Smaller tech companies promote greater innovation in cities

Amazon? Google? Microsoft? No, courting big tech giants may not be a good idea for cities hoping to become tech hubs, according to a recent study by the Complexity Science Hub Vienna and the London School of Economics.

Foreign investments are important contributors to the emergence of technology hotspots around the globe. However, bigger isn’t always better when it comes to fostering local cutting-edge technology. A study published in the journal Economic Geography reveals that small multinationals stimulate more local innovation and growth because they generate greater knowledge spillovers than big tech giants.

“Contrary to much of received wisdom, technology leaders are not the main contributors to local innovation capabilities,” say CSH scientist Frank Neffke, and colleagues Riccardo Crescenzi and Arnaud Dyèvre from the London School of Economics.

“For the most innovative multinational companies, the risk of leaking knowledge to local competitors often outweighs the benefits of learning from those same competitors, thus reducing the incentives of ‘highly innovative multinationals’ to embed themselves fully into the local innovation system,” the authors explain in a blog post.

“Top-ranking multinationals engage in fewer local alliances than second-tier multinationals— those outside the top 5 percent of innovating firms,” Frank points out. “Technology leaders rely less on local labor markets and more on internal transfers of employees. They also go to less developed regions with lower absorptive capacity.”

Patents and socioeconomic information

The team used data from the United States Patent and Trademark Office, covering patenting activity in virtually all countries of the world for nearly four decades. To determine whether or not foreign firms help kick-start innovation processes in the places where they invest in research, the authors looked at all regions that record their first patent created by a multinational company. Next, they compared these regions to areas with similar socioeconomic characteristics, such as having the same level of education and per capita income, but that did not attract foreign research activities.

The study shows that the arrival of tech companies helps promote local innovation. Within five years of the multinational’s arrival, on average, the region’s patenting output rose 14 points on a 100-point scale that ranks all regions in the world by their innovation output, compared to statistically similar regions without such foreign research activities.

This average effect, however, hides considerable heterogeneity across foreign investing firms, according to the authors. It turns out that technology leaders, while attracting other foreign companies to the region, do not boost innovation by local firms at all. “In fact, the spillovers to the local economy are exclusively generated by somewhat less prominent tech companies”, says Frank, who’s an expert in economic transformation and growth and leads the research program Science of Cities at CSH.

Lessons for policymakers

Frank and his colleagues note that the paper offers a number of important lessons for public policy aimed at increasing a local economy’s innovation capacity. First, it may make sense to not overly focus on the largest players when it comes to attracting foreign investments. On the contrary, smaller tech companies may generate more benefits for the local economy than superstars. “Second, it is crucial that foreign research activities become embedded in the local economy. Policymakers can help here,” Frank explains.

“For instance, regions can (co-)invest in skills and technological capabilities by supporting universities and research centers to reduce the gap between the availability of skills and technology in the region and the requirements of foreign firms,” say the authors of the paper. Moreover, introducing policies that promote knowledge transfers, such as workforce training and local sourcing agreements, can play an important role in maximizing the benefits of foreign investments.

Learn more about the study in the blog post “Making foreign direct investment work for innovation clusters.”

The article “Innovation catalysts: How multinationals reshape the global geography of innovation”, by Riccardo Crescenzi, Arnaud Dyèvre and Frank Neffke appeared in Economic Geography.