ISSUE: Whether proximity to cluster of innovative firms causes spill over effect?

SPILL-OVER EFFECT: Firms become innovative because they are driven by competition. The “do or die” culture in the American market competition forces the management to always look for a better mouse trap. This is different from spill-over. Spill-over means that there is a core and peripheral regions of innovation. The peripheral would become innovative only because the core is innovative, i.e. through technology transfer (spill over). However, if we look at the Silicon Valley and, say, China the “distal” discourse would say that China is a periphery. However, the recent and current development in China points towards home grown innovation after years of non-innovations in the earlier period (19970s – 1980s). Israel is another good example of an economy driven by innovation. It is far from the so-called “core” and is in the middle of war-torn region, yet according to the World Economic Forum (WEF 2014) annual report, Israel ranks high in innovation. (See http://www.weforum.org/reports). The Soviet's Sputnik was innovative, "distal" would not be able to explain that event. Japan is considered an innovative and developed economies. If distal theory works, then other countries in the region, particularly the SEAN 10 countries (closer to Tokyo than to Palo Alto, Calif.)  would have done better in terms of economic development. However, these ASEAN countries, with exception of Singapore, still lack behind in innovation.

STATISTICAL FALLACY: Spatial correlation studies may be misleading. In conventional statistical causes, we learned that “correlation” is a measure of association, not causation. Although the Silicon Valley (Palo Alto and the Bay Area in California) has been touted as an innovative hub; however, what writers failed to reveal are the hundreds of start-up companies (equally innovative in their thinking in making new offerings), especially the so-called “dot.com” companies, that failed from the start or after a short running period. Many of these so-called innovative firms comprised of nothing more than a empty office and business plans. If on counts “innovation” just by business models or ideas, it would seem that there is overwhelming evidence that the “Bay Area & Silicon Valley” is a hot bed for innovation. However, other factors, other than distance, may provide clear picture.

OTHER EXPLANATORY FACTORS MAY HAVE BEEN OVERLOOKED:

Statistical analysis may have overlooked some factors that may be critical for nurturing innovation.

(i) Access to Capital: Sixty miles from the Silicon Valley lies the Financial District of San Francisco. This proximity to the source of capital makes the fruition of ideas more tangible. In the developing countries, access to capital does not come in handy. Thus, making the transformation of ideas into production becomes less a reality.

(ii) Infrastructure: the banking and legal structure of the US market is more receptive to business development. The establishing of a new company, i.e. company registration in the US takes less than an hour and cost less than $50. Opening a business bank account could be accomplished in less than 20 minutes. This accommodating infrastructure allows the transformation of ideas to reality more easier for businesses.

(iii) Culture of entrepreneurship: the US has a culture that value individual liberty. In business, this freedom means that individuals can readily express their creativity that would otherwise be hindered in less developed economies whose culture may not be as receptive to new ideas. Individualism, entrepreneurship and innovation are the key elements for business development. The market is also receptive to reward individual efforts and creation, i.e. copyrights, and patent laws favors individual creation and gives protection accordingly. This “protection” means money, i.e. royalty fees.

(iv) Tax treatment: the tax structure in the US is friendly to new businesses; The Federal Revenue Service (IRS), the tax department in the US, allows new businesses to operate an annual loss up to 5 consecutive years. In addition, the State of California, where the Silicon Valley is located, also has favorable tax treatment to new businesses. Small Business Administration (State and Federal) also provides loans and other financial facilities to new and small enterprises that would otherwise be denied credit by commercial banks because of their new or short running period.

(v) Education: The American education system aims to develop the individuals who would realize their potential in the market. Whereas in “many” developing countries, education may not be receptive to individual expression and creativity. For this reason, the “graduates = employees” are the salary earners more than “workers-thinkers-creators.”

These 5 aspects are some of the factors that innovation studies should look at. This list is not exhausted. There may be other factors that explain the innovation among American firms, i.e. incentive-based compensation for innovative ideas, etc.

Dear Silburn,

As you know forever there is a lag between knowledge creation and its circulation and the proximity affect to the firm knowledge from informal communication and have a lag  threshold to be like a spillovers. As Chang-Yang Lee mentioned the net increase in technological knowledge changes its direction at the threshold, and hence, firm growth bifurcates at the threshold: Below the threshold the rate of firm growth is negative with its magnitude increasing with firm age; Above the threshold, in contrast, firm growth is sustained with the rate of growth increasing either at a diminishing rate, showing a less-than-proportionate growth–age relationship, or at an increasing rate , showing an exponential (i.e., more-than-proportionate) growth pattern. 

Appreciate the comprehensive response Paul,

Although Palo Alto was mentioned it was merely an exemplar. In reality I would expect that there would be multiple global centres of knowledge and innovation.  And so for instance, the work by the Chinese R&D scientists on solar PV would be expected to enable their firms to dominate that market.  Similarly, with the Iserali  cutting edge work in the software and electronics arena.

Great insights.

Thanks Eshan,  

Would love to learn morre about the Chang-Yang Lee reference