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Cluster-based Development as an Opportunity for
Job Creation and Poverty Reduction in Egypt
Xiaobo Zhang, IFPRI and Peking...
Clusters
• Clusters are a geographic concentration of a large
number of interconnected businesses.
• They are ubiquitous i...
Outlines
1. Why clusters are particularly suitable for
early stages of development?
2. How to build clusters?
3. Implicati...
Why Clusters Are Particularly Suitable
for Low and Middle-Income Countries?
Major constraints and strengths
4
Major constraints
• Credit constraints: banks are not willing to
extend credit to small and micro enterprises;
• Weak inst...
Mainstream thinking on development
• These constraints set low and mid-income
countries apart from developed countries.
• ...
It is a daunting challenge to do so
• It is impossible to set up a well-functioning
financial system and sound institution...
Failures of MFIs
• Banerjee, A., Duflo, E., Glennerster, R., &
Kinnan, C. (2015). The miracle of microfinance?
Evidence fr...
Major findings
• In 2005, half of 104 slums in Hyderabad, India were randomly selected for
opening of a branch of a partic...
Alternative thinking
• Use existing strengths to generate dynamics in a
small place (for example, clusters).
• In the smal...
Marshall’s three advantages of industrial district:
• Information flow
• Market linkage
• Labor pooling
11
Role of clusters in overcoming
financial constraints
• Fine division of labor lowers the capital requirements
of entry (Ru...
Page 13
Puyuan Cashmere Sweater Cluster
Zhejiang Province
Page 14
The Putting-out System
Yarn
Purchasing
Weaving Assembling Dyeing &
Finishing
Buttoning Ironing Printing
Packing Se...
Integrated factory
15
Page 16
Market
Page 17
Production Organizers
Page 18
Family workshops
Page 19
Workers/entrepreneurs
Initial Capital Investment in Puyuan
Cashmere Sweater Cluster
Average
(10,000 yuan)
Mean/Wage % of initial capital
investm...
The Most Important Financing Source
When Facing Working Capital Problems in Puyuan Cluster
Ruan and Zhang (EDCC 2009)
21
Trade Credit in UK in the 19th Century
“Indeed an understanding of industrial finance during the
nineteenth century is imp...
Trade Credit in Ethiopia
(Handloom Cluster)
Addis Ababa Electrified Not Electrified
Source of raw materials (% of responde...
Existing strengths in low and middle-
income countries
• Abundant in labor
• Strong social capital at the community
level ...
More advantages
• Security
• Flexible production structure under
uncertainty
25
Clustering as an adaption to predators
• Story of brick factories in Gansu;
• Cicada phenomena:
– North American genus, Ma...
Industrial park in Bangladesh
More security;
More space;
Centrally provided gas;
More stable power supply (supposedly).
27
Clustering lowers effective tax rates
.01.02.03.04.05
Effectivetaxrate
0 20 40 60 80 100
Cluster measure
Note: Calculated ...
Coping with weak institutions
• By staying in clusters, entrepreneurs can
better cope with weak institutions, such as
lack...
Flexible production:
In-house production versus outsourcing
“[I]n fluctuating industries the manufacture
might try to keep...
Still true in China
A children’s garment factory in Zhili
Maintain 60 core workers
Outsource any extra order
31
Workers and contractors
A garment factory in Bangladesh
32
How to Build Clusters?
A four stage model, supported by case studies
in China
33
Clusters: 0→ 1→ N→ Q
0→ 1: Create something from nothing
1→ N: Quantity expansion
N→ Q: Quality upgrading
34
Clusters: 0→1
• Planting seeds is the most challenging
part.
• Three universally applicable guidelines
1. Subsidize first ...
Development as a self-discovery process
(Hausmann and Rodrik, JDE 2003)
• The first move takes a lot of risks.
However, hi...
37
Priemier Li visited 3W Coffee.
The rent was highly subsidized
Inside coffee shop
Zhongguancun Startup Street
Strategies to attract first movers
• Provide free/cheap land or tax breaks for leading firms in
industrial parks;
• Provid...
Go-in-group strategy
• When Chinese firms invest overseas, they
often go in group so as to pool resources
to deal with som...
Wenzhou footwear industry→
Bishan (Chongqing)
• Wenzhou is the one of the largest footwear clusters in China.
