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MSME Empowering Policy: Does it Matter for Developing Country?

November 11, 2013 in Conference and Research Paper

Government intervention to enhance the MSME development becomes a critical issue in the debate of MSME literature. Several scholars claim that government intervention for removing developmental obstacles and for empowering and boosting competitiveness of the MSME are urgently required. However many studies show that most of the MSMEs particularly that are located in traditional industrial clusters where government intervention is absent, have an ability to survive and grow. This paradox is examined in this study by analysing the impact of the government policy and the role of governmental institutions on the MSME survival in labour-intensive clusters in East Java Province in Indonesia. Using qualitative approach, this case study discovered that the survival of MSMEs is more influenced by their capability to gain collective efficiency and by their ability to maintenance social capital rather than impact of gGW OCtoberovernment intervention. Thus, this study contributes to the MSME literature by highlighting the importance of local wisdoms in viewing the development of the MSME and provides a policy recommendation for the government and other institutions to consider these factors seriously into account in designing and implementing the MSME empowerment policies.

(This paper is presented in “ The 2013 GW Global Entrepreneurship Conference organized by George Washington University-World Bank-ICSB, on October 17-19, 2003 at Washington DC   )

The Factors of SME Cluster Developments in a Developing Country;

December 14, 2011 in Conference and Research Paper

[1]

By Mukhammad Kholid Mawardi, Ty Choi,  and Nelson Perera [2]   

Since cluster development factors become a a critical issue in the debate of the industrial cluster literature, several scholars have attempted to seek the variables that influence the cluster growth. This paper presents the case of the wood furniture cluster of Bukir-Indonesia to explain the development of SME clusters by identifying its influential factors. We utilize the model proposed by Parrilli(2009) that includes collective efficiency, social capital, and policy inducement variables to explore the driver factors of this cluster growth. Based on the qualitative approach, this case study found that collective efficiency and social capital affect the development of SME cluster being studied, while policy inducement provides limited contribution to the growth of this cluster. The availability of skilled labour, raw materials and the demand of domestic market supports the local external economy of this location while joint action among cluster actors in the form of sharing order and putting-out between SMEs and retailers adds to collective efficiency. Furthermore, social capital as a common value bound the unity among actors in a friendly competition. However, the inducement policy stimulating the development of this cluster has limited impact since there is no deliberative action seriously carried out by the municipal government of Pasuruan. The study recommends more deliberative program  is designed to meet the needs of cluster actors in coping their obstacles.

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Acknowledge       :

This paper was originally taken from our on going projects in Indonesia. We would never have completed it without the support of many people and institutions. Here, we would like to express our gratitude to them. Firstly, we would like to thank anonymous reviewers of the ICSB 2011 conference for recommending this paper to be presented in this prestigious forum. Secondly, the foremost gratitude goes to The Swedish International Development Cooperation Agency (SIDA) for providing us grant to participate in this conference. During our fieldwork, many people helped, so we are particularly indebted to respondents who kindly and patiently spent their time to answer our questions during interviews. Many thanks go to Pasuruan Municipal Government for allowing us to collect data in their authority.                      

Background                                        

A Small and Medium Enterprise (SME) has been acknowledged as a significant actor on the Indonesia economy by providing job opportunity, contributing for non oil and gas export, and alleviating poverty. The data from The Indonesian Ministry of Cooperation and SMEs shows that the number of employment within Indonesian micro, small and medium scale firms was gradually increasing between 2005 and 2008. In 2005, SMEs could employ 83,586,616 workforces and this number was gradually inclining to 90,896,270 workers in 2008 (Kementrian Koperasi dan UKM, 2009). The data indicates their potential in employing more intensive workers than large firms’ during that period. In Indonesia, almost 97% of the Indonesian employment is on SME sectors while the rest is absorbed by large enterprises in informal sectors (Kementrian Koperasi dan UKM, 2009).

Although Indonesian government authorities have been prioritizing SMEs as a target of economy policy and industrial strategy for several decades  (Hall, 2001; Berry et al., 2002; Sandee et al., 2002; Perry, 2005; Tambunan, 2008b), some government regulations tend to erode opportunities for SMEs to further develop. For example, inefficient bureaucracy, unfair tax, and poor public infrastructure are some of the regulations that significantly raise bottleneck for Indonesian SMEs that have been discriminated by government regulations opposed to large scale enterprises. Moreover, low access to formal financial institutions, lack of human resources, and poor technological capabilities are known to be apparent constraints commonly faced by the Indonesian SMEs that hinder their development.

 In addition, most of the Indonesian SMEs are located in a geographical dense location. One of the significant geographical agglomerations that is populated by SMEs is furniture clusters. Hence, the Indonesia government put the furniture cluster industry as an industry development priority. This industry involves  enormous job opportunities (Kamar Dagang dan Industri, 2007). This industry also contributes significantly to the value of Indonesian export. The data compiled by The Indonesian Furniture and Handicraft Industry Association or ASMINDO indicates the increasing export value of Indonesian export value from 2,403 to 2,703 million USD from 2005 to 2010 (Kompas, 14 Maret 2011). Thus, the study on the development of this industry is significant for the development of Indonesian economy.

 Probably because of these constraints, the majority of SMEs in Indonesia tend to be locate in a geographical dense location, which is seemly a formation of clusters (Weijland, 1999). Although Tambunan (2005) employed an eclectic framework consisting of collective efficiency, policy inducement, and social capital as the determinants for cluster performance in developing countries, there has been no evidence, particularly in Indonesia,  suggesting varying degrees of their contribution to the cluster development. Therefore, this study is aimed to address the research problems of how important each attribute has been perceived by the cluster members especially at the stage of initial formation of the clusters and subsequent entry by cluster members. It is expected that  the study would provide the trajectory model of SME cluster in Indonesia and explain the impact of the driving factors being studied on the development process of SME clusters in Indonesia and other developing countries.

 This study adapt theoretical framework developed by Parrilli (2009)  based on three pillars; economy, policy, and social factors in SME clusters development. Particularly, this study aims to verify the adaptability of this model in Indonesian context and seeks the theoretical grounds underlying this framework’s applicability and suitability in cluster development of developing countries.

 The Geographical Agglomeration of the Small Firms

SMEs have been characterized by the lack of organizational capabilities, the poor of managerial skill, the limited resources and the low level of innovative capacity (Garengo et al., 2005; Garengo and Bernardi, 2007; Pansiri and Tentime, 2008). By locating in geographical dense location, these limitations can be coped by SMEs. Aylward’s (2004) argument in accord with this is stating that the SMEs may benefit from knowledge spillover occurs in cluster. Chamindale and Van (2008) asserted that SMEs may benefit from abundant natural resources and  pooling of skilled labours. Finally, easy access to the market also drives SMEs being in this location (Bair and Gereffi, 2001). It is likely that cluster potential generates several advantages for SMEs to mitigate their limitations. 

 According to the cluster theory, cluster is defined as a geographical agglomeration of companies, suppliers, service providers, and associated institutions in a particular field that not only compete but also cooperate (Porter, 2000). Humphrey and Schmitz  (1995) and Sonobe and Otsuka (2006) assert that cluster is a geographical concentration or localization of firms producing similar products or closely related products in a certain area. In both occasions, although the scope of cluster definitions recognizes contributory role of various firms within the boundary of cluster, they fail to recognize both level and factor of significance of those roles played by every cluster actors.

