Coordination Failures, Clusters, and Microeconomic Interventions

The failure of market-oriented reforms to generate high and sustained growth in Latin America has led to the widespread agreement that such reforms should be complemented by other policies.¹ The strategies to complement market-oriented reforms fall into three categories: macroeconomic policies to reduce the region's high vulnerability to crises; institutional and microeconomic reforms to improve the business climate and provide better foundations for growth; and microeconomic or competitiveness policies that include a broad range of government interventions to allow markets, sectors, and companies to take advantage of the opportunities afforded by market-oriented reforms. This paper focuses on the third strategy, which I henceforth refer to as one of microeconomic interventions.

Countries have engaged microeconomic interventions for decades. Since the switch to outward-oriented development strategies in the mid-1980s, the main such interventions have been aimed at promoting exports, attracting foreign direct investment (FDI), and supporting small and medium-sized enterprises (SMEs). Another strategy that is receiving renewed interest is promoting inno-vation.² These types of microeconomic intervention enjoy wide support and are encouraged by international institutions such as the World Bank and the Inter-American Development Bank.

But the conceptual and empirical foundation for some of these interventions is not as solid as many people believe.³ For instance, it is hard to find a convincing theoretical argument in favor of policies to support SMEs. On the contrary, recent research suggests that such policies may have significant negative effects on aggregate productivity under some circumstances.⁴ Empirical research also fails to find evidence for the positive externalities from exports and FDI that form the basis for policies to promote these activities.

A more effective set of microeconomic interventions should specifically address the market failures that are important in the development process. Recent research suggests two kinds of market failures that may seriously hamper development. The first is related to externalities in the entrepreneurial process of discovering new profitable investment opportunities.⁵ The second is associated with coordination failures in taking the necessary actions to increase sectorwide productivity. This paper explores the latter market failures, their relation to clusters and agglomeration economies, and the set of microeconomic interventions that could be followed to deal with them.

The paper is organized as follows. The next section introduces the notion of coordination failures, their relevance to developing countries, and the circumstances under which they occur. The following section then argues that clusters can be seen as agglomerations of firms and organizations in related economic activities among which coordination failures are likely to arise. In other words, clusters provide opportunities for microeconomic interventions that promote coordination and collective action to improve productivity. The paper goes on to explain that although one may alternatively think of clusters as resulting from agglomeration economies, the notion of coordination failures is more useful for deriving appropriate policies to encourage clustering.

I explore this issue formally in a subsequent section, which presents a model of a small economy that is plagued by sector- or cluster-specific coordination failures. This section shows that, rather than trying to reallocate resources toward sectors that are seen as offering high clustering possibilities (as is the case with import substitution), policy should aim at fostering cooperation in sectors in which the economy is already showing comparative advantage.

Next, I discuss a particular application of these ideas to innovation policy. I argue that general policies to increase innovation across the board are likely to be inferior to policies that take the more selective approach of trying to induce the development of innovation clusters in areas of comparative advantage. Finally, I offer some suggestions on how these ideas about coordination failures and clusters can form the basis for a set of effective microeconomic interventions for middle-income countries.

Coordination Failures

A firm's productivity depends not only on its own efforts and abilities and on general economic conditions (such as the macroeconomic environment and the legal system...