# **1. Introduction**

Innovation undertaken by firms is regarded as a significant contributor to long-term economic growth in both theory and in practice (see, for example, Romer 1986). One issue that has attracted considerable attention of researchers is on the geographical distribution of firmlevel innovation within countries. A large body of evidence from the developed world shows that innovative activities, such as R&D and patenting tend to be more concentrated spatially than production. This pattern has raised various questions, such as whether urban agglomerations play a special role in fostering innovation by firms, and if so, what channels are at work. While evidence on these questions is growing, most of it has been obtained from the developed world. For developing countries, there is a lack of systematic evidence on the spatial distribution of firms’ innovation-related activities and whether and how urban agglomeration affects innovation.<sup>2</sup> This paper attempts to fill this gap by utilizing geo-referenced firm-level data from World Bank Enterprise Surveys (WBES) conducted in 25 developing Asian economies from 2012 to 2016 and a recently developed dataset that uses nighttime lights (NTL) imagery to consistently measure city boundaries across Asia (Jiang, 2021). In addition to production related data, the WBES collects information on firms’ innovation related activities—specifically, whether surveyed firms introduced any product and process innovations and invested in research and development (R&D). As regards our city-level dataset, its urban units are referred to as “natural cities” to distinguish them from administratively defined cities. In comparison with the latter, natural cities are consistently defined and measured across countries. They are also more likely to capture the actual economic “footprint” of a city than its administrative boundaries would suggest. By mapping WBES firms onto the natural city dataset, the relationship between firm innovation and urban agglomeration in developing Asia can be examined. Further, an international ranking of universities and academic disciplines or major fields of study is utilized to investigate whether the presence of high-quality universities has any bearing on firm innovation.

This paper finds that innovative activity by firms is concentrated spatially within several large Asian countries. The share of firms that innovate in just a few cities is substantially greater than the share of urban population these cities account for. Further, the data shows that the population size of a natural city is strongly correlated with the propensity of firms in the city to engage in innovative activities. Specifically, the estimates suggest that larger city size is significantly associated with increases in the propensity of firms to introduce product and process innovations and undertake R&D. A doubling of city size is associated with increases in firms’ propensity to engage in product innovation, process innovation, and R&D by 4.3, 3.7, and 2.8 percentage points, respectively, or by 13.5%, 8.5%, and 14.3% against the respective benchmark propensities. Since the biggest natural city is much larger than the smallest one in the data, the effects of agglomeration on firm innovation can be quite large.

> 2 Most research from the developing world focuses on agglomeration effects concerning labor and firm productivity. Duranton (2008), Overman and Venables (2005), Henderson (2005), and Duranton (2014) provided detailed review of this research.

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