Industrial clusters and their implications for local economic policy


Abstract

There are a large number of theories seeking to explain why some regions and countries are more economically successful than others. Michael Porter's notion of industrial ‘clusters' is easily the most popular and well known.

This document sets out Porter's theory and describes the evolution of his theory in UK policy. There are examples of cluster strategies delivered by regional development agencies (RDAs) and practical implications local authorities and other public agencies.


Introduction

Why some national and regional economies grow faster than others is an enduring and difficult question. The question attracts contributions from economists and a range of other people, and pre-occupies governments and policy-makers of nearly all colours.

Easily the most influential theory in recent times has been Michael Porter's account of localised industrial ‘clusters'. This is set out in his 1990 book ‘The Competitive Advantage of Nations'.

At the heart of Porter's theory is the notion of ‘clusters' as geographically concentrated industrial sectors. These consist of a number of rival companies around which are grouped complementary and supporting supplier companies and associated institutions. Geographical proximity allows interaction and efficient flows of goods, services, ideas, and skills. This yields high levels of productivity growth and rapid rates of innovation in both processes and products.

The idea of local concentrations of specialised industrial activities yielding benefits in terms of higher productivity was hardly new. As long ago as 1890, British economist Alfred Marshall set out a description of geographical concentrations of specialised industrial activities. He stated that, once established, they reinforce themselves by attracting complementary activities at various stages in the supply chain. In addition, they created a pool of specialised labour which aided the spillover of know-how between firms.

In ‘Principles of Economics', Marshall wrote:

"The mysteries of trade become no mysteries but are, as it were, in the air, and children learn many of them unconsciously."

Vestiges of these specialised industrial areas remain visible in England. They include the cotton spinning areas of Yorkshire and Lancashire, the potteries in Staffordshire, cutlery and steel in Sheffield and metal manufacture in Birmingham and the Black Country.

These areas are now mere shadows of their former glory. This demonstrates that even successful areas can decline if they fail to innovate or re-invent themselves in the light of forces operating in the global economy.

There is currently a vast literature concerned with issues similar to that which interested Marshall. What Porter called ‘clusters' have been labeled by economic geographers variously as: ‘industrial districts', ‘new industrial spaces', ‘regional industrial complexes' or ‘innovative milieux' - to name but a few. The exact terminology depended on particular theoretical perspectives or research interests.

Nonetheless, despite this plethora of competing but similar ideas, Porter's theory became, for some time, the established ‘industry standard'. Perhaps this was due to Porter's experience of both business and public policy.

Michael Porter was a Harvard business professor who specialised in business strategy. His experience of serving on President Regan's Commission on Industrial Competitiveness prompted him to define exactly what competitiveness is and to identify its national and local sources.

His writings certainly appeared to have rung a bell among the business community. An important criterion of a good theory, in Porter's view, is the portrayal of a world that business people can actually recognise.

Most importantly, Porter's theory has practical implications for policy makers at national, regional, and local levels. Most of these are explicitly set out by the author himself. In other words, he allows a role for governments and public agencies in creating the conditions that sustain competitive clusters.


Porter's theory

Porter's definition of competitiveness derives from his earlier work on business strategy. Put simply, it revolves around high productivity - itself an outcome of successful innovation in processes or products, or both.

Firms should seek to continually innovate in creating value for their customers. The desirable path for a national economy to follow is in high value-added activities that rely on high levels of expertise and skill, and which are able, and need to, pay high wages.

The question he asks in his 1990 book is why are some nations are better at doing this than others? Or, more precisely, why have some countries succeeded in gaining competitive advantage in particular industries.

The answer was in his concept of ‘clusters'. In these, successful firms in particular countries are not isolated cases but belong to successful groups of rival firms within industries. These groups of firms, together with the associated businesses they attract at various stages in the supply chain, are termed ‘clusters'.

Porter saw high productivity growth as the outcome of a ‘diamond' of four factors:

  1. firm strategy, structure, and rivalry
  2. factor conditions (input)
  3. demand conditions
  4. the presence of related and supporting industries.

Porter's growth diamond - on Themanager.org website

Whether or not an industrial cluster exists in a locality does not hinge on the mere presence of firms of a similar type in an area. This is a common mistake. It is in the nature of the interactions between the four elements of the ‘Porter diamond' within an area that properly determines the existence of a cluster.

The most important of these interactions is that of competitive rivalry between firms. The importance of competitive rivalry is probably the most distinctive part of Porter's theory.

The geographic proximity of leading rivals within an industry intensifies the relationships between the four elements of the diamond. Paradoxically, however, an element of collaboration between firms is also an important ingredient of cluster success.

