Chapter 5. Policy lessons: Productivity and growth in regions

Policy co-ordination across regions and cities

Most policies are created by governments for specific jurisdictions – national, regional or local. For regional policies, the region is naturally the focus of attention for policy makers. Yet, it is important to keep in mind that no region exists independently from its surrounding environment. Regions within a country are connected through inter-regional trade, the flows of people and capital and fiscal transfers. Through these links, regions influence each other constantly.

Policies implemented in one region inevitably affect all other regions in a country, even if the effects are often indirect and cannot be clearly attributable to the policy. For example, a policy that creates new jobs in one region would attract unemployed persons from other regions, which positively affects the unemployment levels in these regions. While the effects of a single regional policy on other regions are often so small that they are close to imperceptible, taken together the spillover effects from many regional policies can be substantial.

In some instances, regional spillovers are unequivocally positive. If a region becomes a hub for R&D, it can create innovations from which all regions benefit. In other instances, spillovers can be unequivocally negative. For example, a region might use subsidies to convince a business to relocate from another region to it. This situation (which is discussed in the section, “Productive ways to compete among regions: a race to the top” below) creates economic growth in one region at the expense of another region.

In most cases, spillovers include positive and negative elements, and it is the task of policy makers to ensure that positive spillovers dominate. Thus, regional policies should also be evaluated with respect to their effects on surrounding regions, and national governments should provide policy frameworks that make it attractive for regions to pursue policies that have positive spillovers on other regions.

Related to the issue of policy spillovers is the question of policy co-ordination across regions. In many instances, the optimal geographic scope of policies is above the regional level but below the national level. A basic example of such a policy would be investment in regional public transport. Even though it does not need to be co-ordinated at the national level, regions have to ensure that their regional public transport systems are well connected to those of neighbouring regions. Thus, policy makers need to work with neighbouring regions to ensure effective inter-regional policy co-ordination.

Co-ordination of policies is particularly important between urban areas and surrounding rural regions. Cities serve as hubs that provide essential services for businesses in rural areas. By ensuring that rural areas are well-connected to cities, policy makers can help rural regions benefit from the opportunities that cities offer. Importantly, being well connected in this context should not be understood narrowly, as in the context of transport infrastructure. Non-physical connections are equally important. For example, businesses in rural regions should be connected to universities that create innovation and to banks that provide financing for investments.

This implies that the region in which a policy is implemented and the full extent of the area where benefits arise are not necessarily one and the same. Using the previous example, a policy to better connect research institutions with businesses in rural areas could be implemented in the urban region where the research institutions are located with the goal to help businesses in a neighbouring rural region.

More generally, the examples above show that regional policy makers need to think beyond regional boundaries even if their sole focus is on their own region’s economic improvement. Spillovers and interregional dependencies imply that the solutions to increase one region’s productivity can often be found in another region. To identify and use these opportunities, regions need to exchange information, discuss and co-ordinate policies with each other.

Incentives for tradable sector development

The tradable sector is important if regions are going to “catch up” to their country’s most productive frontier regions (OECD, 2016_[1]). As demonstrated in Chapter 2 of this report and prior OECD research, regions and countries with a higher share of economic activity in tradable sectors innovate more, are more productive, have higher wages and narrow the “productivity gap” faster (OECD, 2016_[1]). Despite this solid evidence, many regions and countries still focus support on non-tradable sectors, to “play it safe”. This puzzling paradox merits attention.

For one, excessive reliance on non-tradable sectors has limited economy-wide productivity growth. Investments in the construction sector, increased access to credit and stimulus of consumption have fostered cycles of artificial demand that subsequently failed to sustain long-term growth, as the first two chapters of this report argue. At the same time, it is important to acknowledge that non-tradable sectors account for the largest contribution to the regional economy, and investments in infrastructure, personnel and housing are often needed. However, investment decisions in these sectors should not be made with the goal of providing a temporary boost to economic growth in the short term. Instead, they should be based on long-term needs and be supported by objective cost-benefit analyses.

The second aspect is the erroneous but widespread belief that the tradable sector is more volatile to shocks and thus riskier, while the non-tradable sector would be safer to invest in. This belief arises from the assumption that shocks that hit a particular sector are the dominant source of volatility. Recent evidence shows, however, that country-specific shocks, which strike all sectors in a certain country, are as damaging as sector-specific shocks with regards to volatility patterns (Caselli et al., 2015_[2]).

Another misleading belief is that openness to trade leads to higher sectoral specialisation, which would make countries and regions more vulnerable to shocks. However, regions where employment shifted most strongly towards non-tradable sectors suffered the most in terms of employment losses following the global 2007-08 crisis (c.f. Chapter 2). Non-tradable sectors are not only indirectly linked to global volatility trends, but they also have had a hard time recovering from the shock of the crisis, since their activity depends solely on local demand.

In fact, the effect of trade openness on volatility depends on the level of economic diversification. That is, if the economy is diversified enough, openness to trade lowers volatility, while, if the economy is not sufficiently diversified, it increases volatility.1 Hence, tradable sectors not only yield higher economic returns, they can also reduce volatility levels, as long as there is enough economic diversification.

For being more productive and less volatile to shocks, tradable sectors should attract more attention from public officials and there are different sets of policies that can help. Beyond policies that can affect non-tradable and tradable sectors alike (e.g. investment in human capital, infrastructure development and support to innovation), this report sets out three sets of policies that can specifically assist tradable sectors.

Well-designed cluster policies can support the formation of economic hubs in selected tradable sectors. When a dominant cluster already exists, regional policy should strive to facilitate the development of related activities. Clusters can provide services and inputs to each other in a complementary rather than competitive fashion, within the same region or across regions (Box 5.1). Indeed, diversification into related varieties is likely to facilitate knowledge spillovers and stimulate innovation, as pointed out in Chapter 3. Policies that succeed in achieving this can spur growth in a region, while also reducing exposure to external shocks.

