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The Evolution of a New Industrial District:
The Automobile Industry in the American Southeast

by Stephan Weiler
Associate Professor of Economics
Department of Economics, Colorado State University, Fort Collins, CO 80523
Stephan.Weiler@ColoState.edu

Eric Thompson
Assistant Professor of Economics
Department of Economics, University of Kentucky, Lexington, KY 40506
ecthom1@pop.uky.edu

and

Terutomo Ozawa
Professor of Economics
Department of Economics, Colorado State University, Fort Collins, CO 80523
T.Ozawa@ColoState.edu

ABSTRACT

The emergence of the southeastern United States as a shared region by global automakers demonstrates the organic development of a new industrial district. Initial core pioneers in such districts tend to develop crucial supplier networks around them, leading to possible upstream cooperation for otherwise competitive downstream assemblers. Empirical evidence suggests that a core plant will spark the formation of a sharable supply network, differentiated by criticalness of parts, distance from plant, and timing of establishment. However, these links may result in skewed private and public incentives, which are modeled in a game-theoretic framework. If left to market solutions, unusual yet potentially significant intra- and inter-regional market failures may emerge, leading to potential justification for planning intervention.


     

    CONTENTS

    I. Introduction

    II. The American Southeast as a New Automobile District

    III. Toyota: Sparking a Network

    IV. Twin Market Failures?

    V. Planning Implications

    References


 

I. Introduction

A rough subset of southeastern American states, often know as "Dixie", as former components of the Confederacy, has recently emerged as a new host region for automakers, both domestic and foreign. General Motors (GM) has long been operating a truck plant in Tennessee and a car plant in Kentucky. In 1983, the first foreign entry was made by Nissan (Japan) when it established an assembly plant in Symna, Tennessee to produce both trucks and passenger cars. Soon afterward, in 1988, Nissan's archrival, Toyota (Japan) moved into Georgetown, Kentucky, similarly to produce vehicles locally. In 1990, the Saturn plant, a brand-new division of GM, was also set up in Spring Hill, Tennessee.

More recently, a group of German automakers were attracted to the South as a direct investment site. BMW was the first German firm to build a plant, in Spartanburg, South Carolina in 1995; followed quickly by Mercedes-Benz's decision to do the same in Vance, Alabama in February 1997, a plant now owned by Daimler-Chrysler. Volkswagen, which once operated a plant in Pennsylvania but withdrew in the early 1980's, is now contemplating its return to the U.S., specifically the South. Most recently, Honda announced the construction of a new plant in Alabama to be completed by 2002. All these moves by the world's major automakers point to the surprising attractiveness of the southeast as an entirely new location for U.S. automobile production. The region is in fact emerging as a favored automobile district over the Detroit area, America's traditional home for car manufacturing.

This paper explores the reasons for the development of such a new industrial district, then conceptualizes and empirically tests the characteristics of this process in the American southeast. The current paper represents a specific case study of previous broader econometric findings, focusing in particular on the implications of such districts for market versus planned outcomes. This paper's combination of empirical findings, which assesses the clustering process around the Kentucky Toyota plant, with game-theoretic analyses highlighting the private firm and public agent decision dynamics, provides insights into the opportunities and challenges of evolving industrial districts.

Empirical evidence shows the clear formation of a sharable supplier network around Toyota in Kentucky. The establishment of a core plant sparked a network of dozens of suppliers, with potential positive spillovers to following carmakers. In addition, such clustering may lead to substantial benefits for the focal local economies (Fujita & Hill, 1995). Given this unusual situation, we consider the pitfalls of private and public incentives in the context of the resultant inter-and intra-regional dynamics through explicit game-theoretic modeling. Significant distortions of both business and government investment patterns may emerge through market outcomes. Associated market failures could create justifications for planning.


II. The American Southeast as a New Automobile District

In their study of Japanese-affiliated automotive manufacturing plants across the United States, Smith & Florida (1994) found that new firms in particular preferred locations near established Japanese automotive assemblers. Given these broad results, the recent growth of international automobile manufacturing in the southeast provides a useful case study setting in which to assess the evolution of a new industrial district. Table 1 summarizes the locations and operational capacities of global automakers in the American southeast.


