Tuesday, September 9, 2014

EACP: A Positive Example of an Innovative Cluster

EACP: A Positive Example of an Innovative Cluster

by Zoltán Szigeti

There has been widespread disagreement among economists about the success of clusters. However, many researchers are very optimistic about the recently formed European Aerospace Cluster Partnership (EACP). So why is it that the Basque Aerospace cluster may be more successful on the medium-run than most other cluster initiatives?

An issue addressed in earlier posts here is that there is no single definition of clusters that everyone uses. A good definition is provided by German economist Alf Lublinski, who defines a cluster as a group of proximate firms interlinked by input/output, knowledge and other flows that may give rise to agglomerative advantages. Clustering of economic activity holds the potential for stimulating growth of an industry as a whole because of a reduction in transaction costs between cluster members and the easier spread of ideas. Furthermore, in a recent study, Wennberg and Lindqvist find that science-based clusters have grown faster than those in other fields. In this way, a policy that creates such a cluster in the Basque country as opposed to Madrid could reduce inequality between the two regions while boosting Spanish GDP.

A set of industrial innovation clusters was sponsored by the local government in the Basque country starting in 2000 in response to a report by economist Michael Porter which identified weakness in competitiveness of Basque industry. Annual funding is limited at 180-220,000 euro per sector. The focus, instead, is on the government devoting time and energy on engaging members to communicate and interact. The selection of targeted sectors involved public/private debate. The EACP  is one of 12 clusters that was formed in 2000 and now has 38 companies, 12,000 workers, 14 research institutes and 5 universities. Its focus is on aeronautics rather than astronautics.

In one of the most influential books in regional economics, The Competitive Advantage of Nations, Michael Porter outlines his so-called diamond model which provides a description of the key factors influencing why particular industries become competitive in particular locations. These factors can be seen in the figure below and I discuss them in turn.

Competitive rivalry is enhanced by physical proximity of firms. The goal of the EACP program is stated as promoting active cooperation and increasing focus on competitive strategic challenges. Project participants across fields are encouraged to compare their practices by exchanging and analyzing case studies. This form of cooperation would ideally lead to the establishment of a knowledge base of best practices to improve business performance. This could be crucial as worldwide competitive pressure mounts with new countries such as India, Russia and China entering the market.

Factor conditions are more relevant to production clusters where proximity to raw materials is important. In the case of a scientific innovation cluster like the EACP the relevant factor conditions are mainly those of skilled labor and infrastructure. Due to the high concentration of aerospace firms in the region, better matches between employers and highly specialized individuals are formed.

Diverse participants include smaller enterprises alongside larger firms like Aernova and Sener. The cluster is located fairly close to Toulouse which is where Airbus is based. Also, several of the other clusters present in the Basque region have related projects including the automotive, telecommunications and energy clusters. There is strong cooperation of firms with the public sector to engage actors not only within a particular cluster but across clusters on key themes. Due to the complexity of the aerospace industry, there is even more need for cooperation among highly specialized individuals than in other industries. Universities provide firms with the ability to reach researchers in their fields more easily. They also provide access to high-tech laboratories and supercomputers.

Demand for air transport of passengers has risen dramatically in recent years, especially in Europe with the expansion of low-cost airlines. One of the reasons that airlines like Ryanair are able to offer very low fares is that new aircraft they use are far more cost efficient than older ones. This shows the importance of innovation in aeronautics. Rising demand is the key argument for supporting innovation in aeronautics in the EU.

Before the crisis hit there had also been a trend of increasing car ownership while in many parts great difficulties are faced when trying to expand capacity of existing roads. The increased use of cars creates an externality-problem meaning the more people use the highway the slower they will travel. Hence people’s decision to drive rather than take a plane increase time costs for others who drive on the same route. Externalities are unfortunately usually left unsolved by free market mechanisms so that government intervention is required. One of the ways the government can intervene in this case is by supporting the airplane industry to provide a better alternative to car travel.

Lastly, as oil becomes a scarcer resource its price is expected to rise. This would reduce congestion on roads unless an alternative energy source to fuel cars was to be found but it would also make the relative cost of taking a plane cheaper compared to that of driving. This is yet another probable scenario through which demand for air travel as well as transport of goods by air would surge.  