However, in ...
Going step by step
• China’s industrial parks/SEZs follow a step by
step approach: first Shekou industrial park in
1979 (o...
42
43
44
Bagamoyo Port:
Tanzania begins construction on a mega project
$11billion are funded by China Merchants Holdings Interna...
45
Slaves were once shipped from Bagamoyo across to the island of Zanzibar to slave markets.
Now it is building the larges...
Clusters: 1→N is easier than 0→1
• There are many indigenous clusters. It is better to
facilitate their growth than buildi...
Cluster development
• Because of lower capital requirement and other
advantage of collective efficiency, entry barriers ar...
Anding potato cluster
• Anding of Gansu Province used to be one of the
poorest places in China (poverty rate 78% in 1980)
...
Major potato production centers in China
Anding potato cluster
Zhang and Hu, 2015, World Development 49
Improve land quality
From the 1950s to 1990s, the government made great efforts to build terrace fields
and irrigation fac...
Adopt potato production
•Potato is more suitable to the dry environment than wheat. Anding
receives only 380mm of rainfall...
Breed better varieties
• Gansu Academy of Agricultural Science bred a high yield variety for
starch processing (high starc...
Price shocks and shift in government policy
0.00
0.20
0.40
0.60
0.80
1.00
1.20
0
100
200
300
400
500
600
700
800
900
1000
...
Market equilibrium in the
supply/demand expansion phases
54
Expand the market
• Establish trader and producer associations.
• Update market information systems.
• Set up a new system...
Acquire and spread market information
• The potato association sends informants to live in
major wholesale markets nationw...
The spatial distribution of markets over time
☆: Wholesale market
○: Village collection point
Blue: Built 1996-2000
Red: B...
Overcome transportation bottleneck
• Lobby for more freight car quotas (up from 1507
in 2003, to 3605 in 2004, and 6145 in...
Build more storages (55% of annual output)
Farmer’s storage: 0.36 million tons
More than 2 storages per
household
Small na...
Develop the processing sector
• Local government intensified their effort to attract investors:
– Provide free land
– Help...
Develop the processing sector
• In 2004, the first two plants produced only
starch.
• Quickly, the product lines have beco...
Role of local government
• Developing cluster/industrial park is a continuous
process with constantly involving in overcom...
Clusters: N→Q
• The rapid quantity expansion often comes
at a cost of quality.
• As the quality problem accumulates, the
l...
Wenzhou Footwear Industry
• Wenzhou (“China’s footwear capital”): one billion pairs
of shoes per year.
• The cluster start...
Wenzhou footwear industry
• On August 8, 1987, China’s Industrial and Commercial
Administration burned 5,000 thousands of ...
Major local industrial polices prior to
and after a crisis
0
5
10
15
20
25
30
35
40
Prior to a crisis After a crisis
Quant...
Implications for Egypt in Particular
67
Egypt’s strengths
• People are extremely enterprising.
Entrepreneurship is in the blood.
• Rather high population density
...
Strategies
• Pay more attention to indigenous clusters, which
have been largely off the official radar screen.
First map t...
Align local government’s interest
• Most clusters/industrial parks are at the local level.
Their development involves cons...
Align local government’s interest
• In China, local governments have strong
embedded interests in promoting
cluster/indust...
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Xiaobo Zhang• 2016 IFPRI Egypt Seminar Series in partnership with ECES: Cluster-based development in Egypt

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IFPRI Egypt Seminar Series provides a platform for all people striving to identify and implement evidence-based policy solutions that sustainably reduce poverty and end hunger and malnutrition. The series is part of the United States Agency for International Development (USAID) funded project called “Evaluating Impact and Building Capacity” (EIBC) that is implemented by IFPRI.

