Industry localization, distance decay, and knowledge spillovers: Following the patent paper trail

This paper investigates Alfred Marshall’s hypothesis that knowledge spillovers increase where industries are localized. At the same time, we take a fresh look at the role of distance in the diffusion of knowledge spillovers. Relying on a cited-citing gravity-like equation with high-dimensional fixed effects that control for multiple sources of observed and non-observed heterogeneity, we implement a Poisson pseudo-maximum-likelihood (PPML) estimator. We find that knowledge spillovers correlate positively with industry localization and that the agglomeration of an industry can offset the adverse effect of distance. The results also corroborate the distance decay effect uncovered in earlier research. Our new approach to estimate the PPML with two high-dimensional fixed effects should prove valuable in applications to a variety of other problems in economics, such as the estimation of gravity equations widely used in modeling migration, trade and other flows among countries and regions.