Agglomeration, catch-up and the liability of foreignness in emerging economies

Given the importance of location choice for accessing knowledge, we examine the location choices of domestic and foreign firms in an emerging economy after market liberalization. In the literature, co-locating with other firms has been associated with agglomerative economies and knowledge spillovers that lower the liability of foreignness for foreign firms. However, as domestic firms are trying to upgrade their capabilities, or “catch up,” they may also prefer locations with other firms, as these locations have knowledge spillover potential. We develop competing hypotheses to test the extent to which catch-up motivations affect location decisions. Examining the location choices of 501 domestic and 68 foreign firms for their R&D laboratories in India during 2005–2010, we find that domestic firms exhibit a stronger preference for cities with high agglomeration than foreign firms do. This shows that upgrading motivations dominate location choice during periods of accelerated catch-up in emerging economies.