The European Union’s goal is to become the “most competitive and dynamic knowledge-based economy in the world” . This phenomenon is not unique to the developed world: Brazil recently announced plans to send 100,000 students to study abroad every year explicitly to accelerate the development of an innovation economy . Recent scholarship has found that technological innovation alone likely accounts for over 50 percent of recent economic growth in the OECD . It is through innovation that we get new products, cost saving processes, and even whole new industries such as the computer industry . Globalization offers the promise of global markets, where regions that succeed at technological innovation, like California’s Silicon Valley, will grow rich exporting their goods throughout the world. At the same time globalization will destabilize many regions as their industries lose market share in the face of cheaper goods from abroad, or are replaced outright by innovations from abroad . Political and business leaders have embraced the innovation mantra in hopes of creating or maintaining a competitive edge in our era of increasing competition and technological change. This begs the question: what exactly is innovation? Perhaps the best definition of innovation comes from Swedish Economist, Charles Edquist, who states simply that innovation is a creation of economic significance . Innovation can occur in the form of a product,vertical rack system a process of production, or in an entirely new organizational structure . Innovation is related to invention, which is the creation of a new idea, technique, or technology .

Either it is sold as a profitable product, or is a labor saving process that increases profitability. There are innumerable inventions that for various reasons—whether cost of production, lack of market, or sheer neglect—never evolved into innovations. Similarly, countless new processes and organizational structures have been conceived of but never successfully developed into innovations. Understanding how innovation occurs is further complicated by the fact that innovations are,necessarily, new to the world. Hence understanding how innovation happens is a formidable challenge. Formulating policies that will ensure innovation is somewhat akin to being asked to predict the future. Policy makers are not alone in this regard. Many scholars have noted that traditional neoclassical economic theory also says surprisingly little about the creation of knowledge, including innovation even though the most important development theories such as endogenous growth theory utilize knowledge accumulation to explain macroeconomic growth . Endogenous growth theory, however, does not attempt to explain how or where this knowledge occurs; yet knowledge is considered to be an aspatial externality . Hence scholars have had to look elsewhere to try and identify the mechanisms behind innovation, most notably toward economic history which has clearly demonstrated that propinquity often matters a great deal in knowledge formation . Although policy makers may never be able to understand the actual mechanics of innovation they can work to create the conditions necessary for its growth. Fagerberg classifies innovations by their relative impacts .Innovations can be simple or incremental improvements, radical—the introduction of a new technology , or full fledged technological revolutions—-a series of inventions that together forge a new order like the computer or communications industry has done . Understanding innovation has always been central to the study of economic development. For example, Adam Smith’s famous pin factory example that explained the massive productivity benefits resulting from the specialization of labor, which is an innovative manufacturing process .

Schumpter who famously wrote of the inevitable “creative destruction” of existing economic systems wrought by innovating entrepreneurs , was directly alluding to Marx’s exhortation of capitalism as itself an innovative economic process that destroyed all previous economic systems. Schumepter’s works largely concentrated on radical or technological revolution as he believed they were the most important because they are the most disruptive . Fagerberg, citing Lundvall points out that subsequent scholars have shown the accumulation of incremental innovations can be just as disruptive and might possibly even have a larger overall effect . Innovation is a form of new knowledge. New knowledge is most often the result of research and development . Following Schumepter’s lead, early theories of innovation often looked to the firm to explain how R&D became economically significant, or innovative , making the logical connection linking to the profit motive, the principal driver of private firms. For example, one endogenous model of firm innovation hypothesized a correlation between R&D investment and innovative activity . This model indicated that innovation would more likely come from large firms that were able to fund R&D efforts. However, empirical studies contradicted this theory finding that small firms often out-performed large ones in innovation . There is a general agreement amongst scholars that knowledge exists outside of the firm. Ausdrestch and Feldman conclude that although firms are often critical to innovation, endogenous theories of firm innovation are not sufficient to explain how innovation occurs in the economy . Ausdrestch and Feldman point out that Jacobs distinguished between information, basic facts and the more complex knowledge, or tacit knowledge, which is difficult to codify , but studies have overwhelmingly documented that regionally concentrated spillovers are occurring . Today it is widely understand that innovation is a consequence of spatial interactions, even though it is difficult to identify the mechanisms of transmission.The geography of innovation can be captured through the study of innovation as a system, rather then focusing on individual agents. However, before we turn to a more detailed explanation of innovation systems, we will examine the closely related agglomeration economies.Although crucial to economic growth, innovation is not the only path to economic success in our era of declining trade costs; other economic benefits that come from agglomeration economies are also germane to our investigation.

