Best Practices in State and Regional Innovation Initiatives: Competing in the 21st Century (2013)

Chapter 2

State and Regional Development and Clustering

In the United States, the proper role of the federal government in economic development has been controversial since the days of Hamilton and Jefferson.¹ There is a general consensus that the federal government should conduct monetary, trade, and regulatory policy and support basic infrastructure such as highways and airports.² Industrial policy is something of an American tradition as well, perhaps most sustained in agriculture³ but also with longstanding support for sectors associated with national security and public health.⁴ However, the idea of supporting new industries, and especially particular firms, is a source of perennial controversy in the U.S. Congress and within U.S. economic policy circles, a fact that is manifested in the frequently erratic pattern of federal support for particular industries.

At the state level, however, the perspective toward economic development is much different, with policy actors relatively unconstrained by

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¹See Nikolaos Karagiannis and Zagros Madjd-Sadjadi, “A New Economic Strategy for the USA: A Framework of Alternative Development Notions,” Forum for Social Economics 41(2-3), 2012.

²This is a long held perspective. See, for example the review by Otto Eckstein, “Federal expenditure policy for economic growth,” The Journal of Finance 17, 1962.

³U.S. agricultural interests, succeeded in securing the establishment of a cabinet-level department to promote their industry in 1889 and succeeded in establishing the proposition that the farm sector was a special industry requiring a special public policy, At various points in the past century U.S. farmers have benefitted from price supports, research and development assistance, import protection, low interest financing, and export subsidies. Paradoxically, this massive federal support has been paralleled by enthusiastic support for laissez-fair principles and free trade by industry spokesmen. Robert H. Wiebe, The Search for Order, 1877-1920, New York: Hill and Wang, 1967, pp. 126-127; Richard Hofstadter, The Age of Reform, New York: Vintage Books, 1955, pp. 122-129.

⁴In the post-World War II era, within the framework of national defense and the imperatives of the Cold War, the Department of Defense and other national security organizations, such as the National Aeronautics and Space Administration and the Atomic Energy Commission, supported the development of technologies and industries associated with national security, including titanium computers, aviation, microelectronics, nuclear power, and lasers. The National Institutes of Health supported research that included fostering U.S. capabilities in pharmaceuticals and biotechnology.

the ideological considerations that have occasionally inhibited implementation of federal policy. In 1988, an academic observer noted an “intensive preoccupation with economic development at the state and local level” that had emerged in the late 1970s and commented as follows:

The 50 states and many of their communities are in the process of fashioning, with varying degrees of vigor and coherence, separate little industrial policies, self-conscious attempts to foster selected industries judged to provide comparative local advantage or to be critical to the local economic future.⁵

The states responded more aggressively to the structural changes besetting the American economy than did the federal government which became mired in Congress-Executive Branch debates about the rectitude and effectiveness of ‘industrial policy’ measures.”⁶

In the years since these observations were made, state and local industrial development efforts have continued unabated while undergoing a qualitative evolution that increasingly emphasizes knowledge-based development. In the 1970s and 1980s, science and research initiatives were implemented by state governments, but these were generally ancillary to larger-scale efforts to shore up established industrial sectors and to recruit out-of-state companies with the objective of preserving and expanding employment.⁷ In recent decades, however, innovation-related initiatives have moved to the center of state and local development efforts, featuring initiatives such as the upgrading of university research infrastructure, faculty recruiting, the promotion of systematic and professionalized university-industry technology transfer, the fostering of start-ups, and the development of research and innovation-based industrial clusters.

NATURAL DEVELOPMENTAL ADVANTAGES
ENJOYED BY STATES AND REGIONS

State leadership in innovation enjoys a rationale that extends beyond the parochial concerns of local leaders. While federal spending on R&D is

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⁵Peter K. Eisinger, The Rise of the Entrepreneurial State: State and Local Economic Development Policy in the United States, Madison: The University of Wisconsin Press, 1988, p. 6.

⁶Irwin Feller, “Federal and State Government Roles in Science and Technology”, Economic Development Quarterly 1997, p. 285.

⁷By 1985, about 35 U.S. states had some type of advanced technology programs involving initiatives such as technical and vocational education, promotion of start-ups through incubators or the provision of venture capital and support for university-industry R&D projects. The U.S. Office of Technology Assessment observed in 1983 with respect to these initiatives that “few of them have been in existence long enough to produce measurable results, and in most cases there has been no systematic evaluation of their effectiveness.” Irwin Feller, “Evaluating State Advanced Technology Programs,” Evaluation Review June 1998, p. 233.

massive, the greatest proportion of this expenditure is devoted to defense and national-security-related technology development projects sponsored by the Departments of Defense, Energy, and Homeland Security.⁸ While much of the defense related research spending benefits private companies conducting contract R&D, the research results frequently cannot be applied in the commercial realm and indeed, federal policy priorities often divert funds and the efforts of private contractors away from consumer and industrial markets.⁹ Accordingly, “state governments justify their involvement as brokers and patrons of the technology-transfer process on the grounds that their priorities lie in the development of innovations to be sold in the open market, transactions that will ultimately enhance the local economy.”¹⁰

“Sub-national governments have a greater capacity to tailor programs to local conditions.” In the United States, a number of academic studies have concluded that in the development of technology pioneering firms, state support has played a key role in pooling multiple external public and private funding sources, including federal funds and venture capital, and directing them to private firms.¹¹ At one of the symposia convened for this project, a Commerce Department official commented that with respect to economic development, “state and local leaders tend to be ahead of the curve.” Regional innovation clusters cannot be legislated—“they are organic. You have to have champions at the local, private sector and state levels. What we can do is work with those

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⁸For a review of the division of federal R&D spending, see AAAS Report XXXVII, Research and Development, FY 2013.

