R&D-heavy firms thrive in diverse economies

Companies that invest heavily in research and development are more likely to benefit from locating near dissimilar businesses, while companies that invest less in technology are better off near businesses in their own industry, according to new research by a team of economists. The findings can help business owners and policy makers design better business strategies and economic policies.

Economists have long studied the economic benefits that result when businesses locate near one another, or agglomerate, and these agglomerations can fall into two different categories, according to Stephan Goetz, professor of agricultural and regional economics, Penn State, and director of the Northeast Regional Center for Rural Development. In specialized agglomeration economies, businesses from the same industry locate near one another. ‘Related variety’ agglomeration economies, on the other hand, are characterized by the presence of many different industries within a related sector.

“Our research shows that whether a particular industry can benefit from either of the two types of economies depends on how technologically intensive that industry is,” Goetz said. “What that means for a specific industry, sector or company, is that if they want to benefit from their location choice, they need to think about where they fall on the spectrum of research and development intensity.”

In an analysis of U.S. industry and county-level data from 2003 to 2013, the researchers found that technology-intensive industries — those with the greatest research and development expenditures compared to total sales — experienced more employment growth if they were located in a county characterized by industrial variety than in a county where industry is specialized.

They also found that industries that are less technology intensive, such as the traditional apparel industry or steel manufacturing industries, experienced more employment growth when located in specialized economies.

The findings are relevant to local governments, since they are often in the position of attracting new businesses to their area, said Jiaochen Liang, University of California, Fresno, who led the study.

“When governments are making development policies for their area, they need to first identify which economic structure exists in their locale,” said Liang. “If industry in their area is specialized in a type of low-tech industry, they should focus on attracting the same or similar type of business, which are more likely to thrive in this kind of environment. And if their economy can be classified as related variety, they should focus on attracting high-tech firms.”

To determine whether a county had a specialized industrial structure or a ‘related variety’ structure, the researchers looked at which industry sectors provided employment in each county and at how the industries in a county relate to one another based on the North American Industry Classification System (NAICS).

“A great example of a specialized economy is in Hollywood, where a large portion of the businesses are in the film industry,” said Liang. “On the other hand, San Francisco’s economy is marked by quite a bit more related variety, with the presence of many different industries related to the IT sector, such as software firms, microelectronics firms, and education institutions training IT talents.”

The study, which was published in Research Policy, is the first to address the effect of an industry’s technology intensity on its likelihood to experience gains or losses from a particular type of agglomeration economy, said Liang, adding that the findings lend support to the idea that the effects of agglomeration vary from sector to sector.

“Industries that invest heavily in research and development place greater value on the creation and exchange of ideas, so it makes sense for them to locate in a diverse network, where exposure to different perspectives can foster innovation,” said Liang. “On the other hand, industries that don’t invest as much in technology tend to value efficiencies that lower the costs of their operations. When these companies locate in a specialized economy, they can derive benefits such as a larger specialized labor pool, or supply chain efficiencies.”

The researchers focused on employment growth as an indicator of gains or losses related to industrial structure due to its importance to the economy, said Liang, adding that there are limitations to this approach.

“Employment is perhaps the single most important measure for business growth, because it directly measures how many economic opportunities the industry can provide to the public,” Goetz said. “That said, employment growth doesn’t necessarily mean efficiency growth. It’s entirely possible that if an industry becomes more efficient, it doesn’t have to employ as many people.”

Future research may include looking at how other industry attributes, such as organizational structure, interact with agglomeration economies.

In addition to the NAICS, the researchers used data from the U.S. Census County Business Pattern database and the U.S. National Science Foundation.

The research is supported by the Northeast Regional Center for Rural Development, which receives funding from the USDA National Institute of Food and Agriculture  and the Penn State College of Agricultural Sciences.

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