Nano-economics and the wealth of regions

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Steven Klepper

Professor Steven Klepper, Carnegie Mellon University, Pittsburgh, received the Global Award for Entrepreneurship Research in Stockholm from the hands of H.R.H. Prince Daniel on Thursday June 16th, on Saturday June 18th he held his acceptance speech and on June 21st he visited Linköping University for a lecture on Nano-economics and the wealth of regions.

He discussed his work on the evolution of four great industry clusters: Silicon Valley; Detroit; Akron, Ohio, the historical center of tire production in the U.S.; and Bangladesh, which has emerged in recent years as a world-class center of cotton garment production.

Using his characteristic nano-economic analysis in which he reconstructs and dissects the evolution of each of the industries that gave rise to the clusters, he develops and tests a novel theory of clustering based on the ideas of organisational reproduction and heredity. New questions are raised about the determinants of a region’s economic performance and novel policies are considered to stimulate clustering and the wealth of regions.

Professor Fredrik Tell, KITE research group, welcomed Steven Klepper and gave an introduction to his work.

Professor Pontus Braunerhjelm, Managing Director Swedish Entrepreneurship Forum introduced the Global Award for Entrepreneurship Research, the most prestigious award after the Nobel Prize. Steven Klepper is the 21st awardee of the prize, which has gained reputation since it was first awarded in 1996.

Professor Steven Klepper started out by introducing his four extraordinary industry clusters and his research questions: why do we get clusters emerging and what can we learn from them? What does it mean for policy? Klepper used nano-economics to dissect the evolution of industries from start for clues. In his new theory he explains involuntary organisational reproduction and inheritance. His theory runs against the more conventional view in which all firms benefit from clusters. During his presentation he convinced the audience that this wasn’t true for our four clusters.

Alfred Marshall presented a basic idea on how companies benefits from clusters 100 years ago. He showed that companies within a cluster have a better availability to choose workers that spillovers of knowledge do occur – the knowledge is in the air and you have better access to specialist inputs. All firms will benefit from the cluster and expand their activity until they reach equilibrium.

– ­This hasn’t occurred in our four clusters. Instead I will argue for an almost biological theory of industry development.

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Steven Klepper

I will show how tacit knowledge, abi-product of own knowledge, make people start own firms and is a key force driver of clusters. It is the spin-offs that will do well, the rest of the firms won’t do better than firms elsewhere.

Steven Klepper applied his theory on four clusters, the first being the semiconductor industry in Silicon Valley. The second and third being Detroit, Michigan (automobiles) and Akron, Ohio (tires). The forth is a story about an entire country, not a region – Bangladesh. The country is as dysfunctional for industry as one can imagine facing political unrest, national disasters, high illiteracy, and being one of the poorest countries in the world. With everything against it, Bangladesh is an industrial freak of nature but it has annually grown five percent since the 80ies relying on one single industry: cotton garments. The story starts when the South Korean company Daewoo faced restrictions on exports. To get around the restrictions Daewoo formed an agreement with Bangladesh and took 126 workers from Bangladesh   and trained them in assembly line production for six months. The result was an unbelievable successand the industry took off on its own after Daewoo left the country. Cotton garments stand for 78 percent of the national exports and are employing 3 million people. Evidently, one industry transformed the whole country.

– But what do these four clusters share and what does it tell us? Can we learn something deeper from them?

What shall we expect to see and look for? Klepper presented a list of observations. There are great early leader(s) in clusters and clusters capture a growing share of industry output via spin-offs. Spin-offs are the key performers in clusters, especially the ones with the right pedigree. He also emphasized that better firms have more and better spin-offs thanks to the inheritance of tacit knowledge. By working you learn how to build a successful industry. Spinoffs in clusters are indigenous – i.e. they don’t venture far geographically. Spinoffs make the region; it is not the region that makes the spinoffs.

– My theory runs from an almost biological idea. That is why I talk about the next generation, parents and inheritance. This is what went on in these for clusters with some variations.

But how do you test a theory like this: you need to track all firms – who founded them and where they came from. My own spin-offs have helped me compiling this evidence and it shows the importance of a great early firm. In the autocase it is Olds Motor Works in Detroit, in tires it is Goodrich in Akron, in semiconductors it is Fairchild in Silicon Valley, said Klepper.

Empirical evidence shows that spin-offs are leaders in their clusters. This is what makes the region. Spin-offs do better than start-ups. In Detroit the firm fertility showed 41 descendants and 62 percent and the picture is similar in the tire industry, 52 percent.

In Silicon Valley Fairchild spawned 11 firms including Intel, which, in turn, includes 31 direct descendants. Fairchild was so important for the descendant firms that they are called Fairchildren.

In Bangladesh the story is somewhat different where firms hired the 126 workers for their tacit knowledge. They did not start new firms themselves but played a key role in setting them up.

– So what do these four clusters have in common? They all emanate from one or a few seeds, the employee movement propagates the seed, spinoffs stay close to home and they grow the percent of industry activity for many years. Cluster performance is mainly distinguished by spinoffs, especially if they are of the right pedigree. Then they can generate enormous regional growth.

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Pontus Braunerhjelm och Steven Klepper

Steven Klepper also presented a “dog that did not bark”, namely the TV industry. He showed the number of TV producers in three cities, Chicago, Los Angeles and New York, covering 73 percent of all firms in the sector. This shows more clustering than our previously mentioned four clusters. New York had 50 percent of all TV producers but lost them all; in LA the story repeated itself. Why did they experience de-clustering in such an extreme way? Because there were no spin-offs among the leading firms. That was the key mechanism in eliminating these clusters. Chicago survived because it had three top-radio-producers.

So what do my questions mean for policymakers? My advice is not to try to build a cluster. To sum up Steven Klepper presented four policy relevant advices.

The first is that the most important educational institutions are not schools but firms – they are the key educators. However, firms will naturally resist playing this role – to prevent being bypassed by their spin-offs. In the US there is limiting trade secrets litigation. Instead, policymakers should make sure that they are creating a culture where defections are acceptable or maybe even celebrated.

The second advice is mobility, mobility and mobility. This is not only relevant for founders, but also for their followers, willing and anxious to move. High level employees should not be prevented from starting own firms or work for a competitor. Policymakers should also get rid of impediments like employee non-compete clauses, defined benefit pensions tied to years of service and favorable seniority rules and they should review capital gains taxes.

My forth advice is to plant a seed. The development in Silicon Valley was based in collaboration between a semiconductor firm and the U.S. military. It was not intentionally meant to become Fairchild, the founding firm of Silicon Valley. Another example is the Taiwanese semiconductor industry which was founded in a government lab, improved in the lab and then formed as a private company. My advice is therefore: Let that seed flower! Referring to Professor Hans Rosling: It is possible to make the impossible possible. And my findings show that we can perform this magic trick again.

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