Understanding Cluster Theories and Regional Innovation

1. Content of the lecture • Discussion of two theories of regional clusters, (Marshallian) industrial districts and Porters regional clusters. • The two cluster theories are discussed in the context of innovation. A main theme is to which extent and how the two types of clusters stimulate the innovation capability of cluster firms. • The interest in innovation is related to some ‘stylised facts’ about firms’ innovation processes: - Firms rely first of all on internal competence in their innovation activity - However, firms also often bring in ideas, information and knowledge from external actors during the innovation process - The ‘quality’ of the external environment and the firms’ ability to use external knowledge determine to a large extent the innovation capability of an economy - Firms often find external actors of importance for their innovation process in their local area. These actors may constitute regional clusters or innovation systems.

2. A remarkable industrial development in the 3. Italy (NEC) from the 1960s • The 3. Italy (NorthEast and Central parts of Italy) demonstrated job growth in manufacturing in the 1960s and 70s while other parts of Italy stagnated or declined in number of manufacturing jobs. • The growth took place in traditional (‘old’) sectors such as textile and clothing, footwear, furniture, ceramic goods and mechanical engineering, regarded as generally stagnating sectors in western countries • The growth occurred in small and medium sized enterprises (SMEs), while the dominating growth paradigm was mass production in large firms achieving economies of scale (Fordist industrial production) • The SMEs in the same sectors were concentrated in specific areas (such as textile areas, shoe areas etc.), where the firms formed local networks, also often containing machine builders. • The growth of SMEs and jobs in the 3. Italy marked a deconsentration of manufacturing from large industrialised cities in the 1. Italy (north west) to smaller towns in the 3. Italy (diffused industrialisation). • The 3. Italia model received great interest by researchers, policy makers and politicians as a possibly new, promising development model.

3. Why did the industrial districts grow? • The growth of the industrial districts took place due to a combination of general and specific factors. The specific factors triggered off the growth when the general factors became favourable for the districts • General factors a. Increased market possibilities outside Italy due to better transportation and EU b. Increased demand for more niche products (quality products in small batches where SMEs have an advantage compared to LSEs) c. Technological innovation, i.e. computerised production equipment that makes small batch production more efficient • Specific factors in the 3. Italy a. Tradition and knowledge in entrepreneurship and management of small firms coming from a specific form of farming (share cropping) b. Tradition of family firms (which are a flexible towards market changes) c. Tradition in craft work and the existence of technical schools d. Knowledge in trade and export (such as the ‘impannatores’ in the textile industry in Prato) d. A reserve of unemployed and underemployed in small scale farming that could work for low salaries (in the development of the industrial districts) e. Egalitarian societies characterised of local identity and solidarity, which stimulates local collaboration. Strengthened by the activity of socialist political parties

4. What is an industrial district? Definition of the districts • The districts have many firms and jobs in one or a few adjacent industrial sectors in a local area. (The area is overrepresented with jobs in a sector compared with the national average, as measured with location quotients) • Local networks between firms creating external economies, i.e. the achievement of effective production through extensive, external division of labour between firms specialising within various phases of a production chain. (What can happen to achieve more effective production when firms share the same suppliers?) • A specific, local socio-cultural dimension denoted as Marshallian agglomeration economies consisting of three factors: a) mutual trust between firm leaders, workers etc. that reduces transaction costs, b) accumulation of skill among workers (denoted as an ‘industrial atmosphere’) c) stimulation of incremental innovations through ‘learning by doing’ and ‘learning by using’ by factor a and b

5. Strength: Firms in the district frequently develop incremental innovations Why? How can the districts’ strength in developing innovation be explained by the districts’ external and agglomeration economies? Weakness: The districts are slow in developing and making use of radical innovations? Why? Which characteristics of the districts may explain their weakness as regards radical innovations? Strength and weakness of industrial districts as regards innovation activity

6. From Mark I to Mark II industrial districts • Mark I Industrial districts: Traditional industrial districts with considerable growth in the 1960s and 70s. The local system of firms is innovative, first of all as regards small, stepwise changes in products and processes (incremental innovations). The innovation activity builds on the experience based competence of entrepreneurs and skilled workers, and on close cooperation between persons and firms in an atmosphere of mutual trust and understanding (i.e. agglomeration economies) • Mark II industrial districts: In the 1980s the traditional industrial districts had to upgrade themselves to mark II districts in order for firms to carry out more radical innovations. Radical innovations were necessary to meet increased competition from low cost countries and to introduce more advanced technology. Upgrading to mark II districts take place through the establishment of centres for real service. The centres have specialised competence for the dominating industrial sectors in the districts. The centres offer subsidised services to firms, such as information about markets and technological development, help in exporting or in introducing new production equipment. The centres supply the system of firms with professional competence that small firms often cannot possess themselves, but competence necessary to carry out more radical innovations

