Industrial Development through Tacit Knowledge Seeding: Evidence from the Bangladesh Garment Industry

Transcription

1 Tact Knowledge Seedng Industral Development through Tact Knowledge Seedng: Evdence from the Bangladesh Garment Industry Romel Mostafa 1 and Steven Klepper 2 Runnng Head: Tact Knowledge Seedng November 2009 Acknowledgements: We thank Lee Branstetter, Bart Hamlton, Bll Keech, Anne Mare Knott, Jackson Nckerson, Lamar Perce, Myles Shaver, Jordan Segel, Francsco Veloso, Todd Zenger, and semnar partcpants of Carnege Mellon Unversty and Washngton Unversty n St. Lous for ther helpful comments. Ths research undertakng would not have been feasble wthout the knd cooperaton receved from about 1,000 entrepreneurs, employees, supplers and buyers of the Bangladesh garment ndustry and the ndustry assocaton, BGMEA. Mostafa gratefully acknowledges a dssertaton fellowshp from the Kauffman Foundaton. 1 The Oln Busness School, Washngton Unversty n St. Lous, mostafa@wustl.edu 2 The Department of Socal and Decson Scences, Carnege Mellon Unversty, sk3f@andrew.cmu.edu

2 Tact Knowledge Seedng Abstract When vtal producton knowledge s tact and cannot be generated ndgenously, entrepreneurs n developng countres have to rely on nternatonal transfer of the knowledge through on-the-job tranng. Once the ntal seedng of tact knowledge occurs, mechansms naturally arse n the local economy to propagate the knowledge and seed new frms. A model of the propagaton process s developed and ts mplcatons are tested on two hstorcal epsodes of the Bangladesh garment ndustry. Emprcal fndngs support the model s predctons, ndcatng tact knowledge seedng was essental for the ntal establshment and subsequent expanson of the ndustry. Keywords: Entrepreneurshp, Industry Development, On-the-job Tranng, Tact Knowledge Spllover JEL Classfcaton: L22, L67, M13, O14, O17, P33

3 Introducton It has been observed that a few narrowly defned products account for the bulk of the exports of developng countres, but these products vary greatly between countres wth smlar factor endowments (Hausmann and Rodrk, 2003; Schott, 2004). Consder, for example, Bangladesh and Pakstan, whch share a common hstory, rank smlarly n the Human Development Index, and are laborabundant. Ther prmary exports are garments and ther largest foregn market s the US. In 2008, out of 246 garment products, the top 10 products exported to the US from Bangladesh and Pakstan accounted for 70% and 83% of ther total US garment exports respectvely. Accordng to the theory of comparatve advantage, countres lke Bangladesh and Pakstan would be expected to export smlar products. However, Bangladesh producers had neglgble exports n fve of the top 10 garment products exported from Pakstan and Pakstan producers had neglgble exports n sx of the top 10 products exported from Bangladesh. What factors explan such heterogenety n products exported and what mplcatons do they have for ndustralzaton? Rhee and Belot (1990) studed 10 hghly successful export ndustres n 11 developng countres. 3 They found that n each case the ndustry was jump-started by a sngle frm that ntated exports on a large scale. They traced the success of the poneerng frms to the tranng of the frms workers by a foregn frm or agent. 4 In all but one nstance, the success of the poneer galvanzed entry nto the ndustry, whch played a key role n the expanson of the ndustry and ts ultmate success. An obvous explanaton for the narrow export specaltes of developng countres s that such catalysts are few and far between. But what exactly s the mechansm by whch catalysts work that mght explan why they are few and far between? Hausmann and Rodrk (2003) provde an explanaton for why catalysts are rare. They argue that entrepreneurs have to experment and dscover what a country s good at producng, but once revealed, successes are readly observed and mtated by other entrepreneurs. Snce the process of selfdscovery nvolves consderable cost uncertantes and mtaton lmts the returns to the dscoverer, prvate ncentve to experment and dversfy the ndustral base s lmted. Self-dscovery becomes a 3 The 11 cases are: garments n Bangladesh, plywood n Indonesa, flowers n Colomba, unforms n Zamba, condments n Honduras, damonds n Inda, sem-processed cocoa n Cote d'ivore, garments n Jamaca, shoes n Guatemala, software n Hungary, and arcraft n Brazl. 4 On-the-job tranng by foregn agents has been argued to be crucal n the development of ndustres n other countres, such as supplers of textle machnery n Tawan (Rans and Schves, 1985) and garments n Maurtus (Romer, 1993).

4 - 2 - random event and when t occurs, mtaton leads to explosve growth, resultng n narrow specalzaton of exports. An alternatve vew s that nstead of expermentaton, entrepreneurs n developng countres need to access organzatonal knowledge generated n ndustralzed countres n order to be compettve nternatonally n ndustres n whch they have the potental to enjoy some comparatve advantage (e.g. Krugman, 1979; Grossman and Helpman, 1991). 5 Whle knowledge s often consdered to be a publc good, we propose that n the typcal ndustry some vtal knowledge related to producton s tact and therefore entrepreneurs n developng countres cannot smply mtate the products manufactured n countres wth successful frms. To access the relevant tact knowledge, a domestc frm has to receve extensve on-the-job tranng by a foregn frm. The success of the poneerng frm then s not based on expermentaton but on the voluntary plantng of a seed by a foregn frm that provdes the key tact knowledge. If the formaton of the poneerng frm effectvely reveals a country s nnate advantage n an ndustry then mtaton could occur at a dstance, wthout any drect transfer of knowledge from the poneerng frm to other entrants. But f the transmsson of tact knowledge va on-the-job tranng s essental for the poneerng frm to be successful, t would be expected that comparable mechansms would be requred for other entrants to be compettve. The growth of the ndustry then wll be catalyzed not by mtaton but by the mechansms that allow the propagaton of tact knowledge from the poneerng frm to new frms. The producton of technologcally unrelated products s expected to requre dfferent tact knowledge. Hence, further seedng through nternatonal transfer of knowledge would be needed to dversfy the ndustral base. We test ths concepton of the development process based on the evoluton of the Bangladesh garment ndustry. Wth annual exports of $12 bllon n 2008, the ndustry today s one of the leadng nternatonal supplers of apparel. But before the formaton of Desh Garments n 1978, only a handful of Bangladesh frms struggled to export garments. Key to Desh s success was a techncal partnershp t forged at ts outset wth a South Korean frm, Daewoo, to tran 126 of ts workers n Korea for sx months. After Desh prospered, numerous frms entered the ndustry. By 1988 there were 664 garment producers and today there are over 4,000 factores exportng varous garment products to all major nternatonal markets. We contend that key to the explosve growth of the ndustry was knowledgeable workers leavng Desh and then other successful frms to set up the producton of later entrants. These 5 For a revew of the lterature nvestgatng the relatonshp between technology and trade, see Grossman and Helpman (1995) and between technology and growth, see Fagerberg (1994).

5 - 3 - workers organzed assembly-lne producton processes, traned workers, and supervsed producton, effectvely dffusng key tact knowledge to new garment producers. We develop a smple model of the market for these workers that yelds hypotheses concernng the types of frms that hred them and the effects of hrng the workers on the frms performance. We test these hypotheses usng data on the early entrants nto the Bangladesh garment ndustry. Annual lsts of producers provded by an ndustry trade assocaton were used to dentfy all the entrants through The backgrounds of the entrants were traced through extensve feldwork, whch also turned up an assocaton of the ntal Desh workers traned at Daewoo. The bulk of these workers were stll lvng and were ntervewed, whch made t possble to reconstruct whch of the workers left Desh to set up producton at subsequent entrants. We were also able to comple smlar nformaton for another frm, Bond Garments, whch also had many workers leave to set up producton of entrants. We use these data and data on frm exports, number of employees, and number of machnes as of 1995 (the frst year for whch such data were avalable) to test the mplcatons of the model. We also explot data for a successful early frm that subcontracted producton to many other frms to assess the role of subcontractng n dffusng key tact knowledge. Later the garment ndustry expanded nto sweaters through a partnershp between a foregn frm and a new domestc producer, smlar to Desh. We were able to assemble data on workers that left the poneerng frm to set up producton of subsequent sweater entrants to test whether the dffuson of crtcal tact knowledge through worker moblty repeated tself. The mplcatons of our theory depart from those of the theory of self-dscovery n two mportant ways. Frst, n our framework development s not lmted by the lack of entrepreneural expermentaton but by the lack of seeds n ndustres n whch a country potentally has a comparatve advantage. Second, the growth of the ndustry followng an ntal seed s not based on mtaton per se but on transfer of tact knowledge through employee moblty. Smlar to Hausmann and Rodrk (2003), though, the process of development s rfe wth externaltes. The seedng of the ntal poneerng frm jump-starts an entre ndustry, and the spllover of knowledge through workers settng up producton at entrants allows the ntal seed to flower. Prvate ncentves to plant the ntal seed are nherently lmted, makng the experence of the Bangladesh garment ndustry a rare event. Bangladesh has always been plagued by numerous problems, ncludng lmted lteracy, hgh corrupton, and weak nsttutons. Wrtng pror to the establshment of the garment ndustry, Faaland and Parknson (1976) characterzed Bangladesh as the world s most dffcult problem of economc development, and f the problem of Bangladesh could be solved, there can be reasonable confdence

