s, East and
West Germany were reunified in 1990 after extensive negotiation.
2. The intersection of the Ruhr River with the Rhine River has underpinned some of the
most densely populated areas of Germany. The Rhine-Ruhr Region falls within the German
state of North Rhine-Westphalia, one of 16 states in the country. The Rhine-Ruhr Region is
a heavily industrialized part of the country, and many industries, corporate headquarters
and emerging technologies are centred in the area. Both the Rhine and Ruhr rivers are
heavily urbanized.
3. The federal state of North Rhine-Westphalia is Germany’s economic powerhouse,

despite its on-going deindustrialization. While North Rhine-Westphalia is half the size of
Bavaria, and is only the 4th largest German state, it outranks all other states in terms of
population, and economic and political power. Thirty of Germany’s 84 largest cities are
located within it. The state owes its economic power to 3 factors:
• a wealth of mineral resources, including large coal reserves in the Ruhr area, the
lignite or brown coal of Köln-Aachen, plus salt and metal ore.
• the largest river in Europe—the Rhine.
• its long history as a center of commercial and political power in central Europe.
4. The Rhine River is the major navigable waterway of Western Europe, iron ore being
moved from Rotterdam, Holland to the Ruhr industrial complex being the major cargo. Other
major upstream cargoes are petroleum, coal, and grain. Major downstream traffic on the
Rhine is dominated by sand and gravel, and steel products. High levels of traffic headed
inland from the North Sea are significant as far as Köln. The Ruhr River flows east to west
to join the Rhine at Duisburg. The Ruhr Valley is a metropolitan industrial area that
produces petrochemicals, cars, iron, and steel. Historically, the valley is also a coal-mining
area, which jumpstarted the region’s development after the Industrial Revolution in the
1800s. The military-industrial complex of the Ruhr Valley was so central to the German
identity and livelihood that it was heavily bombed by the Allies in the Second World War,
which illustrates how crucial the area was to German commerce and to weapon production.
The total population of the Region in 2002 was 11,526,219, and is slowly decreasing.
Densities across the State of North Rhine-Westphalia were 527 people per km2, about
twice the average of other German states. GDP in 2002 was US$ 320 billion, or US$ 27,827
on a per capita basis. This gives the Rhine-Ruhr Region the 16th largest economy in the
world. However, between 1990 and 1998, GRP growth for the Rhine-Ruhr Region was flat,
indicating little if any growth.
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Figure 1: Metropolitan Areas and Agglomerations in Germany
Source: Mackensen (1999); Figure 10.1
5. Overall, as a Functional Urban Region (FUR), the Rhine-Ruhr is the 3rd largest in
Europe in terms of population (after London and Paris). Interestingly, unlike other FURs in
Europe, the Rhine-Ruhr’s population is 14.5% of the national total, but it only contributes
15.3% to national GDP. Other FURs like London, Paris, and the Randstad contribute a
substantially larger proportion to national GNP than their populations would suggest.
6. Despite the population density and wealth generation that has historically taken place
in the Rhine-Ruhr Region, the entire area is—and has been—undergoing massive structural
change. The decline of coal in the 1960s and the OPEC crisis of the 1970s hit the Rhine-
Ruhr Region hard. Many industries declined and failed to invest in new technology or to
adjust to changing markets. Hundreds of thousands of workers lost their jobs, leading to
dramatic outmigration. Many of these deindustrialization processes are still on-going.
7. The cities of the Rhine-Ruhr Region are diverse but share a powerful industrial past,
which traditionally supported the high population density and economic growth. At the same
time, a number of key issues continue to face the Rhine-Ruhr Region: its image; its
economy and deindustrialization; on-going unemployment; its transportation and mobility
E3_2
bottlenecks; and its lack of regional governance and/or cooperation among its local
municipalities.
8. The Rhine-Ruhr Region is polycentric. In the European context, this means that it
contains a number of distinct cities with no clear hierarchy. This urban system developed
around the two rivers – the Rhine and the Ruhr, and it thus takes a linear form. The major
cities are shown below:
City Population (2002) Economic base
Bonn 306,016 Previously the national capital; services

Cologne 967,940 Trans-shipment, autos, machinery, chemicals, clothing, waste
management
Dusseldorf 570,765 Provincial capital, iron, steel, chemicals, textiles, tools
Duisberg 512,030 Port, trade
Essen 591,889 Services, rail transport, chemicals, glass, precision
instruments
Dortmund 589,240 Coal, iron, steel, brewing
9. No one city dominates, and each maintains its own identity and focuses on its own
comparative advantages. The 1991 decision to move the German capital to Berlin had
obvious implications for Bonn, though some ministries retained offices in the old capital.
Bonn is now targeted for research and development investment as well as expansion of the
tourism and cultural sectors. Cologne has an ancient historical legacy and, like Duisberg,
bases its prosperity on port and transshipment activities. Duisberg has reportedly the largest
inland harbour in the world. Dusseldorf complements its industrial base with being the
provincial capital. Another ancient city, Essen, was the historical centre of the region but has
suffered from the decline of coal and the destruction of the war. Surprisingly, it
accommodates a significant number of the headquarters of Germany’s largest corporations.
Finally, Dortmund combines mining and secondary industry with one of the country’s most
important nuclei of expertise in computer science.
10. Each of these cities is proud of its history and accomplishments and jealous of its own
powers, and there appears to be limited interest in cooperating or in building a regional
identity.
11. This pattern is in some ways similar to the settlement pattern in Hebei province.
Though its economy is much less developed than that of Germany, like the Rhine-Ruhr
Hebei has a number of small to mid-size cities with no dominant metropolis. The
municipalities have strong planning and development powers, and there appears to be little
incentive for the cities to cooperate.
E3_3

A. Economic Context
12. There is continued hope that the locational advantage of the Rhine-Ruhr Region at the
centre of Europe’s Golden Triangle (London, Paris and Berlin) will bring advantages related
to trade and communications development. Furthermore, as the European Union (EU)
moves eastwards to countries like the Czech Republic and Poland, being at the centre of
continental trade can only benefit Germany, through which the Rhine-Ruhr Region will also
capitalize.
13. The burden of bringing prosperity levels in the former East Germany up to West
German standards has stalled German growth. This activity—investing in the former East
Germany—has behaved like a tax on the economy. An unremarkable German economic
performance throughout the 1990s and early 2000s reflects this burden. Further, Germany's
aging population pyramid, combined with relatively high unemployment, has induced social
spending that exceeds contribution levels from workers. This situation means that the
national government’s capacity to invest in the Rhine-Ruhr Region is limited.
14. There are also in Germany strict regulations that introduce rigidity into the labour
market (e.g., regulations surrounding lay-offs, and the setting of wages on a national basis)
and tend to increase unemployment. Between 1990 and 2000, the percentage of
unemployed people in the Rhine-Ruhr Region grew by 17.8% from 455,769 to 537,047.
Currently, in 2004, the fall in government revenues and the rise in expenditures have raised
Germany’s deficit above the EU’s 3% debt limit and kept growth at less than 1%. In fact, the
growth of the German economy has been the slowest in the European Union for the past
eight years.
B. Population Decline
15. Population in the Rhine-Ruhr area has fallen over the past 30 years. Between 2000
and 2015, it is anticipated that the population will fall a further 3.3%. The under-25 cohort is
decreasing fastest, while the 25 to 64 remained stable and the over-65 cohort actually
increased from 15.3% to 18.7% between 1990 and 2000. Overall, the aging structure of the
demographic pyramid is a concern for the Region.
16. The Rhine-Ruhr Region has experienced cyclical in-migration and out-migration. For
example, during the Industrial Revolution, the population of the Ruhr area alone increased
from 240,000 in 1820 to 4,100,000 in 1925. After World War II, the region began to lose
people. Later, during the OPEC crisis of the 1970s, dramatic out-migration occurred. Then,
in 1987, in-migration began to increase, but by 1995 the trend was once again out-
migration.
17. People of over 140 nationalities can be found in the Region, and more than 10% of the
population is foreign. Of this foreign base, approximately half are of Turkish origin. Yet, with
no primate city, and no clear contender for the apex of the urban hierarchy in the Rhine-
Ruhr Region, the idea of cosmopolitanism has not reached full realization. In terms of
diversity, the Rhine-Ruhr Region does not compare favourably with London or Paris, or
most urban centres in North America.
C. Transportation
18. Originally, the transportation system in the Rhine-Ruhr Region was designed to serve
industry. As such, there is an extremely dense network of rail lines. Roads were built to
connect industry and housing, and also as feeder roads to the rail network. Yet, there was
no overall plan until 1920, when the Ruhr Regional Planning Authority was created.
19. Airport access to the Rhine-Ruhr Region is good. Bonn and Köln share an airport, and
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Düsseldorf has two: the Express and Düsseldorf International. Dortmund, to the east of the
conurbation, has the final major airport. Traffic at the Düsseldorf International Airport
dominates the region, followed by Köln/Bonn.
20. Concerning surface traffic, the Rhine-Ruhr Region faces problems similar to other
major urbanized regions in Europe: congestion, bottlenecks during peak hours, and
decreasing average traffic speeds.
D. Environment
21. The environmental issues warranting monitoring in the Rhine-Ruhr Region include the
following: emissions from coal-burning electrical utilities; industries contributing to air
pollution; acid rain resulting from sulfur dioxide emissions; hazardous waste disposal; and
chemical spills.
22. Both the Rhine and Ruhr Rivers are heavily polluted, but multi-national efforts are
underway to improve conditions. Air quality in the Rhine-Ruhr Region is important, since the
region is ‘branded’ by its industrial heritage and image of bad air. Large scale industrial
plants have faced more strict European Union guidelines and the closing of many polluting
industries has actually contributed to improved air quality. For example, sulphur emissions
have fallen dramatically from 66 µg/m3 in 1981 to 8 µg/m3 in 1999. The amount of airborne
particulate matter has been almost halved in the same period, despite increased car
ownership.
23. Soil quality in the Rhine-Ruhr Region is questionable. The industrial presence has led
to high levels of soil contamination through industrial residues, fertilizers and biocides. The
closure of many industrial sites has created a land bank requiring extensive and costly
rehabilitation. However, the rehabilitation of so-called brownfields represents a major
opportunity in an environment where greenfields are sold at a premium.
E. Governance
24. Overall, only a weak form of geo-strategy has prevailed in the Rhine-Ruhr Region.
Substantial out-migration, the presence of a layered and fractured regional identity,
institutional rigidities, parochialism (addressing local interests rather than regional interests)
and implicit state policies to control the Ruhr powerhouse all interact to inhibit a strong
regional identity. While a common Ruhr identity exists outside the Region, the same cannot
be said within it.
25. Consequently, local cooperation does not have the necessary incentives to flourish.
There are no outright impediments per se, but encroachment on local interests and
jurisdiction is not encouraged politically. “Regional stakeholders like development agencies,
sub-regional offices or district administration are also only focused on developing their own
areas of responsibility” (Knapp, n.d.). On the other hand, there have been recent
movements towards sub-regionalization in the form of regional development conferences
and the strategic planning process known as the International Building Exhibition (See
Section 4.4).
E3_5
4. Policy Responses
A. Regional Planning and Policymaking
26. The Rhine-Ruhr has been defined as a region in the North Rhine-Westphalia Regional
Development Plan, but effective regional institutions have yet to emerge. Movements
toward greater regionalization are described in the paragraphs that follow.
27. There are a variety of economic interests that could contribute to greater integration of
the Rhine-Ruhr Region. Public-private partnerships like the World Business Rhine-Ruhr or
the Rhine-Ruhr Economic Alliance could bring actors together. Their activities could be
subsidized by Berlin, and used to support the private sector. There is another organization
called the Technologie-Allianz-Ruhr that could have its mandate extended to the entire
Rhine-Ruhr Region rather than just the Ruhr area.
B. New Economic Activities
28. The Rhine-Ruhr Region is attempting to become a competitive location for high-
technology industries (e.g., telecommunications, biotechnology, and the ‘New Media’). In
order to do this and develop economies of scale that lead to comparative advantage, it must
present itself as a unified region. At the same time, it needs to be recognized that Germany
scores poorly in terms of penetration of new technologies when compared to other
European countries. For example, Germans are ranked 8th in Europe according to the use
of e-mail in business, and use of the Internet and other on-line services.
29. The Rhine-Ruhr Region experienced 20% of the German Internet start-ups in 2001
and has the largest concentration of such activity in the country, outstripping Rhine-am-Main
(7% of start-ups), Stuttgart (4%), Hamburg (7%), Berlin (7%) and Munich (9%). Of course,
the Rhine-Ruhr Region is polycentric. When individual Rhine-Ruhr cities are compared to
the rest of the country, they do not perform well at all. Nevertheless, the Rhine-Ruhr Region
is experiencing important innovative capital investment in this sector and this will likely
improve the overall German performance in the future. Köln, Düsseldorf, Dortmund and
Duisburg are where the activity is concentrated. Dortmund, in particular, is currently
regarded as the ‘portal’ through which investors, capital, and foreign and large German
firms can be pulled into the Rhine-Ruhr Region.
C. Clusters
30. A cluster, according to Porter (1998), is “a geographically proximate group of

interconnected companies and associated institutions in a particular field, linked by
commonalities and complementarities.” This definition of a cluster permits including more
than one industry and also captures linkages and spillovers of technology between
industries—important considerations that are central to competition, productivity and
innovation. The clusters of interest in the Rhine-Ruhr Region include the following:
information and communication technology (ICT), pharmacy and biotechnology, creative
industries (advertising, film, music, architecture, engineering, publishing, software and
computer services, photography), finance, the environmental industry, services for the
elderly, tourism, research and development, and media.
31. In the Rhine-Ruhr Region, national corporate leaders are present in all of the clusters.
However, criticisms of the region suggest that there is a lack of sector building, and
problems in integrating different functions into a unified whole. The Rhine-Ruhr cluster
involving ICT is seen as subservient to Paris, and held back by value systems and
implementation capacity. Concerning biotechnology, regional fragmentation is identified as
a concern. With the creative industries, the Rhine-Ruhr Region is seen to have a polycentric
advantage: different points of view from different centres. However, a lack of specialization
is noted. The environmental industry is a locus of specialization—given the area’s legacy of
E3_6
environmental contamination from industry.
D. International Building Exhibition – Emscher Park
32. The 10-year project known as the International Building Exhibition (IBA)—Emscher
Park began in 1988. The Northern Ruhr district (the Emscher Zone) is a densely populated
and dilapidated industrial region. The federal state of North Rhine-Westphalia undertook the
initiative, which was completed in 1999. Its goal was the ecological and economic renewal
of an aging industrial region. With the IBA project, 17 cities were involved, as well as the
river ecosystem. The major initiatives involved in the IBA project include the following:
• rehabilitation of the Emscher River and its tributaries, combined with the
development of modern sewage and drainage systems. A system of tariffs was
introduced to ensure that sewage was paid for according to use levels;
• establishment of a green corridor connecting all 17 cities from Duisburg to

Dortmund, using existing watercourses and green spaces (known as the
Emscher Landscape Park). The green corridor was developed with a network of
bicycle paths and hiking trails, recreational areas and public gardens, as well as
natural reserves;
• the preservation and re-use of the industrial legacy. Industrial buildings were
retrofitted, and marketing was used to increase public awareness of their
significance for the identity of the region.;
• the ecological upgrading of derelict urban-industrial sites through the

development of architecturally significant retrofits of industrial heritage;
• introduction of recycling;
• rehabilitation of industrial worker settlements; and,
• promotion of the tourist industry.
33. The strategic planning process of the International Building Exhibition helped to
improve the co-operative atmosphere, strengthen the regional identification of stakeholders,
intensify contacts between parties active on the regional scale, establish cooperative
structures and procedures, and build a higher degree of consensus.
E. Education Institutions
34. Historically the Rhine-Ruhr Region did not develop many institutions of higher
education, but in recent years major investments have been made in that sector in the
Region. There are now 7 polytechnic universities and 10 universities. Programs relevant to
new economic activities (See Section 4.2) are developing but still limited. The educational
levels of the Rhine-Ruhr Region are currently comparable to elsewhere in Germany.
Approximately 19.7% of the population has higher education and 57.5% has secondary
education.
F. International Commission for the Protection of the Rhine
35. The Rhine River, because of its international nature, is subject to a complex
institutional framework involving local, provincial/state, national and international agencies.
Managing the Rhine River on a watershed basis requires international cooperation and this
is provided in two ways: the International Commission for the Protection of the Rhine (ICPR)
and the European Union (EU). The ICPR was established in 1950 and contains 5 core
states (France, Germany, Luxembourg, the Netherlands, and Switzerland) plus the EU.
ICPR is a voluntary body and its decisions are non-binding on member states. The primary
tool available to the ICPR has been public education.
E3_7
36. The resulting Rhine 2020 program is a continuation of the Rhine Action Program
(1987) that ended in 2000, which targeted bringing salmon back to the Rhine as a priority,
as well as continuing to ensure that the Rhine could be used as a source of drinking water
for the millions of people that live within the basin. The program is multi-pronged, and will be
an important international operation that seeks to improve many of the river’s hydrological
functions.
G. High Speed Rail
37. High quality transportation is key to the development of a polycentric urban system.
Realizing that the existing rail and road systems are inadequate, the state of North Rhine-
Westphalia is currently investigating the development of a magnetic levitation train (called
the Metrorapid proposal), which is to become an integral part of the region’s transportation
system. The state of North Rhine-Westphalia is playing the leading role in the planning of
the Metrorapid. The Deutsche Bahn AG or another private company will operate the system.
Unfortunately, there is no regional transportation plan for the Rhine-Ruhr Region. Each city
develops its own long term transportation plans.
H. Image
38. Recognizing their own economic power—albeit dwindling, the Rhine-Ruhr Region has
been concerned with reimaging. First of all, the architectural icons of the industrial past have
been retrofitted to become post-modern recreation palaces. Secondly, major entrepreneurial
attempts at place-marketing have been undertaken. The image of the old industrial region
with its smokestacks and bad air lingers. In fact, there is a lingering shame about the
industrial past of the area that reveals itself in marketing surveys. Place-marketing and
reimaging efforts have been successful within the Ruhr Region, but have not been equally
effective among Germans outside the Region. In 2000, Focus magazine surveyed German
experts about urban image and Essen was the second lowest score among the 83 cities
considered. Only Duisburg, another Ruhr city, scored worse.
5. Conclusions
39. The Rhine-Ruhr Region was historically an economic powerhouse in central Europe,
but is now in decline. Efforts to reverse the decline are hampered by a weak regional
identity, lack of effective regional institutions, and a polycentric settlement pattern where no
one city is able to take the lead. Effective regional planning and action will require
cooperation among the cities of Rhine-Ruhr, but to date the incentives for such cooperation
are not strong enough. Nevertheless, the Region’s size, its natural advantages, and its
location at the center of Europe with connections to London, Paris, and Berlin suggest that
the potential for a strong recovery is there.
40. Many efforts are underway to assist Rhine-Ruhr to get back on track, the most
significant being:
• The emergence of public-private partnerships for planning and economic