TABLE 1: Automakers in the American Southeast

Plant location Carmaker Starting date Employees Capacity Suppliers
Smyra, TN Nissan MMC June 1983 6,400 450,000 400

Georgetown, KY

Toyota MN

July 1988 7,000 400,000 246
Spring Hill, TN Saturn 1990 3,000 250,000 N.A.
Spartanburg, SC BMW Sept. 1995 1,900   78,000 65
Vance, AL Mercedes-Benz Feb. 1997 1,500   65,000 N.A.
Lincoln, AL Honda 2002 1,500 120,000 N.A.
Tuscaloosa, AL Mercedes-Benz ?
Somewhere in Dixie Volkswagen Forthcoming 2,500 N.A. (estimate) N.A.
Notes: Other than Saturn, GM also has a truck facility in Tennessee and an auto plant in Kentucky.
Source: Based in part on data from Jaffe and Suris (1997), Federal Reserve Bank of Atlanta (1995), and Sherman (1994).


All these automakers are motivated by the need to apply the techniques and organizational structures of lean production. Such structures have become crucial to the success of any entry into the competitive high-margin car market segment. This new production system requires the cooperation of workers in intra-plant activity, and of inter-plant components/parts suppliers in "just-in-time" (JIT) inventory practices. Lean production, originally introduced by Toyota Motor Corporation (Womack, Jones, & Roos, 1990), derives its strengths from two sub-systems: intra-plant (mainly shop-floor) organization and inter-firm relations with key CPA (Components, Parts, and Accessories) suppliers (Smitka, 1991). The flexibility that the integration of these two systems provides yields considerable improvements in both cost-efficiency and quality relative to the traditional Fordist-Taylorist operations in Detroit (Abo, 1994; Maxton & Wormald, 1995).

Automobiles are highly CPA-intensive assembly-based products. As final assemblers, lean-production automakers need to have CPA-suppliers nearby (within an average radius of approximately 150 miles in the present case) for JIT delivery. In addition, many of those CPAs are specific to particular car models, which are highly differentiated in color and engineering design. Yet, because of a single firm's limited scale of operations, final assemblers cannot afford to completely monopolize their suppliers, who in turn are eager to diversify their customer base to gain from both scale and scope economies. There is thus considerable incentive for common patronizing of many suppliers, a foundation of regional localization economies (e.g. Blair, 1991).

The structure of the southeast's new auto district highlights these considerations. Local CPA suppliers used to serve American automakers in a conventional vertically-integrated fashion. GM's original plants in the South, along with other (mostly Detroit-based) American automakers, were producing in-house a substantial portion of key components and parts. Approximately 75 to 80 percent of total CPAs were previously manufactured internally. When American automakers outsourced remaining needs, they resorted to a so-called "built-to-prints" procurement under which successful bidders produced CPAs in accordance with the blueprints given to them. Such contracts were usually short-term, e.g. year-to-year renewal, and made in parallel with at least two sub-contractors to guard against supply disruptions. Since transactional distances were often more than 1,000 miles, just-in-case stockpiled inventories were crucial. CPA suppliers in Dixie catered to the local units of GM, as well as to the customers in Detroit via long-haul shipping. The transactions were strictly arm's-length and impersonal, as predicted by Marshall's (1920) traditional industrial district model.

With the arrival of Japanese automakers -- first Nissan in Tennessee and then Toyota in Kentucky -- the situation began to change. Japanese lean producers began to reorganize their vertical supplier structure by gradually replacing imported key components with local production. Many of their own primary suppliers in Japan were compelled to follow their customers to the southeast, and established local production either on their own or in joint ventures with American suppliers. In contrast to the conventional Detroit system, most major components are outsourced in such a system; remaining in-house production (about 25%) plays only a relatively minor role, and only for the most critical and specific parts. In fact, Toyota and Nissan both use the CPA procurement practice called "design-in" or "black-box" supplier engineering, where the carmakers closely collaborate on new model development with their suppliers from the outset. Thus, they in effect purchase their suppliers' soft engineering capabilities, rather than simply their hard final components.

Once key CPAs are collaboratively designed and engineered, they are delivered just-in-time for final assembly. The contracts are long-term, and assembler-supplier transactions are guided by trust and pursued to the mutual benefit of both parties. Nissan's Tennessee plant, the first foreign arrival in the southeast, has already woven the most extensive/intensive network of supplier affiliates (400), followed by Toyota's Kentucky plant (246). The continued and accelerating entry by auto assembly companies in Dixie seems to be largely motivated by the maturing network of available suppliers (Fed/Atlanta, 1995).