⁹For a classic review of the potential and limitations of military R&D, see John Alic et al., Beyond Spinoff, Boston: Harvard Business School Press, 1992. In 2004, a study was prepared for the U.S. Air Force under Commerce Department auspices, with respect to the attitudes of 447 high tech companies toward collaboration with DoD in R&D and technology sharing, of which 35 percent of the surveyed firms were classified as defense contractors. About 45 percent of the firms surveyed indicated a reluctance to discuss R&D with DoD, citing factors such as non-applicability of technology to non-DoD uses, difficulty or working with federal agencies, inadequacy of financial rewards, and inadequacy of development funding. Nearly 53 percent of the defense contractors surveyed complained about the inadequacy of financial rewards. U.S. Department of Commerce Bureau of Industry and Security, Office of Strategic Industries and Economic Security, Assessment of Industry Attitudes on Collaborating with the U.S. Department of Defense in Research and development and Technology Sharing, January 2004, pp. ii, 25. In 2012, acting in response to a Presidential Memorandum, “Accelerating Technology Transfer and Commercialization of Federal Research in Support of High Growth Business,” October 28, 2011, DoD promulgated a “Strategy and Action Plan” to encourage an increase in DoD technology transfer. The plan features a series of improvements in DoD’s technology commercialization processes and new performance metrics which include the commercial impact of DoD technology transfer. DoD, “Strategy Action Plan for Accelerating Technology Transfer [T2] and Commercialization of Federal research in Support of High Growth Business,” October 4, 2012.

¹⁰Eisinger, Rise of the Entrepreneurial State op. cit. p. 275.

¹¹Andrea Fernandez-Ribas, “Public Support to Private Innovation in Multi-Level Governance Systems: An Empirical Investigation,” Science and Public Policy July 2009, p. 459.

folks as true partners and customize the deployment of federal resources to amplify and accelerate that particular cluster.”¹²

The states and municipalities can often use policy levers with greater precision and effectiveness than the federal government. They control factors of production such as land use and availability, infrastructure, power and water, and waste disposal. Every state supports a system of public universities, institutions that along with their private counterparts have been at the forefront of innovation-driven economic development for well over a century. While federal government research grants and contracts influence the activities of the public and private universities, the largest substantial proportion of the operating budgets (non-targeted funds) of public universities are still derived from state governments, which remain in a position to encourage educational institutions to align their priorities with local economic development.¹³ The states likewise control the provision of public K-12 education, which depending on its quality, can foster the development of an adult work force with the skill levels necessary to support an innovation-driven economy.

U.S. advantages in universities may be eroding. State funding for students at public universities has fallen on a per capita basis by 20 percent over the last ten years.¹⁴ This has been followed in recent times by additional cuts to federal support for university R&D. ¹⁵ And the proportion of state university budgets derived directly from the state has declined sharply, even if the leading U.S. research universities continue to produce more highly cited articles than research universities in other countries.¹⁶

Moreover, most states lack a framework for considering R&D activities, or for integrating R&D at the state level with programs at the federal level. Notably, a 1995 report of The State-Federal Technology Partnership Task Force chaired by the Governors of Ohio and Pennsylvania (the Celeste-

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¹²Comments of U.S. Assistant Secretary of Commerce for Economic Development John Fernandez, National Research Council, Clustering for 21st Century Prosperity: Summary of a Symposium, C. Wessner, Rapporteur, Washington, DC: The National Academies Press, 2012.

¹³National Science Board, Science and Engineering Indicators 2012, Arlington, VA: National Science Foundation, Chapter 6.

¹⁴According to the National Science Board, “State per-student funding for the nation's 101 major public research universities declined by an average of 20 percent in inflation-adjusted dollars between 2002 and 2010, with 10 states experiencing declines ranging from 30 to as high as 48 percent.” NSF, Press Release 12-176, “Science Board Concerned About Declines in Public Research University Funding.”

¹⁵Washington Post, “Sequester cuts university research funds,” March 16, 2013. The article notes that “the federal budget sequester that took effect this month—requiring cuts of about 5 percent in nondefense programs and more than 7 percent in defense—is likely to shrink research spending by more than $1 billion. Advocates warn that the cuts could hamper exploration in biomedical science, among other disciplines, and undercut efforts to ensure U.S. leadership in science and engineering.”

¹⁶National Science Board, Science and Engineering Indicators 2012, op. cit., Chapter 6.

Thornburg Report,) called attention to this disjunction and offered policy recommendations to remedy it.¹⁷

In contrast, for countries such as Singapore, Taiwan, and Korea, the health of the innovation economy is a central focus for policymakers, as is the acquisition and development of new technologies for commercialization and export.¹⁸

Where the federal authorities in the U.S. sometimes hesitate to support promising sectors, especially in a sustained fashion, countries in East Asia, as well as in Europe, provide sustained policy attention and substantial public investment.¹⁹ They provide continued high level policy attention and substantial investment, backed by education and development policies.

Even so, the notion that individual U.S. states are overmatched in competition with other more mercantilist and more advanced countries may well be misplaced. While state levels of population and GDP are not always comparable to those of technology-intensive foreign countries, they are not altogether dwarfed by them. More significantly, U.S. states appear to enjoy an edge with respect to a key element in technology competition, the presence of first-rate universities.