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Xiaobo Zhang• 2016 IFPRI Egypt Seminar Series in partnership with ECES: Cluster-based development in Egypt

  1. 1. Cluster-based Development as an Opportunity for Job Creation and Poverty Reduction in Egypt Xiaobo Zhang, IFPRI and Peking University September 6, 2016 Egyptian Center For Economic Studies (ECES) , Cairo 1
  2. 2. Clusters • Clusters are a geographic concentration of a large number of interconnected businesses. • They are ubiquitous in both developing and developed countries. • They are widely observed in the early industrialization period of developed countries. – Adam Smith’ Wealth of Nations describes vividly the fine division of labor for the linen shirt production across dispersed producers in nearby towns. – Alfred Marshall’s Principle of Economics includes four chapters on industrial districts (the name preceding clusters). 2
  3. 3. Outlines 1. Why clusters are particularly suitable for early stages of development? 2. How to build clusters? 3. Implications for Egypt in particular 3
  4. 4. Why Clusters Are Particularly Suitable for Low and Middle-Income Countries? Major constraints and strengths 4
  5. 5. Major constraints • Credit constraints: banks are not willing to extend credit to small and micro enterprises; • Weak institutions: extortions, lack of enforcement, and so on; • Poor infrastructure: high transportation cost, power outages. 5
  6. 6. Mainstream thinking on development • These constraints set low and mid-income countries apart from developed countries. • Therefore, it is crucial to first remove these constraints: – Develop micro finance institutions (MFI) – Institution rules – Invest in infrastructure (road and electricity) 6
  7. 7. It is a daunting challenge to do so • It is impossible to set up a well-functioning financial system and sound institutions in a day; If low and middle-income countries can achieve these goals, they would have already been developed countries. • Facing a limited budget and many competing needs (such as education and public health), it is not an easy task for governments in low and middle-income countries to invest in infrastructure. 7
  8. 8. Failures of MFIs • Banerjee, A., Duflo, E., Glennerster, R., & Kinnan, C. (2015). The miracle of microfinance? Evidence from a randomized evaluation. American Economic Journal: Applied Economics, 7(1), 22-53. • MFIs do not have any impact on intended development outcomes. 8
  9. 9. Major findings • In 2005, half of 104 slums in Hyderabad, India were randomly selected for opening of a branch of a particular microfinance institution (Spandana) while the remainder were not, although other MFIs were free to enter those slums. • 15 to 18 months after Spandana began lending in treated areas, households were no more likely to start any new business. There was no effect on average monthly expenditure per capita. • 3 to 4 years after the initial expansion (after many of the control slums had started getting credit from Spandana and other MFIs ), the probabilities of borrowing from an MFI in treatment and comparison slums were the same. Consumption was still no different in treatment areas, and the average business was still no more profitable. There are no changes in any of the development outcomes that are often believed to be affected by microfinance, including health, education, and women’s empowerment. 9
  10. 10. Alternative thinking • Use existing strengths to generate dynamics in a small place (for example, clusters). • In the small place, the seemingly large constraints can be overcome much easily than for a country as a whole. • Over time, hopefully the growth spillovers to other places and induces more institutional innovations 10
  11. 11. Marshall’s three advantages of industrial district: • Information flow • Market linkage • Labor pooling 11
  12. 12. Role of clusters in overcoming financial constraints • Fine division of labor lowers the capital requirements of entry (Ruan and Zhang, 2009). • Social trust, repeated transactions, and proximity make it possible for producers to use trade credit and informal contracts to fill the void of formal financial and legal institutions (Grief, 1993). 12
  13. 13. Page 13 Puyuan Cashmere Sweater Cluster Zhejiang Province
  14. 14. Page 14 The Putting-out System Yarn Purchasing Weaving Assembling Dyeing & Finishing Buttoning Ironing Printing Packing Selling Sweater Shops (VPCS) New Style Designing Computer Aided Designing Integrated Producing Factories Yarn Purchasing Weaving Assembling Dyeing & Finishing Buttoning Ironing Printing Packing Selling New Style Designing Computer Aided Designing The Vertically-integrated System Two business model in Puyuan Cluster Ruan and Zhang, EDCC(2009)
  15. 15. Integrated factory 15
  16. 16. Page 16 Market
  17. 17. Page 17 Production Organizers
  18. 18. Page 18 Family workshops
  19. 19. Page 19 Workers/entrepreneurs
  20. 20. Initial Capital Investment in Puyuan Cashmere Sweater Cluster Average (10,000 yuan) Mean/Wage % of initial capital investment from banks Yarn dealers 12.45 6.25 0.00 Family weaving workshops 7.31 3.65 2.90 Dyeing factories 340.07 170.05 20.63 Finishing factories 177.82 88.90 25.68 Printing workshops 10.60 5.30 0.00 Ironing workshops 3.83 1.90 0.00 Sweater shops 12.74 6.35 6.95 Three-wheeler drivers 0.54 0.25 0.00 Logistics company 4000.00 ------ 50.00 Integrated enterprises 263.84 131.90 21.13
