The Division of Labor and Changing Industrial Locations: Evidence from Taiwan * Tetsushi Sonobe and Keijiro Otsuka Abstract Increased congestion and rapidly deteriorating living conditions in urban metropolises in developing countries are becoming a major concern among policy makers and development economists. This concern dovetails with the surge of interests in the geographical dimensions of industrial development in the economic literature with a particular focus on the role of industrial clusters. Based on a theoretical model, we hypothesize that a major advantage of industrial clusters lies in economizing on coordination cost of inter-firm transactions of parts and intermediate products. We also hypothesize that such an advantage becomes stronger over time as the quality control of transacted commodities assumes greater importance. We test these hypotheses by estimating employment growth, firm size, and value added ratio functions by industry in Taiwan for the 1976-86 and 1986-96 periods. The results indicate that industries tend to concentrate in suburban clusters to realize the benefit of inter-firm transactions. Thus, development policies should facilitate the development of industrial clusters in suburban areas. Before drawing clear-cut policy implications, however, more micro-level in-depth case studies, which are capable of assessing the effects of specific policies, must be conducted. ________________________ * We are indebted to M. Kawakami for suggestions and assistance in gathering the data used in this paper, and to Y. Hayami, F. Yamauchi, Y. Sawada, and other participants of the Development Economics Seminar at FASID for useful comments. Tetsushi Sonobe is an associate professor of economics at Tokyo Metropolitan University. Keijiro Otsuka is a a professor of economics at Tokyo Metropolitan University.