Conceptual Underpinnings

Clusters present a new way of thinking about economies, both national and local, and they define new roles for the government, businesses and other changemakers in enhancing competitiveness. Thisis the reason that today they are being studied by a variety of scholars from different fields including economists, social scientists, and strategists, and also by a growing number of business practitioners and policymakers (Saric, 2011). As a result, the knowledge on the capacity of clusters to promote prosperity and the role of industrial policy in creating clusters has increased rapidly.

This proliferation of studies has led to a multiplicityof definitions and schools of thought, each of which interprets the role of clusters differently. It thus becomes difficult to delineate what constitutes a clusterand how cluster-based economic development should be approached. The different school of thoughts are mentioned below.

The study of clusters and agglomerations traces its roots back to Alfred Marshall’s study of industrial districts of England in 1890s. Marshall talked about concentration of industries in certain localities in Principles of Economics (1890). Marshall identified three main reasons for co-location of firms: labour market pooling, knowledge spill overs and supplier specialization.

The Californian school studied the successful technology districts in southern and central California based on transaction cost-based analysis. They argue that due to vertical disintegration of production the external transactions that a firm enter into increase rapidly. These transactions are less predictable and thus more complex which further adds to the transaction cost. In order to control them firms tend to locate near each other. This agglomeration then not only helps them by a reduction in transaction cost but also by increasing flexibility and minimising risk.

As their study is based on the general theory of transaction cost, its applicability is much more than the New Marshallian Districts. This theory can be applied to any region, any sector and to the firms of all sizes.

UNIDO defines clusters as “geographical concentrations of inter-connected enterprises and associated institutions that face common challenges and opportunities”.

This definition highlights two essential features of clusters: – they consist of a critical mass of enterprises located in geographical proximity to each other and enterprises within them share many common features.

Apart from enterprises, clusters also include support institutions, such as:

• business associations;
• business development service (BDS) providers;
• financial service providers, including banks;
• public authorities such as local, regional and national governments and regulatory agencies;
• training agencies such as vocational schools, universities, etc.

According to Porter (2000), clusters affect competition in three broad ways:

By increasing the current (static) productivity of constituent firms or industries
By increasing the capacity of cluster participants for innovation and productivity growth
By stimulating new business formation that supports innovation and expands the cluster

The productivity within clusters enhanced as:

• clusters provide highly specialized inputs at a low cost
• clusters lead to a reduction in the transaction cost
• clusters facilitate complementarities between activities of cluster members
• clusters provide easy access to information, thereby reducing if not eliminating the information asymmetries

Clusters contribute to innovation in the following ways:

• by easier and faster access to new processes needed for innovation
• by proceeding faster with innovations due to the proximity of potential suppliers
• by making the availability of specialized professionals easy
• by identifying new technological, operating and delivery opportunities
• by direct observation of other firms

Clusters lead to the new business formation as:

• they offer lower barriers to entry (and exit) as the cost of specialized inputs is lower compared to non-cluster areas
• they provide information about new business opportunities
• they provide an environment rich in social capital