Governments can also support industries in tradable sectors via negotiated deals. In the British model of Sector Deals, the government works with specific sectors, e.g. the life sciences, that organise themselves behind strong leadership (EEF, 2017_[4]). The model is based on existing sector strategies in the aerospace and automotive industries. The deal can involve: addressing regulatory barriers; aligning policies on skills and training around a sector; creating institutions to support innovation creation and diffusion; and working together to increase exports and to commercialise research. Sector Deals are supposed to create a close relationship between the government and firms that are members of the deal (EEF, 2017_[4]). They have limited geographic scope, i.e. they are localised to some extent. Sector Deals require a firm commitment from both sides, without overlooking the interests of smaller companies or companies that are not part of the deal. This relationship can help regions and industry sectors to better address challenges and foresee changes.

Lastly, the tradable sector can also be supported by facilitating exports led by specific agencies or networks. It can be particularly challenging for small and medium-sized enterprises (SMEs) to access external markets, given bureaucratic barriers, language challenges and even issues of scalability.

Export promotion agencies assist firms in entering external markets and overcoming foreign trade barriers. They can also help solve asymmetric information problems regarding tastes of foreign consumers, quality standards and regulations in other markets and business opportunities. A study across 103 countries finds that export promotion agencies have a positive effect on exports (Lederman, Olarreaga and Payton, 2010_[5]).

Even though – as previously argued – developing tradable sectors is generally a less risky strategy than expanding the non-tradable sector, economies that export more and that are more open to trade should, nonetheless, be prepared for eventual trade shocks. Benefits from trade are also unevenly distributed, with some sectors benefitting more than others, which can have significant repercussions for employment in specific industries or specific regions. Trade adjustment programmes can provide assistance to such areas. This point will be addressed in more detail in the following section.

The territorial dimension of trade adjustment programmes

Trade adjustment programmes assist workers and enterprises that are negatively affected by trade policy reforms or changes in trade flows. Evidence confirms that some groups of workers face temporary unemployment and lower income when they lose their jobs due to heightened international competition (François, Jansen and Peters, 2011_[6]).

These programmes offer temporary assistance to specific groups of workers. Often, workers need to file a collective petition demonstrating that the globalisation shock disproportionally affected their group in order to benefit from governmental assistance. Assistance can include unemployment subsidies, training and counselling. It is important to notice that these measures complement existing policies to support workers in general, such as employment assistance, skills retraining and lifelong learning.

One example of a programme that supports trade-affected workers is the Trade Adjustment Assistance (TAA) programme developed by the U.S. Department of Labor. The programme is implemented through partnerships with state agencies. It provides income support, assistance with health insurance premiums, job search and relocation allowances, and skills training. Workers who file the collective petition are on average 46 years old and have at most a secondary education degree. They often have obsolete skills in the manufacturing sectors, with on average over 12 years’ experience in jobs that frequently no longer exist.

Other country-wide programmes operate in parallel. The Economic Adjustment Assistance Program of the Department of Commerce targets communities in distress. It provides technical, planning and infrastructure assistance to regions experiencing economic stress that may occur suddenly or over time. These economic changes include, but are not limited to, shocks from trade or automation. The Partnerships for Opportunity and Workforce and Economic Revitalization (POWER), a joint initiative of the U.S. Economic Development Administration and the Appalachian Regional Commission, assists workers impacted by changes in energy policy, notably those in coal mines and coal-fired power plants.

In the European Union, the main trade-adjustment instrument is designed to assist workers made redundant by the effects of globalisation. The European Globalisation Adjustment Fund (EGF), established in 2006, co-funds active labour market policies such as job search assistance, training, and knowledge-transfer for start-ups (Cernat and Mustilli, 2017_[8]). EU member states provide the other part of the funding and are responsible for implementing the defined measures. The programme has successfully increased support in cases where restructuring programmes are already well-established.

Even though these adjustment efforts are fairly comprehensive and important, there is room for improvement. One criticism is that they are reactive, providing help after the fact, i.e. after a plant has shut down or workers have been laid off. The programmes could provide counselling, assistance and training to workers at an earlier stage, e.g. before a shock hits, or when a given firm makes plans for restructuring.

One example of proactive assistance, this time offered by a firm, is the case of Saab Automobile in Sweden (Eurofund, 2014_[9]). The downsizing of the firm was accompanied by social programmes to inform and prepare workers for the new circumstances. The firm offered regular counselling, psychological guidance and training for workers while they were still working at Saab. These measures could assist workers in transitioning to a new position faster, which not only brings financial benefits but can also improve their self-esteem and well-being. Proactive programmes give more time for workers to plan ahead and move forward.

Trade adjustment programmes can also support firms. Shocks from foreign competition can cause substantial harm to the regional fabric of firms. Policies should be designed to rebuild and sustain this fabric. By helping firms to thrive where they are and preserve their local roots, policymakers can strengthen the link that these firms have with the territory and ensure that local workers keep their jobs.

The Trade Adjustment Assistance for Firms (TAAF) of the U.S. Department of Commerce exemplifies this assistance to trade-affected firms. The programme aims at assisting firms affected by import substitution to develop and implement projects to expand markets, strengthen operations, increase profitability and regain global competitiveness. This assistance usually comes in the form of technical assistance, which is used to develop business recovery plans. In fact, federal funds are used to pay third-party consultants who, in turn, develop a customised business recovery strategy. Manufacturing, production and service firms are equally eligible to receive assistance. Firms do not receive funds directly and share costs with the administration.

Another strategy to rebuild the regional fabric of firms is to encourage firm creation. That is, besides supporting existing firms to stay in the market, programmes can also support new firms to enter it. These programmes can further operate as a combination of firm and worker support, via entrepreneurship and start-up assistance. By supporting trade-affected workers in becoming self-employed, these programmes would at the same time help expand the regional fabric of firms.

For instance, the Austrian Steel Foundation, formed by a group of firms in the steel sector, assists steel workers affected by structural changes in the industry. Assistance for creating a new business is one of the different types of training offered..2 The Foundation hosts an administrative centre where office space and basic infrastructure such as telecommunication services are provided. It also hires business consultants to carry out market analyses and develop business plans for workers who seek to start their own business. More than one hundred firms have been successfully created in the field of consulting and services, machinery and energy and environmental technology (Winter-Ebmer, 2001_[10]).

