For about 20 years now, economic development literature has been singing the praises of industry clusters and the advantages of creating clusters of similar industries in a particular region. The underlying idea behind the theory is that if you get a bunch of similar industries in one place, the can take advantages of “economies of agglomeration.” That is to say, if they share the need for similarly skilled workers or similar types of supplies, the agglomeration of that demand for workers or supplies will create an efficient supply system and provide that cluster of industries with a sustained competitive advantage.
Recent research by economists William Kerr, Oliver Falck, Christina Günther and Stephan Heblich suggests that those vaunted agglomeration economies may be more apparent than real. The researchers found a case study to test the theories of agglomeration. When Germany was divided after World War II, there was a massive relocation of machine tool firms from East to West. According to this theory, the firms would cluster together and this would drive down each firms factor costs. That’s not how it turned out:
[Our] results show that heightened firm density can raise costs for incumbent firms in addition to the often-cited agglomeration benefits. This is an important consideration, for example, when policymakers contemplate efforts to promote their local areas by targeted cluster initiatives, bids to attract large firms (Greenstone et al. 2010), and similar. Policy efforts that are neutral in orientation, like physical infrastructure investments or initiatives to improve the generation and dissemination of knowledge, may be more effective alternatives. . .
The research is based on one industry in one country long ago. But it does raise some important caveats about attempts to build regional clusters as a form of economic development. You can read the full post here.