During the recession of the early 1980s, the state of North Carolina suffered the loss of its traditional economic backbone. Jobs in tobacco processing, textiles, and furniture manufacturing declined dramatically. Faced with this crisis, Governor Jim Hunt decided to emphasize innovation-based economic development, eschewing low-wage manufacturing jobs in favor of broad-based wealth and prosperity. At the time, North Carolina was already home to the Research Triangle Park. But steady and consistent state policy, investment tax credits, and quasi-governmental, sector-specific agencies helped create the vibrant entrepreneurial economy that now exists contiguous to the park. The life-science cluster located there is the third largest in the United States, behind Massachusetts and California, employing more than 58,000 workers and paying above-average wages in a range of occupations from researchers to lab and production technicians.

But this isn’t just a North Carolina story. Across the United States, innovative clusters have proliferated beyond early high-tech leaders like Silicon Valley, Route 128 (in Massachusetts), and the Research Triangle. Newer and emerging conglomerations in San Diego, Austin, and the greater Washington, D.C. area, for example, have gained considerable traction over the past 20 years. These clusters specialize in a range of high-tech sectors, including telecommunications, human bio-therapeutics, and computational technology. Other regions have established successful clusters in a variety of specialized functions, such as non-woven textiles in Raleigh, furniture in northeastern Mississippi, shipbuilding in Maine, and medical devices in Minnesota, to name just a few examples.

What can the rise of these clusters tell us about entrepreneurship policy? Innovation and entrepreneurship are two sides of the same coin: Entrepreneurs recognize opportunity and innovate. Location becomes important not only for recognizing opportunity but also for cultivating an environment dedicated to the entrepreneurs’ activity, which in turn lowers the cost of innovating. But while entrepreneurship is a private-sector activity, it is public policy that sets the stage by establishing property rights, providing incentives to encourage experimentation and discovery, and determining how the rewards will be allocated. Beyond that, policy is often needed to fill in elements of the ecosystem not provided by the private sector, supply information about opportunities, and offer incentives that lower the risk of engaging in innovative activity, making it easier for new firms to develop. To encourage clusters and the entrepreneurial spirit, the federal and state governments should know not only when and what policy interventions are needed, but also when their efforts get in the way.

The Benefits and Pitfalls of Clusters

Think of economic development as nested Russian dolls, with one layer fitting snugly into the others: first companies, then the cluster, next the region, followed by the state and the nation—and ultimately the entire world.

The idea that location benefits economic activity flies in the face of globalization’s relentless logic and challenges the importance accorded to the search for low-cost locations. Grounded in place, innovation and entrepreneurship rely on an ecosystem of firms (both suppliers and customers), universities and community colleges, government agencies, and trade associations, all systematically aligned to encourage creativity and experimentation. Once started, concentrations of industries within places become self-reinforcing as talent is attracted to opportunity, the flow of ideas increases, and their potential is understood and appreciated. With that dynamic, it becomes easier and less costly for entrepreneurs to realize their dreams.

Clusters burgeon through self-organization as resources are attracted to a place and subsequently accumulate. This in turn cultivates a buzz around the potential of a locale. For example, the California gold rush of the 1840s and ’50s attracted suppliers, such as Levi Strauss, who invented the blue jean as the perfect clothing for prospecting. To this day, Levi’s remains a global brand headquartered in San Francisco.

But there are three potential pitfalls associated with clusters: first, overspecialization and its possible negative impact; second, aggregate consequences confined to the geographic location; and third, the deleterious tendency of firms to limit their potential by “following a leader” and thus concentrating their efforts on the same industries and technologies.

The first problem arises when successful places become overspecialized. When a dominant industry matures, leading firms can fail to innovate and fall prey to what Harvard’s Clayton Christensen calls the “innovator’s dilemma.” This is what happened in Akron, Ohio, in the late 1970s as the tire manufacturers located there failed to respond to the introduction of French radial tires, thinking their 80 percent global market share was secure. Akron’s economy had become specialized around tire manufacturing and did not diversify into other industries. Similar stories can be told about the demise of the steel industry in Pittsburgh, textiles in both New England and the South, and automobiles in Detroit.

