Location, Location, Location: Creating Innovation Clusters

During the recession of the early 1980s, the state of North Carolina suffered the loss of its traditional economic backbone. Jobs in tobacco processing, textiles, and furniture manufacturing declined dramatically. Faced with this crisis, Governor Jim Hunt decided to emphasize innovation-based economic development, eschewing low-wage manufacturing jobs in favor of broad-based wealth and prosperity. At the time, North Carolina was already home to the Research Triangle Park. But steady and consistent state policy, investment tax credits, and quasi-governmental, sector-specific agencies helped create the vibrant entrepreneurial economy that now exists contiguous to the park. The life-science cluster located there is the third largest in the United States, behind Massachusetts and California, employing more than 58,000 workers and paying above-average wages in a range of occupations from researchers to lab and production technicians.

But this isn’t just a North Carolina story. Across the United States, innovative clusters have proliferated beyond early high-tech leaders like Silicon Valley, Route 128 (in Massachusetts), and the Research Triangle. Newer and emerging conglomerations in San Diego, Austin, and the greater Washington, D.C. area, for example, have gained considerable traction over the past 20 years. These clusters specialize in a range of high-tech sectors, including telecommunications, human bio-therapeutics, and computational technology. Other regions have established successful clusters in a variety of specialized functions, such as non-woven textiles in Raleigh, furniture in northeastern Mississippi, shipbuilding in Maine, and medical devices in Minnesota, to name just a few examples.

What can the rise of these clusters tell us about entrepreneurship policy? Innovation and entrepreneurship are two sides of the same coin: Entrepreneurs recognize opportunity and innovate. Location becomes important not only for recognizing opportunity but also for cultivating an environment dedicated to the entrepreneurs’ activity, which in turn lowers the cost of innovating. But while entrepreneurship is a private-sector activity, it is public policy that sets the stage by establishing property rights, providing incentives to encourage experimentation and discovery, and determining how the rewards will be allocated. Beyond that, policy is often needed to fill in elements of the ecosystem not provided by the private sector, supply information about opportunities, and offer incentives that lower the risk of engaging in innovative activity, making it easier for new firms to develop. To encourage clusters and the entrepreneurial spirit, the federal and state governments should know not only when and what policy interventions are needed, but also when their efforts get in the way.

The Benefits and Pitfalls of Clusters

Think of economic development as nested Russian dolls, with one layer fitting snugly into the others: first companies, then the cluster, next the region, followed by the state and the nation—and ultimately the entire world.

The idea that location benefits economic activity flies in the face of globalization’s relentless logic and challenges the importance accorded to the search for low-cost locations. Grounded in place, innovation and entrepreneurship rely on an ecosystem of firms (both suppliers and customers), universities and community colleges, government agencies, and trade associations, all systematically aligned to encourage creativity and experimentation. Once started, concentrations of industries within places become self-reinforcing as talent is attracted to opportunity, the flow of ideas increases, and their potential is understood and appreciated. With that dynamic, it becomes easier and less costly for entrepreneurs to realize their dreams.

Clusters burgeon through self-organization as resources are attracted to a place and subsequently accumulate. This in turn cultivates a buzz around the potential of a locale. For example, the California gold rush of the 1840s and ’50s attracted suppliers, such as Levi Strauss, who invented the blue jean as the perfect clothing for prospecting. To this day, Levi’s remains a global brand headquartered in San Francisco.

But there are three potential pitfalls associated with clusters: first, overspecialization and its possible negative impact; second, aggregate consequences confined to the geographic location; and third, the deleterious tendency of firms to limit their potential by “following a leader” and thus concentrating their efforts on the same industries and technologies.

The first problem arises when successful places become overspecialized. When a dominant industry matures, leading firms can fail to innovate and fall prey to what Harvard’s Clayton Christensen calls the “innovator’s dilemma.” This is what happened in Akron, Ohio, in the late 1970s as the tire manufacturers located there failed to respond to the introduction of French radial tires, thinking their 80 percent global market share was secure. Akron’s economy had become specialized around tire manufacturing and did not diversify into other industries. Similar stories can be told about the demise of the steel industry in Pittsburgh, textiles in both New England and the South, and automobiles in Detroit.

A second problem is that clusters can have a negative impact on the local community. If residents are not able to take jobs in the cluster industry, the influx of new workers can result in increased local congestion thereby requiring the construction of new roads and schools. Dramatic population increases can also inflate housing prices, which raises the property taxes for long-time residents. Neighborhoods in Phoenix experienced these consequences as population growth of 15 to 40 percent in the past decade strained the region’s capacity. In addition, the immigration of skilled workers, who may be more highly compensated than the local workforce, can result in a widening of income disparities that may produce social and political tensions. This was notable in Silicon Valley as the influx of high-tech workers crowded out the agricultural workers who had been there for decades.

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