Business Clustering: Panacea or Placebo for Regional Australia?

Introduction

According to Michael Porter, a cluster is a geographically proximate¹ system of interconnected companies and associated institutions linked by commonalities and complementarities. Due to the emergence of external economies, its value, as a whole, is greater than the sum of its parts. For this reason, clustering has been extolled as an almost universal cure for ailing economies, be they national or regional. According to its popularisers, clustering is the economic grail of productivity, development, and wealth creation. A growing number of governments have begun to develop a clustering approach to economic development, believing they can maximise their resources by focusing on their “core competencies”— key sectors in specific places. “But have policymakers responded too enthusiastically?” asks Edward Feser. Does the presence of collocated firms deliver real benefits for regional economies, or is clustering no more than a developmental placebo given to humour a patient who, though perhaps making a modest recovery, will eventually succumb to the forces of the global market? Feser believes that the logic behind many clustering initiatives is often poorly specified and that, at the local level in the U.S. at least, the approach often involves little more than the application of traditional development initiatives to industries that have a regional specialisation.

Theory

Casual observation of economic development suggests that location matters, and even in the information age, it can play a vital role. The importance of clusters stems from:

• A process which might start with an initial natural advantage or chance use of a location, leading to collaboration among several firms.
• These firms might attract common suppliers or prove to be a magnet for the attraction of customers who can go to one location to find a group of firms offering similar products. The technical term for these attractions of a cluster is “network externalities.”
• Over time the firms within a cluster develop relationships which depend on close proximity and trust. We can call this “relational capital.” This improves productivity and innovation and serves as a further attractor to new entrants.
• Research and training facilities develop around the cluster which serve to enhance the inventiveness and productivity of existing firms.
• Eventually a cluster may stop growing or decline as the customer and knowledge base changes.

These steps are illustrated in Figure 1.

Figure 1: The Cluster Process.

An alternative view of the cluster process is provided by Michael Porter of Harvard (see Figure 2). In his book, The Competitive Advantages of Nations, Michael Porter makes the case for thinking about economic development in a different way than public policy makers have done in the past. Porter argues that economic vitality is a direct result of the competitiveness of local industries and that local conditions have a profound effect on international competitiveness. Conditions affecting competitiveness are not, however, always cost-related factors or natural resources.

Figure 2: Sources of Locational Competitive Advantage.

The four key determinants of competitiveness, which Porter calls the “Diamond of Competitive Advantage,” are based on cases from around the world:

1. factor conditions, such as a specialised labor pool, specialised infrastructure, and sometimes selective disadvantages that drive innovation;

2. home demand, or demanding local customers who push companies to innovate, especially if their tastes or needs anticipate global or local demand;

3. related and supporting industries, internationally competitive local supplier industries who create business infrastructure and spur innovation and spin-off industries; and

4. industry strategy, structure, and rivalry, intense local rivalry among local industries that is more motivating than foreign competition, and a local “culture” which influences individual industries” attitudes toward innovation and competition.

In addition to these four areas, Porter includes the roles of chance and government. Often historical accident and/or government actions play significant roles in the early development or site location of local industry clusters.

The importance of clusters stems from the assumption that economic development flows from innovation and productivity, which are driven by cluster collaboration and competitiveness rather than resources and factors of production. Hence:

Examples of the impact of clusters through this process include:

• Australia:

• Torquay and the surf products cluster

• Daylesford and tourism

• Albury/Wodonga and food processing

• IT in North Sydney

• Horse breeding around Scone

• and overseas

• The Basque country

• Cambridge (Mass. and UK)

• Italian leather

• Silicon Valley.

Clusters can be broad or narrow. The existing timber products and winery clusters in Western Victoria are relatively narrow and not yet fully developed. However, the potential for expansion vertically (along the supply chain) and horizontally (bringing in firms in similar product market space) is illustrated by the maps of wine and timber products clusters in California and Sweden respectively (see Figures 3 and 4).

Clusters and Public Policy

Outside the confines of interventionist approaches to clusters (where economic development might seek to “build” clusters), the only approach that commands significant support in modern market economies is one which helps to support and upgrade clusters. Extending support for clusters in a local economic context might involve:

• Complementary assets: help create training programs, research institutes, roads and infrastructure
• Technology transfer: link SMEs with technology providers at home and overseas
• Linking with seed capital and venture finance
• Lobbying: work collaboratively with firms and other institutions to build local facilities and attract government funded research
• Fostering networks: provide information and forums
• Attract investors: prioritise key investors, develop investor recruitment marketing plans
• Seed develop advanced and specialised factors
• Map, benchmark and encourage: maintain a data base on the cluster
• Rates relief
• Develop reputation and image of the cluster.

