The Challenges of Industrial Clustering

A generation ago, the banks of Cleveland’s Cuyahoga River thrummed with the big machinery of steel foundries, paint factories, and oil refineries. Indeed, there were so many different industrial complexes in the city that when the river infamously caught fire in 1969, when sparks from a passing freight train ignited an oil slick, investigators were entirely unable to trace the source of the spill.

Today, city officials seeking to reverse the Forest City’s long economic decline are finding a much cleaner environment, but also a much less diverse industrial base on which to build. That’s why, when Clevelanders set out a few years ago to redevelop 1,600 acres downtown, they ended up placing their hopes on a single industry—biotech. But were they right to place all their chips on one square?

By most standards, Cleveland’s HealthTech Corridor looks like a big success, and a smart way for this Rust Belt city to enter the 21st-century economy. Since its opening in 2010, the Corridor has attracted 135 biomedical companies and, just in 2014, $398 million in new venture capital. But there’s another side to the story. Over the last year, key investors say growth in the Corridor has slowed. And besides the city’s healthcare sector, Cleveland lacks another robust industry to drive growth.

Cleveland is not alone among large U.S. cities in its increasing dependence on one or two industries, nor in its growing fears that this strategy may not be enough to recapture commercial glory. A growing body of evidence suggests that cities’ reliance on only one or even a few industrial clusters can result in a brittle economy and a high concentration of economic risk. As researchers Trefor Munn-Venn and Roger Voyer noted in their major study of industrial development strategies, dependence “on a single cluster can be particularly perilous, and regions with a number of well-developed clusters are likely to demonstrate more stability over time.”

Fewer Industries, Less Innovation

The recent idea that a community should focus on developing only one or just a few industrial clusters traces largely to the work of Harvard Business Professor Michael Porter and his 1990 book, The Competitive Advantage of Nations. This economic development strategy is simple: Identify an industry du jour, lure a concentration of businesses active in that sector, add a non-profit investment promotion office to “accelerate” new businesses, partner with nearby research institutions like universities, and reap the rewards of specialization.

Porter’s theory quickly gained traction in the academic and business communities, and in recent years, cities have set out to build clusters in industries ranging from the manufacture of storage batteries to the prefabrication of wood buildings.

One of the greatest cluster success stories is Alabama’s Automotive Hub of the South. Before the state struck a deal with Mercedes-Benz in 1993, Alabama produced zero passenger vehicles. But, in 1997, the first Mercedes M-Class rolled off the production line, followed by the 2,000,000th vehicle just last year. Then, in 2001 and 2005, Honda and Hyundai Motors followed Mercedes into the state, lured in by Alabama’s rapidly increasing number of automotive parts suppliers. Today, the three companies manufacture more than 700,000 cars a year in the state, and a slew of smaller vehicular suppliers—metal stamping shops, power train parts manufacturers, and motor vehicle seating businesses—support these larger players.

But increasing evidence suggests that the cluster strategy might not be working as well as it did a decade or so ago.

Footloose Corporations, Far-Flung Planning, and Fragility

One of the simplest theories as to why clustering might not be delivering the boost it once did involves the cost of luring in industries. Communities will often launch a cluster by enticing a large and well-known corporation, but will then invest most of their available tax subsidies on these established companies, rather than on the upstart players.

Tax credits look increasingly like a form of “tribute payment that localities must make to footloose business as the price for community survival,” says Fordham University Professor Paul Kantor. The young enterprises that need infusions of capital the most end up benefitting the least. To make matters worse, he says, a poorly conceived investment scheme can also choke off vital public services, like transportation and libraries.

This is true even of successful clusters like the “Automotive Hub” in Alabama. To lure Mercedes to build that first U.S. auto plant, Alabama had to offer the car maker an initial $253 million in incentives, the equivalent of $169,000 for each of the 1,500 jobs the company promised the state. This included charging Mercedes-Benz only $100—a little more than the cost to replace one tire—for the 1,000-acre site of its factory. The package also granted the corporation a 20-year exemption from state income taxes, forgoing revenue that normally would have gone toward education and infrastructure.