7. Why the large interest in industrial districts? • The interest in industrial districts far exceeds their empirical significance. Districts are of some importance in countries with craft traditions like Italy, Spain, France, Denmark (and examples are found in Norway) • The interest of the districts is rooted in: a) the fact that the districts may constitute a possibly new and more human-centred industrial development. The model symbolise the possibility of small firms and craft skills in a world of impersonal big firms and deskilling b) the emphasizing of social and cultural factors (as traditions and trust) in economic life, i.e. that industrial development rely on more than ‘economic factors’, c) what the districts can tell about the mechanisms of innovation, learning and knowledge flow, i.e. that these build on factors in the local environment and not just on factors internal to firms, d) what the districts have to say about the possibility of independent SMEs to be internationally competitive as long as the SMEs collaborate, i.e. that local areas can develop without relying on large firms

8. Industrial districts as a sign of wider industrial changes in western countries: A Second Industrial Divide • A famous book from 1984 (Piore and Sable: The Second Industrial Divide: Possibilities for Prosperity) put the development of industrial districts in Italy and other places (as Baden Württemberg) into a wider context. • The authors saw the development of industrial districts as empirical proofs of wider, epoch-making changes in the world economy, i.e. as the coming of a new, dominating way of organising industrial production, which they called flexible specialisation, and which could at least partly replace the then dominating Fordist production regime (mass production of standardised goods) • Flexible specialisation is effective in the production of quality products for quickly shifting markets • The new flexible production method reflects changing in market condition (more uncertainty, increased demand for tailor-made products) requiring more flexible production methods • The flexible specialised production was seen to occur in particular in local networks of SMEs using computerised production equipment (while we now also see diversified production in large firms)

9. Critics of the industrial district /flexible specialisation hypothesis • The hypothesis of a widespread growth of industrial districts and a new dominating production principle has been criticised. The critics point to: a) too broad generalisation of fairly few empirical cases. The formation of industrial districts is partly based on some place-specific factors (i.e. socio-cultural factors) which are difficult to transfer to or copy in other areas. That is, the Italian type of industrial districts cannot be found in very many places. b) poorly defined central concepts. This lead to many types of agglomerations (clusters etc.) being classified as industrial districts without satisfying the strict definition of the districts. Thus, the phenomenon of a new flexible specialised economy is overstated • However, the main diagnosis by Piore and Sable of main trends in the economy seems right, and the 1970s marked a basic change in the economy of western countries • Important is a) the trend towards vertical disintegration (outsourcing), b) more long-term collaboration between clients and suppliers, and c) the growth of different types of industrial districts and regional clusters

10. Challenges for industrial districts in the more global economy • The industrial districts grow in the 1960s and 70s as local networks of SMEs, i.e. most of the firms in the value chain were found within the same local area • A more global economy challenge the districts in several ways: a) firms in the districts begin to source cheap components from abroad (from low cost countries, in particular from Eastern Europe) – destroying the local production system, b) knowledge-intensive firms in the districts are incorporated in international corporations – destroying the local control over important firms in the district b) in some areas leader firms arise (from within) that are capable of technological and market leadership, and of managing complex subcontracting relationships – destroying the dominance of SMEs and the symmetric relations between firms • Why do such development trends (a-c) threaten the industrial district idea? • One important researcher in industrial districts asks what is necessary to qualify as an industrial district: ‘Does it simply become a centre of design, ideas and innovation (…) or does it have to contain the entire division of labour in an industry? (Amin 2000: 166)

11. The boat-building industry in the Arendal-Grimstad region: The growth of an industrial district? The development of the industry: Six historical phases • The start: Tradition and knowledge about boatbuilding from the period of sailing vessels, when Arendal was by fare the largest shipping town in Norway • The revolution with the building of glass fibre boats in the 1950s. This kind of boat building started in Arendal by the linking of external knowledge and local competence • Spreading of the knowledge in the local area in the 1950s and 60s, giving rise to many start-ups and growth • The growth of giant firm Fjord Plast, and the centre for the building of motor boats in Europe • Restructuring in the 1970s and 80s. Start-ups, specialisation on firm level and growth of subcontractors

12. The background of Porter’s cluster theory • Michael Porter departs from studies of firm strategies, particularly the question of how individual firms can compete internationally • In the 1980s he started to study what makes a nation’s firms and industries competitive in global markets. This research led to the theory of clusters, first national clusters (1990), then regional clusters (1998) • The central idea behind the cluster theory is: a) that the national (or regional) environment is of central importance in stimulating firms’ competitiveness (‘Competitive advantage is created and sustained through a highly localized process’), b) that the environment influences the ability to succeed in particular industries or industry segments (nations become the home base for competitive firms in some particular industries, and most important is competitiveness in sophisticated industries), c) that the international successful firms in an industry constitute systems or clusters of firms, and d) that firms and industries become competitive by continually upgrading and innovation (and by developing new and sophisticated industries)