 Two compelling theories attempt to elaborate these shortcomings by disseminating factors that may drive cluster performances. While one school emphasizes business environment, collective efficiency, and institutional support as factors of cluster performance (Porter, 1998a; Lundequist and Power, 2002; Newlands, 2003; McDonald et al., 2007a), other schools emphasise social variables affecting the development of cluster (Cooke and Wills, 1999; Nadvi, 1999b; Parrilli, 2007; Molina-Morales and Martinez-Fernández, 2010; Nam et al., 2010; Parra-Requena et al., 2010)

 While abundance of research supports evidence of collective efficiency and institutional support such as policy inducement to be the key drivers of cluster development in developing countries, social variables have been neglected in many occasions. Interestingly, some studies have found that significance of social variables on the cluster/SME development in developing countries. For example, Nadvi (1999b) exhibits  how social network and cultural values contribute to the success of Sialkot cluster in Pakistan. Nam et al (2010) also recognize the contribution of human and social capital on the internationalization of knitwear cluster in Southern Vietnam. Although not geographically focused, Cooke and Wills (1999) assert the importance of social capital to enhance the performance of clustered SMEs. Contrary to above theories, a recent study by Parrilli  (2009) argues more dominant the role of social capital as the key driving factor of cluster growth more so than collective efficiency and policy inducement.

 Collective Efficiency

The collective efficiency perspective has been used in some studies to capture beneficial effect of cluster for SME development in developing countries (Nadvi, 1999a; Schimtz, 1999; Caniëls and Romijn, 2003). Schimtz (1999) defines collective efficiencies as competitive advantages derived from local external economies and joint actions provided by SME industrial district. If  a local external economies or agglomeration economies are automatically gained by cluster participants due to their geographical location in industrial districts, the joint action should be deliberatively acquired by cluster actors to raise more potential benefits (Nadvi, 1999a; Schimtz, 1999; Caniëls and Romijn, 2003; Parrilli, 2009).

 Externalities exist where the utility functions of consumers or the production functions of producers are affected not only by their market activities but also by the activities of other economic agents (producers or consumers) (Stewart and Ghani, 1991). Papandreou (1994),  cited in Schimtz (1999) asserts that external diseconomies are when  social costs are higher than private costs. In contrast, if the social benefits are higher than private benefits, it is called external economies. Those two definitions of externalities lead to a conclusion that externalities are advantages enjoyed by cluster participants due to their dense geographical location and inter-related relationship in certain industrial district regions.    

 External economies can be classified onto real and pecuniary external economies. Stewart and Ghani (1991) asserts that the real externalities are the effects of the production function toward of a firm other firm’s production function, while the pecuniary externalities affect the price (including input price and output price) set by other firms. Moreover, Caniëls and Romijn (2003) categorizes real external economies as a spillover effect, while pecuniary external economies as a cost reduction effect. Those two general types of external economies have already been recognized by Marshal (1920) cited in Schimtz (1999), and have been echoed by several studies (Nadvi, 1999a; Giuliani et al., 2005; Parrilli, 2009), as a form of agglomeration effect

 Even though external economies presented by industrial districts raise the efficiency, accelerate the learning and upgrading, and enable SME to face external challenges, there is more opportunity to reach greater advantages through collective action with other actors in cluster (Nadvi, 1999a; Schimtz, 1999; Giuliani et al., 2005). Joint action could be in the form of horizontal and vertical ties. If the horizontal linkages connect the firm with the competitor individually or collectively, the vertical ties could link backwardly with supplier and forwardly connect with buyers (Giuliani et al., 2005).

 Considering the forms of those inter-actors cooperation, Schimtz (1999) identifies some forms of horizontal bilateral (horizontal ties within individual firms), such as joint purchasing of input, joint production, joint marketing, order sharing, sharing equipment, exchanging information of market and know how, and also recognizes  the existence of cooperative as a horizontal multilateral relationship. Parallel with those forms, Sandee and Roetveld (2001) identify the horizontal relationship occurring in a roof tile cluster in Karanggeneng-Central Java in the form of  upgrading traditional technology. Furthermore, Caniëls and Romijn (2003) also recognize other forms of horizontal linkages, such as the existence of  private-public project and vocational training initiatives in Banglore cluster, India. Horizontal linkage is also often collectively constructed by some firms in the form of industrial and trade association, such as Confartigianato (craft and industry association) in Italy (Parrilli, 2009) or SIMA (Surgical Instrument Manufacturers Association) in Sialkot cluster in Pakistan  (Nadvi, 1999a). Those collective co-operations might play mutual role as a pressure group and also provider of supporting service for SME.

 In addition to the horizontal relations, joint action could be in the form of vertical linkage that connects firms with suppliers or buyers in the same value chain. The sub-contract linkages between SME and large enterprises are common forms of vertical network used by SME to distribute the product or absorb new information about market (Nadvi, 1999a; Sato, 2000; Berry et al., 2002; Giuliani et al., 2005; Andadari, 2008; Nam et al., 2010). Moreover, the vertical linkage between SMEs and the supplier are able to reduce input cost and minimise uncertain risks. Therefore, horizontal and vertical linkages as forms of collective action could provide greater benefit for clustered SMEs, in addition to  to advantages provided by external economies.

 Social Capital

Social capital refers to the common norm or value influencing the interaction between individual-social network (Putnam, 2000; Bowles and Gintis, 2002). Practically, social capital can be in the form of social interaction, trust, and shared vision (Molina-Morales and Martinez-Fernández, 2010). Social interaction is any contact or relations that an actor from one firm keeps with other actors from other firms in the community. Nadvi (1999b) indicates that social network often relies upon kinship, family, and localness. If kinship is primarily shaped on tribal lineage while family refers to lineage both immediate and extended family, localness is formed more socially. It can be obtained by being located within the local community and neighbourhood.

 Moreover, trust refers to the degree to which an actor or a firm is considered to be fair and honest in the interchange of whatever resources (Morales and Martinez-Fernández,2010). The significance of the trust in inter-firms connection is also recognized by Parrilli (2004; 2009). He asserts that trust contributes to the cluster growth, instead of self realisation. Parrilli (2004; 2009) argues, furthermore, that when trust and social cohesion are not open, the participations of external actors are not going to be smoothly absorbed by the local community, which may lead to higher transaction costs (contracts, employment). Higher transaction cost may limit the increasing number of firm in cluster (Parrilli, 2009).

 Finally, shared vision refers to an attribute that people and firms may have that can facilitate and offer them certain benefits (Morales and Martinez-Fernández,2010). The second dimension of social capital identified by Parrili (2009), self-realisation, can likely be put in this category, because self realisation is defined as the spirit to encourage entrepreneurship, innovation, firm creation, and spin off. It can also be shared within clustered SME. In turn, cluster may stimulate the emerging of new business (Porter, 1998). In other words, if the industrial district lacks of self-realisation value (as a one type of social capital), it may decrease the entrepreneurial orientation among cluster members and in turn it often discourages the emerging of new firms.

 Social capital can be identified not only from its type, but also from its significant roles within cluster. It encourages the emergence of trust based on social-transactional relationship (Bowles and Gintis, 2002) and facilitates connection among the members of society (Putnam, 2000). In a more specific context, several cluster studies emphasise the contribution of social capital on the commercial performances (Cooke and Wills, 1999; Cooke et al., 2005), on the innovation (Dakhli and Clercq, 2004; Cainelli et al., 2007; Molina-Morales and Martinez-Fernández, 2010; Parra-Requena et al., 2010), and on linkage  with global buyers (Nadvi, 1999a; Nam et al., 2010).    

 Social capital also facilitates the firms to access global market. Nadvi (1999b) indicates that social capital plays a significant role in the developmental process of Sialkot cluster, Pakistan. Nam et al (2010) inserts the role of social capital in connecting  the clustered firms  to the global market. 

Policy Inducement

Cluster policy is defined as a set of policy or measurement aiming to induce and support inter-linkage between cluster participants and to increase value added to their activity (Boekholt and Thuriaux, 1997; Fromhold-Eisebith and Eisebith, 2005). Cluster policy, moreover is designed to overcome market failures, provide public good and service, and boost the competitiveness of industrial cluster (McDonald et al., 2007b). The emerging of policy inducement in cluster development is underscored by Porter (1998b). He argues that the basic macro economy and general micro economy policy may not be sufficient to enhance the competitiveness of cluster, because it solely creates precondition and shapes the conductive environment for the initial development of SME cluster rather than induces the dynamics and the growth of cluster. Therefore, the specific solutions and cluster-target policy, such as the provision of credit, the training of worker and entrepreneur, the provision of real service, and wage negotiation are needed to overcome the specific  constrains faced by cluster (Altenburg and Stamber, 1999; Ceglie and Stancher, 2009; Tambunan, 2009).  

