Voices

Why do businesses cluster together?

By Kat Hanna

02 May 2017 - 14:28

What causes industries to cluster together in certain parts of a city, and is it a good thing? We asked Kat Hanna, Research Manager at the Centre for London, a think-tank focusing on the UK capital.

Why do certain areas of a city become linked with certain industries? 

There is a close, complex relationship between a city’s geography, its built environment, and its economy. Let's take London as an example. In the early days of London’s history, certain areas became linked with particular industries, thanks to access to natural resources, and infrastructure. Today it is four times the size of the next largest city in the UK. It is home to one in five private sector jobs in the UK, and a number of world-class educational institutions.

London’s existence as a trading hub has its roots in its role as a port city, importing and exporting goods via the river Thames. You can see this history of trade written in London’s street names, such as Poultry, Milk Street, and Bread Street, named after the produce sold there in the 16th century. A number of areas became closely located with trades – leather tanning in Bermondsey and silk weavers in Spitalfields.

As large-scale manufacture and trade declined in London, different types of industries took their place. The deregulation of trading in 1986 led London to become a hub for financial services. These companies needed large offices with big floor plans and enough connectivity for electronic trading. Some firms want to be near relevant institutions or centres of activity – a number of banks in London are close to the Royal Exchange, originally designed to be a centre of commerce.

When an industry puts down roots in one part of the city, other related businesses are likely to follow – for example, corporate law firms pop up next to banks. The more similar businesses in one neighbourhood, the greater the incentive for smaller, specialised businesses to set up around them, providing goods or services to the industry in question.

London’s landscape will continue to change. The breadth of the city's economy means that it is no longer shaped by the needs of a single sector. London is increasingly shaped by new ways of working together, rather than by products.

What are the advantages of industries clustering together? 

As far back as 1890, the economist Alfred Marshall recognised that cities’ high concentration of people led to two big benefits. The first is lower costs (thanks to shorter distances to transport goods, for example). The second is the smoother flow of information, skills and ideas.

Where lots of businesses cluster, people have plenty of potential employers. They can share infrastructure, from public transport to restaurants and theatres. And workers and businesses are likely to learn more from one another when they're close. This is called 'knowledge spillover'.

Lots of businesses in one place create a critical mass with clout when seeking support or investment. It also creates competition, which pushes companies to improve.

Skilled people working together tend to form networks. Institutions, including universities, play an important role in forging and shaping these networks, which encourage the sharing of knowledge and generate social capital: valuable relationships. Networks can be formal, such as research partnerships between universities and private firms, or informal.

Can you measure the benefits of clustering?

Quantifying the exact benefits is notoriously difficult. It means having data about how well local businesses are doing, which isn’t necessarily available. There are, however, some ways of measuring it by looking at numbers of start-ups and new businesses, or networking events in an area.

What we can say is that educated cities have grown at a faster rate than comparable cities with a lower-skilled population. Not only do higher-skilled cities grow faster, they are also more productive and adaptive to change. You can see this in a number of so-called 'innovation districts', where derelict industrial land has been repurposed into mixed-use spaces, where offices, cultural and educational institutions sit side by side. An example is King's Cross in London, which includes the British Museum, Central St Martin's art and design school, and new Google offices.

Can a derelict area attract businesses to set up shop there?

The role of government in supporting business clusters is hotly debated by academics and policy makers. Some argue for a laissez-faire approach, while others think there should be more intervention. Most believe that the role of government is to create the conditions clusters need. This could include ensuring reliable local transport and internet connectivity.

Some boroughs and cities use incentives to attract investment and talent. The London Borough of Croydon offers a year’s relief from business tax rates to new or growing businesses setting up in the borough. Places like Shanghai have launched entrepreneur visas to attract the best global talent.

Most people will agree, however, that simply saying ‘we want a Silicon Valley’ or ‘we want a tech city’ is rarely successful. Policy makers need to know what assets the area already has – whether transport connections, or informal co-working space, and then build on those strengths.

One thing that most economists, urbanists and policy makers would agree on is the importance of investing in skills. This is one area where government can make a difference, and where it is harder for the private sector to make an effective, large-scale contribution.

What are the downsides to many companies working on the same thing in the same place?

When a number of people compete in a fixed amount of space, congestion increases, house prices rise, and those owning land (or homes) get rich, resulting in inequality.

There are several concerns about what happens to cities that become home to particularly successful clusters. The first is around the impact of high rents on new businesses, who are competing with large corporates.

A second concern involves inequality and whether local people can access the jobs being created on their doorstep. This is why it is so important to provide training in the skills they might need. It's an area where institutions such as universities can play a role in connecting young people to new job and training opportunities.

A third concern is the impact that ‘tech ghettos’ can have on public services and public space. Openness and collaboration do not just happen. They require consistent planning and discussion between the institutions involved.

The speedy growth of knowledge-based industries in cities risks creating ‘tech enclaves’, complete with dedicated transport and housing for tech and creative workers above a certain income. This means it is not just businesses that risk being priced out, but existing residents. As a result, we need to think about how benefits are distributed, and understand how everyone experiences the impact of a city’s changing economy. This is a big challenge, but starting with these 'innovation districts' can help us think about changes at a local level.

Kat Hanna’s research interests include housing, technology and innovation. She is the author of Spaces to Think, a report on the geography of London's knowledge economy.

Kat will speak at Going Global, the British Council's international higher education conference taking place in London from 22 May to 24 May 2017.

Find out more about Kat's session, 'Innovation districts: city panacea or urban myth?'.

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