The advantages of such integration make the completion of an unusual collage of competitive yet cooperative inter-firm relations likely in the near future. Each major automaker will have its own primary suppliers of key components. But those CPAs which are more standardized (i.e. lower asset specificity) will be catering simultaneously to all the local assemblers to gain scale and scope economies. Even if some CPAs are assembler-specific in design and engineering, flexible production (e.g. multi-purpose robots and adaptable manufacturing techniques, such as fabricating a variety of differentiated CPAs on a given assembly line) can still accommodate considerable diversity in upstream supplier products.

The end result of this situation is likely to be a shared and cooperative use of specialized CPA suppliers. Thus, car makers may cooperate in upstream supplier operations, while vigorously competing in downstream assembly and marketing operations. The case of the Fremont (California) NUMMI plant is actually an advanced form of cooperative competition. GM and Toyota cooperate in joint production but compete vigorously in marketing by using their separate brands (Corolla for Toyota and Geo Prism for GM) for cars that are physically nearly identical.


III. Toyota: Sparking a Network

The primary hypothesis flowing from such a perspective is that a core assembler should either bring or attract a network of suppliers around the assembly plant. Furthermore, given the necessity of JIT practices to modern competitiveness, clustering of the most critical part suppliers should occur most quickly and most closely around this core plant as well. The supplier network of the Toyota Motor Corporation assembly factory in Georgetown, Kentucky provides a useful example of this phenomenon. The assembly plant has attracted a significant number of new suppliers to the area, particularly from Japan, thereby contributing to the base of regional suppliers. The assembly plant also has utilized a number of existing suppliers, in part present in the region to supply previously established regional assembly plants. These assembly plants include the Ford Motors facility in Louisville, Kentucky; the General Motors Corvette facility in Bowling Green, Kentucky, and the Nissan Motors facility in Smyna, Tennessee.


Analytical framework

The empirical analysis will examine the development of the supplier network for this Toyota plant both geographically and over time. In particular, the analysis will assess whether critical suppliers for Toyota: 1) tend to be located closer to the assembly plant; and 2) be more likely to be new investments. This projected relationship is schematically illustrated in Figure 1. Criticalness, which represents the asset-specificity of CPA for Toyota, is measured on the vertical access, and distance of suppliers from the core plant is measured on the horizontal access. A negative relationship between criticalness and distance is hypothesized; more critical and asset-specific part suppliers are expected to be located closer to the Toyota assembly plant. In addition, those critical suppliers locating near the core plant are likely to be more recently established to satisfy just-in-time delivery needs.


  Criticalness of CPA
FIGURE 1
Distance of CPA supplier
from assembly plant

Nearby suppliers ............................................ Distant suppliers
Just-in-time delivery ....................................... Just-in-case

More recently established inventory ................

Previously existing suppliers
Competition ................................................... Cooperation

In-house production........................................

Supplier sharing through out-sourcing

FIGURE 1: Criticalness of CPAs as a Locational Determinant of Suppliers


Data and methodology

A measure of criticalness will be developed for the parts produced at each Toyota supplier plant. Distance from the plant in miles will then be measured, as will the age of the plant, to determine whether the plant was opened before the Toyota assembly plant, or afterwards.

A data set was assembled of regional parts suppliers for the Toyota sedan assembly plant in Georgetown, Kentucky. The region was composed of the states adjacent to Kentucky: Illinois, Indiana, Missouri, Ohio, Tennessee, Virginia, and West Virginia. Data was gathered on the location, age, and part of each of 118 parts suppliers located in the Commonwealth of Kentucky and adjacent states. Of the 118 regional suppliers, 38 were located in Kentucky, 26 were located in Ohio, 17 in Indiana, 15 in Illinois, and 12 in Tennessee.

The supplier list was for production in 1992. Thus, the supplier list developed reflects what existed in Kentucky and adjacent states five years after assembly began at the Toyota facility in 1987, and seven years after the site was chosen in 1985. The list of suppliers was not acquired directly from Toyota, which naturally limits its release of information about its suppliers. The list was based on Haywood (1992). Haywood published information about the city of location and type of part supplied by each supplier. Further study was used to identify the beginning year of operation, and where possible, more specific information about the type of part produced.