 Additionally, cluster policy as a manifestation of government intervention in industrial policy often plays dual significant roles. On the one hand, it stimulates the emerging SME industrial cluster while, on the other hand, cluster policy has to maintain the dynamic process of cluster  (Parrilli and Sacchetti, 2008). At the initial stage, the regional or national authority should work together with private sectors and stimulate investors to take  part in the industrial district by spending their capital (Porter, 1998b; Parrilli and Sacchetti, 2008). At the next stage of development, the public policy could evade the static governance in cluster, which tends to be controlled by large dominant enterprises, by promoting transfer of knowledge from larger firms to SMEs (Parrilli and Sacchetti, 2008), rather than allowing  SMEs to suffer from unfair allocation of labour and technology (Oyelaran-Oyeyinka and Lal, 2006).

 To obtain these dual functions, policy inducement of cluster should consider some criteria, such as partnership within cluster members (Porter, 1998b; Schmitz and Musyck, 1999; Bair and Gereffi, 2001; Aylward, 2004; Fromhold-Eisebith and Eisebith, 2005; Oyelaran-Oyeyinka and Lal, 2006), characteristics of cluster (Altenburg and Stamber, 1999; Parrilli, 2004; Fromhold-Eisebith and Eisebith, 2005), self help orientation (Schmitz and Musyck, 1999), and the existence of social capital (Porter, 1998b; Karaev et al., 2006; Chaminade and Vang, 2008).

 Methodology

To gain answers to the research questions regarding of how the SME clusters understudied grow and how the certain driving factors (collective efficiency, social capital, and policy inducement) of cluster development affect the trajectory of these clusters, a case study is applied. Yin (2009) asserts that case study suits whit type of research questions of “how” and “why”. He further asserts that case study is used to investigate a contemporary phenomenon within real-life context, especially when the boundaries between phenomenon and context are not clearly evident. For this study, a contemporary phenomenon of the focus is the developmental process of SME cluster being studied, and the context is the driving factors (collective efficiency, social capital, and policy inducement) of the cluster development.  

 The phenomenon of this case study is the developmental process of Bukir furniture cluster while the context bounding of this phenomenon is the driving factors of cluster development. Hence, the cluster being studied is the case of this study (Miles and Huberman, 1994). This cluster is selected because it has similar characteristics to the cluster where Parrilli’s model was developed (Parrilli, 2009) and it provides a significant contribution to the Indonesian economy by creating enormous job opportunities and alleviating the poverty (Kamar Dagang dan Industri, 2007).

 Owners or managers of firms in Bukir cluster, managers of cluster support institutions, and government officers that have authority for developing SME cluster were the respondents of this study. They were selected as participants in the study due to their knowledge and experience in managing firms within the cluster, their information on service available within the cluster, and their experience in cluster inducement policy (Porter, 1998a; Nadvi, 1999a; Parrilli, 2009).

 To support the data collection, this study used several sources of evidence: documentation, interview, and direct observation (Miles and Huberman, 1994; Creswell, 2007)  The first source of evidence is documents on the existence of clusters being studied, project reports investigating the implementation of cluster policy, and local news informing issues about cluster, each of which was analysed in the study. Moreover, as the Indonesian cluster policy has been decentralized from national into local level (Marijan, 2006), exploratory interview as the second source of evidences was carried out with government officers from the  regional level. Semi structured interviews were conducted with managers or owners of the SMEs and managers of the supporting institutions within the cluster. Finally, direct observation was conducted to observe interactions among cluster actors in obtaining collective efficiency and social capital benefits, and anticipating the government policy.

 As the study used multiple sources of evidence for gaining a broader range of historical and behavioural aspects of cluster actors, triangulation and respondent validation we used to obtain the quality of the criteria. If the previous mechanism functioned to confirm the same fact of phenomenon (Yin, 2009), the latter procedure was to ensure the trustworthiness of the criterion credibility (Bryman and Bell, 2007).  These procedures allowed the researcher to associate the facts generated from different sources of evidence (document, local news, and interview) and also provided the opportunity for the participants to check whether the researcher’s interpretations from the interview correctly represented their idea.

 

The Wood Furniture Cluster Industry of Bukir: a Case from Indonesia

Most Indonesian SME clusters root to the local economy and culture and tend to spontaneously grow without government intervention (Weijland, 1999; Marijan, 2005, 2006). They are mostly are located in a remote area but  some are located in an urban area with sufficient supporting infrastructure (Weijland, 1999).

 Bukir is a village located in Pasuruan, East Java-Indonesia that is recognized as the biggest furniture cluster in East Java. The common profession among the villagers is a carpenter or craftsman[1]. Marijan  (2006) indicates that the wood furniture of Bukir started around the 1930s when some people from Bukir worked as a carpenter for Dutch businessmen and other in the city of Pasuruan. The wood furniture carpenters, awareness that being entrepreneurs in a wood furniture industry is more profitable than solely being a carpenter has lead them to starting their own business. 

 Event though, there is no valid data about the growth of the wood furniture cluster industry of Bukir, the development of this cluster was confirmed by respondents. Interviews with respondents between March and April 2011 illustrates that the development of this cluster was fluctuating. The rapid growth of the Bukir cluster occurred during 1980 – 1990s.  To illustrate this phenomenon, Agg, about 40 years old, a government officer from UPT Pasar Bukir[2] by told the researcher that due to intensive trade transaction within Bukir cluster at that time, particularly on weekend when the peak season occured, Gatot Subroto[3] street was closed by the authority for public access. Domestic buyers from other parts of Indonesia visited the cluster to make direct transaction with producer of furniture.

 The rapid growth of Bukir cluster also drove the geographical expansion of the cluster. Initially, the label of Bukir was taken from the name of an urban-village (kelurahan) Gading Rejo sub-district where SMEs producing furniture are located. However, at the next stage, Bukir cluster included not only SMEs within Bukir urban village but it also covers all SMEs producing furniture located within Gading Rejo and the neighbouring areas. This geographical expansion was due to the increase of the people’s interest industry. They started the business by establishing workshops and showrooms. Most of these new entrepreneurs come from the other urban villages of Bukir in the sub-district of Purworejo and Bugul Kedul. (Marijan, 2006).  The magnetic effect of the development of Bukir cluster also leads to the pooling labour from outside area of this cluster. A manager of SME, Sdt, about 28 years old, confirmed that several workers within Bukir cluster are hired by SME owners from out of Bukir area. [4] The effect generated by Bukir cluster justifies  the positive feedback of industrial cluster in the form of stimulating a new business formation (Porter, 1998a)

 To respond to the rapid growth of Bukir cluster, The Indonesian Industrial Department established The Technical Service Unit for Wood Industry Pasuruan (UPT Kayu Pasuruan) in 1984. This UPT aimed to support the SME clusters performance by providing service in production and marketing of wood furniture and training for furniture workers. Recently, The UPT is decentralized from the central government into the Industrial and Trade Service of East Java sub-national government.

 The performance of Bukir cluster inclined during 1997-1998 because of Indonesian economic crisis. This situation affected the consumer purchasing power and it impacted to the declining of the furniture demand nationally (Marijan, 2006). The economic crisis let most of SMEs located within Bukir cluster severe because they were domestic oriented. Some of them discontinued their operation and would reopen their business when the furniture market improved.