Productive ways to compete among regions: A race to the top

A typical approach to economic development has been to attract firms from elsewhere (OECD, 2009_[11]). This approach calls for tax exemptions, fiscal incentives, wage restraints, flexible environmental and labour regulations and cheap land availability. After all, lower costs of relocation and operation could be enough of an incentive for firms to move into a certain region, in the absence of other desirable characteristics such as skilled labour markets, dense transport networks or a large base of suppliers or customers.

However, this approach has proven to have modest effects. The mere concentration of resources in a place does not automatically translate into economies of agglomeration. Instead, they are conditioned on the existence of a pooled labour market, linkages among firms and knowledge spillovers (OECD, 2009_[11]). Moreover, this approach can translate into a “race to the bottom”, leading to revenue losses and weaker labour and environmental standards. Lastly, from a regional (national) standpoint, if existing economic activity is simply transferred from one location to another within the same region (country), net benefits are at best zero, and usually negative.

Instead of competing for existing economic activity, regions should grow by tapping into underutilised potential and maximising their own advantages. Accordingly, competition among regions should occur in the form of positive-sum games rather than zero-sum games. In other words, competition should improve the general economic conditions and increase economic activity in general rather than just relocating existing economic activity from one place to another. The difference between positive-sum competition and zero-sum competition can be illustrated as follows.

In a positive-sum game, regions can seek to attract businesses by providing better services and infrastructure. In such cases, even regions that lose the competition to attract a business are likely to benefit in the long term. By improving their general business environment, they foster the growth of existing businesses and are more likely to attract additional ones in the future. If the region has better infrastructure, skilled labour and more knowledge spillovers, new firms will seek to take part in this vibrant ecosystem.

In contrast, zero-sum competition does not lead to generally improved conditions. For example, regions can try to attract businesses by providing indirect subsidies by selling land at below market prices. They can also offer direct tax incentives, as the section below explains. This benefits businesses at the expense of taxpayers, without increasing the capacity of the economy. Even though the region that manages to attract a business might benefit, overall economic growth would not occur. No overall increase in economic activity is expected as a consequence of zero-sum competition.

One example of a policy instrument that supports “productive” competition across regions is the Core Regional Growth Areas in Germany (OECD, 2012_[12]). The Brandenburg Region selected 15 Core Regional Growth Areas to receive preferential financing, providing that they display growth potential and develop integrated development strategies with the territories in which they are located. This policy intended to create a pool of knowledge that many firms can benefit from, hence stimulating innovation and productivity growth. It has brought about a new spirit of competitiveness, in which different territories are stimulated to become growth centres while at the same time benefitting from co-operation arrangements amongst themselves. The growth centres have been a key element in weening the region off subsidies and transfers and becoming more focused on development growth (OECD, 2012_[12]).

To this point, regions benefit from solidifying their competitive advantage, rather than emulating or attracting success from elsewhere. Regions have to identify their distinct strengths and create a vibrant ecosystem around them that supports productivity growth (OECD, 2016_[1]). Smart specialisation strategies could promote development, in advanced and more traditional sectors alike.

One example is the incorporation of Information and Communication Technology (ICT) and innovative technologies to support the production of a local distinctive cheese, La torta del Casar, in Extremadura, Spain. The Shepherding School aims to keep the tradition of producing the cheese alive by training highly professional shepherds, embracing ICT and the latest technological advances in the field. This strategy aims to address a weakness of the territorial production system, which is the capacity to incorporate knowledge-based innovation. So far, innovation at the local level has received a boost, and a more rounded perspective on rural development is being fostered.3

Another example of a smart specialisation strategy that builds upon existing industries is found in Emilia-Romagna (Italy), which combines an automotive cluster with investment in R&D and higher education and promotion of automobile-related tourism. The higher education institutions in the region successfully train high-skilled workers and promote the knowledge economy (Ortega-Argilés, 2012_[13]). The region also supports collaborative research projects for SMEs through research laboratories and innovation centres (Ortega-Argilés, 2012_[13]). The region further leverages the strength of traditional automobile industries in advertising itself as the “Motor Valley” of Europe and attracts related tourism, having created thematic museums across the region, organised fairs and festivals, and partnered with tourism agencies to offer specialised tours (Alberti and Giusti, 2012_[14]).

Regions can also invest in “niche” sectors based on location-specific advantages, geographic characteristics or natural resources (see also Chapter 1). Regions benefit from unlocking this potential, especially rural ones. The most productive rural areas benefit from natural resources they can leverage through promoting solid industrial sectors and investing in human capital to work on extractive, ideally regenerative, technologies and related services (OECD, 2016_[1]).

To illustrate, the natural characteristics of the northern regions of Sweden, Finland and Norway have resulted in the development of particular competences and technologies (OECD, 2017_[15]). The Arctic climate in the area combines extremely cold winters, short summers, low precipitation levels, and high levels of radiation. The region is abundant in natural resources, such as hydrocarbons, rare minerals, forests, and fresh water. These advantages have been leveraged by many different businesses, with research institutions also making valuable contributions. Some key activities include cold weather vehicle testing, data storage centres, energy saving technologies and construction solutions.

The cases of satellite launching in New Zealand (Box 5.3) and an optical cluster in Wales exemplify how location-related advantages can be used to promote economic niches. In New Zealand, it is the combination of natural characteristics, low population density and low sea and air traffic that makes it safe for frequent satellite launches. In Wales, an optical cluster of compound semiconductors is being developed, thanks to the stable and vibration-free ground soil in the area, which is an advantage for the production of advanced optical instruments.4

When developing a regional strategy, regions should be aware of what the neighbouring regions are doing, to prevent the duplication of strategies.5 Duplication can lead to lower effectiveness and increased competition for the same markets, reducing profitability. For instance, research investments have been plagued by a “me too” syndrome, in which regions make investments in similar and fashionable areas such as ICT, nanotechnologies and biotechnologies (Sörvik and Kleibrink, 2015_[16]). Hence, a region’s specialisation strategy should consider in which promising niches and knowledge-creation activities other regions are investing (OECD, 2015_[17]).