THE INNOVATION CLUSTER PHENOMENON

The states have been the primary movers in the widespread and growing practice of fostering innovation clusters as an economic development tool. In his seminal 1990 book The Competitive Advantage of Nations, Michael Porter argued that in advanced economies, regional “clusters” of related industries—not individual companies or sectors—are the primary source of competitiveness, export growth and rising employment and income levels.²⁰ Clusters are geographically localized concentrations of firms in related sectors that do business with each other and have common needs for trained workers, infrastructure and technology. Although the cluster concept predates Porter by nearly a century, and the cluster phenomenon itself is as old as history, Porter popularized it so effectively that since his book appeared the cluster concept has

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¹⁷The State-Federal Technology Partnership Task Force—Final Report, September 5, 1995. Report Developed by 20-member State-Federal Technology Partnership Task Force assigned by Governors Celeste and Thornburgh.

¹⁸National Research Council, Rising to the Challenge: U.S. Innovation Policy for the Global Economy, C. Wessner and A. Wm. Wolff, eds., Washington, DC: The National Academies Press.

¹⁹Ibid. This is not to say that all foreign interventions in new technologies and new firms succeed. Many do not, just as U.S. investments in new technologies and new weapon systems do not always succeed. Yet, continued pursuit of these goals, and continued investment, is the global norm, and seen to be in the national interest.

²⁰See Also Michael Porter, “Clusters and the New Economics of Competition,” Harvard Business Review 1998.

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²¹For a history of the organization, see, 60 Years of Fraunhofer-Gesellschaft, Munich: Fraunhofer-Gesellschaft, 2009. The publication can be accessed at <http://www.germaninnovation.org/shared/content/documents/60YearsofFraunhoferGesellschaft.pdf>.

²²House of Commons Science and Technology Committee, Technology and Innovation Centres. Second Report of Session 2010-11, Vol. I, Report, p. 27.

come to dominate the economic development thinking in advanced countries, including the United States.²⁵

At present, most state and regional development efforts in technology-intensive industries are based on cluster formation.²⁶ A 2010 report by the Brookings Institution observed that “with little or no past federal support,

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²³A*STAR, “Singapore Science, Technology, and Enterprise Plan 2015,” Singapore: A*STAR, 2011.

²⁴Tekes website at <http://www.tekes.fi/en>.

²⁵Prior to industrialization, clustering was often essential because of the limitations of transportation and communications. However, the phenomenon persists at present notwithstanding the relative ease of global transport and communication. Prior to industrialization, clustering was often essential because of the limitations of transportation and communications. However, the phenomenon persists at present notwithstanding the relative ease of global transport and communication. Of course, clusters were identified a long time ago by Marshall and others. Until the 1960s, clusters were the only way that most industries could develop because of the limitations of communications and transportation. Over 100 years ago, the Census Bureau created enormous volumes setting out and analyzing in detail U.S. manufacturing clusters (see section XXXIX of <http://www2.census.gov/prod2/decennial/documents/05457254v7ch02.pdf>). Interest in clusters has revived since the 1990s as a reaction to the downsides of dispersion.

²⁶Mary J. Waits, “The Added Value of the Industry Cluster Approach to Economic Analysis, Strategy Development and Service Delivery”, Economic Development Quarterly 14(1):35-50, February 2000.

numerous U.S. regions and states today operate several hundred distinct cluster initiatives—formally organized efforts to facilitate cluster growth.”²⁷

Clusters attract the attention of state, regional, and local policymakers “because of the economic vibrancy that a successful cluster can give an area.”²⁸ NorTech, a highly regarded non-profit technology-oriented development organization serving Northeast Ohio, recently summarized the local benefit clusters can deliver: “(1) transition from unemployment to high-skill employment; (2) create new higher-wage job opportunities; (3) develop local businesses less susceptible to offshoring; (4) stabilize communities by re-purposing idle assets and people; and (5) manufacture products in the region for export, restoring value to the region.”²⁹

Geographic concentrations of specialized artisanal and industrial activities can be traced back to the beginnings of recorded history, and a rich literature on the subject has developed since the writings of the great English economic historian Alfred Marshall in the late Nineteenth and early Twentieth Centuries. Marshall and his contemporaries identified a number of “agglomeration” forces underlying such concentrations, including reduced transportation costs with respect to inputs, availability of a skilled labor pool, the desire to capture “secrets of the trade,” through local presence, enhanced likelihood of innovation, and sharing resources that entail substantial fixed costs.³⁰ More recently, Michael Porter has emphasized the manner in which local clusters ease the management of modern value chains, in which companies outsource various elements of design production, assembly, testing, and system management.³¹

As dramatic advances in transportation and communications unfolded, such as the railroad, the telegraph, and mass printing, many observers—including Marshall himself—believed that the advantages of localized industrial concentrations would diminish. On the basis of this logic, the advent of the

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²⁷Mark Muro and Bruce Katz, The New ‘Cluster Moment’: How Regional Innovation Clusters Can Foster the Next Economy, Washington, DC: The Brookings Institution, September 2010, p. 20.

²⁸Eugene Seeley, “A New View on Management Decisions that Lead to Locating facilities in Innovation Clusters”, Journal of Business Inquiry, Vol. 10. 2011.