development;
• High number of Internet startups;
• Strong activity in creative industries;
• Recent investment in higher education;
• International efforts to improve the Rhine River;
• High-speed rail project to link the dispersed cities.
E3_8
References/Further Reading:
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1995. Pages 313-327.
Belina, Bernd and Gesa Helms. 2003. Zero Tolerance for the Industrial Past and Other Threats: Policing and Urban
Entrepreneurialism in Britain and Germany. Urban Studies. Volume 40, Number 9. pp. 1845-1867.
Bogumil, Jörg. 2001. Party Competition, Constraints to Negotiate and Economization—Changes in Municipal Decision-Making:
The Example of North Rhine-Westphalia. DFK Journal. Volume 40, No. 2.
Briscoe, John. 1994. Implementing the New Water Resources Policy Consensus: Lessons from Good and Bad Practices. A
Special Session of the VIIIth World Congress of the International Water Resources Association, Cairo, Egypt. November,
1994.
Dematteis, Giuseppe. 2000. “Spatial Images of European Urbanization” in Cities in Contemporary Europe. Arnaldo Bagnasco
and Patrick Le Galès (eds.). Cambridge: Cambridge University Press.
Dieleman, Frans and Andreas Faludi. 1996. Randstad, Rhine-Ruhr and Flemish Diamond as One Polynucleated Macro-
Region? In Tijdchrift voor Economische en Sociale Geografie. Vol. 89. No. 3. 320-327.
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Technologies Programme.
Economist. 2002. An Uncertain Giant. Economist. December 5, 2002.
th
Economist. 2004. Germany: Country Report. Political Structure. January 15 , 2004.
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www.empirica.com/en/index.html.
European Conference of Ministers of Transport, 2001. Implementing Sustainable Urban Travel Policies. National Peer Review:
The Netherlands. Paris: OECD.
Friedmann, John. 1986. The world city hypothesis. Development and Change. Volume 17. ppages 69-84.
Friedmann, John. 1995. Where we stand: a decade of world city research, in P. Knox and P.Taylor (Eds) World Cities in a
World System, pp. 21– 47. New York: Cambridge University Press.
Frijters, Ine and Jan Leentvaar. 2003. The Rhine Case Study. Water Management Inspectorate, Ministry of Transport, Public
Works, and Water Management, the
Netherlands.Availablefrom:http://www.ce.utexas.edu/prof/mckinney/ce397/Topics/Rhine/Rhine.htm
Geliner, Arrol. 2004. Europeans are giving new life to relics of the industrial era. Chicago Tribune, February 1, 2004. On-line
edition. At www.chicagotribune.com.
Gongal, Shailesh. 1999. The Ruhr Region in Atlas of Urban Regions. Hong Kong-Pearl River Delta Research Group: Gerry
Flood, Shailesh Gongal, Adair Smith and Ming Zhang. Available at
www.mit.edu/afs/athena/course/11/11.hkstudio/www/hkrpt99 sept.pdf
Grier, Charles. 2002. Comparative Analysis of the Rhine-Ruhr Metropolitan Region. Dusseldorf Regional Government. August,
2002.
rd
Hall, Peter. 1984. The World Cities. 3 Edition. London: Weidenfeld and Nicholson.
Van Houtum, Henk and Arnoud Lagendijk. 2001. Contextualising Regional Identity and Imagination in the Construction of
Polycentric Urban Regions: The Cases of the Ruhr Area and the Basque Country. Urban Studies, Vol. 38, No. 4, 747–767.
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Iaurif. 2002. Growth Sectors/Clusters in Dublin, London, Paris and RhineRuhr: Synthesis and Recommendations. Paris: Iaurif.
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http://www.iaurif.org/en/doc/studies/metropoles_en_chiffres/randstad.htm
Kishlansky, Mark et al. 1998. Civilization in the West: Volume 1 to 1715. New York: Longman.
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Planning Studies. 6 (4): 379-393.
Knapp, Wolfgang and Peter Schmitt. 2003. Re-structuring Competitive Metropolitan Regions in North-west Europe: On
Territory and Governance. European Journal of Spatial Development. No. 6. Oct, 2003.
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International Workshop on “New Approaches to Land Management for Sustainable Urban Regions” at the University of Tokyo.
Ministry of National Land, Infrastructure and Transport, October 28-31, 2001.
Kupiszewski, Marek et al. 1998. Internal Migration and Regional Population Dynamics in Europe: Germany Case Study.
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Meijer, Martine. 1993. “Growth and Decline of European Cities: Changing Positions of Cities in Europe” Urban Studies.
Volume 30. No. 6. Pp. 981-990.
Porter, Michael. 1998. Michael Porter on Competition. Boston Harvard Business Review.
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Sassen, S. (1991) The Global City: New York, London, Tokyo, Princeton, NJ: Princeton University Press.
Scott, Ralph. 1996. Introduction to Physical Geography. New York: West Publishing Company. 1996.
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Wood, G. (1995) Restructuring policies: the Emscher Park International Building Exhibition, in: P. Cooke (Ed.) The Rise of the
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Wood, G. 1997. Regional alliances in North Rhine–Westphalia, European Urban and Planning Studies, 4, pp. 262–269.
E3_10
E4: Case of South Korea
Prepared by Chreod
Chreod Ltd.
Case Study E4: Seoul, South Korea 23 February 2004
1. Introduction and Context

1. The Seoul Metropolitan Region, with a population of 21,700,000, is five times the size of
South Korea’s next largest city and contains nearly one-half of the country’s population.
Covering over 11,000 km2, it includes the secondary cities of Bucheon, Goyang, Inch’on,
Seongnam, and Suweon. It provides a useful example of how governments have attempted
to direct spillover benefits from the core metropolis to surrounding cities, and towns, and
may provide some insights into spillover benefits from Beijing and Tianjin to Hebei.
2. Over 4 million South Koreans died in

the Korean War between 1950 and 1953,
and considerable infrastructure and
housing stock were destroyed. Yet,
reconstruction after the Korean War
provided Seoul with the opportunity to
modernize its infrastructure and introduce
urban planning techniques on a previous
morphology that was both colonial and
organic. This new reality provided Seoul
with many elements of contemporary
planning: plazas, high-rises done in the
modern style, and wide tree-lined
boulevards.
3. In the 1960s, Seoul began to

experience explosive growth. After 1961,
South Korea attempted to escape chronic
poverty by employing an export-oriented
industrialization policy that was sustained
by low wages and inexpensive agricultural products. During this period, Seoul’s financial
district—Yeouido—emerged. Soon after, in 1971, a Greenbelt was imposed to control
Seoul’s exponential growth.
4. In the 1960s and 1970s, the government began to aggressively build bridges to the south
side of the Han River, the major waterway traversing the city. Modern low-rise apartment
complexes began being built to the south of the river in areas like Yongdongpo. The
Kangnam Islands in the Han River were also developed, including Yoido Island, which was
targeted as a secondary business district. Successive waves of waterfront revitalization of
the Han River took place. When Seoul became the site of the 1988 Summer Olympics, the
Kangnam district in the southeast was developed, and, later, the World Trade Center was
built in this area. Following the Olympics, Seoul never lost its momentum. Citywide
construction involved new subway lines, bridges, roadways, cultural venues and private
building projects that changed the skyline.
5. The Asian financial crisis of 1997 forced Seoul to correct some of the structural problems
inherent in its debt-ridden, conglomerate-centred economy, and to address issues of
unemployment, labor discontent, homelessness, and social welfare. Growth has since
rebounded, and Seoul has emerged as a major international player. However, even with
phenomenal economic growth, Seoul remains saddled with an inventory of serious problems
resulting from overpopulation, rapid growth, environmental pollution, squatter settlements,
housing shortages, and traffic congestion.
6. Densities in Seoul are among the highest in the world. The urbanized area of Seoul has
a population density of 20,700 people per km2. The central business district is one of the
world’s largest, with more than 1.2 million people and comparable in scale to the central
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business district of London or Osaka.
7. The spatial structure of Seoul was greatly influenced by rail lines before highways.
Commuting distance to Seoul by rail influenced the early development phase experienced in
the 1960s. In the 1970s and onwards, the refurbishment of electrified railroads like the
Seoul-Inch’on and Seoul-Suwon lines helped immensely. Later, the Seoul-Pusan and Seoul-
Inch’on highways also contributed to growth. Following the model provided by London, the
Greenbelt was imposed in the 1970s and prevented extensive infrastructure development to
the east of Seoul—at least in the beginning. Some analysts think that both population and
employment would have been much lower in the central city and the inner suburbs without
the presence of the Greenbelt.
8. Employment density in the central business district has, as in many other major cities,
declined dramatically. The employment share of the central business district declined from
34.5% in 1981 to 17% in 1996. During this period, approximately 170,000 jobs migrated out
to the periphery. Two employment sub-centers have emerged since 1981, and the role of the
CBD as a provider of high-order services has migrated to these new locations. As well, with
the emergence of a polycentric structure, commuting times in Seoul have increased
dramatically.

A. Economic Context
9. As one of the Four Dragons of East Asia (along with Taiwan, Hong Kong and
Singapore), South Korea has achieved a short but enviable history of economic growth and
integration into the global economy. Only 30 years ago, GDP per capita in South Korea was
comparable to the less-developed countries in Asia, but now it is comparable to the smaller
economies of the European Union (e.g., Spain, Portugal, Greece). In particular, South
Korea’s growth has been buffeted by export-oriented trade. In 2001, total foreign trade
represented over 70% of total GDP, analogous to Taiwan but considerably higher than
Japan or the US.
10. Despite its success, the Asian financial crisis that lasted from 1997 to 1999 revealed
many of South Korea’s structural weaknesses (e.g., high debt/equity ratios, enormous levels
of foreign borrowing, and a financial sector that was ‘undisciplined’). Following the Asian
financial crisis, the government maintained a good record of success in reforming the
banking sector. In particular, taxpayers’ money was used to recapitalize banks that were
failing and forced weak banks to merge with strong ones.
11. An important element of the Korean economy is the chaebol - the so-called
conglomerates -, which were established after the Korean War. In 1995, the top 30 chaebol
produced more than 16% of South Korea’s GDP. Examples of chaebol include Hyundai,
Samsung, and Daewoo, names that are familiar to many consumers around the world.
12. In South Korea, manufacturing maintained an increasing share of GDP until the late
1980s, increasing to 33% in 1988 from 25% in 1973. The explanation for this was the fall in
the share provided by agriculture, forestry and fishing. In the most recent decade, however,
an increase in employment in the services sector has largely buoyed the economy. Between
1997 and 2001, the share of services in employment increased from 66% to 70% while the
manufacturing share fell from 23% to 19.5%.
13. During this period of ongoing growth, Seoul endured dramatic economic restructuring.
From the late 1980s onwards, there was acceleration of technological development and
automation, growth of high-tech industries, a decline in labor-intensive industries, and the
trend toward the division of labour via subcontracting to smaller firms. Interestingly,
outsourcing to other Asian countries was often preferred to other regions of South Korea
because of better cost profiles due to lower wages and weaker labor unions.
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14. While nearly one-half of South Korea’s population resides in the greater Seoul region,
virtually all of South Korea’s central government agencies are located there. Corporate
headquarters (48 out of the top 50) and 61% of Korean business managers are also located
in the area. All of the country’s stock brokerages, foreign bank offices, offices of foreign
media and broadcasting are in Seoul. Seoul ranks as 7th in the world in terms of the number
of industrial Fortune 500 transnational corporation headquarters. Recognizing these factors,
Seoul is one of the world’s most important cities in terms of the global economy.
15. South Korea is faced with scarce natural resources and has a relatively small domestic
market. Consequently, the phenomenal growth of its economy has been dependent on a
comparative advantage exerted by low wages and a dependency on foreign trade and
sources of investment. As well, Seoul’s transnational corporations are industrial rather than
finance or producer-service companies. When compared to New York, the difference
between Seoul and other world cities becomes more apparent. Sixteen of the top 20 firms in
New York are financial or producer-services firms. In Seoul, only 3 of the top 20 firms are in
the same category.
16. Even though manufacturing has experienced downturns, there are also emerging
opportunities. The publishing and media companies are concentrated in Seoul, and this
means that the infrastructure to support them provides a comparative advantage for
information and communication technologies.
B. Population
17. Seoul’s population has increased from 250,000 in 1890 to more than 10 million in 2000.
Thousands of Koreans continue to move to Seoul from other parts of the country each year.
18. South Korea’s fertility rate has declined rapidly due to the implementation of family
planning programs. The population growth rate declined from 3.0% in 1960 to .93% in 1990.
In other words, the demographic structure is evolving from the traditional pyramid shape to
the bell-shape. The productive-age population, considered to be between 15 and 64, has
risen to 71.5% in 2002 from 54.4% in 1970. An aging population is not an immediate
concern for South Korea, although the proportion of the elderly cohort is increasing, primarily
due to improved health care for the aged. The dependency ratio for the elderly is offset by
decreasing dependency ratios for children. In the short run, South Korea can ride the wave
and will not be forced to adjust to its aging population as soon as many European countries.
19. South Korea is one of the most homogeneous countries in the world in terms of ethnicity.
Called the Hermit Kingdom during the latter years of the Yi Dynasty due to Imperial policies
forbidding contact with foreigners, the borders of the country were closed to in-migration for
centuries. Consequently, Seoul - with its influx of foreign business people and media - is the
most cosmopolitan of Korean cities.
C. Environment
20. The source of drinking water for Seoul is Paldanghoho Lake and the Jamsil underwater
reservoir. The Han River’s pollutant loads are a function of water levels: in winter, when
water levels are low, pollution loads are much higher. As well, it is thought that 70% of the
underground water in Seoul is already unsuitable for drinking water. Over 99% of Seoul
residences are served by tap water. However, the efficiency of the water delivery system is
compromised by high water leakage in the pipe system. Of the 18,010 km. of water pipes in
Seoul, 15,256 km are 15 years or older, facing corrosion, and needing replacement. An
aggressive plan for installing non-corrosive pipes is in place and the entire older system
should be revamped by 2005.
21. All wastewater generated in Seoul is treated at four sewage treatment plants before
being discharged. Overall, the water quality of the Han River has improved between 1990
and 1998.
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22. Seoul is surrounded by mountains and is susceptible to immobile air. While sulfur-based
pollutants have been declining due to government efforts, the levels of nitrogen oxide, dust,
carbon monoxide and hydrocarbons continue to increase due to escalating automobile
ownership. More than half of all automobiles in South Korea are found in Seoul.
23. A variety of air improvement measures are being implemented: expansion of clean fuel
supplies, mandatory installation of car exhaust filters, sulfur dioxide control measures.
D. Transportation
24. Seoul is notorious for its traffic congestion. Despite lower car-ownership rates than the
US, the traffic congestion experienced in Seoul is more than twice that experienced in Los
Angeles. Until the early 1990s, the attempted solution involved providing more freeways and
more subways, but since 1993, the Seoul Metropolitan Government has focused on demand
management and improvement to the level of service provided by public transit. With high
land prices and a dense built-up area, building more freeways to solve traffic congestion is
no longer viewed as a possible solution. An underlying problem with the Seoul transportation
system is its radial structure, which contributes to excessive congestion in the core.
25. A complex web of subway lines demonstrates the commitment of the Seoul Metropolitan
Government to public transit. The Seoul subway system reaches into every domain of the
city and gives greater accessibility to the system to more commuters. In the 1990s, Seoul
conducted the world’s most ambitious subway extension program by adding 160 km of new
lines to its existing network. The port city of Inch’on is now linked to Seoul by subway.
E. Governance
26. Three levels of government influence the planning and development of the Seoul Region.
The Seoul Metropolitan Government, despite its name, has jurisdiction only over the City of
Seoul. The city is a single urban entity that covers 605 km2 north and south of the Han River.
The Seoul Metropolitan Region was established by the central government in 1977 as the
area including the City of Seoul, its adjacent jurisdictions and Inch’on City. The region is
roughly 50-60 km in radius from the city centre. Finally, the Capital Region was established
in 1984 in order to manage the regional growth of Seoul, Inch’on, and the surrounding
Kyonggi province (11,234 km2). Three upper-tier local governments - Seoul, Inch’on and the
Province of Kyonggi - and 64 lower-tier local governments are involved.
27. As described below, these various levels of government have been involved in many
initiatives over the years to shape the urban region.
4. Elements of Solution
A. Growth Strategies
28. Growth management plans in Seoul have a relatively recent, post-Korean War history.
The official tenet of growth management in Seoul is “to steer the location of people and
industries away from the Seoul Metropolitan Area and to ultimately achieve a balanced
development among regions in the nation” (Ahn and Ohn, 2001). While this basic policy
platform still holds, the strategies employed to achieve it have evolved in four stages since
the Korean War. In this sense, Seoul represents a living laboratory of what works and what
doesn’t in terms of growth management. According to Ahn and Ohn (2001), the four stages
of growth management policy envelopes are:
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29. Stage 1. 1960-1971. In 1964, the Special

Measures for the Restriction of Population Growth
in Seoul was announced. Strategies included
relocating government offices in Seoul to other
major cities; development of growth poles (either
garden cities or industrial cities) in strategic areas
outside Seoul; and direct control of new industry
and new educational institutions in Seoul. In 1969,
even more restrictive policies were imposed:
prohibition of factory construction, forced
relocation of factories that were violating zoning
measures or were polluting, and complete
restriction on growth of educational institutions
(including construction).
30. Stage 2. 1972-1979. In this period, policy objectives for growth management were
becoming more clearly defined and legal tools began to be employed. Reacting to the crisis
of growth, a new socio-political organization called Yushin emerged. Yushin was a crisis
management system and was tasked with intervening on every possible avenue that could
control growth. Officials formulated the first National Physical Development Plan for Seoul.
The plan introduced planning of large-scale industrial estates in the periphery plus the
expansion of infrastructure like power, water, roads,
harbours and communication corridors outside of
Seoul. Simultaneously, new tax laws began to
target industries locating in Seoul, and a new poll
tax was introduced that targeted residents. Several
new towns (e.g., Changwon, Yuochon, Kumi,
Ansan and Kwachon) were constructed in a variety
of areas to fulfill a variety of roles outside of Seoul.
31. The Greenbelt has had a profound impact on

the spatial structure of Seoul. First of all, with strong
government support, protection of the Greenbelt
has been effective. Secondly, government support
for new town development beyond the Greenbelt
contributed to leapfrogging and eventually a jobs-
housing imbalance because housing dispersed much more quickly than jobs. In the satellite
image below, the effectiveness of the Greenbelt is demonstrated. Seoul, in the center of the
upper right quadrant, is fully enclosed by the Greenbelt except where the built-up area
stretches out towards the shore of the Yellow Sea along the Han River.
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32. Stage 3. 1980s. In this period, the entire Capital Region was used as the planning unit. A
region-wide land use control system was introduced in the mid-80s and persists in a revised
form to today. The Second National Physical Development Plan was set forth in 1982,
introducing two new ideas: the integrated living
sphere strategy and concentrated decentralization.
The integrated living sphere strategy attempted to
provide better transportation linkages between
rural and urban areas. The hope was that better
access to urban nodes outside of Seoul would
improve service and job opportunities to rural
residents. The concentrated decentralization
strategy attempted to create employment magnets
outside of Seoul. Fifteen provincial cities were
targeted for investment.
33. However, a lack of government will to support

the effort was evident. Ultimately, “the government
did not take any measures to reorganize the socio-physical structure of the region to be an
integrated urban complex. Rather it strengthened the control over the outgrowth of the SMA
physically” (Ahn and Ohn, 2001). Basically, the plan (including the second Plan) worked
relatively well at restricting growth outside the Greenbelt, but could not control it inside Seoul
proper, nor along the Seoul-Inch’on and Seoul-Suwon axes.
34. Stage 4. 1989 to today. Growing criticism of earlier strategies had emerged and new
solutions were sought following the strong growth inside the greenbelt of the previous period.
The failure of previous plans was heralded by the government’s sudden announcement that
it would build five new towns, three outside and two inside the greenbelt, housing over 1.2
million people. In essence, the government was reacting to escalating housing prices in
Seoul—which was causing social unrest.
35. In retrospect, there is much criticism of the restrictive policies imposed by the
government. In particular, the growing inequality in incomes between urban and rural areas
and between Seoul and its hinterland are cited. As well, despite the large envelope of
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restrictions, there was little government money to finance infrastructure development that
would support decentralized growth.
36. More recently, spatial structure in Seoul has been more closely linked to dispersion and
axial development. In 1985, the dominant development corridors were Seoul-Inch’on and
Seoul-Suwon-Pyongteak. However, in the 1990s, new corridors were emerging outside the
30 km. radius of central Seoul: Seoul-Songnam-Yongin, Seoul-Koyang-Paju and Seoul-
Inch’on-Yoju. Not surprisingly, housing development is leapfrogging along major arterial
roads beyond the Greenbelt in a North American-like type of sprawl.
B. Environment
37. The Korean government has generated an environmental plan called Environmental
Vision 21, which is one of several long-term plans for conserving the environment. The
principles underlying the plan are the following:
38. prevention before environmental degradation takes place;
39. harmony between development and preservation;
40. assessment of the financial burden that must be incurred by those agents who use
and/or destroy environmental assets;
41. use of creative economic measures to induce voluntary compliance with strategies to
improve the environment;
42. transparency and credibility of environmental policies by making information open to the
public and encouraging public participation in decision making; and
43. the promotion of clean fuels and low-sulfur oil.
44. The use of sewage treatment plants is improving, and over 70% of sewage is now being
treated. In 2001, a pay-by-volume trash policy was imposed. This led to increased recycling
(by 43%) and a reduction of landfill space required by 43%.
45. South Korea has been implementing a wide variety of waste-related strategies—many of
them entailed by Agenda 21. For example, the Volume-Based Waste Fee System was
introduced in January, 1995. Under this program, people discharging waste are required to
pay fees according to the volume of waste generated. Even earlier, the Deposit-Refund
System for products with noxious materials or processes involving high waste generation
was imposed. The Deposit-Refund System encouraged the retrieval and recycling of
reusable items. Also in 1992, the Waste Treatment Charge System was employed to curb
consumption of products and containers, which are difficult to collect, dispose, recycle or
manage.
46. Environmental Impact Assessment, introduced in 1977 by the Environmental

