Clustering on the Hi-Tech Bandwagon

By Robert Skidelsky and Pavel Erochkine

Economists have started to become interested in the economics of clusters. Why do many industries concentrate in one or two locations? Why do some countries, regions and districts grow much faster than others? In the past the answer was obvious: What determined industrial location was climate or proximity to natural resources. But most modern economies are not like this. You do not need to have a particular climate or be near a steel plant to make computer chips or develop software. Location is much more likely to be the result of accidents or deliberate government policies.The U.S. economist Paul Krugman asks: “Where do you live if you work in the film industry? Probably in Los Angeles. Why? Because the other film industry people you need to work with are there. But they are there because they need to be near people like you.” Nobel Prize winner Robert Lucas makes the same point: “What can people be paying Manhattan or downtown Chicago rents for, if not for being near other people?”

Economic clusters aggregate complementary skills, capital, services and ideas so that they work together in the same place to produce value that would not be produced if they were widely scattered. These clusters illustrate the importance of increasing returns to scale and external economies of scale (effects accruing to clusters rather than to individual firms). The crucial importance of clusters is that through them human capital (knowledge) develops and spreads, and the accumulation of human capital is the main engine of growth.

Virtuous circles get started for all kinds of reasons, but then persist through self-reinforcing mechanisms or “positive feedback.” And the same is true of vicious circles. That’s why we have long cycles of rise and fall rather than instantaneous rearrangement of the pieces, as classical economists assume.

Why is this relevant for Russia? Because policy can start history moving. The United States’ technological supremacy is built on an ecosystem of interrelated companies, universities, government institutions, bankers and lawyers set in motion by the needs of the defense industry after World War II.

The key to unlocking Russia’s growth potential is to develop these high-tech clusters. Russia is an economy to which geography has given minerals and a history of a high level of science and technology. But this human capital remains scattered: The aim of policy must be to unite science, technology and products in “creative communities.”

Parts of Russia are well suited to follow in the footsteps of Bangalore, the home to India’s main high-tech clusters, where high-tech companies sprang up around old and cash-rich heavy industry and turned the area into the Silicon Valley of the East. Russia has also inherited a very large and also geographically concentrated industrial base from the Soviet Union. Numerous universities, laboratories, large energy-related companies and state-controlled strategic enterprises could provide the backbone around which high-tech industries could develop. But this process needs to be sped up by creating an encouraging environment for knowledge-based businesses and by facilitating access to seed capital. Russia is already moving in this direction.

First, IT and Communications Minister Leonid Reiman has already created the legislative framework for development of “techno-parks” (or what the British call “science parks”). The British model is for the science parks to provide accommodation, links to universities and proactive business support services for start-ups. This is aimed at generating the right environment for development of the knowledge-based businesses and stimulating interactions between these, universities and regional communities. In fact, support services for start-ups and professional networks are often more important than cheap rent or easy access to seed capital, and this is the area where Russia lacks experience and should learn how to establish this supporting infrastructure from other countries.

Second, the so-called Russian Venture Company, or RVC, which will have authorized capital of 15 billion rubles, or almost $500 million, has been set up. It will act as a fund of funds, investing in privately managed funds that invest in IT, telecommunications, biotechnology, medicine, nanotechnology, environmentally friendly energy and other “innovative” areas. There are private initiatives as well — the Skolkovo Business School, due to be launched in 2012, aims to have 20 percent to 25 percent of its graduates open their own business within five years of graduation and will establish a 1 billion ruble ($40 million) venture fund to achieve this aim. The Russian government should think about setting up a Russia-wide scheme of this kind in addition to the RVC. This could be a way of linking the development of IT and other innovative sectors to President Vladimir Putin’s national projects.

The two best-known European models of state-controlled provision of seed money are Britain’s National Endowment for Sciences, Technology and the Arts, or NESTA, and Germany’s Reconstruction Credit Institute, widely known by its German acronym, KfW.

NESTA has been provided with an endowment of ?300 million ($561.2 million, about the same as the 15 billion rubles provided for Russia’s RVC) by Prime Minister Tony Blair’s government. The British fund is managed independently of the government in order to protect innovation policy from short-term political influence. It invests its income in early-stage businesses and in programs that investigate the educational and cultural side of innovation. KfW, on the other hand, behaves like a commercial bank, buying funds wholesale on world capital markets without having to pay dividends to shareholders. It then lends money to small firms, through retail banks, at a mere 0.5 percent above base rates. Many Russian small businesses, carrying the risk they do, regularly pay 10 percent to 15 percent above the base interest rate. These are working models that could be adjusted to Russian conditions, so there is no need to reinvent the wheel.

An important point to keep in mind is that high-tech is inherently non-linear, and so tiny insights can yield huge outputs. Russia already has a massive knowledge base, skilled labor and most of the basic infrastructure. Carefully targeted support from the state could quickly take it over the tipping point and turn it into a global leader. This is what happened to Bangalore less than a decade ago.

All this sounds exciting — and it is. But the decision makers should not get carried away about what can be achieved. Even in Britain, GDP accounts show that sales of Indian food are bigger than those of its high-tech industry.