A second problem is that clusters can have a negative impact on the local community. If residents are not able to take jobs in the cluster industry, the influx of new workers can result in increased local congestion thereby requiring the construction of new roads and schools. Dramatic population increases can also inflate housing prices, which raises the property taxes for long-time residents. Neighborhoods in Phoenix experienced these consequences as population growth of 15 to 40 percent in the past decade strained the region’s capacity. In addition, the immigration of skilled workers, who may be more highly compensated than the local workforce, can result in a widening of income disparities that may produce social and political tensions. This was notable in Silicon Valley as the influx of high-tech workers crowded out the agricultural workers who had been there for decades.

A third pitfall is the tendency of places to attempt to follow the same strategies or develop industries that are similar to those established in other places. Known as “technological isomorphism,” these practices pit jurisdictions and companies against one another in bidding wars for local incentives. While it appears to be easier to follow the lead of another place, this strategy certainly does not ensure success. Many emerging clusters within the United States and around the world often look to the successes of Silicon Valley and Route 128 as they attempt to promote their emerging economy. What can often be their downfall, however, is that these emerging clusters try to replicate the actions of the leading economies rather than fill a new niche by diversifying. For example, Taiwan, while successful in electronic, information-technology, and semiconductor products, has not been able to repeat the same successes in biotech that are found in U.S. clusters. Neither simple repetition nor uncritical emulation guarantees the emergence of a cluster.

A Blueprint for Clusters

Cluster formation takes a long time and requires the sustained commitment of local entrepreneurs, educational institutions, nonprofits, and government. Each and every successful cluster has its own story. That said, there are some general trends and best practices that are useful to their establishment and management.

State and federal governments, in particular, provide considerable resources to help firms grow. Ideally, market forces should induce suppliers who identify the opportunity in the cluster to flock to that location. However, information about opportunities is often not broadly disseminated or available. Intellectual property and business development attorneys, certified public accountants, and marketing specialists are often difficult to attract to new locations. Even when highly skilled human capital exists in an area, the resources to support it are notably scant. Here, government programs like the Small Business Administration’s (SBA) cluster initiative step in, recognize the need, and attempt to provide the services that are necessary to aid the formation, development, and growth of firms within clusters. Through the Regional Cluster Initiative, the SBA supports annual multiple fixed-price contract awards ranging up to $600,000. These awards are aimed at bolstering regional growth through the support of business training, commercialization and technology-transfer services, mentoring, and other related services.

Another federal program, the Small Business Innovation Research (SBIR) initiative, funds small businesses developing new technologies. The program provides an opportunity to commercialize a technology for a government agency with the perspective of a lead user for a large market. But many firms haven’t heard of the SBIR or don’t think that they qualify. Indeed, firms frequently do not know about government programs that can offer financial capital, assistance in writing grants, and aid in navigating the growth process. A recent study examining the efficacy of public programs for a key area in western Pennsylvania and northeastern Ohio found that the majority of firms were unaware of the myriad public resources available at the local, state, regional, and even national levels. While the researchers found that firms tended to tap state and local programs more than federal ones, the demand for support outweighed the supply of public resources. Federal funding for commercialization programs is less than 10 percent of the $150 billion a year we invest in basic scientific research. At the regional level, programs depend on current federal innovation policy funds to complement their own efforts to commercialize their science and technology discoveries and provide the basis for future growth. More funding for such commercialization programs and a better outreach effort to inform firms about such resources would help encourage entrepreneurs and clusters.

Perhaps the least visible and most undervalued factor in local economic development is social capital. Roughly defined as the norms, networks, and stock of social trust that people can draw on to solve problems, social capital is generated via delicately crafted networks that allow knowledge to be shared and collaborations to be formed, thereby increasing the stock of knowledge and the amount and quality of innovative activity. A high degree of social capital is associated with fully functioning clusters like Silicon Valley. Government investments in social capital—through support of local business and civic associations or the formation of new ones—can assist the process of building a cluster. One city, Pittsburgh, has been a leader in such efforts to build a more robust network of public, private, and community organizations engaged in cultivating a cluster economy. To increase this resource, government grants can provide incentives for local inter-firm collaboration. One such program, the National Science Foundation’s aptly named Partnerships for Innovation, specifically funds collaborative projects that build on emerging local expertise.