The Industrial and Logistics Park in Burgas, Bulgaria

The Industrial and Logistics Park in Burgas, Bulgaria

By Petya Krastanova

Bulgaria is the least developed country in the European Union. Despite the funding absorbed through Cohesion and Structural funds, the disparities between the capital region and the rest of the country are still widening. Measures for stimulating economic activity in the lagging regions should be taken and I believe that the seaside city of Burgas can serve as a good example of progress in this direction.

Burgas is the fourth largest city in Bulgaria. It is situated on the Black sea coast and it has the biggest sea port and the second biggest airport in the country. It is an important industrial, transport, cultural, and tourist center. The biggest manufacturer in the region – Lukoil Neftochim Burgas is the largest oil refinery in South-Eastern Europe and the largest manufacturing plant on the Balkans. However, several years ago the city municipality announced its plans to increase further the economic importance of Burgas through the development of its new project – an industrial and logistics park.

 The park is built in the area of a former swamp and it has good connections to the Burgas airport (10km), the port of Burgas (4km), and Trakiya highway (11km) – the main highway which connects it to the capital Sofia. A big advantage of the park’s location is the fact that it is situated next to a railway cargo station and it has a direct railway connection to the port of Burgas. The good transport connections of the industrial park can assure lower transport costs for the goods produced in the park. This project was initiated by the city municipality because of the strong belief that the newly build industrial zone can create employment (estimations point to at least 2000 new jobs), improve the business environment in the region, develop modern infrastructure, and diversify the city economy through the creation of new production lines and the introduction of new services. The services offered for investors in the park are quite diverse but accent is put on institutional support, fast administrative services, assistance with all the necessary documentation and permits for launching a project, professional services and consulting, intermediary activities.

From an urban economics perspective there are several distinguishable advantages of the creation of the industrial park. It will introduce investment stimuli and modern technical infrastructure satisfying the needs of the businesses. As a result, producers will have high accessibility to international distribution channels and improved market access. The park will stimulate the concentration of interrelated activities, it will create a business environment with a high concentration of financial, manufacturing and human resources, and it will improve the access of firms to labor pools, new technologies, R&D centers and possibilities for the establishment of joint ventures. Therefore, there will be a spillover of knowledge, information, technological innovation, business culture and experience resulting in an overall increase in firms’ productivity and a better economic performance of the region.
 The aforementioned advantages are a result from the urbanization economies of an agglomeration. This means that firms from different industries will be able to benefit from the concentration of shared resources, competitors and customers. However, agglomeration economies may have negative externalities caused by the clustering of firms and people. Such externalities can be congestions and pollution. The Burgas municipality has taken this treat into account and tries to implement measures that will if not prevent then at least reduce the occurrence of negative externalities. For instance, only ecologically friendly productions are favored. Recently, the German company Bayer expressed its wish to buy a parcel in the industrial park and build an insulation plant. After the municipality got familiar with the production process and the high risk of pollution, it cancelled the deal. Furthermore, regular control and high sanctions are stipulated for firms that throw their waste in the area of the industrial park. 

The industrial park does not aim at creating a specific cluster, but rather to attract investors from different production fields, thus creating a diversified urban agglomeration. So far several investors have bought parcels there – a Polish company producing yachts, and several Bulgarian companies engaged in logistics services and the production of pet food. It is expected that by April 2014 around 300 job positions will be created. Still, most of the parcels in the industrial park are not sold out yet and the city municipality hopes to attract investors from high-tech industries such as electronics and logistics. There is an ongoing national campaign trying to promote the industrial park within Bulgaria and abroad and so far mainly investors from Russia, China, Vietnam, and other Asian countries have expressed a strong interest. This fact is not surprising since Bulgaria has a strategic location and can serve as a connecting point between Europe and Asia. Many investors see the opportunity to start production in the country where taxes and production costs are low, and then export their goods into the EU market.  But only time will tell whether the industrial and logistics park in Burgas will serve the purpose with which it was created and whether it will lead to growth and prosperity in the region.

Spatial Concentration in Budapest: Why do Bridal Salons, Galleries, Banks and Fast-Food Restaurants Colocate?