Firms of a similar type might support trade or professional associations. These can maintain and upgrade standards in skills and products, lobby local or regional governments for investment in appropriate public goods or support collective marketing activities. For example, the successful Italian tile industry was supported by vigorous promotional activity by its trade association.

The geographical concentration of clusters affects competitiveness in three ways:

  • It increases productivity - firms can operate with lower levels of stock because of the local presence of specialised suppliers, and they have access to specialised skills and human resources, aided by specialised and local training providers.
  • It increases the capacity for innovation by facilitating interaction and the dissemination of knowledge - competition between firms raises the incentive to innovate, which in turn raises the capacity to adapt to changes and external shocks
  • It stimulates and enables new business formation through ‘spin off' enterprises which face lower barriers to entry than in other localities - this in turn creates a positive feedback loop through more competition, innovation, and so on.

Much of Porter's theory is concerned with what maintains and sustains clusters. In explaining why clusters come into being originally, historical accident has a part to play. During World War II, for example, Coca-Cola became a worldwide entity because of the need to supply US troops in Asian and European theatres.

However, the ability of an industry or a country to capitalise on chance depends on the quality of each of the four elements of the ‘diamond'. A scientific breakthrough is not of much use commercially without the appropriate skills base and business and institutional networks to bring it to market.

Governments are important, because of the influence they have over factor conditions - especially skills - and the regulatory environment. Subsidies can over-protect industries and hence stifle innovation. Although Porter is against governments propping up failing industries, he is no proponent of simple ‘laissez-faire' capitalism.

In some of his later writings, competitiveness can be seen to be nurtured by strong private-public partnerships. Trade unions are among the desired partners listed in public-private coalitions.


The evolution of UK cluster policy

The 1998 Competitiveness White Paper ‘Our Competitive Future: Building the Knowledge-driven Economy' highlighted the importance accorded to clusters by government in contributing to regional and national competitive advantage.

An early development was the setting up of the Biotechnology Clusters team. This recommended premises and ‘incubators' and the importance of effective networks. In 2000, the latter was later referred to as ‘institutions of collaboration'.

In 2000, a Clusters Policy Steering Group was set up at ministerial level, which sought to develop policies to encourage cluster growth. The group examined the planning system and its impact on business competitiveness. It fed into the review of the planning process being carried out by what was then Department of Environment, Transport and the Regions (DETR). It also had some influence on the development of policies for skills and higher education.

In 2001, the Department of Trade and Industry (DTI) - now Business, Enterprise and Regulatory Reform (BERR) - published ‘Business Clusters in the UK: a First Assessment'. This identified industrial clusters in all UK nations and regions. The research was carried out by a consortium led by Trends Business Research.

The report identified some of the empirical difficulties of identifying clusters. The broad nature of the cluster concept is a strength, in that it allows for flexibility in policy response. Policy can - and should - be adapted to specific local circumstances.

Clusters cover all types of activities, from manufacturing to services, and can vary hugely in size and geographical scope. But the elasticity of the concept is also a weakness: its vagueness means that clusters can be hard to identify with precision.

The research team used a four-way classification of clusters to assist analysis. The assessment of clusters depended on:

  • stage of development - clusters could be ‘embryonic', ‘established' or ‘mature'
  • depth - the possibilities here are ‘deep, ‘shallow' and ‘unknown'; a ‘deep' cluster will have a large number of industrial and institutional linkages
  • employment dynamics - classified as ‘growing' ‘declining' and ‘stable'
  • geographic significance - regional, national or international.

Based on 1999 data, the research team identified 154 clusters, with the number by region varying from eight to 18. The clusters identified included both service and manufacturing industries, and covered a wide range of sectors and technologies, including:

  • agriculture and food processing
  • metals
  • automotive
  • biotechnology
  • financial services
  • tourism.

Some of the clusters, such as nuclear fuel processing in the northwest and ceramics in the West Midlands, were unique to one region. Others, such as motorsport and marine engineering, crossed regional boundaries.

Although described as an ‘initial assessment', the study team agreed with Porter's assessment that the UK is not ‘strongly clustered'.

The Clusters Policy Steering Group was wound up in early 2003, by which time regional cluster strategies had been worked up by the RDAs. At the national level, strategy was taken forward by the RDA Cluster Sub-Group, consisting of representatives from all of the RDAs and the DTI. One of the last actions of the group was the commissioning of Ecotec to produce a practical guide to cluster development.


Examples of clusters taken forward by the RDAs

Motorsports

The UK has a leading position in the technology-driven motorsport industry. It has a large number of motorsport companies. Their precision engineering and advanced technology skills are increasingly exploited by the mainstream automotive industry.