One advantage of this 1992 list relative to a current list is that the 1992 list only represents suppliers to production at the Georgetown assembly plant. A more current list could include suppliers to plants in either Georgetown, or Buffalo, WV, where engines are now built. Further, the list from 1992 reflects substantial development in Toyota's supplier network. As of 1998, the number of Kentucky suppliers had only risen from 38 in 1992 to 56, indicating that at least for the Kentucky supplier network, the network was already well developed by 1992 (Haywood, 1998).

Each regional Toyota parts supplier also was assigned a rank for "criticalness." This term reflects the extent to which the part supplied is custom designed for Toyota sedans assembled at Georgetown. Criticalness was ranked at a value of 0 through 2. A value of 0 was assigned to purchases of basic products, which are products of use in a number of industries besides auto assembly such as raw steel, solder, chemical coatings, and paints. Purchases that are specifically auto parts but tend to be standard across many makes and models such as tires, wheels, window glass, and engine belts were assigned a ranking of 1. Auto parts likely to be specialized for a particular make and model such as stampings, trim, seat assemblies, engine tubing, throttles, and break and suspension components received a ranking of 2. The average value for criticalness among all 118 regional parts suppliers was 1.1.


Results

The network of regional parts suppliers to the Toyota Motor Corporation's Georgetown plant follows the expected geographic and temporal pattern. Plants producing parts more critical to Toyota sedan production tend to be located closer to the Georgetown plant. These plants also are much more likely to be newer facilities that opened the same year that production at the Georgetown plant began (1987), or opened a few years afterward.

Table 2 contains some basic statistics about the regional suppliers listed by Haywood (1992). The table shows the percentage of regional suppliers that are new facilities built during or after 1987, both overall and by criticalness rank. Suppliers with a high criticalness rank are much more likely to have been built after 1987. Of suppliers with the highest criticalness rank, 40 percent were built during or after 1987, compared to just 15 percent for Toyota suppliers with a rank of 1, and 5 percent for suppliers with a rank of 0. Plants that began operation in 1987 or later were much more likely to be among the most critical Toyota suppliers.


TABLE 2: Summary Statistics on Location and Age of Regional Parts Suppliers to Toyota Motor Corporation By Criticalness Ranking
 Criticalness Ranking
0 1 2 Overall
Number of Suppliers 37 34 47 118
Share of Suppliers that Began Operations During or After 1987 5.4% 14.7% 40.0%* 21.2%
Average Distance of Suppliers From the Georgetown, KY Assembly Plants (in miles) 224 245 157 204


Table 2 also shows the average distance of regional suppliers from the Toyota Georgetown assembly facility. The distance is illustrated for regional suppliers overall and for the three different criticalness ranks. The regional suppliers that are ranked most critical are located nearer to Georgetown, Kentucky. In particular, parts suppliers producing the most critical ranked parts were on average located from 70 to 90 miles closer to the Georgetown plant than parts suppliers producing less critical parts. Looked at another way, supplier plants located closer to an assembly plant are much more likely to be suppliers of critical parts.


TABLE 3: Results of an Ordered Logit Regression of Criticalness and Distance of Supplier from the Georgetown, Kentucky Assembly Plant

Variable Coefficient Standard Error Z-statistic Probability
Distance from Assembly Plant -.003202* .001307 -2.45 .0143

LR Index = .02397
* Statistically significant at the 5 percent level


To test this proposition, an ordered logit regression was run relating criticalness rank with distance from the Georgetown assembly plant. Results of this regression are illustrated in Table 3. Regression results indicate that the likelihood of a supplier producing the most critical parts falls with distance. The negative and statistically significant coefficient indicates that, as suppliers move further from an assembly plant, the suppliers are less likely to supply the plant with the most critical types of parts. Figure 2 illustrates the likelihood that a supplier making a most critical part falls from 55 percent for a supplier plant located within 1 mile of an assembly plant to a probability of 32 percent for a supplier plant located 300 miles from an assembly plant.


FIGURE 2

FIGURE 2: Probability of a Supplier Making the Most Critical Part (Rank=2) Given Distance of Supplier from the Georgetown, Kentucky Assembly Plant


In sum, the results discussed above indicate that Toyota tended to procure more critical parts from plants that are located closer to the Georgetown assembly plant, and from newer parts suppliers opened concurrently with or after the Toyota assembly plant began operations. Toyota has organized a supplier network where the most critical parts are made nearby, and by new suppliers attracted to the region. Toyota brought critical suppliers to Kentucky and adjacent states to build its supplier network, but also utilized the existing network of regional suppliers. This behavior is consistent with just-in-time manufacturing and co-design between supplier and assembler for customized parts.


