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The Silicon Valleys of Latin America – searching for “Shared Value” development models

January 11, 2013 • Global Business

Between 2003 and 2012 Latin America has lived through an unprecedented period of stability and positive economic performance. A region once associated with high inflation, macroeconomic instability, guerrilla uprisings and oppressive dictators has grown steadily in spite of the 2008-2009 crisis. With the exception of Argentina and Venezuela, most countries achieved high levels of economic growth whilst maintaining low inflation. Growth in Latin America was of great help to many global companies that were over-exposed to the European crisis, such as Santander, TIM and Fiat – a far cry from the times when Latin American operations needed several years of cross-subsidies from their headquarters before being able to break even, let alone generate profits.

This period of economic growth is generating new opportunities for businesses and governments (Santiso, 2006). For global businesses, it provides the opportunity to expand Latin American operations in ways that not only generate value and profits, but also contribute to local economic and social development, as postulated by Michael Porter’s “shared value” idea (Porter and Kramer, 2011). Local firms benefit from being based in fast-growing markets where a new middle class is emerging. For governments, economic growth provides extra resources to tackle the structural problems that continue to affect the region, ranging from poverty to infrastructural deficiencies and excessive red tape. Many countries in Latin America promote the formation of high technology industrial clusters as a way of fostering sustainable economic growth and development.

 

Clusters and local economic development
Clusters are agglomerations of companies and other organizations engaged in the production of a set of related goods and services – e.g. the firms that design shoes, produce the rubber sole, develop the machinery needed to assemble the shoes, and the training institutions that prepared skilled workers (Porter, 1998). A large body of empirical evidence illustrates that firms based in clusters perform on average better, especially in times of crisis (Schmitz, 2000). Clusters can be important drivers of local economic growth and development (Becattini, 2004). The firms and organizations that form clusters interact and engage in cooperative initiatives, which allow them to become more competitive than they would be if they operated individually (Porter, 1998). By working together, sharing some of their resources, and interacting with different types of public and private sector organizations, even very small enterprises can become globally competitive. Clusters facilitate coordination and cooperation economies, which help businesses overcome their resource constraints, for example by gaining better access to credit or benefitting from a common brand (Piore and Sabel, 1984).

Clusters also support innovation. Companies and research labs operating in isolation can invest large sums in research and development (R&D), pushing technological change. However, unless their research teams access ideas and inputs from other organizations, the extent to which they can innovate will be limited – they will suffer from the limitations of closure (Bell and Albu, 1999). The cross-fertilization of ideas and the exchange of knowledge across organizational barriers lay at the core of the innovative processes. A competitive cluster facilitates these phenomena by providing loci for organizations to exchange knowledge as well as mechanisms to support innovative initiatives, such as venture capital funds specializing in high tech start-ups and incubators (Audretsch and Feldman, 1996). After all, some of the most admired companies in the world, such as Apple and Microsoft, started as micro enterprises. They could develop and become global leaders not only because of the genius of their founders, but also thanks to the network of venture capitalists, clients, suppliers and advisors with whom they interacted in Silicon Valley – the most talked about cluster in the world.

Clusters help attracting capital and skills – investors and skilled laborers are likely to move to agglomerations where there are opportunities in their field. If a cluster grows, it generates skilled jobs and wealth (Porter, 1998). A competitive cluster also generates exports and links with other specialized clusters located in different areas, evolving from being a local agglomeration into a hub part of a larger globally integrated production network (Saxenian, 2006). The positive effects that clusters can have on both business and local development are particularly important for Latin America, which, despite its current economic growth, continues to suffer from several market failures and institutional weaknesses (Khanna and Palepu, 2010). For these reasons, several governments in the region attempt to promote industrial clusters (Altenburg and Meyer-Stamen, 1999).

The positive effects that clusters can have on both business and local development are particularly important for Latin America, which, despite its current economic growth, continues to suffer from several market failures and institutional weaknesses.

