Understanding the inputs into innovation: Do cities substitute for internal firm resources?

We examine whether there is a trade-off between employing internal (firm) resources and purchased external (local) resources in process innovation. We draw on a rich dataset of Internet investments by 86,879 US establishments to examine decisions to invest in advanced Internet technology. We show that the marginal contribution of internal resources is greater outside of a major urban area than inside one. Agglomeration is less important for firms with highly capable IT workers. When firms invest in innovative processes they act as if resources available in cities are partial substitutes for both establishment-level and firm-level internal resources.