Spatial Concentration in Budapest: Why do Bridal Salons, Galleries, Banks and Fast-Food Restaurants Colocate?

by Viola Monostoriné Grolmusz

When searching for your wedding dress in Budapest, you should definitely start your trip from the Grand Boulevard (Nagykörút). As almost half of all the bridal salons of Budapest are located in this concentrated area, a large variety of styles and prices can be found in a close proximity: why bother then travelling across the city to visit a single bridal salon? And what if you would like to buy a new piece of artwork? Look no further than Falk Miksa Street...

Figure 1: Bridal salons (dark blue) and jewelry stores (light blue) in Budapest (as of 2011) 

[source: Baji Péter: A City kulturális életjelenségei Budapesten]

Art galleries and bridal salons are not the only retail units that are usually located close to their competitors. We can observe a ruin pub hub along the Kazinczy Street and an agglomeration of street food places in Október 6 Street. As we can see from Table 1, jewelry stores, banks, hotels and restaurants also show a highly concentrated locational pattern. This phenomenon is not exclusive to Budapest; it is widespread in other large metropolitan areas as well. There might be several reasons for such agglomeration of economic activity. The locational choices of specialized retail units such as bridal salons and art galleries can be best explained by the Hotelling model of spatial concentration. My other examples such as the concentration of bank branches and fast-food restaurants in city centers might be better explained using theories that relax the assumptions of the Hotelling model and include inhomogeneous demand and central market theory (i.e. the fact that a location near the city center is more valuable).

number of units
average distance
from closest neighbor (m)
Jewelry stores
Bridal salons
Spar supermarkets

[source: Baji Péter: A City kulturális életjelenségei Budapesten]

To understand the conclusion that two similar stores are likely to be located near each other, let’s look at the Hotelling model briefly. Assume that there is a linear city and two competing stores, each selling a homogeneous product for the same price. Shop owners want to maximize their market shares by drawing the largest number of costumers. Consumers are distributed evenly along the line and they prefer buying the product from the nearest shop as walking to the shop is costly. If shop A settles in the middle of the street and the shop B settles at the end of the street, A will capture ¾ of the market share as for 75% of the costumers, A will be the closest store (see the upper panel of Figure 2). The owner of B therefore moves its shop just next to A in the middle of the street: this way, half of the population will choose to shop in B and half of the population will choose to shop in A (see the lower panel of Figure 2). Both shops located in the middle of the street results in an equilibrium: neither owners would like to relocate their shops, as then they would attract fewer costumers.

Figure 2: Examples for locational choices in the Hotelling Model
(the lower panel indicates the equilibrium)

The assumptions of the model are quite strong, however, its conclusions might hold for the art gallery and the bridal salon examples as these stores offer a similar set of goods and demand for wedding dresses and paintings might be homogenous across space. Moreover, neither the Falk Miksa street, nor the Grand Boulevard could be considered as ultimate city centers. If the main reason for the concentration of galleries and salons was to be close to the city center, they would likely be located in the most frequented parts of district V.

What if we consider a more life-like setup where locations have different values (having a store in central Budapest where population is dense is the most valuable for the owner as more people are expected to shop in his store) and there are more than two stores? Why is that the average distance between bank branches is only 314 meters in Budapest and why are there both a Burger King and a McDonald’s just across the street at Astoria? To get an answer to these questions, we should consider a simple game theoretic example.

Assume OTP bank and Erste bank each wants to open 5 new branches in Budapest. There are 10 possible locations that have different values: location 1 has a value of 1 (it’s far from the center), location 2 has a value of 2 and so on. This means that if OTP sets up a bank branch in location 1, it will gain an income of 1 from that branch. If both banks choose the same location, their incomes will be equally split; their incomes will therefore depend on their and their competitor’s location decision. The two banks simultaneously decide on where to set up their 5-5 branches and they want to maximize their market shares (i.e. their incomes relative to the sum of incomes).

Consider an example where OTP chooses locations 6,7,8,9,10 and Erste chooses locations 5,6,7,8,9 (they will have to split incomes at locations 6,7,8,9). Their incomes will be the following:
-          incomes of OTP: (6+7+8+9)/2 + 10 = 25
-          incomes of Erste: 5 + (6+7+8+9)/2 = 20
OTP’s market share is then: 25/(25+20)=0.56, and Erste’s market share is 0.44. Is it worth for Erste to move its branch from location 5 to location 10? We can see that its incomes won’t change:
-          incomes of OTP: (6+7+8+9+10)/2 = 20
-          incomes its of Erste: (6+7+8+9+10)/2  = 20

However, this way the market share is 50% for both banks, so Erste increases its market share in this latter setup. These strategies result in an equilibrium outcome since both banks maximize their market shares and neither has an incentive to relocate a branch as that would reduce the bank’s market share. 