Another important investment governments can make is in information sharing and dissemination. Investments in information sharing not only help to give an area a “brand” but also provide a forum for discussions and a central information repository. For example, NC Textile Connect—an organization that provides “a holistic, knowledge-intensive, innovative, global, collaborative, and flexible website” designed to deepen ties among companies, academia, and all levels of government—has become an essential clearinghouse for the North Carolina textile complex in an increasingly fractured and globalized sector. The website, run by the North Carolina State University College of Textiles, received initial funding from the state’s Department of Commerce. Where the market fails to provide a service, such investments can fill a void and assist entrepreneurs and budding industries.

In developing clusters, increasing the competitiveness of local firms is essential. Yet small- and medium-sized firms generally lack the resources to develop their own research, design, or engineering departments, and are heavily dependent on services available in their local environment. In addition, small firms do not have the capacity to provide specialized training, hampering their ability to develop a company’s most critical resource: skilled employees. A best practice in cluster development is to provide tailored services that small firms need, such as technical assistance, design services, and legal advice. Frequently, nonprofit organizations such as JumpStart in northeastern Ohio provide these services and fill voids in the entrepreneurial ecosystem. Successful incubators, such as Symbion in Copenhagen, build entrepreneurs’ skills through intensive boot camps, actively monitoring firms’ progress and loaning out personnel to help firms overcome hurdles and address internal deficiencies. Meanwhile, community colleges often provide specialized education, with the most responsive institutions (Pittsburgh Technical Institute, for example) effectively using local businesspeople as advisory board members to understand what skills are in demand, what types of equipment are to be used, and how local industry is changing.

But for all of the help government can provide in developing clusters, it is essential to remember that it can play only a supporting role. Ultimately, it is the private sector—innovators and entrepreneurs—that can and should take the lead in the creation of clusters. Companies should take charge of cluster development efforts through active engagement and by championing the development and sustainability of their regions. When engaged, local entrepreneurs who identify shared resources will help build both their individual firm and the cluster of firms. Through these efforts, the virtuous cycles of economic growth are sustained.

Innovation and Terroir

One of the strengths of American federalism is that each level of government has a role to play. In the case of clusters, regional and local agencies are better able than federal entities to tailor programs to the specific needs of local industry. Meanwhile, federal programs, perhaps because of larger funding amounts, are seen by entrepreneurs as more beneficial. Policy-makers need to pull all this together if the United States is to succeed and become a leader in innovation.

Each locally organized cluster will be different, and thus will need flexibility in using support from local, state, and federal governments. Connoisseurs of food and wine talk about terroir, a French term used to denote the special characteristics that geography bestows. The term is translated literally as “soil” but more poetically as a “sense of place.” The term captures the total effect that the local environment has on the product—when the total effect is more than the sum of its parts and the effect is difficult to replicate elsewhere. For wine and coffee, it is the climate, angle of the sun, age of the stock, and growing and harvesting traditions that create a unique product. Even the best vineyards produce different vintages, reflecting temporal variations, but what matters for success is the adjustment to this variation. Innovation works in a similar manner, and policy to cultivate innovation requires the same care and attention to local conditions and potential.

Will Facebook and other still-to-be-diffused new technologies destroy the advantages that accrue to clusters? Certainly the death of distance has been forecast before with the introduction of the telegraph, the telephone, and the Internet. Yet we see that the tendency for innovative activity to cluster spatially has not diminished. As social beings we are attracted to places where our creativity can thrive and be appreciated. Throughout human history, innovation has tended to concentrate in certain places and at certain times—consider Florence under the Medici, Paris in the 1920s, England during the Industrial Revolution, and Silicon Valley today. For every generation, there is some location that captures the imagination as a locus of creative activity and energy. The activity changes, but the importance of place remains.