8. Cluster Development, Agglomeration Economies & The Role of Informality

Question 1

What is an industrial cluster?

Answer 1

“geographic concentrations of interconnected companies and institutions in a particular field” (Porter, 1998)

“groups of similar and related firms in a defined geographic area that share common markets, technologies, worker skill needs, and which are often linked by buyer-seller relationships”

‘New Economic Geography’ from the 90s (Krugman)

• maybe comparative advantages of countries do not lie in geographic location, but in the creation of regional hubs or industrial clusters (e.g. Hollywood, Silicon Valley, Bangalore, East Coast in China, Mpesa in Kenya)
• not to be confused with industrial districts (clusters are more concentrated geographically)

Question 2

Strengths & Weaknesses of clusters

Answer 2

Strengths:

• physical proximity to suppliers and other service providers that saves time and money
• there is a lot of knowledge spillovers that firms can take advantage of
• thick labor market (there is a big market of skilled people)
• institutional interdependencies from related supporting businesses

Weaknesses:
- because of such concentration of production and exports, the cluster is vulnerable to shocks at regional and global levels (e.g. Financial Crisis, COVID)

Question 3

What are the characteristics of an enclave?

Answer 3

Arias et al (2014)

Enclave structure is characterized by:

• MNCs presence in the area of mineral extraction
• weak productive linkages to the local firms
• Foreign ownership of capital
• Exporter of goods with low or no value-added
• Asymmetry of negotiating power between the MNCs, the government, and local firms
• High barriers to exit, due to the fixed character of natural resources -> this obliges MNCs to interact with the region, but it does not prevent them from exporting profits to international headquarters and from capturing public goods
• High labor productivity because of capital intensive operations

Question 4

What are similarities between clusters and enclaves?

Answer 4

Arias et al (2014)

• the ‘hub-and-spoke’ structure: one or more large companies, normally MNCs, which form the ‘hubs’ of the productive system, have high degrees of vertical integration, and dominate regional production; supplier SMEs act like ‘spokes’
• the high rates of growth and export orientation
• the presence of internal economies of scale
• the specialization of local firms in services
• the low level of cooperation between suppliers and lead firms
• the cooperation of the hubs with companies outside the agglomeration

Question 5

How does a cluster differ from an en enclave?

Answer 5

Arias et al (2014) describe ideal types of clusters and enclaves to create their analytical equivalence in order to show how they could differ:

Ideal Enclave:

• > Lack of a division of labor and weak productive linkages
• > Non-thick labor market: managerial functions are usually located outside the region, while the occupations within the enclave are manual, physical, and routine
• > Limited knowledge spillovers: R&D activities in the region are marginal and the productive process leaves little space for innovation; patents are internalized by MNCs; limited competitiveness of local firms

Ideal Cluster:

• Division of labour: strong forward and backward linkages with local firms that lead to significant multiplier effects and reduce the costs of inputs and final outputs; allow for the creation of new companies (“wide shoulders”)
• Thick labor market: local qualified workers and a relatively high level of turnover of workers among companies that facilitates the transference of knowledge
• Knowledge Spillovers: they exist outside the market relations, based on the interactions among workers, employers and members of other public and private organizations (“long arms”)

Other differences:

In the enclave

• The key investments are decided upon in the headquarters of the MNCs
• Contracts are short term
• High proportion of workers from other regions

In the cluster:

• key investments are decided locally
• contracts are long term
• large companies are supplied by the local labor market

Question 6

Does the mining sector fall under an enclave or cluster structure?

Answer 6

Every region should be analyzed individually because historical contexts are very important.
Arias et al (2014) look at the case of Antofagasta, Chile, and based on their descriptions of ideal types of enclave and cluster, conclude that it’s more an enclave than a cluster:

• Division of labor:
  Both the forward and backward linkages of copper mining in the Antofagasta Region are below the average of the ‘key sectors’ of other regions of the country; Weak forward linkages reflects that mining activity in Antofagasta exports almost all of its output. There is increasing subcontracting which indicates a growing division of labor, but there is low competitiveness among local companies
• Thickness of labor market:
  MNCs headquarters are in metropolitan regions where they can benefit from technological externalities of large agglomerations and have access to international markets and suppliers. Branches and production sectors on the other hand are close to the mines -> this limits the arrival of more qualified workers
• Knowledge spillovers:
  the existence of knowledge spillovers is not evident in regions dominated by MNCs, especially when the cognitive distance to local SMEs is too large;
  no incentives for MNCs to transfer the knowledge and technological innovations developed in their headquarters to the local firms

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Question 7

What are agglomeration economies?

Answer 7

Moreno & Monroy (2012)

Agglomeration economies exist when the output of an enterprise depends positively not only on its production factors but also on the output and factor usage of other enterprises.
E.g. when firms are located close by, they can generate increasing returns to scale from which they can all benefit

Question 8

What are the types of agglomeration economies?

Answer 8

Moreno & Monroy (2012)
2 types:

1. localization economies -> enterprises belonging to the same industry and the same geographical area (clusters)
2. urbanization economies -> belong to same geographical area, but carry out different economic activities

Question 9

What are the sources of agglomeration economies?

Answer 9

Moreno & Monroy (2012)

1. supply-side mechanisms:
   - greater access to specialized inputs, labor market pooling, knowledge, and tech spillovers
2. demand-side mechanisms:
   - reduced consumer search costs
3. the result of enterprises seeking proximity to fixed factors such as natural endowments or public goods

Question 10

What is an informal enterprise?

Answer 10

Moreno & Monroy (2012)

An organization using inputs to produce goods and/or services while operating under different legal constraints than formal enterprises

Small, short life, uses little capital, has low productivity levels, operates from the household or street

Often marginalized from accessing the same resources or participating in the same economic transactions as formal firms (can’t access credit, access subsidies, sign business contracts)

Traditional Informal Enterprise -> involuntary subsistence activities to survive
Modern Informal Enterprise -> deliberate choice to avoid regulation and taxation

Question 11

Can agglomeration economies arise from the informal enterprises?

Answer 11

Moreno & Monroy (2012)

Existing urban economic literature cherry-picks cases.

Agglomeration economies can arise from the interaction between formal and informal sectors through:

• backward linkages where informal enterprises get inputs from formal companies
• forward linkages where informal enterprises supply intermediate or final goods to formal enterprises (sub-contracting or distribution of formal goods)

In short, informal enterprises participate in the value chains and benefit from agglomeration effects but there is an asymmetrical relationship between formal and informal enterprises.

If we look at the quality of agglomeration:

• low: large and growing number of informal enterprises in congested industries
• high: an increasing number of enteprises in different segments contribute to and benefit from agglomeration economies; potential for spillovers is maximized