During the last twenty years, Latin American government began promoting clusters not only in traditional industries, such as car manufacturing, but also in new high tech industries, such as medical devices and Information and Communication Technologies (ICT). The development of Silicon Valley clones in Israel, Ireland, India, and Taiwan, and their positive effects on economic and social development acted as a stimulus to foster ICT clusters. The new economic and political stability of Latin America, together with the dynamism and globalization of the ICT industry provided an unprecedented opportunity for governments and businesses alike. The ICT industry is fragmented at the global level – companies perform different sets of operations in spatially distant locations, and then integrate them for the final costumer. By doing so, they benefit from different costs and skills that each cluster and location can offer. Searching for more efficient production locations and organizational structures, multinational firms also create opportunities for the countries and firms that can offer the right set of skills at the right price at the right time (Ciravegna, 2012).

The Taiwanese ICT electronic manufacturing cluster emerged thanks to the first wave of outsourcing by American producers during the 1980s (Amsden and Chu, 2003), whereas the Indian clusters developed when Silicon Valley firms began outsourcing programming and other services to reduce their costs during the 1990s (Athreye, 2005). As of 2012, several of the global companies that dominate the ICT industry originated in emerging market clusters: the Taiwanese firm Foxconn, which producers the likes of the Apple IPhone and IPad, is one of the largest players in the industry, employing an estimated 800,000 people in 2010; the Indian firms Tata Consulting Services, Wipro and Infosys, have become some of the top providers of outsourced information technology services in the world; Acer, a Taiwanese computer manufacturer, moved from being a subcontractor of components to develop its own brand of personal computers.

As I have documented in my book Promoting Silicon Valleys in Latin America, many countries in Latin America have adopted specific policies to foster the development of ICT clusters. Their objective is to become hubs for the development and production of ICT, an industry capable of generating exports, well-paid jobs, and positive externalities to the rest of the economy. Several countries in the region can exploit these trends to their advantage to develop local Silicon Valleys: they already have solid trade and investment links with North America and Europe and expanding domestic markets that provide further business opportunities. Many American companies invested in Latin American ICT clusters precisely to benefit from spatial proximity – “near shoring” as it is defined in the industry (Gereffi et al, 2009).

The senior executives I interviewed pointed out that shorter flying time from the headquarters generated advantages that compensated for higher labour costs than in India, China and the Philippines. Climatic conditions and less prominent cultural differences seemed to be important factors for executives that had to relocate: many countries in Latin America, such as Brazil and Costa Rica, rank very highly among tourist destinations. Other location advantages include the presence of creative industries, such as music, media content, and cinema, which are becoming increasingly intertwined with the ICT industry (Lopez, Ramos, and Torres, 2009). The countries in the region that will manage to develop the needed conditions for ICT clusters to flourish, may finally succeed in building their own Silicon Valleys, as India and Taiwan did, hopefully in ways that are consistent with the shared value principles.

The main element of the cluster promotion policies adopted by Latin American countries is the attraction of foreign direct investment. Most countries that are promoting Silicon Valleys provide special benefits for the large ICT companies that decide to invest there, for example tax exemptions and subsidies. These policies rest on the assumption that multinational companies are the most important sources of capital and technology in the world economy (Lall and Narula, 2004). A few global leaders in the industry structure the global production networks that link clusters located in India, Israel, Ireland and Taiwan to Silicon Valley. Attracting them can provide demand for specialized inputs, skilled jobs, and generate a powerful signal about the competitiveness of a given location or cluster (Ciravegna, 2011).