²⁹NorTech, “Why Clusters Matter.” Access at <http://www.nortech.org/clusters/why-clusters-matter>.

³⁰See generally Nancy Dorfman, “Route 128: The Development of a Regional High Tech Economy,” Research Policy, 1983. Dorfman credits the development of high technology in the Boston area in the 1970s to agglomeration effects, meaning that the local growth in the size and number of firms operating in a specific industry (as well as related support industries) make an area alternative for a firm. Dorfman indicated that there are “important advantages in locating near to complementary and competitive enterprises.” Ibid.

³¹Michael E. Porter and Mark R. Kramer, “Creating Shared Value,” Harvard Business Review January 2011. While it is quite evident that innovative activity is spatially distributed in an uneven manner, the reason(s) why this is so has given rise to numerous hypotheses. For a survey of these theories and the complex issues surrounding the “geography of innovation,” see Ian R. Gordon and Phillip McCann, “Clusters, Innovation and Regional Development,” Centre for Economic Policy Research, 2003.

Internet and other forms of instantaneous communication today should further undermine the advantages associated with specialized geographic industrial concentrations. In fact, that has not happened, particularly with respect to innovation-intensive forms of industrial activity, reflecting the fact that key aspects of knowledge formation and transmission favor location in specific places.

The persistence of clusters in the global era is closely associated with so-called “tacit knowledge”, which confers a competitive edge on geographic localities where knowledge creation and transmission are occurring. Contrasted with codified or formal knowledge which is written down on paper or stored or transmitted through electronic media, tacit knowledge—e.g. “know-how”—is attained through actual operating experience, observation of results, and hands-on experimentation, and is typically conveyed to others on a face-to-face basis through repeated demonstration and coaching, as for example, traditionally occurred in an industrial apprenticeship or laboratory practicum.³² Codified knowledge can be transmitted anywhere in the world instantaneously; transmission of tacit knowledge generally requires close geographic proximity³³. Michael Polanyi, a Twentieth-Century scientist who developed understanding of tacit knowledge, summarized it in 1958:

An art which cannot be specified in detail cannot be transmitted by prescription, since no prescription for it exists. It can be passed on only by example from master to apprentice. This restricts the range of diffusion to that of personal contacts. We find accordingly that craftsmanship tends to survive in closely circumscribed local traditions.³⁴

The demands of tacit knowledge creation and transmittal usually require not only close personal interaction, but also localized facilities and infrastructure that permit practical, hands-on application and testing of theoretical concepts. For example, protracted aircraft propeller wind tunnel testing conducted at Stanford University by professors W.F. Durand and E.P. Lesley between 1916 and 1926 was necessary because “there was no way in which the body of scientific knowledge would permit a more direct determination of the optimal design of a propeller given the fact that ‘the

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³²Jan Youtie and Philip Shapira. “Building an Innovation Hub: A Core Study of the Transformation of University Roles in Regional Technological and Economic Development,” Research Policy. 37:1190-1191, 2008.

³³“Know-how is practical knowledge about how to get something done, as opposed to ‘know-what’ (facts), ‘know-why’ (science), or know-who (networking). Know-how is often tacit knowledge that means it is difficult to transfer from one person to another by means of writing it down or verbalizing it. “Intellectual Property (IP) and Know-How: Defined,” Charlotte Examiner June 20, 2011.

³⁴Michael Polanyi, Personal Knowledge: Toward a Post-Critical Philosophy, Chicago: University of Chicago Press, 1958, p. 52.

propeller operated in combination with both the engine and airframe…and it must be compatible with the power-output characteristics of the former and the flight requirements of the latter.”³⁵ Similarly, optimal scale for a plant cannot necessarily be determined by reference to codified knowledge or even by simply scaling-up from a small-scale model. “The key experimental tool of the…engineer is therefore the pilot plant, and inferences drawn from experimental data provided by such plants. Such optimal size will be found to differ from one…product line to another.”³⁶ The late Eugene S. Ferguson, an engineer and historian of technology, made the following pertinent observation two decades ago:

I was fortunate to learn early that an engineer’s intelligent first response to a problem that a worker brings in from the field is “Let’s go see.” It is not enough to sit at one’s desk and listen to an explanation of a difficulty. Nor should the engineer refer immediately to drawings or specifications to see what the authorities say. The engineer and the worker must go together to the site of the difficulty if they expect to see the problem in the same light. There and only there can the complexities of the real world, the stuff that drawings and formulas ignore, be appreciated.³⁷

The need and desire to capture tacit knowledge has long been recognized as a key factor underlying the location of research and development activity.³⁸ That fact favors locations with existing manufacturing, testing, and research and development operations that are all potential sources of tacit knowledge. A 2009 survey of U.S. semiconductor producers by the Semiconductor Industry Association found that these firms physically located their process R&D activities wherever their manufacturing operations were,

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³⁵Nathan Rosenberg, and W. Edward Steinmueller, “Engineering Knowledge.” SIEPR Discussion Paper No. 11-022, p.11, The authors note W. Vincenti’s observation that “what the Stanford [wind tunnel] experiments eventually accomplished was something more than just data collection and, at the same time, something other than science. It represented, rather, the development of a specialized methodology that could not be directly deduced from scientific principles, although it was obviously not inconsistent with those principles… [T]he strength of experimental parameter variation is precisely its ability to provide solid results where no useful quantitative theory exists. Ibid pp. 13-14.

³⁶Ibid. p. 21.