In a few instances, clusters have failed entirely. In 2005, the Malaysian government spent $150 million to open BioValley, a biotechnology complex aimed at growing the nation’s “knowledge economy.” But the project shuttered after only four years due to a lack of talented local employees and an inability for the nation to attract foreign pharmaceutical companies. Locals now call the site the “Valley of the BioGhosts.”

Clemson University Economics Professor Emeritus David Barkley says another big problem with such clustering strategies is the top-down planning necessary to make them work. “It’s a leap of faith to assume that development authorities appreciate regional, national, and international economic processes well enough to accurately assess regional competitive advantage.” Outside consultants and city officials often lack the proper information to make smart investment decisions.

Another issue with clusters is that they are inherently fragile. A report from Italy’s Centre of Research on Innovation and Internationalization describes how a biotech cluster in Lombardy, Italy, was undone in large part by a domino effect after one of the larger companies closed its doors. This resulted in a set of “competence gaps,” which made new biotech companies even less likely to join the cluster—until none were left at all.

A New Model

While most local officials might be sticking with the cluster strategy for now, UCLA professor David Rigby says that a growing number of experts are finding empirical data that proves that diversified economies perform better. Largely inspired by city planning expert Jane Jacobs, who advocated for a community-based approach to urban planning, proponents of this model say it offers better potential for city revitalization and job creation, and leads to less industrial dependency and financial risk.

A good example is Washington, D.C. After the 2008 financial crisis, many single-industry cities like Charlotte and Hartford stagnated. But according to University of Kentucky Professor Michael Samers, the nation’s capital rebounded quickly, and not only because of higher government spending. It was also, Samers says, due to Washington’s unique “combination of highly diversified technology companies, internationally-oriented legal [and] management and political consulting firms.”

University of North Carolina Professor William Rohe, author of a book called The Research Triangle, says a good example of such diversification is NC State’s Centennial Campus. That cluster comingles university departments, diverse early-stage businesses, and non-profits, Rohe says, allowing for spillover effects and the sharing of knowledge. The initiative represents a modern interpretation of North Carolina’s famous Research Triangle Park, and has acted as a springboard for the development of environmental health, information technology, nanotechnology, and smart grid technology companies.

A setting like Centennial Campus that provides a steady stream of new research, or an economy with many different industries, may also facilitate spin-offs of new, often unexpected, businesses. In this respect, this new approach is actually replicating some very old models. More than a century ago, for instance, St. Louis grew to become America’s second largest industrial city through a number of unplanned interactions among disparate industries.

Take the relationship between the meatpacking, tanning, and shoemaking industries. As University of California, Santa Barbara, quantitative sociologist Otis Duncan noted, “The development of new tanning processes in the latter part of the 19th century encouraged a shift in hide tanning toward the stockyard cities of the Midwest.” East St. Louis slaughterhouses and meatpacking plants sold cowhides to tanneries, which then sold their finished leather products to shoe companies.

The innovative tanning processes and large quantities of readily available cowhides contributed to the emergence of large manufacturers like Brown Shoe Co. and International Shoe Company. In 1910, for instance, St. Louis’s budding shoe industry produced over 26.3 million pairs of shoes.

In today’s 21st-century economy, many of the same rules apply. A report from the Research Centre on Biotech Business on pharmaceutical research reinforces the idea that the greater the diversity of research and manufacturing companies within a community, the higher the number of awarded patents. “Research with sufficient novelty and commercial viability to be patented often requires this diversification,” the report concludes.

Cleveland’s HealthTech Corridor may yet prove to be the success that Cleveland’s boosters hope it will be. But the wisest course for the community may be to direct future incentives for investments along the Cuyahoga to industries that have something else to offer besides just more biotech.