Attracting multinational corporations does not per se generate sustainable and competitive clusters (Altenburg and Meyer-Stamen, 1999). If, for example, these companies invest only to take advantage of low costs of production, with little additional value being created through time, they may relocate when their costs rise. After the signing of NAFTA, Mexico attracted a large number of electronic manufacturers in its Guadalajara ICT cluster, becoming the most important ICT producer in Latin America. However, the main reason for locating in Mexico was lower labour costs than in the US and less stringent health, safety and environmental regulations (Gallagher and Zarski, 2007). The cluster lacked at the time the mechanisms to develop a local specialization than went beyond being a low cost manufacturing hub – the value created increased only marginally, as well as the sophistication of the operations carried out in the cluster, and the links connecting local actors to the global production networks.

The arrival of Intel put Costa Rica on the world map of ICT producers, giving it credibility as a production location and attracting other MNCs to invest there.

As other locations offered much lower costs, a large number of ICT manufacturers delocated from Mexico, moving mainly to Chinese clusters. The boom of the Mexican cluster lasted approximately ten years. Gallagher and Zarski (2007) also point to evidence of less than optimal standards in the ICT factories, which resulted in episodes of pollution and damage to workers’ health. Meanwhile, Costa Rica, a small country in Central America more famous for coffee and forest than for its industry, developed a highly competitive cluster, becoming the first producer and exporter of ICT goods and services per capita in Latin America (Ciravegna, 2011).

As Monge-Gonzalez et al observe – “Costa Rica’s ICT fame essentially began in 1996 when it successfully lobbied Intel to establish its only Latin American plant there, outcompeting Argentina, Brazil, Chile and Mexico. This was the most visible step of its ICT cluster promotion policy, others being investment in infrastructure and education. The arrival of Intel put Costa Rica on the world map of ICT producers, giving it credibility as a production location and attracting other MNCs to invest there. Costa Rica’s exports of electric and electronic goods increased from 3% of total exports in 1985, to 28% in 2003, replacing perishable goods as the first export category (Monge-Gonzalez et al, 2005).”

After its initial investment, Intel continued to upscale its investment in Costa Rica, opening another factory and a research laboratory. By 2005, the estimated value of Intel’s investments in Costa Rica was US $732 million. Many other companies, such as Teradyne, set up shop in Costa Rica to provide Intel with inputs. Others, such as Avionix and Cypress Creek, perform completely different operations, such as software development. IBM, HP and Fiserve invested in business process outsourcing operations.

In sum, Costa Rica did not just attract Intel, an ICT manufacturer. It developed the conditions that made it a competitive location for ICT service providers. By the year 2012, Costa Rica hosted over one hundred multinational corporations specialized in business process outsourcing (BPO) and information technology outsourcing (ITO) as well as two hundred local firms, two research universities, two incubators, and several other organizations supporting the cluster. The cluster now employs an estimated 10% of the Costa Rican workforce and accounts for about 28% of national exports.

The ICT cluster contributed positively to the economic performance of Costa Rica, which has become one of the richest countries in Latin America. However, as many entrepreneurs and managers point out, economic growth pushed wages up, and with them costs of production. The US, the main buyer of ICT services produced in Costa Rica and its main investor, went through its worst economic crisis since 1929. The Costa Rican ICT cluster not only withstood the 2008-2009 economic downturn successfully, it continued to grow, attracting new investments by HP and IBM. It gradually moved from a focus on ICT manufacturing to a focus on services, a more environmentally sustainable business. Meanwhile, Intel and its suppliers operated along a shared value strategy – they contributed to their communities by developing the curriculums of schools and helped designing new stringent environmental regulation. Costa Rica enforced its regulation so that the operations of multinational corporations and local businesses alike complied with standards similar to those imposed in rich economies’ clusters. As a result, twenty years after its inception, the cluster has not only survived, it prospered and generated positive externalities for the economy and society at large.