Figure 3: The California Wine Cluster Source: Porter, M. On Competition, 1998.

Internationally competitive industry.

Figure 4: Forest Products Cluster in Sweden

Source: Porter, M. On Competition, 1998.

Clusters are central to economic development but their impact is greater in some areas than others. In brief, clusters seem to attract capital (new investment) and lead to knowledge spillovers. These twin effects help promote productivity and innovation which, in the long term, has a direct impact on economic development and jobs growth.

There is a role for government in cluster development, however it is not the same role as that seen in interventionist public policy. Instead, it is to support and upgrade all clusters and to lobby for a particular region.

Clustering and Collaboration in the Food Processing Industry: Some Examples.

Japan

As for Ballarat, the potato industry is a mainstay industry in Hokkaido, as are the beet, bean, and wheat industries. Cluster managers in Hokkaido have described how potatoes can form the heart of a cluster which creates new businesses and industries through research and development and the promotion of cooperation within industrial fields other than agriculture. For example, potato production can expand into the field of new materials through the application of potatoes to polymer technologies and machinery.

Hokkaido have developed a rich cluster model centering on potatoes which involves the following fields:

• Biotechnology—chemical free agriculture
• New production technology—the development of labor-saving machinery can lead to the development of robots which work under severe conditions, Processing technology
• New materials—polymer and biodegradable technology, extraction of pigments, starch production
• Environmental—utilisation of micro-organisms
• Energy and resources—heat treatment technology, utilisation of waste liquid
• Storage and distribution
• Tourism.

Washington and Brazil

In Washington, several food-processing companies share the cost of a common industrial wastewater system. In Brazil, one major food processor has integrated independently operated meat, bakery, and distribution plants in order to minimise logistical costs.

Minnesota

The Initiative Fund of Southeastern and South Central Minnesota together with the State and Local Policy Program conducted an industrial cluster study which identified four principal clusters including food. To ensure the growth of these clusters the study recommended increased workforce training and education as a priority. The study also pointed out that the food processing industry benefited from close proximity to suppliers.

Mid-Murray

The Mid-Murray region is made up of the Goulburn Valley and Southern Riverina areas. It contains 109 firms in the food-processing sector. A recent study of this region recommended:

• Building more extensive clusters of economic activity
• Developing new export opportunities
• Reducing the reliance on imported capital equipment
• Strengthening the local sales market
• Developing alternate sources of finance and marketing.

Sydney

The Sydney Food Group is a network (rather than a cluster) of food-related businesses. Regular contact between network members has led to new business contacts or opportunities, a change in the level of business involvement with people working for firms in the network, an increase in the sharing of resources with others in the network, and an increase in the dollar value of business with other firms in the network.

Hunter Region

The Hunter Regional Development Organisation (HURDO) was formed in 1994 under the Federal Labor Government”s Regional Development Program. To date they have identified 23 clusters including agribusiness, of which food processing is a sub-category. They have set themselves the goal of building a more diverse agribusiness cluster in the region with a focus on export opportunities.

The Role of Government

If, as W. W. Arthur argues, a complex economy is best viewed as “process dependent, organic, and always evolving” then “policies succeed better by influencing the natural processes of formation of economic structures than by forcing static outcomes.” Indeed, “governments should avoid both extremes of coercing a desired outcome and keeping strict hands off, and instead seek to push the system gently toward favored structures that can grow and emerge naturally.” And this is perhaps the key point. Rigidity is the bane of cluster development. The role of governments should be to maximise the dynamics of related industries and to ensure blockages do not occur.

Government’s role in economic development has moved from selective intervention and “spotting winners” to the promotion of traditional macro-stability and the achievement of micro efficiency. Specifically, in the context of cluster development we can see what this means through Porter’s competitive diamond (see Figure 5).

Figure 5: Government Influences on Cluster Upgrading

Source: Porter, M. On Competition. 1989.

