Foreign investment and development of firms within clusters creates higher levels of learning and adaptation for domestic firms. According to a study of intra-industry knowledge spillovers in the Review of Development Economics, the R&D stock of foreign-owned firms had a positive impact on the productivity of domestic firms within the same industry creating significant knowledge spillovers that led to faster adaptation (Todo, Zhang, & Peking, 2011). Encouraging foreign R&D investment can improve local growth through the creation of a greater product knowledge.
The study used firm-level panel data from a Chinese science park, known locally as China's "Silicon Valley". What they found was that R&D activities of foreign investment had a significant impact on the innovative abilities of domestic firms through knowledge sharing. Local firms quickly adjusted and changed after introduction to new technologies and information.
The process is similar among domestic firms, but doesn't create as much adaptation as compared to when highly developed companies invest in the area. It is a little like playing "catch up" after a student has fallen behind. The new international knowledge drastically changes the playing field for local firms that need new ideas and information to compete.
Firms don't operate in isolation but share information through the hiring and movement of employees, working with suppliers, and obtaining needed resources. Knowledge transferred from more advanced firms, to less advanced firms, in a way that increased productivity through innovative development.
When administrators foster cluster creation, it is helpful to consider attracting foreign firms, specifically firms with advanced technologies, into the cluster to keep local firms growing and changing. While it is helpful to attract firms in the same industry, it is also beneficial to attract firms in similar industries that share related products and knowledge.
The study originated in China but does highlight the need to encourage foreign investment as an important catalyst for local cluster growth. Attracting national and international firms into a cluster with varying degrees of sophistication can lead to growth for related industries that share similarities. There is an inherent value for firms to move their operations into a cluster in order to maintain their competitive offerings, while those that do not, may be limited by a lack of knowledge sharing.
Todo, Y., Zhange, W. & Zhou, L. (2011). Intra-industry knowledge spillovers from foreign direct investment in research and development: evidence from China's 'silicon valley'. Review of Development Economics, 15, (3).