Preservation Act, is now routinely undertaken in South Korea. The 1993 Environmental
Impact Assessment Law aims to balance environmental preservation and economic
development through the investigation, analysis and mitigation of environmental impacts
anticipated via development.
47. Since air quality is a regional concern, Seoul, Inch’on and Kyonggi Province have formed
the Regional Committee for Air Quality. In order to reduce emissions from vehicles, the city
of Seoul plans to replace all city buses with CNG-powered buses. A legal framework is now
in place to support the purchase of the CNG-powered buses, including tax incentives and
financial support. NOx emission standards will also be made more stringent for smaller
vehicles, and ground-level ozone level alerting stations are now operational - reporting to the
residents of Seoul whenever ozone levels exceed 0.12 ppm.
C. Transportation
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48. Attempts to improve public transit have taken many forms. For example, in support of
bus companies, the Seoul Metropolitan Government provides long-term loans for bus
replacement and direct subsidies to debt-ridden companies, and has introduced circular bus
routes around the core and bus-dedicated lanes. A Traffic Impact Fee is imposed on owners
of large buildings that can be reduced when a company implements supporting strategies
designed to mitigate its impact on traffic.
49. A major spatial restructuring is anticipated with the new investments in rail infrastructure
between Seoul and Pusan, on the southeast coast of South Korea. Approximately 70% of
the country’s economic and industrial activity is already focused along the corridor from
Seoul through Chaunan, Deojon, Taegu and to Pusan (Kim, 2000). The new line between
Seoul and Pusan will have a maximum speed of 300 km/hr and will transport up to 520,000
passengers daily. New developments will likely cluster around rail line terminals and major
nodes, resulting in dramatic increases in commercial and business activity.
5. Conclusions
50. The growth of Seoul has generated significant economic spin-offs well beyond the
metropolitan area. This is likely due to its status as a primate city in South Korea, its
phenomenal growth rate, development of transportation axes from Seoul to other cities, a
consensus that limiting the growth of Seoul is desirable, and the presence of strong regional
institutions.
51. However, the Seoul case study demonstrates how difficult it is to control the growth of a
major demographic and economic pole. Few governments have tried as hard to manage
urban growth and to steer development away from the metropolitan area. Virtually all options
have been explored and many have been implemented. Despite some notable
accomplishments, success is still elusive. New towns were built and populated and new
transport routes dramatically stimulated the growth of some secondary cities well beyond the
Metropolitan Region, but governments were unable to resist pressures for development
inside the city. Problems of housing shortages, high costs, and traffic congestion continue to
plague the city proper.
52. Development of efficient transportation axes between Seoul and a number of other cities
have helped to decentralize population and employment in a linear pattern radiating out from
Seoul. This could be an efficient pattern if development was directed to high-density nodes
(including employment) easily serviceable by public transit, but there is evidence that around
Seoul the pattern is tending toward sprawl. The proposed 300-km per hour link from Seoul to
Pusan at the other end of the country will be the ultimate test of the efficiency of axial
development. At least, it has the potential to generate economic spin-offs in places quite
distant from Seoul.
53. The Greenbelt around Seoul has been protected and has had a major influence on urban
form. It offers vast green spaces close to very large populations, an amenity not available in
many large cities. It may have functioned to limit sprawl, at least for a time. On the other
hand, development has leapfrogged to sites outside the Greenbelt, with government support,
probably increasing transport times and servicing costs.
54. Regional forms of government exist at three levels (See Section 3.5) and have furnished
a good institutional base for planning and policymaking. Significant efforts to solve some of
the region’s transport and environmental problems have been mounted by these
governments, alone and in combination. It has proven to be possible to reach consensus on
very far-reaching initiatives, thanks in part to the strong regional identity these governments
have produced.
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REFERENCES
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Summers, Lawrence. Commanding Heights. Up for Debate: Contagion. President of Harvard University, 1999-2001 and
Assistant Secretary of the U.S. Treasury during the Asian Financial Crisis of 1997.
E4_10
F1: Case of South Korea and Canada
Small and Medium Size Enterprises Financing

in South Korea and Canada
Chreod Ltd.
Case Study F1: SME Financing in South Korea and Canada 23 A
1. SMEs: Small and Medium Size Enterprises

1. Small and medium-size enterprises (SMEs) are seen as vital parts of the economies of
many countries, both in the developed and developing worlds. Individually, SMEs employ small
work forces (generally less than 500 employees) and generate small outputs (less than $20
million annually), but as a component of national economies they are more and more important.
In many countries they produce at least one-third of the GDP and employ over half the work
force. Their size allows them to be more flexible and quick to react to market opportunities than
large firms and, in many cases, it is a country’s SMEs that have developed new products and
created new markets.
2. SMEs can face many difficulties:
• Lack of access to credit due to an untested track record, insufficient collateral, or

insufficient equity;
• Lack of management skills due to the inexperience of the founders and

inadequate funds to pay for experienced managers;
• Limited access to market information because much of this information is

generated by the large companies;
• Lack of support services like training because it is unaffordable or the principals

do not understand its importance;
• Difficulties in acquiring the latest technology due largely to the high cost;
• Inadequate legal and regulatory frameworks, particularly in developing

economies; and
• Tough international competition.
3. Governments throughout the world are attempting to assist the development of the SME
sector through:
• Improving legal and regulatory frameworks that were originally designed for large
public or private corporations;
• Providing training and help in management practices, recruitment, training, and

access to information;
• Financial measures such as tax exemptions, loan programs, venture capital

initiatives, special funds for investment in SMEs, guidelines or mandatory
allocations of commercial credit to SMEs, and government loan guarantees.
4. In the developing world, International Financial Institutions (IFIs) and bilateral assistance
programs are increasingly targeting the SME sector with technical assistance, loan programs,
credit guarantees, provision of physical facilities, and equity participation.
2. The SME Sector in China

5. SMEs are generally private companies, which in China have only begun to develop in the
last 20 years. After a period of being allowed only on the fringes of the economy, the private
sector has emerged as an important source of income and employment, thus helping to mitigate
F1-1
the costs and loss of employment occasioned by reform of the SOE sector. Many of the new
private companies grew out of collective and state-owned enterprises, but others were started
from scratch by entrepreneurs.
6. The priority accorded to the private sector in China is partially due to two major current
issues. China’s entry into the WTO will necessitate relatively rapid adjustments in most sectors
of the economy, and private businesses are likely to be the main agents of this change.
Secondly, the Western Region development strategy is faced with the problem of reforming
economies that are over-reliant on old, sometimes uncompetitive, SOEs. One way of
addressing this issue is to encourage the emergence of small private firms in sectors where
there are comparative advantages
7. Today the private sector generates over one-third of China’s GDP, and a constitutional
amendment in 1999 formally recognized the private sector as a legitimate and important
segment of the economy. Increasingly private economic activity is dominated by domestic
players rather than foreign-invested enterprises, though the latter remain important.
8. Three phases can be identified in the evolution of private business in China . The period of
1978 to 1983 marked the official revival of private business, but they were limited to individual
businesses (getihu), which developed in a regulatory vacuum. Such businesses were seen as
filling gaps left in the planned economy, and as such were on the periphery. The development
of private businesses was especially important in rural areas. After economic management in
agricultural devolved to households, some households began to practice non-agricultural
activities, becoming in effect a private business. By 1983, the government was implementing a
number of regulations for the licensing and control of private business.
9. The second phase, from about 1984 to 1992, was the era of the rise of the privately run
enterprises (siying qiye) as contrasted with the getihu. These larger private enterprises resulted
mainly from the growth of getihu or the leasing of state or collective enterprises to individuals.
The Tentative Stipulations on Private Enterprises in 1988 helped to create a regulatory
framework for these firms. Still they were seen officially as a supplement to the socialist, publicly
owned economy.
10. The third phase, from 1993 to the present, coincided with the emergence of a coherent
strategy of transition to a market system based on the rule of law. The strategy called for a level
playing field among types of enterprises, a rule-based market system, and clarification of
property rights and ownership. Perhaps most importantly, private enterprise was recognized as
an important component of the economy in its own right.
11. The challenge of the present phase is for private businesses to evolve from an informal
structure and style of management to a more formal model of corporate governance. Though
matters are improving, many small private enterprises still possess only vague ownership
structures, corporate governance mechanisms, financial records, and rights to market access.
At the same time, government needs to shift from a discretionary way of regulating and taxing
the private sector to a rule-based system.
3. SME Financing in Korea

12. SMEs as a sector are particularly strong in Korea. They constitute 99% of companies,
provide 75% of employment, and produce 46% of GVIO. They are distributed throughout all
sectors, including manufacturing, transport, construction, wholesale and retail trade, hotels and
restaurants, and personal services.
13. It was not always this way, however. From the early 1960s, the government encouraged
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chaebols, large family-owned conglomerates that focused on penetrating export markets. These
companies were the focal point of production and dominated employment and export growth.
This continued in the 1970s, though with the emphasis on establishing heavy and chemical-
oriented industries. Increasing imbalances between economic sectors and regions of the
country forced Koreans to begin to question this focus on large enterprises in the 1980s, and
the Asian economic crisis of 1997-98 hastened the search for a different development model.
Some have blamed the severe impact of the crisis on Korea on the dominance of the chaebols.
14. In the 1990s the Korean Government implemented a number of measures to encourage
SMEs. New laws oriented to the needs of SME development were promulgated (See Box 1),
new programs were designed, and the Small and Medium Business Administration (SMBA) was
formed. The government expects the SME sector to become the driving force of the economy.
Benefits are expected to include a higher rate of job creation, greater efficiencies, development
of new technologies, a more equitable distribution of income, and more balanced regional
development.
15. Korea is an interesting case study for China’s development of SMEs. Like Korea, China’s
economy has been built on large enterprises that tended to monopolize essential production
factors and government attention, to the detriment of smaller, newer companies. The difference,
of course, is that China’s large enterprises were state-owned whereas Korea’s were private.
The Chinese Government is now attempting to convert major parts of the economy to private
ownership and to stimulate development of new small and medium-size firms. Korea has recent
and largely successful experience in this field.
Box 1: Korean Laws Relevant to SMEs
Korean laws relevant to SMEs consist of the Constitution, 9 general laws, three special acts and others:
• Article 123 of 'Constitution' provides for the protection and promotion of SMEs and promotion of self-help
organization by the government.
• The 'Framework Act on Small and Medium Enterprises' stipulates the scope of SMEs, goals, main directions of
the supporting policies, regulations, etc.
• The 'Support for SMEs Establishment Act' stipulates various support systems for start-up companies like
business incubators, indirect tax exemption and the like. Especially the 'Act on Special Measures for the
Promotion of Venture Business' put into place in 1997 contains various support systems for fostering venture
enterprises like venture capital companies, limited-partnerships, start-up companies coming from university or
research institute's laboratories, etc.
• The 'Act on Assisting Women Enterprise' provides a legal basis for a variety of active support programs to
promote women's start-ups, business management and general operations.
• The 'Promotion of SMEs and Encouragement of Purchase of Their Products Act' and the 'Act on Special
Measures for Supporting the Structural Improvement and Managerial Stabilization of SMEs' stipulate the
systems for promoting the procurement of goods made by SMEs, expanding the SMEs market and improving the
structure and management of SMEs.
• The 'Act on the Protection of the Business Sphere of SMEs and Promotion of Their Cooperation' and 'Act on
Subcontract Trade Fairness' stipulate systems to prevent large companies from intruding into SME business
spheres and conducting unfair trading.
• The 'Small and Medium Enterprise Cooperative Act' concerns the organization of cooperatives and the operation
of mutual assistance funds.
• The 'Act on the Balanced Region Development and Promotion of Regional SMEs' and the 'the Act on Regional
Guarantee Fund' stipulates the systems to facilitate startups in regional areas and induce balanced development
between large cities and provinces by promoting regional SMEs.
• Additionally, the Industrial Bank of Korea, the Korea Credit Guarantee Fund and the new Technology Business
Finance Korea Technology Credit Guarantee Fund, each of which have been established under 'the Industrial
Bank of Korea Act', the 'Korea Credit Guarantee Fund Act' and the ‘Act on the Support of New Technology
Business Finance' are reducing the fund raising difficulties of SMEs by providing loans and credit guarantees.
F1-3
16. In Korea, companies are designated as SMEs if they have 300 or fewer employees and
paid in capital of less than $ 6.7 million , with different criteria for the primary sector and
services. SMEs must not be subsidiaries of one of the nation’s 30 largest firms.
17. Despite their strength, Korea’s SMEs face problems of weak management, high debt
ratios, low levels of investment in technology, excessive dependence on government support,
and low public recognition of their importance. A variety of government and non-profit
organizations are working toward the resolution of these problems. The degree to which they
have succeeded is evident in the large contribution SMEs now make to employment and GDP.
18. It is important to add, however, that SMEs in Korea tend to be labor intensive and exhibit
poorer labor productivity performance than large enterprises. Value added per employee in
SOEs in 1997 was 38% that of large companies, and average wages 64% that of the larger
firms. Though these figures may have improved somewhat since 1997, the large companies
continue to outpace the SMEs in productivity.
19. There is some concern that SMEs have become too dependent on government support
and risk losing their competitive edge. Many SMEs went bankrupt during the crisis of 1997-98,
and some analysts fear that they will not be able to adapt quickly enough when the next
economic crisis hits. SMBA, to its credit, is emphasizing forms of assistance that place the onus
on individual firms to address their own weaknesses, to explore new markets and to sustain a
climate of innovation.
20. Government policies for promotion of SMEs include tax incentives, facilitation of equity
investment, grants and loans, and technical support. In 2000 the national government spent $
3.4 billion on SME-related programs. Government programs are discussed below according to
the aspect of SME business they are designed to influence.
A. Start-up
21. The Korean Government is moving away from start-up loans and toward equity investment
through joint public-private venture investment funds. The major fund, called Da-San Venture
Company Ltd., is managed independently by private sector experts. It is intended for firms that
have difficulties attracting private investment because they are viewed as risky. It is hoped that
an investment from Da-San in a firm will induce additional investments from the private sector.
The government also encourages domestic financial institutions and foreign venture capital to
expand their investments in private venture funds. Foreign investment from venture firms and
major internationals has been attracted.
22. Government has strengthened the management of the KOSDAQ Market, a stock market
specializing in high-tech and small companies, and the over-the-counter market for non-
registered, non-listed stocks. It has tightened registration, screening, supervision, and public
notification procedures. An increasing number of small companies are obtaining financing
through listing on KOSDAQ. In 1999, 114 firms went public through the KOSDAQ, and another
140 in 2000.
23. An “angel” investor is an individual or group who agrees to help finance an SME startup or
expansion into new markets or products. Often the angel investor is a friend or relative of the
firm’s principals, and the investment takes place outside normal channels. In Korea, angels get
certain tax incentives. They can deduct 30% of amounts invested in venture firms from income,
and there is no tax on gains on the transfer of stocks and equity. Angels have invested $ 159
million in 310 enterprises.
24. There are over 300 business incubators in Korea, mostly in universities and research
institutes that prepare SMEs for startup. Entrepreneurs can collaborate with academics, take
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advantage of the bodies of specialized knowledge resident in the university, and use lab
equipment. Universities are allowed to start their own small businesses. In addition, the
government provides a variety of training courses for both top management of SMEs and
potential entrepreneurs.
B. Diversification and Expansion
25. Financial assistance for existing SMEs is diversified and is available from private financial
institutions, the Bank of Korea, and special government funds. There are no quotas or
guidelines for the amount of credit private financial institutions should extend to SMEs, but the
government strongly encourages them to continuously expand this service. It has introduced
better credit screening and evaluation models, and can issue credit guarantee certificates to
facilitate SMEs obtaining private financing.
26. Government funds are used in cases where private institutions cannot function – very
small firms, firms in unproven markets, companies suffering temporary problems, and
businesses at an early stage. Increasingly, government funds are lent to venture capital
companies who then invest in SMEs. Direct government loans are still used, but normally as
part of a diversified set of financing instruments.
27. Industrial parks designed specifically for SMEs are provided by a non-profit organization
called The Small and Medium Industry Promotion Corporation. SMEs can purchase land or
buildings, or rent space in apartment-type factory buildings.
28. The SMBA encourages large firms to recognize that their growth potential will be
enhanced through business relationships with SMEs. Various incentives, including financial
ones, are available to large firms for this purpose. Attempts are made to link the 30 largest
companies with SMEs operating in the same sector.
29. The government has special assistance programs for very small companies with several
employees. These include provision of consultants specially trained for this purpose and
financial support.
C. Technology
30. SMEs in Korea have been faced with problems in technological development due to the
lack of capital and specialized human resources. The government has implemented a number
of measures to assist:
• Loans of up to 75% of the cost of technological development related to new

products for qualified SMEs;
• Creation of a consortia composed of industries, universities, and research

institutes to develop critical technologies. The general funding formula has been
50% national government, 25% local government, and 25% enterprises;
• Testing of new products with a view to increasing the chance of successful

commercialization;
• Use of research personnel and facilities of universities About 18 universities

allow SMEs to participate in their R&D projects to augment their capacities in
technological development.
31. To encourage technology transfer and trade the government has established the Korea
Technology Trade Center. This Center has set up an integrated information network for SMEs
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and high tech firms, and advanced technology evaluation techniques have been introduced.
32. The government provides help to qualified SMEs in developing information systems
through technical assistance and training. This includes systems related to management of the
firm, as well as website design and e-commerce.
D. Exporting
33. To help SMEs penetrate export markets, the government has established export support
centers throughout the country to provide them with the help they need. It also operates a
website (The Korean Marketplace – www.smipc.or.kr) through which SMEs can advertise their
products to overseas buyers. Some 60,000 products from 12,000 companies are currently
advertised on this Website. Training and matching of domestic and foreign firms are also
provided.
34. The Korean Government has established the Korea Venture Center in Washington, D.C.
to help arrange partnerships with foreign firms and help Korean SMEs list on the NASDAQ
Exchange.
35. Partly as a result of these initiatives, SMEs’ share of total Korean exports stands at about
40%, and their share of Korean overseas investment has varied between 7% and 17% in recent
years.
E. Regional Development
36. Korea is attempting to use SME policy as one way of addressing issues of regional
imbalance. The President can designate regions of the country where SMEs are provided with
special forms of assistance.
37. To nurture region-specific SMEs, financial assistance and credit guarantees are provided
in targeted regions through provincial governments. Startup companies that agree to open their
business outside the Capital Region are eligible for special financial and tax incentives, and
Capital Region firms that agree to move to other regions are under certain conditions exempted
from corporate taxes. Also under certain conditions, SMEs created in regions designated by the
President can have their property tax reduced by 50% for five years, and they are exempt from
stamp duty, registration tax, and acquisition tax.
F. Summary
38. Korea has placed strong emphasis on SMEs in its efforts to diversify and grow its
economy, to correct some of the imbalances resulting from the chaebol era, and to nurture the
capacity to adapt quickly to economic crises. A large number of government, NGO, and private
programs have been put in place and are continuously being fine-tuned as circumstances
change.
39. Though there is concern that SMEs have become too dependent on government
assistance, in general the record is one of success. Many financial institutions have increased
their loans to SMEs while decreasing loans to large companies. The attitudes of large
companies to SMEs are changing to one of cooperation rather than trying to dominate them.
SMEs, for their part, are lessening their debt loads under restructuring programs, thereby
improving their financial status and cash flow. SMEs have been increasing their investment in
R&D in order to remain competitive. Finally, SMEs are more and more cooperating with
overseas firms and gaining entry into foreign markets.
40. There may well be lessons for China in the Korean experience. Like China, Korea was
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faced with an economy dominated by very large firms, sectoral and regional imbalances, and a
weak capacity to adapt to change. Korea has tried virtually all possible forms of assistance to
SMEs – loans, grants, equity investments, credit guarantees, technical assistance, and others.
Though not all of these will be feasible under Chinese conditions, in-depth study of some of
them would be worth the effort.
4. SME Financing in Canada