  21. 21. The Most Important Financing Source When Facing Working Capital Problems in Puyuan Cluster Ruan and Zhang (EDCC 2009) 21
  22. 22. Trade Credit in UK in the 19th Century “Indeed an understanding of industrial finance during the nineteenth century is impossible unless this [trade credit] taken into account. The factor acted as a link between the banks and the small makers who could not then resort to them for credit. Through the factor, industry was supplied with its working capital; for though the domestic workers and shop owners might not all receive their materials from the factor, they all depended on him for weekly advances from which they might meet their expenses of production.” --- G. C. Allen, The Industrial Development of Birmingham and the Black County 1860-1927, published in 1929. Page 155. 22
  23. 23. Trade Credit in Ethiopia (Handloom Cluster) Addis Ababa Electrified Not Electrified Source of raw materials (% of respondents) Open market 1.5 22.1 41.8 Third party 0.0 0.7 0.0 Shop 98.5 77.2 58.2 Most important supplier (% of respondents) Open market (same town) 2.6 24.1 19.9 Open market (other town) 0.0 0.7 28.8 Shopkeeper (same town) 91.3 69.0 20.6 Shopkeeper (other town) 6.2 6.2 30.8 Visiting trader 0.0 0.0 0.0 Other 0.0 0.0 0.0 23 Zhang et al., JDS, 2011.
  24. 24. Existing strengths in low and middle- income countries • Abundant in labor • Strong social capital at the community level (people know each other for generations). 24
  25. 25. More advantages • Security • Flexible production structure under uncertainty 25
  26. 26. Clustering as an adaption to predators • Story of brick factories in Gansu; • Cicada phenomena: – North American genus, Magicicada, which has a number of distinct "broods" that go through a 17-year life cycle. 26
  27. 27. Industrial park in Bangladesh More security; More space; Centrally provided gas; More stable power supply (supposedly). 27
  28. 28. Clustering lowers effective tax rates .01.02.03.04.05 Effectivetaxrate 0 20 40 60 80 100 Cluster measure Note: Calculated by the author based on China Economic Census 2004. The tax rate is the average rate among firms in locations corresponding to each percentile of the cluster measure. 28
  29. 29. Coping with weak institutions • By staying in clusters, entrepreneurs can better cope with weak institutions, such as lack of security, poor infrastructure, extortions, and high tax rate. 29
  30. 30. Flexible production: In-house production versus outsourcing “[I]n fluctuating industries the manufacture might try to keep his overhead charges low by having an establishment large enough to deal with normal demand, and he might extend his output by employing garret- masters.” --- Allen (1929, page 156) 30
  31. 31. Still true in China A children’s garment factory in Zhili Maintain 60 core workers Outsource any extra order 31
  32. 32. Workers and contractors A garment factory in Bangladesh 32
  33. 33. How to Build Clusters? A four stage model, supported by case studies in China 33
  34. 34. Clusters: 0→ 1→ N→ Q 0→ 1: Create something from nothing 1→ N: Quantity expansion N→ Q: Quality upgrading 34
  35. 35. Clusters: 0→1 • Planting seeds is the most challenging part. • Three universally applicable guidelines 1. Subsidize first movers 2. Go in group 3. Go step by step 35
  36. 36. Development as a self-discovery process (Hausmann and Rodrik, JDE 2003) • The first move takes a lot of risks. However, his success creates a large externality. Once seeing a successful example, others will imitate. • Thus, sometimes it makes sense for the government to (financially and politically) support the first mover. 36
  37. 37. 37 Priemier Li visited 3W Coffee. The rent was highly subsidized Inside coffee shop Zhongguancun Startup Street
  38. 38. Strategies to attract first movers • Provide free/cheap land or tax breaks for leading firms in industrial parks; • Provide ready-to-go factory buildings • Create an enabling micro environment within clusters/industrial parks. • Need to review the literature more carefully to evaluate the evidence. 38
  39. 39. Go-in-group strategy • When Chinese firms invest overseas, they often go in group so as to pool resources to deal with some common concerns, such as on security, lack of infrastructure, short of suppliers, and red tapes. 39
  40. 40. Wenzhou footwear industry→ Bishan (Chongqing) • Wenzhou is the one of the largest footwear clusters in China. However, in recent years, due to rising wages and lack of land for industrial use, firms have lost competitive advantage in Wenzhou and started to look for places to relocate • Bishan in western China set up a 1,800-acre industry park for footwear industry. • Go in group: bring the whole supply chain • Bring the management team: a retired district party secretary in Wenzhoen footwear cluster was hired to lead the new industrial park for five years. After that, the management right was turned over to local government. 40
  41. 41. Going step by step • China’s industrial parks/SEZs follow a step by step approach: first Shekou industrial park in 1979 (only 11km2), then larger scale Shenzhen special economic zone (328km2) in 1980, 14 coastal opening-up cities in 1984, finally China’s joining WTO in 2001. • We observe the same experience in Tanzania. 41
  42. 42. 42
  43. 43. 43
  44. 44. 44 Bagamoyo Port: Tanzania begins construction on a mega project $11billion are funded by China Merchants Holdings International and Oman's State Government Reserve Fund.