What lessons can we learn from the Costa Rican case? I would start by examining how Costa Rica attracted foreign investment by flagship corporations, despite having higher labor costs and more stringent regulatory frameworks than other locations. CINDE, the Costa Rican Investment Promotion Agency (IPA), is one of the most competitive in the world. In 2009 the World Bank ranked it 10th out of 213 IPAs surveyed around the world (The World Bank Group, 2009). As I illustrated in my research, CINDE was an essential player in supporting cluster development (Ciravegna, 2011). Not only did it attract Intel, it worked together with other institutions such as the Inter-American Development Bank, venture capital funds and the Latin American Center for Competitiveness and Sustainable Development of the INCAE Business School to ensure that other multinationals invested in Costa Rica, and that there were sequential investments aimed at increasing the technological sophistication of the operations flagship companies carried in the cluster. Multinational enterprises operating in Costa Rica upscaled their operations, offsetting rising costs by moving towards higher value added activities. They coordinated their actions with universities and technical schools, in order to ensure that they generated the skills needed for their ever-more sophisticated activities in the cluster.

CINDE was an efficient instrument to promote the formation and development of the cluster for several reasons. First, it employs highly skilled professionals, who are familiar with negotiating with high level executives and know the characteristics of the industry they target. Second, it worked closely together with the Costa Rican government and other sectors of the economy, such as banks and large local business groups, to ensure that the cluster policy was well embedded in a broader development policy context (Ciravegna, 2012). The lesson for other countries in the region is that for investment attraction to be effective and carried out within a shared value perspective, investment promotion agencies have to be well funded and targeted to specific sectors. An additional lesson is that being sufficiently independent from the executive ensures a certain degree of continuity, which, as Nelson illustrates, if missing, can hinder the efforts to build competitive clusters (2009). If, for example, there is a change in government in the midst of an important negotiation with a multinational corporation, and a given IPA changes its conditions, the targeted company may simply opt for other locations, and be worried about the continuity of the conditions offered.

Costa Rica’s investment in social welfare and education contributed positively to its cluster policy – it trained the engineers and technicians that work in the cluster and that founded local companies. Costa Rica also benefitted from having a stable democratic environment, characterized by high level of respect for nature and workers’ rights, a functioning welfare state, and a peaceful tradition (The World Bank Group, 2006; Dunkerley, 1990). Marketing the cluster and linking it to other local advantages further boosted its global competitiveness – Costa Rica leveraged its reputation as a tourist destination to lure expatriates to establish offices there. The ICT and Tourism clusters benefit from the fact that Costa Rica receives a high number of tourists and has a large set of English speaking professionals. Both clusters benefit from Costa Rica’s image as a natural paradise, safe and friendly to foreigners. An important lesson for other countries that are promoting Silicon Valleys in the region is that designing cluster policies in ways that are socially and environmentally sustainable can generate multiple positive dynamics for development. On the contrary, focusing mainly on job creation can have dramatic negative externalities (Gallagher and Zarski, 2007).

An important lesson for other countries that are promoting Silicon Valleys in the region is that designing cluster policies in ways that are socially and environmentally sustainable can generate multiple positive dynamics for development.

What are the features of the other clusters of Latin America? The Latin American countries that have thus far developed ICT clusters are Argentina, Brazil, Chile, Colombia, Costa Rica, Mexico and Uruguay. I will briefly outline some of their characteristics. Brazil and Mexico naturally lead the way in terms of total production of ICT, as they are the largest economies. Yet, whereas ICT clusters represent only a minimal part of the Brazilian and Mexican economies, they have become one of the key driving forces of the Costa Rican and Uruguayan economies. Both Costa Rica and Uruguay have developed clusters that specialize in the provision of outsourced business processes and information technology processes, which export the majority of the services they generate. They benefit from having a highly educated workforce, and built their clusters as export hubs – they attracted foreign investment by leading multinational corporations, and generated the environment where local businesses could prosper. In this sense, they are following the path established by Ireland and Israel – two countries with similar populations to Costa Rica and Uruguay, which have developed some of the most competitive ICT clusters in the world in spite of their smallness.