41. In Canada, SMEs are defined as enterprises with less than 500 employees and less than
$20 million in sales. This is further broken down into small and medium enterprises.
42. About 98% of firms are SMEs; 94% have fewer than 20 employees and 75% fewer than 5.
The Canadian Government’s goals in its efforts to assist the SME sector are:
• Create a level playing field of competition for SMEs;
• Eliminate disadvantages faced by SMEs due to their size or other economic and
social conditions;
• Give full play to the positive role of SMEs in promoting economic growth, creating
job opportunities, fostering market dynamism, sustaining the prosperity of local
economies, and improving the quality of life for Canadians.
43. The Canadian Government recognizes that SMEs need different forms of financing at
different stages in their growth. The following figure shows sources of financing used by SMEs
in 1996, broken into small (<20 employees) and medium (<500 employees):
2.8
Public equity 1.1
2.8
Venture capital 2.6
5.1
Love money (equity) 5.1
5.6
Informal investment 5.3
15.3
Love money (debt) 17
28.1
Leasing 23.6
40.4
Long-term debt 36.2
43.4
Receivables 40.7
61.9
Short-term debt 58.4
54.8
Personal capital 59.1
60.7
Retained earnings 57.5
0 10 20 30 40 50 60 70
Small Firms Medium Firms

Figure 1: Per Cent of Canadian SMEs Using Various Forms of Financing (2000)
44. The data show that there is very little difference in the financing sources used by small
and medium size enterprises. A majority of firms use retained earnings, personal capital, and
short-term debt for financing purposes. Many also use receivables, long-term debt, and leasing.
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Perhaps surprisingly, very few use informal investment, love money in the form of equity,
venture capital, or public equity. Thus the traditional forms of financing are still much more
important to the SME sector than the more adventurous avenues like venture capital or IPOs.
45. Normally startup capital is organized from an equity stake on the part of the entrepreneurs,
sometimes aided by family and friends. Startup firms often have difficulty raising debt from
financial institutions. As the firm grows, it re-invests retained earnings in the business. Once it
achieves a record of success, a number of other financing options become available, usually in
the form of debt instruments. Firms that grow very rapidly generally require outside equity to
support their expansion – informal investment, venture capital, and listing on a stock exchange.
A. Debt Financing
46. In 2000, 23% of SMEs made a request for debt and 82% of these requests were
approved. About 86% of the debt requests were made to banks and credit unions, and only 8%
to government institutions. The most common instruments used were term loans and lines of
credit.
47. One of the major government debt financing programs is the Small Business Loans
Program administered by the Department of Industry. The program is designed to facilitate the
granting of loans by banks and other lenders to new and existing small business enterprises
which otherwise might be unable to secure funding. It can finance the purchase and
improvement of fixed assets necessary for the operations of the small business. Eligible
businesses must have gross revenues of less than $5 million and be a sole proprietorship,
partnership, or incorporated company. The interest rate cannot exceed 3% above the prime
lending rate.
48. The loans are made directly by SBLA approved lenders to those small business
enterprises that meet specific credit and risk criteria of the lender, who is chosen by the small
business. The federal government is not involved in the determination of credit worthiness,
which is strictly the prerogative of the chosen lender. SBLA provides for the federal government
to share in any loss that a lender may sustain as a result of making a business improvement
loan.
49. Business improvement loans may be made to finance up to 90% of the cost of the asset
(to a maximum of $250,000) to finance:
• the purchase of land necessary for the operation of a small business enterprise;
• the renovation, improvement, modernization, extension, construction and

purchase of premises;
• the purchase, installation, renovation, improvement and modernization of new or

used equipment.
50. The Business Development Bank of Canada (BDC), a federal government agency that
reports to the Minister of Industry, also offers financing in the form of term loans for the
purchase of equipment, land, or buildings. The amount of the loan can attain 125% of the value
of the asset to cover additional costs.
51. BDC also administers the Micro-Business Program to support the early growth needs of
some of the smallest businesses. The Program provides entrepreneurs with counseling and/or
training, and financing of up to $15,000 for new business and $25,000 for existing business,
provided their business proposals demonstrate potential for growth and good prospects for
success. Eligible firms must have fewer than five employees and gross revenues below
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$500,000.
B. Risk Capital
52. Only 2.4% of Canadian SMEs requested risk capital in 2000, but these were in many
cases the fastest growing, most dynamic firms. Risk capital most often came from friends or
family; informal, so-called “angel” investors; and venture capital funds. In 2000, $6.6 billion of
venture capital investment was recorded. Little hard data are available on the amount of
informal investment, but researchers suggest it probably totals from $1-20 billion annually.
53. Venture capital companies take an equity position in the company to help it carry out a
promising but risky project. They may invest at startup but usually prefer to wait until the
expansion phase. Venture capital companies are financed by government funds, private funds
(especially from chartered banks) or public funds (pension funds, mutual funds).
54. Their investments, sometimes very substantial, often focus on high-growth sectors such
as information technology, communications, and biotechnology.
55. BDC has a Venture Capital Division that supports leading-edge companies strategically
positioned in a promising market. Like most other venture capital companies, it gets involved in
only a limited number of startups, preferring to focus on major interventions when a company
needs a large amount of financing to get established in its market.
56. ”Angels” fall into the category of private investors who risk their personal assets to invest
between $25,000 and $250,000 in exchange for a significant equity position in the company and
a seat on the board of directors.
57. Angels are demanding but are more willing to invest at the seed or startup stage. Their
involvement expedites the launching of the business given that they concentrate on areas they
know well. Companies they take under their wing will therefore benefit from their experience
and numerous contacts.
58. Labor-sponsored Venture Capital Corporations (L-SVCC) provide a vehicle for equity
investment in small business. Investment in a L-SVCC earns a 20% federal tax credit on the
first $5,000 per year. In some cases, this credit is matched by provincial governments.
C. Other Sources of Financing
59. Canadian SMEs often use lease financing to finance their equipment and facility needs.
Leasing is used for such items as vehicles, machinery, computers, office equipment, and
buildings and land. Such instruments are generally arranged with either suppliers or leasing
companies. This allows the SME to finance the full value of the leased asset without tying up its
operating capital.
60. Some 29% of all SMEs made purchases using supplier credit in 2000. Subordinate
financing is a hybrid product that brings together some features of both debt financing and
equity financing. Subordinate financing mimics debt financing because the borrower has the
obligation to repay the loan. Moreover, part of the cost is in the form of a fixed interest coupon
(a deductible expense.) Subordinate financing also has characteristics similar to equity
financing in that the repayment of the loan is based on cash flow, rather than depreciating
company assets, and because it is subordinated to secured lenders.
D. Technology
61. The Industrial Research Assistance Program (IRAP) of the National Research Council of
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Canada (NRC) has as its goal to enhance the competitiveness of Canadian firms through
acquisition, development and exploitation of appropriate technology.
62. The IRAP portfolio of services has four main components:
Technology Expertise and Advisory Services
Financial Assistance for R&D activities
Networking
Partnerships
63. Canadian SMEs with fewer than 500 employees and industrial associations desiring to
enhance their technological capability are eligible for support. NRC-IRAP Industrial Technology
Advisors (ITAs) help to identify and address the technical and research needs of SMEs, as well
as their sustainable development issues, at each stage of the R&D development process and
the innovation cycle.
64. IRAP provides non-repayable contributions to Canadian SMEs on a cost-shared basis for
research and pre-competitive development technical projects, upon assessment of a project
and firm by a team of ITAs. The IRAP-Technology Partnerships Canada Program provides
SMEs with repayable financial assistance for projects at the pre-commercialization stage. Firms
use these funds to develop technology for new or significantly improved products, processes or
services, as well as to support initial demonstration and pilot projects.
E. Exporting
65. The overall goal of the federal government's Program for Export Market Development
(PEMD) is to increase Canadian prosperity and competitiveness in international markets.
Specifically, PEMD strives to increase export sales of Canadian goods and services by sharing
the costs of activities that companies could not or would not undertake alone, thereby reducing
the risks involved in entering a foreign market. Preference is given to Canadian companies with
annual sales greater than $250,000 CDN. and less than $10 million CDN., and /or with less than
100 employees for a firm in the manufacturing sector and 50 in the service industry.
66. The PEMD program is comprised of four major elements: Market Development Strategies
(MDS), New-to-Exporting Companies, Capital Projects Bidding and Trade Association Activities.
The key MDS element focuses on assisting companies with the implementation of a simple
marketing plan designed to penetrate an international market. Intended for smaller businesses,
both experienced and new to exporting, it shares the risk of the international marketing initiative
with the Canadian private sector. PEMD also provides assistance to companies that are New-to
Exporting to introduce them to export markets without undue financial strain. The Capital Project
Bidding element of PEMD supports Canadian companies in bidding for major capital projects
outside Canada by contributing to the cost of bid preparation or proposal preparation at the pre-
contractual stage. Trade Association Activities supports export market development strategies
of national trade and industry associations meeting PEMD eligibility requirements.
F. Tax Incentives
67. The tax measures for small business provided by the Canadian government include:
• The Small Business Deduction (SBD) reduces a small business' income tax rate
to 12% on the first $200,000 of income. The normal rate for Canadian-controlled
private corporations is 28%. The SBD, combined with the dividend tax, is
intended to ensure salary income and dividend income from small corporations
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are taxed at about the same rate.
• The capital gains exemptions eliminates taxation on the first $500,000 earned
from eligible small business shares.
• The Allowable Business Investment Losses allow capital losses of shares or debt
of a small business corporation to be written off against other income. Normally
share or debt caused capital losses would be written off only against other capital
gains.
• The Scientific Research and Experimental Development Tax Credit provides a

35% tax credit on qualifying expenditures for small business. Further, tax credits
earned on current expenditures are fully refundable in cash up to certain limits.
• The Goods and Service Tax (equivalent to Value-Added Taxes in other

countries) does not apply to earnings below $30,000.
G. Regional Development
68. Canadian governments make frequent use of business assistance programs to target
specific regions or populations. There are specific assistance programs that target:
• Certain sectors e.g. farming, tourism, cultural; most often, these are specialized
funds that come under different departments.
• Certain regions (Canada Economic Development in Quebec, Atlantic Canada

Opportunities Agency, Federal Economic Development Initiative in Northern
Ontario and Western Economic Diversification Canada).
• Certain population groups (aboriginals, women, new immigrants, young people,

etc.) in connection with projects that are often supported by Human Resources
Development Canada.
69. An example is the Atlantic Canada Opportunities Agency (ACOA), a federal government
agency that serves the needs of SMEs in the Atlantic Region.
70. ACOA’s Business Development Program (BDP) provides interest-free, unsecured,

repayable contributions for start-ups, expansions and modernizations, innovation, marketing,
training, quality assurance, public bid tender preparation and business studies. Eligible sectors
include aquaculture, business service industries, commercial research and development
facilities, manufacturing and processing, mining and tourism. Up to 50% financing is available
for capital projects like construction of a building, machinery and equipment, and infrastructure.
Up to 75% of costs is permitted for marketing, training, consultant advice, business proposal
development, and other soft expenses.
71. The Atlantic Innovation Fund (AIF) is a $300-million, 5-year program designed to
strengthen the economy of Atlantic Canada by accelerating the development of knowledge-
based industry. The objectives of the AIF are to:
• build capacity for innovation and R & D which leads to technologies, products,
processes or services that contribute to economic growth in Atlantic Canada;
• increase the capacity for commercialization of R & D outputs;
• strengthen the region's innovation capacity by supporting research, development

and commercialization partnerships and alliances among private sector firms,
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universities, research institutions and other organizations in Atlantic Canada's

system of innovation, and to increase their critical mass; and
• maximize benefits from national R & D programs.
72. The program has been used primarily for the following sectors: aquaculture, environmental
technologies, information technologies (e.g., communications, geomatics), health and medical
technologies, ocean technologies, and biotechnology.
73. The AIF will entertain proposals from commercial and non-commercial entities such as
universities, colleges, other post-secondary educational institutions, business associations,
research institutions and private sector firms.
74. Eligible costs include all reasonable incremental costs deemed essential for the
implementation of the project including the following:
• incremental wages and salaries directly associated with the project;
• equipment, computers, and software required for the project; and
• operating costs for the project including materials, R&D subcontracts and travel.
75. Contributions will be negotiated to be the least amount required to allow a project to
proceed. The upper limit of assistance for commercial projects is 75% of total eligible costs, and
the limit of assistance for projects undertaken by non-commercial organizations is 80% of total
eligible costs. Contributions under the AIF to the private sector that involve the
commercialization of a technology, product, process or service are conditionally repayable
based on the commercial success of the project. Contributions to non-commercial organizations
are non-repayable.
H. Summary
76. The financing of small business is largely in the private domain in Canada, supported by a
number of government programs. The most important sources of financing are retained
earnings and personal capital, and loans from banks and other financial institutions. Most
government programs are designed to facilitate private financing by providing technical
assistance, credit guarantees, and tax incentives. An exception is the programs designed to
stimulate economic development in lagging regions, which are heavily used in Canada. These
programs include grants, interest-free loans, and free technical assistance.
77. Venture capital, though used by a small minority of firms, is crucial to rapidly growing
companies. Most venture capital firms are private, but there are important publicly aided ones.
Informal, “angel” investments are fairly common and growing.
78. The Canadian experience in using government funds and expertise to enhance, not
replace, private sector financing is an important one for China. The Chinese financial system
may not be organized at present to provide the same services as the Canadian financial
system, as reforms continue it will move toward the Canadian model and some of the tools used
in Canada may be adaptable to Chinese conditions.
79. Canadian’s heavy use of business assistance programs to stimulate regional development
is also worthy of further study. Though such policies are questioned in many circles, they are
nevertheless in place in many countries. China will likely want to use some of its business
improvement initiatives for similar purposes.
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REFERENCES
Websites:
Atlantic Canada Opportunities Agency: www.acoa.ca
APEC Center for Technology Exchange and Training for Small and Medium Enterprises: www.actetsme.org
Business Development Bank of Canada: www.bdc.ca
Korean Small Business Administration: www.smba.go.kr
National Research Council Canada: www.nrc-cnrc.gc.ca
Fukui, Ryu, SME Promotion Policies and Finance: Issues Across Regions (Powerpoint) (2000)
Gregory, Gary et al, Korean SMEs in the Wake of the Financial Crisis: Strategies, Constraints, and Performance in a
Global Economy (2000)
Hall, Chris & Harvie, Charles, A Comparison of the Performance of SMEs in Korea and Taiwan: Policy Implications
for Turbulent Times (2003)
Industry Canada, Small and Medium Sized Enterprise (SME) Financing in Canada (2003)
International Finance Corporation, China’s Emerging Private Enterprises (2000)
Jeong, Young-Cheol, Korea-Venture Business, Venture Capital and KOSDAQ (2001)
Oh, Kyung-Chul, DFI’s Roles in SME Development (2000)
Orser, Gasse and Riding, Factors Relating to SME Growth: A Review of Findings, (1996)
F1-13
G1: Case of Australia
Fiscal Case Study of AUSTRALIA

Prepared by George Peterson
Chreod Ltd.
Case Study G1: Australia January 2004
FISCAL CASE STUDY

AUSTRALIA
George E. Peterson
Part One: Australia
1. Introduction: Australia is a sparsely populated country of about 20 million. Its per

capita income in 2000 was US$24,970. Fiscal reform has generated a good deal of
political attention in recent years in Australia, as the three levels of government—
Commonwealth, states, and municipalities—have attempted to sort out their respective
service functions, revenue sources, and fiscal relationships. In many respects, Australia is
viewed as being in the vanguard of fiscal reform initiatives.
2. Governmental and fiscal structure: Australia is a federal nation. The national