 In 2006, Indonesia’s economic outlook was more positive. Economic growth accelerated to 5.1% in 2004 and reached 5.6% in 2005. Growth was driven primarily by domestic consumption, which accounted for roughly three-fourths of Indonesia’s gross domestic product. This situation stimulated the development of the furniture market. Consequently, the wooden furniture industry in Pasuruan started to grow.  

Table 1

The performance of wood furniture industry in Pasuruan

2006-2007

 

Indicators

2006

2007

  Number of establishment

2,295

2,314

  Employment

20,516

20,644

  Value of investment (IDR.000)

115,291,686

117,225,323

  Value of production (IDR. 000)

565,232,282

569,00,951

Volume of export (kg)

3.594.402

4.549.652

Value of export (USD)

5,290,048

6,287,040

       

(Badan Penanaman Modal dan Pelayanan Terpadu Pasuruan, 2008)

 Table 1 exhibits the performance of wooden furniture industry in Pasuruan. The number of wooden furniture production had grown from 2,295 to 2,314 units during 2006-2007. Moreover, the number of employment involved in this industry also increased from 20,516 to 20,644 workforces. The increasing trend also occurred in the value of investment and of production of wooden furniture industry. 

 The wood furniture cluster of Bukir is dominated by SMEs that commonly use limited number of workers (not more than ten workers) and limited financial sources. They use semi-modern equipment and process in producing furniture. In addition, workshop is usually located close to the house of the owner, so the business and manufacturing operations of the furniture unify with her/his daily life. A manager of SME, Sdt, about 28 years, shared his story about how his father introduced “furniture life” to him in since childhood. He obtained skills needed in furniture industry from “learning by doing” process.  It continued until his adulthood, when his father preferred providing financial support for running the furniture business than sending him to university.[5] In other words, furniture industry has likely becomes of Bukir cluster inhabitant’s life. To identify the factors that contribute to the development of wood furniture cluster of Bukir, the next section is explaining how collective efficiency, social capital, and policy inducement impact on the development of this cluster.

 Firstly, the collective efficiency can be seen from the existence of local external economy provided by cluster and joint actions among cluster members. By locating in Bukir cluster, SMEs may gain external economy in the form of sufficient infrastructures, such as road, electrical power and communication network, the availability of wood as a main raw material, market demand, and the abundant skilled labour. As explained earlier, the central business of Bukir cluster is located in Gatot Subroto street, the main road of East Java. Several SMEs  are located in urban villages surrounding this central business.

 Although, the distribution of teak wood (Kayu jati) or Tectona Grandis, the main raw material of furniture product, is strictly regulated by government through the state-owned enterprise in forestry or Perhutani[6],  the scarcity of teak wood is not a serious problem for furniture producers. They can buy non-forest teak wood or use other types of wood, such as mahogany and gembili. These two types of raw material are available in large number in Bukir cluster because the popularity of Bukir as wood furniture cluster motivates the wood suppliers from other cities within East Java region to distribute woods to this region.

  The reputation of Bukir as a furniture cluster also drives the continuity demand for furniture commodities. Most of the retailers that buy product from SMEs within the cluster link to the intermediary agents out of the cluster. These agents distribute the furniture product to the domestic and foreign market. Regarding to this phenomenon, Sdt, 28 years old, one of successful entrepreneurs in Bukir cluster argued that “ I am already overwhelmed with domestic market  so why I have to reach foreign market? Selling domestically or exporting my product does make a difference; the main thing is getting money from this”. It is likely that the abundant domestic demand of furniture products satisfies the SMEs within Bukir cluster, so most of them merely focus on the domestic market. This fact also illustrates that the Bukir cluster is able to provide external economy for their members by providing sufficient raw materials and continuing demand.

 

In spite of these advantages, the development of Bukir cluster is affected by the pooling number of skilled workers in furniture industry. The workers employed in furniture industry within Bukir cluster are not merely inhabitants of Bukir urban village, but they also come from other places out of cluster region. Interestingly, they have a specific skill related to the furniture industry based on where they are from.  Sdt confirmed that carpenters that are employed by SME managers commonly own a certain skill in producing furniture product. Workers from similar places usually have the same skill, for instance: the skills for producing bed and cupboard belong to workers of Randu Agung and Krapyak while skills for producing chair and table are owned by Randusari and Sebani workers[7].

 Furthermore, transfer of knowledge also occurs within cluster members in Bukir. The style of crafting and types of product are spreading across the SMEs. Jepara[8] style is spreading easily among SME managers and workers within Bukir cluster since several Jepara products were distributed by retailer in this cluster.

 Another type of collective efficiency gained by the Bukir SME cluster is joint action. This type of collective efficiency is obtained by clustered firms through deliberative action, such as vertical, horizontal, and bilateral partnerships. Vertical relationship among SMEs within cluster takes place in the form of sourcing wood as a raw material and putting-out mechanism.  Most of the furniture producers buy wood from the traders that are located within Bukir cluster. Due to the strong relationship between buyers and traders of wood, transactions occur easily and the term of payment is negotiable among them. Consequently, sourcing raw material is not a problem for furniture producers. Moreover, vertical partnership within the Bukir cluster can be seen through the putting-out mechanism when retailers buy products from SMEs producing furniture.

 If sourcing material and putting-out transaction take place vertically among cluster members, the horizontal partnership occurs in the form of sharing order. Sharing order is also carried out by SMEs when they get the orders with different specification to the product specification they have made. For instance, SMEs focusing on cupboard and bed production will share the order of chairs and other types of products to their partners, and in return they will get bonus for this mechanism.  It can be seen that joint action among cluster actors occurs informally and naturally rather than formal cooperation through trade association (Nadvi, 1999a) or strict contract between contractors and sub-contractors (Sato, 2000; Hayasi, 2002). However this mechanism is a common type of joint action within Indonesia clusters (Kuncoro, 2000; Sato, 2000; Berry et al., 2002; Hayasi, 2002). Berry and Levy (1999) cited in Berry et al (2002)  asserts that partnership between SMEs within cluster and  large enterprises may exploit local value for export commodity . 

 Secondly, Social capital is likely to affect the development of Bukir cluster. The social capital can be broken down into self realisation for  continuing (family) business (Parrilli, 2009), social network (Nadvi, 1999b), and trust (Molina-Morales and Martinez-Fernández, 2010), and informal social capital  (Miguel et al., 2005) . In Bukir context, a self realisation as a manifestation of social capital (Parrilli, 2009), occurs among entrepreneurs within the cluster to keep the existence of the cluster in the future. The furniture industry has become part of the daily live of Bukir people. Several successful entrepreneurs intend to pass down the legacy of the business to their family. The case of Sdt, a young SME manager, illustrates the strength of intentions for continuing family business owned by his father. Although his father has financial sources for sending him to university, he preferred to support Sdt as a manager who would continue the family business[9] .

 Trust is indicated by researcher has significant influences on business transaction among Bukir cluster members. It can be seen in the mechanism when an SME manager does the business transaction with his partner in supply chain of furniture. The manager is able to obtain raw material (wood) from a supplier without direct payment because the supplier has known him well and thus trusts him. The price of wood can be fully paid by the SME manager when the product is finished and sold. Moreover, this similar mechanism takes place between a retailer and SME producing furniture. The retailer often provides down payment for the orders and will fully paid when the goods are sold. Sdt, 28 the manager of SME that operates in wood trade and furniture industry, indicates these mechanisms as a common payment method within Bukir cluster because the linkages among SMEs are trust based relation.

In addition, the significant role played by informal social capital within Bukir cluster can be seen from the family apprentice mechanism. An owner of furniture SME, Slmt, about 50 years, shared his work experience.  Initially, he worked as a carpenter in the firm belonging to his brother. Having adequate skill for producing, enough experience in marketing furniture, and financial support from his brother, Slmt started running his business independently[10]. This fact echoes Wejland’s (1999) study that indicates the role of informal networking to stimulate the emergence of new business formation.