13. The sources of locational competitive advantage in a nation (‘the diamond’) • Four broad attributes of a nation form an environment that can promote or impede the creation of competitive advantage by firms in specific industries 1) Factor conditions. Factors of production (inputs) such as skilled labour, natural resources, capital or infrastructure. Important factors are created, and disadvantage of factors can contribute to sustained competitive success (e.g. automation because of high labour costs) 2) Demand conditions. The quantity and particularly quality of home demand for the industry’s products / services (the importance of sophisticated and demanding customers for innovation). Important in small countries like Norway? 3) Relating and supporting industries. Supplier and related industries that are international competitive. Support cost-effective supplies and stimulates innovation 4) Firm strategy, structure, and rivalry. How companies are created, organised, and managed, and the nature of domestic rivalry. How firms are managed support some type of industries more than others (f.ex. liberal and coordinated market economies ‘support’ different types of industries) • Two additional variables can influence the national system in important ways; chance and government policy

14. The environment (‘diamond’) and clusters • The factors (the ‘diamond’) influence and reinforce each other and combine into a dynamic system • Domestic rivalry and geographic industry concentration have especially great power in transforming the ‘diamond’ into a system. Domestic rivalry promotes upgrading of the whole national ‘diamond’. How?Geographic concentration magnifies interaction within the ‘diamond’. ‘The process of clustering works best when the industries involved are geographically concentrated within a industry’. (Porter in 1990 then foresaw the regional cluster from 1998) • Nations succeed in industries where the national environment (home base) supports firms’ innovation activity and accumulation of specialised assets and skills in unique ways (which means that the advantages are difficult to copy by firms in other places) • Nations succeed not in isolated industries, but in clusters of industries connected through vertical (buyer/supplier) and horisontal (common customers, technology etc.) relationships. A nation’s economy contains a mix of clusters. Why? • The factors in the ‘diamond’ in particular influence innovation activity and dynamism in a cluster

15. Putting Porter’s theory of national clusters into practice in Norway • Reve and Jakobsen (2001) studies six selected, important industrial sectors in Norway: - seafood (aquaculture and fishing, including upstream activities like fodder production, equipment and boat building, and downstream activities like production, marketing sale, distribution) - energy (mainly oil and gas, including searching, refining, distribution etc.) - maritime, including shipping / shipowners (the hub), ship building, equipment, sea insurance, classification, ship brooking, ship finance, maritime IT etc. - ICT, including software producers, hardware producers, distributors and traders, and network operators - trade - finance and insurance • Three of the sectors are seen to constitute strong national clusters: seafood, oil and gas and maritime. These industries have in particular strong market relations (demanding customers and export), relation to other national actors (seafood has the highest score), and factor conditions (oil and gas has the highest score) • The three sectors constituting clusters perform better (with some exceptions) than the three other sectors. The clustered sectors grow faster, have higher productivity and higher wage level. Why? Explained by upgrading.

16. Porter’s definition of regional clusters Porter (1998) defines (regional) clusters in different ways and attaches large importance to clusters • Definition: Clusters are geographic concentrations of interconnected companies and institutions in a particular field. (…) Many clusters include governmental and other institutions (…) that provide specialised training, education, information, research, and technical support (p. 78). Similarities and differences with national clusters (the ‘diamond’)? • Relation between firms: Clusters promote both (horisontal) competition and (vertical) cooperation (p. 79) • The role of the local environment: Clusters reveal that the immediate business environment outside companies plays a vital role as well (p. 78) • Importance: The enduring competitive advantages in a global economy lie increasingly in local things – knowledge, relationships, and motivations that distant rivals cannot match (p. 78) • Importance: Today’s economic map of the world is dominated by (…) clusters: critical masses – in one place – of unusual competitive success in particular field (p. 78)

17. Clusters and upgrading mechanisms, or why clusters are critical to competition Dynamic regional clusters are seen to stimulate innovation activity and the competitiveness of cluster firms. That is, clusters have three important upgrading mechanisms (that explains why cluster firms are competitive): • Innovation pressure, which requires a) advanced, demanding customers, b) rich communication between customers and suppliers, and c) that clients can choose between alternative suppliers (competition between suppliers). The innovation pressure may be spread backward in the value chain • Complementarity, which means that firms share common resources (such as infrastructure, experienced labour, suppliers and services). The resources may become better and cheaper when there are a larger market for them (f. ex. better roads, schools, or cheaper services) • Knowledge flow, when firms cooperate (f. ex in innovation projects), when workers change jobs, when firms use the same consultants and suppliers, and when research are commercialised To which extent are the upgrading mechanisms dependent on the activity of regional clusters? Or may the mechanisms function also when firms are not co-located?