6 - 4 - that less dffcult problems of development can also be solved. Our fndngs suggest that part of the soluton nvolves the seedng of an ntal domestc frm wth knowledge from a foregn producer. Despte all of ts problems, subsequent mechansms arose n Bangladesh to dffuse the transferred knowledge, whch provdes some encouragement that the explosve growth of the garment ndustry mght be replcated n other ndustres and countres wthout a complete re-engneerng of ther economes. Whether n fact the lessons of the Bangladesh garment ndustry apply elsewhere reman to be studed, but the frst step s determnng exactly what these lessons are. The paper s organzed as follows. Secton 2 provdes hstorcal background on Bangladesh and ts garment ndustry. Secton 3 outlnes the model. Secton 4 summarzes the data collecton methods and provdes some descrptve statstcs. Secton 5 presents the fndngs, whch are dscussed n Secton Background of Bangladesh and ts Garment Industry 6 In 1971, the people of what was then known as East Pakstan ganed ther ndependence after a nne-month bloody war that clamed three mllon lves and left the nfrastructure of the naton severely battered. The new country, Bangladesh, natonalzed the few major ndustres t had and adopted an mport-substtuton strategy. Whle subsequent regmes gradually lberalzed the economy, only after 1991 dd Bangladesh serously embark on relaxng trade polces (Rana, 1997). The country s effort to establsh good governance was almost non-exstent. Bangladesh has been characterzed as a poltcally unstable naton where corrupton s rampant, government nterventon n the economy s frequent, and the enforcement of property rghts s weak. 7 Remarkably, Bangladesh has sustaned steady growth snce 1980, when ts per capta GDP (PPP) was only $601. In the next 25 years ts per capta GDP (PPP) grew by an average of 5% per annum to $1,997, puttng Bangladesh on the verge of relnqushng ts status as a Less Developed Country (LDC). Fgure 1 shows that a major mpetus to the underlyng economc growth was the rse n exports. The share of exports as a percentage of GDP rose from 5% n 1980 to 13% n Ths growth was fueled by one ndustry, garments, whch currently accounts for 78% of the country s total exports. In 1978 only a handful of garment producers used a prmtve producton system n whch ether all or a large number 6 The hstorcal descrpton of the ndustry s based on feldwork that was conducted between June 2006 and September A detaled dscusson of the ndustry s provded n Mostafa (2009). 7 Bangladesh ranks poorly on perceved corrupton by Transparency Internatonal and on nsttutonal ndcators by The Hertage Foundaton.

7 - 5 - of operatons of makng garments were carred out by talors usng outdated machnes. Today the ndustry has more than 4,000 factores usng sophstcated assembly-lne methods of producton. In 2006, Bangladesh was the thrd and sxth largest exporter of garments to the EU and US respectvely. The modern garment ndustry was effectvely started by Desh Garments (Quddus and Rashd, 2000). Desh ntroduced assembly-lne manufacturng of garments, whch paved the way for mass producton and mproved qualty. Desh learned how to conduct an assembly-lne process from Daewoo, a leadng South Korean garment producer. Daewoo s garment export growth was on the declne due to rsng domestc wages and quotas mposed by governments n major markets. Daewoo was reluctant to nvest n Bangladesh, but was wllng to tran Desh s workers and market ts products n exchange for a share of Desh s export sales Fgure 1 somewhere here As part of the partnershp, Desh sent 126 of ts ntal workers to Daewoo s state-of-the-art faclty n Pusan, Korea. Of those 126 Desh workers, 10 held upper management postons, 17 were lne chefs, and the other 99 consttuted the workforce. Almost all the recruts had no pror experence n garments but most of them had at least a hgh school degree. Tranees receved on-the-job tranng n Daewoo s actual export producton lnes. Then, under the supervson of ther Korean traners, Desh workers set up assembly-lnes at Daewoo s faclty ntally to produce unforms for Daewoo s workers and subsequently to execute some of Daewoo s export orders. Toward the end of ther tranng, Desh workers were able to produce at an mpressve rate of about three shrts per mnute from a sngle producton lne. Upon ther return, the Desh workers along wth a few techncans from Daewoo set up Desh s factory n Chttagong. When the constructon of the factory was complete n 1980, Desh had the largest garment factory n Bangladesh wth 450 machnes and 500 workers. It ntally exported men s shrts and subsequently dversfed nto other woven tems, such as trousers and women s blouses. On June 30, 1980, Desh termnated the contract wth Daewoo, but t contnued to perform strongly. By the fscal year , Desh s total exports reached $5.28 mllon, regsterng a 91.7% average annual growth snce ts frst export n By 1984 when the total number of frms n the ndustry had shot up to 294, about 75% of the 126 orgnal Desh workers had left Desh. Many of the workers were hred away by other entrants to help set up ther factores and head producton. They were nvolved n nstallng machnes, settng up

8 - 6 - assembly lnes, and recrutng and tranng workers. By 1988, 59 new frms had hred Desh workers to help set up ther factores. Some of the workers traned by Desh techncans later were nvolved n tranng workers of other frms. For example, Bond Garments, whch hred a couple of Desh workers to head ts producton durng ts formatve years, became very successful and by 1988 many of ts ntal workers had left to set up factores for other entrepreneurs. To attract Desh and Bond workers, entrepreneurs offered salares that were multples of what the workers earned at Desh or Bond. Salary data dsclosed by some of these workers ndcate that entrepreneurs were wllng to pay a hgher premum for Desh than Bond workers, suggestng that the former were the preferred choce n settng up factores. Daewoo s nvolvement and the subsequent success of Desh attracted nternatonal buyers to Bangladesh. They were reluctant, however, to place orders n factores that dd not have sound producton managers. Early on, there were more entrants than qualfed domestc workers avalable to set up producton of new factores. Some entrants hred foregn techncans to set up producton, although ths dd not generally work smoothly. Language barrers often made t dffcult to communcate wth foregn techncans. Furthermore, foregn techncans requred hgh salares and perks to compensate for extended stays away from ther cultures, and they dd not always perform as expected. Such challenges were less pronounced when entrepreneurs hred domestc techncans from dstngushed frms. Intally, there were no alled ndustres to support garment exports. Producers had to rely on mported machnes, fabrcs, and accessores. Garment entrepreneurs pressed the government to mplement three polces to help the ndustry: duty-free mportaton of machnes, bonded warehouses, and back-to-back credt facltes. Bonded warehouses allowed garment manufacturers to mport fabrc and accessores wthout payng dutes, whle back-to-back credt facltes provded the workng captal to procure mported nputs. 8 Beyond those three polces, the government of Bangladesh dd not ad the ndustry n any sgnfcant way. Infrastructural support n the country was weak. Almost all factores sprang out around two busy ctes, Dhaka, the captal where Bond was located, and Chttagong, the port cty where Desh was located. Many entrepreneurs rented floors and turned them nto factory shops. These factores suffered from acute shortages of electrcty and gas. Communcaton lnks were poor and congeston at ports 8 Interestngly, smlar types of polces were also n place n countres lke South Korea and Tawan. Rhee (1986) ponts out that Desh and Daewoo played an mportant role n formulatng these polces n Bangladesh.