For both banks, it is worth opening new branches in the same, most valuable locations: that is a likely reason why we see competing bank branches, fast-food restaurants, hotels, jewelry stores etc. so close to each other.


Dalton - The Carpet Capital of the World

The Carpet Capital of the World
by Polina Bublykova

This is a unique story of how a small city of Dalton became the carpet capital of the world despite hard-packed clay, poor farmland and being the last choice of areas of Georgia in the United States to settle. 

This is a unique story of how a small city of Dalton became the carpet capital of the world despite hard-packed clay, poor farmland and being the last choice of areas of Georgia in the United States to settle. In the case of Dalton a cluster was formed - a geographic concentration of interconnected businesses, suppliers, and associated institutions in a particular field, such as textile. Dalton is a great example that shows the role of chance in creating a business cluster and how firms that clustered with their industry peers can eclipse those who remain as loners or who prefer to be an unconnected enterprise.
In 1895 Catherine Evans, a fifteen-year-old Dalton girl, revived a traditional technique of hand tufting a bedspread. Her first work, which was a bedspread as wedding gift at wedding of her sister-in-law Addie Evans, was highly admired and the demand for this product extremely increased. Later Catherine sold her first spread and in order to meet a rapidly growing demand she taught her family, friends and neighbors how to tuft. The same technology was later applied in producing bath mats, robes, throw rugs etc.
When bedspreads were completed, women would put them on clotheslines to dry and they were visible from Dalton-Cartersville highway. Thus, tourists could enjoy the possibility to buy hand-tufted spreads "off the line" (not only in department stores). This boulevard, where spreads were hanging, became very famous and got the name "Bedspread Alley" or "Peacock Alley", because these feathered birds with spreading tails were the most popular pattern.

In 20 years after the first spread Addie Evans opened the first women's actual business - Evan Manufacturing Company - that triggered opening of retail stores and small tufting operations in sheds, small homes or even in unused chicken houses. It was mainly a home-based family production, hence men participated in this business as well, hauling materials and modifying and repairing sewing machines in order to use them for tufting. Many people came to Dalton to start their own business. New commercial laundries were opened to do shrinking and fluffing. During the Depression years the bedspread income was an additional source of money that helped many families to survive.

So, we can notice that growth of this cluster triggered opening of lots of new small competitive firms, related businesses and suppliers that render essential services for supporting the cluster. Moreover, in 1930-1940 the federal government legislated a minimum wage and there were no possibilities to hire "free-lance". As a result, many people went to work to local spreadhouses.
After the Second World War there was a technical advance that enabled production of tufted carpets. Due to advantages of new efficient technology, the carpets became more affordable for middle class, and this led to a boom in Dalton area. By 1980, Dalton was producing around 80% of America's carpets and started to export them. That was the time when the city was honored with the name of the Carpet Capital of the World.
In 1980-1990 because of housing boom and increase in car production, where carpets began to be used, the demand for carpets significantly rose. However, in late 1990s a drop in popularity of carpets as a domestic floor covering caused a decline in sales and profits. The most economically effective and expected reaction of a mature industry in this situation would be to consolidate ownership, which would allow to rationalize production capacity and to maximize economies of scale.
Today there are 3 big Dalton-based companies in carpet industry: Shaw Industries, Inc., Mohawk Industries, and Beaulieu of America; the Dalton area produces more than 70% of the total output of the world-wide industry of over $9 billion.
Thus, the wedding gift of Catherine Evans can be considered as a random event that gave an impulse to create a business cluster. However, Dalton's association with carpets is not a mere accident. Proximity to sources of raw material (cotton and later synthetics), transportability of the finished product, presence of supporting industries and qualified human resources, high demand and intense rivalry gave reasons for carpet industry to be competitive and to concentrate around Dalton. These four main interconnected factors of success: demand conditions, related and supporting industries, factor (input) conditions and firms strategy, structure and rivalry - are the building blocks of the Porter's Diamond theory, which explains why clusters become competitive in particular location.
The Dalton area has a great theoretical background for clustering a carpet industry. And I hope it will continue to improve and develop the cluster and will be a carpet capital of the world for long time. Good luck, Dalton!