  45. 45. 45 Slaves were once shipped from Bagamoyo across to the island of Zanzibar to slave markets. Now it is building the largest port in East Africa with 100 square km of special economic zone.
  46. 46. Clusters: 1→N is easier than 0→1 • There are many indigenous clusters. It is better to facilitate their growth than building new ones from scratch. • For example, Egypt has at least 145 clusters, which have been formed largely in the absence of government interventions. 46
  47. 47. Cluster development • Because of lower capital requirement and other advantage of collective efficiency, entry barriers are initially very low, resulting in a spurt of extensive firm growth. • In this stage, the government policy should focus on supporting cluster expansions, such as building market places, improving infrastructure, holding exhibits (generic marketing), and enhancing security. 47
  48. 48. Anding potato cluster • Anding of Gansu Province used to be one of the poorest places in China (poverty rate 78% in 1980) and didn’t produce potato until 1960s. • Now it has become one of the three largest potato production centers in China. • Potato accounts for two-thirds of the cropping area; Anding provides every Chinese with one kg potato per year. Farmers generate about 60% of their income from potatoes. 48
  49. 49. Major potato production centers in China Anding potato cluster Zhang and Hu, 2015, World Development 49
  50. 50. Improve land quality From the 1950s to 1990s, the government made great efforts to build terrace fields and irrigation facilities at the river basin level. Of the land compatible to terracing, 93.7% has been converted into terrace. 50
  51. 51. Adopt potato production •Potato is more suitable to the dry environment than wheat. Anding receives only 380mm of rainfall per year, compared to 1000mm in Washington DC. •Potato was introduced in the 1960s as a secondary crop for coping with food shortage. However, wheat is much more appealing than potato in the Chinese diet. In addition, government had guaranteed procurement price for wheat but not potato. •The local government first asked village cadres to set up demonstration fields on their own land. It took years to scale up potato production as seen below. 51
  52. 52. Breed better varieties • Gansu Academy of Agricultural Science bred a high yield variety for starch processing (high starch and low sugar contents). • County agricultural extension station and a farmer accidently bred Xiadaping, the most popular vegetable potato; the “Atlantic” was imported from the US for chips and French fries. • The county set up a breeding center to produce toxin-free potato seeds. Anding is one of the largest potato breeding centers in China. 52
  53. 53. Price shocks and shift in government policy 0.00 0.20 0.40 0.60 0.80 1.00 1.20 0 100 200 300 400 500 600 700 800 900 1000 1996 1998 2000 2002 2004 2006 2008 2010 Croppingarea(millionmu) Price(Yuan/ton) Cropping area Price Shift in government policies from stimulating supply to expanding market 53
  54. 54. Market equilibrium in the supply/demand expansion phases 54
  55. 55. Expand the market • Establish trader and producer associations. • Update market information systems. • Set up a new system of local wholesale markets. • Apply for more freight car quotas. • Subsidize farmers to build storages. 55
  56. 56. Acquire and spread market information • The potato association sends informants to live in major wholesale markets nationwide to collect market information. • The county broadcasts the information in local media (radio, TV, and newspapers) and on large monitors in major gathering places (central squares, railway and bus stations). • Greater market transparency makes it harder for traders to cheat farmers. 56
  57. 57. The spatial distribution of markets over time ☆: Wholesale market ○: Village collection point Blue: Built 1996-2000 Red: Built 2001-2005 Yellow: Built 2006-2010 57
  58. 58. Overcome transportation bottleneck • Lobby for more freight car quotas (up from 1507 in 2003, to 3605 in 2004, and 6145 in 2009). Transportation cost to Shanghai: By car: 450 yuan/ton By train: 225 yuan/ton Anding to Guangzhou: Anding, China: potato train 58