9 - 7 - common. Procedures for obtanng mport-export and busness lcenses were complcated and entrepreneurs had to brbe offcals to obtan the necessary documents. Establshed frms that were behnd schedule resorted to subcontractors to meet ther export deadlnes. Durng the ndustry s formatve years, qute a few hgh performng frms, ncludng Bond, Mohammad, and Stylecraft, were nvolved n employng new frms as subcontractors. Establshed n 1983, Stylecraft hred a Desh worker to head ts producton and between 1983 and 1988 employed 20 entrants as subcontractors and provded them wth extensve tranng. The ndustry attracted entrepreneurs from all walks of lfe. Intally a large number of small busness owners entered the garment ndustry by quttng ther prevous busnesses. Some entrepreneurs who had larger busnesses, such as constructon and transportaton frms, dversfed nto garments. Many professonals, ncludng lawyers, retred mltary personnel, teachers, doctors, poltcans, and even a few fresh college graduates who had access to famly money also jumped on the bandwagon. Influenced by Desh and Daewoo, Bangladesh manufacturers ntally produced shrts and related woven products for the US market. Startng n 1986, the US started mposng quota restrctons on garment products manufactured from Bangladesh and frms began to dversfy nto the European market, whch was not under any quota restrctons. A few years after the mposton of quotas n the US market, exports of kntwear and sweater products took off. To manufacture products n these new ndustry segments, frms requred producton processes dfferent from the technology avalable n the woven segment. The expanson of the new segments was led by entrants that had no pror woven manufacturng experence. 9 A key event n the sweater segment of the ndustry was the establshment of Cheung Heung Sweater Bangladesh n Cheung Heung was formed as a jont venture between a local entrepreneur and a Chnese marketer that had been sourcng woven products from Bangladesh and had nternatonal clents that were eager to buy sweaters too. The Chnese partner provded mported machnes and brought a team of about 30 foregn techncans to set up Cheung Heung s factory n Dhaka. Wth 1,045 machnes, t was then the largest sweater factory n Bangladesh. It took about a year to hre 2,800 workers and brng the sweater factory to full capacty. Lke Daewoo, the Chnese marketer dd the entre marketng for the jont venture and then a few years later a dsagreement led to the Bangladesh entrepreneur assumng 100% ownershp of the company. Subsequently, the frm s domestc workers began to assume greater responsblty n the frm and were hred away to set up producton of 9 For a dscusson of the development of the kntwear segment see Mostafa (2009).

10 - 8 - other sweater entrants. As of 1994, 25 of the 52 frms that establshed sweater factores had hred experenced workers from Cheung Heung to head ther producton. 3. Theory of the Dffuson of the Intal Seed The man contenton of the paper s that the ntal seedng of tact knowledge by Daewoo through the creaton of Desh was essental to get the garment ndustry gong n Bangladesh. Pror to the formaton of Desh, the productvty of garment producers was such that they could not compete nternatonally.e., the profts of potental Bangladesh entrants nto garments was less than the earnngs they could generate n alternatve endeavors. Ths all changed wth the partnershp between Desh and Daewoo. Desh was able to attan a level of productvty that made t compettve nternatonally and enabled t to become a successful exporter of garments. In turn, workers at Desh learned about how to set up and manage garment producton n order to be compettve nternatonally, whch made these workers valuable to entrants that wanted to establsh ther own garment factores. The purpose of ths secton s to model the market for such knowledgeable workers to derve a few testable propostons f ndeed the emergence of such a market was key to growth of the garment ndustry followng the formaton of Desh. The alternatve hypothess s that the establshment of Desh demonstrated Bangladesh s nnate advantage n garments, enablng entrepreneurs to mtate Desh wthout the need for any transfer of knowledge. In that case, mechansms that allow for the nter-frm transfer of tact knowledge would not be expected to affect frm performance. Research on tact knowledge suggests that t s dffcult to artculate, formalze, and communcate (Polany, 1962). Snce the knowledge becomes embedded wthn the worker s sklls, abltes, and ntuton, ts nter-frm dffuson requres ndvduals possessng the knowledge to physcally move to new organzatons and transmt ther knowledge through on-the-job tranng (Wnter, 1987). Wthn a new organzaton, the dffuson of tact knowledge s consdered a gradual process of dssemnaton (Szulansk, 1996) and ts successful transfer requres the experenced transmtter to tran workers at the recpent organzaton. By hrng an experenced techncan from a successful frm to set up ts factory, an entrant could effectvely access the tact knowledge. Intally, Desh was the man source of domestc workers that were capable of settng up factores for other entrants. The knowledge transferred by hrng Desh workers to set up factores s called prmary dffuson. Once an entrant accesses the tact knowledge through prmary dffuson, the knowledge becomes embedded n workers of the new frm, whch over tme become another source of transmtters

11 - 9 - of tact knowledge. The knowledge transferred by hrng workers from such a source to help set up factores s called secondary dffuson. We wll focus n partcular on one such frm, Bond Garments, that tself ntally hred a couple of Desh workers to oversee ts producton and then served as the source for a number of workers that helped set up producton of other frms. Frms that become successful by accessng tact knowledge va prmary or secondary dffuson can transfer ths knowledge to entrants by hrng them as subcontractors. Frms have a vested nterest n tranng ther subcontractors to produce export qualty goods on ther behalf n order to complete ther export orders. We wll focus on one such frm, Stylecraft, whch hred a Desh worker to set up ts factory and later was actvely nvolved n employng entrants as subcontractors. We analyze the performance of Stylecraft s subcontractors to gan nsght nto the role of subcontractng n dffusng tact knowledge to entrants. A more drect way by whch tact knowledge emboded n workers can dffuse to new entrants s by those workers foundng ther own garment frms, whch we call ntra-ndustry spnoffs. 10 Captal markets were neffcent n Bangladesh, and sklled techncans had lmted opportunty to seek outsde fnancng. Therefore, spnoffs were not a promnent source of entrants durng the early stage of the ndustry and are not featured n our analyss. 11 Accordng to our feldwork, the contrbuton of foregn techncans n transmttng tact knowledge to entrants was lmted and so ths mechansm s also not featured n our theoretcal model but s analyzed n the emprcal secton. 3.1 Basc Model Set-up We frst consder the process of prmary and secondary dffuson. We assume that frms can hre three types of local workers to set up and oversee ther producton: Desh (D) and Bond (B) workers and Other (O) workers from varous sources. Suppose that on ts own a frm s producton functon s of the Cobb-Douglas form: Q = γ L α K β, where Q s the output of frm, L and K are the amount of labor and captal employed by frm, γ s the nnate productvty of frm, and α + β < 1, so that producton s subject to decreasng returns to scale. Furthermore, suppose that a frm can hre a qualfed worker from Desh, Bond, or elsewhere to ncrease ts productvty by an amount θ j to γ + θ j, where the ncrease from hrng a worker from Desh, denoted as θ D, s greater than the ncrease from 10 See Klepper (2001) for a revew of the lterature on spnoffs. 11 For a detaled analyss of spnoffs durng the later stage of the evoluton of the ndustry when they were more prevalent, see Mostafa (2009). He provdes suggestve evdence that over tme some of the early Desh workers accumulated suffcent assets to start ther own ventures.

