Industrial Clusters and Global Value Chains

An industrial cluster is a geographic concentration of interconnected firms, suppliers and institutions in a particular field, and a global value chain (GVC) is the full range of activities, from design and production to marketing and support, that bring a product from conception to the final customer, spread across many countries. In brief: clusters such as Silicon Valley, the Italian textile district of Prato and Bangalore’s technology sector show how local concentration drives innovation. GVCs split production across places, so a country can specialize in one stage. The “smile curve” shows that value added is highest in design, research and branding at the start of the chain, and in marketing and services at the end, and lowest in assembly in the middle.

Clusters and value chains describe how production is organized at the local and the global scale, and they are central to industrial policy and development strategy. This guide explains how clusters work, how GVCs are governed, how firms and countries upgrade, compares the types of governance in a table, works through value-added calculations, outlines the history and corrects common mistakes.

What are industrial clusters?

Michael Porter defined clusters in 1990 as “geographic concentrations of interconnected companies and institutions in a particular field.” A cluster includes the main firms, specialist suppliers, service providers, related industries and supporting institutions such as universities, training bodies and trade associations. It works through both competition and cooperation, which spur innovation and the creation of new firms. Porter’s “diamond” describes four conditions that support competitive advantage: factor conditions (skills, infrastructure), demand conditions (demanding local customers), related and supporting industries and firm strategy and rivalry.

Examples include Silicon Valley in California (electronics and software, built around Stanford University and venture capital), Hollywood (film), the Third Italy (networks of small firms in Emilia-Romagna and Tuscany, such as the textile district of Prato and the ceramic district of Sassuolo), the Bangalore technology cluster, the Cambridge region in England, Shenzhen in China for electronics, and Detroit in the 20th century for cars. Clusters develop through history, chance, strong institutions, entrepreneurs and policy. They can also decline because of “lock-in” to old technologies, as in some old industrial regions.

What are global value chains?

A GVC divides the production of a good or service into stages that are carried out in different countries according to cost, skills and access to markets. The stages include research and design, sourcing of raw materials, manufacturing of components, assembly, logistics, marketing, sales and after-sales service. The world economy has been reshaped by this process since the 1980s, helped by cheaper transport and communication, lower trade barriers and the rise of transnational corporations. A large share of world trade now consists of intermediate goods, which cross borders more than once. Typical examples include smartphones, cars, clothes and electronics.

The smile curve, proposed by Acer’s founder Stan Shih in 1992, plots value added against the stages of production. Both ends of the curve (R&D and design, and branding, marketing and services) have high value added, while the middle (manufacturing and assembly) has low value added. Studies of early iPhone models found that the assembly in China captured only a few percent of the retail price, while the brand owner and its suppliers of key components captured much more, with the brand owner receiving around half or more. This helps to explain why developing countries seek to move from assembly to higher-value activities.

How are value chains governed?

Gary Gereffi and colleagues (2005) identified five types of governance, according to the complexity of transactions, the ability to codify information and the capabilities of suppliers.

• Market: simple, arm’s-length transactions with little coordination, and low switching costs.
• Modular: suppliers make customized products to the buyer’s specification, using their own know-how and standardized interfaces (common in electronics).
• Relational: complex interactions with mutual dependence, based on trust, reputation and proximity (for example, specialized machinery and high-end design).
• Captive: small suppliers depend on large buyers who control standards and technology (often in clothing and agriculture).
• Hierarchy: the firm controls the activities within its own ownership (vertical integration).

Lead firms, such as Apple, Nike and Walmart, set standards for quality, cost, delivery and labor and environmental conditions, and they can shift orders between suppliers and countries. This creates opportunities for suppliers but also risks, including price pressure, poor working conditions (as in the Rana Plaza factory collapse in Bangladesh in 2013), loss of local control and exposure to shocks, as the pandemic and the war in Ukraine showed.

How can firms and regions upgrade?

John Humphrey and Hubert Schmitz (2002) described four types of upgrading: process upgrading (more efficient production), product upgrading (moving to more sophisticated products), functional upgrading (taking on higher-value functions such as design or branding) and chain upgrading (moving to a different chain with higher value). The experience of Taiwan, South Korea and increasingly China shows that countries can climb from simple assembly to design and their own brands, helped by investment in education, technology transfer, local supplier networks and industrial policy. Barriers include the dominance of lead firms in design and marketing, the cost of branding, intellectual property rights and the risk of being locked into low-value roles. Clusters can help local firms to pool resources, share knowledge and meet the standards of global buyers.

Governance types compared

Worked example: value added along a chain

The values are hypothetical and illustrate the arithmetic of a smile curve.

1. Retail price and shares: a gadget sells for 500. The shares are: design and R&D (brand owner) 120, key components 140, other components 60, assembly 15, logistics 25, marketing and distribution (brand owner) 40, retailer margin 60 and the brand owner’s remaining profit and licensing 40. The total is 120 + 140 + 60 + 15 + 25 + 40 + 60 + 40 = 500.
2. Share of assembly: assembly gets 15 ÷ 500 = 3% of the price, while the brand owner (design 120 + marketing 40 + profit 40) has 200 ÷ 500 = 40%.

3. Value added by stage: if the components cost 200 in total (140 + 60) and assembly adds 15, then the value added by assembly relative to the value of the final product made in the factory (215) is 15 ÷ 215 = 7%.
4. Gross exports versus domestic value added: a country assembles the gadget and exports it for 215, but imports components for 200. Gross export value is 215, but the domestic value added is only 215 − 200 = 15, which is 15 ÷ 215 = 7% of the export value. This is why counting trade in value-added terms gives a different picture of trade balances.

5. Functional upgrading: if the country begins to design the product and increases its share from 15 to 15 + 120 = 135, its value capture rises from 3% to 135 ÷ 500 = 27% of the retail price, nine times as much.

6. Location quotient of a cluster: a region has 6% of all national jobs but 18% of the jobs in an industry. The LQ is 18 ÷ 6 = 3.0.

How did the ideas develop?

Alfred Marshall described industrial districts in 19th-century Britain, such as Sheffield (cutlery) and Lancashire (cotton). Researchers in the 1980s, including Michael Piore and Charles Sabel, drew attention to the flexible networks of small firms in the “Third Italy” and to Silicon Valley, and AnnaLee Saxenian compared Silicon Valley’s open networks with the more closed structure of Route 128 near Boston (1994). Porter’s The Competitive Advantage of Nations (1990) popularized the idea of clusters in policy. The concept of “commodity chains” by Gereffi and Korzeniewicz (1994) became the global value chain approach in the 2000s, which is now used by the WTO, OECD and World Bank in studies of trade. Recent events have brought attention to the resilience of chains, regionalization, “friend-shoring” and the effects of digital technology and automation.

Which mistakes are common?

Mistake 1: Assuming that joining a value chain automatically brings development

Participation can create jobs and learning, but countries can also stay stuck in low-value assembly if they do not invest in skills and capabilities.

Mistake 2: Using gross exports to judge a country’s gains

Exports contain imported inputs. Value-added measures show how much income is actually created in the country.

Mistake 3: Believing that clusters can be created simply by government decree

Successful clusters grow from existing strengths, skills, institutions and entrepreneurs. Policy can support but rarely creates them from scratch.

Mistake 4: Thinking that local and global scales are separate

Local clusters are often linked into global chains. Their success depends on both local networks and relationships with global buyers.