Most UK motorsport firms are based in an area known as ‘Motorsport Valley'. They supply the technology used in Formula One and dominate the production of cars and components to ‘Champ Cars' and other top US racing formulae.

Motorsport Valley is an area based largely in southern and central England. Here most specialist motorsport firms have their research, design, engineering and production facilities. It acts as a global centre for the production of cars and parts.

About 4,000 companies are involved in the UK motorsport manufacturing industry and its wide-ranging support activities. The engineering sector of the industry has an annual turnover of £2.9 billion, more than half of which is exported.

Motorsport Development UK is the partnership responsible for implementing a five-year investment in British motorsport. Funding for the programme comes directly from BERR and four regional development agencies:

  • Advantage West Midlands (AWM)
  • East of England Development Agency (EEDA)
  • East Midlands Development Agency (EMDA)
  • South East England Development Agency (SEEDA).

The investment agenda is focused on five areas seen as key to a successful motorsport cluster in the UK. They are:

  • business development and technology transfer
  • a Motorsport Academy to improve skills and coordinate learning
  • a Motorsport Learning Grid of educational activities
  • development of energy efficient motorsport (EEMS) in the UK.

Biotechnology

‘Bionow' is the brand name for the biotechnology, pharmaceutical and healthcare cluster programme within the North West Regional Development Agency (NWDA). The Bionow team sits within the Business Relations Group of the RDA's Enterprise, Innovation and Skills Directorate. The Bionow programme is supported and advised by a panel of industry members and representatives of key cluster organizations.

England's northwest has one of the UK's top three clusters for the biomedical sector, which includes biotechnology, pharmaceuticals and healthcare. There are several major pharmaceutical companies in the region and internationally renowned academic and clinical research establishments.

The northwest is home to some 230 biomedical companies employing 25,000 people. These include seven multinational pharmaceutical firms. The region is the highest exporter of pharmaceuticals in the UK - £3.4 billion.

Bionow assists both existing companies and new ventures in the region by supporting strategic infrastructure programmes. In addition, it hosts a networking community and promotes the science and research base. Bionow manages a strategic project portfolio worth in excess of £65 million. Key projects include:

  • the National Biomanufacturing Centre (NBC) in Liverpool - a £30 million project developed by the NWDA for product development and early stage biopharmaceutical manufacturing
  • the Liverpool School of Tropical Medicine - a medical school dedicated to the development and treatment of tropical and infectious diseases which is expanding with the help of £9 million in funding from the NWDA
  • the Core Technology Facility in Manchester - a £25 million project supported by the NWDA which provides grow-on space and specialist services for companies moving from the Manchester Biotechnology Incubator
  • UK BioBank in Manchester - a £60 million project supported by the NWDA that will look at genetic and environmental factors that impact on human health and disease
  • Nowgen - the Northwest Genetics Knowledge Park based in Manchester, which is supported by the NWDA.

Food and drink

The food and drink sector in the northeast comprises more than 1,500 companies. Collectively these firms generate an annual turnover of £3.5 billion and employ 45,000 people. Food and drink processing is a leading employer in the region's manufacturing sector, employing about 20,000 people. It has attracted some of today's leading producers, including Nestle, United Biscuits, PepsiCo and Kerry Foods and contributes approximately £2 billion a year to the regional economy.

One NorthEast and regional partners are investing in this sector to develop growth and competitive advantage. Key actions include:

  • developing and funding a food group for the region
  • building supply chain capacity
  • providing start-up grants for new firms in the sector
  • addressing shortages of premises
  • supporting export initiatives
  • promoting and providing access to training and development.

Porter's 2003 assessment of the UK economy

In 2003, in a paper written for the UK government, Porter set out his views on UK competitiveness. The assessment was mixed. Noted was the success of macroeconomic policy, most notably in historically low levels of inflation and unemployment. However, the assessment of UK business performance pointed to:

  • insufficient investment in capital assets and innovation
  • positioning on low input costs rather than high added-value
  • adoption of modern management techniques was lagging.

Contributory factors to the state of UK businesses included:

  • the short-tem outlook created by the UK's equity-based financial market
  • a low level of complementary public capital assets
  • low workforce skills
  • low investment in universities and the public research sector.

Competitiveness, he argued, increasingly relies on a country's appropriate structure of roles, institutions and processes to enable, organise and drive efforts to improve business environments and clusters.

Governments are important because they help shape factor conditions - through, for example, education and training. They also add legitimacy to efforts to improve competitiveness at national, local, and regional levels. Universities have become more important as the boundaries between basic science and commercial applications of technology have become blurred.

The group already referred to as ‘institutions for collaboration' support research, professional and vocational training, export promotion, and the general dissemination of information, ideas, and benchmarking standards.