12 hrng a worker from Bond, whch s denoted as θ B, whch n turn s greater than the ncrease from hrng an Other techncan, whch s denoted as θ O. Ths orderng of workers corresponds to the premums that were typcally pad to workers to set up and oversee producton at entrants: Desh workers commanded the hghest premums, followed by Bond workers and then workers from other frms. Our analyss focuses on the determnaton of the premums pad to these workers and on the frms that hred them to set up and oversee ther producton. We assume that frms dffered n terms of ther nnate productvty γ based on ther backgrounds. Some frms dversfed from other ndustres, addng garments to ther product lne. We assume that ceters parbus, these frms had greater productvty than the average new frm by dnt of ther pror organzatonal experence and greater access to complementary assets (Teece, 1986). Among new frms, we assume that those that were founded by ndvduals wth experence workng n other garment frms.e., ntra-ndustry spnoffs had greater productvty than other new frms wth nexperenced founders. Last, we assume that the educaton of the founder of the frm also condtoned the frm s productvty, wth those headed by college graduates, and especally ones wth an engneerng degree, havng greater productvty. We model the market for workers that could set up and oversee producton at new frms at each tme t. Let the number of entrants at tme t wth the requste productvty to be compettve nternatonally f they hred a qualfed Desh, Bond, or Other worker to set up ther producton be denoted as T P. We assume that the number of qualfed set-up workers from Desh, denoted as T D, and the number of qualfed set-up workers from Bond, denoted as T B, are such that T D + T B < T P, so that not all entrants could hre Desh or Bond workers to set up ther producton. To smplfy, we assume that the number of Other set-up workers T O s such that T O + T D + T B > T P, so that all frms could hre some type of worker to help set up ther producton. 3.2 Market Equlbrum Our analyss focuses on the premums that are pad by entrants to have ther producton set up by Desh and Bond workers and the frms that hre these workers at each tme t. Let PR j be the premum at tme t pad to workers from frm j = D, B, or O that are qualfed to set up and oversee the producton of entrants. The premum pad to set-up workers from frm j s assumed to be greater than the wage they receve at frm j, reflectng that set-up knowledge s not valuable to already establshed frms. The market for set-up workers was new durng the early evoluton of the ndustry and partcpants

13 presumably had lmted ablty to antcpate how the market would evolve over tme. Accordngly, we assume that at tme t entrants made decsons about hrng set-up workers based on the premums pad to these workers at tme t and the expected effect of hrng them on ther proftablty at entry, choosng to hre the set-up worker that maxmzed ther profts at entry net of the premum pad to the worker. Analogously, we assume that at tme t qualfed set-up workers made employment decsons based on the premums offered for ther set-up servces at tme t. Consder frst the gross profts earned by hrng set-up workers from frm j = D, B, or O gven by α β Π = ( γ + θ j) L K Px wl rk, where Px s the prce of the product, w s the wage of labor, and r s the cost of captal. We assume that Px s determned n the world market and Bangladesh producers take P as gven. Dfferentatng wth respect to x the optmal amount of labor and captal: L and K and solvng the frst-order condtons yelds L α( γ + θ j s = w * ) β P X 1 1 α β and K 1 1 α β γ θ α β + 1 * ( j ) s PX =, w where wβ s = s the techncal rate of substtuton between K and rα expressons for Q and L. Substtutng * L and Π yelds the optmal levels of output and gross proft as functons of * K n the γ and θ j : Q *, θ j j ) 1 α β = ( γ + θ Z and 1 *, j j 1 1 α β Π θ = ( γ + θ ) M, 1 α β α Px where Z s w β α+ β 1 α β α β 1 α β and M β α + s Px ( α β) w 1 1 > 0. The maxmum amount a frm would be wllng to pay to hre a Desh set-up worker relatve to a Bond set-up worker s the dfference between the frm s gross profts from hrng a Desh and Bond setup worker. Lkewse, the maxmum amount t would pay for a Bond versus Other set-up worker s the dfference between ts gross profts from hrng these respectve workers. Fgure 2 presents three curves that plot frm gross profts from hrng a Desh, Bond, and Other set-up worker as a functon of the frm s nnate productvty, γ. Dfferentatng the proft functon wth respect to γ yelds: * δ Π α+ β, θ j 1 = 1 ( θ j + γ α β ) M > 0. δγ 1 α β Snce θ > θ B > θ O t follows that D

14 * * δπ, θ δπ D, θ δ Π B θ > > γ γ γ *, O. Ths s reflected n Fgure 2 by the steeper slope of the gross proft functon from hrng a Desh than Bond set-up worker, whch n turn s steeper than the gross proft functon from hrng an Other set-up worker. Hence the dfference n gross proft from hrng a Desh versus Bond set-up worker and a Bond versus Other set-up worker s an ncreasng functon of the frm s nnate productvty. 12 Therefore, the greater a frm s nnate productvty then the greater amount t wll pay for a Desh versus a Bond set-up worker and a Bond versus an Other set-up worker. Consder the premums pad to Desh and Bond set-up workers. The most productve frms are wllng to pay the most for a Desh versus Bond set-up worker and so the T D frms wth the greatest productvty hre a Desh set-up worker. The margnal frm must be ndfferent between hrng a Desh and Bond worker n order for the market for these workers to clear. In Fgure 2, the productvty of ths frm s denoted byγ. Therefore, the dfference n the premums pad to a Desh and Bond worker, (PR D - D PR B ), must equal the dfference n the gross profts from hrng a Desh and Bond set-up worker for the margnal frm. An entrant wth an nnate productvty γ such that γ D < γ wll hre a Desh set-up worker snce the extra gross proft earned by hrng a Desh set-up worker mnus the premum for a Desh set-up worker s greater than the extra gross proft earned by hrng a Bond set-up worker mnus the premum pad for a Bond set-up worker Fgure 2 somewhere here The dfference n the premums for Bond and Other set-up workers, (PR B -PR o ), can be derved smlarly. It s determned by the margnal frm wth productvty γ as llustrated n Fgure 2. Frms wth nnate productvty γ such that γ B < γ B γ D earn greater profts net of the premum for the set-up worker by hrng a Bond versus Other worker. The frm wth productvty γ B s ndfferent between hrng a Bond and Other set-up worker and all those wth productvty less than γ B hre an Other set-up worker. 12 Ths reflects that frms that are more productve produce a larger level of output and thus beneft more from any 2 * gven boost n ther productvty, whch follows drectly from δ Π 2α+ 2β 1, θ j 1 = θ 1 α β 2 j + γ M > 0. δθ δγ 1 α β j ( ) ( )

15 We posted that dversfers and ntra-ndustry spnoffs have more valuable pre-entry experence, provdng them wth greater nnate productvty than other entrants. Furthermore, we conjectured that a frm s productvty would also be determned by the educaton of ts founder. Wth the most productve frms hrng Desh set-up workers and the next most productve Bond set-up workers, ths mples: Hypothess 1: Dversfers and ntra-ndustry spnoffs and frms wth more educated founders were most lkely to hre Desh set-up workers followed by Bond set-up workers. 1 *, θ j θ γ 1 α β The frm s output s gven by Q ( j ) = + Z. Snce * Q, θ j γ > 0 and γ s related to the frm s pre-entry experence and the educaton of ts founder, t follows that: Hypothess 2: Controllng for the productvty of workers hred to set up producton, the output of producers s greater for dversfers and ntra-ndustry spnoffs and those wth more educated founders. * δq α+ β 1 = + 1 α βz > 0 andθ D > θ B > θ O, t readly follows that δθ 1 α β, θ j Snce ( θ j γ ) j * * Q, θ > Q D, θ > B * Q, θ O, whch mples: Hypothess 3: Controllng for frm pre-entry experence and the educaton of founders, frms hrng Desh set-up workers have a larger output than frms hrng Bond set-up workers, whch n turn have a larger output than frms hrng Other set-up workers. 3.3 Dffuson of Tact Knowledge through Subcontractng Suppose a potental entrant had suffcently low nnate productvty that t could not proftably enter even f t hred a qualfed worker to help set up ts producton. Nonetheless, t mght be proftable for the frm to enter as a subcontractor f t expected to receve tranng that would ncrease suffcently ts productvty. Suppose that whle t s a subcontractor, ts output s less than the average output of exporters, but f ts tranng as a subcontractor s suffcently good then ts productvty would rse to the level of the average exporter, n whch case ts output would be equal to that of the average exporter. Furthermore, suppose that entrants cannot dstngush a pror the qualty of the tranng they wll be provded by a frm for whch they work as a subcontractor. Assumng that the sze of a subcontractor s (future) output s less than that of an average exporter f t does not receve good tranng as a subcontractor, t follows that:

16 Hypothess 4a: At a later date, the expected output of frms that begn as subcontractors s less than the expected output of frms that begn as exporters. The better a frm s as a traner, the greater the probablty that ts subcontractors wll become exporters and thus the greater the expected future exports of ts subcontractors. However, on average the best subcontractors wll do s to produce as large an output as exporters. Therefore: Hypothess 4b: Entrants that receve better tranng through subcontractng have greater future output, but on average entrants that begn as subcontractors wll have exports less than or equal to the exports of frms that began as exporters. Stylecraft was a successful frm that ntally hred a Desh worker to help set up ts factory and then later extensvely used subcontractors to produce ts output. Because t reled heavly on subcontractors, t devoted a lot of effort to tranngs ts subcontractors. Consequently, based on Hypothess 4b t would be expected that ts subcontractors would later have greater exports than other frms that began as subcontractors but no greater exports than frms that began as exporters. 3.4 Probablty of a Worker Beng Hred to Set up an Entrant Not all workers at Desh, Bond, or elsewhere n any gven perod t would be qualfed to set up producton at other frms. Suppose that workers have to acqure suffcent set-up sklls to be qualfed to set up the producton of entrants. Assume that the set-up sklls of workers depend on ther nnate ablty and ther work experence. Intally, suppose that there are two levels of workers hgh and low ablty workers. The average set-up ablty of hgh ablty workers s greater than that of the low ablty workers. Suppose that as they gan experence over tme, all workers mprove ther set-up sklls, wth hgh and low ablty workers mprovng ther set-up sklls at the same rate. Assumng that eventually workers attan suffcent set-up sklls to be able to set up the producton of entrants, t follows that: Hypothess 5: At every pont n tme, the fracton of workers settng up producton at entrants s hgher for hgh than low ablty workers and over tme the fracton of workers at each level that are hred to set up producton at entrants rses.

17 Data Collecton Strategy and Summary Statstcs We test the mplcatons of our theoretcal model on two epsodes of the ndustry. The frst epsode spans the early evoluton of the ndustry through 1988, whch s 10 years after the establshment of Desh. The second epsode nvolves the expanson of the ndustry nto sweaters, whch was spurred by the formaton of Cheung Heung, and covers the eght years after the establshment of Cheung Heung through For each epsode we dentfed all the entrants and ther year of entry and collected nformaton on the backgrounds of ther entrepreneurs (.e., founders), key workers they hred to set up ther factores, and whether the entrants started producton as exporters or subcontractors. We also constructed measures of frm performance based on frm data on exports, employees, and machnes. Data were assembled from three sources: Bangladesh Garment Manufacturers and Exporters Assocaton (BGMEA), the man assocaton of the ndustry; ntervews of entrepreneurs and key workers; and thrd party sources, such as employees, supplers, and buyers. 4.1 Archval Data and Membershp Catalogs Data from BGMEA were used to dentfy all entrants n the ndustry through 1988 and ther year of entry. Startng n 1990, BGMEA publshed yearly catalogs that reported all factores n the ndustry, the name of ther managng drectors, ther locaton, and type of products they produced, and snce 1995 the number of machnes and number of employees used n producton. BGMEA also provded data on annual exports begnnng n 1995 for each factory n Dhaka, whch consttute about 85% of all factores n the ndustry. Usng the product nformaton n the annual catalogs and our ndustry sources, all frms that entered the sweater segment through 1994 and ther year of entry were dentfed. 13 All data from BGMEA are at the factory level. Factores were grouped nto frms usng nformaton collected from ntervews of founders and ndustry veterans, by matchng founder names and addresses n the drectory, and usng sem-annual BGMEA electon voter lsts, whch contaned pctures and names of entrepreneurs along wth names of ther factores. Although the catalogs report all exstng and new factores establshed n a year, they usually do not drop nactve factores as long as entrepreneurs contnue to pay ther nomnal membershp fees. Consequently, years of survval s not a relable measure of frm performance. Instead, we use exports, 13 Pror to 1990 when catalogs were not publshed, there were very few sweater factores n the ndustry and these were well known and are ncluded n our sample.

18 number of employees, and number of machnes n the frst year they were avalable, 1995, as alternatve measures of performance Feld Data To collect nformaton on the backgrounds of frms, an extensve on-ste feld study was carred out between June 2006 and August Intally, a few entrepreneurs were approached to carry out a plot study, whch helped refne the ntervew questons. Cell phone numbers of about 1,000 entrepreneurs were collected from varous sources. Intally a phone call was made to explan the purpose of the research. Intervews were carred out on ste or by phone, whchever the entrepreneur preferred. Intervews usually lasted between mnutes and entrepreneurs were asked a seres of questons to elct nformaton on the factores they owned, ther educaton and pre-entry experence (ncludng f the entrant dversfed nto garments from other busnesses), the key workers they hred to set up ther factores, the type of work they ntally carred out (whether they worked as subcontractors or exporters), and so on. Usng phone and on-ste ntervews, only 21.9% of the early entrepreneurs agreed to be ntervewed. Furthermore, even those that agreed to be ntervewed were unwllng to talk about who they hred to head producton n ther factores. Consequently, an alternatve approach was pursued to collect data. A few knowledgeable early entrepreneurs and employees n the ndustry were asked to provde nformaton on the backgrounds of early entrants. In partcular, we were nterested n whether entrants were dversfers or spnoffs and the level of educaton of ther founders, all of whch were expected to nfluence ther performance. We also wanted to dentfy frms wth foregn nvestors or that employed foregn techncans to set up ther producton to gauge the extent to whch such sources could substtute for acqurng knowledge by hrng domestc workers to set up producton. Dversfers, spnoffs, and frms wth foregn partners and/or techncans were well known to our nformants and were readly dentfed. In the end, we were able to dentfy the pre-entry experence and level of educaton of 71.1% and 58.9% of early founders respectvely. 15 Our nformants had much less knowledge about the ntal organzaton of frms and the type of work they carred out. Fortunately, the feldwork revealed another way to collect ths nformaton. The ntal Desh workers traned n Korea formed an assocaton that publshed a drectory of ts members n Usng ths drectory, 88 of the 126 Desh workers traned In Korea were contacted and ntervewed. 14 The reported number of employees and machnes for frms that do not produce but contnue to pay ther membershp fees s lkely to overstate ther sze and so has to be used carefully. 15 Informaton on an entrepreneur from at least two dfferent sources was obtaned and cross-checked.

19 They provded nformaton about ther educaton, the tranng they receved n Korea, and ther subsequent careers outsde Desh, ncludng the frms they helped set up and the backgrounds of the entrepreneurs that hred them. They also provded smlar nformaton on the bulk of ther peers who were deceased or could not be found. We ntally ntervewed a few Bond workers and collected contact nformaton for other Bond workers, who were also ntervewed. In total the work hstores of 33 of the 55 ntal Bond workers were traced, ncludng the frms they helped set up. Informaton on whether an entrant began producton as a subcontractor or an exporter was collected through ntervews of the founders and workers who set up factores. Detaled nformaton on the subcontractors of Stylecraft was obtaned from an ndvdual who had worked n a hgh level poston n Stylecraft. A smlar strategy was employed to dentfy the pror experence and level of educaton for entrants n the sweater segment. We were able to collect ths nformaton for 90.4% and 92.3% of the entrants respectvely. Frms that hred Cheung Heung workers to help set up ther sweater factores were dentfed by a former senor manager who had helped place experenced Cheung Heung workers n other factores. These data were corroborated by two other ex-employees of Cheung Heung. 4.3 Summary Statstcs of Early Entrants Table 1 summarzes the data assembled for entrants through We classfy entrants nto four groups accordng to the pre-entry experence of ther founders: Dversfer (the frm dversfed nto garments from other busnesses); Spnoff (the entrepreneur prevously worked n the garment ndustry); Foregn Investor (the entrepreneur was of foregn orgn); and Inexperenced (the rest of the entrepreneurs). Each category s defned by a dummy varable that takes a value of 1 f the entrepreneur had the relevant pre-entry experence and 0 otherwse. The table ndcates that durng the early years of the ndustry there were few spnoffs and foregn nvestors but many dversfers. We have two measures of an entrepreneur s educaton: College, whch s equal to 1 f the entrepreneur had at least a college degree and 0 otherwse, and Engneer, whch s equal to 1 f the entrepreneur had an engneerng degree and 0 otherwse. About 62% of the entrepreneurs whose level of educaton could be dentfed had a college degree, whch s a much hgher percentage than n the country overall. Our two varables that dentfy prmary and secondary dffuson are Desh Set-up, whch s equal to 1 f the entrant hred a Desh worker to set up ts factory and 0 otherwse, and Bond Set-up, whch s equal to 1 f the entrant hred a Bond worker to set up ts factory and 0 otherwse. We also dentfed