 Lastly, the policy inducement insignificantly affects the development of Bukir. The cluster development in Indonesia has been discussed at the national level during the last decade. The deputy of SME resources development at The Ministry of Cooperative and SME, I Wayan Dipta asserted that an SME may operate efficiently and access financial resources from bank and non bank organizations easily by locating it self within the cluster. The efficiency operations and strong financial support lead to the competitiveness of SME (Metronews.com Monday 8 November 2010). In conjunction with the earlier statement, The Vice Chief of The East Java Chamber of Commerce, Muhammad Rizal, acknowledged the strategic value of cluster to leverage the market capacity of SME. He further argued that financial support from Corporate Social Responsibility program of state owned enterprises may enforce the production capacity of SME (Citra, 2010). The economics observer, Irawan (2010 ) addes that cluster is able to create multiple effects in the long term by stimulating the emerging of new business formations. However, both of them regret the absence of clear implementation of cluster policy.

 Regarding with this issue, Sutrisno (2009) asserts that the initiative of Indonesian Government  to develop SME cluster was originated from the establishment of SMECDA (Small Medium Enterprises and Cooperative Development)[11]. This forum has three fundamental functions in developing SME cluster, to develop business operation, provide financial support and stimulate investment, and provide consultation. SMECDA also significantly contribute to the institutional and policy transition from The Directorate General of Small Scale Industry under Department of Industriy to The Directorate General of SME Development under The Ministry of Cooperative and SME.

 This transition process thus leads to the emergence of programs for SME cluster development in Indonesia. Sutrisno (2009) identifies the two most successful programs: Business Development Service (BDS) and Modal Awal Pendanaan (MAP) or the initial capital programs within SME cluster. While BDS facilitates managerial and technical supervision, MAP provides financial support mainly from micro financial institutions.  The Indonesian Statistics survey reveales the significant contribution of these programs to the increasing sales among 25% cluster SMEs participating in the program, and the stimulation of  SMEs survival during the economy crisis (Sutrisno, 2009). These finding echo Rosyadi’s (2005) study on the association between services provided by BDS and the performance of cluster SMEs in East Java region.

 Since the implementation decentralization policy in Indonesia, the local government have greater authority to promote SME cluster than before. However, Pasuruan municipal government is likely to have limited direct policy to induce the development of Bukir cluster. For instance, The Cooperative, Industrial, and Trade service of Pasuruan Municipal government solely invite and support limited number of SMEs of Bukir to participate in wood furniture trade exhibition. Additionally, the application of the financial capital support program for SMEs within Bukir cluster was not successful because of the low level of repayment among SMEs.

 Regarding with these constrains of cluster policy implementation, Yns, 50 years old, officer from The Industrial Development Division of The Cooperative, Industrial, and Trade service of Pasuruan Municipal, explained that although participating in furniture exhibition is a strategic step to promote furniture from Bukir cluster, his institution has no capacity to facilitate all SMEs within the cluster to participate in this event. Moreover, the local government are reluctant to provide financial support for SMEs within Bukir cluster with financial support because of their low repayment of this program. This is because most of the SMEs owners/managers view this credit as a grant from government, so they sense no obligation of repaying [12].     

The other type of government initiative to stimulate development of Bukir cluster is played by UPT Kayu by providing service and technical assistance for SMEs Bukir. This service assistance is supported by the equipment owned by UPT Kayu, such as spindle moulders, spindle planners, clean dryers, a wood-oven machines, and others equipment. However, most of the SMEs feel that this institution provides limited service for the member of because UPT Kayu sets for each service. Besides, service provided by UPT Kayu  is also provided by SMEs, so it does not provide significant aid. This phenomenon illustrates the insignificant impact of policy inducement implementation on the development of Bukir cluster..  

 Conclusion 

The study provides several findings that may be beneficial for development of SME cluster in developing countries.  Most of Indonesian SME clusters, including Bukir cluster are rooted to the local economy and culture, and tend to spontaneously grow without government intervention (Weijland, 1999; Marijan, 2005, 2006). The case of Bukir cluster illustrates that the absence of direct policy inducement to stimulate the cluster growth does not mean the cluster is unable to develop. The existence of collective efficiency and social within cluster is likely contributes to the development of Bukir cluster. Sufficient infrastructures, available raw material, abundant market demand, and skilled labour, and knowledge spillovers are the forms of collective efficiency that can be found within the cluster. In addition, social capital can be seen in Bukir cluster in the form of a self realisation, informal networking, and trustworthy.

 This study also justifies the function of the wood furniture cluster of Bukir to stimulate new business formation that has already been justified by Porter  (1998a). This function is indicated by the geographical expansion of the cluster to the villages around Bukir. However, the Bukir cluster has wider effect for both local economy of Pasuruan and national economy of Indonesia if it designed through deliberatively action to meet the needs of SME actors. Porter (1998a) and Parrilli and Sacchetti  (2008) suggest that the regional or national authority should work together with private sectors and stimulate investors to take  part in the industrial district by spending their capital.  

As the study identified the majority of SMEs within Bukir cluster are lack of financial sources, the central and local government may stimulate the business sector to participate in cluster development by spending their fund for corporate social responsibility. Moreover, central government through their authority should encourage the stated owned enterprises to actively involve in small sector development through financial, technical, and managerial assistance.     

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[1]  The data is obtained by researchers from urban village office (kelurahan) of Bukir, almost  1,789  inhabitants of Bukir worked as a carpenter in 2010. 

[2] UPT or Unit Pelaksana Teknis is the technical service unit provided by The Cooperative, Industrial and Trade service of Pasuruan municipality to facilitate marketing of commodity within Bukir furniture cluster.

[3] Gatot Subroto Street is about 2 km main road of East Java province that connects cities within east part to the west part of East Java region. Most of SMEs within Bukir cluster are located nearby this street.   

[4] Interview with Sdt in Pasuruan on 26 March 2011

[5] Interview with Sdt in Pasuruan on 26 March 2011

[6] Due to intensively usage of teak wood through illegal or legal logging, it causes the deforestation. To copes this serious problem, the Indonesian government through the state-owned enterprises in forestry or Perhutani strictly regulates the distribution of kayu jati. Although, people are allowed to plant teak wood individually, they must obtain permit letter (pass) from Perhutani  if they plan to sell it to the market Marijan, K. (2006), Decentralization and cluster policy in Indonesia, Airlangga University Press, Surabaya, Indonesia.

[7] Interview with Sdt in Pasuruan on 26 March 2011

[8] Jepara is the biggest furniture cluster in Indonesia, it is located in  Central Java region.

[9] .  Sdt, 28 years was selected by his father to continue the family business that includes wood trade, furniture enterprises and transportation service.  He has a younger sister (a medical student in a big private university in Surabaya) and a younger brother (a national soccer player). These two status are acknowledged by Indonesian people as a “wealthy status”

[10] Interview with Slmt in Pasuruan on 21 March 2011

[11] SMECDA intensively coordinate the development of SME cluster through online communication at http://www.smecda.com

[12] Interview with Yns, in Pasuruan on 11 April 2011


[1] The paper was presented in 56th annual world conference  of International  Consortium for Small Business, on 15-18 June 2011, Stockholm-Sweden

[2]   Mukhammad Kholid Mawardi  is a lecturer at Business Administration Department of Brawijaya University, Indonesia,

Ty. Choi is a lecturer at Sydney Business School, University of Wollongong, Australia  

Nelson Perera is an Associate Professor at Sydney Business School, University of Wollongong,

Adress correspondence to : Mukhammad Kholid Mawardi, Business Administration Department of Brawijaya University, Indonesia, E-mail : mk_mawardi@ub.ac.id

 

 

 

The Role of Business Clustering to Enhance Competitiveness of Indonesian Small and Medium Enterprises (SMEs) Facing The ASEAN-China Free Trade Area (ACFTA)