18. Question • What are the main differences between Porter’s cluster theory and the theory of industrial districts? What are the differences as regards the definition of clusters / districts and the mechanisms underpinning innovation and competitiveness of clusters / districtricts?

19. The life-cycles of clusters Porter (and other) propose a historical development of clusters consisting of birth, development and possibly decline. Five main phases are proposed: • Formation of pioneer firms often based on specific local knowledge, and specific local demand, followed by new firm spin-offs. • Creation of a set of specialised suppliers and service firms, and a specialised labour market. • Formation of new organisations that serve cluster firms. • Attraction of outside firms, skilled workers, and fertile grounds for new local companies. • A period of decline for the clusters may occur due to both external and internal factors. External factors are particularly technological discontinuities and market changes. Internal factors are less local rivalry, groupthink

20. Critique of Porter’s cluster theory • Porter’s cluster theory has received some critique from other researchers: • Are clusters a functional phenomena (related industries and firms within a nation) or a geographical phenomena (geographic concentration of interconnected firms? Changing perspective by Porter from 1990 to 1998. Focus on firms’ home base, which are geographical concentrated, while suppliers etc. are found over a larger geographical area • Very elastic definition of the ‘cluster area’. Porter writes: ‘The geographic scope of a cluster can range from a single city or state to a country or even a group of neighbouring countries’. Then clusters are a very divers phenomena, giving the rise to ‘political cluster’, i.e. a cluster is what someone decides to call a cluster • What is the role of public actors in supporting clusters? Government policy as a less important factor in the ‘diamond’ model, or cluster as the way to carry out industrial policy? • Why the large importance of clusters these days? Porter dos not situate his cluster theory in any spatial and historical context, like the industrial district theory proposing that districts as growing owing to some specific local factors in the third Italy in particular, and as a sign of larger changes in the world economy (the coming of flexible specialisation as new dominating way of production)

21. The development of regional clusters in Norway. • Delimiting potential regional clusters in Norway by use of statistics. Criteria: 1) Start with labour market areas (the regions) 2) Delimit industries and regions with a location quotient (LQ) higher than 3,0 3) Chose regions with more than 200 employees and 10 firms in the dominating industry (LQ > 3,0) • Job growth in the regional clusters. Two development trends: 1) Relatively high job growth (small job loss) in the regional clusters compared with the same industries in Norway. Some support for the cluster hypothesis? 2) The exception is first of all some clusters in the large cities demonstrating relatively large job losses. This reflects the national deconsentration of Norwegian manufacturing industry

22. Hammerfest Vadsø ô ô ô Alta ô Nord-Troms ô Rørvik Tekstil og bekledning (2) Næringsmiddel (e.g. fisk) (4) Fiskeoppdrett (17) Trelast og varer av tre (9) Møbler og annen industriproduksjon (4) Kraft- og vannforsyning (2) Transportmiddel (e.g skip) (5) Utvinning av råolje og naturgass (2)Elektronisk og optisk industri (3)Bergverksdrift (1)Papirmasse og papir (1)Kjemikalier og kjemiske produkter (3)Gummi- og plastprodukter (2)Ikke-metallholdige mineralprodukter (2)Metallvarer (2)Maskiner og utstyr (3)Off. adm. og forsvar (1) Namsos Finnsnes ô ô Brekstad P Andselv ô Frøya/Hitra ô ô Vesterålen ô Kr.sund Lofoten Surnadal ô Ålesund Ørsta/Volda ô Ulstein- vik Ørsta/Volda Ørsta/Volda N.Gudbr.dal Nordfjord ô ô vik Elverum Mosjøen Sogndal/ Årdal Florø ô ô Høyanger M Sandnessjøen Hamar ô N. Sunnhordland Kongsv. Brønnøysund Drammen Kongsb. Moss M Haugesund Vest-telemark Halden Stavanger/ Sandnes M Sandefj./Larvik Jæren Skien/Porsgr. Lyngdal/Farsund Mandal Arendal P M M Gjø Askim/Mysen Fr.stad / Sarpsb.

23. Lessons from the cluster theory for designing industrial policy • A shift from comparative (better access to raw material, cheap energy sources, natural harbours, large market) to competitive advantages (unique, place-specific factors stimulating learning and innovation activity). Clusters are places that in particular stimulates the formation of competitive advantages according to Porter • Thus, policy should promote cluster formation and upgrading. This can be done by ensuring the supply of inputs (skilled workers, infrastructure), stimulate rivalry (how?) • Government should support all clusters, however, governement should reinforce and build on existing and emerging clusters rather than attempt to create entirely new ones