20 entrants that hred foregn techncans to set up ther factores; the varable Foregn Techncan Set-up s equal to 1 f the entrant hred a foregn techncan and 0 otherwse. In the sample, 59, 18 and 69 entrants hred Desh, Bond and foregn workers, respectvely, to set up ther factores Table 1 somewhere here There are four dummy varables that characterze the type of ntal producton of entrants: Subcontractor s equal to 1 f the entrant started producton as a subcontractor and 0 otherwse; Subcontractor of Stylecraft s equal to 1 f the entrant started producton by subcontractng from Stylecraft and 0 otherwse; Exporter s equal to 1 f the entrant began producton by drectly servng foregn markets and 0 otherwse; and Intal Producton Unknown s equal to 1 f there s no nformaton on the frst producton of the entrant and 0 otherwse. For 25% of the entrants n our sample we were able to dentfy ther ntal type of producton. Among these frms, 105 began as subcontractors, ncludng 20 that were subcontractors of Stylecraft, and 55 began as exporters. Garment frms were located n two areas, Dhaka and Chttagong, and the varable Locaton s equal to 1 f the frm was located n Chttagong and 0 otherwse. Only 17.8% of the entrants were located n Chttagong. Table 1 also reports descrptve statstcs on frm Exports, Employees (number of employees) and Machnes (number of machnes) n Table 2 presents descrptve statstcs for all 52 sweater manufacturers that entered by Among the sweater entrepreneurs whose backgrounds we could dentfy, 38% and 73% dversfed from other busnesses and had a college degree, respectvely, suggestng that sweater entrepreneurs were more experenced than early entrepreneurs (for early entrants, these fgures were 24% and 62%, respectvely). The varable Ex-CH Set-up s equal to 1 f a factory was set up by a former employee of Cheung Heung and 0 otherwse and the varable Foregn Techncan Set-up s equal to 1 f a frm hred a foregn techncan to set up ts factory and 0 otherwse. Twenty-fve entrants hred Cheung Heung workers whle only eght hred foregn techncans to set up ther factores Table 2 somewhere here The varable Sweater Frst Factory s equal to 1 f the factory s the entrepreneur s frst n the garment ndustry and 0 otherwse. About 73% of the frms that entered n ths segment dd not prevously manufacture garments. Locaton agan equals 1 for frms located n Chttagong and 0

21 otherwse, wth seven entrants (13.5% of the sample) located n Chttagong. The value of exports, number of employees, and number of machnes are reported for sweaters only. For frms that dversfed from other garment products, these values were obtaned by accessng the factory level data, whch had nformaton on the product the factory produced. The data are not a random sample of frms. In partcular, nformaton obtaned from thrd party sources s lkely to be based towards better known frms. Fortunately, the backgrounds of a large fracton of entrepreneurs were dentfed. When they could not be dentfed, the varables Unknown Experence, whch equals 1 f the pre-entry experence of ther founders could not be dentfed and 0 otherwse, and Unknown Educaton, whch equals 1 f the level of educaton of the founder could not be dentfed and 0 otherwse, are ncluded n the analyss. 5. Results 5.1 Characterstcs of Early Entrepreneurs that Hred Desh and Bond Workers to Set up Ther Factores To nvestgate how the ndustry ntally developed, we frst examne whch early entrepreneurs hred Desh or Bond workers to set up ther factores. Accordng to hypothess 1, more experenced frms and entrepreneurs wth greater educaton would be expected to hre the most qualfed workers to set up ther producton, wth the most experenced frms and educated experenced entrepreneurs hrng Desh workers and the next most experenced frms and educated entrepreneurs hrng Bond workers. We test ths hypothess by estmatng separate Probt models for hrng a Desh set-up worker and a Bond set-up worker. In the equaton for hrng a Desh set-up worker, the explanatory varables nclude the pre-entry experence varables Dversfer, Spnoff and Foregn Investor, wth Inexperenced the omtted category, the two educaton varables College and Engneer, and Frm Age and Locaton. In the Probt model for hrng a Bond set-up worker the varables Spnoff and Foregn Investor were excluded along wth the observatons for these frms because no spnoff or frm wth a foregn nvestor hred a Bond set-up worker. Addtonally, no frm wth an unknown background or wth a founder whose educaton was unknown hred a Desh or Bond set-up worker; hence observatons for these frms had to be dropped, whch reduced the samples for analyzng hrng of Desh and Bond set-up workers to 384 and 348 respectvely. Desh entered before Bond and thus t was expected that older frms would be more lkely to hre Desh than Bond workers. Desh was located n Chttagong and Bond n Dhaka and so t was expected that frms located n Chttagong would be more lkely to hre Desh workers and frms located n Dhaka would be more lkely to hre Bond workers.

22 Table 3 provdes the coeffcent estmates for the Probt models, wth the frst column reportng results for hrng Desh workers and the second column for hrng Bond workers. Consstent wth hypothess 1, the coeffcent estmates of Dversfer and College are postve and sgnfcant for both types of workers, ndcatng that dversfers and frms wth more educated founders were more lkely to hre these workers to set up ther producton. As hypotheszed, the effects of both varables are larger for Desh than Bond workers: the predcted probabltes of hrng Desh and Bond set-up workers are 0.22 and 0.06 respectvely for dversfers and 0.15 and 0.05 respectvely for frms wth a college educated founder. In the Desh analyss, the coeffcent estmate of Spnoff s postve and Foregn Investor s negatve but nether estmate s sgnfcant. In both analyses, the coeffcent estmate of Engneer s negatve but not sgnfcant. The coeffcent estmates of Frm Age and Locaton are postve n the Desh equaton and negatve n the Bond equaton, wth all but the coeffcent estmate of Frm Age n the Bond equaton sgnfcant. Ths s consstent wth our conjecture that older frms and frms located n Chttagong were more lkely to hre Desh than Bond workers. 5.2 Prmary and Secondary Dffuson and Subcontractng Our model predcts that frm output s greater for dversfers and spnoffs and frms wth more educated founders (hypothess 2) and also for frms that hred Desh and Bond set-up workers, wth the Desh effect larger than the Bond effect (hypothess 3). We test these predctons usng exports n 1995 as our measure of frm output. Export data were only avalable for frms n Dhaka and so the sample s restrcted to the 546 entrants through 1988 that were located n Dhaka. Frst, a model was estmated wth the frm background varables Dversfer, Spnoff, Foregn Investor, College, and Engneer. The varables Unknown Experence and Unknown Educaton were also ncluded to allow for the possblty that frms whose backgrounds could not be dentfed were worse performers. Older frms had longer to grow and thus were expected to have greater exports n 1995, and so the varable Frm Age was ncluded as an explanatory varable. The dependent varable s censored at 0 and so Tobt estmaton s employed. The coeffcent estmates are presented n Table 4 under the column headed Model 1. The coeffcent estmates of Dversfer and Spnoff are postve and sgnfcant, as predcted. The coeffcent estmates of College and Engneer are both postve, wth the former sgnfcant, whch also conforms wth the predctons. The coeffcent estmate of Foregn Investor s postve but small and nsgnfcant, whch suggests that frms founded by foregners dd not fare better than domestc frms. The coeffcent

