Association for Public Policy Analysis & Management

This paper quantifies the effect of industrial clusters on the innovation of small businesses versus large ones. Due to the endogeneity of firm size and the cluster status, as well as the imprecise measurement for the spatial scale of clusters, prior studies fail to deliver a reliable estimate. This paper solves endogeneity with two instruments—the size and usage of land parcels in 1973, and compares the magnitude by which clusters improve innovation across different geographical scales. It also probes into the effect of clusters on firm bankruptcy and re-location. Using establishment-level data for the state of Maryland and patent application data from 2004 to 2013, this paper finds that industrial clusters at the spatial scale one mile in radius increase citation-weighted patent filings by 3.2% in small businesses, but discourage patent filings by 6.4% in large businesses. The 3.2% increase in innovation in small businesses is equivalent to a 6.4% increase in R&D investment. This effect attenuates by distances and disappears beyond ten miles. At the same time, businesses in industrial clusters, large or small, suffer from tougher competition and sustain a 1.3% lower survival rate. Since small businesses account for the majority of the establishment population and are major job creators, promoting business concentrations at a local scale makes a promising option for practitioners to encourage innovative activities and boost local economic development.