³⁷Eugene S. Ferguson, Engineering and the Mind’s Eye, Cambridge, MA: The MIT Press, 1992, p. 56.

³⁸“[O]ne distinguishes between information on the one hand, and knowledge or know-how on the other. For this purpose, the distinction is in the tacit character of knowledge, not the formal conception of an innovation, but the skill and experience associated with effectively implementing it. Although advances in information technology may have caused the cost of transmitting the formal conception to become invariant to distance, effectively transmitting tacit knowledge requires proximity, and hence creates the potential for agglomeration.” Gilson, “Legal Infrastructure of High Technology Industrial Districts,” op. cit. p. 582. 1999. Citing Maryann Feldman, The Geography of Innovation, 1994, p. 53.

reflecting the fact that the best process R&D requires close interaction with actual manufacturing operations.³⁹ Tesla Motors chose Michigan as the site of a 2007 technical center, in part, on the basis of Michigan’s existing infrastructure—“we felt it was smart to use the existing test tracks, validation equipment, wind tunnels and more, rather than duplicating these costly investments.”⁴⁰

Notwithstanding the intrinsic advantages arising out of co-location of innovative enterprises and research institutions in clusters, the fact remains that key innovative technologies originated in various regions of the United States have migrated to other countries for commercialization. The reasons for this vary from case to case but commonly involve the existence of superior and/or lower cost manufacturing competencies and infrastructure in other countries, work force issues, the availability of financing, and incentives deployed by foreign governments.⁴¹ The President’s Council of Advisors on Science and technology commented in a 2011 report that:

Foreign firms now manufacture many products invented here. For example, the United States no longer has the knowledge, skilled people, and supplier infrastructure required to produce light-emitting diodes for energy-efficient illumination, components for consumer electronic products like the Kindle e-reader, or advanced displays for TVs, computers, and handheld devices such as mobile phones.⁴²

“HISTORY MATTERS”—
PATH DEPENDENCY AND PATH CREATION

While an appreciation of the role of tacit knowledge aids in the understanding of why clusters exist and convey advantages to firms that locate in them, a more basic question confronting localities is how and why clusters come to exist in the first place and what can be done to encourage their growth. One perspective is that clusters require the right combination of resources and other factor advantages exist in a given location, and that these need to be

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³⁹Semiconductor Industry Association. Maintaining America’s Competitive Edge: Government Policies Affecting Semiconductor Industry R&D and Manufacturing Activity. 2009. A recent example of this phenomenon is the decision announced in 2013 by GlobalFoundries that it would locate its global R&D facility adjacent to its most advanced wafer fabrication facility in Malta, NY. “GlobalFoundries to Invest $2 Billion in New Malta Research and Development Facility,” The Saratogian January 8, 2013.

⁴⁰“Tesla Motors Opens Michigan Technical Center to Focus on company’s future products,” Press Release, January 26, 2007.

⁴¹For a case study of the latter phenomenon, see Semiconductor Industry Association, China’s Emerging Semiconductor Industry: The Impact of China’s Preferential Value-Added Tax on Current Investment Trends, October 2003.

⁴²PCAST, Report to the President in Ensuring American Leadership in Advanced Manufacturing, June 2011, p. 4.

present at a sufficient scale.⁴³ Another is that scientists, engineers, and other highly educated and creative people seek to live in an environment that emphasizes learning, culture, and a good physical environment.⁴⁴ However, most individuals who have addressed the question—including many who have been involved in attempts to form clusters—have concluded that there is “no magic formula” for doing so and that the task itself is daunting.

Professor Maryann Feldman has observed that cluster formation “is a process predicated on the actions of entrepreneurs and their symbiotic relationships with their local environments. The cluster and its characteristics therefore emerge over time from the individual activities of the entrepreneurs and the organizations and institutions that evolve to support them.”⁴⁵ This perspective is widely shared. It follows that because clusters are rooted in the language and culture of a particular time and place, “replicating a successful cluster model elsewhere can be highly elusive.”⁴⁶ A considerable amount of academic literature has applied the term “path dependency” to the factors underlying the emergence of clusters in a given geographic district, meaning the evolution is shaped not by the rules of economics but by “the details of the seemingly transient and adventitious circumstance” associated with their beginnings.⁴⁷ Put another way, “history matters.”⁴⁸ The roots of success of districts such as Silicon Valley and the achievements of Research Triangle are more likely to be found in the historical idiosyncrasies and traditions, culture, and actions of individual movers in California and North Carolina, respectively, than in economics textbooks.⁴⁹ It follows that attempts to replicate some or all of the best features of these regions elsewhere requires an understanding of their individual history, innovation culture, and key individual movers.

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⁴³See, for example, Nancy S. Dorfman, “Route 128: The development of a regional high technology economy,” Research Policy 12, 1983.

⁴⁴See for example, Richard Florida, The Rise of the Creative Class, Revisited, New York: Basic Books, 2012.

⁴⁵Maryann Feldman and Johanna Francis, “Homegrown Solutions: fostering Cluster Formation,” Economic Development Quarterly May 2004.

⁴⁶National Research Council, Growing Innovation Clusters for American Prosperity: Summary of a Symposium, C. Wessner, Rapporteur, Washington, DC: The National Academies Press, 2011, p. 8.

