why do firms cluster? chapter 3 mcgraw-hill/irwin copyright © 2012 by the mcgraw-hill companies,...
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Why Do Firms Cluster?
Chapter 3
McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
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Why do firms locate close to one another?
• Localization economies: firms in an industry cluster
• Urbanization economies: firms in different industries cluster
• Firms cluster to
– Share intermediate inputs
– Share a labor pool
– Get better matches of workers and labor tasks
– Share knowledge
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Clustering to Share Intermediate Inputs
• An Example: Dressmakers produce high fashion dresses– Rapid changes in fashion and output: Firms are small &
nimble
– Scale economies in buttons large relative to demand of single dressmaker
– Face time require to design and fabricate buttons to fit dresses
• Dressmakers share a button-maker, and cluster to facilitate face time
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Another Example: High-Technology Firms
• Rapidly changing products necessitates intermediate inputs– Electronic components
– Testing facilities
• Firms share intermediate input suppliers to exploit scale economies
• Face time in design and fabrication requires proximity and cluster
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Self-Reinforcing Effects of Clustering
• The Tradeoffs
– Benefit: Localization economies reduce cost of intermediate input
– Cost: Competition for workers increases labor cost
• Starting with isolated firms, will a cluster form?
• How many firms will join the cluster?
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Clustering to Share a Labor Pool
• Varying demand for each firm: Software & TV programs
• Fixed industry-wide demand: zero-sum changes in demand across firms
• Example: success of one firm’s GIS software at expense of others
• Locational equilibrium: Wage in cluster = expected wage in isolated site = $10
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Computing Profits• Labor Demand: marginal benefit = revenue
contribution = MRP
• Profit from an individual worker = MRP - wage
• Profit from workforce: Triangle between demand curve and wage line– Panel A: Expected profit for isolated firm = $48
– Panel B: Expected profit for isolated firm = (1/2) • ($147 + $3) = $75
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Move to Cluster Increases Expected Profit
• High demand (good news): more profit in cluster because of lower wage and more workers
• Low demand (bad news): less profit in cluster because of higher wage
• Good news dominates bad because firms respond to changes in demand– High demand: hire more workers to exploit lower wage
in cluster
– Low demand: hire fewer workers to cushion blow of higher wage in cluster
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Clustering to Facilitate Labor Matches
• Firms and workers not always perfectly matched
• Mismatches require training costs to eliminate skill gap
• Show that larger city generates better matches
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A Model of Labor Matching• Workers have varying skills on circle– Each firm enters market with a skill requirement on unit circle
– Workers incur training cost to close gap
• Scale economies in production: 2 workers per firm
• Monopolistic competition: Zero economic profit & Wage = MRP– Competition: Unrestricted entry generates zero economic profit
– Firms are differentiated with respect to skill requirement
– Firms offer wage and workers accept highest net wage
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Clustering to Share Knowledge
• Firms in an industry share ideas and knowledge
• Mysteries of trade are “in the air”
• Innovations are promptly discussed, improved, and adopted
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Evidence of Knowledge Spillovers
• Spillovers more important in idea industries
• Most innovative industries are the most likely to cluster
• Spillovers have range of a few miles
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Evidence of Localization: Productivity & Births
• Higher Labor Productivity – Henderson: Elasticity (output per worker, industry
output) = 0.02 to 0.11
– Mun & Huchinson: Productivity elasticity = 0.27
• Firm Births– Carlton: Elasticity (births, industry output) = 0.43
– Head, Reis, Swenson: Japanese plants cluster
– Rosenthal & Strange: births more numerous in locations close to industry concentrations
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Evidence of Localization: Employment Growth
• Henderson, Kuncor, Turner: growth more rapid close to existing concentrations
• Rosenthal & Strange: rapid growth close to locations with existing jobs
• Localization economies attenuate rapidly
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Urbanization Economies• Agglomeration Economies Across Industries• Result in large diverse cities• Sharing, Pooling, and Matching– Intermediate goods: business services (banking,
accounting), hotels, transport services
– Pooling: Workers move from industries with low demand to industries with high demand
– Matching: Common skills and inter-industry matching, e.g., computer programmers
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Corporate HQ and Functional Specialization
• Corporations cluster in cities to share firms providing business services
• Large cities increasingly specialized in managerial functions
• Small cities increasingly specialized in production
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Urbanization Economies and Knowledge Spillovers
• Diverse city is fertile ground for new ideas
• Bulk of patents issued to people in large cities
• Disproportionate number of patent citations from same city
– Local nature of citations decreases over time as knowledge diffused
– University patents are most fertile, followed by corporate patents
• Evidence of Urbanization Economies
– Elasticity of productivity w.r.t. population is 0.03 to 0.08
– Diversity promotes employment growth, especially in innovative industries
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Other Benefits of Urban Size• Joint Labor Supply
– Large cities offer better employment opportunities for two-earner families
– History: metal-processing firms (men) located close to textile mills (women)
– Current: power couples attracted to cities, with better employment matches
• Learning Opportunities
– Human capital increased by learning through imitation
– Urban migrates acquire skills and experience permanent increase in wage
• Social Opportunities: Better matches of social interest in large city
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