Additional effects on the parts supplier network

The location of the Toyota assembly plant appears to have had an additional impact on the establishment of a supplier network in the region, beyond the regional location of parts suppliers to Toyota. In particular, since the opening of the Toyota assembly plant, Kentucky has become the chosen location for numerous new auto parts companies that do not supply Toyota. This is especially true in the case of foreign direct investment.

We obtained a list of new auto parts companies locating in Kentucky from 1987 through 1998 from the Kentucky Cabinet for Economic Development. That list contained 75 companies, about one-third of which were the result of foreign direct investments. Of these 75, 38 supplier plants located in Kentucky from 1987 to 1992, while 37 located in Kentucky from 1993 to 1998. Many of the 38 new parts plants locating in the state from 1987 to 1992 were not identified as Toyota suppliers. Further, given that the total number of Toyota parts suppliers rose by only 18 from 1992 to 1998 (Haywood, 1992; 1998), it is likely that many of 37 new auto parts plants established since 1993 were also not Toyota suppliers.

This suggests that assembly plants contribute even more to the formation of foreign supplier networks than expected. Apparently, the location of the assembly plants and parts suppliers in an area makes the area an attractive location for other auto parts makers, perhaps through agglomeration effects such as skilled labor supply; and for foreign direct investment because there is an existing community of foreign managers and professionals. Smith & Florida's (1994) results suggest that such factors are indeed important in determining the viability of particular locations for automotive-related manufacturers in the United States.


IV. Twin Market Failures?

Once established, such an assembler-supplier network should provide both cost-efficiency and near-customer-specific market niches for participating car companies, as well as a likely local economic boom. Yet the intra- and inter-regional dynamics make such a structure potentially difficult to initiate, through the skewing of both private and public incentives. The resulting twin set of market failures may thus slow the rooting and growth of the new industrial district, as well as distort the optimal pattern of private and public resource allocation. Justifications for planning intervention may thus emerge.

The potential returns to a region's economy of becoming the seedbed of both the core plant and the expanding web of supplier firms are considerable. Particularly given the high value-added character of this market segment, the inflow of export earnings and multiplied manufacturing employment could significantly influence even the most marginalized area's economic fortunes. Spillovers from such enterprises to the local (service and retail) sector are likely to be exceptionally large, given both the high-wage employment structure that develops and the reverberating needs for proximate service and retail outlets (Bartik, 1992). The spoils to the victor region would flow handsomely for several generations.

However, this benevolent cycle of core-to-supply network development requires a spark by some first-moving firm. The nature of this market segment necessitates that a minimal supplier network be established alongside the pioneer assembly plant. The first-mover thus must invest in the crucial supply cornerstones herself. Initial sunk costs are tremendous. Furthermore, such infant networks have very few of the anticipated scale and scope economies, which only develop in tandem with the overall growth of the regional assembler/supplier network. Note that if such a self-reinforcing pattern of growth indeed takes place, the eventual established web of suppliers will reduce the costs for all core followers.

This strategic interaction can be modeled in a game-theoretic framework. Pioneers must weigh the risky entry into a potentially innovative location, which will shoulder them with significant supplier network costs, which could also yield sizable profits. Yet other firms might also eventually consider probing the promise of the new district, shouldering the supplier burden while costlessly illuminating the true viability of the area for that initial entrepreneur. Each player thus needs to consider the strategic implications of their actions. The market failure develops in the divergence between private and social benefit-cost considerations.

A two-person non-cooperative game theory model can be helpful in understanding this critical first-mover decision, which is similar to the perspective used to analyze incentives in urban redevelopment (Weiler, 2000). Figure 3 summarizes an extensive form game, where each player makes a decision on whether to enter (E) the greenfield area. No entry (N) results in zero newprofits (and zero losses). If a first-mover enters and fails, losses -L will result. If a first mover enters and succeeds, the first period's (monopoly) profits will be M, based on the greenfield location's quasi-rents. Further profits will depend on further entry. If the first-mover remains alone, M will continue. Otherwise, competitive profit levels C will result for both entrants, reflecting both the advantages gained by the pioneer as well as the lower supplier investment by the follower. Note that similar profitability is a conservative assumption, given that the pioneer will still have shouldered the sunk costs of the core supplier network. This game is one of incomplete information, where a probability is assigned to the uncertainty regarding the potential for success in this district. In effect, this viability probability p makes the reality of imperfect information tractable (Harsanyi, 1968). For simplicity, risk-neutrality is assumed, which allows a comparison of expected values to determine entry. This assumption sets an optimistic benchmark for investment; any risk aversion would make entry even less likely in the face of an unknown viability.


