CLUSTER POLICIES CAN THREATEN SOME FIRMS’ SURVIVAL
Tax incentives aimed at encouraging firms from the same industry to locate together
may cause some incumbent companies to fail, so that the benefits of clustering are
outweighed by the costs of increased competition. That is the main finding of research
by Oliver Falck and colleagues, presented at the Royal Economic Society’s 2011
annual conference.
The study looks at the forced reallocation of firms in the machine tool industry in
Germany following the Second World War and the division of the country. Between
1949 and 1956, 33 firms representing one-fifth of the machine tool industry in eastern
Germany moved to the allied-controlled west. These relocating firms quickly regained
their production capacity, thus dramatically affecting the local economy.
The study finds that nearby competing firms were 25% more likely to fail, suggesting
that the costs of increased competition dominated the benefits of clustering together.
Thus, the findings challenges the wisdom of policies that provide tax incentives aimed
at persuading companies to locate together with the idea that they will benefit from
shared ideas and knowledge.
More...
Regional planners around the world argue for incentives to attract new firms to their
region. One obvious reason is, of course, to create additional tax revenue. To capture
the consent of incumbent firms, regional planners often refer to agglomeration
economies from increased firm clustering that are also beneficial for incumbent firms.
This paper shows that local competition effects for local resources resulting from the
new location of firms can be stronger in absolute terms than agglomeration effects.
Incumbent firms can be crowded out by new firms due to the increased local
competition for scarce resources if those resources cannot further expand.
This kind of firm competition may be good from a welfare perspective, but it is important
to recognise the impact this competition has for incumbent firms when choosing to
promote new firm entry.
To identify the effect of new firm locations on the performance of local incumbents, the
study exploits a quasi-natural experiment – the division of Germany into four
occupational zones after World War II.
By 1949, the three western zones occupied by France, the UK and the United States
formed the Federal Republic of Germany. The eastern part developed into a satellite
state of the Soviet Union, and most believed in 1949 that this eastern zone would adopt
the Soviet Union’s socialist system. The fear of expropriation (or worse) prompted many
firm owners to flee to western Germany where they re-established their firms.
The researchers study this relocation in the context of the machine tool industry. This
industry is a good setting to investigate these localised agglomeration and competition
effects. The industry’s product markets are international in scope, but its production
processes benefit from agglomeration economies due to specialised knowledge and
workers, exchanges of material goods, and similar.
The industry is characterised by strong manufacturer-user relationships, which are the
main impetus of innovation in this industry, and it largely consists of small and mediumsize firms. While relatively small at 2% of German industrial production, the machine
tool industry serves as an important foundation for the broader metalworking sector.
Moreover, the relocation of the machine tool industry from eastern to western Germany
was quite substantial.
The study identifies 33 relocators that fled from the Soviet zone to the American or
British occupation zones. These 33 firms represent an 8% increase in total industry size
for the receiving zones. Some of these firms are quite large, including the predecessor
of Audi, for example.
At a regional level, the localised increases ranged from 0% and 200%, with an average
of 11% for regions experiencing a relocation to their region. In total, a fifth of the
machine tool industry present in eastern Germany migrated during a narrow window of
1949-56. This was a one-time event, as no prior or subsequent migrations occurred
within the industry across German regions, eastern or western.
Yet, on arrival, these relocating firms substantially affected local industrial conditions as
the firms quickly regained much of their former production capacity. The study finds that
relocation of a firm significantly increased the likelihood of incumbent failure by 25%,
which suggests that the costs of increased competition dominated the potential benefits
from agglomeration economies.
By contrast, new start-up entrants during the post war period – whose location choices
were more opportunistic – were not associated with increased incumbent failure rates.
These differences provide additional confidence in the experimental design. The
researchers provide evidence that these effects are due to increased competition for
local resources by examining local workforce conditions after the war.
ENDS
‘From Russia with Love: The Impact of Relocated Firms on Incumbent Survival’ by
Oliver Falck, Christina Guenther, Stephan Heblich and William Kerr
Contact
Oliver Falck
Email: falck@ifo.de
Telephone: +49 89 92241370
Mobile: +49 160 96991442