Beyond openness and awareness, regions can collaborate with each other by having complementary strategies. Regions with interrelated competences and strategies can innovate together and expand their markets. As argued in Chapter 3, regions do benefit from producing a variety of goods and services in related sectors, as this generates more knowledge spillovers. In this way, when productivity is enhanced by innovation the benefits are shared across the broader economy.

For instance, in the European Union, there is room for co-operation in smart specialisation strategies. Co-operating regions combine related strengths, invest in joint research initiatives and leverage access to global value chains. They can, for example, operate in complementary niche sectors that share technologies or generate inputs for one another. Moreover, a macro-regional strategy can be developed whereby different regions come together to develop a shared smart specialisation strategy. In this type of collaboration, stakeholders from across the macro-region join forces, align strategies and pool common resources, to promote their common prosperity through research and innovation.6

How relocation incentives work (or not)

One of the clearest signals of how much competition across regions shapes policymaking is the widespread adoption of incentives to firms. These incentives include subsidies, tax breaks, subsidised loans, grants and infrastructure improvements. The main goal of such incentives is to influence firms’ location choices and hence contribute to local job creation. Given the widespread adoption of incentives as local economic development tools, positive and negative examples abound (Jensen, 2017_[18]).

One positive example of incentives is investment subsidies given to manufacturing firms in economically disadvantaged areas in the United Kingdom (Criscuolo et al., 2016_[19]). The programme awards discretionary grants to manufacturing firms, to spend on property, plant or machinery, with the expectation of job creation that would not happen otherwise – the so-called “additionality criteria”.

It has been shown that subsidies have a statistically significant impact on job creation (Criscuolo et al., 2016_[19]). Importantly, the positive effect is not attributed to job relocation but appears to come from the pool of unemployed living in the area. However, the positive effects of this UK programme are mitigated for large firms, which are more able to “game” the system (i.e. taking the investment subsidy without making additional investments that would have not been made otherwise). The effect of business support was thus stronger on smaller firms (under 50 workers).

One negative example of tax incentives to firm relocation is the one in the metropolitan area of Kansas City in the United States. Kansas City is divided between the states of Kansas and Missouri, which both offer tax breaks and subsidies for firms to locate in their jurisdiction, as long as they create and sustain jobs. Given that the functional urban area of Kansas City extends over both states, it is relatively easy for firms to move from one side of the border to the other.

In Kansas City’s “border war”, firms have accepted substantial fiscal advantages to periodically move their headquarters or plants to the other side of the urban area. From 2009 to 2013, 3 289 jobs were added to Kansas from Missouri, at a cost of $140 million in tax incentives. At the same time, 2 824 jobs moved to Missouri from Kansas, at a cost of $72 million. Together, these two states spent $212 million on job relocation across the four-year period, with Kansas achieving a net gain of a meagre 465 jobs (McGee, 2015_[20]).

This simple example shows that jobs have been mostly shifted across administrative borders, at high costs for the public budget. If each state is considered separately, a significant number of jobs were added from 2010 to 2015. However, given that most jobs were eventually shuttled out of one state to the other, the total gain was lower than job creation statistics divided per state indicate.

Moreover, many of these jobs cannot be directly attributed to the programme. Very few beneficiary firms in Kansas affirmed that job creation would not have occurred without the programme, and statistical analysis shows no significant evidence in this direction (Jensen, 2017_[18]). In all, relocation incentives in Kansas City illustrate the type of competition that lowers standards and benefits firms, at the expense of public budgets.

Location incentives for private firms are subject to criticism. One critique is that incentives are redundant and fail in changing the behaviour of firms. Extensive research shows that firms typically praise the incentives, but say that they would have moved to a certain place even without the subsidy (James, 2013_[21]). Once the location decision is made, firms negotiate or look for tax breaks and subsidies to “sweeten” the deal. This argument corroborates the notion that location matters more than temporary financial incentives. Ultimately, firms choose their location based on access to key inputs, suppliers and customers, not on tax breaks.

Another critique is that the majority of incentives are reaped by large firms, while research shows that their impact is more socially beneficial when small firms receive them (Criscuolo et al., 2016_[19]). An evaluation of state aid programmes in three US states (Florida, Missouri and New Mexico) showed that 68% of state economic development spending goes to large firms, while only 19% are targeted at small firms and 13% have flexible eligibility criteria.7 To avoid this, states should gear eligibility criteria towards small firms.

Thirdly, requirements for job creation that are tied to incentives can be too low. Moreover, requirements are not always linked to the quality and long-term viability of jobs. In the Start-Up NY programme, for instance, firms are required to create one new full-time job and to not reduce employment in subsequent years. In exchange, they are exempt from a range of taxes for up to a decade.8 The first evaluation of the programme in 2014, the first year of the programme, showed that 76 jobs had been created by 30 participating companies, at a cost of USD 56 000 in tax benefits, by 2016 the programme had expanded and a total of 722 jobs been created since the inception of the programme with tax benefits in the year amounting to just over USD 3 million.9 The appeal of incentives based on tax reductions is that they only arise after the firm operates and little risk is involved for the public sector. But the tax breaks do not include the personnel cost in the administrating agency, nor the significant marketing cost that the agency had to spend on the programme, which amounted to more than USD 45 million between October 2013 and October 2014.10

On the other hand, defenders of financial incentives to firms claim that targeted location incentives spur economic growth. The attraction of major firms to a given area can catapult economic development, due to real estate values, wage growth and by attracting other firms. If a tax incentive can make one key firm relocate to the area, the private investments that follow can easily outweigh the costs borne by the public sector (Kline and Moretti, 2014_[22]).

It is important to highlight that – as previously stated – regions can use other policies beyond tax incentives to encourage firms to move to their region. For example, simplifying administrative and legal procedures can make regions more attractive to firms because complicated and burdensome administrative procedures can create high costs. In this sense, improving business licensing processes, simplifying tax codes at all levels of government and streamlining requirements are all good measures to improve the ease of doing business and to attract firms, without foregoing tax revenues.