FIGURE 3

FIGURE 3


Given the game's Subgame Perfect solution to Figure 3, the first mover will receive

[ p ( M + C ) ] + [ (1-p) (-L) ]

(1)

profits if she initially enters, derived from the monopoly then competitive profits she earns if the area is viable and the losses she incurs from non-viability. Both payoffs are weighted by the probability of viability. If she does not enter, she will receive

p C.

(2)

by virtue of her second-round entry following an alternative successful pioneer. So, the condition for entry is

[ p ( M + C ) ] + [ (1-p) (-L) ] > p C.

(3)

The solution is both simple and intuitive. A company will only establish a greenfield site if it perceives the probability of success to be

p > L / (M + L).

(4)

In other words, if L is considerably larger than the expected one-period (or short-term) monopoly profits, which seems both realistic and likely, no one will move first. Curious entrepreneurs are unwilling to shoulder the substantial pioneering risk burden, which parallels Weiler's (2000) findings in the case of inner-city redevelopment. Even if successful, they have to share many of the fruits of their experiment, including the supplier network.

However, while the crucial private spark may not exist, pioneering may still be socially desirable. Spillovers to followers due to the supplier network investment represent additional external social benefits in addition to those destined for the private investor. Using S to signify such spillovers, entry is socially desirable if

[ p ( M + S ) ] + [ (1-p) (-L) ] > 0.

(5)

Monopoly profits are social benefits, since innovative pioneering (like other new inventions) creates a market where none had existed before. However, since competitive profits are assumedly equal to the opportunity cost of capital, they are not included as a social benefit.

Social planners would therefore have a lower viability threshold,

p > L / (M+L+S),

(6)

than that of the private entrepreneur. While private investors may not be willing to risk investment unless the perceived probability of viability is relatively high, social planners would be willing to accept lower viability chances given the greater total social rewards with success. Note that introducing risk aversion would make potential pioneers even more reluctant relative to local governments, who can spread risk and downside losses.

From another perspective, if the scale of losses L occurs at a level above the acceptable private maximum but below the social planner's maximum threshold

[p/(1-p)] (M+S) > L > [p/(1-p)] M,

(7)

pioneering, while socially desirable, will not occur because of the vital entrepreneur's narrower focus on her own private risk and returns. In general, such private decisions will be more socially suboptimal with greater total spillovers (S).

While establishing whether potential social benefits outweigh total costs must be considered on a case-by-case basis, it is clear that private actors will not fully incorporate the overall social impact of their actions. Marginal private investments could nevertheless yield projects with considerable net social benefits. In sum, the private market may underprovide investment to a promising greenfield area. A potential pioneer may wait (eternally, in this game) for another private investor to test the potential district first. Property rights approaches to this problem, such as buying adjacent land in anticipation of possible future capital gains, are fraught with tremendous risk alongside an even greater initial capital outlay.

While Toyota's success indicates that greenfield sites can indeed be profitable even with the sizable peripheral supplier investment, situations that have less obvious a priori viability may be neglected. Public support may thus be justified in motivating pioneers to invest, mitigating the noted market failure and enhancing broader social welfare. However, clearing that pioneering hurdle by the justifiable support of the public sector is likely to amplify the second market failure. The spoils of winning the greenfield siting of a new auto production center, with both core manufacturers and their supplier network, could substantially bolster a regional economy's fortunes (Fujita & Hill, 1995). The regional multiplier, where a further regional boost is provided by new export dollars respent locally, is likely to be enhanced by precisely the nature of the desired intra-regional production cycle.

