Firms of a feather cluster together: The role of industry clusters on attracting additional investment.

• Author: Slaper, Timothy F.

There is an expression: Birds of a feather flock together. This observation and expression has something of an equivalence in economics--agglomeration of similar companies. That is, in economics, there are competitive and productivity benefits associated with the concentration and colocation of related industries--often called industry clusters. Why birds of a feather may flock and colocate together is not of our concern here, but we are interested in whether and the extent to which firms in certain industries choose to locate together.

It turns out that U.S.-based research is sparse on whether regions with specialized industry clusters--that is, industries flocking together if the reader will allow--magnetically attract investment from firms outside the region. According to theory, industry colocation creates benefits for related industries, but to what degree do these externalities attract similar or complementary firms?

To explore this question, Indiana Business Research Center (IBRC) analysts examined greenfield foreign direct investment (FDI) data at the U.S. county level (see Figure 1) and conclude that incoming firms do indeed tend to be attracted to locations that have a relatively high absolute concentration of employment in their industry cluster. In other words, firms of a feather cluster together. Second, we also found that high-tech industries have a different FDI attraction profile than non-high-tech industry clusters--an important consideration for economic development practitioners to consider as they create their development strategies. Third, several regional characteristics that are considered important by site selectors--those informing the FDI location decisions--are more salient than other regional characteristics and attributes.

These results are largely similar and robust across several statistical methods, irrespective of whether the variable of interest (the dependent variable) is receiving FDI of any kind, the number of projects or the number of jobs associated with the FDI.

This article summarizes the main findings from this analysis. For a more complete exploration of the empirical method and regression results behind it, read the full report, "Why Invest There?," which was funded by the Indiana University Center for International Business Education and Research (CIBER).

Background

Industry clusters--also known as business clusters or competitive clusters--are groups of similar or related firms that play an important role in the success of regional economic development. Clusters share a common market, facilitate the exchange of suppliers, and develop localized worker skills and know-how. An industry cluster represents a broadly defined industry from suppliers to end producers, which is different from the classically defined industry sectors that are organized according to production technologies.

Clusters, like cheese-making in Vermont or tech companies in California's Silicon Valley, can strengthen competitiveness as they increase productivity, stimulate innovative new partnerships and present opportunities for entrepreneurial activity. Suppose you would like to expand your surfboard business... which is a better choice, Hawaii or Colorado? It isn't a stretch to argue that location decisions are made due to the presence of strong industry clusters.

Industry clusters are commonly used to measure what kind of firms locate in close proximity. The empirical evidence indicates that there are competitive and productivity benefits associated with the concentration and colocation of related industries. In this article, these benefits are called colocation externalities.

It has sometimes been said that clusters form "because there is something in the air." That something is beneficial externalities associated with similar or related firms sharing geographic proximity. Long-established firms benefit as they are effectively forced to become more productive by competitive pressures. New firms--start-ups--can also take advantage of a well-developed regional labor force and supply chain. One might say that these firms experience metabolic growth based on the resources, labor and know-how in the regions--combined with increasing demand for the cluster's goods and services from outside the region.

On the other hand, clusters can also grow "magnetically," that is, a region can attract firms to take advantage of that region's competitive advantage in resources, supply networks and human talent. There might be significant benefits to close geographic proximity for young or mature firms to move into the region in order to take advantage of the colocation externalities. Greenfield FDI is an example of magnetic growth.

Either way, via metabolic growth or magnetic growth, one can understand why the concept and presence of industry clusters may attract the attention of those advocating for a region or state's economic growth. Indeed, the importance of industry clusters to boost regional economic development has widely gained scholars' attention, most notably, the Harvard Professor Michael Porter (1998 and 2003).

Much of the empirical work focuses on the benefits of clusters on industrial employment, innovation and productivity, but less systematic empirical attention has been paid to identifying strong regional clusters and the regional characteristics that attend cluster formation and growth. For this reason, IBRC researchers wanted to empirically confirm whether strong, established, growing clusters tended to attract incoming firms in the form of any "foreign" direct investment? ("Foreign" here is any investment from outside the region regardless of international and national.)

Industry cluster strength can be viewed as the relative concentration of an industry cluster, without regard to the balance or concentration of industries within that cluster. Economic development practitioners and policymakers often use the concept and measure of a location quotient (LQ). An LQsimply compares a proportion of industry employment in a region against some other benchmark like the national average proportion of employment in an industry. If one hears that Indiana is the most manufacturing-intensive state in the union, it isn't because it has more workers (in absolute size) in manufacturing than, say, Texas. The claim is based on an LQ (i.e., relative size). Indiana has more workers in manufacturing as a proportion of its workforce than any other state (with Wisconsin close behind). (1)

While not the polar opposite of specialization, diversity is in contrast to specialization. For example, if one's stock portfolio consists of one firm, that would be a polar opposite of diversity, but one may have a stock portfolio with all technology stocks. While specialized in technology firms, there would be some diversity of firms within that category of stocks. This latter example would...