The paper aims to highlight the extent to which the institutional context of a country can inhibit entrepreneurial activity in clusters.

Case study method employing exploratory survey questionnaire and interviews administered to 78 firms in the Denizli textile cluster in Turkey.

Findings show that Denizli district firms nurture effectively only some of the features of an industrial district, that is flexibility, participative managerial structure and trust. However, there is limited availability of skilled workers, and limited co‐operation in the form of joint projects and investments for innovation owing to the weak institutional context in which these firms are embedded. Although this might be expected to discourage economic benefits, performance, particularly in terms of efficiency and relations with internal and external customers, is perceived to be high by the cluster firms.

It is not adequate to argue that policy makers of developing countries should take particular systems of organizing, such as cluster formation, into consideration for their industrialization efforts. One needs to consider the wider institutional context in which entrepreneurial activity is embedded that can limit the degree to which clusters can stimulate economic development. This has implications for the applicability of a cluster approach to foreign contexts, particularly where global value chain governance is of a quasi‐hierarchical form.

Although district firms can strategize on the basis of their flexibility, trust relations and managerial structures within the confines of a state‐organized institutional environment and a quasi‐hierarchical global value chain, further improvements such as relocation of production and equity participation are needed to meet the global challenge.

This study shows that the institutional make‐up of a country can discourage actors from changing patterns of organizing for innovation. Although a substantial number of studies have been carried out for more than a decade on the internal structure and formation of clusters, these pertain predominantly to operations in developed nations and, by and large, ignore developing countries. The paper argues that clusters may not generate the same economic benefits when embedded in weak, state‐organized institutional settings as when operating in strong collaborative institutional contexts. The study is of value particularly to policy makers.