Constitution recognizes only the first two tiers of government: the Commonwealth (or
federal government) and the states. Municipalities and other elements of “local”
government are creations of the states, subject to state laws and state regulations. Twice
in the past two decades Constitutional amendments have been presented to the voters at
referendum, proposing formal Constitutional recognition of municipalities as a third tier of
government. However, the proposed Constitutional amendments were rejected by voters.
3. The Australian Constitution defines relatively few exclusive powers for central
government (national defense, international relations, monetary control). Most
governmental responsibilities are identified as “concurrent” powers that both the
Commonwealth and the states—and with state authorization, municipalities—can perform.
In cases of conflict, Commonwealth laws prevail.
4. The Constitution also allows the Commonwealth to make grants to states and
municipalities on such conditions as it chooses. In practice, the Commonwealth has used
this power to shape the state and local sector’s spending and revenue patterns, by making
participation in its grant programs contingent upon lower level governments’ adopting
specified revenue or expenditure policies. However, the procedures followed in Australia
involve a high degree of voluntary participation by the states. A formally defined process
of consultation between states and Commonwealth is used to reach policy agreement,
which is then ratified by signed intergovernmental compacts, whenever a major change in
fiscal relationships is proposed. For the most part, Commonwealth grants to municipal
governments pass through the states and are distributed according to criteria established
by each state. However, the Commonwealth provides some program-specific funding
directly to municipalities. The most significant example of such direct funding is for road
construction and road rehabilitation.
5. Expenditure assignment: Most domestic expenditure functions in Australia are

defined as “concurrent” responsibilities between the Commonwealth and states.
Translated into practice, this relationship has meant that states are responsible for most
service delivery, while receiving large amounts of financial assistance from the national
government. States are responsible for the universal provision of primary and secondary
schooling; for the majority of universities; for health services ranging from local health
clinics to major hospitals; for public safety, including police protection and firefighting; for
urban development; parks, recreation, and culture; for transportation, including most of the
investment in roads, highways, and airports; provision of potable water and collection and
treatment of wastewater, as well as other investments in infrastructure facilities.
6. National government (the Commonwealth) retains responsibility for Australia’s social

welfare system—including old age pensions, unemployment insurance, and welfare
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(poverty) payments. The country’s social welfare system has been undergoing drastic
reform over the past decade. In 1992, Australia introduced individual savings accounts
(the Superannuation Guarantee) for almost all of the country’s workforce.1 Employers and
employees pay into one of many approved investment plans. Retired couples are
guaranteed a starting pension equal to 42% of average male earnings. Pension benefits
are fully portable, thereby reinforcing the mobility of labor. Within the past year the
Government announced a high-priority overhaul of the country’s welfare assistance
program for non-elderly. All recipients would be required to engage in community work,
participate in job training, and conduct active job searches, as a condition of eligibility.
This proposal represents a sharp reversal of Australia’s past policy, which has made
welfare assistance available to all poverty households and all unemployed, without
conditions.
7. Municipal governments traditionally have been responsible primarily for property-

related investment, particularly in roads and transportation. Until the late 1960s, spending
on roads and transportation constituted 50 percent of municipal governments’ total
spending. It is still the largest single expenditure category—at 26-28 percent—but
municipalities have gradually broadened their involvement in human and social services,
and have been delegated by the states greater responsibility for providing and financing
recreation and culture services. The issues associated with the broadening of municipal
service mandates are discussed below.
8. Tables 1 and 2 show the broad distribution of public spending at different levels of
government. The small role of municipalities in the total fiscal picture is noteworthy.
Table 1
Division of Public Expenditures
Average of 1990s
Local Government (Municipalities) 4.6%
States 39.2%
Commonwealth 56.2%
Total 100%
Table 2
Functional Distribution of Expenditures
By Level of Government (average of 1990s)
Item Commonwealth States Local

Education 3% 25% Less than 1%
Health 12% 16% Less than 1%
Social Security and Welfare 44% 5% 4%
Transport & Communication 6% 9% 26%
Public Order & Safety less than 1% 7% less than 1%
Defense 11% —- —-
Recreation and Culture —- 5% 14%
Housing & Community Amenities in “other” in “other” 16%
General Public Services 8% 9% 17%
Other 16% 24% 23%
Total 100% 100% 100%
9. Revenue assignment: Responsibility for revenue generation in Australia has gradually

shifted to the national (Commonwealth) government. The shift in revenue assignments
has resulted from four factors:
The belief that national tax administration can more efficiently levy and collect
1
In 1998, 92.5% of men workers and 89.7% of women workers were covered, including part-time workers and
self-employed.
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taxes
The conviction that tax competition across states—i.e., competition among states
to lower tax rates for state-imposed taxes—has distorted overall economic growth
for the country and led to an erosion in the capacity of states to raise revenues
A desire to offset part of the differential in fiscal capacity among states, by

collecting tax revenues at the national level and distributing them among states
according to formulas that take into account fiscal capacity or poverty
Rulings by the High Court of Australia that several of the taxes traditionally levied
at the state level are unconstitutional
10. When the Australian federal Commonwealth was formed in 1901, the constituent states
agreed to surrender what was then their principal source of revenue, customs duties. The
High Court has subsequently ruled that this Agreement prohibits states from imposing not
only customs duties but any other kind of duty on goods. Until World War II, the states
controlled personal and business income taxes. The need to generate revenue at the
national level for the war effort led to the conversion of the income tax into a
Commonwealth tax in 1942. A nationally uniform rate structure was established. States
were reimbursed for the loss of tax revenue through a series of grant programs, originally
called income-tax reimbursement grants. The High Court has ruled that the Agreement
struck between the states and the Commonwealth prohibits the states from re-imposing
income taxes at the state level. In 1997, the High Court ruled that states could not levy
another important source of state revenue, the business franchise tax.
11. As a result of these decisions, Australian states are prohibited from imposing taxes that
account for the main sources of revenue in other OECD countries: the personal and
business income tax, taxes on the production, distribution, or sales of goods, as well as
franchise taxes. This has forced states to adopt a large number of lesser taxes, levied on
narrow tax bases. The multiplicity of state-level taxes, levied at different rates in different
states, and particularly burdening the financial sector, has been a common source of
complaint, especially by firms doing business in Australia. Some of the taxes also are
economically inefficient, in the sense that they significantly distort the allocation of
investment resources.
12. Structure of State-Local Revenue: In practice, the following taxes had evolved as the
principal sources of state and local revenue, as of the year 2000. Part II of this paper
describes the tax reform that was put in place starting in July 2000.
13. Payroll tax (levied at state level). The payroll tax is levied monthly by each state on the
payrolls of employers who pay wages in excess of a prescribed threshold. Both the
exempt level and the rate of tax vary by state. The payroll tax originally was a
Commonwealth tax, but it was transferred to the states as part of an intergovernmental
agreement. It is an indirect way to allow the states to tax (some) incomes, in a form that is
acceptable to the High Court.
14. Financial institutions duty, transfer taxes, and other financial transaction taxes. States
levy a wide variety of taxes on financial transactions. (See more detailed discussion in
Part II.) Australia is one of very few countries to single out the financial sector in this
manner. It has done so, because the High Court has ruled that taxes on goods and
traditional services violate past Agreements between the states and Commonwealth.
Duties on financial services were the only kind of tax on services that escaped this ruling.
States have imposed taxes on financial transactions at widely different rates, despite
intermittent attempts to co-ordinate rates across states. The resulting tax competition, and
discrimination against the financial sector, led the national Government in 2000 to propose
a sweeping tax reform that would replace the states’ financial taxes and duties with a
general value-added-tax at the national level, whose revenue would be distributed entirely
G1_3
to the states. (See Part II.)
15. Motor vehicle taxes. Tax rates on motor vehicles are differentiated by the type and
value of motor vehicle, and also by state.
16. Gambling. State taxes on gambling were introduced in the latter part of the 1990s and
have been a rapidly growing source of state revenue.
17. Real property taxes. Municipal governments derive almost all of their tax revenue from
real property taxes, levied on improvements and on land. The municipal property tax is
called “rates” in the Australian system.
18. Table 3 summarizes the state and local sector’s distribution of own-source revenues as
of 1997-98, prior to the most recent tax reforms.
Table 3
Australia: Own-Source Revenues, State and Local Sector
$A bil. and Percenta
1997 - 1998
Item A$ %
Payroll Tax $8.1 21.2%
Taxes on Real Property $7.7 20.2%
--Land Tax $1.7 4.5%
--Municipal Rates $5.7 14.9%
--Other $0.3 0.8%

Financial Institution
$9.8 25.6%
Duties and Financial Transaction Taxes
Gambling Taxes $3.8 10.0%
Motor Vehicle Taxes $3.6 9.4%
Franchise Taxes $4.5 11.8%
Other $0.7 1.8%
Total $38.2 100%

a Totals may not sum because of rounding
19. Overall, states raise much less revenue from own sources than they spend. The
difference—the so-called “vertical imbalance”—is covered by shared taxes collected at the
national level and grants from the center. In 1998-99 states were responsible for 39.3% of
consolidated public sector spending, but raised only 22.5% of consolidated public sector
revenue from their own sources. This differential was increased as a result of the 2000 tax
reforms (see below.)
20. Institutions that help coordinate national and state-local taxation: Australia has
developed a consultative method of reaching agreement on its intergovernmental tax
structure and expenditure assignments. The country has several institutions, and many
historical precedents, that help coordinate Commonwealth and local taxation.
21. First, any proposed change in intergovernmental allocation of tax or expenditure

responsibilities must be approved both by the Commonwealth and by the states. This
agreement takes the form of negotiated settlements signed by all parties, or, sometimes, a
G1_4
series of bilateral agreements signed by the Commonwealth and individual states one at a
time. Changes are first vetted and approved in principle at the annual Premiers
Conference that brings together the premiers of the states and the Prime Minister of the
Commonwealth. Most tax changes have involved the federal (national) government
agreeing to make additional transfers to states in return for their acceptance of limitations
on their right to levy certain taxes or their agreement to levy uniform tax rates on certain
state taxes. Under Australia’s system of federal government, the Commonwealth cannot
legally alter the structure of state taxes without the states’ consent. In political terms, it
cannot adopt federal tax or grant policies, or devolve expenditure responsibilities, that
would force the states to raise more revenues at their levels without the states’ consent.
22. Second, Australia has a permanent Grants Commission that plays an important role in
intergovernmental financing. The Grants Commission is a federal body, which typically
consists of senior minister officials, senior academics, and senior financial experts. The
Commonwealth consults with the states before making appointments to the body and
extends de facto veto power to the states in the event of controversial appointments. The
principal responsibility of the Grants Commission is to design the formulas that allocate
Commonwealth grants and shared taxes among the states. These formulas incorporate
the principles of equalization that are widely accepted in the Australian federation. All of
the major grant formulas and tax-sharing formulas seek to compensate states that have
weaker fiscal capacity on their own.
23. Third, Australia has an intergovernmental Loan Council that advises on state and local
borrowing. The Loan Council comprises the Commonwealth Treasurer, the treasurer of
each state, and selected other financial experts. Approval of the Loan Council is not
legally required before state or local governments issue debt. However, their judgments
and recommendations are widely followed. All state and local units proposing to issue
debt must submit information on the proposed borrowing to the Loan Council. The Loan
Council monitors overall debt levels and the potential impact of high loan activity on fiscal
conditions. It also sets standards for financial disclosure by state and local borrowers. All
of the conditions of loans must be transparent and accessible to the public at large. Any
guarantees must be spelled out and counted as part of contingent debt. The use of
government guarantees is strongly discouraged by the Loan Council. Any other
arrangements supporting municipal or state debt must also be fully disclosed and limited—
especially in the case of project financing where there otherwise might be thought to be
implicit government guarantees.
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PART TWO: FISCAL REFORM ISSUES
24. Australia has been a leader in implementing intergovernmental fiscal reforms in recent
years. This section examines four initiatives that have special relevance for China and
Hebei Province.
25. Substitution of national tax-sharing of VAT for selected state taxes: Australia’s
states have relied for own-source revenues on a variety of taxes levied on business and
financial transactions. These taxes included stamp duty on the sale of marketable
securities, conveyance duties on the sale of business property, stamp duty on credit
arrangements and rental agreements, stamp duty on mortgages, bonds and other loans, a
special tax on financial institutions, a tax on all debits, and a so-called Bed Tax on hotels
and other accommodations.
26. These taxes were widely believed to impede business and financial activity, and were
generally viewed as causing inefficiency in business transactions, as firms would seek to
structure transactions so as to minimize tax liability. It was also believed that the
complicated state-level structure of taxes on financial transactions damaged Australia’s
international competitiveness in seeking to attract business investment, and held back
Australia’s development as a financial center. The high level of state taxes on financial
institutions and financial activity, as well as the unpredictability of future state tax rates,
placed Australia at a disadvantage relative to Asian nations in attracting financial-sector
business. Further, the high burden placed on property sales, mortgages, and rental
agreements generally was believed to have discouraged household and small-business
mobility, further contributing to economic inefficiency. Finally, tax competition between the
states was eroding all states’ tax bases. Certain states had established themselves as “tax
havens” by waiving some of the stamp duties and taxes on financial activity, while keeping
rates lower than other states’ on other financial taxes. This had led to a concentration of
financial-sector investment in these states, even when such locations were not
economically appropriate. Other states then came under pressure to lower their tax rates in
order to compete.
27. In November 1998 the Prime Minister announced a blueprint for future tax reform. The
centerpiece of the reform program was the introduction of a broad-based Value Added Tax,
called the Goods and Services Tax or GST, whose revenues would be shared with the
states, and which would replace nine different state taxes thought to interfere with business
development and Australia’s economic development. The changes were scheduled to go
into effect July 1, 2000.
28. Implementation of the tax reform program illustrates both the importance of fiscal issues
on the intergovernmental agenda, and the special procedures used in Australia to negotiate
mutually acceptable reform outcomes between the Commonwealth and the states. The
states did not want to surrender all of their taxing authority. More importantly, they wanted
to ensure stable growth in transfers from the central government. In the end, therefore, a
uniform GST administered by the central government was imposed at a 10% rate. All of
the revenues from this tax were to be distributed to the states. In return, the states
surrendered the right to levy certain of the financial taxes, those believed to be most
damaging to commerce—namely, the financial institutions tax, the stamp duty on sales and
conveyances of marketable securities, the debits tax, and Bed Taxes. In addition, it was
agreed that the central government would terminate all general-purpose grants (called
Financial Assistance Grants) to the states. The Commonwealth guaranteed each state that
it would receive at least as much total revenue from GST tax-sharing as it had previously
generated from the taxes and grants that were abolished. Total tax-sharing revenues in the
future would grow commensurately with overall economic activity in the nation.
29. This negotiated outcome was expressed in a formal Intergovernmental Agreement on

the Reform of Commonwealth-State Financial Relations, signed by the Prime Minister, all of
the State Premiers, and the Territorial Chief Ministers. The new arrangements are being
G1_6
phased in, starting in the year 2000. As part of the Agreement, it was also agreed that a
special joint study of the feasibility of eliminating the other state-level taxes on financial
activity would be conducted, with recommendations to be made on their retention or
removal by the year 2005. In the spirit of fiscal equalization, the revenues from GST are
being shared with the states according to a formula that steers a greater share of revenues
to states with weak fiscal capacity—subject to the provision that no state will receive less
revenue than it did prior to the reform.
30. Application of national competition policy to state and local government:

Australia, like many nations, has been re-structuring its public sector to allow more equal,
market-based competition between public enterprises and the private sector. The federal
government (Commonwealth) and the states have agreed to a package of legislative and
regulatory reforms that:
Separates the regulatory from the commercial functions of public monopolies (e.g.
authority over the regulation of water extraction and distribution by third parties has
been removed from the public utilities that provide potable water service.)
Provides third-party access to infrastructure facilities and services on the same

terms as the public sector—whether as an alternative provider of services or as a
user of services
Requires government-owned enterprises to be subject to the same tax and

regulatory regime, and the same user charges, as private-sector enterprises.
31. As part of this Agreement, the Commonwealth agreed to make competition payments to
states that were moving ahead to implement the Agreement’s provisions. The
Commonwealth has the right to withhold competition payments from states that are failing
to implement a level playing field between public enterprises and private enterprises,
whether at the state or local level. In fact, in 2001-2002 the national government withheld
certain payments to the state of Queensland, on the grounds that one of the cities in the
state refused to reform its water tariff schedule to treat public enterprises and private
enterprises equally. Several Australian states have established parallel competition
programs of their own, which they use to provide financing to encourage municipal councils
to move more quickly and thoroughly in competition reforms, including opening entry of
private companies into infrastructure and other service provision.
32. Australia’s initiatives to place public and private enterprises on an equal footing have
had significant impact in opening up competition and in encouraging both states and
municipalities to seek the most cost-effective means of providing services, regardless of
governmental connection.
33. Expansion of municipal government service responsibilities and the

displacement of infrastructure investment: One issue that has generated a great deal of
policy concern in Australia is the decline in the portion of state and municipal budgets
devoted to infrastructure investment. The steep decline over three decades in road
spending as a share of municipal budgets is displayed in Table 4. Similar trends have
marked investment in water and wastewater systems in those states where these functions
are a municipal-level responsibility. The Commonwealth Grants Commission, in its most
recent assessment of local (municipal) government performance, notes that municipalities
have been taking on a broad range of human service and community functions, and that
these new functions have placed pressure on the municipalities’ traditional role as
infrastructure investors and providers of property-related services.
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Table 4
Share of Transport and Communication
In Municipal Expenditures
(Primarily Roads)
YEAR 1965-66 1975-76 1985-86 1995-96 1997-98
Percent of Municipal Expenditures 50% 39% 30% 28% 26%
34. In 2002-2003, the Australian Parliament asked the House of Representatives Standing
Committee on Economics, Finance, and Public Administration to examine the reasons for
this trend in municipal expenditures, and make recommendations regarding future policy.
The Committee found that municipal governments were in fact devoting significantly larger
shares of their budgets to human, environmental, and cultural services—including such
activities as supplemental safety protection, local assistance to poor families, basic health
clinics, development and operation of parks and recreation. Nothing in Australia’s laws
prohibits municipalities from entering these fields. However, the corresponding service
responsibilities are formally assigned to the states. The Committee found that, although
some of the expansion of municipal service responsibilities resulted from citizen pressure
for greater municipal involvement, the single largest factor in municipalities’ service
expansion was a reduction in states’ service provision levels. When states withdrew from
service functions, or failed to meet growing demand, municipal governments had to step in
to sustain service levels. Most often, the reductions in state-provided services at the local
level were not part of a formal policy announcement, but a de facto step taken by states in
response to their own budget pressures.
35. The Committee recommended three major policy changes:
First, it recommended that states be required to enter into formal agreements with
municipalities when they cut back local services, or shifted service responsibilities
to municipal governments. These Agreements would identify the increased service
functions expected to be performed by municipal governments, and would identify
how the financial resources to perform the augmented functions were to be
generated, whether by increased state financial assistance or through other
means. This preference for formal Agreements reflects the same structure used
between the Commonwealth and States when fiscal responsibilities or revenue
sources are shifted.
Second, it recommended that the Commonwealth (national) government intervene

directly with program-specific grants directly to municipal governments, to support
programmatic areas of national priority. The national Government already had
begun this process in 2001 with a program of financial assistance for local road
repairs and restoration, intended to reverse the decades-long decline in relative
investment in roads under municipal responsibility. The Committee recommended
continuation of this program and use of the same model for other specific sectors
when appropriate. Direct national assistance to municipalities runs counter to the
main channel of funds flow in Australia, where national-level grants normally flow
to the states, and then are distributed by the states to municipalities according to
each state’s distribution criteria.
Third, the Committee recommended strengthening municipal governments’

capacity to increase own-source revenues, both through local tax increases and
greater flexibility in establishing user fee levels. It particularly criticized the practice
in some states of placing a state-level ceiling on municipal property tax rates, and
the practice in some states of requiring state-level approval of municipal-level user
fees for water systems and other local services.
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36. The report of the Parliamentary Committee on Economics, Finance and Public
Administration was issued in October 2003. It is too early to determine how completely its
recommendations will be adopted. However, the report itself is a once-in-a-generation
examination of the functional responsibilities and financing of municipal governments, as
well as the relations between states and their municipalities.
37. Asset and debt management at the municipal level: Australia has been a worldwide
leader in public-sector asset management. The experience of Australian municipalities and
states is perhaps even more relevant in China than it is in Australia, since municipal
governments and their affiliated enterprises in China own a much greater variety of
property, having a far greater value, than do their counterpart municipal governments in
Australia. The property market for urban land is also much stronger in China. Balanced
against this is a far higher level of municipal indebtedness by most larger Chinese
municipalities—debt that typically is directly or indirectly secured by municipally owned
property as collateral. This reality makes the kind of balance sheet accounting and
reporting reforms accomplished in Australia of paramount importance to municipalities in
Hebei Province and elsewhere.
38. At the core of Australia’s reforms has been the requirement that every public entity
prepare a balance sheet recording in transparent fashion its assets and liabilities. These
balance sheets are part of the public record, and available to all who desire access. They
are relied upon by credit-rating agencies, by higher levels of government, and by taxpayer
groups. On the asset side of the balance sheet, all types of property are recorded. For
potentially marketable property, including urban land owned by municipal institutions,
property is valued at its estimated market value. Infrastructure is recorded for balance
sheet purposes at cost minus depreciation. However, special studies typically accompany
the balance sheet that identify the replacement cost of infrastructure assets and analyze
the extent of physical deterioration due to inadequate maintenance. On the liability side of
the balance sheet, all debts are recorded and information provided on the terms (interest
rate, maturity etc.) of outstanding indebtedness. There are special provisions for the
recording of government guarantees.
39. Application of this balance sheet approach has made municipalities far more skillful
owners and managers of assets. It forces municipalities to recognize the potential
economic value of key real property assets, and calls attention to the failure to extract
economic value from the assets, when the assets lie unused and unmarketed, or are being
leased at below-market rates. Public access to a transparent balance sheet, with full
disclosure of ownership and leasing terms, also has been found to be the strongest means
of limiting corruption and insider favoritism in asset leasing and sales. All property
transactions must be publicly reported.
40. At the national and state level, Australia has been moving toward imposition of an
economic charge on all property assets held by public institutions. This arrangement
recognizes the economic value of property held by public institutions, and is intended to
force them to make economically rational decisions about the use or disposition of property.
The institution should be able to recover the fee charged from leasing or user charges.
Public sector entities then have to face the true cost of occupying property in their budgets.
If the institutions holding the real property cannot recover the economic charge through
leasing arrangements, they have an incentive to sell the property. This incentive is
designed to overcome the public sector’s inertia, which often leads institutions to hold onto
property, even when they have no clearly defined economic use for it, or when it will be
more efficiently operated by the private sector. Exceptions are provided for in Australian
law for facilities, like wastewater treatment plants, where full recovery of capital costs may
be deemed inappropriate, given the external benefits they generate.
41. The initiatives launched by Australia and New Zealand in real property asset
management are now being spread to most other OECD countries, and are being taken up
by many developing nations.
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42. Table 5 summarizes the aggregate balance sheet of municipal governments in