  59. 59. Build more storages (55% of annual output) Farmer’s storage: 0.36 million tons More than 2 storages per household Small natural ventilation storages: 0.185 million tons Centrally air conditioned: 10000 ton each Natural ventilation storages: Medium size 200 Yuan Subsidy/storage 59
  60. 60. Develop the processing sector • Local government intensified their effort to attract investors: – Provide free land – Help secure subsidized bank loans – Guarantee stable potato supply • This is consistent with Hausmann and Rodrik’s idea “development as a discovery process” (because the first mover generates externality, it makes sense to subsidize it). • The number of processing plants increased from 0 in 2003, 2 in 2004, to 12 in 2009. Now it can process about 1/3 of total output. 60
  61. 61. Develop the processing sector • In 2004, the first two plants produced only starch. • Quickly, the product lines have become more diversified: – Modified starch for industry use – Frozen French fries for fast food chains – Potato chips – Potato flour – Even export to the Middle East and Southeast Asia. 61
  62. 62. Role of local government • Developing cluster/industrial park is a continuous process with constantly involving in overcoming constraints. • The one-size-fits-all type interventions may work for once, but not all the time. • After a policy helps remove one binding constraint, another emerges, that in turn, requires a new set of local policies. • Continuous tinkering is often required. 62
  63. 63. Clusters: N→Q • The rapid quantity expansion often comes at a cost of quality. • As the quality problem accumulates, the likelihood of quality crisis increases. • Policies should shift from supporting quantity expansion to quality upgrading. 63
  64. 64. Wenzhou Footwear Industry • Wenzhou (“China’s footwear capital”): one billion pairs of shoes per year. • The cluster started in the late 1970s and early 1980s. Production was dispersed in different households/workshops. The division of labor lowered the capital barriers to entry. • However, easy entry made it difficult to control quality in the cluster. • By 1987, Wenzhou shoes were notorious for its bad quality with nicknames including “day shoes,” “week shoes,” and “falling heel hoes.” 64
  65. 65. Wenzhou footwear industry • On August 8, 1987, China’s Industrial and Commercial Administration burned 5,000 thousands of Wenzhou shoes and had the event broadcasted on TV. Subsequently, Wenzhou shoes were burnt in ten other cities. • Wenzhou footwear industry was on the verge of collapse. Under the pressure, the local government and the industry joined hands in making some changes: – Established footwear association, which blacklisted enterprises with a bad reputation and shamed them with all its members. – Set up a footwear quality management office, which certified all the shoes produced in Wenzhou. – Provided various incentives for firms with sound brand names and banned those firms with bad reputation from posting advertisement in Wenzhou. 65
  66. 66. Major local industrial polices prior to and after a crisis 0 5 10 15 20 25 30 35 40 Prior to a crisis After a crisis Quantity expansion Quality upgrade Ruan and Zhang, 2015 66
  67. 67. Implications for Egypt in Particular 67
  68. 68. Egypt’s strengths • People are extremely enterprising. Entrepreneurship is in the blood. • Rather high population density • Robust power supply and good infrastructure 68
  69. 69. Strategies • Pay more attention to indigenous clusters, which have been largely off the official radar screen. First map them out. • Take advantage of the global relocations of labor-intensive manufacturing industries 69
  70. 70. Align local government’s interest • Most clusters/industrial parks are at the local level. Their development involves constantly tinkering with various bottlenecks. • It is important to put local governments on the driver’s seat considering their informational advantage over the central government. • A question arises: how to align local governments’ interest with local economic development? 70
  71. 71. Align local government’s interest • In China, local governments have strong embedded interests in promoting cluster/industrial park development: – Fiscal competition among local governments – Career competition among local officials • More research is needed to understand the incentive structures of local governments in other countries, including Egypt 71

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