The two sides of proximity in industrial clusters: The trade-off between process and product innovation

According to the literature on industrial districts, the proximity of small firms operating in a similar sector can lead to several positive externalities, which enhance collective efficiency. We investigate this assumption by building a microeconomic model in which a set of small firms trades off two opposite effects. First, the closer they are to each other, the more they can share fixed costs or pool risks, and the more they can innovate on more efficient processes. Second, the closer they are, the less diverse is their cognitive environment, and the less they innovate on products. We find that there is a "bell-shaped relationship" between proximity and the firms' performance. Moreover, equilibrium configurations tend to produce too much proximity from the consumers' and the workers' point of view, but too few proximity from the firms' point of view.