THE COMPANY YOU KEEP

To make matters worse for, say, a new country trying to get into the fray, it is not only your own name that counts. Japanese cars are known to be well built, Italian cars are famous for being stylish, German cars are great to drive.

However, suspicion of newcomers can also turn into a self-fulfilling prophecy. If almost no one buys the car, the company will collapse and customer service will cease. Or if everybody expects the Egyptian rugs to fade, then they will sell for very little money and therefore it would not pay for entrepreneurs in Egypt to invest in producing higher quality rugs. It’s a vicious cycle.³⁶

The curse of low expectations can be very hard to overcome. Even if a firm chooses to deliver the highest-quality products, sufficiently pessimistic buyers will assume it is just a matter of time before the quality goes down. This is where it can be very useful to have the right connections: someone who knows you and will vouch for you.

It is no accident that ethnic Indians and Chinese who lived and worked in Western countries played an important role in their native countries’ transition when they returned home. They used their reputation earned and business cards collected to assure buyers (often firms where they had already worked) that things would be okay.

The presence of some success stories can set off a virtuous cycle. Buyers tend to flock to firms that have had one successful breakthrough, reassured by the fact that others have continued to do business with them. Most young sellers who get an order, recognizing this is their one chance to break the vicious cycle of low expectations, will try their best to deliver when given a chance.

For example, in the rose export market in Kenya,³⁷ local producers work with intermediaries to export their roses to Europe. Neither the buyer nor the seller in this industry can rely solely on formal contracts to enforce good behavior. Roses are very perishable, so upon receiving a shipment a buyer could always claim the roses were not of an acceptable quality and refuse to pay. But, on the other hand, the seller could also claim the buyer somehow spoiled the roses to avoid paying. This means that establishing a reputation for reliability is important. During a period of political unrest in Kenya after the disputed presidential election of 2007, when workers were scarce and transportation was dangerous, new producers who were yet to establish a reputation went to great lengths to continue delivering to their buyers. Some even hired armed guards to protect their roses during delivery. The buyers stayed happy and the Kenya rose market survived the unrest.

Of course, even such desperate measures may not always save your skin. The overall reputation of the industry matters, and it may take only a few bad eggs to ruin the reputation of an otherwise high-quality industry. Governments, recognizing this, have tried to find ways to penalize individual producers who cheat on quality. In 2017, the Chinese government decided these penalties needed to be upped. China Daily quoted Huang Guoliang, director of the administration’s quality supervision department: “Current law generally imposes administrative penalties on violators of product quality law, which are too lenient… A system under which violators of the law would suffer devastating consequences would act as a deterrent [italics added].”³⁸

The best-case scenario in this world of fragile and interconnected reputations is often an “industrial cluster,” a concentration of firms in the same industry in one location, all benefitting from the reputation associated with the cluster.

There have been knitwear factories in Tirupur in India since 1925, and throughout the 1960s and 1970s, the industry grew, producing mainly the white cotton tank tops Indian men wear under their shirts.

China has scores of very large specialized manufacturing clusters (“socks city,” “sweater city,” “footwear capital,” etc.). For example, the Zhili cluster in Huzhou has more than ten thousand enterprises producing children’s wear, employing 300,000 workers. In 2012, it was responsible for 40 percent of the GDP of its region. The United States has clusters too, some better known than others. Boston has a biotech cluster. Carlsbad, near Los Angeles, specializes in golf equipment, and Michigan has clocks.⁴¹

The organization of the garment industry in Tirupur reveals the value of a name. The whole industry is organized around jobbers, subcontractors who take care of one or more stages of the production process, or even do all the stages for part of a shipment. The jobbers are the invisible people. Buyers deal instead with a smaller number of known names who secure orders and then distribute them among the jobbers. The advantage of this model of production is that it allows production at a very large scale, even if no one has the wherewithal to invest in a single immense factory. Everyone invests what they can and leave it to the intermediaries to put the pieces together. This is another reason why the industry needs to be clustered.

A similar system operates in many large exporting clusters throughout the developing world, where the reputation of some secures the employment of many others.

Interestingly, this system may be changing. A substantial part of the business model of two of the world’s most successful companies, Amazon and Alibaba, is to insert themselves in place of these intermediaries by allowing individual producers to build their own reputations on their sites, for a price of course, thereby not requiring certification from the intermediary. This is why after you receive a package ordered through Amazon Marketplace, you get repeated entreaties for feedback from Amazon sellers. It is in pursuit of these ratings that they are selling you the socks or the toy for an absurdly low price. Their hope is that one day they will have ratings both numerous and high enough that they can name their price. Of course, it will take some time for these new marketplaces to cement their reputations as guarantors of quality (and they may yet fail). Until they succeed, it is essentially impossible for an isolated producer in the third world to start competing on the international market, however good its product is and however low its prices are.