Clusters have, over the last decade, become an increasingly popular topic of academic research and economic practice. The number of conferences attended and articles written on the topic, (including one in fDi’s October/November 2003 issue) keeps on rising. All the while, hundreds of cluster initiatives formed by groups of business executives and public sector officials are engaged in upgrading the competitiveness of “their” cluster.

Company executives and government officials in charge of FDI attraction have taken notice. Costa Rica’s success in attracting a major investment from Intel against competition from Brazil and Mexico, for example, has been credited, at least in part, to their cluster-based approach. Many other investment attraction agencies, from Sweden’s ISA to Eastern Germany’s IIC to the Singaporean government, have organised their activities around clusters. In the US, the Governor of Maryland recently even appeared on Boston radio to promote his state’s life sciences cluster to the biotech community in Massachusetts.

Research results

What has recent research in this field been all about, and what are the implications for FDI practitioners?

In research, two issues stand out: First, research in the field has become much more serious about quantitative data and empirical testing. While in the past typical work focused on using individual case studies to deduct concepts, now much interest is devoted to creating broad data sets that can be used to systematically test theory and compare clusters.

Second, research has started to distinguish much more clearly between clusters as an empirical phenomenon and clusters as a tool for economic policy. While proving the existence and economic benefits of clusters is important, it turned out that alone it is insufficient to be able to turn these insights into effective practical policy.

For FDI practice, the new research opens up further avenues for applying the cluster concept. For government, it suggests improvements for the way FDI attraction is done. More thoroughly tested concepts, better data, and more systematic thinking on the role of FDI in efforts to upgrade competitiveness are now available.

For companies, it can lead to more efficient locational decisions and FDI follow-up. Locations can be evaluated using a broader set of indicators better tied to company strategy, choices can be made based on more available data, and companies can get guidance on how to best get involved in improving their new location once the investment has been made.

Recent findings

The quantitative data now available indicates that even within a given field, say IT, different locations have developed unique positions. You do not need to be Silicon Valley to have an IT cluster – and your ambition might not be to be the leading innovation centre in the world. A good example is the multitude of shoe clusters in Europe: Portugal specialises in quick runs for the European market, Italy in design and high quality, and Romania in medium-quality production for Italian companies. Romania also shows that when FDI is used to migrate activities to another country, it again tends to co-locate, in this case to the Timisoara-region.

The same is true for outsourced business services in India, which are strongly concentrated around New Delhi and Bangalore. De-clustering through FDI is a myth; instead new clusters are emerging and old ones are getting more focused on areas of inherent strength.

The data now available also provides clear evidence on the economic benefits of clusters. In the US, wages in clusters drive the overall wage level in regional economies, and regions with higher and increasing shares of employment in clusters in which they have a strong position do better in terms of their wage level and their wage growth.

For countries receiving FDI, the data is sketchier but the actual investment decisions are revealing: FDI flows seem to target existing or emerging cluster locations, not avoid them. Companies clearly see the cluster benefits such as the ready access to specialised suppliers and employees as sufficient to outweigh the often-higher costs at cluster locations.

Finally, some clear lessons are emerging on how to turn clusters into an effective tool for policy. Should active cluster development be tried at all? The answer from research is at least a cautious ‘yes’: cluster development is a history-dependent process driven by decisions of multiple actors, and in such situations co-ordination can help a cluster reach an evolutionary path associated with higher prosperity.

The research suggests that a key part of the puzzle is the tight co-operation between all companies and public agencies in the cluster. Working together, they can identify and address existing bottlenecks in their business environment that hold back innovation and productivity. If that bottleneck is a missing specialised supplier or service provider, FDI attraction might just be the action needed.

Implications for FDI

Governments can use clusters both to become more successful in attracting FDI and to increase the economic value FDI generates for their economies. Countries should concentrate their marketing efforts on companies that fill gaps or increase depth in clusters where they have an established or at least emerging position. First, for such companies the country will be inherently attractive because it provides established markets, suppliers, and skilled employees. This increases the likelihood of attracting them.

Second, the negotiations with such companies will tend to quickly move away from financial incentives alone and concentrate on the quality of the cluster-specific business environment and how it can be improved. In these areas much more can be done, especially when the ability to compete on financial packages is increasingly restricted such as in the EU.

Third, attracting such companies not only creates direct benefits through job creation. It also improves the quality of the location for the companies already present in the cluster, partly by adding relevant activity in the cluster and partly by upgrading the business environment to attract the new company. This will increase the sustained impact of the FDI attraction, and it avoids the focus on foot-loose plants exploiting only short-term arbitrage opportunities.

Location selection

Companies, too, can use clusters to improve their strategy of selecting new locations for their activities. Existing clusters indicate the presence of beneficial conditions for companies located there. Clusters thus provide much more specific information than the generic data on labour market conditions, physical infrastructure, and tax rates that many regions use to market themselves. And because clusters take so much time to develop, their existence also indicates a more stable presence of beneficial conditions than the one-time commitment of a government providing financial incentives.

Also, by tapping into additional clusters, companies can get direct access to skills and ideas that otherwise would not be as readily available. By choosing locations in order to strengthen activities critical for the strategic positioning of a company, FDI can improve the uniqueness of a company, not just its effectiveness in terms of production or serving new markets.

Furthermore, companies can limit their initial exposure in a new market by investing in a cluster. In existing clusters a new investor will find many of the related services and supply activities that it would otherwise have to cover itself in order to be able to operate at the new location.

What’s ahead?

There is one lesson from the research on clusters that can help both FDI attraction agencies and investing companies to get more out of their efforts: look at investments into clusters as the beginning of a continuous effort, not as a one-time event.

For government agencies, FDI attraction needs to be embedded in a broader strategy to upgrade the cluster and the overall quality of the region/nation as a location to do business. The successful investment is just a small step on a long road. Organisationally, investment attraction agencies need to be better integrated with other parts of the public sector affecting the business environment; much more so than when FDI attraction is based on financial incentives alone.

For companies, the sustained value of a new location depends on a continuous process of upgrading the external business environment as well as internal operations. This process will only be successful if companies get engaged in cluster upgrading rather then treating it as the public sector’s responsibility. Being part of cluster and regional competitiveness efforts is not only a sign of good corporate citizenship for foreign (or domestic) investors; it makes good business sense.

For further information see:

www.isc.hbs.edu on further research and U.S. cluster data

www.weforum.org/gcr on the strength of clusters across nations

www.cluster-research.org on cluster initiatives and Swedish clusters

www.clustercompetitiveness.org on measuring cluster initiatives effectiveness