Australia. One of the most remarkable aspects of the aggregate balance sheet is the low
level of debt owed by municipalities. In fact, in 2000-2001, the most recent year for which
data are available, municipalities’ total outstanding debt was less than their holdings of
cash and cash equivalents, producing a net positive cash balance.
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Table 5
Summary Balance Sheet
Municipal (Local Government) Sector
2000-2001
ASSETS Australian $ (millions)

Financial Assets
Cash and Cash Equivalents 4,008
Investments, Loans, Equity 4,563
Total 8,571
Non-Financial Assets
Land 40,817
Buildings 12,687
Infrastructure 90,705
Plant and Equipment 2,970
Other 936
Total 148,115
Total Assets 156,686
LIABILITIES
Borrowing 5,546
Unfunded Pension Liabilities 1,529
Advances & Other 2,013
Total 9,088
NET WORTH (Taxpayer Equity) 147,558
43. The practice of preparing a publicly accessible balance sheet for each local public
institution, as well as a consolidated balance sheet for municipal government as a whole, is
a fundamental reform that is even more critical in places where local indebtedness is large
and where municipal debt is secured directly or indirectly by municipally owned assets.
Selected References
Australia, Government of. 2004. Pocket Brief to the Australian Tax System.
www.treasury.gov.au/documents/775/PDF/Pocket%20brief.pdf
Australia, Government of. 2003. Fiscal Developments in the States. Budget Paper
No. 3, 2003-2004 Budget.
www.budget.gov.au/2003-04/bp3/html/chapter2.htm.
Australia, Government of. 1999. Federal Financial Relations. Budget Paper #3.
Canberra: Government Publishing Office.
www.treasury.gov.au/1999-2000/bp3/bp3.html
Australia, Government of. 1999. “Fiscal Policy Framework,” Chapter 1 of Making

Transparency Transparent: An Australian Assessment.
www.treasury.gov.au/contentitem.asp?pageId=&contentID=178.
Australia, Government of. 1998. Prime Minister’s Office. Blueprint for Tax Reform.
Canberra: Government Publishing Service.
Commonwealth Grants Commission. 2001. Review of the Operation of the Local

Government. Canberra: Government Publishing Office
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Craig, Jon. 1997. “Australia,” in Teresa Ter-Minassian (ed.), Fiscal Federalism in

Theory and Practice. Washington, DC: International Monetary Fund.
Doing Business in Australia. 1996. The Competitiveness of Australia’s Tax System.

Sydney: Clayton Utz Law Firm
Korczyk, Sophie M. 2003. Women and Individual Social Security Accounts in

Chile,Australia, and the United Kingdom. Washington, DC: Public Policy Institute of
AARP.
House of Representatives, Standing Committee on Economics, Finance and Public

Administration. 2003. Rates and Taxes: A Fair Share for Responsible Local
Government.
www.aph.gov.au/house/committee/efpa/localgovt/report/front.pdf
National Office of Local Government, Department of Transport and Regional

Services. 2003. Local Government National Report [2001-2002 Report on the
operation of the Local Government (Financial Assistance) Act].
www.nolg.gov.au/publications/national_report/01_02/
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G2: Case of India
Fiscal Case Study of INDIA

Chreod Ltd.
Case Study G2: India January 2004
FISCAL REFORM CASE STUDY

INDIA
George E. Peterson
Part One: India
1. Introduction: India is the world’s second most populous nation, having a population of
approximately 1.05 billion people. Although the country covers some 3.3 million square
kilometers of territory, it is quite densely developed, with more than 550,000 villages and
some of the world’s largest metropolitan regions. In the year 2000, India had a per-capita
income of US$ 1,440. India has had less consistent economic growth than China, but its
projected growth rate for 2003 and 2004 is 8.5%.
2. Until recently, India’s development strategy looked primarily inward. The country had a
low volume of foreign trade relative to GDP, and tended to isolate itself from international
capital markets, by maintaining central government control over the financial sector and by
requiring that a large part of national investment be allocated according to national
development plan priorities. In the past several years, India has moved toward integrating
its economy more fully with international markets, while removing many of the requirements
or incentives that mandated national “plan” investments by agents other than the central
government.
3. Government and fiscal structure: India has a federal governmental structure, but one
where the national (Union) government has considerably more power than is found in most
federations. The Union has the legal power to limit the rights of the 25 states and 7 Union
territories (which include a separate territory for the capital region, Delhi). It can intervene to
take over complete administration of a state when it deems necessary, including during
financial emergencies. This power to supplant elected officials has been exercised on
numerous occasions in the past. Even under normal conditions, top administrative power in
the states is exercised by members of the elite, national Civil Service.
4. Until 1993, the Indian Constitution did not make reference to municipal governments.
Constitutional Amendment #74, approved in 1993, recognized municipal-scale governments
for the first time, and expressed a national commitment to enhance their role in governance
through decentralization. Municipalities, as well as other municipal-scale and metropolitan-
scale entities, are legal creations of the states. Their revenue-raising powers and
expenditure responsibilities are defined by state laws, and differ greatly from one state to
another. The states can revoke powers that they devolve to municipalities. As part of the
1993 Constitutional amendment, urban local bodies were given the right to have elected
mayors, with limitations placed on the power of states to intervene and replace elected city
officials with state-appointed administrators. Prior to 1993, states had commonly intervened
to suspend local elected governments—sometimes for as long as two decades or more.
5. One distinctive feature of fiscal relations in India is the Finance Commission. At the
national level, a Finance Commission is appointed every five years. It recommends changes
in the structure of fiscal relations between the Union and the states, including such matters
as the states’ sharing in national tax revenues, central government grants policy toward the
states, and policy toward state and municipal borrowing. It also reviews national fiscal
policy. Although recommendations of the Finance Commission are not legally binding, they
traditionally have been followed closely by the national government and Parliament. The
eleventh national Finance Commission began its work in 1998, and some of its
recommendations still are being implemented. The twelfth Finance Commission
commenced work in 2003. As part of the 74th Amendment, the states are now required to
establish State Finance Commissions every five years. The State Finance Commissions
recommend changes in state fiscal policy and in fiscal relations between each state and its
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municipalities.
6. The national Planning Commission traditionally has set public sector investment
priorities, including investments by the states. Recently, the national government has
relaxed its controls over state and municipal investment and over the financial–sector
institutions that provide credit financing for this investment. The planning function has
become more decentralized, with central government more frequently using incentives such
as matching grants or credit subsidies to shape state and local investment, rather than
allocative controls.
7. Overview of intergovernmental finance
8. Three features of Indian intergovernmental financing stand out in international

comparisons.
9. First, the state and municipal sector plays an important part in India’s consolidated public
sector budget. States and municipalities end up with more than half of the revenue
generated by India’s fiscal structure, and are responsible for more than half of final public
spending. Table 1 shows the trend in states’ (including municipalities) share of consolidated
public expenditure, as well as the trend in total public outlays.
Table 1
Public Sector Expenditure
States’ Expenditure
Public Expenditure
Year as % of Total
as % of GDP
Public Expenditure
1985-86 33.7% 52.6%
1990-91 33.8% 53.1%
1995-96 29.6% 55.8%
2000-2001 29.3% 56.9%
10. States and municipalities have relatively weak revenue-raising powers of their own.
They are dependent upon national tax-sharing and grants-in-aid for a large share of their
revenues. This financial assistance helps fill the “vertical gap” between the state and local
sector’s own-source revenue and its expenditures. During the late 1990s, between 40 and
44% of total state revenues came from central government transfers.
11. Second, all levels of government in India historically have tended to run large fiscal
deficits. India’s consolidated public sector deficit has been one of the largest in the world.
Reducing the public sector deficit has been a high priority of national fiscal reform—
emphasized in Finance Commission reports and eventually in government policy. Before
the 1990s, the principal fiscal concern lay with central government deficits. In 1992, the
Indian government launched a series of economic reforms designed to reduce the role of
government in the economy, to open up the economy to international markets, and to control
the central-government deficit. These initiatives bore fruit in some central-government
deficit reduction. (See Table 2) However, in the late 1990s, state government deficits began
rising at an alarming rate, precipitating fiscal reforms adopted in 2000 aimed at reducing
deficits at the state level. (See Part II for a discussion of these reform measures.) For a
time, state deficits seemed to fall in response to the new policies. Most recently, however,
state budget deficits have again begun to grow and have emerged as the principal focus of
intergovernmental fiscal reform.1
1
According to the IMF, only Argentina has had a larger state and local deficit as a percentage of GDP—before
that country’s recent fiscal reforms.
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Table 2
Gross Fiscal Deficits of Union and States
as % of GDP
Year Union States Combined

1985-86 7.8% 2.9% 10.7%
1990-91 7.8% 2.7% 10.6%
1995-96 5.1% 2.7% 7.8%
1999-2000 5.6% 4.6% 10.2%
2001-2002 5.7% 3.8% 9.5%
2002-2003 5.6% 4.6% 10.2%
12. Third, municipal level governments in India are a small part of the overall fiscal picture.
Urban local bodies account for only about 4% of total state spending, while rural local bodies
have almost no expenditure responsibilities. The standard Reserve Bank of India statistics
do not even recognize municipalities as a separate expenditure or revenue category in
public sector accounts. A handful of states have taken initiatives to engage urban local
bodies and rural governance units in public service delivery reforms. On balance, however,
decentralization of governance roles to the municipal level has not proceeded as rapidly or
as thoroughly as foreseen at the time of the 1993 Constitutional Amendments.
13. Expenditure assignments: The Indian Constitution specifies the expenditure

responsibilities of different levels of government in three lists: one corresponding to central
government, one corresponding to the states, and one covering concurrent responsibilities of
the two tiers. State governments, through state constitutions and state legislation, can
decide which of the state responsibilities will be devolved to municipal governments. In
cases of conflict over concurrent responsibilities, national law supercedes state law.
14. Table 3 summarizes the expenditure responsibilities of the central government and
states in India. The lines of division between central government and states’ responsibilities
are drawn somewhat differently than in other countries. Emphasis is placed on the role of
the two tiers in economic development, reflecting the traditional importance given to national
economic development planning in India’s public sector. The national government is
assigned control over industrial development, while states are assigned control over
agriculture and rural development. This governmental and fiscal structure preserves in the
Constitution the division traditionally drawn in India’s Five-Year Development Plans between
the “modern” industrial sector and the “traditional” agricultural sector.
Table 3
India: Expenditure Assignments
Central Government State Government

Defense Irrigation
Railways, inter-state highways, air transport Rural development
Post and telecommunications Agriculture
Heavy industry Power
Strategic industry Basic education
External affairs Health
Foreign trade Public order
Roads
Water supply, sanitation
Concurrent
Population and family planning
Infrastructure linkages between state and national systems
Higher education
Social welfare assistance
15. Social welfare service-delivery functions like health and education are state
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responsibilities. Old-age pensions are restricted primarily to the government sector, and are
the financial responsibility of the level of government employing the government workers.
Pension funds for the non-governmental sector are in a nascent stage, as is the rest of the
social safety net. The monies invested in pension and other provident funds traditionally
have been managed under national government control, but recently have begun to be
opened to private investment firms.
16. Each state maintains its own laws regarding the service delivery functions of
municipalities and municipal-level institutions. This has produced a highly variegated set of
municipal-level functions. Water supply, for example, in some states is a municipal
government responsibility; in other states (or other parts of the same state), water is supplied
by a state government agency, by a state-level enterprise, by a municipal-level enterprise, or
by the private sector under contract. As a broad generalization, in most states responsibility
for capital investment in the water sector, like other urban sectors, is retained principally at
the state level. Management and operations of infrastructure systems may be delegated to
municipalities or retained by the states. Rural local bodies have very few formalized
functions, although in a few reform-minded states there have been attempts to involve both
urban and rural local bodies in the delivery of education.
17. Revenue assignments: India divides central-government and state-local revenue

sources along sectoral lines, parallel to each tier’s respective expenditure responsibilities.
The Constitution seeks to assign each type of tax to a single level of authority, in order to
avoid tax overlapping.
18. The national government has nearly exclusive authority to tax income and wealth, except
that associated with agriculture. Specifically, the Constitution assigns central government
the right to levy a personal income tax on all sources of income, except that from agriculture
and self-employed professionals. States have the exclusive power to tax agricultural income
and income from self-employed professionals. However, agricultural income in fact is taxed
by only a few states.
19. The authority to levy taxes on property, wealth, estates, and capital transactions also is
divided between national and state governments by type of property. State government has
the legal power to tax agricultural wealth and property. However, no state presently uses
such taxes. States can levy stamp and registration duties on a broad range of transactions
and types of property. However, transactions on the stock exchange and stock registration
(“modern” forms of property holding) are an exception. Taxation of these activities is
reserved to the central government. States have the legal right to tax urban immovable
property and urban land ownership. This taxing authority for property and land taxes often is
devolved by the states to municipal governments.
20. The central government has the exclusive right to impose excise duties at the production
stage, except in the case of alcohol and narcotics, where tax and regulatory authority is
assigned to the states. The Constitution assigns states the sole right to tax retail sales. A
broad retail sales tax is the main source of revenue for state governments. State sales taxes
are gradually being transformed into state value-added taxes. However, the taxes still have
only limited coverage of services. Services are not expressly identified as permitted objects
of taxation in the Constitution, which was written long before services acquired the
importance they now have in the Indian economy.2 The states have ceded to the central
government the right to levy sales taxes on certain products (textiles, tobacco, and sugar)
which the national government now taxes, but whose revenues are passed on in their
entirety to the states.
21. Inter-jurisdictional trade is still widely taxed in India. States have the right to impose a
special sales tax on sales to other states, although they have surrendered administration of
this tax to the national government, which now levies a uniform tax on out-of-state sales,
2
The 2002-2003 Budget message proposed a Constitutional amendment to permit broader taxation of services.
Software and financial services are the fastest growing segment of the Indian economy.
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while returning the monies collected to the states based on point of sale. Municipalities in
several states are allowed to tax merchandise “imports” brought into the municipality (the
octroi). Although some states have withdrawn municipalities’ right to levy the octroi, on the
grounds that it inefficiently interferes with trade, it remains the most important and most
stable source of revenue for many municipalities, including some large cities. The octroi is
levied on goods entering a town at dozens or hundreds of points of entry.
22. Table 4 summarizes India’s tax assignments. In principle, where a level of government
has the authority to establish a type of tax, it also has the right to set tax rates, unless the
Constitution expressly empowers the Union to impose rate limitations because of the impact
on national trade or national priorities.
23. Tax Sharing. Two main types of Union taxes are subject to tax sharing. The Personal
Income Tax collected by the national government is shared with the states according to a
formula recommended every five years by the Finance Commission. In recent years, the
states’ share has averaged 77.5 percent of total collections. The allocation formula
governing distribution of the shared revenues has a strong equalization element. It is
designed to favor states with weak fiscal capacity. Union excise taxes are also shared with
the states, with the states receiving 47.5 percent of total revenue. The states’ share of
Union excise taxes is distributed among states according to two formulas designed by the
Finance Commission. One formula distributes a portion to all states. The remainder is
distributed exclusively to states with below-average fiscal capacity.
Table 4
India: Tax Assignment
Central Government Taxes

Corporate profits tax
Import duties
Wealth taxes (except agriculture)
Personal income tax surcharges (on other than agricultural income and self-employment
income)
Stock exchange stamp duties
Shared Taxes (collected by Union and shared in part with states)

Personal income tax (except agricultural income and self-employment)
Excise duties (except alcohol and narcotics)
State-Government Taxes
Personal income tax (agricultural income)
Tax on professions, calling, and trade
Retail sales tax
Stamp and registration duties (except stock exchange)
Typical Municipal Taxes (dependent upon each state’s laws)

