Understanding the Inputs into Innovation: Do Cities Substitute for Internal Firm Resources?

Abstract:     
We examine whether there is a tradeoff between employing internal (firm) resources and purchased external (local) resources in process innovation. We draw on a rich data set of Internet investments by 86,879 U.S. establishments to examine decisions to invest in advanced Internet technology. We show that the marginal contribution of internal resources is greater outside of a major urban area than inside one. Agglomeration is less important for firms with highly capable IT workers. When firms invest in innovative processes they act as if resources available in cities are partial substitutes for both establishment-level and firm-level internal resources.

Keywords: innovation, agglomeration, localization of substitution, internal and external resources

JEL Classifications: R30, O33, L86

Working Paper Series