December 14, 2011 in Conference and Research Paper

By : Mukhammad K. Mawardi
Abstract
Small and medium enterprise has long been acknowledged as significant actor in Indonesian economy by providing job opportunities and contributing to value of non oil and gas export. However, the significant role played by SMEs tends to be eroded by free trade agreements in the form of ACFTA rather than be stimulated to compete globally. Therefore, this article proposes conceptual model in enhancing the competitiveness of Indonesian SMEs throughout cluster approach. The model relies upon critical literature review undertaken by author. Finally, the model would academically contribute to the development of cluster theory and provide benchmark for policy maker in designing the local development. .
Keywords: cluster, competitiveness, SME

Introduction
Since ASEAN leaders signed the agreement with China leader on 4 November 2002 in Phnom Penh, Cambodia and followed by the implementation of ASEAN–China Free Trade Area (ACFTA) on 1 January 2010 (Cheng, 2004), the globalization of economy was intensively discussed in Indonesia. The debate of ACFTA emphasizes on the crucial questions whether Indonesian industry is or not ready facing the global competition. Several Indonesian experts and official governments are sceptic about the readiness of Indonesian industry to participate in free trade agreement. However some of them are optimist about this global challenge by putting ACFTA in positive perspective. They belief that the emerging of global business is about the time, and is not relating to the readiness of the Indonesian manufacture (Chandra, 2004). It is interesting to consider the survey undertaken by Lingkaran Survey Indonesia from 1-10 May 2010 which involves 1,000 respondents. The survey revealed that more than 60% respondent did not know about the existence of AFCTA, but 57.3% respondent believed that this free trade agreement would disadvantage Indonesia and 55% of them were worried that domestic market would be flooded by China’s commodities. (The Jakarta Post,31 July 2010). This survey justifies that the dissemination of information of ACFTA is more important rather than anxiety of the negative impact of this free trade agreement, because most of Indonesian do not know and do not realize that they are facing global competition.
Consequently, the Indonesian industry, including SME sector have to begin preparing for global competition. This intention could be realized by involving all stakeholders in strategic project to enhance the competitiveness of Indonesian firm, particularly SME. Small business sector become important, since it plays significant role in Indonesian economy. Tambunan (2008a) asserted that Indonesian SME plays significant role in providing job opportunity and contributing for non oil and gas export. Therefore, enhancing the competitiveness of Indonesian SME raises importance for national economy.
The contribution of SMEs in creating job opportunities is figured out by data from The Indonesian Ministry of Cooperation and SMEs in table.1. It shows that the number of employment within Indonesian micro, small and medium scale firms was gradually increasing between 2005 and 2008. In 2005, SMEs could employ 83,586,616 workforces and this number was gradually inclining to 90,896,270 persons in 2008. Furthermore, the data also indicate that SMEs employed workers more intensive than large firms in that period, almost 97% of Indonesian labours were working in micro, small and medium sectors and only 3% of them are absorbed by larger enterprises in formal sectors. The evidence visibly justifies that small scale industry plays significant role in reducing unemployment problem in Indonesia.
The next function of SMEs in the Indonesian economy is as a contributor of non oil and gas export. Table 2 demonstrates that micro, small, and medium enterprises increasingly exported commodities during 2005-2008. Their value of export rose from Rp. 110,338 billion to Rp. 183, 759 billion during that time. By contrast, the value of export contributed by large firms was fluctuating because it decreased in 2006 and was increasing for the next two years. Furthermore, the data reveals that micro, small, and medium firms share in total non oil and gas export in Indonesia at lower level compared to large firms, but the tendency data points out that export value contributed by SMEs remained increasing. Therefore, it could be indicated that small scale industries are potential to consistently support the Indonesian export.

Table 1
The number of Indonesian employments by industrial scale
Scale employments (person)
2005 2006 2007 2008
Micro, Small and Medium 83,586,616 86,834,807 88,739,744 90,896,270
Micro 69,966,508 79,993,756 81,732,430 83,647,711
Small 9,204,786 3,758,199 3,864,995 3,992,371
Medium 4,415,322 3,082,852 3,142,319 3,256,188
Large 2,719,209 2,697,593 2,788,518 2,776,214
TOTAL 86,305,825 89,532,400 91,528,262 93,672,484
Source: The Indonesian Ministry of Cooperation and SMEs (2009)
Table 2
The Indonesian non oil and gas export by industrial scale
Scale Value ( Million rupiah)
2005 2006 2007 2008
Micro, Small and Medium 110,338,065 121,950,799 143,012,332 183,759,076
Micro 13,477,193 15,024,845 20,247,208
Small 28,048,167 29,365,374 34,661,828 44,148,312
Medium 82,289,898 79,108,232 93,325,659 119,363,556
Large 604,394,520 485,135,439 572,228,650 727,168,860
TOTAL 714,732,585 607,086,238 715,240,982 910,927,936
Source: The Indonesian Ministry of Cooperation and SMEs (2009)