⁴⁷Ronald J. Gilson, “Legal Infrastructure of High Technology Industrial Districts: Silicon Valley, Route 128, and Covenants Not to Compete,” New York University Law Review, 1999 74(3):577, citing Paul A. David and Joshua L. Rosenbloom, “Marshallian Factor Market Externalities and the Dynamics of Industrial Localization,” Journal of Urban Economics 28:349, 368, 1990. A concrete example of path dependency is the fact that the United States has not fully adopted the metric system despite numerous major advantages associated with doing so. As a result of the short-run dislocations and costs associated with any transition from the English to metric system of measures, the U.S. remains locked-in to a system of measures that was determined centuries ago.

⁴⁸Gilson, “Legal Infrastructure of High Technology Industrial Districts,” op. cit. p. 577.

⁴⁹See Martin Kenney and Urs Von Burg, “Paths and Regions: The Creation and Growth of Silicon Valley” in Raghu Garud and Peter Karnoe, Path Dependence and Creation, New York: Psychology Press, 2012, pp. 127-148.

The Local Industrial Legacy

Studies of successful innovation clusters reveal that they emerged from an existing local industrial context that favored the emergence of new high technology industries. Boston’s high technology cluster known as Route 128 emerged from an industrial milieu characterized by thriving electrical manufacturing companies that had benefitted from federal military research expenditures during World War II organized around Harvard and MIT.⁵⁰ The San Francisco Peninsula was the home of numerous radio and electronic companies in the decades prior to the War, one of the factors credited with fostering the postwar emergence of an information technology industry in the region⁵¹. At present, Ohio’s historical competencies derived from production of glass, polymers, and machinery are facilitating the emergence of clusters concentrating on photovoltaics, flexible electronics, and medical instruments, respectively.

Innovation Culture

In an extensively cited 1994 work, Annalee Saxenian makes the case that the culture of a region can be a decisive factor in its emergence and survival as an innovation center. She noted that Silicon Valley had not only survived a series of severe economic shocks but continued to flourish as a result of its network-based industrial system that fosters collective learning and knowledge sharing among producers of complex technologies:

The region's dense social networks and open labor markets encourage experimentation and entrepreneurship. Companies compete intensely while at the same time learning from one another about changing markets and technologies through informal communication and collaborative practices; and loosely linked team structures encourage horizontal communication among firm divisions and with outside suppliers and customers. The functional boundaries within firms are porous in a network system, as are the boundaries between firms themselves and between firms and local institutions such as trade associations and universities.⁵²

Although the current hallmark of Silicon Valley is the individualistic entrepreneur, the region has a long cultural tradition of informal cooperation and

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⁵⁰See David R. Lumpe, Route 128: Lessons from Boston’s High Tech Community, New York: Basic Books, 1992.

⁵¹See generally Timothy J, Sturgeon, “How Silicon Valley Came to Be,” in Martin Kenney, Understanding Silicon Valley, Stanford CA: Stanford University Press, 2000.

⁵²Annalee Saxenian, Regional Advantage: Culture and Competition in Silicon Valley and Route 128, Cambridge MA: Harvard University Press, 1994, pp. 2-3.

mutual assistance, even by direct competitors, which predates the existence of Silicon Valley itself and may help account for its genesis. William Hewlett and David Packard of the Valley’s founding generation encouraged other entrepreneurs, shared technical knowledge, and worked to persuade companies to work together on common problems. Similarly although very different from the culture of the San Francisco peninsula, that of mid-Twentieth Century North Carolina was characterized by a longstanding tradition of generous philanthropy, civic-mindedness, collective spirit, and openness to institutional experimentation that transformed the state from a low-tech agrarian and light manufacturing economy into the more prosperous economy of the Research Triangle Park. Without the long-ago contributions of many ordinary North Carolinians, including hundreds of anonymous donors who provided the initial capital, the Research Triangle Park, today one of the country’s leading high technology clusters, would not exist.⁵³

Annalee Saxenian observes that in Silicon Valley labor is highly mobile and adaptable, characterized by “decentralization [which] encourages the pursuit of multiple technical opportunities through spontaneous regroupings of skill technology and capital.”⁵⁴ She cites research by two academics that show that production in Silicon Valley grows from “a set of individuals with a strong sense of entrepreneurship, joined around a project mission, associated with a technology-driven change, who remain in contact frequently and informally with multiple levels and functions within the company through intense informal communications.”⁵⁵ These core teams are supported by larger groups of employees, often temporary or contract workers with a variety of specialized skill sets; while the “possibility for meaningful participation and upward mobility” may be less for this group, their availability in large numbers on a flexible basis is an important aspect of the Valley’s success.⁵⁶ As noted above, in 2007, Tesla Motors, a Silicon Valley based start-up entering the high-performance electric vehicle market, chose Michigan as the site for its new technical center, in part because of the availability of a deep pool of local talent with engineering expertise in the auto industry.⁵⁷

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⁵³See generally, Albert N. Link, A Generosity of Spirit: The Early History of Research Triangle Park, Research Triangle Park: Research Foundation of North Carolina, 2005.

⁵⁴Annalee. Saxenian, Regional Advantage: Culture and Competition in Silicon Valley and Route 128, op. cit. pp. 9.

⁵⁵Ibid. p. 55.

⁵⁶Bryan C. Taylor and David Carlane, “Silicon Communication: A Reply and Case Study.” Management Communication Quarterly, 2001, p. 295. Saxenian quotes a local computer executive who comments that the Valley has a “huge supply of contract labor that want to design your own chips, there are a whole lot of people around who just do contract chip layout and design. You want mechanical design. It’s here too. There’s just about anything you want in this infrastructure. Annalee Saxenian, Regional Advantage: Culture and Competition in Silicon Valley and Route 128, op. cit., pp. xi.