The essence of a cluster based economic development policy is not the picking of specific areas for upgrade but rather upgrading across the board. Government policy must be directed at:

• Ensuring public sector investment relates to and supports local clusters
• Through its own policies and practices, motivate and facilitate collective action by the private sector
• Identify and support training and research and development initiatives
• Encourage and target new investment with complementary cluster characteristics
• Facilitate information networks between cluster organisations.

Recent work on food processing firms in Ballarat highlights these points. The existing linkages between these firms indicates that the industry is important to employment and economic development in the city, but no more so than many other areas in Victoria and less than some. In the context of food processing in Ballarat the following forms the basis of a possible approach to cluster upgrade:

• Target food processing investment in general but also specific firms which might complement the existing Ballarat cluster: users of flour and bakery mixes, alternative users of potato and potato waste, SMEs in microbrewing, Asian foods, gourmet meals, petfoods, and a “magnet” firm in dairy foods
• Develop an investor recruitment plan and work alongside Austrade in the attraction of new Foreign Direct Investment
• Support the development of a niche applied research and consultancy food nutrition institute
• Assist in location of overseas technology partners for local SMEs
• Sponsor a regular “Food Expo” in Ballarat possibly working with other councils in the Wimmera and Central Highlands
• Support local networks and the collection and collation of cluster specific information with a web site and printed material
• Support and enhance ancillary industries in packaging, hi-tech and refrigerated transport, restaurants and waste recovery
• Establish and support Ballarat and western Victoria as the “Clean Green” centre for food processing
• Work with local companies (particularly SMEs) in the promotion of exports.

Ballarat (like most regional centres) is still a relatively small player on the world food stage. However the reduction of tariffs and non-tariff support in Europe and the US may provide significant opportunities for a fit and dynamic Ballarat industry. A critical issue for Ballarat’s regional and global competitiveness is the extent to which SMEs can maintain world class standards in productivity and innovation.

One route to helping firms could be to implement a supported technology transfer scheme, similar to ones already tried, with considerable success, in Canada and the UK

This could support individual firms and assist in the development of initiatives around areas of current core competencies (e.g., potato processing). It would help the region access partners, investors and new technology from other parts of the world where there is complementary expertise to that which already exists in Ballarat.

Conclusion

An analysis of the recent literature on clustering shows that there is a lack of consensus as to the existence of clear causative links between clustering and economic development. There is considerable dispute as to what policies are best suited to achieving desired results, and even whether they can—especially as globalisation becomes more intense. It seems unlikely that this dispute will be resolved for some time.

But what is clear is that many commentators make the mistake concentrating on a limited number of factors as being THE main factors affecting economic success. As with all success stories, cluster development is a propitious combination of many forces. “The right place” is only one element in a complex formulation that economic models can not hope to describe nor discursive case studies hope to explain. Given that “location” lies at the heart of theories of cluster dynamics, and given that no two locations are identical, descriptions of how clustering occurs in Italy are perhaps of little value in assisting the development of clusters in Bendigo, Ballarat, or Birchip. Unless all the factors which influence cluster development are properly balanced and nurtured, clustering may indeed be a placebo rather than a panacea for economic development in regional Australia.

References

Arthur, W. B. (1999) “Complexity and the Economy,” Science. Vol. 284 (5411). Pp. 107-109.

Kuhn, M. E. (1998). “Shared Facilities Provide Competitive Advantages For Savy Processors.” Food Processor. Pp. 67-68.

Feser, Edward J, (1998) “Enterprises, External Economies, and Economic Development.” Journal of Planning Literature, Vol. 12 (3). Pp. 283-303.

Feser, E. and E. Bergman. (2000) “National Industry Cluster Templates: A Framework for Applied Regional Cluster Analysis.” Regional Studies, Vol. 34 (1). Pp. 1-19.

Fulop. L. (1995). A Survey of Industry Network Initiatives in NSW, Report Three: Sydney Food Group. Kingswood, NSW: University of Western Sydney, Nepean.

McKean, C. ed. (1999). Australian Food: The Complete Reference to the Australian Food Industry. 2^nd edition. East Melbourne, Vic : Agri Food Media in association with Australian Food and Grocery Council.

Porter, M. E. (1998). The Competitive Advantage of Nations 2^nd ed. London, MacMillan Press.

---. (1998). On Competition. Boston : Harvard Business School.

¹ The geographic scope of a cluster can range from a single city to a network of neighbouring countries.