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What policy should do to help the clustered new economy thrive

The underperformance of major UK cities is holding back innovative firms gathered in hotspots.

Blog post published on 12 September 2023 by Paul Swinney and James Evans

Clustering – that is the co-location of firms – has long captured the imagination of policymakers. And it wouldn’t take long to find countless examples over the years in bids to government and economic development strategies by places claiming to house a neighbourhood with a special attraction to innovation firms. This interest continues today, with Gordon Brown highlighting hotspots in his Commission on the UK’s future for the Labour Party, and the Chancellor championing Investment Zones where Government will support clustering firms in specific sectors.

But what role does clustering play in the UK? Where can it be found, and why? Using data on ‘new economy’ businesses, our latest report identifies ‘hotspots’ of innovative activity where cutting-edge firms cluster together over short distances.

Hotspots play a small but outsized role in the economy

There are 344 hotspots of new economy activity in the UK (see Figure 1). Despite accounting for just 0.6 per cent of all businesses and 0.1 per cent of land, firms within these hotspots punch above their weight. Together, they account for around 1 per cent of national output and 200,000 jobs. The places where hotspots can be found are also more productive and have enjoyed faster economic growth since the financial crisis than those without them.

Source: ONS, The Data City, and Centre for Cities calculations

Now 1 per cent sounds underwhelming. To some extent this shouldn’t be a surprise – the new economy lies at the frontier of the economy, and as these firms mature it is likely that they will account for a disproportionate amount of productivity growth in the UK in the coming decade. But it does also caution how important these things are – the amount of space they inhabit in the imagination of policymakers perhaps isn’t quite as large as their share of the national economy.

Hotspots are overwhelmingly urban

Nearly 90 per cent of clustered firms are found in urban areas, and just over half are located in city centres. This trend results from the inherent advantages cities offer in relation to access to workers and other knowledge-based businesses.

Within this there is varying performance. Some cities, such as Bradford and Huddersfield, have no hotspots at all. Meanwhile, many of the largest cities have fewer and smaller hotspots than expected. Their broader economic underperformance has been remarked upon before, and cities such as Birmingham, Liverpool, and Sheffield stand out in terms of their lack of clustering. While these cities are effective at organising their new economies into hotspots, they have proportionally fewer innovative firms than other places.

That they aren’t helps explain why there is so many of the UK’s innovation hotspots are in the Greater South East. This part of the country does well because London offers the array of benefits that businesses at the frontier of the economy are looking for. Because the other large cities don’t to the extent that they should be means that there is a lack of clustering in their wider regions.

Investment Zones have a too-narrow focus on sector-specific hotspots of innovation activity

Contrary to prevailing ideas about hotspots being centred around one industry, clustering over short distances is rarely specialised. Just 24 of the hotspots identified in the report are specialised around one industry. Instead, hotspots are almost always melting pots of different innovative activities. While the government’s Investment Zones policy focuses heavily on specific sectors with potential for growth and innovation, this report suggests that place and the benefits that places offer to businesses provide a more useful lens for policy.

Policy should be supporting and growing existing hotspots, rather than devoting significant resources to creating new ones

If policy is to encourage localised clustering among innovative companies, then it should concentrate on three main areas:

Ensure that land use policy permits the expansion of office space near existing hotspots and other well-connected locations to allow the clustered new economy to grow.
Improve the performance of large cities by:
- Prioritising addressing the major cities’ connectivity problems. This is especially the case in their city centres, which host most of their clustered new economy businesses.
- Formulate Investment Zone proposals that support the growth of existing hotspots – an area for Metro Mayors to act on.
- Taking a cautious approach to specialising hotspots in certain sectors. Supporting clustering at small scales depends far more on offices and connectivity, amenities which are applicable to a wide variety of businesses rather sector specific policies.
Where hotspots do not appear to be operating under specific constraints, such as in business and science parks in non-urban parts of the country, stakeholders should look to hotspots as anchors for other interventions, such as transport investment and regeneration schemes, and support existing activity as required. National interventions to promote levelling up should similarly consider places with hotspots as locations within cities, towns, or regions as among the best potential destinations within their areas to capitalise on new investment.