Executive summary

How do firms organize their activities and compete in the market economy? Individual producers have to make a series of complex and interrelated choices regarding what to produce, how much to produce, what technology to employ, how to organize their operations, and where to locate. When the structure of production within industries and across economies is examined, it is difficult not to be struck by the presence of considerable heterogeneity. The existence of heterogeneity acknowledges that firm-specific assets—management skills, organization, behavioral routines, size, knowledge, technology, and even location—are highly variable. Over much of the last two decades, evidence has been accumulated regarding the extent of firm heterogeneity and how the characteristics of individual business establishments shape their own performance and, in aggregate, the dynamics of industries and regions. In line with this work, a basic distinction can be drawn between those businesses that have the internal capacity to generate competitive advantage and those that seek advantage through co-location with others.

There is abundant evidence that many firms cluster together in space and that there is an association between clustering and productivity. This paper moves beyond identifying the broad effects of clustering and explores how different types of firms benefit from agglomeration. It advances research on agglomeration by showing, first, that not all firms gain from co-location and, second, that businesses with different internal capabilities capture different forms of geographical externalities.

For contrasting groups of firms, panel models are employed that regress firm-level labour productivity on firm-specific and place-specific characteristics. The place-specific characteristics represent varying types of agglomeration economies. In part, these economies may stem from (1) labour market pooling (local specialization in labour skills), (2) density of upstream suppliers (the development of localized buyer-supplier networks) and (3) knowledge spillovers (knowledge that spill across firms working in the same industry in the same location). The impacts of these externalities are compared across small and large plants, establishments that are part of multi-unit and foreign firms, and those that comprise single-plant firms. Also distinguished is how different economies of agglomeration benefit younger plants versus older plants, and how place-specific attributes influence the performance of plants born to incumbent firms vis-à-vis those born to new firms. The empirical analysis focuses on Canadian manufacturing establishments operating over the period from 1989 to 1999.

Dense concentrations of economic activity are generally seen as giving rise to increasing returns that may be shared by business units that cluster in space. Theories of the firm and of strategic management argue that competitive advantage originates in the development and exploitation of firm-specific assets or capabilities that may be internal or external to the firm. Older, larger, foreign-controlled, and multi-plant firms are anticipated to have greater internal resources upon which they might build advantage. Young, small, domestic, and single-plant businesses cannot draw upon these same resources and are more likely to develop strategies for survival that rest on place-based economies generated in particular locations. The analysis presented here is an attempt to identify the sources of these external resources and to examine whether they benefit all businesses or only some. It finds the following:

  1. Labour market pooling: The analysis shows that virtually all plants reap productivity benefits from being located in places where the occupational distribution of workers matches the demand for labour by occupation. However, these benefits tend to be larger for small and young businesses, which is consistent with these firms relying more on local labour markets to find workers with the skills that match their needs. Larger and older firms, while still relying on local pools of labour, may have developed the internal resources to find and attract workers from farther away.
  2. Knowledge spillovers: Knowledge spillovers, measured by own-industry plant counts within a radius of 5 kilometres, also generate productivity gains for plants, regardless of size or whether they are part of a single or multi-plant firm or are foreign owned. Younger establishments, however, which are expected to have less well developed capabilities to generate knowledge, rely more on local knowledge pools.
  3. Density of upstream suppliers: The local density of upstream suppliers does not benefit the firms that are expected to have few internal resources. Rather, older firms, regardless of size or complexity, derive the largest benefit from having upstream suppliers nearby. This is consistent with the argument that older firms are better able to exploit the advantages of local supplier networks, because their production processes are more standardized and, therefore, portions of which are more amenable to being outsourced to specialized suppliers.