Another set of policies that can be adopted to support local job creation regards supporting local entrepreneurship, and investing in skills and education. As argued in this report, human capital development and support aimed at helping the creation of new businesses are important factors in promoting local growth.

Taking advantage of opportunities for territorial branding

Territorial branding can be a useful tool for regional development, if well-articulated and well-promoted. Places have their own characteristics, products and people, i.e. economic, geographic and cultural attributes that can be identified as unique or special. Branding is a way to promote the uniqueness of places, and today a commonly explored route for policy makers.

One lesson from place-branding is that a clearly identifiable brand is more beneficial than many different, segmented ones. Investing in several different brands for the same place can limit the impact of the marketing strategy and create market confusion. Oliveira (2015_[23]) notices that, in the case of Portugal, the proliferation of tourism brands has created a cacophony of names and slogans. What is more, these brands have been promoted with little attention to the economic and social issues behind place-making.

In this sense, brand creation needs follow-up action to consolidate it. The literature has extensively noted that logos and slogans alone have little significance in fostering economic restructuring and social cohesion (Oliveira, 2015_[23]). Places should follow up on actions that can transform the region, in order to realise the potential of the brand. The place makes the brand; the brand does not make the place. From the different accounts of territorial branding, key lessons emerge.

The case of the brand Produit en Bretagne (Made in Brittany) in France shows how shared values and collective efforts to expand and solidify the brand can yield positive results (Donner, 2016_[24]). The oldest regional food brand in Europe, Produit en Bretagne was created in 1986 to strengthen regional solidarity and employment. Since then, an association of producers was created, which includes today members of the service sector such as hotels, restaurants as well as the cultural and creative sectors. The association is in charge of quality controls on products and coordinates a marketing strategy with an array of stakeholders. The association successfully created a business incubator to support innovative projects, too (Donner, 2016_[24]).

This example also signals the importance of participatory territorial branding, i.e. of involving local stakeholders in brand development and consolidation. Promoting synergies and consensus among regional stakeholders has been identified as one of the key elements in keeping a brand alive and well in the long run.

Successful territorial branding strategies are not just about marketing a territory. They require the creation of an identifiable brand, linked to the specific socio-cultural and economic context of the region. But they also demand investments in productive activities that are related to the brand, be them tourism, agri-business, industry clusters or even natural resource preservation. Furthermore, the promotion of common values, the involvement of local stakeholders and public-private co-operation are key factors in this process. In the long run, the level of local embeddedness will determine if a branding strategy can have long-term success.

A place-based approach to skills development

OECD research over the past ten years shows that human capital is a robust determinant of regional growth.11 Several policy sectors can contribute to increasing human capital in regions. For instance, reforms of tertiary education systems to enhance access and improve quality have been recommended (OECD, 2010_[27]). Lifelong learning via skills training and innovative workplaces has also been advocated. Supporting international mobility of labour, research and education is another valid recommendation (OECD, 2010_[27]).

These recommendations need to be enhanced by awareness of the different stakeholders operating in a given territory. A place-based approach to skills and human capital development requires that regional economic development strategies be connected with education and labour policies for local skills development (OECD, 2016_[28]). This has been challenging for regions in an array of countries, as the examples below indicate.

The region of Geelong, in Australia, has developed a strategic regional development strategy. A multi-stakeholder alliance was formed to identify local strengths and promote a co-ordinated approach to regional growth (OECD, 2013_[29]). One of the main aspects of this strategy is the transition from traditional manufacturing sectors to new and more dynamic sectors, including niche tourism as well as innovative tech-food and agri-business practices. However, very little in the regional strategy refers to developing the skills that workers will need to adjust to this new environment. Consequently, the OECD (2013_[29]) has recommended to the Geelong region that it would be better to invest in human capital development, and link it closely with its regional strategy.

In the case of the region of Pomurje in Slovenia, employment and labour market instruments were adopted to address structural changes, without the backup of a regional development programme (Eurofund, 2014_[9]). As a result, few jobs were available in the region and retrained, skilled workers ended up commuting to Austria to access jobs. Also, the Pomurje region continued to show the poorest economic and labour market indicators across the country. In response, the region launched a regional development programme to foster competiveness, support employment creation and facilitate private investments. The existing labour-market instruments were coupled with business support strategies, and were anchored in a clear understanding of regional needs.

By helping would-be entrepreneurs to start their own businesses and develop their skills, regional policies are made more effective, as it is the case in Pomurje. As the above section on trade adjustment programmes discusses, by assisting firms to locate and thrive in a given territory, policymakers are also supporting workers. Without a solid regional fabric of firms, even well-trained workers would not find jobs or their skills would remain underutilised.

Furthermore, social policy should include regional development strategies. Social policy programmes can advance the employability of marginalised and vulnerable groups, which is an integral part of inclusive growth. Housing policies, in particular supply-side ones, can contribute to keeping housing costs at reasonable levels. They can also help reduce the spatial job mismatch of low-skilled workers. Public childcare facilities help reconcile work and family life and are a tool to increase female labour force participation (OECD, 2017_[30]).

One example of a policy instrument that effectively addresses this link is the Territorial Employment Pacts in Austria.12 The Pacts function as contractual partnerships signed between public authorities at the regional and local levels. The authorities develop integrated projects, co-ordinate policies and streamline processes across different departments that deal with employment and social inclusion. Their main goal is to provide co-ordinated measures to improve the integration of marginalised groups into regional labour markets. The measures include employment assistance, social advice, counselling, crisis intervention, housing, and recovery and health issues.

These cases demonstrate that regional development programmes should address labour, skills and social policy while also supporting innovation and business creation if they are to effectively promote productivity growth (OECD, 2016_[28]). Under a place-based approach to skills development, training workers also means trying to ensure that there are firms where they can find work and assuring that their surrounding environment is safe and healthy.

Skill development and utilisation: A shared responsibility

Skill development has to be a central priority for governments, especially when facing the challenges brought on by globalisation, migration and digitalisation (European Commission, 2017_[31]). Moreover, equal access to high-quality education and training is a powerful way of reducing inequality in societies. As the section above indicates, there are many different policies that governments can invest in, from employment assistance to skills training and social counselling.