The challenge for Costa Rica and Uruguay is that their policies have been successful. As their clusters grow, wages increase and with them the costs of producing ICT locally. Given that their domestic economy is not attractive, to continue expanding their clusters they have to produce an ever more sophisticated range of services. In other words, they have to climb the value chain of the ICT industry. To do so, they need to form more linkages that support innovation – develop cooperative research and development (R&D) initiatives, mechanisms to finance new business, especially venture capital, and provide their universities with the needed resources and regulatory framework to become hotbeds of innovation, not just generators of skilled labourers.

Israel is the leader in this field – its R&D spending is amongst the highest in the world on a per capita basis. This results in an extremely high per capita production of patents. This innovativeness is not just the fruit of high R&D spending by both the public and private sector. It is the result of a highly integrated innovation system underlying the cluster, made up of universities, research laboratories, venture capital funds, advisors, state agencies, and private firms (Breznitz, 2007). In Costa Rica and Uruguay, not only does R&D spending remain very low, but cooperation between different actors of the ICT clusters has not yet developed to the levels observed in Israel, especially with regards to R&D activities.

Chile is also developing an outward oriented ICT cluster that focuses on services. It also has a very stable democracy and economy, and a skilled workforce. Although its cluster generates less sales and exports than that of Costa Rica, Chile has several advantages – an open, less bureaucratic business environment, a highly sophisticated financial services industry (which typically generates high demand for ICT services), and business links with Asia. Chile has also adopted a set of policies that distinguish it from other Latin American countries. It does not only attempt to attract leading global businesses, it also designed Start Up Chile, a special program to attract new companies, such as start-ups, by providing financial incentives and specific work permits. The so-called Chilecon Valley has attracted hundreds of high technology new firms in its first year of operation, a large number of which left Silicon Valley to set up shop in Chile precisely because of problems related to their migration status in the US. If it succeeds in attracting more investment in ICT by lead multinational corporations and generating connections between its competitive sectors and its emerging ICT cluster, Chile could become an important outward oriented regional hub, threatening the position of Costa Rica and Uruguay.

The so-called Chilecon Valley has attracted hundreds of high technology new firms in its first year of operation, a large number of which left Silicon Valley to set up shop in Chile precisely because of problems related to their migration status in the US.

Brazil, Latin America’s superpower, is promoting a large number of ICT clusters. Leveraging its dynamic economic growth and the size of its internal economy, it attracted most of the global providers of ICT services. It also developed a growing number of local software producers. Despite these similarities, Brazil is very different from India, another large economy that hosts dynamic ICT clusters. Whereas the Indian ICT clusters export more than half of the value of the services and products they generate, Brazil’s ICT clusters are mainly inward oriented. Brazil still suffers from having one of the highest taxation rates in the world, coupled with high levels of bureaucracy and red tape, which hinder the competitiveness of its clusters and the businesses that operate there, especially if they aim to sell their services globally. Government policies to promote ICT clusters have often involved ad hoc tax exemptions and occasionally large contracts from the public sector to boost demand. However, these measures typically benefit only selected businesses, further distort prices, and create additional layers of bureaucracy. One of the factors hindering Brazil from becoming a more competitive hub for the production of ICT is its business environment, which could be improved by simplifying the regulatory framework across the board.

On a positive note, Brazil benefits not only from a large domestic market, but also from the most sophisticated stock market, which in turn fuels demand for specialized ICT services. Some Brazilian clusters are highly integrated with universities and with other industrial clusters. The ICT cluster of Rio, for example, has several links with the petrochemical cluster that is developing near there. The ICT cluster of Blumenau provides services to the manufacturing industries of the south of Brazil, such as car producers. The common link here is that most of the Brazilian clusters emerged to serve already existing industrial agglomerations, which in turn are mainly oriented towards the domestic market. On the one hand, this is a very positive development – previous clusters have stimulated and sustained the growth of new ICT clusters. On the other hand, it reinforces the reliance of Brazilian manufacturing businesses on the internal economy. Unless the Brazilian ICT clusters, and especially local firms, diversify and begin to target foreign clients, they may remain vulnerable to internal economic fluctuations and insufficiently linked to the global networks that drive innovation in the industry. Interesting developments may occur as the Brazilian ICT clusters form links with the highly lively Brazilian music and cinema industry.

Argentina has a similar set of ICT clusters to Brazil – its clusters have developed largely to serve already existing manufacturing hubs, such as the automotive industry in Cordoba. Like Brazil, Argentina provides subsidies and other incentives to the ICT industry. Its clusters benefitted from fast economic growth since 2002, as Argentina recovered from its crisis. Argentina also has some of the lowest average wages of Latin America for ICT professionals. However, its business environment remains challenging. It shares with Brazil a complex and cumbersome fiscal system, high levels of red tape and bureaucratic inefficiency, but with a much smaller domestic market. Additionally, its economic policies have generated macro economic instability and uncertainty, which negatively affected not only foreign investments but also local business. As a result, the Argentinean clusters have grown but maintain an inward orientation, despite having a low cost, highly skilled workforce, and vibrant industries to link with, such as music, cinema, and media production. It is likely that these clusters may go through a period of accelerated growth if the business environment of Argentina improves, which depends mainly on the nature and policies of its future governments.

Mexico has followed Costa Rica and moved from promoting ICT manufacturing clusters to promoting ICT clusters specialized in services. After China’s signing of the WTO and Mexico’s increased domestic wages, most of the multinational companies that invested in Mexico to produce electronics left and relocated to Asia. This caused a decline in employment, exports, and demand for local specialized inputs (Gallagher and Zarski, 2007). Mexico also suffered from sluggish economic growth and a surge in criminal violence, which may have also deterred further investments in its clusters. Nonetheless, local companies continued to grow serving the domestic economy, and many of them providing outsourced services to the United States. Mexico benefits from having the closest business, trade and investment links with the US. Mexico benefits also from another asset – its huge migrant population, which demands services, such as banking, pensions, and money transfers, in Spanish. This generates important business opportunities for Mexican companies that develop the right services at the right time. The Mexican ICT clusters have great potential to develop further if they integrate their services more with the local manufacturing hubs.

Colombia, one of the most dynamic economies of Latin America since the 2000s, has also been promoting the formation of ICT. Both Bogotá and Medellín have successfully attracted leading multinational corporations such as HP, leveraging an urbanized, well-educated middle class, which demands lower wages than its Costa Rican and Brazilian counterparts. Local software and media content companies are also growing, driven mainly by demand from local businesses. The Colombian clusters combine some of the features of the Brazilian clusters with those of the Costa Rican and Uruguayan clusters. They emerged as locations providing outsourced services to clients in the US and Europe. Yet, the growth of the local economy is creating further incentives to invest in Colombia and pushing cluster growth. New discoveries of oil, gas and minerals are generating demand for specialized services, including some from the ICT industry, which combinations of local and multinational companies provide. The signing of the free trade agreement with the US is also changing the structure of the Colombian economy, opening new export markets for several local producers, and the opportunity to import cheap inputs for others. As large companies modify their strategies and their product mixes, they may demand supporting ICT services to adjust – again another potential driver of domestic demand. The main weaknesses of the Colombian clusters is that most companies operate in isolation and with very few links with universities and other organizational actors. If they grow in a more organic way, developing links and cooperative dynamics, they have the potential to become important new features of the Colombian economy.

About the Author
Dr. Luciano Ciravegna is a Lecturer (Assistant Professor) in Strategy and International Business at the Royal Holloway School of Management, University of London. His background includes a BSc (Honours) at the London School of Economics, an MPhil at St Antony’s College, University of Oxford, and a PhD at the London School of Economics. His research examines small business clusters in emerging markets, with a focus on Latin America. He authored the book Promoting Silicon Valleys in Latin America, published by Routledge, and several articles in peer reviewed academic journals, such as the Journal of International Business Studies, and the Journal of Development Studies.

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