Even in this age of globalization and modern telecommunications, executives are rediscovering timeless truths about the advantages of proximity. In the German city of Wolfsburg, Volkswagen (VW), the local government, and McKinsey are working together to create a regional economic cluster—a concentration of companies and related institutions focused on a specific technological area. The project is designed to attract high-technology start-ups, as well as suppliers and other relevant companies, to VW’s doorstep and thus to cut local unemployment in half (the equivalent of creating 10,000 new jobs) by 2003.

Here, in the home of the world’s largest auto plant, the partners have formed a technology center based on the automotive industry. As well as showing corporate citizenship, VW hopes to benefit by creating a vibrant entrepreneurial community and improving the local supplier base. At the same time, city officials want to combat high unemployment and to revive a dwindling service and retail sector. VW and the local government have so far invested about $12 million and $10 million, respectively, in the project.

Wolfsburg, some 100 miles west of Berlin, lies close to the border with the former East Germany. It is a classic company town: about 50,000 people—more than...