That said, other actors should get involved in the aim of improving skills development policies. Public offices responsible for employment assistance and related up-skilling activities can only do so much. Their role is to provide temporary support to unemployed workers in order to find a new job, and often training is restricted to “recycling” skills or to acquiring skills that are industry-specific. In this sense, employers and educators can have an important and comprehensive to play in skills development.

Employees’ or employers’ associations should play an active role in skills development to ensure skills are fully utilised at the workplace. There are potentially high returns from investing in workers’ skills, since better-qualified workers are more productive, are more flexible to undertake new tasks, and earn higher wages. Workforce development should hence be a functional part of an enterprise’s business model in order to be sustainable in the long run (OECD/ILO, 2017_[32]). The workplace should be a place of continuous learning and training. Employers could offer on-site qualification and courses on a regular basis.

Employers can also encourage their employees to take part in practice-based learning. They can communicate with educators about the skill sets they need, helping them to refine their programmes. They can host students from these programmes in their firms, to carry-out practice-based projects and train for specific skills.

In addition, in the event of firm restructuring, employers bear responsibility towards workers. To the fullest extent possible, employers should plan the scaling-down in advance. With the aim of supporting the transition to new jobs, employers or other entities can provide education and training, or fund education facilities. Matching services could further address the challenges of skills mismatch and of economic restructuring. Box 5.5 contains a few examples of such initiatives.

Skills development strategies should be adapted to the needs of a region. Different regional economic specialisations can require very different skills profiles from the workforce. Furthermore, structural changes within the regional economy can create specific challenges, such as the need for retraining a large number of workers with a skills profile that has suddenly become obsolete (Box 5.6).

Vocational training and apprenticeship systems that combine workplace-based learning with classroom-based learning are one of the most important ways to safeguard the provision of a well-trained workforce at the regional level. Different types of vocational training and apprenticeships target different skill levels. They can range from basic post-secondary education in trade schools to advanced higher education in universities.

Vocational training is important for regions because it can provide close links with regional and local businesses (OECD/ILO, 2017_[33]). By relying strongly on workplace-based training and inputs from firms for curriculum design, vocational training programmes ensure that transferred skills match the needs of the regional industry. Since one of the key characteristics of vocational training programmes is close collaboration between the education sector and regional firms, measures enabling regional authorities to become actively involved in the process will need to be set up.

In Germany, the curricula of post-secondary vocational training programmes are developed in partnership with unions and industry associations, who also contribute to the funding of the programmes. They define a common set of standards for a given trade, but offer sufficient flexibility to adapt the content of programmes to regional needs. The possibility to adapt vocational programmes to specific challenges has also been proven to be effective in other countries (Box 5.6).

Classroom-based education in vocational training programmes often takes place in trade schools, but can also involve higher education institutions. Polytechnics, community colleges and universities of applied sciences frequently provide joint classroom-based and workplace-based programmes. At the same time, they offer stand-alone undergraduate and graduate degree programmes.

Furthermore, universities of applied sciences and similar institutions can have an important place-based dimension. They exist in many mid-sized towns and are important regional centres for the training of specialised high skilled workers. In contrast to many regular universities that are predominantly located in larger cities, students do not have to move outside the region to study and are more likely to look for work in the region later on. In this sense, it has a strong regional dimension of retaining skilled workforce and firms in a given territory.

Professors should be well-qualified to teach industry-relevant skills, and even higher education institutions that do not specifically focus on teaching job-related skills can benefit from links with non-academic institutions. A possible approach is to hire professors with cutting edge industry experience, or create research centres affiliated with the university that link researchers with public or private sector projects. Moreover, educational institutions should show flexibility to part-time and non-exclusive job contracts, for teachers to work in the industry in parallel if desired. It is of course critical in this context that academic standards are upheld.

Lastly, higher education institutions can invest in practice-based research, in partnership with businesses and industry sectors. Instruments of practice-based research include internships and work-study contracts, but also collaborative research projects, open labs and business incubators. The latter will be further explained in the section below on “Effective university-industry collaboration”.

Taken together, skills development requires an effective partnership between government, employers and educational institutions. It is far from being an easy task. Complex, fragmented and frequently unresponsive systems that fund and deliver education and workforce training will need to be connected and co-ordinated (Liu, 2016_[34]). This requires different instruments for training and education, which have to be flexible enough to adapt to a changing world but concrete enough to guarantee prompt access to the labour market.

Innovation diffusion across the supply chain

Regional clusters can be, among other reasons, beneficial for regional economic development, because they offer possibilities for different actors within the region to learn from each other and thereby benefit from “innovation spillovers”. Participation in production along Global Value Chains (GVCs) add an important international dimension to this process (c.f. Chapter 3). By linking regional businesses to firms from across the globe, they can potentially facilitate knowledge spillovers from advanced regions in other countries.

If and how learning occurs within GVCs depends on how firm-to-firm relations are structured within them. In GVCs that are built on arm’s length transactions, learning is primarily based on unstructured knowledge spillovers. In GVCs that are based on relational interactions, learning can occur through regular contact among employees from different firms. In GVCs based on hierarchical or captive relations between firms, learning is potentially most structured. Dominant firms within the GVC might employ targeted knowledge-transfer or training programmes to help subordinate firms to acquire the knowledge and skills they need to perform their role within GVCs (Pietrobelli and Rabellotti, 2010_[38]). While such direct knowledge transfer can be highly effective, it is often also narrow in its scope. As a consequence, the transferred knowledge might be of limited use for expanding a firm’s activities beyond its role in the GVC.

However, innovation diffusion along the supply chain does not always take place. For one, competitive relationships in the supply chain can undermine innovation. Sporadic interactions with little or no trust do not encourage the supplier to search for innovative solutions to present to the customer. The customer refrains from transferring technology to this type of supplier, too. On the flip side, collaborative relationships build trust between actors, thus enabling technology transfer and increasing supplier-driven innovation.13

Second, it can be difficult for innovation to travel along the supply chain. Firms do not always share technologies, and knowledge spillovers are greatly facilitated by spatial concentration. To overcome these barriers, research-oriented institutions that work closely with the private sector can be of great value. They can generate innovation that is shared along a whole industry sector, and transfer technology from one sector to another. They can foster networks and joint product development, too. Their role is explained in the section below on “Effective university-industry collaboration”.

Furthermore, regional firms should diversify across different customers in different GVCs in order to increase productivity (Humphrey and Schmitz, 2002_[39]). Thus, instead of selling to one customer within a single value chain, firms perform better if they have multiple customers in multiple GVCs. By learning from differences in internal production processes, firms can innovate and increase productivity. Regional authorities can help this process by providing support to firms seeking to diversify across markets.

In order to strengthen learning, it is recommended that governments seek partnerships with dominant firms within GVCs to encourage knowledge sharing along the GVC (UNCTAD, 2013_[40]). In contrast, if dominant firms within a GVC try to prevent regional firms from diversifying their customer base, governments should use antitrust policies to prevent or penalise any anti-competitive behaviour of dominant firms within GVCs and ensure that weaker firms are not prevented from seeking business opportunities outside the GVC.

Effective university-industry collaboration

The benefits of linking universities and firms are widely acknowledged today. They include – but are not limited to – higher productivity, improved innovation processes, skills training to students, creation of spin-off companies and higher patenting rates. Given these benefits, most OECD countries have adopted strategies and programmes to promote university-industry collaboration, albeit some of them have been considered fragmented, uncoordinated and limited in scope (OECD, 2016_[41]).

To promote a more integrated approach, regional governments should adopt several knowledge transfer and R&D tools (Table 5.1). They can support businesses by offering grants, contract opportunities and innovation vouchers, for instance. With new technologies, businesses can develop innovative products and innovative organisational practices. They can support universities by providing strategic funding to patent development and creation of spin-off companies, among other tools. They can support both firms and universities by launching programmes to encourage student hiring by industry and by establishing collaborative, open research laboratories (Table 5.1).

Besides these commercial tools, there are also purely knowledge-related tools, such as publications, conferences and standards, which can be valuable ways to transfer knowledge, regardless of direct commercial output. Conferences and networking events can allow informal connections to be formed, thereby enhancing trust. Trust has been found to be one of the key elements to jump start formal collaborations between researchers and entrepreneurs (Vallance et al., 2017_[42]).

For university-industry collaborations to work, certain structural conditions should be in place. Beyond creating a certain programme or adopting a certain tool, policymakers should invest in a framework enabling these tools or programmes to operate successfully, including consistent funding, clear property rights and confidentiality issues, career incentives for professors to be involved in industry collaboration and trust among actors (Edmondson et al., 2012_[43]).

Piecemeal funding has been a characteristic of several programmes. Ad hoc, project-oriented funding is flexible and can be adapted to different circumstances. Yet, this type of short-term funding can halt the development of a more all-encompassing, long-term strategy, focused on priority areas. Enduring university-firms partnerships can have positive results, such as increased levels of knowledge transfer and greater trust among actors, which can facilitate future collaboration.

In this sense, consider the example of innovation vouchers. Under this programme, SMEs receive vouchers that can be used to consult academic expertise for a specific purpose. The purpose can be accessing a new technology, developing a marketing strategy, altering the organisational structure of the firm – anything that can generate innovation and requiring external expertise. SMEs may particularly lack the expertise and the resources to generate innovation without such support.

The voucher programme in Lombardy, Italy has yielded positive results. Vouchers increased the competitiveness of local firms and strengthened the dynamics among actors of the Regional Innovation System, providing grounds for future collaboration.14 Vouchers can raise awareness among SMEs regarding the benefits of collaborating with academia (OECD, 2011_[44]). Still, given that vouchers are a one-off funding opportunity, future collaboration will depend on the initiative of regional actors.

Universities need to engage their faculty in such partnerships. To do so, universities could broaden their performance evaluation criteria, beyond publication track records. Activities such as co-ordinating innovation labs, filing patent applications and developing innovative products for industry partners or spin-offs could be used as additional performance criteria. This could encourage more professors and research staff to engage in partnerships with industry without harming their careers.

Another challenge is that the different tools for partnerships between university and industry seem to be disconnected. France, for instance, has witnessed a proliferation of different agreements, contracts, partnerships and scholarships. The lack of co-ordination between mechanisms and the parties involved is a handicap, since it does not allow the State to provide a coherent range of mechanisms or avoid overlapping supervision roles and responsibilities (OECD, 2014_[45]). One exception to the French system is the long-lasting CIFRE convention of student hiring by industry (Box 5.8).

University-industry partnerships should have clear rules and regulations, notably concerning patent and ownership issues. For that to happen, universities can create specialised offices to manage collaborations with industry. These offices can serve as “one-stop shops” for private partners looking to work with the different university departments, in different research fields. The offices develop expertise in signing agreements, commercialising products and forming partnerships. They become especially knowledgeable on matters of licensing and intellectual property, which further allows the university or regional consortium of universities to have a single policy for patenting and product commercialisation.

For instance, the Society-Academia Collaboration for Innovation (SACI), established in 2007, works as a one-stop shop for companies interested in collaborating with Kyoto University. SACI provides up-to-date information on technology developed or under development by the university. SACI also promotes entrepreneurship education in the university community via the Venture Support programme, which offers educational programmes and funding to help inventors and innovators make their ideas and concepts more commercially successful (OECD, 2016_[41]).

In Austria, the regional Knowledge Transfer and Intellectual Property Rights Exploitation Centres promote co-operation between universities and companies. Their main areas of activity are: educating university personnel in practical intellectual property rights matters, invention spotting, filing and management of university patents, marketing of university inventions, and assisting the establishment of spin-off companies. They also boost strategic patent funding and provide funding for prototypes. The patent promotion scheme awards funding for universities to strategically develop patents for which successful commercial exploitation can be expected. This centralised approach has strategic benefits, fuelling the industry’s pipeline while also generating long-term revenue streams for the university.15

The role of technology centres in knowledge transfer

Research and technology organisations (RTOs), also called “technology centres”, “industrial research centres” or “public research organisations” are non-profit organisations that provide research and development technology and innovation services to enterprises and governments. They function mainly as a support platform for companies, generating and facilitating the use of technological knowledge, providing local companies with research, development and innovation services.

RTOs can fulfil their role through a variety of instruments. Partnerships with regions can be developed to test new technologies and help regions to design innovation strategies. RTOs can facilitate cluster interactions among firms and support collective activities such as the structured monitoring of technology trends. They can support a whole industrial sector, by functioning as an R&D centre whose main role is to transfer technology to the sector. They can work with individual firms by subcontracting research and developing accelerators or incubators.

RTOs funded by an industrial sector develop and share technology across the firms within this sector, or across complementary sectors. One example is the AIMEN Technology Centre in Spain. Created in 1967, AIMEN promotes and executes R&D activities and technological services promising high value-added. AIMEN supports several industrial areas, from aeronautics to chemical and petrochemical, automotive, shipbuilding, construction, energy, and more. Besides providing technological services to individual firms, the fact that innovation can be shared across sectors facilitates cross-sectoral collaboration. The EURAC research centre in Italy and the VTT Technical Research Centre of Finland are other examples of cross-sectoral research and technology organisations with a broad mandate.

The Fraunhofer Institute is one of the most successful examples of a RTO, and also the largest of its kind in Europe. The institutes are embedded in universities, with the director of the Fraunhofer Institute who also occupies a faculty chair at the same time. The model maintains separation between the university and RTO functions, but organically links the two elements. It offers opportunities for postgraduate students to engage in practice-oriented research. At the same time, it allows innovation in firms and industries to be guided by cutting-edge research, while granting important revenue streams to the university.

Innovation-friendly procurement

Public procurement can be used to encourage innovation in a market-friendly way.16 Because of their purchasing power, governments can foster innovation in firms, directly or indirectly, and create a signalling effect as a lead user, influencing the diffusion of innovation. First, regular public procurement can be made “innovation-friendly” by incorporating innovation-related criteria in the tender specifications and in the evaluation of proposals. This can work for different products and services purchased by public authorities, from construction and energy to catering services.

Second, public procurement can also be strategic, such as when the government requests specific technologies for the delivery of public services in sectors such as transport, healthcare or defence. It involves the acquisition of a product, service or system that does not exist yet but could be developed within a reasonable timeframe by companies responding to the call for tender. The purchasing authority should specify the requirements of the desired product or service.

Third, the public sector can use public procurement to stimulate technological advances that require R&D, before any market solution can be launched. This type of procurement is called pre-commercial, because it is directed to support research, not to purchase a given product in the market. In some cases, pre-commercial procurement is used to offset biases against innovation driven by new and small companies. In Korea, for example, this instrument is used to guarantee innovations developed by SMEs will be purchased, offsetting the costs of research (OECD, 2011_[47]).

Innovation in the service sector

The importance of innovation in services has often been underestimated or neglected in favour of technological change in the manufacturing sector. Services were long regarded as activities that did not need innovation. For one, it is true that the service sector had been lagging in the use of advanced technologies. Secondly, in manufacturing innovation often results in a new product (at least for measurement purposes), while in the service sector products are often intangible, and innovation is more likely to be measured as changes in the production process or organisational aspects (Morrar, 2014_[48]). Today, with the rise of the service economy and of the so-called “servitisation” of firms in manufacturing, it is extremely important to understand and measure innovation in the service sector.

One way that innovation often occurs in the service sector is by generating new technologies or incorporating technologies that are already used in the manufacturing sector. For example, the adoption of information and communication technologies in service activities can make services more innovative and productive.

In this sense, technological innovation in the service sector can be stimulated by the traditional mechanisms that support innovation in the manufacturing sector. As argued above, governments can do so by promoting entrepreneurship, investing in R&D, offering specific assistance to SMEs and linking research centres and firms, among other mechanisms.

Another way to innovate is via non-technological incremental changes that are specific to services. Innovation can occur in marketing strategies, organisational structures, service customisation and problem-solving approaches. Innovation in the workplace can also occur by making better use of the workers’ skills. Besides better matching them to jobs, the way in which the service delivery processes are organised can be made more efficient. This perspective stresses firm organisational structure and human resource management.

Policies to support non-technological innovation in the service sector can include support for entrepreneurship, creation of leadership centres and technology agencies, and soft mechanisms such as awards for workplace innovation, as indicated in the examples below.

Support for entrepreneurship can come in the form of innovation vouchers. In Barcelona, the FAD-INS programme gives vouchers to SMEs in the sectors of fashion, design and audio-visual technologies to contract external expertise with a view to improving their business.17 This expertise can involve a new marketing strategy, more efficient organisational processes or better human resource management. This voucher programme effectively supports SMEs to generate innovation that is not necessarily attached to high-technology advances.

One example of a public agency working on service sector innovation is Tekes, the Finnish Funding Agency for Technology and Innovation. Unlike more traditional innovation agencies, the Finnish one focuses on workplace development, through the Liideri programme. In particular, the agency helps to develop management practices and forms of working that promote the active utilisation of the skills and competences of employees. It reflects an emphasis on demand and user-driven innovation (OECD/ILO, 2017_[32]).

In addition, public authorities can assist businesses in making better use of the skills that their employees already have, with actions such as leadership centres and awards for workplace innovation. In Australia, for instance, the Centre for Workplace Leadership supports capacity building in leadership and promotes a high performance work culture. In Europe, the Workplace Innovation Network stimulates awareness and knowledge-sharing regarding workplace innovation. Awards such as the Australian Training Awards and the Productivity Olympics in the Philippines recognise small and medium enterprises that have developed best productivity practices (OECD/ILO, 2017_[32]).

There is no panacea for regional development and each of these policies to foster innovation will create only small increases in productivity if implemented separately. Yet, if they are implemented in combination with other policies discussed throughout this report, they can generate substantially higher productivity growth. By pursuing policies to strengthen the tradable sector, to become more innovative, to support knowledge diffusion, to raise skill levels and to utilise their unique advantages, regions will not only ensure they remain competitive, but will raise living standards for all residents.