Urban property tax
Octroi (now prohibited in several states, with state-level grants provided to
replace former octroi receipts).
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PART II
FISCAL REFORM ISSUES
24. Intergovernmental fiscal reform has occupied an important part of India’s policy agenda
over the last decade. In this section, we examine four issues that have been at the center of
public policy debate. Each of the issues has relevance for fiscal reforms now under
discussion in Hebei Province or relate to issues that are likely to become important policy
questions in China.
25. Controlling state (provincial) budget deficits: As noted, state government deficits in
India have exploded in recent years. The states’ Gross Fiscal Deficits reached 4.6% of GDP
in 1999-2000, up from 2.4% of GDP in 1993-94. Deficits of this magnitude have raised
policy concern at many levels.
26. The states’ deficits are large enough to introduce macroeconomic instability into India’s
fiscal picture. The IMF, among other international institutions, repeatedly has warned of
escalating deficits at the state level and the impact that these deficits can have on India’s
credit ratings and fiscal flexibility. More importantly, whereas borrowing in state budgets
previously was used to finance capital investment, deficits are now being used to cover
deficits in the states’ operating budgets. Interest costs on outstanding debt have grown to
the point that they are squeezing out states’ public investment. Table 5 compares the rapid
growth in the states’ operating budget deficits, the rise in interest costs, and the
corresponding decline in states’capital investment. India’s top economists repeatedly have
called attention to the harmful effect that state budget deficits are having on infrastructure
investment and hence on longer-term prospects for national economic growth.
Table 5
States’ Operating Deficits, Interest Costs, and Capital Investment
(as % of GDP)
Operating Capital
Year Surplus/(Deficit) Interest Investment
Costs
1981-82 0.8% 0.8% 3.6%
1985-86 0.3% 1.0% 3.2%
1991-92 (0.9%) 1.7% 2.5%
1995-96 (0.7%) 1.9% 2.3%
1998-99 (2.5%) 2.0% 2.0%
1999-2000 (2.8%) 2.4% 2.2%
27. Although China does not face the same type of provincial budget deficits that have
troubled India, the spiral created by increasing reliance on short-term debt financing to pay
for capital projects, followed by increased interest costs in the operating budget, the use of
new borrowing to finance the costs of debt service, and eventually budget competition
between borrowing to pay off past debt and borrowing to finance new capital investment is a
phenomenon that can be observed in some municipalities and should be guarded against at
the provincial level.
28. India has attempted to address the state-deficit issue through short- and intermediate-
term measures, while attempting to re-structure the states’ revenue sources to provide a
longer-term solution. In 1999, the Eleventh Finance Commission recommended the
establishment of a Fiscal Reform Facility that would provide performance-based grants tied
to improvement in states’ fiscal performance. Whereas previously grants and loans had
been allocated on the basis of fiscal need—measured in part by the size of states’ budget
deficits—the new incentive fund was designed to provide deficit-filling grants only to states
that reduce their budget deficits. Each state was required to draw up a Medium Term Fiscal
Reform Program and negotiate a Memorandum of Understanding with the national
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Government showing how it would increase revenues and decrease expenditures over the
period from 2000-2001 to 2004-2005. The Fiscal Reform Facility provides funds each year
to states that reduce their operating deficit by at least 5 percentage points. The goal has
been to reduce the combined current account deficit of all states to zero by 2004-2005.
29. The incentive grants initially had a favorable impact, reducing states’ Gross Fiscal
Deficits from 4.6% of GDP in 1999-2000 to 3.8% of GDP in 2001-2002, and closing the
operating deficit by a larger amount. Most recently, however, state deficits have begun to
climb again.
30. As an intermediate-term measure, the national government in 2002 announced that it

would allow states to re-finance their outstanding debt to central government institutions
through the market, thereby allowing them to take advantage of the substantial decline in
interest rates that had occurred. This initiative will relieve states of some of their interest
payment burdens, while increasing the role of market-based financing in state and local
debt. .
31. More fundamental reforms will have to be put in place to fully resolve the problem of
state deficits over the longer term. On the revenue side of the budget, states will need
access to more buoyant revenue sources and greater control over their own tax rates. At
present, states are almost entirely dependent upon sales and excise taxes for their own-
source revenues. National and state governments are gradually moving toward adoption of
a comprehensive value-added tax for states that would include services, the fastest-growing
part of the economy. States will also require greater control over their expenditures. By far
the largest component of state budgets is personnel compensation. A national Pay
Commission sets compensation rates for state bureaucrats while national labor force rules
make it difficult for states to reduce employment levels. The result is a state budget gap that
is difficult to close on either the revenue or expenditure side, without greater state decision-
making authority.
32. In summary, control of state deficits will require application of hard budget constraints at
the state (and municipal) level—i.e., requiring states to live within their operating budget
revenues, without bail-out assistance, while giving states and municipalities greater power to
raise revenues and control expenditures. Although economic analysts within India and in
international organizations have agreed on this policy remedy, it has been difficult for central
authorities to surrender powers that would make the states less politically dependent upon
the center.
33. Fiscal responsibility and management act: As part of the debate over India’s
consolidated public debt, a Fiscal Responsibility and Management Act was adopted. The
Bill, introduced in 2000, was debated for three years and finally passed near the end of
2003. It establishes a series of fiscal rules governing central government fiscal conduct.
The Act requires central government to build up current account surpluses, establishes a
central-government annual deficit limit of 2% (similar to the European Union rules), sets
limits for central government outstanding debt as a percentage of GDP, limits annual
issuance of guarantees, and prohibits central government borrowing from the Reserve Bank
of India. Most of the provisions are to be gradually phased in over several years.
34. The Fiscal Responsibility and Management Act is an attempt to establish predictable and
transparent rules for government fiscal behavior. The Act applies in its present form only to
the central government, but it has generated debate over whether a similar set of rules is
appropriate for states and municipalities, and how the transparency objectives of the Act can
be met in intergovernmental relations. The expert consensus holds that fiscal relations in
India are greatly hampered greatly by lack of fiscal transparency. In fact, lack of
transparency will make it difficult to monitor whether the Fiscal Responsibility and Budget
Management performance targets are being met. One possible response to its requirements
will be to shift deficit spending away from on-budget institutions to off-budget institutions.
35. Debate over the Fiscal Responsibility and Management Act has identified several
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priorities for future fiscal reform to institutionalize fiscal transparency, particularly at the state
and local level. These would require:
Arm’s-length transactions, and publicly transparent accounting, of all dealings

between general government bodies and related public utilities or public enterprises.
The shifting of funds and property between such entities is not adequately disclosed
at present or independently audited.
Greater transparency and arm’s length dealings between governments and public
enterprises, on the one hand, and government-controlled or government-influenced
suppliers of credit, on the other. At present, subsidized credit still is steered to
governmental recipients as a form of incentive or reward.
Greater transparency and arm’s length dealings between so-called public

accounts—provident funds and small-saver deposits— on the one hand, and
governments and public utilities, on the other. The flows of funds from these
government-controlled savings vehicles often are not publicly disclosed at present
and are made at below-market terms. This practice penalizes the masses of
households who have no alternative savings vehicles, and has the effect of
perpetuating state and local dependence on non-competitive channels of financing.
36. India has made impressive progress over the past decade in terms of moving toward
arm’s length transactions between governmental bodies and sources of financing. However,
much remains to be accomplished.
37. Strengthening the domestic credit market for states and localities: India’s states
and municipalities long have relied on government-controlled sources of funds for their
credit. In fact, most of states’ debt is owed to agencies of the central government or to the
Reserve Bank of India. Even commercial debt consists almost entirely of borrowing from
government-controlled financial institutions or government-owned commercial banks, or
market borrowing that is implicitly guaranteed by the central government. Borrowing of this
kind involves political calculations. Econometric and policy analyses have found that Central
Government allocates loans to cover states’ budget deficits according to the same political
criteria they use in allocating discretionary grants—shared political affiliation between the
state and the party coalition in control at the Center, and the salience of the state in national
elections.
38. Nonetheless, India is moving toward greater market orientation in developing its state
and local credit market. Substituting market discipline for political favors in obtaining credit is
thought to be essential both for bringing states’ deficits under control and for more efficient
allocation of investment resources. Some of the key steps taken by the country include:
The Reserve Bank of India formerly made loans to state governments at a uniform
non-market interest rate. It now lends to states only at market rates, and has begun
to differentiate lending rates according to states’ credit risk as determined by
independent credit ratings.
The Government has encouraged states to re-finance their borrowings from central
government through market institutions. This has reduced states’ debt to central
authorities, while also lowering their interest costs due to the decline in general
interest rates.
The Government no longer provides guarantees for state debt. It is attempting to

wean the state and local credit market from the expectation that there is an implicit
guarantee on state debt from the central Government.3
3
One sign that this message has reached the credit markets is the downgrading in late 2002 of Maharashtra State
by independent credit rating agencies from BB+ to D (for default grade), as a result of the failure of the national
government to come to the rescue of defaulted bonds issued by a state special purpose vehicle for irrigation.
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In its new investment financing initiatives, the national Government has sought to
leverage market-rate capital rather than finance projects only through Government
grants and Government loans. For example, the 2002-2003 Budget launched a
new program aimed at supporting state and local investment in wastewater
collection and treatment. It provides below-market loans funds from a central
Facility, but only if the state-government and municipal-government match the
subsidized lending with longer-term market-rate funds raised from the capital
market.
39. With the help of international agencies, some Indian states, like Tamil Nadu, have set up
Urban Development Funds that provide long-term financing at market rates to municipalities
and municipal special purpose vehicles to help pay for investment in local infrastructure.
The Urban Development Funds typically lend funds for 10-12 year periods, reducing the
fiscal strain on municipalities created by short-term lending for infrastructure projects. The
Tamil Nadu Urban Development Fund has gone further by helping municipalities to issue
their own infrastructure bonds directly to the capital market, either individually or as a pool of
smaller municipalities. Infrastructure bonds of this type have been used to finance toll roads
and bridges, urban water distribution systems, and wastewater collection and treatment. All
of the bonds have a lockbox provision, guaranteeing that project revenues are paid directly
into a special account dedicated solely to debt service. Project revenues are reinforced by
the contractual right of lenders to “intercept” part of the state’s automatic revenue sharing
with the municipality, as a further support for debt service payment.
40. The World Bank, Asia Development Bank, and several bi-lateral international agencies
have offered to help establish similar state-local development funds in other Indian states
and in other Asian countries. Most would follow the Tamil Nadu model, where the Fund is
sufficiently independent from general state government to be able to make its own business
decisions about lending and debt collection, while operating within a framework that
encourages overall development of the state-local credit market.
41. Urban water pricing
42. Intergovernmental attempts to attract investment to the urban water and wastewater
sector have run into the reality of urban water tariffs. India’s water supply system is
notorious, both for its poor quality and for its fiscal deficits. Water consumers in most cities
have access to water supply for only a few hours per day. Urban water consumption per
capita is far below national standards. Recent five-year development plans, as well as a
special commission’s study of urban infrastructure needs, have singled out urban water
supply and wastewater removal as an urgent infrastructure backlog throughout the country.
43. In the face of massive investment needs, the Indian Government has attempted to
increase capital flows to urban water and sanitation systems by tapping the private capital
markets for loans and by attracting private sector investment in construction and operation of
infrastructure facilities. Until now, the great majority of these initiatives have founded
because of an inadequate tariff regime.
44. Urban water tariffs in India are both low and institutionally difficult to adjust. A special
study carried out by the National Institute of Urban Affairs in 2001 found that on average
water tariffs recovered only 82% of operating and maintenance costs, and none of the costs
of capital investment. Domestic users were the most heavily subsidized, with 30-40% of
households paying nothing at all for water use, and remaining households paying a small
fraction of the tariff rate for industry and commercial property. Moreover, the tariff system
was rigid and bureaucratically tangled. Calcutta, for example, has 46 different classifications
of water consumers, each with its own tariff schedule. Changes in tariffs must be proposed
by the water supply company, then approved by different layers of bureaucratic and elected
officials.
45. The result of this tariff regime is that the water and wastewater sector cannot attract non-
governmental funds for investment. Project revenues are not sufficient to repay lenders.
G2_9
Private investors wanting an adequate return on capital shun the water and wastewater
sector. At a time, when national and state governments are attempting to curb their
destructive budget deficits, the tariff system for water and wastewater services has made it
impossible to generate capital investment except through government grants and
government-subsidized lending.
46. India has just begun to address this issue. Part of the solution may lie in more innovative
ways of blending government subsidies with market-rate capital, as described in the
previous section. Over the longer term, however, only an overhaul of the antiquated tariff
regime will address the sector’s investment needs. In the few metropolitan areas where
water suppliers have been given clear rules as to the cost conditions under which they may
raise tariffs, and have the institutional independence to do so quickly, subject to ex post
audit, the suppliers have been able to generate operating surpluses and make inroads into
attracting capital for water and wastewater investment.
G2_10
G3: Case of Korea
Fiscal Case Study of KOREA

Chreod Ltd.
Case Study G3: Korea 16 February 2004
FISCAL REFORM CASE STUDY

KOREA
George E. Peterson
Part One: Republic of Korea

1. Introduction: The Republic of Korea [Korea] has begun a process of political and fiscal
decentralization, following a long tradition of centralized governance. Previously, local
governments served solely as administrative arms of the central government authority. A
rearrangement of intergovernmental expenditure and taxing authority is gradually being put
in place to replace the former top-down financing of local governments. Korea, however,
retains a unitary form of government, and the centralized control of fiscal relations is being
modified slowly.
2. Korea has a population of about 49 million and a per-capita income in 2000 of

US$17,300, placing the country in a transition category between upper-middle and high-
income nations according to the World Bank classification. The intergovernmental fiscal
structure of the country generally resembles that of Japan.
3. Political and fiscal organization: Within its unitary form of governance, Korea has a
three-tiered structure of government, consisting of the national (central) government,
regional governments, and municipal-scale governments. Regional governments include the
Seoul metropolitan area, five large cities called jurisdictional cities, and 9 provinces covering
the rest of the country. Municipal-scale governments include 22 autonomous districts and
33 self-governing sub-districts under Seoul and the jurisdictional cities, as well as 67 small
cities and 137 rural counties that are under the provincial governments. Collectively, the
local governments of various descriptions are called local autonomous bodies. In function,
they still serve largely as decentralized administrative units of the unitary state.
4. On the expenditure side of the budget, local governments carry out functions assigned to
them by national government laws. On the revenue side of the budget, local governments
receive their funding in part from nationally prescribed local taxes and in part from a
combination of transfers and tax sharing from national government.
5. Political decentralization commenced in Korea with passage of the Local Autonomy Law
in the early 1990s. The first local elections were held at the provincial and municipal levels
in 1994. Greater fiscal decentralization was expected to follow thereafter, but it has occurred
in fits and start, leading observers to disagree as to how seriously the government is
committed to decentralization.
6. Overview of fiscal relations: In international comparisons, several facts about Korea’s

fiscal picture stand out. First, the share of public expenditure in GDP is relatively low. On a
general government basis, Korea’s public expenditure in the year 2000 was 23% of GDP, as
compared to an OECD average of 36.9%. Part of this difference may be attributed to
Korea’s lower level of income relative to most OECD countries. However, Table 1 shows
that Korea’s public sector spending is also low relative to European countries of comparable
income levels. Differences in public spending are most pronounced in the category of
‘income transfers and social welfare payments.’ OECD studies have called attention to the
fact that Korea is in the early stages of building a government-funded social safety net. Low
public spending on social welfare is only partially offset by a relatively high level of privately
funded social expenditures, both voluntary and mandatory, including traditional family care
for the elderly. It seems clear that a major claim on public resources in future years will
come from enlargement of the publicly financed safety net. Korea’s rapidly aging population
will place pressure on traditional family-provided social protection.
Table 1
G3_1
General Government Expenditures

Korea and OECD
(Percent of GDP, 2001)
Interest
Country Total Outlays Income Transfers Capital Outlays
Payments
Korea 23.0% 3.6% 8.3% 0.7%
OECD Total 36.9% 12.4% 2.9% 3.5%
European 44.6% 14.2% 5.6% 3.8%
Comparables (a)
a. Czech Republic, Greece, Hungary, Poland, and Portugal
7. Another distinctive characteristic of Korea’s fiscal picture concerns capital spending and
capital finance. Overall, capital outlays account for an unusually high proportion of Korea’s
public spending, as compared to other OECD countries. (See Table 1.) Despite this, Korea
has low levels of public debt. Public debt accounts for only 22% of GDP, as compared to an
average level of 74% in OECD countries. Interest payments on public debt also are low
(See Table 1). The apparent discrepancy can be explained by Korea’s tradition of fiscal
conservatism, which has led the nation to finance most of its public investment from public
savings (i.e., government operating surpluses.) Although at low levels by international
standards, Korea’s public debt has risen steeply since the Asian financial crisis, as the
government has used deficit financing to stimulate the economy and rescue financial
institutions.
8. Intergovernmetal Fiscal Relations. Table 2 provides a basic picture of how provincial

and local governments are financed. Local autonomous bodies collectively spend a good
deal more than they raise in local taxes. Part of the difference is covered by national
transfers. These transfers take three forms: tax-sharing of centrally collected taxes, a
national subsidy allocated among local autonomous bodies with equalization objectives, and
a specific transfer fund that is used to finance centrally-priortized capital investments. Table
2 shows that, despite the announced program of decentralization, which increased local
bodies’ reliance on own-taxes for a period in the mid-1990s, the general trend has been
toward greater dependence upon national resources in the financing of local budgets.
9. Korea’s local government sector is marked by profound differences in local fiscal

capacity. Korea has one of the world’s highest degrees of concentration of population and
economic activity. The area encompassing metropolitan Seoul is estimated to have 45
percent of the nation’s population, to generate a higher share of national economic product,
and to produce as much as 71 percent of the nation’s personal income tax revenue and 85
percent of its corporate tax revenue.
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Table 2
Local Government Revenues
(Billions of Won)
Year Local Tax Shared Tax National Capital Local Tax

Subsidy Transfers %
1990 6,367 2,765 2,068 0 56.8%
1995 15,316 5,275 3,888 1,870 58.1%
2000 20,600 8,365 9,893 3,671 48.4%
2001 (a) 23,187 10,304 10,349 4,780 47.7%
a. Excludes from Local Tax a new education tax. This tax is labeled a “local” tax, but it is deposited into
special accounts under control of the central government. Local governments have no spending discretion
over these accounts.
10. Korea’s transfer system is designed to offset much of the differential in local fiscal
capacity. The National Subsidy distribution formula attempts to take into account the cost of
providing standardized services in different locations as well as local governments’ capacity
to generate revenues from standardized tax rates. As a result, Seoul City receives virtually
no central government transfers, but is almost entirely self-financing. Other metropolitan
cities, as well as the self-governing districts under Seoul , also generate a large share of own
revenue. This is especially true once user fees and earnings from municipal enterprises are
taken into account. Table 3 demonstrates just how great the differences in local revenue
structure are. These differences have influenced the entire debate over fiscal
decentralization, since the potential self-governing capacity of Seoul and other large cities is
much greater than that of the rest of the country.
Table 3
Korea: Revenue Structure of Local Governments
late-1990s
Composition of Revenues (%)
. Local Local Other Central

Government Taxes Local Government
Revenues Transfers
Seoul
City Government 78.8% 19.5% 1.7%
Self-govt. 31.4 35.8 32.8
Districts
Metropolitan Cities
City Government 57.7 30.1 12.2
Self-govt. 18.0 32.6 49.4
Districts
Provinces 37.0 14.9 48.1
Cities 23.4 41.0 35.6
Counties 10.9 25.0 64.1
TOTAL 33.6% 28.1% 38.3%
11. Expenditure assignment: The Law on Local Autonomy defines the expenditure
responsibilities of Korean local governments. The law both requires local autonomous
bodies to provide certain types of services and prohibits them from performing other types of
activities, which are the exclusive domain of the national government.
12. The mandated responsibilities fall into three categories:
Local public administration and property protection (e.g., collection of local taxes,
G3_3
firefighting, local civil defense activities)
Support for the local and regional economy (e.g., local economic development,
promotion of farming, consumer protection, urban and regional planning,
construction and maintenance of local roads)
Provision of basic social services and education (primary and secondary schooling,
sports and recreational facilities).
The Law on Local Autonomy specifically prohibits local governments from engaging
in other activities. These prohibitions include involvement in:
National security, public safety and public order (including local police)
National economic policy (including a long list of prohibited areas, such as price
controls, management of grain stocks, other than local economic development
programs, establishment of industrial standards, etc.)
13. The above lists appear to draw a clear distinction between what local government can
and cannot do--based on the principle that local governments should perform services of a
local character and avoid activities that have national externalities or involve national policy.
In practice the distinctions often are not maintained. In their capacity as agents of the
national government, local governments perform at national instruction activities on the
“prohibited” list--such as supporting national economic development programs through local
infrastructure investments. On the other hand, the national government helps finance many
local services, and imposes numerous regulations and standards on local government
regarding the delivery of those services, even though the services formally fall within the
domain of local “autonomy.” Education is a prime example of a service assigned to the local
level but almost entirely controlled by national funding and national service standards. All
pay rates for education personnel are established by the national government, as is the
school curriculum and all other school standards. Schooling is financed from separate
budgets at the local level that cannot be mixed with the rest of a local body’s budget and are
subject to detailed central oversight. National government issues a variety of other
administrative instructions, ranging from the pricing of local public transportation to food
inspection standards, that local governments must comply with.
14. Table 4 shows the broad division of expenditures between national government and local
autonomous bodies. There is a great deal of service overlap between central government
and local governments in specific functional areas. This sometimes creates confusion about
local governments’ responsibilities, and can result in over-provision or under-provision of
services depending upon the practical relations between local and central government
authorities in particular regions. A high proportion of local government spending--around 40
percent--is devoted to capital investment, often in conjunction with central government’s co-
financing or pursuant to central government development plans.
G3_4
Table 4
Korea: Distribution of Sectoral Expenditure
between Central and Local Governments (late-1990s)
(% of total)
Item Central Local