⁵⁷“There are thousands of highly experienced automotive experts in this area. Growing Tesla Motors and creating higher-volume models requires more talented automotive engineers with experience in developing, manufacturing and assembling high-volume cars. We can hire the best, most

Although very different from that of Silicon Valley or Michigan, during the past generation, the workforce culture of Arkansas has helped the state attract investment by innovative companies. Nucor Steel, arguably the most innovative U.S. steel company to emerge in the past century, has located a number of major facilities in Arkansas, where local hires were typically “farmers or machinery workers who have been ingrained with a strong work ethic since childhood.” Dan DiMico, an executive at the company, which emphasizes employee responsibility and merit-based compensation, commented that “we hire good people, put them in a culture that encourages them to do well, give them the tools, and the opportunity to excel and then we get the heck out of their way.”⁵⁸ Similarly, Mitsubishi Power Systems Americas Inc. cited Arkansans’ “extraordinary work ethic” as a factor underlying its decision to locate a $100 million manufacturing facility for wind turbines in Fort Smith, Arkansas. A Mitsubishi executive said that “we looked for a part of the country where manufacturing is not some lost art.”⁵⁹

A region’s innovation culture can also exert negative influence on the development of innovative industries. Saxenian documents how the hierarchical, secretive big-company culture of the Route 128 innovation cluster led to its eclipse by Silicon Valley in computer technology.⁶⁰ Workforce culture in some of the Rust Belt states has suffered from the legacy of the Twentieth Century “American system of manufactures” based on the theories of Frederick Winslow Taylor and the industrial methods of Henry Ford, which emphasized the segmenting of manufacturing operations into extremely narrow, comparatively unskilled tasks performed repeatedly by individual workers under close supervision of low level managers, with fluctuations in demand addressed through layoffs.⁶¹ This system placed a low emphasis on employee skills and perpetuated an adversarial relationship between labor and management. In the 1980s and 1990s, when international competition forced a punishing series of contractions on the old industries of the upper Midwest and Northeast, hundreds of thousands of relatively unskilled production line workers were cast adrift, lacking adaptability or skills relevant to anything other than jobs that no longer existed. In some U.S. regions, the lingering legacy of the “Ford/Taylorist”

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experienced automotive talent here in Michigan.” “Tesla Motors Opens Michigan Technical Center to Focus on company’s future products,” Press Release, January 26, 2007.

⁵⁸“Nucor Makes Blytheville Steel Capital of the South,” Arkansas Business December 16, 1996.

⁵⁹“Mitsubishi Breaks Ground on Nacelle Facility in Arkansas,” North American Windpower October 8, 2010.

⁶⁰Annalee Saxenian, Regional Advantage: Culture and Competition in Silicon Valley and Route 128, op. cit., pp. 9.

⁶¹David C. Mowery, and Nathan Rosenberg, “The U.S. National Innovation System” in Richard R. Nelson, ed., National Innovation Systems: A Comparative Analysis, Oxford: Oxford University Press, 1993, pp. 35-36.

system arguably still stands in the way of industrial adaption through innovation.⁶²

Innovation by its very nature entails substantial risks, and in the United States most start-ups seeking to pioneer new technologies end as failures. A region’s cultural attitudes toward failure directly influence would-be entrepreneurs’ appetite for risk and willingness to break new technological ground. Annalee Saxenian observes with respect to Silicon Valley that “not only was risk-taking glorified, but failure was socially acceptable … [T]here was little embarrassment or shame associated with business failure. In fact, the list of individuals who failed, even repeatedly, only to succeed later, was well known within the region.”⁶³ By contrast, as the former Mayor of Bloomington, Indiana, pointed out in 2012, in explaining the relative slow rate of start-ups in the region, “[F]ailure is not okay” in the Midwest. “You are ostracized, and you have huge problems with your next funding.”⁶⁴

Finally, the environment of a region plays an important role in its success in fostering innovation. In the past decade, factors such as the high quality of schools have worked in favor of upstate New York’s initiative to foster knowledge-based industries centered on nanotechnology. In the cases of Akron and Youngstown, Ohio, part of the effort to stimulate local innovation-based economic development involved demolition of old industrial areas and creation of new green spaces, parks, and attractive urban neighborhoods.

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⁶²Taylor was a mechanical engineer who is regarding as the “father of scientific management.” He commented on labor-management relations that “only through enforced standardization of methods, enforced adoption of the best implements and working conditions, and enforced cooperation that this faster work can be assured. And the duty of enforcing the adoption of this cooperation rests with management alone.” On the value he placed on worker skills, he stated, “I can say, without the slightest hesitation, that the science of handling pig-iron is so great that the man who is…physically able to handle pig-iron is sufficiently phlegmatic and stupid to choose this for his occupation is rarely able to comprehend the science of handling pig-iron.” David Montgomery, The Fall of the House of Labor: The Workplace, the State and American Labor Activism 1865-1925, Cambridge: Cambridge University Press, 1989, pp. 229, 251.

⁶³Annalee Saxenian, Regional Advantage: Culture and Competition in Silicon Valley and Route 128, op. cit., pp. 38-39.

