Economic Clusters, Productivity, and Growth in Latin America

This post was co-authored by Gilberto Garcia, research associate for Latin America Studies at the Council on Foreign Relations.

How can countries boost productivity and economic competitiveness? Many economists and business leaders turn to economic clusters as an answer.

English economist Alfred Marshall first wrote about clusters—the geographic grouping of firms in the same or similar industries—at the turn of the twentieth century. He saw numerous entrepreneurs drawn to particular locations due to physical endowments, and their parallel efforts leading to whole new industries—think California vineyards, Texas oil, or Maine lobster. Proliferation and proximity then brought other advantages: developing a pool of skilled workers, and attracting industry suppliers. As a cluster grew, firms would specialize on a particular step of the production process, increasing their productivity and profits.

A century later Harvard Business School professor Michael Porter picked up the idea, envisioning clusters as a way for firms to become or stay competitive in the global economy. For him, the biggest advantage is that proximity enables cooperation. In addition to the workforce and supply chain benefits, firms are more likely to come together to form active business associations, to work with local governments to invest in infrastructure, and to partner with local universities to tailor coursework and research.

In the United States, Silicon Valley is the most successful example—with the interaction between startups, large corporations, local governments, and world class universities creating trillions of dollars in wealth and redefining daily life through inventions including the smartphone (Apple), streaming home video (Netflix), and online social networking (Facebook).

Many of Latin America’s most promising sectors came about through clustering as well. The aerospace industry in Queretaro, Mexico began with Canada’s Bombardier in 2006, initially attracted by low wages. The state and federal government then worked to attract other producers through tax incentives, cutting bureaucratic red tape, and new trade agreements. The government started a new Aeronautic University, and together with the companies, developed curriculum and shared tuition costs. More than a dozen aerospace companies now operate in the city, bringing in some $500 million in foreign direct investment over the last five years. In 2014 Mexico’s aerospace industry exported more than $6 billion, supporting 45,000 direct jobs and at least twice that number indirectly.

In Chile, business and government came together to expand and transform the salmon farming industry. Like minded companies came together to form Salmonchile, a business association that established industry standards and sought out new markets, in particular the United States. The public-private Chile Foundation backed pioneer firms, funded R&D, and passed on best practices to other emerging producers. Over time, Chile’s salmon clusters acquired know-how and developed new technologies, increasing production. By 1992, Chile became the second-largest global salmon producer, and by 2014, exports topped $4 billion, second only to copper.

Other Latin American efforts have failed. In the 1970s and 1980s as Brazil opened its markets, shoemakers in Rio Grande do Sul grew rapidly, making leather shoes for numerous large U.S. buyers. Supported mostly by their international clients, numerous Brazilian firms upped production and improved quality. Yet by the early 1990s, these same firms were undercut by cheaper Chinese shoes. With little inter-firm cooperation or support from the government, the potential cluster lost its edge, falling behind in output and never expanding into shoe design or branding.

Can, and if so, how can nations create these dynamic ecosystems? Chile is trying with Start-Up Chile, a government program that gives $40,000 and a temporary one-year visa to foreign entrepreneurs to begin their ventures in the Southern Cone nation. Now five years old, it boasts few successes. The young companies are hindered by the short time horizon and limited local venture capital money (a few of the best can receive another $100,000 in financing). 80 percent of participants leave after completing the program, many headed to the United States.

If history is a guide, successful clusters grow locally and organically. Still, there is a role for governments to play in nurturing economic constellations. To start, they can protect property rights and open markets through free trade agreements. They can invest in education—including creating higher educational institutions equal to those in other nations (today no Latin American university makes the world’s top 200 as measured by Times Higher Education). And they can boost infrastructure spending, now just half of the 5 percent of GDP the World Economic Forum recommends.

State and local governments in particular can encourage and work with local business associations, invest in public works and supportive zoning, develop specialized educational curriculum and training, and fund research and development. In all these efforts policymakers need a long time horizon, as changes and benefits often appear slowly. Yet it is these local custom initiatives that can constitute “smart” industrial policy, and provide promise as Latin America’s nations insert themselves into global markets.