AGGLOMERATION ECONOMIES AND EXTERNAL EFFECTS

Many of the theories that concern clusters of innovative activity focus on external effects and the resulting agglomeration economies. A local external effect is anything that raises the return to particular firms located in a region as a result of the location of other firms in the same region. External effects can be direct, as when managers or technologists learn about market or technical developments from colleagues in neighboring firms, when firms in closely related industries serve as one another's customers or suppliers, and so on. External effects can also be indirect, as when key inputs are in abundant supply or when the overall level of commercial technology activity is high. These indirect external effects arise from increasing returns to scale in the supply of key inputs such as venture capital, which may locate where entrepreneurship is dense but support the development of new entrepreneurial firms; a thick labor market in technical personnel; or commercially oriented activities in universities or national laboratories, to name just a few. Both direct and indirect external effects generate positive feedback loops that insure that technology-related firms locate in regions where other technology firms are already located.

These external effects have (at least) two distinct implications for welfare. One implication is for economic growth, both within a region and to the broader economy. External effects among innovative firms inventing general-purpose technologies are highly leveraged mechanisms for increasing the rate of growth of an overall economy.