23 estmate of Frm Age s postve, as expected, but not sgnfcant and the coeffcent estmates of Unknown Experence and Unknown Educaton are negatve, as expected, although nether s sgnfcant. In model 2, we add the varables Desh Set-up and Bond Set-up to test whether frms that hred these workers had a larger output after controllng for ther backgrounds. We also nclude the varable Foregn Techncan Set-up. Consstent wth hypothess 3, the coeffcent estmates of Desh Set-up and Bond Set-up are both postve and sgnfcant, wth the coeffcent estmate of Desh Set-up sgnfcantly larger than the coeffcent estmate of Bond Set-up (F(2, 535)=19.15, p<0.00). The average exports of frms n 1995 were $3.2 mllon. The estmates mply that an entrant that hred a Desh worker or a Bond worker to set up ts factory receved a boost n ts 1995 exports of $12.9 Mllon and $6.4 Mllon respectvely relatve to frms that hred Other workers. The coeffcent estmate of Foregn Techncan Set-up s postve but small and nsgnfcant, whch s consstent wth our earler observaton that foregn techncans were not a partcularly useful source of tact knowledge Table 4 somewhere here Model 3 adds the varables pertanng to subcontractng, ncludng Subcontractor, Subcontractor of Stylecraft, and Intal Producton Unknown, wth frms that began as exporters the omtted category. Consstent wth hypothess 4a, the coeffcent of Subcontractor s negatve and sgnfcant, ndcatng that frms that began as subcontractors had lower exports n 1995 than frms that began as exporters. Consstent wth hypothess 4b, the coeffcent estmate of Subcontractor of Stylecraft s postve and sgnfcant, ndcatng that Stylecraft s subcontractors fared better than the average frm that began as a subcontractor. The coeffcent estmate of Subcontractor of Stylecraft plus the coeffcent estmate of Subcontractor s negatve but not sgnfcant, whch conforms wth hypothess 4b that even subcontractors of the best frms do not perform better than frms that begn as exporters. The coeffcent estmate of Intal Producton Unknown s negatve and sgnfcant and ts magntude s sgnfcantly greater than that of Subcontractor (F (2, 532) =9.67, p<0.00), ndcatng that frms for whch we were unable to dentfy ther type of ntal producton performed worst. The coeffcent estmates of Desh Set-up and Bond Set-up contnue to be postve, sgnfcant, and substantal. We were concerned that the coeffcent estmates of Desh Set-up and Bond Set-up n Models 2 and 3 mght be based upward and thus could overstate the effect of hrng Desh and Bond workers on frm output. The frm background varables crudely control for dfferences n frm productvty and snce frms wth greater productvty were more lkely to hre Desh and Bond set-up workers, part of the effect

24 of frm productvty on exports may be pcked up by the varables Desh Set-up and Bond Set-up. We can address ths for Desh Set-up by explotng the fact that frms n Chttagong were more lkely to hre Desh workers to set up ther producton. Assumng that the dstrbuton of nnate productvty of frms located n Chttagong was smlar to that of frms located elsewhere, we can use the varable Locaton as an nstrument for Desh Set-up to get a consstent estmate of the effect of Desh Set-up on frm performance. Snce we have no export data for frms located n Chttagong, we use Employees and Machnes n 1995 as our measures of frm performance. 16 We follow the nstrumental varable strategy outlned n Wooldrdge (2002). Frst, a Probt model for Desh Set-up as a functon of the same varables as n Table 3, ncludng Locaton, s estmated. Observatons wth unknown background and mssng data on employees/machnes had to be dropped, reducng the sample for analyzng Employees and Machnes to 256 and 274 frms respectvely. 17 Second, the predcted values from the Probt estmaton are used as nstruments n a lnear probablty model for Desh Set-up wth the same explanatory varables. Fnally, the predcted value of Desh Set-up from the lnear probablty model s used n leu of Desh Set-up n the Tobt model wth Employees and Machnes as the dependent varables and the same explanatory varables as n Table 4 excludng Unknown Experence and Unknown Educaton. Table 5 presents the man fndngs. The frst column of each panel reports the Tobt estmates of the full model wthout the nstrument for hrng Desh workers. The estmates broadly replcate prevous analyses on exports of Dhaka frms. The coeffcent of Spnoff for both Employees and Machnes s postve and sgnfcant, ndcatng that spnoffs were better performers than nexperenced entrepreneurs. The coeffcent estmates of Dversfer and College are postve for both Employees and Machnes and sgnfcant for Machnes, suggestng that frms wth more experence and wth more experenced founders were better performers. The coeffcent estmates of Engneer and Subcontractor of Stylecraft are postve but not sgnfcant n ether analyss. Fnally, the coeffcent of Desh Set-up s postve and sgnfcant for both Employees and Machnes, ndcatng that frms that hred Desh workers to set up factores had sgnfcantly more employees and machnes than frms that hred Other workers. The second column of each panel reports coeffcent estmates of our nstrumental varable (IV) approach. The coeffcent estmates of Desh Set-up for both Employees and Machnes are postve and sgnfcant and they are smaller than those of the correspondng coeffcent estmates n the Tobt 16 A smlar strategy was not employed for Bond Set-up because only one frm located n Chttagong hred a Bond worker to set up ts producton and ts data on machnes and employees were mssng % and 31% of frms n the sample had mssng data on employees and machnes.

25 models. Nonetheless, the estmated effects of Desh Set-up reman large. By hrng a Desh worker, a frm receved a boost of 771 employees and 374 machnes relatve to a frm that hred an Other worker, whch s 157% and 166% more than the average number of employees and machnes respectvely Table 5 somewhere here The Lkelhood of Desh Workers Beng Hred Away to Set up Factores To nvestgate the process by whch experenced workers were hred away from establshed frms by entrants, we analyze the departure of Desh workers to set up other factores. Recall that workers at Desh ntally were assgned to three herarchcal postons upper management, lne chef, and the workforce. The few workers assgned to upper management left Desh to work for multnatonal companes or to found ther own frms. Consequently, we lmt the analyss to lne chefs and the workforce, wth the varable Level equal to 1 f the worker was a lne chef and 0 f the worker was assgned to the workforce. Fgure 3 shows the survval curve of Desh workers by ther ntal poston, where survval s defned as not havng left Desh to help set up the factory of an entrant. Consstent wth hypothess 5, at every pont n tme the fracton of Desh workers settng up factores s hgher for md-level than lowlevel workers, and over tme the fracton of workers at every level that are hred to set up factores rses Fgure 4 and table 6 somewhere here We estmate a Cox hazard of ext model, where ext corresponds to leavng Desh to set up producton at another frm. The explanatory varables nclude Employee College, whch equals 1 f the worker had a college degree and 0 otherwse, Employee Age, whch s the age of the worker n 1979 when hred by Desh, Male, whch equals 1 for male workers and 0 otherwse, and Level. Table 6 presents the fndngs. The coeffcent estmates of Employee College and Male are both postve and sgnfcant, ndcatng that males and more educated workers were more lkely to be hred to set up producton of other frms. Most mportant, consstent wth the survval curves, hgher level workers were more lkely to be hred to set up producton of other frms.

26 Dversfcaton nto the Sweater Segment If the patterns observed n the early development of the ndustry were repeated n the subsequent evoluton of a dfferent segment of the ndustry, t would provde further support for the theory. Accordngly, we analyze the evoluton of the sweater segment, whch requred technologcal capabltes dfferent from those possessed by frms n the ndustry when sweater producton began. Our sample contans all 52 frms that entered the sweater segment by Cheung Heung was conjectured to be the seed for the development of the sweater segment of the ndustry and so attenton focuses on whch frms hred Cheung Heung workers to set up ther sweater producton and the effects of hrng these workers on ther performance. Table 7 reports the coeffcent estmates of a Probt model of hrng a Cheung Heung worker for set up n whch the explanatory varables nclude Dversfer, College, Engneer, Frm Age, Sweater Factory Age, whch s the number of years snce the frm establshed ts sweater factory, and Sweater Frst Factory, whch equals 1 for frms that dd not produce other garments before sweaters and 0 otherwse. No spnoff, frm wth a foregn nvestor, unknown background, unknown educaton of ts founder, or that located n Chttagong hred a Cheung Heung worker to set up ts factory so these frms had to be dropped from the analyss, reducng the sample to 35 entrants. The coeffcent estmate of Dversfer s postve and sgnfcant, whch accords wth the results for hrng Desh and Bond workers to set up the producton of early entrants. The other coeffcent estmates are nsgnfcant, ncludng the coeffcent estmate of College, whch was sgnfcant n the analyss of hrng Desh and Bond set-up workers. Ths may be because most of the founders of sweater frms were college educated and so College does not vary much wthn the sample Table 7 somewhere here To test f hrng experenced workers from Cheung Heung affected the performance of frms, we estmated Tobt models for frm Exports, Employees, and Machnes n the years 1995, 1996, and All three output measures pertan to the frm s sweater output only. We nclude as explanatory varables Dversfer, Spnoff, Foregn Investor, Unknown Experence, College, Engneer and Unknown Educaton. We also nclude the varables Ex-CH Set-up and Foregn Techncan Set-up to test whether hrng Cheung Heung workers and foregn techncans ncreased a frm s productvty. To probe whether havng pror experence n other garments nfluenced frm performance, we nclude as an explanatory varable Sweater Frst Factory. Older sweater factores were expected to have a greater opportunty to grow.