New elements in the European Union cohesion policy in 2014-2020

New elements in the European Union cohesion policy in 2014-2020

by Gábor Kiss

Important changes take place in EU Cohesion Policy these days, but some fundamental questions about the potential for success of such policies remain unanswered. 

The new programming period of European cohesion policy is about to be launched in 2014. The legislative package contains numerous novel elements. Some of these seek to enhance the orientation of interventions towards results, while others include policy instruments that are considered more effective in reaching goals related to territorial cohesion.

The key tools devised to create linkages between country and EU level objectives and funding are the Partnership Contracts with the European Commission. These documents have to be prepared by every recipient country, and they will set out the commitments of national and regional level partners. The contracts will contain important new elements called “ex ante and ex post conditionalities”. The former are necessary conditions to be met by member states in order to start their programmes, and they contain mainly regulations and other institutional criteria that can ensure the effective use of Union support. The aim of the ex post conditionalities is to strengthen the performance of the programmes by setting out milestones related to outputs and results of the interventions. 5% of the budget of the relevant funds will be set aside to be allocated only to those member states which reached the milestones. Furthermore, the failure to achieve the milestones may result in the suspension or even the cancellation of funding. The stakes are high: altogether more than EUR 320 billion is allocated for the entire 7 year period. The member state level allocations can be seen in the following graph:

Two new policy instruments explicitly focus on the territorial aspects of development policy. One of these is the “Integrated Territorial Investments” (ITI), while the other is called “Community-led Local Development “(CLLD). Both aim at supporting integrated local and sub-regional development strategies that are tailor-made to the needs of the respective territories. The CLLD instrument builds on bottom-up initiatives by local groups of actors, an approach similar to the one used in rural development policy in the previous periods. It is the local action group that determines the content of the local development strategy. The ITI is a more comprehensive instrument, which aims at the coordinated use of various types of support (e.g. financial instruments, grants, consulting) to meet the specific local needs. This tool can combine top-down and CLLD-type decision making and empower sub-regional actors (e.g. local authorities, non-governmental organisations) by partly delegating the management tasks to them. In addition, earmarking sums to such programmes can ensure the funding of integrated actions.

The result oriented regulations and new policy instruments are built on the experience of the past, but both broad categories of novelties raise important theoretical questions. The conditioning of payments on reaching milestones (i.e. the achievements of indicator targets) is certainly reasonable when applied to the outputs of a policy intervention, such as new roads, renovated schools, or environmentally friendly energy production facilities. On the other hand, results, such as the decrease in pollution or increase in the test outcomes of high school students are affected by many other factors which are really hard to control for. In order to avoid the risk of payment withdrawal, national and regional policy makers have the incentive to set the targets for results (and also outputs, to some extent) as low as possible. Thus, such incentives can undermine the whole point of conditionality, namely the achievement of development goals.

The second question is related to the possibility of strengthening growth through external support. If the policies are well implemented, increasing the level of physical and human capital can elevate the level of per capita income up to the so-called steady state level which is determined by exogenously given parameters according to the neoclassical growth model. These models, however, do not consider processes taking place on the regional level. The theoretical implications of the territorial nature of economic activities are grasped by the models of New Economic Geography. These models have different predictions depending on what assumptions they make, but one of their ultimate implications is that when certain kinds of economic activities are geographically concentrated, it requires a very large shock to change the distribution of activities related to mobile production factors. 

In the context of regional development policy, this can imply that even if the local strategic initiatives give rise to higher levels of human and physical capital due to the publicly funded investments, after the compulsory maintenance periods the bulk of these activities will migrate to the “economic core”. This implies that such interventions can be successful only if they support the periphery to an extent which is possibly beyond the scope of any policy consistent with capitalist systems. On the other hand, based on the approach of the spatial equilibrium model, a more favourable outcome can also arise. If policy measures are able to create appealing environment to business in the periphery, which is also supported by local amenities and benefits specific to the people living there, there is a chance that investments in these two forms of capital can contribute to the long-term development of these areas as well.

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