Since Indonesian SMEs tended to locate in dense location, cluster might be one of the solutions for the problem in SMEs. The cluster which was initially developed by Marshal (Belussi and Caldari, 2009) as a concentration of industry in certain localities, likely appropriates in removing the barriers and enhancing the productivity of SMEs(Weijland, 1999; Tambunan, 2005). This solution also underscored by several studies(Fromhold-Eisebith and Eisebith, 2005; Tambunan, 2005; Karaev et al., 2006; Parrilli, 2007; Mesquita and Lazzarini, 2008) in different countries, they have discussed the issue in line with the importance of cluster or industrial district as an alternative approach in promoting SMEs. According to Eisebith and Eisebith (2005)and Karaev et al (2006), cluster may generate ‘agglomeration effect’ or geographical proximity advantages in form of higher specialization, innovation and knowledge transfer, which is capable of reducing the transactional cost. The decreasing transactional cost allows clustered SMEs to increase their competitiveness and innovativeness (Tambunan, 2005) and to electively grow (Parrilli, 2007). Finally, the competitive and innovative clustered firms would be able to access global market(Mesquita and Lazzarini, 2008).
In regards with the importance of cluster approach to enhance the competitiveness of the firm, this study aimed to propose conceptual model of cluster strategy in stimulating the development of Indonesian SMEs in facing ACFTA. In order to support the feasibility of the proposed conceptual model, sufficient theoretical underpinnings and previous relevant studies are critically reviewed in this study. Furthermore, to obtain the objective of the study, this study discuses the cluster and SME competitiveness and the driving factors of cluster development, and proposes the conceptual model of cluster strategy. Finally, the study is ended by provide several recommendations.
The cluster and SME competitiveness
The two stances of literature refer to the initial definition of geographical agglomeration of firms are cluster and industrial district theories. Fundamentally, these theories root on similar theory, moreover they also recognize significant role played by cluster to enhance the competitiveness of the firm. However, cluster and industrial district theories have different perspective in describing the dynamics of cluster actors and in identifying influential factors of cluster performance (Porter and Ketels, 2009).
According to the cluster theory, cluster is defined as a geographical agglomeration of companies, suppliers, service providers, and associated institutions in a particular field that compete but also cooperate (Porter, 2000). Moreover, Humphrey and Schmitz(1995), and Sonobe and Otsuka (2006) asserted that the cluster is a geographical concentration or localization of firms producing similar product or closely related product in certain area. Those definitions recognized that cluster includes not only the firms which compete and cooperate with others firm in the similar value chain but also institutional supports which sustain the dynamics of cluster. Yet, the definitions solely emphasized to the identification of the cluster members rather than explicitly recognize the level of significance of roles played by every cluster actors.
In contras, Parrilli (2009), Becattini (2004), and Bianchi (1994) cited in Cainelli (2008) highlighted that the industrial district is a socio-geographical entity of small and medium enterprises (SMEs) producing a specific commodity in industrial atmosphere. The socio-geographical entity is characterized by the existence of interpersonal relationship among actors, and the common social and cultural background owned by SMEs. Furthermore, the definition of industrial district also explicitly recognized the dominant role played by SME as a central actor in the industrial district. SMEs often gain more benefits being member of cluster, due to the existence of industrial atmosphere. Industrial atmosphere facilitates the emergence of agglomeration effect, such as knowledge and innovation spillovers, external economies and joint actions. In other word, the industrial district is typically dominated by SMEs with their social and cultural embeddedness. Furthermore due to the similar characteristics between industrial district explained before and the SME cluster in Indonesia, industrial district might be appropriate to capture the phenomena of SME cluster in developing countries, more specific in Indonesia. Therefore, the concept of industrial district would be employed in this section to represent the agglomeration of SMEs in certain regions. Yet, cluster and industrial district terms would be remain used in this study because the interchangeable usage of industrial district and cluster seems to be common and acceptable (Schimtz, 1999; Parrilli, 2007; Landabaso and Rosenfeld, 2009).
Considering to the roles of the cluster in enhancing the competitiveness of the firm, there are several functions might be performed by cluster, such as increasing the productivity, boosting the innovation and facilitating the global access. The first role functioned by cluster is increasing the productivity of clustered firms. The increasing of productivity of cluster members is contributed by the raising number of output(Sandee and Rietveld, 2001) and the decreasing of production cost (Caniëls and Romijn, 2003; Karaev et al., 2006). Sharing order and sub-contracting might stimulate the increasing demand of commodity among firm locating in industrial district (Sato, 2000; Molina-Morales and Martinez-Fernández, 2010; Nam et al., 2010), while transferring of new knowledge and adapting new technology stimulate the efficiency and capacity of production (Sandee and Rietveld, 2001; Chaminade and Vang, 2008). In turn, the increasing number of demand and the high capacity of production positively affect the output quantity of the enterprises locating in cluster. Meanwhile, the availability of abundant workers and low price of material contribute to the reduction of production cost (Nadvi, 1999a; Caniëls and Romijn, 2003). It could be concluded that the large number of output and the efficient cost of production would increase the productivity of the clustered firms.
The next function of cluster is nurturing innovation of the firm. Study carried out by Bell (2005) in Canadian mutual fund companies has revealed that clustered firms might perform more innovatively rather than non-clustered firms. Parallel with Bell’s study, Molina-Morales and Martinez-Fernández (2010) underscored that SMEs located in cluster members have higher innovative capacity, in term of product and production innovation compared to non district members. If Bell (2005) Molina-Morales and Martinez-Fernández (2010) did not consider the age of the firm, Gilbert et al. (2008) confirmed, moreover, that industry cluster improves the innovation performance of new ventures confronted with high uncertainty. Furthermore, the increasing innovation capacity within cluster members is stimulated by formal and informal transfer knowledge (Muscio, 2006) that may in the form of informal communication among cluster members (Caniëls, 2003). In sum, it could be highlighted that SMEs inside in cluster could enhance the innovative capacity by establishing network relying on diverse type of ties and links.
The last function of cluster is facilitating its member to be global firm. This function drives clustered firms, in particularly SMEs to compete globally by linking with foreign buyer or participating in a global value chain. The collective efficiency generated by cluster, in the form of horizontal and vertical linkages might facilitate clustered firm to access global market and link with foreign buyer (Nadvi, 1999a; Mesquita and Lazzarini, 2008). Based on his study, Nadvi (1999a) argued that in cluster, the collective efficiency could be passively acquired from external economies and actively generated through joint action by firm. Moreover, the advantages of joint action within cluster member also indicated by Mesquita and Lazzarrini (2008), they asserted that horizontal and vertical linkages among SMEs associate with collective efficiency which in turn help SMEs to access global market. Participating in global value chain also enforces cluster members to market their product overseas (Andadari, 2008). Specifically, Giuliani et al (2005) justified that there is relationship between upgrading, collective efficiencies, and global value chain. In other word, cluster contributes for enhancing the competitiveness of the firm by stimulate their members to link with foreign buyer and compete globally.
The driving factors of cluster development
According to Parrilli (2009), three fundamental and influential determinants of cluster development are collective efficiency, policy inducement and social capital. Collective efficiency represents economic motive attracting SMEs to locate and maintain inter-linkages action within cluster participant, whereas policy inducement refers to regulation or mechanism designed by government or inter-nations organization to facilitate and stimulate the dynamics of cluster. Furthermore, social capital embodies the local value strengthening ties within clustered SMEs.
The first driving factor of the cluster development is collective efficiency. Schimtz(1999) defined collective efficiencies as competitive advantages which derived from local external economies and joint actions provided by SME industrial district. As a local external economies or agglomeration economies are automatically gained by cluster participants due to their geographical location in industrial district, the joint action should be deliberatively acquired by cluster actors to raise more potential benefits (Nadvi, 1999a; Schimtz, 1999; Caniëls and Romijn, 2003; Parrilli, 2009)
The external economies could be classified onto the real and pecuniary external economies. Stewart and Ghani (1991) asserted that the real externalities are the effects of firm’s production function toward others firm’s production function, while the pecuniary externalities affect the price (including input price and output price) faced by others. Moreover, Caniëls and Romijn (2003) categorized real external economies as a spillover effects, while pecuniary external economies as a cost reduction effects. Those two general types of external economies have already recognized by Marshal (1920) cited in Schimtz (1999), and have echoed by several studies (Nadvi, 1999a; Giuliani et al., 2005; Parrilli, 2009), as a forms of agglomeration effect
Even though, external economies raise the efficiency, accelerate the learning and upgrading, and enable SME to face external challenges, there is more opportunity to reach greater advantages through collective action with other actors in cluster(Nadvi, 1999a; Schimtz, 1999; Giuliani et al., 2005). Joint action could be in the form of horizontal and vertical ties, if the horizontal linkages might connect the firm with the competitor individually or collectively, the vertical ties could link backwardly with supplier and forwardly connect with buyers (Giuliani et al., 2005).
Considering to the forms of these inter-actors cooperation, Schimtz (1999) identified some forms of horizontal bilateral (horizontal ties within individual firms), such as joint purchasing of input, joint production, joint marketing, order sharing, sharing equipment, exchanging information of market and know how. Despite horizontal relations, joint action could be in the form of vertical linkage that connect firm with the suppliers or buyer in the same value chain. The sub-contract linkages between SME and the large enterprises are common forms of vertical network used by SME to distribute the product or absorb new information about market (Nadvi, 1999a; Sato, 2000; Berry et al., 2002; Giuliani et al., 2005; Andadari, 2008; Nam et al., 2010). Moreover, the vertical linkage between SMEs and the supplier able to reduces input cost and minimizes uncertainty risks.