27 Accordngly, we nclude Sweater Factory Age as an explanatory varable. Last, we ncluded Frm Age as an explanatory varable to test f overall garment experence nfluenced the performance of sweater producers. Observatons wth mssng data on employees or machnes were dropped from the respectve analyses. Table 8 presents the coeffcent estmates. One dfference from the results concernng the early entrants s that dversfers and spnoffs do not seem to have been superor performers; all but one of the coeffcent estmates for these two varables are nsgnfcant. The same s true for College, although ths varable does not vary much wthn the sample. In contrast, there s some evdence that founders wth an engneerng degree performed better; the coeffcent estmate of Engneer s postve and sgnfcant n a number of the analyses. There s also some evdence that frms wth foregn nvestors performed better, whch also dffers from the results for the early entrants, but ths seems largely to reflect the great success of Cheung Heung tself when Cheung Heung s dropped from the sample the coeffcent estmate of Foregn Investor drops sharply and becomes nsgnfcant. The coeffcent estmate of Sweater Factory Age s consstently postve and sgnfcant whereas the coeffcent estmates of Frm Age and Sweater Frst Factory are generally not sgnfcant, suggestng that only experence n sweater producton and not garments more generally affected frm performance Table 8 somewhere here The coeffcent of Ex-CH Set-up s consstently postve and sgnfcant, ndcatng that frms that hred Cheung Heung workers to set up ther sweater producton performed better than those that hred Other workers. By hrng a Cheung Heung worker, frms receved an export boost of about $3.6 mllon, $4.4 mllon and $5.4 mllon n the years 1995, 1996, and 1997 respectvely. These values are more than 148%, 97%, and 104% of the average sweater exports n the respectve years. Last, the coeffcent estmate of Foregn Techncan Set-up s only sgnfcant n one analyss, where t s negatve. Consstent wth the fndngs for the early entrants, hrng foregn techncans does not appear to have been an effectve mechansm for transmttng tact knowledge to sweater entrants.

28 Dscusson Over the last 30 years, Bangladesh has become a sgnfcant player n the nternatonal apparel market. The effectve begnnng of the ndustry was n 1978 wth the creaton of Desh Garments, whch receved an extensve nfuson of tact knowledge about the producton of shrts and related woven tems from the Korean frm Daewoo. We nvestgated how the formaton of Desh catalyzed the subsequent growth of the Bangladesh garment ndustry. A model featurng mechansms through whch tact knowledge dffused from Desh to other entrants was developed and ts mplcatons were tested on a dataset of early entrants nto the ndustry. Consstent wth the model s predcton, we found that local entrepreneurs dversfyng from other busnesses and havng greater educaton were more lkely to hre set-up workers from Desh (prmary dffuson) and Bond (secondary dffuson). Based on the IV estmates, frms that hred Desh workers to set up ther factores had 771 more employees and 374 more machnes n 1995, whch s 157% and 166% more than the average number of employees and machnes respectvely. In contrast, frms wth foregn nvestors or that hred foregn techncans dd not fare partcularly well, suggestng that these were not partcularly useful sources of tact knowledge. Entrants that worked as subcontractors for Stylecraft, whch tself hred a Desh worker to set up ts producton, performed better than other entrants that began as subcontractors, whch s suggestve that ths was another mportant mechansm by whch tact knowledge dffused to entrants from Desh. Our fndngs for the sweater segment of the ndustry concernng the hrng of Cheung Heung workers to set up producton replcate those for the early entrants concernng the hrng of Desh and Bond workers to set up ther producton, renforcng our confdence n the role of traned workers beng key conduts for dffusng tact knowledge. Bangladesh s success n garments s especally noteworthy gven that t was, and stll s, severely lackng n some of the prerequstes of growth envsoned by modern economsts, such as human captal and good governance. The experence of the Bangladesh garment ndustry suggests that once an exemplary performer s seeded, such factors may not be necessary for tact knowledge to propagate to other frms. Despte havng lmted lteracy, Bangladesh had a suffcent number of educated entrepreneurs wth some pror busness experence who could gather the relevant resources and establsh garment factores, whch helps explan the tremendous number of entrants n the ndustry after Desh s success. The vast majorty of garment workers had lmted formal educaton, but the ndustry was relatvely low-tech and they could pck up the necessary sklls through on-the-job tranng.

29 Mostafa (2009) fnds that entrepreneurs that prevously worked n the ndustry were less daunted by challenges such as corrupton and port delays, whch could help explan why these challenges dd not pose major mpedments to the growth of the ndustry. In both the epsodes that were studed, a sngle seed catalyzed the growth of the ndustry. The seeds became exemplary performers due to ther partnershp wth successful foregn frms, whch wanted to establsh supplers from Bangladesh to servce ther own customers. The ntal seeds were bg, local frms and they became breedng grounds for developng a large pool of domestc workers, who were traned across the relevant organzatonal functons, had the opportunty to clmb up the organzatonal ladder, and, n the process, accumulate supervsory experence to tran new entrants. Otherwse, the role of foregn frms n the growth of the Bangladesh garment ndustry was lmted, 18 whch s consstent wth pror emprcal research on the contrbuton of foregn frms to the productvty of domestc entrants n ther ndustry (Atken and Harrson, 1999; Javorck, 2004). Our fndngs ndcate that the potental spllovers from seedng an ntal frm can be great, suggestng that government subsdes to nduce foregn frms to brng technology to developng countres mght be warranted. Polces such as provdng tax breaks or reducng set-up costs through the establshment of ndustral parks, however, may not be suffcent to catalyze growth. The challenge s to craft polces that nduce foregn frms to tran local workers to the pont that the workers become capable of tranng others n new organzatons. An nterestng case n ths regard s the way the government of Tawan dealt wth Snger, whch receved extensve ncentves for settng up ts faclty n Tawan but at the same tme was forced to tran local workers and those of ts local supplers (Rans and Schve, 1985). It remans to be seen f such a carrot and stck approach would be effectve n another ndustry or country. The phenomenal success of the garment ndustry n hstorcally such a dysfunctonal economy as Bangladesh suggests that tact knowledge seedng can be a powerful force for ndustral development. Rhee and Belot s (1990) fndngs suggest that Bangladesh was hardly alone n developng a vbrant export-orented ndustry from a sngle seed. Whether the seed catalyzed other ndustres they studed n the same way that tact knowledge dffused n Bangladesh remans to be studed. Such a research undertakng has the promse of advancng our understandng of how seeds flower n dfferent settngs 18 The example of Youngone, a Korean multnatonal, s nstructve. In 1980, Youngone establshed a garment factory n Bangladesh by brngng n ts own techncans and managers to lead ts producton. The tranng t provded to domestc workers was narrow and they assumed low level postons n the company. Durng the ndustry s formatve years not a sngle worker from Youngone was hred away by other entrepreneurs to set up ther factores.

30 and what t wll take to advance the development of other LDCs wthout reengneerng ther entre socetes. If an ndustral mracle can be acheved n a country lke Bangladesh, then there can be reasonable confdence that smlar mracles can be created by plantng seeds elsewhere.

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32 Fgure 1: Exports and Number of Garment Factores Number of Garment Factores Number of Factores Exports from Garments Total Exports Exports ($ Mllon) Year Fgure 2: Gross Proft Functons and Premums Gross Proft ( Π ) Π, θ D PR D PR B Π, θ B PR B PR O Π, θ O γ B γ γ D γ γ max Innate Productvty (γ ) T B T D

33 Fgure 3: Kaplan-Meer Survval Estmates of Desh Set-up Tme Level = 0 for the Workforce and = 1 for Lne Chefs