These rewards can be expected to spawn, and have in fact produced, effective bidding wars between previously cooperative regional neighbors, given the spoils that accrue to the victor. Interestingly, these infamous incentive packages rank low in a firm's appraisal of an area's desirability for greenfield investment (Hansen, 1993; Kieschnick, 1981). Firms know that they can, and do, generally force matching packages between competing regions (Jenn & Nourzad, 1995). In such a Bertrand-type price war, the final effect of the bidding process would logically shift all the potential economic rents to the firm, since those rents are the effective bonus that a region would inherit with a successful bid. The originally efficiency-justifiable inclusion of the public sector is likely to only worsen this situation, since public officials would include the net social spillovers to the community, and thus be willing to proffer public funds to attract the desired firm.

Forthcoming work by Ellis and Rogers (2000) shows that in a game-theoretic context such a situation turns local economic development into an inter-regional Prisoner's Dilemma. The application to the present greenfield scenario is particularly noteworthy. All regions would be better off cooperating by not entering into an inter-regional competition for the new plant and its satellites. However, since the individual region's incentive at that point is to proffer just a little extra incentive to win the contest, the cooperative solution quickly unravels into its suboptimal non-cooperative counterpart. As hypothesized above, such bidding is likely to degenerate into a Bertrand-type price war. The result of such a Bertrand game is that all of the potential regional private and public gains would be bid away, leaving the winning region bereft of its spoils even before the arrival of the prize.

In addition, global efficiency losses could result, since the bidding process might distort the location decision of the firm away from the most efficient production point. The short-run political benefits of acquiring a target industry rarely match the true longer-term stream of benefits. Political considerations are thus likely to skew proper assessment of benefits, which can themselves be difficult to determine accurately. Furthermore, officials rarely discount the inevitable additional costs of a new plant, such as congestion and infrastructural wear (Blair, 1991). Public sector efficiency itself could be lost as well, as the myopic focus on the prize industry shifts resources away from other public needs which may have greater merit based on opportunity costs.


V. Planning Implications

This paper explores the formation of a new industrial district and its potential impact on market outcomes through the example of the automobile assemblers and suppliers in the southeastern United States. The modern characteristics of the industry necessitate establishment of an intricate network of suppliers, whose criticalness to the production process determines the closeness of their ties and their sites to the core plant. The statistical results from the Toyota plant in Kentucky support this trend. Honda's recent announcement of a new assembly factory in Alabama reinforces perspectives of this work. This new core plant explicitly will take advantage of the now well-established supplier network, while still making the unusual decision to fabricate its most crucially specific component, the engine, in-house at the very same factory as its assembly line (Bradsher, 1999).

However, the creation of other new industrial districts may pose potentially large challenges to market-based solutions, as shown by the game-theoretic model. The combination of substantial pioneer risks and potentially large social spillovers may interact to produce efficiency distortions that hurt not only the local community but also the wooed industry. The two market failures in fact reinforce each other, since the first-mover problem can justify public intervention on its own efficiency merits. But the non-cooperative incentives of regions to attract such core-and-network structures are further increased by the consequent inclusion of the public sector and its social benefit calculus, which may effectively shift not only private but also (poorly specified) social spillover benefits to the prospective plant. Even the latter may be hurt in its own market by establishing itself in an inefficient site, as relative resource prices are skewed by the blizzard of incentives.

In sum, such industrial districts pose distinct challenges to traditional market approaches, as their outcomes may be socially sub-optimal. Such situations suggest possible planning solutions for these intertwined market failures. While inter-related, the public and private aspects of the noted market failures need to be addressed separately given their differing sources. The public incentives problem, whereby each region has an incentive to (over)compete for the focal investment, could be addressed by more cooperative arrangements at the supra-state level. Sites could be coordinated to maximize global efficiency by promoting the site offering the greatest net social benefits. By distributing the net gains to regions under consideration, the cooperative solution could net the broadest gains for all areas.

Yet even given the removal of this public incentives problem, private pioneers are likely to underinvest in promising areas given both the core-plus-network investment costs and advantages of following such pioneering efforts. This private incentives problem could be mitigated by tapered incentive structures to offset the initially high but declining divergences between private and social benefits of investment. Pioneer assemblers are supporting broad supplier networks with minimal scale economies. In addition to the fixed costs of supplier plant investment, the consequent high average costs of components leads to substantially lower private net benefits than the social benefits of the new economic activity in the region. Subsidies to close this gap are thus most justified in these pioneering cases. However, as more assemblers arrive, scale economies of the supplier network take hold, with consequent reductions in the private vs. social benefit/cost gap, as costs are significantly reduced for each ensuing follower.


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