The second influential factor of cluster development is policy inducement. Since cluster has long been developed throughout deliberative policy, the government intervention toward industrial district becomes demanding issue arise in cluster study. Chamindale and Van (2008) pointed out that government facilitate the development of several industrial districts by providing favourable facilities, stimulating involvement of private sector, and initiating social network program. Another type of institutional participation in cluster development could be in the form of public-private partnership (Aylward, 2004). In addition, the broader initiative to enhance the competitiveness of SME cluster across the countries was conducted by the Organization of Economy Cooperation Development (OECD) (Möhring, 2005; Ceglie and Stancher, 2009). OECD was successfully developed the capacity building of SME cluster in South America countries (Mexico, Nicaragua, and Honduras) (Ceglie and Stancher, 2009) and in the Eastern Europe countries (Möhring, 2005).
Cluster policy is defined as a set of policy or measurement aiming to induces and supports inter-linkage between cluster participants and to increases value added of their activities. (Boekholt and Thuriaux, 1997; Fromhold-Eisebith and Eisebith, 2005). Cluster policy also designed, moreover, to overcomes market failures, provides public good and service and boosts the competitiveness of industrial cluster(McDonald et al., 2007). The policy inducement in cluster development is underscored by Porter (1998b), he argued that the basic macro economy and general micro economy policy may not be sufficient to enhance the competitiveness of cluster. Moreover, Porter (1998b) stated that it solely creates precondition and shapes the conductive environment for the initial development of SME cluster rather than induces the dynamics and the growth of cluster. Therefore, the specific solutions and cluster-target policy, such as the provision of credit, the training of worker and entrepreneur, the provision of real service, and wage negotiation, are needed to overcome the specific constrain faced by cluster (Altenburg and Stamber, 1999; Ceglie and Stancher, 2009; Tambunan, 2009).
In conclusion, policy inducement has been considered as a factor determinant in cluster development because government or inter-governmental organization may deliberatively stimulate and manage cluster, in the micro, meso and macro level and also induce the emerging of social capital within cluster. Consequently, it could be hypothesized that
The last factor affecting the industrial district development is social capital. Social capital refers to the common norm or value influencing the interaction between individual-social network (Putnam, 2000; Bowles and Gintis, 2002). In practically, Molina-Morales and Martinez-Fernández, (2010) conceptualized dimensions of social capital onto social interaction, trust, and shared vision. Social interaction is any contact or relations that an actor from one firm keeps with other actors from other firms in the community. Social interaction can affect their access to and use of knowledge resources of the firm. In respect with this issue, Nadvi (1999b) indicated that social network often relies upon kinship, family and localness. If kinship is primarily shaped on tribal lineage while family refers to lineage both immediate and extended family, localness is formed more socially, it can obtained by being located within the local community and neighbourhood.
Moreover, trust refers to the degree to which an actor or a firm is considered to be fair and honest in the interchange of whatever resources (Morales and Martinez-Fernández,2010). The significance of the trust in inter-firms connection also recognized by Parrilli (2004; 2009), he asserted that trust contribute to the cluster growth, instead of self realisation. Parrilli (2004; 2009) argued, furthermore, that when trust and social cohesion are not open the participations of external actor are not going to be smoothly absorbed by the local community, which may lead to higher transaction costs (contracts, employment). Higher transaction cost may limit the increasing number of firm in cluster (Parrilli, 2009).
Finally, shared vision refers to an attribute that people and firms may have that can facilitate and offer them certain benefits (Morales and Martinez-Fernández,2010). The second dimension of social capital identified by Parrili (2009), self-realisation, likely can be put in this category. Because self realisation is defined as the spirit to encourage entrepreneurship, innovation, firm creation and spin off and it can be shared within clustered SME. And in turn, cluster may stimulate the emerging of new business (Porter, 1998). In other word, if the industrial district lacks of self-realisation value (as a one type of social capital), it may decrease the entrepreneurial orientation among cluster members and in turn it often discourages the emerging of new firms.
The proposed conceptual model of cluster strategy
Considering to the significant role and the driving factor of cluster discussed below, this section explains the proposed conceptual model of cluster strategy to enhance the competitiveness of Indonesian SME. The model originally developed by Parrilli (2009)
to explains the developmental process, the constraint and the growth prospect of SME industrial district in Forly Italia. Due to the similar characteristics among Forly cluster Italy and Indonesian cluster, in terms of how collective efficiency, policy inducement and social capital affect on the cluster development, the model is assumed will appropriate to be adapted in Indonesia.
As this model emphasizes on three driving factors of cluster growth, collective efficiency, policy inducement and social embeddedness or social capital, the strategy to enhance the competitiveness of Indonesian SME within cluster could be analysed from these factors. Firstly, the growth of SME cluster could be stimulated by generating the collective efficiency. The fundamental forms of collective efficiency are external economy and joint action (Nadvi, 1999a; Schimtz, 1999; Caniëls and Romijn, 2003; Parrilli, 2009). Furthermore, Study undertaken by Sandee and Rietveld (2001) and Sato (2000) revealed the emerging of external economy within several Indonesian SME clusters. If Sandee and Rietveld (2001) indicated that clustered SMEs have more opportunity to absorb new knowledge and upgrade new technology, Sato (2000) recognized that inter-linkage formation within cluster encourages SME to obtain abundant order and get more information about market. In spite of external economy, joint action was facilitated in Indonesian SME cluster. Several SMEs located in cluster often participate in global vale chain (Andadari, 2008)and engage in sub-contract partnership with large firms (Berry et al., 2002). These studies justify that Indonesian SME cluster has potency to generate collective efficiency, therefore strengthening capacity of cluster to generate more benefits for SMEs and managing the dynamic of cluster may enhance the competitiveness of clustered firms.
Secondly, since a cluster strategy has long been adapted by government and inter-nation organizations across the globe to develop the competitiveness of both region and firm, it provides lessons could be learned by Indonesian government. Cluster strategy should be put as a national strategy in obtaining national and regional competitiveness (Porter, 1998; Tambunan, 2005). The recommendation toward the application of cluster approach have been echoed by Porter (2009) in his presentation to Presiden Susilo Bambang Yudhoyono on 28 Septmeber 2009. However, the implementation of cluster strategy to enhance the competitiveness of SMEs remains uncertain. The limited attention paid by government in developing SMEs, has been indicated by Hall (2001). He asserted moreover, that Indonesian government have never enunciated a coherent, clearly defined and prioritized SME policy and strategy. Hence some regulations tend to erode the competitiveness of business sector, in particularly SMEs rather than stimulate to compete globally (Tambunan, 2007). Therefore, collective awareness is required for enhancing the competitiveness of Indonesian SME facing global competition. The collective awareness may be realized by implementing cluster approach to promote the competitiveness of SME. Tambunan (2005) argued that cluster approach is appropriate to promote the Indonesian SMEs., due to comprehensive framework and advantages provided by cluster.
Lastly, the model also acknowledges the importance of social capital as a “glue” to bonds firms within cluster. The main dimensions of social capital are social cohesiveness and relation (Parrilli, 2009). If social cohesiveness relates to the value tie firms within cluster, social relation refers to the forms of social network among clustered firm. The Indonesian SMEs often located in specific region with common culture value (Perry, 2005a). Hence, they have strong social cohesiveness in doing business within cluster. The social cohesiveness or social tie commonly relies on religion or culture value. Religion and culture generate common value in conducting daily activity, including doing business. The common value may in the form of honesty, collectiveness (gotong royong), or familiarity (kekeluargaan). Moreover, Sandee and Roetveld (2001) indicated that these values commonly influence the social network among actors in cluster. Their study revealed that the transfer of knowledge circulates within actors with family tie in initial stage. However some values likely have been degraded during the developmental of cluster (Nadvi, 1999b). The recent phenomenon shows that more developed SMEs be more individualistic; they tend to monopolize or take advantages from their business network rather than voluntarily share their link. Therefore, the management of cluster should be designed by maintaining local value and also adjusting the potential development.

Conclusion and recommendation
The study shows that AFCTA as a type of global economy forces is viewed in contradict perspectives. In initially stages, this trade agreement is negatively viewed due to the its impact on domestic market and more optimistic perspective view AFCTA as an opportunity for Indonesian product to enter foreign market. However, the latter perspective requires the commitment to prepare the Indonesian industry, including SME sector facing this challenge. Therefore, this study proposes the conceptual model to enhance the competitiveness of Indonesian SMEs throughout cluster approach.
Cluster may enhance the competitiveness of Indonesian SMEs by increasing the productivity, boosting the innovation and facilitating the global access. The first role functioned by cluster is increasing the productivity of clustered firms. However, to support the development of cluster, there are three fundamental factors should be taken into account, collective efficiency, policy inducement and social capital. Therefore, the interpretative comprehensive model which was developed by Parrili, is proposed to increase the competitiveness of Indonesian SME.
Beside proposes the conceptual model in enhancing the competitiveness of Indonesia SMEs, the study also provides theoretical challenge and raises methodological issue in conducting study in cluster, particularly in Indonesia context. Moreover, the study also echoes the importance of cluster strategy for national and regional government in developing their regions.