Innovation and Industrial Clusters Shahid Yusuf DRG World Bank ISEAS, Singapore June 13, 2008

Sources of Growth Middle and high income countries are deriving most of their growth impetus from relatively few urban centers which frequently host dynamic industrial clusters. An increasing share of growth will stem from gains in total factor productivity (TFP). Innovation is a major determinant of changes in TFP and the driving force being the upgrading of cluster capabilities and the transition to new clusters as existing ones lose competitiveness.

What is an Innovative Urban Environment for Clusters? Its economic progress springs from a dynamic and diversified base of industry and services. Dynamism and growth is the result of an urban system that routinely generates ideas and absorbs ideas from the rest of the world to produce new and innovative products, processes, and services of commercial value. Innovation as measured by patenting or the introduction of new products/services, is greater in the larger cities and cities with higher employment intensity (96 percent of U.S. patents from metro areas and the 25 largest cities with 12 percent of the population, accounted for 20 percent of patents). However, there are exceptions e.g. Turku in Finland and Cambridge U.K.- where universities and local authorities have created innovative industrial clusters.

Key Characteristics of an Innovative Urban Environment Large urban centers (or a sub-national region where scale effects are achieved through the networking of smaller cities) confer several advantages: Size and composition of regional economy; Urbanization economies (from industrial scale and diversity); Localization economies (from specialization, often in satellite or edge cities in a metro area, or in polycentric sub-national regions with multiple interlinked cities: however, doubling of distance from metro centers reduces productivity by 15 percent); Concentration of universities and research entities; Density of labor market; Quality of infrastructure and international connectivity; Services providers (finance, legal, engineering, managerial) (Business services tend to concentrate more in urban centers.); and Concentration of company HQs.

Human Capital and Urban Capital Knowledge, based on technical skills and R&D, is the principal driver of productivity. Urban environment, infrastructure, and services determine knowledge spillovers and multiplier effects. Investment in the quality of primary/secondary education linked with economic performance. Quality of education, including tertiary education, affects innovativeness. Tertiary education attainment associated with high earnings premium and low unemployment rates.

Entering a virtuous spiral: What it takes Regional economy, industrial composition, knowledge producers, intermediaries and firms. Large, prosperous regional economy with an expanding population influences fortunes of cities. Mix of industry and services in region/city affects incentives for research and scope for innovating. Proximity of current local technology to the frontier, can determine returns from higher education and research. Findings of basic research and tacit knowledge diffuses slowly, hence universities and research institutes generating ideas are at the core of the innovative city. Translating innovation into commercial products/services is the function of entrepreneurial firms doing applied research and development. Promoting an uptake of research is the work of intermediaries- and also firms. Coalition of supporting private interests, e.g. financiers, urban developers, NGOs, and industrial and professional bodies.

Urban Knowledge System: Regional and Industrial Composition Growing regions with large and stable economies, support innovative cities and attract skilled entrepreneurial workers. Scope for innovation depends on type of industries and services, present or emerging. However, innovation and gains in total factor productivity are as likely in R&D/skill intensive activities (such as the life sciences) as in others (such as retail, wholesale, logistics, construction, and medical care).

Contributions to Total Factor Productivity by Industry (U.S. Experience, )

Urban Knowledge System: the University Universities with research capabilities are a necessary ingredient. They produce many of the ideas. Education levels of an urban region correlated with entrepreneurship, and can stimulate R&D by firms. Returns to higher education and research greatest when industry moving rapidly to incorporate advanced technologies. The best research universities depend on strong graduate programs, multiple public/private sources of funding, large R&D budgets and effective allocation mechanisms, competitive pressures, and autonomy. Special programs catering to firms as pursued by Stanford and MIT, help raise funds from the business sector, leverage talent in firms and build local partnerships.

Urban Knowledge System: the University (Contd.) Specialization in core areas, and networking among second tier universities, is a means for building technological capabilities in the absence of large world class universities. Such networking, which allows differentiation and specialization among providers of tertiary level training, can build spheres of excellence and much needed critical masses of complementary skills. Medicon Valley (Copenhagen and the Skane region of Sweden) an example. Multidisciplinary programs are increasingly important for raising productivity of scientists and engineers. Networking and knowledge circulation among universities via formal and informal channels, a big plus e.g. co-authorship, multi-university research teams, the EU’s Erasmus program etc. University research contributes most to biotech/pharma, IT and electronics.

Urban Knowledge System: The Intermediaries Municipal governments determine business environment, quality of services, tax incentives and attractiveness of amenities for knowledge workers. Through inter-jurisdictional coordination, they can build, integrate and maintain infrastructure. University technology licensing offices (TLOs) can serve as matchmakers between researchers and potential users. Regional, industrial bodies and other institutes can provide incentives and mechanisms for universities and firms to link-up and pool research assets (Cambridge-MIT, KIC initiative, TAMA Association in Japan, TEFT program in Norway, Georgia (USA) Research Alliance of six major universities, UCSD CONNECT, the IC2 Institute at UT Austin and ITRI in Taiwan). SPINNO/TEKES (Finland) assists new starts.

Venture capitalists and angel investors can provide start-up capital, coaching and contacts – but depend on local financial institutions and tax and company laws to gain traction. Developers work with local public authorities to create infrastructure and affordable housing for urban industry and knowledge workers. Other services providers underpin efforts of firms. Urban Knowledge System: The Intermediaries (Contd)

Urban Knowledge System: Firms Bulk of applied research done by firms (between 50 and 80 percent). Access to universities advantageous because open innovation is more fruitful. However, research intensity depends on industry; services and resource based industries do little research. Most R&D and patenting in few industrial categories. In the EU, 42 percent is by electronics, engineering, vehicles and telecom. Proactive firms with own (exploratory) R&D programs and strategies based on innovation, better able to seek out ideas and work with universities. Major firms can serve as anchors for clusters and regional innovation systems (within a country as in the US, or across countries as with the Medicon Valley). Examples are Novo Nordisk and Astra Zeneca, in Medicon, HP in Silicon Valley, Boeing and Microsoft in Seattle.

R&D Intensity

Hybritech and its Daughter Firms in San Diego

Linkabit and its ‘Children '

CCL and Daughter Firms in Cambridge, UK

Firms headed by those with tertiary education likely to hire skilled and technical workers and encourage innovation. Firms operating in an urban region with significant industrial/technological breadth, more likely to diversify into new fields, once old ones are commoditized and rents squeezed. Urban Knowledge System: Firms (Contd)

Sustaining Growth of the Innovative City : National Level Policies National innovation system must underpin and stimulate dynamic urban centers. Tax incentives, an education strategy, public support of R&D and IP (intellectual property) institutions, are among the policies required. Quality and research intensity of national universities and openness to international students and competition (national as well as regional), is a way of sustaining flow of ideas. Early foundation of creative and STEM (science, technology, engineering and math) skills forms the basis for gains from higher education and the utility of lifelong learning programs. Public programs and procurement for innovative products and services buttress private demand. In some instances, public enterprises and research institutes play key role.

Few urban centers have the potential of becoming “innovative cities”. Realistic assessment and expectations are the basis for identifying and realizing potential.