It includes - for example:

  • chambers of commerce
  • industry associations
  • professional associations
  • trade unions
  • technology transfer associations
  • quality centres
  • ‘think tanks'
  • university alumni associations.

These were, suggested Porter, less numerous and less effective in the UK than in competing countries.

One consequence of these relatively weak ‘institutions of collaboration' was a general tendency in the UK to lag in adopting modern management techniques. Some new management techniques are difficult to communicate in the abstract. They are best learned through interaction with other managers or professionals in the same cluster or industry - processes which institutions for collaboration facilitate and support.

Porter noted that in the UK, in contrast to the US, there has been a divergence in regional prosperity. Interestingly, Porter attributed this persistent prosperity gap between regions in part to the absence of effective regional or local government in the UK.

Where power is overly-centralised, he argued, public spending is less well adapted to local or regional opportunities or needs. Private sector leaders are less willing to engage in local or regional development efforts.


Conclusions and policy implications

In the conclusion to his 2003 study, Porter argued that the UK economy had reached a transition point. UK companies must shift from competing on low input costs. They must move instead to competition based on more distinctive and innovative products and services.

The transition will require changes in management behaviour, but also targeted investments in the business environment and the strengthening of new types of institutions.

Action needs to come from a broad coalition of government entities at different levels, private businesses, trade and professional associations and universities. Six key priorities were identified, which might be the sole or shared responsibilities of different levels of government, the private sector, or of multi-level public and private partnerships:

  1. Public investment, particularly in the education system, the transport infrastructure and in the UK's scientific and technological capacity - there should be a review of the regulatory structures for privatised activities.
  2. A productivity-driven regulatory context - or the creation of a policy context that raises the pressures and incentives for investment and upgrading.
  3. Clusters - the UK should mount a sustained programme of cluster development, involving the mobilisation of businesses and business institutions.
  4. Regions - more is needed to empower regional and local leaders in strengthening the regional focus of the UK's economic policies.
  5. Roles and institutions - a new set of institutions are needed in economic policy, and the private sector should be empowered to take a leading role in actions aimed at stimulating competitiveness.
  6. Management - UK managers have to re-orientate company strategies towards higher levels of innovation and the provision of higher value goods and services.

Given the current proposals in the sub-national review for an economic assessment duty, a key early task for local authorities should be the identification of clusters operating in or around their areas. This should be part of the overall assessment of the economic structure and dynamics of the area and part of the identification of its strengths and weaknesses as a place.

The clusters identified might not conform precisely to the full definition used by Porter. They may not command a large export share. They may not exhibit especially high productivity and their institutional and industrial links might be shallow but they might form the basic building blocks for further development. The Trends Business Research and Ecotec reports both provide guidance on how to identify and analyse clusters.

The Ecotec report provides guidance on how to sustain clusters. Since its publication, a good deal of expertise will now be embedded in RDAs. It is important to remember that there is no ‘one size fits all' strategy for clusters, and that the general advice now available should be adapted to the circumstances of place. However, from all that has been said above, there are clearly a number of factors critical to successful clusters applicable to all circumstances. They are:

  • the presence of functioning networks and partnerships
  • a strong innovation base with supporting research and development (R&D) facilities
  • a strong skills base
  • adequate physical infrastructure
  • the presence of large firms
  • an entrepreneurial culture
  • access to finance.

Clusters are mostly market-driven, and the main players involved in their development are the firms themselves. However, councils and others can ‘work with the grain' of the market to influence the functioning and quality of some of the factors listed above.

Supporting business networks or other ‘institutions for collaboration', for example, is a feasible activity for councils in some circumstances. Local government can influence the supply of premises, the quality of local transport services, and can assist the creation of a business support infrastructure. Most of all, they can influence the quality of education and the supply of skills.

An assessment of Baden-Wurttenburg, one of Germany's most successful regions, listed the quality of the local government agencies and the nature of the local political leadership as contributory factors to its success. Building strong partnerships with business, becoming involved in local business networks and developing a detailed knowledge of how the local economy works is critical to the role of local government as a place shaper.


References

Michael Porter (1990) ‘The Competitive Advantage of Nations'

Buy from Amazon UK. Price: £25. ISBN: 0-333-51804-7

Miroslav Jovanovic (Ed) (2007) ‘Economic Integration and Spatial Location of Firms and Industries'

This provides the best introduction to economic geography. It contains contributions from Marshall and Porter but also some heavy-duty economic theory.

Buy from Edward Elgar Publishing. Price £495 (online discount available). ISBN: 978-1-84542-583-8


Useful links

Business Clusters in the UK: a First Assessment - on the BERR website

A Practical Guide to Cluster Development (PDF, 81 pages, 580KB) - on the BERR website

2 May 2012

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