Agglomeration economies, the principle driver of a city’s economic productivity, are the benefits derived from the clustering of economic activities, people, or firms. Agglomeration economies, which result in the clustering of people, activities, and firms creating a dense diversity, are the main economic justification for cities to exist . The Puga and Duranton identify three primary benefits that arise from agglomeration economies: sharing, matching, and learning mechanisms. Density generates savings through economies of scale and scope that result from sharing infrastructure, resources, markets, and labor. Similarly a diversity of inputs, products, markets,mobile grow rack and labor increases the chances of successful matching between firms and labor, or consumer and products. Learning comes about primarily through knowledge spillovers—also known as Jacobian externalities after the aforementioned urban scholar Jane Jacobs—the diffusion of knowledge, commonly called tacit knowledge, that results from interaction . Density also enhances the chances of adoption of products—such as the telephone—that rely on network effects for success, i.e. they require a wide number of users to function efficiently . Diversity also ensures that a wide range of products will be created to satisfy varied local demand. Agglomeration also creates problems, or diseconomies, such as congestion and pollution. These diseconomies require solutions—or even new innovative products entirely . Larger agglomerations, with more people and resources, are more likely to create solutions and therefore have additional advantages over smaller agglomerations. Although it should be noted this does not always happen, and that smaller concentrations have other advantages. Not all agglomeration diseconomies can be solved and therefore can act as a damper on the growth of agglomeration. A dense diversity ensures efficient matching of resources, firms, labor, and even technologies, while promoting learning and knowledge spillovers that enhance productivity and often lead to innovation . Economic scholars often further sub-classify agglomeration economies into two, or even three types: urbanization, localization, and industrialization. Urbanization economies are the production savings of agglomerating economic activity in a city. Loesch was the first to distinguish between urbanization and localization economies. Industries in cities with large home markets will be more efficient then those in smaller cities due to the economies of scale that result. Localization and industrialization economies are often lumped together and are also commonly referred to as Marshall Arrow-Romer externalities, named after the economists whose theories explain the respective economies that give localization . These are the economies that result from an agglomeration around a certain important location or industry.

For example the global fashion industry agglomerates around New York, Paris, or Northern Italy, or the American automobile industry historically clustered around Detroit . All three agglomeration types primarily manifest in urban regions, but some industrial agglomerations—particularly polluting industries— occur in regions of low density. Agglomerations of closely related industrial activities—or in the terms of Alfred Marshall, the first economist to label the phenomenon, industrial districts —are not simply agglomerations of similar businesses, but include interconnected companies such as specialized suppliers, or service providers, as well as associated institutions like universities or trade associations ; therefore, these agglomerations, or clusters, are not entirely captured by industry sectoral code systems such as SIC, which generally only identify the dominant industry. City-regions are the key nodes in our global trade network and the physical locations where agglomeration economies manifest, thus city-regions are the primary beneficiaries of increased trade . High productivity city-regions with strong agglomeration economies have a comparative advantage in trade because goods and services more created more efficiently and at less cost. . Trade can be costly when transportation and transaction costs that are incurred bringing a good to a distant market reduce or nullify a region’s productivity cost advantage. Economic theory and history demonstrates that when trade costs decline—from either technological advances or freer trade regimes—regions begin to shift production patterns accordingly, often concentrating internal production on goods that can be profitably exported while importing goods that are produced more efficiently or cheaply elsewhere . If the global era of lower trade costs continues, economic theory predicts that highly productive specialized regions—those with strong localization or industrialization economies—will likely become global centers of production. The business management scholar Michael Porter has developed a simple model of successful industry clusters. A successful cluster must begin with ready-access to the right kind and amount of factor endowments that are the critical inputs to the production process. Simply having an abundance of a necessary endowment factors could lead to inefficient production. There must also exist a the right kind of demand for the product as well as multiple firms that compete to serve that demand and institutions that provide the necessary services, in order to foster industry growth. Firms adopt innovations and grow more productive through competition. Local demand is critical to Porter’s conceptualization. As Mehrizi writes: “Domestic demand is more influential on the sector because signals are received faster by local firms and the rich interaction between local demand and businesses heightens the process of interactive learning” . The more sophisticated and specialized the local demand the more likely the cluster will become a global center—with the caveat that the specialized local demand must be shared by external markets, or else the competitive advantage of the cluster in serving that demand is moot. According to Porter’s theory the clustering of production in certain regions can unleash a virtuous cycle of growth as agglomeration economies and knowledge spillovers accelerate productivity gains. Industry specific infrastructure might be built to deliver the necessary inputs at less cost, and deliver outputs to markets. Local political lobbies arise to ensure local preferential treatment and promote industry trade interests. Specialized labor and interconnected companies, such as suppliers and specialized service providers, will begin to cluster at these centers, and associated institutions such as universities or trade associations arise to further enhance productivity through knowledge sharing. If these clusters are in an emerging industry they can potentially evolve into major centers of innovation. For Porter, however, this requires a heterogeneity of competing firms rather then a monopoly . More firms mean more competition for innovation, but a diversity of firms will breed niche firms specializing or creating new products altogether. A diversity of heterogeneous suppliers further enhances this possibility. Conceptually, Porter’s model relies heavily on Jacobs’ earlier work The Economy of Cities where these ideas were first formally articulated.The basic elements of a successful cluster—inputs, outputs, related firms, and supporting institutions—can be enhanced through effective government.