Business | Schumpeter

Silicon Valley 1.0

Cleveland can teach valuable lessons about the rise and fall of economic clusters

WHEN the Republican Party decided to hold its national convention in Cleveland back in July 2014 no one dreamed that Donald Trump would be the party’s presidential nominee. Yet the city and the man are oddly suited. It is hard to think of a city that better illustrates Mr Trump’s campaign theme of making America great again. For Cleveland is a city that has clearly fallen from greatness. It is also hard to name a city that better illustrates the fears of Mr Trump’s critics. It is clear that the politics of anger and resentment have done nothing but hasten its decline.

Cleveland was the Silicon Valley of the second industrial revolution. John D. Rockefeller founded Standard Oil Company there in 1870. Steel barons built mills along the Cuyahoga River and Lake Erie, drawn both by the supply of iron ore and by excellent transport links to the east coast. Immigrants came in their thousands. Charles Brush pioneered electric lighting there; Sidney Short and fellow inventors came out with electric street cars. By 1900 Cleveland was so successful, leading in patent registration and venture capital, that it opened a stock exchange.

The city was also home to one of America’s greatest political machines, put together by a local boy, Mark Hanna, an iron-and-steel magnate turned political Svengali, and his front-man, William McKinley, from nearby in Ohio. McKinley won the presidency in 1896 on a platform of nationalism, protectionism and (qualified) isolationism, and his party held the presidency for all but eight years until 1932. (Karl Rove, George W. Bush’s own Svengali, modelled himself on Hanna, and wrote a biography of McKinley, though Mr Bush’s unpopularity and Mr Trump’s rise suggest that he was less successful than his role model.)

The relics of Cleveland’s greatness can still be seen everywhere. The city boasts one of America’s greatest orchestras. The Lake View Cemetery contains the bones of Rockefeller and those of America’s 20th president, James Garfield. The suburbs are dotted with the palaces of former industrial barons. But they only serve to remind you of how far the place has fallen. Cleveland embodies all the classic signs of rust-belt decline. The centre often looks barren. Crime and begging are a problem. The population has fallen from 900,000 in the 1950s to less than 400,000 today.

Economists from Alfred Marshall on have dwelt on the self-reinforcing characteristics of successful clusters. They can protect their pre-eminence by producing distinctive cultures (Marshall said that there was something “in the air” in Sheffield that was conducive to steelmaking) and by attracting talent and money. And they can entrench themselves by investing in robust institutions like universities. The most prominent example of a successful cluster today is Silicon Valley. But there are plenty of others: the City of London in England or the car industry in Stuttgart.

Cleveland is a reminder that decline can be as self-sustaining as success. There are three reasons why clusters fail. One is that they over-specialise in products that are later improved elsewhere. Sheffield stuck to steelmaking even as others learned to make it better and cheaper. A second is that they complacently fail to upgrade their productivity. Detroit succumbed to Japanese carmakers in the 1970s and 1980s because it thought more about providing its cars with ornate fins (and its workers with gold-plated benefits) than it did about their performance. The third is that they suffer from an external shock from which they fail to recover, as could be the case with the City of London in the wake of Brexit.

Naomi Lamoreaux, an economic historian at Yale University, says Cleveland falls into the third category. It led in a wide variety of industries into the 1920s, including cars, chemicals, paints and varnishes, machine tools and electrical machinery as well as iron and steel. It spent money on R&D. But then came a series of external shocks. The Depression destroyed the local financial institutions that had supported Cleveland’s start-ups. Regulations adopted in its wake gave New York’s banks such a competitive advantage that local capital markets withered. The federal government’s wartime policy of dispersing manufacturing industry eroded the city’s industrial base.

Fanning the flames of hate

Cleveland’s decline became self-reinforcing. Firms downsized, closed or relocated. The inner city fell prey to crime and dysfunction. The white middle-class moved to suburbia. Politicians responded not with pragmatic ideas for reform but by whipping up anger and resentment, which only hastened white- and business-flight. Dennis Kucinich, the mayor in 1977-79, who much later ran for president, refused to privatise the electric utility and, in 1978, took the city into bankruptcy. A once-proud city was mocked as “the mistake on the lake”. To cap it all, Cleveland paid the price for its earlier successes: by 1969 the Cuyahoga River was so polluted that it caught fire, an event that is still celebrated in one of its local brews, Burning River Pale Ale.

The city’s story is also a warning that rebuilding clusters is fiendishly hard. It has had some success by focusing on education and medicine, though not as much as its fellow rust-belt city, Pittsburgh. The Cleveland Clinic is one of America’s great medical institutions. The city’s record with various mega-projects is mixed. In the early 1990s it spent over $300m on a sports complex for its baseball team, the Indians, and its basketball team, the Cavaliers. But downtown can still feel like a ghost town at night. More recently the city fathers have built lofts and bicycle paths to attract millennials. But then so has every other city in the country.

Perhaps the most important lesson from Cleveland is that the likelihood that you’re going to remain a top cluster for ever is small. Even if you diversify your risks and invest in your future, as Cleveland clearly did, some unforeseen event might knock you for six. And reversing decline is harder than capitalising on success. Success is a delicate flower that can easily be killed. Failure is a weed that it is almost impossible to exterminate.

This article appeared in the Business section of the print edition under the headline "Silicon Valley 1.0"

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