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The Case for Clusters

President Obama gave a good speech yesterday in Troy, N.Y. that nicely linked the renewal of fading manufacturing centers like Troy to the implementation of the administration’s emerging national innovation strategy.

 All through his remarks, the president did well to situate how national policy drift has left communities like Troy “dealing with what amounts to almost a permanent recession for years” and how a concerted national innovation strategy points the way to revitalization.

It’s too bad, then, that Obama did not mention in his speech (though it’s in the accompanying white paper) a particularly relevant new idea gaining traction in the administration and its Commerce Department that would have the federal government invest modestly in the enhancement of regional industry clusters--networks of interconnected, geographically concentrated businesses in the same industries.

Along these lines, the president’s budget requested $50 million in planning and matching grants for Commerce’s Economic Development Administration (EDA) “to support the creation of regional innovation clusters that leverage regions’ existing competitive strengths to boost job creation and economic growth.” Grants would be allocated on a competitive basis to local governments or non-profits to support initiatives in knowledge-sharing, workforce training, or marketing. The idea holds considerable promise and is drawn from a large body of economic and business literature, as well as a report we released in April of 2008.

Alas, the proposal has not been embraced wholeheartedly by Congress. House members representing rural districts--which have clusters that would benefit from the proposal-- have been especially cool to an idea perceived as transferring EDA money to urban areas. Other members are reportedly concerned that the competitive application process would result in too many regional losers and only a small number of beneficiaries. Others simply pooh-pooh the notion of industry clusters. As a result, both chambers of Congress support the program but only at something like a 30 percent discount.

So, why is funding cluster initiatives a good idea?

To begin with, there are powerfully supportive theoretical arguments, which date back to Alfred Marshall’s 1890 economics treatise. Through easier access to shared ideas, skills, and transactions, clusters exhibit external benefits that no one company can expect to capture, making the social benefit larger than the private costs. Cluster initiatives can reinforce these advantages through, for example, training and R&D projects, which are under-provided privately because some share of the gains leave the company. Federal support is crucial, even in good times, because metropolitan cluster economies traverse local and state boundaries. A final point is that coordinated cluster-based assistance can help revitalize declining areas reliant on a weakened industry by helping that industry adapt. Think the industrial Midwest, grappling with the decline of the auto-industry.

But let’s go beyond theory. As it happens, there is a robust body of empirical work from economists documenting that clusters generate large public benefits. In a classic paper, J. Vernon Henderson uses plant level data and finds that the presence of other firms in the same industry and county dramatically increase productivity and productivity growth. Ryohei Nakaruma uncovers a similar effect in Japanese and UK industries. Rosenthal and Strange show, in a number of papers, that job growth and entrepreneurship is enhanced in areas with a high density of businesses, especially smaller businesses, within a one mile radius. Finally, Wheaton and Lewis find that wages are 16 percent to 46 percent higher for workers living in metropolitan areas with more concentrated industries. And contrary to what some might think, population density is not an essential component to these benefits. Clusters in rural places also exhibit higher wages, as Gibbs and Bernat demonstrate, and faster job growth, according to Mollick.

To be clear, the federal government cannot and should not create clusters ex nihlo. But it can intensify the forces of agglomeration that attract companies from the same industry to locate in the same region, and it can support the revitalization of declining industries, on the one hand, or further enhance vigorous industries on the other.

Advancing modest resources to further stimulate the collaborative activity of regional industry clusters would be a great way to tap the innovation potential of U.S. metros, whether in Dubuque, Albuquerque, or…Troy. The Obama administration is right to advance these policies, however tentatively, and Congress should support its efforts with full funding.