Government Governments
General Administration 20% 80%
Public Order and Safety 85 15
National Defense 100 --
Education 19 81
Primary and Secondary 8 92
Tertiary 64 36
Health 30 70
Social Welfare 73 27
Housing and Community 47 53

Development
Economic Services 50 50
Agriculture and Fishing 58 42
Mining and 69 31
Manufacturing 49 51
Roads 15 85
Transportation and
Communication
Other 54 46
Total Capital Investment 45 55

(included in above)
Total Expenditure 51 49
15. Local government taxing and revenue authority: The Korean tax structure assigns
tax bases either to national government or to local autonomous bodies. There is no
overlapping taxation of the same base by different levels of government.
16. Legislative Authority for New Taxes. The national government has sole authority to
legislate new local government taxes, to transfer existing taxes between levels of
government, and to legally define the taxable base for each local tax. Local governments in
Korea can levy taxes only on tax bases that have been expressly authorized in national law
for that category of local autonomous body. Since 1995, the central government has
introduced two new local taxes. One is fuel tax, whose revenues were used to reduce the
rate of local taxation on car ownership. The other is a “local” education tax, which at least to
this date has not been used to expand local budgetary discretion. Its revenues are
deposited into special accounts controlled by the central government and used to help pay
for local schooling.
17. Central-government restrictions involving other sources of local revenue than taxes are
less clear. Many urban governments raise revenues through fees levied on private
economic activity or through public operation of income-generating activities that are not
expressly authorized or are prohibited under national law. In fact, one fear that has been
expressed as the national government attempts to privatize some public operations is that
local governments will step in and sponsor more “market-replacing” types of local public
enterprises.
18. Tax Rate Authority. According to the Law on Local Autonomy and the Ordinance for
Implementation of the law, local governments have the right to set tax rates for several local
G3_5
taxes within ranges established by national legislation. National law stipulates “standard” tax
rates for these taxes, but allows a range of variation around the standard rate, at local
discretion. This system follows the model used in Japan, except that in Korea some tax rates
can be moved up and down from the standard tax rate, at least in theory. In Korea, the tax
rate for the inhabitants tax, for example, can be modified by plus or minus 50 percent at local
discretion, according to law. The automobile tax can be raised by 50 percent (but not
lowered) from the nationally stipulated “standard” rate. The regional development tax has a
permissible range of plus and minus 50 percent.
19. In practice, however, no Korean local government body makes use of any of the tax-rate
options legally available to it. All local governments, without exception, levy the “standard”
national tax rate for every local tax. Most commentators conclude that in practice Korea has
had a system of nationally prescribed local tax rates, without room for local flexibility.
20. Earmarking. Local discretion in the use of local tax revenues is further limited by the
practice of earmarking. The regional development tax, the city planning tax, and the
inhabitants tax are all heavily earmarked for specific expenditure uses, by national law. The
first two taxes are earmarked primarily for public investments in support of publicly planned
development. All of the “local” education tax is earmarked for local education accounts
controlled by the central government.
21. Tax assignment: In Korea, the tax bases having the greatest revenue yield and greatest
growth potential are assigned by national law to the central government. These include
VAT, the personal income tax, and the corporate income tax. Although a large number of
taxes have been assigned to the different types of local autonomous bodies--see Box 1--
more than two-thirds of all local tax revenue is obtained from some variant of property
taxation. Some of the local property taxes are levied on the ad valorem principle. Other
types of property taxes are levied at flat rates, according to fee schedules that are adjusted
only intermittently, or are levied on transactions involving real estate.
G3_6
Box 1
Korea: Taxes Levied by Central Government and Local Governments
Central Government Direct Taxes Taxes for Provinces and
Personal Income Tax Metropolitan Cities
Corporate Income Tax Real property acquisition tax
Tax on the excess increase of land Real property registration tax
value Horse race tax
Inheritance (estate) tax Community facilities tax
Excess profits tax Regional development tax
Central Government Indirect Taxes Taxes Only for Metropolitan Cities

Value-added tax Inhabitant tax
Special excise tax Automobile tax
Liquor tax Farmland tax
Telephone tax Tobacco consumption tax
Stamp tax Butchery tax
Securities transaction tax City planning tax
Transportation tax Fuel tax
Customs duties Taxes for Cities and Counties

Education tax Property tax
Special tax for rural development Aggregate landholding tax
Inhabitant tax
Automobile tax
Farmland tax
Tobacco consumption tax
Butchery tax
City planning tax
Fuel Tax
22. As can be seen from the above summary, the local tax structure in Korea is
characterized by a large number of taxes, several of which generate insignificant amounts of
revenue. These nuisance taxes serve little purpose. They often involve high administrative
and compliance costs, despite their low tax yield. Table 5 below summarizes the revenue
yield of Korea’s local taxes. The seven largest-yielding taxes provide more than 93 percent
of local, own-source tax revenues.
23. The heavy reliance that local governments place on property as a taxable base is clear
from Table 5. Most of the revenues derived from property-related taxes actually come from
the sale and registration of real property rather than from recurring taxes on land or building
values. At one time, emphasis on taxing real property transactions may have been justified
by administrative convenience. Real property sales are easy to identify and the tax base
(sale price) can be ascertained relatively clearly. These traits make taxes on property
transfers easy to administer and collect. Property registration takes place through a local
public office and tax evasion is difficult for properties of significant value. Now, however,
Korea has a computerized cadastral system that covers essentially all of the country. It
would allow for accurate taxation of real property on a recurring basis, not just at time of
sale.
24. Transfer taxes on real property have at least two important deficiencies as a primary
source of revenue. They are unstable and unpredictable sources of revenue. Property
transactions tend to follow and magnify cyclical swings in economic activity, since the
volume of property acquisition is highly sensitive to economic conditions. In addition, heavy
taxes on property sales and purchases tend to discourage labor mobility. Especially in a
country like Korea, where the immobility of the labor force already is a concern of national
economic policy, and exacerbates regional development differentials, many commentators
have thought it unwise to further discourage labor movement by taxing heavily the sale and
purchase of housing and other real property.
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Table 5
Korea: Structure of Local Government Tax Revenue, late-1990s
Item Share of Total Local Tax

Receipts
Taxes on Income 12.9%
Inhabitants Tax 11.3
Other 1.6
Taxes on Property 69.4%
Acquisition tax 17.8
Registration tax 24.1
Property tax 3.2
Automobile tax 10.2
Aggregate land tax 8.2
City planning tax 4.3
Community facilities tax 1.5
Taxes on Consumption 17.2%
Tobacco tax 14.2
Horse race tax 1.4
Other 1.6
Other 0.5
25. Shared taxes: In addition to the revenues generated from local taxes, local governments
participate in the shared tax system operated by the national government. The national
government operates two tax-sharing pools. One, called the Local Shared Tax Fund,
allocates to local governments a portion of the general tax revenues received by central
government, according to a fixed formula. The proportion of national revenues assigned to
the general tax-sharing pool was raised from 13.3% to 15% in 2000. The other tax-sharing
arrangement, called the Local Transfer Fund, assigns a defined portion of specific national-
level taxes to a revenue sharing pool that allocates funds to local governments primarily for
capital investment purposes. Revenues are allocated according to criteria established by
sectoral ministries or sectoral statutes, taking into account local fiscal capacity. The Local
Transfer Fund has been used mostly to help finance local road construction, local water
systems, and rural development. Revenues have been allocated primarily to poorer rural
areas, but the program requires a local financing match.
G3_8
PART II
FISCAL REFORM ISSUES
26. Most of the policy issues surrounding fiscal reform in Korea involve the strategy toward
decentralization. Is Korea committed to significant decentralization of its fiscal system?
Should the pace of decentralization be accelerated? Which aspects of fiscal decentralization
stand most in need of reform?
27. Clarity of expenditure assignments: Local public services were not differentiated in
law from central government services until 1995, and the distinction remains murky in
practice, leading to lack of clarity as to when local governments can make their own
expenditure decisions. As noted in Part I, although the law appears to distinguish “local”
from “central” government service functions, in practice there is a great deal of overlap.
Moreover, the law assigning service functions to different levels of government is prefaced
by a general provisional clause that states that the assignments can be overridden if
“otherwise stipulated in law.” In practice, this means that each individual law approved at the
national level can introduce its own differentiation between local and central service
responsibilities, regardless of the language in the Local Autonomy Act.
28. The extent of confusion over service assignments is symbolized by two aspects of
national legislation. On the one hand, the Local Autonomy Law states that locally provided
services are “public services that enhance local residents’ welfare,” seemingly opening the
way for local discretion in deciding service responsibilities and priorities. On the other hand,
the central government has adopted decrees specifying how more than 2,500 different
government functions are to be delegated or devolved to local governments. For the most
part, these delegated functions retain tightly defined central government service standards,
central government financing, and central government audits. In 1998, the newly elected
government set up a Presidential Commission on Promotion of Decentralization, which
turned over 493 highly specific (and minor) functions to local government, subject to the
same kind of oversight.
29. An issue now before Parliament may help to more clearly define expenditure
assignments. Seoul has led the way in demanding more local responsibility for service
provision. Parliament agreed that purely local services provided by the Seoul government
would be exempted from national auditing standards starting in 2003. This has made it
necessary to define more exactly which services are purely local and therefore exempt from
national audit, and which are not. Seoul has argued that roughly 70% of the public services
it manages should be regarded as purely local functions. The central government has
argued that the proportion is much lower. As of 2003, this disagreement remained to be
resolved. If the parties can agree on a definition of “local” public services for this purpose, it
may lead to greater clarification for the entire fiscal system. One strong possibility is that,
over time, differential decentralization will be put in place, allowing the fiscally strongest local
bodies, or those that meet certain performance standards, to have greater latitude in
managing and prioritizing public services. This so-called asymmetrical decentralization is
used in many countries, where it is administratively unrealistic to presume that all local
governments are capable of handling the same degree of revenue and expenditure
independence.
30. Simplification and reform of local tax system: The local government tax system in
Korea is widely viewed as involving too many separate tax bases and taxes, and being too
complicated to administer efficiently. At present, the local sector generates own-source
revenue from a large number of low-yielding taxes, many of them variants of taxation on
property transactions, which have high administrative costs relative to their tax yields. Tax
reform has been proposed that would simplify the local government tax structure and reduce
the number of individual taxes and tax bases that have to be administered. In return, local
governments would obtain access to a major tax base with greater long-run elasticity. A
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general property tax, imposed annually on land and improvement values, would meet this
criterion.
31. At present, local governments follow without exception the “standard” rates of taxation
established by the central government for each tax, even though they formally have the right
to modify the local tax rate from this standard according to the law. None of the standard
rates for local taxes has been changed by the central government since 1995. The result is
that local governments face a totally rigid local tax system, where tax rates never change
and tax bases do not grow commensurately with the economy, except for property
transactions, which are subject to violent cyclical swings. It is possible that a large local
government—perhaps Seoul—in the near future will try to exercise its legal right to set its
own tax rate for certain local taxes. The government’s response to such an initiative may
help clarify the practical discretion that local authorities have over their “own-revenue”
sources.
32. The rigidity of the local tax system has another effect. It tends to drive local
governments--particularly urban governments--into other forms of competition for economic
development and revenue generation. Local governments in urban areas often have
inserted themselves into lucrative economic markets as a way of generating public revenue,
by using their favored public position to displace private sector economic activity. Under
conditions of fiscal pressure, such activity by local governments may multiply. Competition
of this kind between local public enterprises and private enterprises diverts local government
from its main mission of providing efficient public services. It also retards private sector
market development, especially when local public enterprises are exempted from local taxes
or receive more favorable pricing from public utility services.
33. Local government borrowing: Local government borrowing has become a focus of
fiscal reform in Korea. The local debt market is severely distorted by the factors described
below. As Korea attempts to integrate its domestic credit market more fully with worldwide
markets, these factors will have to be addressed. In the absence of reform, the local
government credit market cannot play its fundamental role of revealing the true cost of
capital, and helping public officials make efficient investment decisions, based on the cost of
capital.
34. One distorting factor is the way credit is provided to local governments. The majority of
lending to local governments (86%) takes place through central government funds. This
lending occurs outside a market framework. It is provided by central government as part of a
financing package for centrally approved investment projects. The financing package
typically combines centrally provided grants with centrally provided loans. Local officials do
not look upon this as “borrowing” so much as central government allocation of financing for
approved capital investment projects. However, the debt ends up on local government
books and inhibits development of a market-oriented debt market.
35. The second largest category of local government debt in Korea is “compulsory” bonds.
When citizens register automobiles, obtain licenses, or obtain local development permits,
they frequently are required to buy special local development bonds. Proceeds from these
bonds typically are used to pay for subway construction or other public infrastructure
investments associated with local economic growth. From the individual’s perspective, the
bonds are a form of forced saving for public financing and basically equivalent to a licensing
fee or registration fee. The fact that these compulsory bonds account for a significant
portion of outstanding local government debt, however, further complicates development of
the local credit market. Compulsory debt is substituted for voluntary demand for holding
debt securities, with the result that market forces do not play a role in steering investment
decisions.
36. Even within the market-oriented portion of the local credit market, there are major
distortions. The largest amounts of such borrowing have been for subway construction in
Seoul and other large cities. Subway bonds are not issued by municipal governments,
however, and do not appear on their financial accounts. The bonds are issued by special
G3_10
subway enterprises. The amount of subway debt outstanding has escalated rapidly and has
exceeded the capacity of subway enterprises to repay according to the initial bond
schedules. This has forced issuers to re-structure their debt. It also has raised politically
explosive questions as to who is responsible for repaying such debt when the subway
enterprise cannot make payment. The market has perceived these bonds to carry an implicit
government guarantee. In Seoul’s case, the national government initially helped with bond
repayment. However, the central government then refused further bailouts, forcing the City
government to come to the assistance of the subway enterprise. As debt burdens mount,
the relationship between Seoul municipal government, the Seoul subway company, and the
national government has become a high profile political issue. 1 Besides the immediate
question of how subway debt will be paid, and what type of spending restraint will be
imposed to limit future increases in indedtedness, pressures have grown to establish a more
transparent financial and institutional relationship between the City and the subway
enterprise, given the de facto liability of the City for bonds issued by the subway enterprise.
37. All of these conditions are hampering the development of a sound local government
credit market. In such a market, the responsibility for debt repayment is clearly spelled out,
and the guarantees, if any, provided by general-purpose municipal or provincial
governments are well defined and strictly limited. Financial markets then can assess the risk
involved in local government lending. If lending risks had been more clearly defined in the
case of Korea’s subway construction, the market would have forced a slower pace of
construction from the outset—rather than wait for a ‘crisis’ atmosphere. The lack of market
discipline on subway borrowing has been compounded by the fact that a substantial portion
of the debt is “compulsory debt” which citizens and firms had no choice about acquiring.
Selected References
Bank of Korea. 2001. Economic Statistics Yearbook. Seoul.
Chu, K.Y. and John Norregaard. 1997. “Korea” in Teresa Ter-Minassian (ed.),
Fiscal Federalism in Theory and Practice. Washington, D.C.: International
Monetary Fund.
Ha, Y.-S. 1997. “Public Finance and Budgeting in Korea under Democracy: A
Critical Appraisal.” Public Budgeting and Finance 17(1): pps. 56-73.
Kim, Junhun. 2003. “Republic of Korea” in Local Government Finance and

Bond Markets. Manila: Asisan Development Bank.
Nam, Young-Sook and Randall Jones. 2003. Reforming the Public Expenditure
System in Korea. Paris: OECD.
National Tax Administration, Republic of Korea. 2001. Statistical Yearbook of

National Tax. Seoul: National Tax Administration.
Oh, Y.-C. 1992. “The Local Tax System,” in Kwang Choi, et al., (eds.), Public
Finance in Korea. Seoul: National University Press.
Shin, Roy W. and Yeon-Seob Ha. 1998. “In Search of Decentralization and
Deconcentration: Local Autonomy and Fiscal Reform in Korea.” Journal of
Budgeting, Accounting and Financial Management (Spring); pp. 192-218.
1
In January 2004 the central government announced that it may write-off 40% of local subway debt, providing
that subway operators raise fares, reduce workforces, and bring continuing subway finances under control. The
total amount of outstanding local subway and related local public transportation debt is 13.33 trillion won
(US$11.14 billion). Five cities in addition to Seoul have such outstanding debt.
G3_11
G3_12

International Case Studies: Chreod

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Chreod

Asian Development Bank

International Case Studies

Chreod Ltd. Chreod Ltd.

A1: Case of California

A2: Case of New York City

B1: Case of South Korea

B2: Case of Transitional Economies

C1: Case of Pittsburgh, Pennsylvania

C2: Case of Ireland, Portugal and Canada

C3: Case of Pueblo, Colorado

D1: Case of South Korea

E1: Case of Paris

E2: Case of Randstad, The Netherlands

E3: Case of Rhein-Ruhr, Germany

E4: Case of South Korea

F1: Case of South Korea and Canada

G1: Case of Australia

G2: Case of India

G3: Case of Korea

A1: Case of California, USA

Water Markets as a Mechanism for Inter-

California: Water Markets as a mechanism for inter-sectoral and

3. Economic theory indicates that markets increase economic efficiency by allocating

2. California’s Water Market

A2: Case of New York City

Case Study: New York City

11. Building Inter-Jurisdictional co-operation: The program involves direct investment

of the Watershed communities.”

16. The Catskills/Delaware watershed management plan reflects an integrated approach to

1. Watershed Agricultural Program: The City teamed with upstate stakeholders to

2. Conservation Reserve Enhancement Program: A City/federal cost-sharing

4. Environmental Infrastructure Programs: The City has funded a program that in

5. Environment and Economic Partnerships Program: The program has allocated

6. New Watershed Regulations: The 1997 watershed regulations replace outmoded,

7. Environmental Monitoring System: The water management program is premised

Compliance monitoring – to ensure compliance with the MOA

program outlines a comprehensive program of investments and budgeted. The investment

Local Leadership is central to successful participatory programs

B1: Case of South Korea

South Korea’s Experience Upgrading its Heavy

Korea, Inc.: A Review of South Korea’s

Economic Competitiveness Group

© 2004 Economic Competitiveness Group, Inc. All Rights Reserved.

© 2004 Economic Competitiveness Group, Inc. All Rights Reserved.

© 2004 Economic Competitiveness Group, Inc. All Rights Reserved. B1-1

Many economic development professionals presently advocate a more “bottom-up” approach to

© 2004 Economic Competitiveness Group, Inc. All Rights Reserved. B1-2

2. Historical Setting: Underlying Reasons for Upgrading

© 2004 Economic Competitiveness Group, Inc. All Rights Reserved. B1-3

3. Implementation Strategy: How Acceleration in South

1. Diversification, or entrepreneurial decisions concerning penetration of new industries-

Table 1: Korea’s Industrial Vision and Strategy 7

Deepening Raising FDI Strategy Raising Promotion of

© 2004 Economic Competitiveness Group, Inc. All Rights Reserved. B1-4

The Interventionist State

© 2004 Economic Competitiveness Group, Inc. All Rights Reserved. B1-5

State as the primary driver of entrepreneurial activity for big businesses

Protectionist Policies: Subsidies and Price Controls

© 2004 Economic Competitiveness Group, Inc. All Rights Reserved. B1-6

Discipline the State Exercises over Private Firms

The importance of the government’s central disciplinary role cannot be overstated: