The case of Shenzhen SEZ

Acquisition of technology capability through special economic zones (SEZs): The case of Shenzhen SEZ

Wei, Xie

ACQUISITION OF TECHNOLOGICAL CAPABILITY THROUGH SPECIAL ECONOMIC ZONES (SEZs): THE CASE OF SHENZHEN SEZ’

Special economic zones (SEZs) have been adopted by many countries, particularly in the Asia region, as a popular means by which to foster and stimulate economic development (along and Chu 1985; Oborne 1986). Encouraged by the success of SEZs in other Asian regions and countries in the 1960s and 1970s, China set up four SEZs in 1979, including one in Shenzhen.2 As a result of its extraordinary growth and success, Shenzhen SEZ has itself become a positive example and impetus for the rest of the world.3 Although a large number of SEZs are already in operation around the globe (approximately 400), it is likely that a growing number of SEZs will continue to appear, both in Asia and worldwide.4 This is because SEZs have generally proved to be a successful means of fostering economic growth and prosperity. However, despite their general effectiveness, there do exist variations in the relative success of SEZs both within China, and between China and other countries. For example, within China, Guangdong’s other two SEZs lag far behind Shenzhen SEZ (Liao 1999). Indeed, Shenzhen SEZ is perhaps the most successful example of a SEZ in the world, having enjoyed explosive growth (Kasliwal 1998).5 Shenzhen also stands in stark contrast with some rather unsuccessful SEZs in other countries, including those near Bombay and the Kandla SEZ in India.

As well as variations in the relative success of SEZs in achieving economic growth, variations also exist in the abilities of particular SEZs to sustain their performance. Whereas several SEZs initially brought about unprecedented growth, their growth did not continue. Moreover, their importance gradually faded with time as the economy as a whole started to acquire the capabilities and resources that were formerly concentrated in the SEZs, thanks to special policy treatments in the areas of taxation and investment.’ For instance, three EPZs of Taiwan, namely Gaoxiong (Kaohsiung), Nanze and Taizhong, played an important role for economic development through the 1960s and the first half of the 1980s. In 1981, they accounted for no less than 7 per cent of the overall export volume of the entire inland. In Korea, from 1974 to 1979, exports from Masan SEZ represented 4 per cent of South Korea’s total exports (Wong and Chu 1985). However at present, the contribution of these zones in terms of exports and industrial output appears far less impressive-because the country as a whole has caught up with the firms within the SEZ. This raises an important question: what determines the long-term sustainable competitiveness of SEZs? Why do some SEZs experience spurts of economic growth but fail to sustain them? Is it appropriate that SEZs be phased out of operation as a country successfully industrializes?

Since the end of the 1960s, an extensive body of literature on SEZs has evolved (EPZ Authority 1981; UNCTAD 1983), including works focused on Shenzhen SEZ (Vogel 1989; Thoburn 1990; Sung 1991; Zhang 1994; Wu 1996; Chan 1999; Ching 1999; Li and Huang 1999). In addition to performance evaluation of SEZs,8 most studies have focused on the debate concerning the role of SEZs in economic development, in terms of the kinds of benefits or constraints they may bestow. Some studies stress the benefits of SEZs for achieving rapid growth. Arguments advanced in favour of SEZ development generally point to the positive role that SEZs can play in at least four ways: (i) overcoming a common problem experienced by less-developed countries, namely the lack of resources required to make large-scale investments in all regions within a country simultaneously (Litwack and Yingyi 1998); (ii) experimentation-based learning and trade-based learning (USAID 1983); (iii) attracting Foreign Direct Investment (FDI), and promoting export growth and employment generation (UNIDO 1988); and (iv) facilitating economic liberalization, including trade, financial and institutional liberalization (Wu 1996). Others emphasize the limitations and disadvantages of SEZs. Potential drawbacks commonly identified include: (i) the idea that as interconnected relations and complementarities exist among regions and sectors, all sectors and regions should be developed simultaneously, thus making SEZs an inappropriate choice for less-developed countries (Murphy et al. 1989; Nafziger 1990); (ii) the limited learning related to non-complex assembly work (Zhou 1984); (iii) the idea that contribution and performance seem to be less important when viewed from a different angle, because of possibly inefficient distribution of resources (Sufen 1993); and (iv) the risk of increased economic disparity among regions within a country and the resulting risk of social instability (Lin 1997).

In this paper I focus on the role played by SEZs in accelerating technology transfer (UNCTAD 1994). In the field of innovation studies, quite a number of books and papers have been written on the subject of acquisition of technological capability in developing countries.” Several papers have developed the model of acquisition of technological capability in developing countries (Hobday 1995; Mathews 1996), while some have been concerned specifically with the case of China (Hendryx 1986; Stewart 1988, 1992; De Bruijn and Jia 1993; Andreosso and Qian 1999). Surprisingly little attention has been paid to the particular issue of technology transfer in SEZs (UNCTAD 1994; Liang and Nkasu 1997; Mathews 1999), or to the development of technological capability in SEZs.

This paper seeks to fill this gap in the literature, by examining the following questions. (1) How, in a rural zone, has indigenous technological capability been acquired in Shenzhen SEZ? (2) What role is played by the municipal governments in the process? (3) What kinds of policies were helpful in fostering acquisition of technological capability in SEZs? Highlighting the acquisition of technological capability through a SEZ system, this paper draws lessons concerning possible recipes for success, which may be of interest to other developing countries, particularly if they are currently attempting to emulate the success of Shenzhen SEZ.

SHENZHEN SEZ

In 1978, Shenzhen was a small border town located in Guangdong province with a population of about 20,000.11 When it was designated as China’s first SEZ in 1979, Shenzhen boasted nothing more than a few thousand hovel-dwelling farmers, and only 26 small factories with a total industrial output of less than US$ 10,000. Shenzhen’s major activity was agriculture. Food products represented 61 per cent of the industrial production revenue.

After 20 years of development, Shenzhen SEZ has evolved into a modern city of 3.5 million people with a per capita GDP of approximately US$4,000. Over its period of development, the annual rate of GDP growth reached 32 per cent, while the share of primary industry in GDP steadily declined as shares of secondary and tertiary industries increased notably, as shown in Table 1.

As well as rapid growth, the Shenzhen SEZ has built the necessary technological capability to enhance the competitiveness of economy. In 1998, as shown in Table 2, Shenzhen accounted for 14 per cent of world output in floppy disks, 6.2 per cent of output of PC motherboards, nearly 8 per cent of hard disk drives, and 10 per cent of magnetic heads. It accounted for 70 per cent of Chinese output in liquid crystal displays (LCDs), for 33 per cent of Chinese output of digital wireless telephones, for 30 per cent of personal computers, and no less than 85 per cent of Chinese output of floppy disks.

Moreover, the manufacturing industries within Shenzhen SEZ have been steadily upgrading in terms of technological sophistication. As shown in Figure 1, Shenzhen SEZ is becoming a centre for high-technology industries, indeed a “new technology tiger” in its own right (Guynne 1993). In 1998, high-technology industries accounted for nearly 40 per cent of industrial output within Shenzhen SEZ. High-technology industries, rather than labour-intensive industries, now support Shenzhen SEZ’s dynamic economy.

SEZ establishment and its purpose

Before 1978, China was an autarkic economy, in which foreign investment and operations were closed, except for Soviet Union assistance in the 1950s. Under the leadership of Deng Xiaoping, China opened its economy to foreign trade and investment in order to close the growing gaps between China’s technology and efficiency levels and those of the developed economies. After 30 years of communism and complete state control of the economy, China designated four SEZs as laboratories for its experiments with market economy and foreign investment. These were Shenzhen SEZ (next to Hong Kong), Zhuhai SEZ (next to Macau), Xiamen SEZ and Shantou SEZ (these last two across the Taiwan Strait opposite Taiwan). The rationale behind the establishment of these zones was that if foreign participation in the industrialization programme were to be applied immediately to the economy as a whole, conflict with existing political, economic and social systems would probably emerge. Therefore, the openness was confined at first to the designated SEZs.

Following the experience of other countries, the goal of establishing SEZs in China was to foster and stimulate economic development through attracting foreign investment, expanding exports, and technology imports. Of course, as a test of the “Open Door” policy, the success or failure of SEZs would have important policy implications for further economic liberalization of China.

Technology transfer through Foreign Direct Investment

Shenzhen SEZ was, in the early stages, a technologically backward zone lacking in capital with only limited access to international markets. In the short-term therefore, production and managerial know-how and capital had to be imported. The attraction of overseas capital and technology was accorded a high priority in the Shenzhen SEZ.

In 1979, the incentive package devised for the SEZs was announced for Shenzhen, Zhuhai and Shantou SEZs (Liu 1986). The fundamental incentive system was designed to attract foreign direct investment (FDI) via the following measures (along and Chu 1985; Oborne 1986; Lin 1997): streamlined administrative control; relative independence for local planning authorities; direct access to provincial and central level planning units; access to tax breaks; free or low duties on imported equipment and production materials; free or low-rent business accommodation; flexibility in hiring and firing workers; depreciation allowances; negotiated limited access to the domestic Chinese market for goods produced within SEZs; and residence and work permits and income tax exemptions for foreigners working within the SEZs.12 All SEZs were treated equally under the incentive scheme.

By the end of 1998, more than US$12 billion in FDI had flowed into the Shenzhen SEZ. Regional percentage shares of the national FDI total since 1979 are shown in Table 3. Interestingly, through the 1980s and 1990s, FDI was concentrated in the 11 so-called opened coastal provinces (OCPs). Of total FDI inflows to China during the 1994-98 period, their share of FDI has remained about 82 per cent. Shenzhen SEZ has consistently been the leading destination. In almost all years under investigation, its FDI intake was no less than that of any single province or municipality in China, including Shanghai and Beijing.

The success of Shenzhen SEZ in attracting FDI is a result of the following factors:

(1) Low-cost labour surplus. Agricultural reforms have released the underlying labour surplus in the Chinese countryside. The wage of the average Chinese worker, even in Shenzhen SEZ is about one-tenth that of the average Hong Kong worker.

(2) Preferential treatment for FDI. SEZs have preferential treatment for FDI, including a better incentive package to attract foreign capital than other Asian regions (along and Chu 1985; Liu 1986).

(3) Geographical proximity to Hong Kong. The global city of Hong Kong has been a major source of FDI. Hong Kong and Shenzhen also have similar cultural background and common language, so mutual communication is very convenient and transport cost is low, even more than with Zhuhai (next to Macao).

In sum, attracting overseas capital was relatively easy in Shenzhen SEZ because of its geographical advantage and preferential terms for FDI.13 However, it is important to note that technological capability is not the automatic by-product of FDI (Bell and Pavitt 1992, 1995). Acquisition of technological capability is complex and time consuming, and sometimes it is necessary for the public sectors to act as collective risk-taker in up-grading technological capability (Mathews 1999).

ACQUISITION OF TECHNOLOGICAL CAPABILITY WITHIN SHENZHEN SEZ

The acquisition of technological capability through FDI in Shenzhen SEZ can be discussed as a process that moves through three stages: a formative stage, a labourintensive stage and a technology-intensive stage. This provides a platform for discussion of the technological enhancement process.

Stage 1: Formative stage of the Shenzhen SEZ

In 1981, as Table 4 shows, during the early stages of development, more than twothirds (67.8 per cent) of FDI in Shenzhen went to tourism and real estate development and only 16.3 per cent to manufacturing activity. Tourism and real estate development were initially more successful than manufacturing in attracting overseas capital to Shenzhen SEZ because of inadequate infrastructure (such as unreliable supplies of electricity and water, and a lack of housing and communication links). Investment in manufacturing also requires a large capital outlay and a longer period of return on investment (ROI) which involves an inherent risk, whereas in real estate development the period of return is shorter and profit margins are higher. FDI in tourist industries can be explained by the relative ease with which such investment is recouped, given that tourism caters exclusively for overseas visitors in possession of hard foreign currencies (along and Chu 1985; Changyu 1994). A third factor in the relative scarcity of manufacturing FDI was a lack of adequate institutional framework.

After the Shenzhen SEZ authority realized this problem, massive investments were made in infrastructure development. 14 Up until August 1982, over US$265 million was spent for such purposes in the Shenzhen SEZ, with overseas investors contributing about one-third. In particular, most high-rise housing in Shenzhen was built by Hong Kong construction companies.” In the meantime, a lack of efficient administrative, legal and financial systems had also deterred many potential investors from undertaking large-scale manufacturing investments. They preferred to wait and see how things developed before committing themselves. Then, the Shenzhen SEZ authorities reformed the structure of government and issued some legal regulations, and worked hard to improve the infrastructure and cut down bureaucracy in Shenzhen in order to interact smoothly with foreign investors and attract more FDI.

In summary, while industrial growth was originally to be top priority, with industrial production forming the basis of the zone’s economy, it was not possible to fulfil this objective during the formative stage of Shenzhen SEZ due to the lack of welldeveloped energy, transportation and telecommunications systems.

Stage 2: Labour-intensive stage of development

At the end of 1982, Shenzhen SEZ issued guidelines regarding the sectors in which FDI should focus, sending a clear “signal” to foreign investors. Since then, with the help of ever-improving economic infrastructure and business-friendly government, the number of investment projects in the manufacturing industry began to increase. Initially, most foreign direct investors in manufacturing came from Hong Kong. The average investment for each manufacturing project was small and mainly involved labour-intensive manufacturing activities in mature industries (SBSZ 1985; Sit and Wong 1988).

The following factors may explain this. At that time, Hong Kong was readjusting its industrial set-up due to rises in labour and land costs. In the meantime, China had a lot of semi-skilled and unskilled low paid labour in the countryside. Lots of potential complementarities existed between the two partners. Shenzhen SEZ was lacking technological and marketing capability and funds, but Hong Kong had sufficient funds and technological capability in a number of industrial areas. The Qishan furniture factory established in 1985 under the arrangement of co-operative production between Hong Kong and Shenzhen SEZ provides a good example of this. Initially, the partners were not equal in status. The Hong Kong party, as the dominant partner, provided the capital, equipment, management skills and technology, and was responsible for sales products in Hong Kong. The Shenzhen SEZ partner provided the labour and land in exchange for learning opportunity. Through two years of co-operation, as the Shenzhen partner gained experience and skills, they established an equity joint venture.

The Shenzhen SEZ government, in order to channel the necessary technology and capital to manufacturing, had devised four flexible and practical forms of foreign financial participation in projects: joint venture; co-operation production; wholly foreign-owned companies; and other direct investment. FDI flows came into Shenzhen SEZ mainly through three kinds of vehicles: wholly owned subsidiaries, joint ventures and co-operative firms, as shown in Table 5.

Within the category of foreign investment, there is also the category “other direct investment”, with a distinct operating mechanism: it usually includes processing and assembly, compensation trade and international leasing, shown in Table 6. In the category “other direct investment”, the most common is “processing and assembly”. Table 6 demonstrates that at the setting-up stage between 1979 and 1984, in addition to “foreign direct investment”, “processing and assembly” also played an important role for firms of Shenzhen SEZ with less technological capability and capital. In some respects, it was an appropriate entry strategy. For example, Konka Group was the No. 1 manufacturer of colour TV sets in China in 1999. It evolved from a co-operative arrangement between Shenzhen and Hong Kong under the category of “processing and assembly”. Under this arrangement, Konka learned necessary production skills and accumulated capital through assembling tape recorders for international orders. Just one year later, Konka established a joint venture with the same Hong Kong partner and began to assemble colour TV sets in 1984. For firms of Shenzhen SEZ, lacking in capital and technology, “processing, assembly and compensation trade” is a suitable choice at the setting-up stage.

During the period 1980-90, more than 90 per cent of “processing and assembly and compensation trade” partners came from Hong Kong (Nan 1995). At this stage, the key industries were the labour-intensive processing light industries such as clothing, toys, shoes, packing and bicycles. Cheap labour combined with guaranteed production capability only involved minor technological adaptation capability. Output increased for the domestic Chinese market and the overseas export market. In the overseas market, the competitive advantage was the low cost. In the domestic Chinese market, advantage was based upon product novelty (overseas product design and fashion) and quality (compared to other enterprises in other Chinese regions, supported by more advanced technology, equipment and better quality control). Those firms within Shenzhen SEZ generally supplied the domestic middle class with goods that would not have been realistic a decade ago.

In this latter process, enterprises needed to acquire technological adaptive capability in order to succeed in the domestic Chinese market. They needed the capabilities to achieve the following kinds of activity: change the product in accordance with local market conditions; adapt product and/or process to take account of special features of local raw material supplies; adapt the process to local physical conditions (climate, temperature, etc.); modify the process to take account of domestic Chinese market size; and adapt process technology to take account of different relative prices of factors of production.

While Hong Kong firms came mostly to use Shenzhen SEZ’s low-cost labour as a manufacturing base to export or for sales in the domestic Chinese market, the Shenzhen SEZ had an incentive to welcome them in order to gain access to foreign capital and technology. The ability of FDI to perform successfully in large domestic Chinese and export markets, however, was dependent upon how effectively they could transfer their technological capability. Technological learning in “processing and assembly and compensation trade” enterprises was significant. Seventy per cent of these enterprises were technologically upgraded to various extents (Lu 1993). Through the learning process, “processing and assembly and compensation trade” enterprises accumulated the necessary production experience and improved the production capability significantly. They have now accumulated manufacturing experience to the extent of being able to design their products, make samples and manage production inside China.

During this development stage, the government performed three critical roles, encompassing the formulation of a development plan, the development of a strategy for channelling FDI, and providing for a constant supply of labour.

Formulation of a development plan of Shenzhen SEZ. Although the newly established Shenzhen SEZ government preferred factories that used advanced technology, this emphasis on technological capability acquisition reflects a concern with promoting its long-term development. Incentives were provided for foreign investors with advanced technologies. However, the inadequate supply of local technicians, engineers and other technologically ancillary facilities was a major impediment to their establishment.

In fact, initially, Shenzhen SEZ aimed at attracting “high-technology” transfers, and began to allow firms that were willing to transfer high technologies special sales access to the domestic Chinese market. Without defining the term carefully and given low starting technological capability in Shenzhen SEZ, “high-technology” transfer was impossible. The government then took a flexible and pragmatic attitude. Government revised the incentive packages in 1984 and dropped the word “high technology” from the text, and granted incentives to firms within labour-intensive industries, that merely transferred some “technology” which was needed and was in accordance with the absorptive capability in the area.

Specific FDI strategy. This referred to as “Liangtou zaiwai” (placing two heads outside). This means relying on the outside world for both input supplies (new “hardware”, “disembodied technology” and capital) and market outlets. China had been cut off for so long from the outside world that there was an obvious lack of knowledge of Western consumer tastes, which made exporting difficult. Hong Kong firms did much to alleviate this. This strategy was easy to implement at low risk. Chinese partners thus needed to ensure not only that their Hong Kong partner had access to capital, but also that they could market the output and help with production (Lu 1993). Between 1988 and 1994, Konka Group not only sold products in the domestic market under their own brand name, but also exported products to other countries under the brand name of foreign companies provided by vendors.

Competitive position in the labour-intensive industries. Shenzhen SEZ was originally a small town with a relatively small population. The chronic problem in the labour-intensive stages of development was the maintenance of an adequate supply of labour. Shenzhen SEZ government set up a special company, the Labour Services Company, which provided manufacturers with candidate employees in order to keep the competitiveness in the labour-intensive industries. Most of the workers were brought into the Shenzhen SEZ by this company. This resulted in migration from other Chinese regions to Shenzhen, and the population of Shenzhen SEZ experienced a dramatic growth over ten years (Parry 1992).

Stage 3: Technology-intensive stage of development

Towards the end of the 1980s, the Shenzhen SEZ authorities began to define their development objectives more clearly, and to formulate policies in greater detail to attract foreign investment. They also shifted back their focus to technological-intensive industries, by way of response to two main changes in the local economic situation.

(i) Cost of land. The phenomenal rise in the price of land and rents in Shenzhen SEZ (Guynne 1993). Shenzhen was no longer a suitable place to focus on labourintensive manufacturing activities (The Economist 1995). The costs of land and labour in the Shenzhen SEZ, though still low compared to Hong Kong and other East Asian tigers, had risen over the years. Land prices in the SEZ were several times those found in inland China, and rising labour costs had damaged competitiveness. Faced with increasing costs, many companies based in Shenzhen SEZ were beginning to relocate to other parts of China.

(ii) Competition from inland China. Encouraged by the success stories in attracting foreign investment, many municipalities in China had sought to by-pass central regulations by taking steps to offer potential overseas investors additional benefits such as concessions on land rentals, labour charges and other local levies. Such preferential treatment often outweighed the benefits Shenzhen SEZ could offer (Zhang 1994). The nearly exclusive preferential status-trade and investment incentives once unique to the Shenzhen SEZ had now spread to other parts of the country. Shenzhen SF.Z’s labour-intensive products faced stiff competition from inland China. For example, Huizhou city, which had no industry in the late 1970s, produced 40 per cent of China’s telephones in 1993 and posed a serious challenge to manufacturers of telephones within Shenzhen SEZ.

The Shenzhen SEZ government realized that the two trends constituted a serious threat to the further development of Shenzhen SEZ, and that the SEZ was at a structural turning point. The municipal government acknowledged that technological capability played an important role in the process of industrialization (tall 1992) and could help Shenzhen SEZ shift from a stage of very rapid labour-intensive growth into a technology-intensive stage. As a response to the challenges, the municipal government gradually shifted their policy priorities to technology-intensive industries and issued a number of policies such as the: “science and technology development plan”, the “strategy of science and technology development”, the “high and new technologybased industries development plan”, and so on (STBSZ 1995, 1998). The introduction of technology-intensive production units was being encouraged under a deliberate policy, including such measures as the following.

1. Special allowances and incentives

The extension of tax holidays for technologically advanced ventures, and priorities in obtaining the services of public utilities and various other concessions. All joint ventures and wholly foreign enterprises received the right to exchange foreign exchange among themselves, and were subject to simpler export and export licensing procedures. In China, more attractive incentives such as tax exemption are given to foreign investment projects which are qualified as “technologically advanced” in order to encourage them to transfer their technologies to China (Xie and Wu 1997). For technologically advanced enterprises established in Shenzhen SEZ, central government also accommodated foreign investors’ interests by allowing technologically selected joint ventures to target the domestic Chinese market. FDI also played an important role in this stage, 80 per cent of enterprises engaged in high-technology industries are joint ventures. Contrary to prior practice, most leading-edge technology now comes from developed countries, rather than from Hong Kong. Between 1992 and 1999, more than 100 multinationals invested in at least 200 projects under various arrangements. Some of these were first rank companies, including Dupont, DEC, Emerson, Compaq, HP, Xerox, Intel and IBM from the United States; Toppan Printing, Nichmen, Hitachi, Sanyo, Mitsui, Ricoh, Mitsubishi, National, Dai Nichmen and Komatu from Japan; Samsung Electronics from Korea; and Philips, Siemens and ABB from Europe. The result was an inexorable shift towards higher value-adding activities. 16

2. Tecbnological infrastructure support

(i) Quality support services. Shenzhen Quality Assurance Centre was established in 1992, funded by Shenzhen Technology Monitoring Bureau. Its services help manufacturers build quality into their design, management and production.

(ii) Productivity enhancement services. The government started to fund the Shenzhen productivity promotion centre to maintain a wide range of productivity enhancement services, including laboratory facilities, specialized training courses, and a variety of consultancies.

(iii) Information services. The Shenzhen Science and Technology Bureau established the Technology Market Centre in 1993. The purpose of the centre is to present the information of new technology for industrial firms, and promote the diffusion of new technology. In addition to the centre, The Shenzhen Institute of Science and Technology Information also plays a similar role in innovation process and technology acquisition.

(iv) Protecting intellectual property. With the source of imported technologies and foreign investors changing, a concern of companies transferring technologies to Shenzhen SEZ is the loss of intellectual property. In order to encourage the transfer of more technologies to Shenzhen SEZ via FDI, and to motivate technological innovation, Shenzhen SEZ government has taken numerous steps to protect intellectual property. First, it enacted laws and regulations, including “Protection regulations on the enterprises’ know-how (1995)”, “Regulations on the methods of rewarding R&D persons in enterprises (1993)”, “Regular methods of evaluation of intangible assets in Shenzhen SEZ (1994)”, and so on (STBSZ 1995, 1998). Second, the government is making considerable efforts to bring intellectual copyright violation under control, including the imposition of severe penalties on offenders.

The influx of engineers and scientists from inland China and abroad has transformed Shenzhen into a high-tech centre. Notably, partly benefiting from the directives and incentives provided by Shenzhen SEZ’s government, remarkable transformation is taking place in China’s telecommunication industry, in which Shenzhen Huawei Technology Co. Ltd and Shenzhen Zhongxing Telecommunication Co. Ltd, located in Shenzhen SEZ, play an important role.

China’s market for telecom equipment is the second largest in the world, following United States. With its huge market potential, there are at least 16 large multinational firms making and selling telecom equipment in China, such as Siemens, Lucent, NEC, Alcatel and Fujitsu. In 1995, local equipment makers had less than 10 per cent of the Chinese market, and supplied cheap and low capacity gear to the rural market. In 1997 and 1998, the rise of Huawei and other local firms represented a challenge for the multinationals. With fierce competition, prices for switches in China are now about 80 per cent of the price for comparable equipment elsewhere. This difference arises from good research of low-cost highly educated labour, rather than from lower manufacturing cost, because most multinationals also have production and distribution networks in China. For example, in order to shift into high-end, high-value-added segments of the market, Huawei made huge efforts to employ lots of engineers, whose average salary was about one-seventh that of the average employees in multinationals, and in 1996 established the largest in-house R&D centre of China’s telecom industry. Based on the improved own product design competencies, by 1998 Huawei had 70 per cent of the market for broadband access networks, which were specially designed to fit customers’ requirements in China.

FACTORS IN THE SUCCESS OF SHENZHEN SEZ

The success story of Shenzhen SEZ over the past two decades has important implications for the role that SEZs may play in other countries. The Shenzhen case reveals that SEZs may have a positive impact not only in small economies, like Taiwan, but also large continental economies such as China (Litwack and Yingyi 1998). Moreover, Shenzhen SEZ’s growth experience has shed some new light on the question of why some SEZs may experience spurts of economic growth but be unable to sustain them.

Tecbnological upgrading

“Processing and assembly and compensation trade” played an important role in the acquisition of technological capability. At the outset, Shenzhen SEZ was a technologically backward region. At the same time, Chinese universities and research institutes were not sufficiently equipped to supply adequate technology, hindered by past lack of contact with the outside world (Mangrove 1994). Through the development stages of Shenzhen SEZ, we have observed that most industrial technologies were transferred from overseas via FDI. Among the different forms of FDI, “processing and assembly and compensation trade” played the dominant role, especially in the labour-intensive stage. Through “processing and assembly and compensation trade”, Shenzhen SEZ could not only attract foreign capital at low risk, but also acquire the technological capability from overseas, including management know-how.” “Processing and assembly and compensation trade” acted as a training school for the transformation of the Shenzhen SEZ industry, steering it onto the path of effective and efficient production. Building upon the integration of the accumulated experiences with “processing and assembly and compensation trade” manufacturing, these enterprises then began to diversify their product offerings and to follow the rapidly evolving technological trajectories of these industries. Although it arose from the arrangement of “processing, assembly and compensation trade”, Konka Group then established a joint venture with a Hong Kong partner. Today, the main products of Konka include colour TVs, washing machines, refrigerators, air conditioners and mobile phones. Konka has established joint ventures in four countries: Mexico, Indonesia, Russia and India. Last year, Konka marketed 25,000 TV sets in the United States, accounting for 1 per cent market share in USA. Most significantly, Konka Group now can develop and produce HDTV, and won the “Innovation 2000 Award” for its innovative products at the 2000 Las Vegas Electronics Fair.

The Mayor of Shenzhen SEZ” confirmed this view on the role of “processing and assembly and compensation trade” when he stated that to some extent, “processing and assembly and compensation trade’s role in the acquisition of technological capabilities in Shenzhen SEZ is similar to the role played by OEM manufacture in Korea”.

In comparison with other domestic regions in China, Shenzhen SEZ now has a higher technological capability and as such it constitutes a world-class competitive region in the world economy. High-technology industry accounted for very nearly 40 per cent of Shenzhen SEZ’s industrial output in 1998. Although export growth fell to 3 per cent in 1998, Shenzhen SEZ has continued to lead China in exports for the sixth year in a row, representing 15 per cent of the country’s total exports. Some scholars believe that based upon its industrial capacity and acquired technological capability, Shenzhen SEZ will keep its competitive position in China and the world, even after its preferential policies have been phased out by the end of 2003, as is presently required.

A unique learning model

Acquisition of technological capability in developing countries is an important research area, but few models focus on the regional level. In this paper, the author has tried to describe the process of technology evolution in Shenzhen SEZ, as shown in Table 7. This analysis of Shenzhen SEZ’s experience can assist us in forming a better understanding of the acquisition of technological capability at the regional level. Possible lessons may include the following.

Infrastructure enhancement. As a backward region, during the formative stage, infrastructure building and institutional framework formation is necessary, otherwise it will be difficult to form an industrial base and attract foreign investment.

Building on resources. Based on the achievement realized in the formative stage, development should then be based upon the advantages offered by the Special Economic Zone, such as land, labour, including its geographical advantages. At this stage, labour-intensive activities may be suitable. FDI with low technological capability can also be helpful, not only because it helps to accumulate capital and acquire some technological capability, but also because it is in harmony with the technological capability level of the zone. Acquisition of technological capability in labour-intensive and mature industries may be the necessary prelude to enter technology-intensive industry

Shift towards higher value-adding activities. Because of the rising cost of production factories (land, labour, etc.), and competition from other low-cost regions, manufacturing must gradually shift into technology-intensive industries.

Compared to other models of acquisition of technological capability, for example in Korea, Shenzhen SEZ’s model has four key characteristics.

(1) Inward and outward market orientation. In the development process, its market is both inward- and outward-oriented, never completely depending on only one of them. The large size of the domestic Chinese market played a key role in the upgrading of the industries in Shenzhen SEZ. Export-oriented manufacturing did help the transformation, but it did not play a dominant role in acquisition of technological capabilities. Instead, export orientation combined with active promotion of the domestic Chinese market served to simultaneously create incentives and opportunity for enterprises to develop and acquire technological capabilities. This may limit the applicability of the Shenzhen SEZ model to only other large developing countries with growing domestic market.

(2) Labour-intensive phase for competitive advantage. Shenzhen exploited its low labour costs as a development strategy. In the labour-intensive stage, most of its technologies and capital source came from Hong Kong;19 a new industrial region, not a developed region. In the technology-intensive stage, developed countries begin to play an important role. Most leading edge technologies came from developed countries, not from Hong Kong, because Hong Kong’s technological development even lags well behind that of Taiwan, Korea and Singapore. Shenzhen is shifting from the stages of exporting labour-intensive products to one in which technology and knowledge-intensive products dominate. In technology-intensive industries, Hong Kong’s technological capability is limited, and it lacks R&D and manufacturing capabilities as engines of growth (Mingrove 1994; Amsden 1997). In this respect, Shenzhen may leapfrog Hong Kong. Facing the challenge posed by the Shenzhen SEZ, Hong Kong is also looking to tap the mainland Chinese labour and academic pool to help it develop higher levels of technology.zo

(3) FDI as capital source. FDI has been the most significant source of the acquisition of technological capability in Shenzhen, whereas in Korea, licensing and equipment purchase ranks first (Kim 1997).

(4) Clear guidance from government. Throughout the process of development, there has been guidance and the setting of goals by municipal and other levels of government. This has been of help in the acquisition of technological capability, but the government’s role must change according to different stages of development (Amsden 1989; Kim and Dahlman 1992). Shenzhen SEZs experience demonstrates that the government can help and speed up the acquisition of technological capability in manufacturing, if its focus is shifted in a timely manner. Because Shenzhen SEZ was bigger and perhaps more backward than SEZs in other Asian countries, most foreign capital was channelled into infrastructure building in the formative stage. The government had to devise different forms of FDI in order to attract foreign capital, and help to find a suitable labour source nationwide in order to keep its competitive position in the labour-intensive stage and to take advantage of the massive labour source in inland regions. The government had to make a timely response to the changes in the local economic situation, and gradually shifted their policy focus to technology-intensive industries. At some appropriate times, the government has had to pay particular attention to the building of technology infrastructure in order to lower the risk and cost of development of enterprise’s technological change.

Of course, in the different stages, the government devised and implemented the tax and duty privileges for FDI. On this point, there exists a major difference between Shenzhen SEZ and other developing countries. Some literature has come to the conclusion that investment in human capital and in technological knowledge is a crucial condition for economic growth (Lall 1985, 1990; Pack and Westphal 1986; Dahlman et al. 1987; Katz 1987; Enos 1991; Bell and Pavitt 1992). In Shenzhen SEZ, however, the government played less attention to this aspect, because there existed a large sum of low-cost and high-quality human capital in inland China.

FDI effects

Shenzhen SEZ has depended for its success on its massive inflow of FDI. Table 8 shows that FDI’s contribution to total fixed asset investment in Shenzhen SEZ is, in most cases, much greater than other regions in China. This is linked to its geographical proximity to a rapidly developing region. This provided numerous advantages, including learning from other experiences and benefiting from technology spill-over across boundaries. Shenzhen enjoyed a relatively cheap and abundant labour supply, supported by a labour surplus from the Chinese countryside.

SEZs of other countries which are generally believed to have been successful, share the characteristics identified above, including Gaoxiong, Nanze and Taizhong of Taiwan and Masan EPZ of South Korea. Some of them are not geographically near a rapidly growing region, but located in a coastal region where port facilities are available.

In some respects, Shenzhen SEZ has realized transformation from the labourintensive stage to the technology-intensive stage. The commodity structure of products within Shenzhen SEZ is becoming more and more physically and human capital intensive. At the labour-intensive stage, Shenzhen SEZ maintained strong comparative advantages, mostly from low-cost and unskilled or semi-skilled labour. By contrast, at the technology-intensive stage, comparative advantages come from low-cost highly educated labour and well-developed technology infrastructure.

By contrast, the other SEZs, even if they initially enjoyed spurts of economic growth, did not sustain them. This is because they did not realize the timely transformation into the technology-intensive stage. For example, at present in Taiwan, the fast-moving area is Hsinchu industrial park, not the former three EPZs.

Moreover, the question of what factors promote the transformation is worthy of discussion. The experience of Shenzhen SEZ supports the following two propositions.

(i) With targeted and deliberate policies, the government can help speed up the acquisition of technological capability.

(ii) Special policy treatments for a SEZ are aimed at stimulating economic development, not creating a monopolistic status of the SEZ within an economy. After setting up SEZs in an economy, there must exist competition between SEZs and other regions. Competition reduces profits, creating financial pressures that induce technological learning, promote economizing behaviour, and stimulating the structural transformation of a SEZ economy.

China has taken a “gradualistic” approach to the market economy, the transition strategy has relied on the creation of market competition through deregulation and the entry of new domestic producers. With regard to SEZs, four SEZs were established in 1979. Five years later, in 1984, 14 coastal cities were designated as “open cities” for foreign investors. In 1987, Hainan Island was created as the fifth SEZ. In 1991, the Pu Dong of Shanghai was set up as a special zone with more preferential treatments than Shenzhen SEZ (MacDonald 1999). Therefore, over the past 20 years, Shenzhen SEZ, as the most successful zone of China, was always facing fierce competition from other zones and regions within China and abroad, and its comparative advantage from preferential policies was relatively eroding. In this respect, the experience of the Shenzhen SEZ suggests that the tax and duty privileges of firms in SEZs should be deliberately and gradually curtailed in order to stimulate technological learning and structural transformation in a timely fashion,21 not to create the monopolistic status of firms within SEZ which will constrain learning and innovation. In short, economic growth does not necessarily lead to structural transformation in a SEZ. Rapid growth, technological learning and the absorption of new technology combined can alter relative factor endowments in a SEZ, which in turn changes the prices of the factors of production as well as those of basic and intermediate inputs. Thus the SEZ contributes to, and is in turn affected by, the process of development within a country.

1 I would like to express my thanks to Professor Christian DeBresson for his early guidance and constant interest during the research, and Mr Liu Jun for data collection. I am also indebted to Professor Mathews, an anonymous referee and my colleagues for helpful advice and comments, and Elizabeth Thurbon for her time and patience to edit this paper. Finally, I am thankful to the Xiao Linshi Research Fund of the School of Economics and Management of Tsinghua University and NSF of China, which funded much of the research for the paper (NSF Research Project Reference: 79900005). The author takes sole responsibility for the views expressed in this paper.

2 An export processing zone (EPZ) is generally considered to be like the “free ports” established in the nineteenth century by Britain (Mathews 1999). along and Chu (1985) define SEZs as the latest development of the concept of free trade zones and EPZs. UNCTAD (1994) holds that EPZs are one of the most popular forms of SEZs for attracting FDI. While there do exist some differences between EPZs and SEZs, conditions under which SEZs and EPZs operate are generally depicted as quite similar in the literature. In the field of SEZs studies, researchers generally employ an interpretation of a SEZ that is broader than common use of the term. Sometimes it applies to any geographical area that receives one of two particular types of special policy treatments in the areas of taxation and investment. Sometimes the terms SEZ and EPZ are used interchangeably. The greatest difference between EPZs and SEZs is that, EPZs are usually located in countries with a market economy, whereas SEZs are typically found in an economy transition from planned economy to market economy (along and Chu 1985). For convenience, in most cases, the term SEZ is used throughout this paper.

3 For example, Professor Amartya Sen delivered a lecture entitled “What we can learn from China: thoughts from Shenzhen SEZ” at the Delhi School of Economics in November 1999.

4 The question of SEZs has drawn much attention in Russia in recent years. A few selected regions such as Kaliningrad, Nakhodka and Ingushetiia, have gained temporary status as special zones, with preferential tax treatment for foreign trade and investment. In August 1998, the Russian government established the town of Zelenograd as a SEZ to encourage high-tech investment. India recently planned to set up another six SEZs in the coastal regions.

5 Kasliwal (1998) argued that among the EPZs set up worldwide, one of the most successful examples is the entire province of Guangdong, including Shenzhen SEZ. Economic data on Shenzhen SEZ also include those of the two rural districts, Baoan and Longgang. Shenzhen SEZ has been recognized by the Chinese government as an important model of rapid economic growth and economic reforms in the transition from a centrally planned to a market-based economy.

6 There exist differences between EPZs in other Asian countries and the SEZs of China. For instance, Shenzhen SEZ is the largest in scale among EPZs of other Asian countries. Secondly, in other Asian EPZs, foreign investments are usually confined to manufacturing, but economic activities in the Shenzhen SEZ are much more comprehensive, embracing not only manufacturing but also agriculture, tourism, commerce and real estate development (along and Chu 1985).

7 I am grateful to the referee’s helpful advice and comments on this point.

8 In terms of the utilization of foreign direct investment (FDI), export growth, employment generation, domestic linkages and regional development (Fitting 1982; along and Chu 1985; Oborne 1986).

9 For a critique of balanced and unbalanced growth see Nafziger (1990: 86-89).

10 See for example Bell (1984), Dahlman et al. (1987), Enos and Pack (1987), Katz (1987), Amsden (1989), Enos (1991), Bell and Pavitt (1992), Kim Linsu and Dahlman (1992), Kim Linsu (1997), Mathews (1999), and Mathews and Cho (1999).

11 Shenzhen Municipal Government, formerly named Baoan county, is about 2,020 square kilometres.

12 This incentive package has been evolving over the past two decades, for the most part by lowering taxes and extending duty free status to new categories of articles imported into the SEZs. For example, the preferential treatment was originally granted for a five-year period, and later extended to 10 years.

13 Compared with other long-established EPZs in other Asian countries, Shenzhen SEZ offers two new incentives: one is more preferential treatment such as reduced land utility costs and longer tax exemptions. The other is to accommodate foreign investors’ interests by allowing selected FDI to target the Chinese domestic market (Shenzhen Special Zone Daily 24 January 1983).

14 Sit and Wong’s (1988) survey shows that transport and electricity are the major difficulties encountered by the Hong Kong partners.

15 Shenzhen Special Zone Daily 24 December 1982.

16 Parry visited most of the factories located in the Shenzhen SEZ, driven by the government directives and by competitive pressure, found that: “a number of Chinese firms are shifting from cost-driven emphasis on price to an emphasis on upgrading product quality and incorporating state-of-art technology into their products” (Parry 1992).

17 Recent work on technology has highlighted the fact that there exist large differences in total factor productivity between plants in different countries using the same production techniques, and also between firms in the same country (Pack 1987).

18 Sbenzben Special Zone Daily 16 June 1998.

19 With the help of Hong Kong in providing market information and channeling foreign trade, Shenzhen was able to make fantastic progress in exporting. Most of Shenzhen EPZ’s exports go through Hong Kong. For more details on this see Nan (1995).

20 industrial and technological upgrading within Hong Kong has slackened off over the last ten years, due largely to the spread of Hong Kong manufacturing capability into the south of China in search of low-cost manufacturing (Mathews 1999).

21 In 1995-97, there existed a controversy in China over whether or not the privileges of SEZs should be cut. The debate has now reached a final conclusion: since January 1999, China began to eliminate preferential tax treatment for SEZs, but at present, preferential tax policies in SEZs of Shenzhen, Zhuhai, Shantou and Xiamen remain unchanged. Their preferential policies will be phased out by the end of 2003 (East Asian Executive Reports 15 September 1998).

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Xie Wei is a Lecturer of the School of Economics and Management, Tsinghua University, China. He received the BS degree in automotive engineering and the PhD in management in 1989 and 1999, respectively. His research interests include strategic management, technology transfer and innovation and industrial development. He has authored and co-authored more than 20 papers in China and abroad.

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