⁶⁴John Fernandez, “An Overview of Federal Cluster Policy,” in National Research Council, Building the Illinois Innovation Economy: Summary of a Symposium, C. Wessner, Rapporteur, Washington, DC: The National Academies Press, 2013. Robert Wolcott, a professor at Northwestern University’s Kellogg School of Management, recalls his experience at a party in Chicago, where he found “the usual conversation about sports real estate and banking. When asked what he was doing, he replied that he was an entrepreneur. Asked how big his company was, he said he had just started it and times were difficult. At that point the questions stopped and the conversation returned to real estate. He recalls “I knew what was in their minds. He’s between jobs.” Robert Wolcott, “Driving Entrepreneurship in Illinois,” National Research Council, Building the Illinois Innovation Economy: Summary of a Symposium, op. cit.

THE IMPORTANCE OF ENTREPRENEURSHIP

A recent academic work has noted the contradiction between the deterministic aspects inherent in the concept of “path dependency” and the theory of entrepreneurship itself. Proponents of path dependency “relegate human agency to choosing to go with the flow of events” determined by “historical accidents” that “actors have little power to influence in real time. ” The authors argue instead for the term “path creation” which integrates the acknowledgement of historical context with recognition of the importance of the individual:

Entrepreneurs meaningfully navigate a flow of events even as they constitute them. Rather than exist as passive observers within a stream of events we see entrepreneurs as knowledgeable agents with a capacity to reflect and act in ways other than those prescribed by existing social rules and taken-for-granted technological artifacts⁶⁵

Indeed, small businesses are a major driver of high-technology innovation and economic growth in the United States, generating significant employment, new markets, and high growth industries.⁶⁶ American innovation has long been driven by creative and often eccentric individuals with a powerful sense of the potential for practical application of their new ideas. Optimizing the ability of innovative small businesses to develop and commercialize new products is essential for U.S. competitiveness, economic growth, and employment. Developing better incentives to spur innovative ideas, technologies, and products, and ultimately bring them to market, is a central policy challenge for state governments, as it is for the national government.

Challenges Facing Innovative Small Businesses

Despite their value to the U.S. economy, small business entrepreneurs with new ideas for innovative products often face a variety of challenges in bringing their ideas to market. Because new ideas are by definition unproven, the knowledge that an entrepreneur has about his or her innovation and its commercial potential may not be appreciated by prospective investors. ⁶⁷ For

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⁶⁵Raphu Garud and Peter Karnoe, “Path Creation as a Process of Mindful Deviation” in Garud, Raghu and Peter Karnoe, Path Dependence and Creation, New York: Psychology Press, 2012, pp. 2.

⁶⁶See Zoltan Acs and David Audretsch, “Innovation in Large and Small Firms: An Empirical Analysis,” American Economic Review 78(4):678-690, September 1988. See also Zoltan Acs and David Audretsch, Innovation and Small Firms, Cambridge, MA: The MIT Press, 1990.

⁶⁷Joshua Lerner, “Public Venture Capital,” in National Research Council, The Small Business Innovation Program: Challenges and Opportunities, C. Wessner, ed., Washington, DC: National Academy Press, 1999. For a seminal paper on information asymmetry, see Michael Spence, Market Signaling: Informational Transfer in Hiring and Related Processes, Cambridge, MA: Harvard University Press, 1974.

example, few investors in the 1980s understood Bill Gates’ vision for Microsoft or, more recently, Bill Page and Sergey Brin’s vision for Google.

The challenge of incomplete and insufficient information for investors and the problem for entrepreneurs seeking seed capital. Because the difficulty of attracting investors to support an imperfectly understood, as yet-to-be-developed innovation is especially daunting, the term “Valley of Death” has come to describe the period of transition when a developing technology is deemed promising, but too new to validate its commercial potential and thereby attract the capital necessary for its continued development.⁶⁸ This reality belies a widespread myth that U.S. venture capital markets are so broad and deep that they are invariably able to identify promising entrepreneurial ideas and finance their transition to market. In reality, angel investors and venture capitalists often have quite limited information on new firms

Given their obligations to their investors, venture capital firms tend not to invest upstream in the higher-risk, early-stages of technology commercialization, and they have been moving further downstream in recent years. In 2012, venture capitalists in the United States invested $26.5 billion over the course of 3,698 deals. However, only 3 percent of these venture capital funds were directed to firms in the seed stage of development.⁶⁹

Recognizing their importance for regional economic growth and employment, many states are seeking to encourage entrepreneurship through a variety of means including the use of innovation prizes, efforts to attract SBIR grants though Phase Zero funding, encouragement of Angel funding, through tax

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⁶⁸For an academic analysis of the Valley of Death phenomenon, see Lewis Branscomb and Philip Auerswald, “Valleys of Death and Darwinian Seas: Financing the Invention to Innovation Transition in the United States,” The Journal of Technology Transfer 28(3-4), August 2003.

⁶⁹PriceWaterhouse 2013 MoneyTree Report.

incentives, and state-backed early stage and venture funding, such as Ohio’s Jumpstart program.

LESSONS LEARNED

•   State, regional, and local governments are in a strong position to lead local innovation-based economic development, reflecting their control over local factors of production and influence over the education and research infrastructure, and knowledge of local innovation culture.

•   State and regional governments are pursuing the establishment of innovation clusters as their major development policy tool.

•   Most of the state and regional developmental efforts that the Committee has considered seek to build on existing local advantages arising out of their geography, industrial legacy, and culture, rather than seek to establish entirely new competencies.

•   Regional culture and attitudes toward innovation, collaboration, and entrepreneurialism are a key determinant of success as failure in innovation-based development.

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