Studies effects of spillovers, external economies or agglomeration economies on FDI location choice goes back to Alfred Marshall (1920). Agglomerations economic benefits that accrue to firms that locate in geographically concentrated areas or “clusters” (Smarzynska 2005) such asSilicon Valley. Several types of benefits can occur when firms collocate. First, geographically concentrated group of activities in a particular sector creates specialized skilled labor, which may lead to lower search firm and training costs.
Secondly, due to mobility of labor and social networks, companies can potentially get some knowledge of the patented technologies and processes of their competitors. At the same time, of course, companies also risk losing some of their own knowledge in this context. Third, specialized vendors are often located next to clusters, again, (Porter 1998) reducing costs of companies and firms to provide choices to make or buy decisions.
Fourthly, when clusters exist, firms and countries often make substantial investments in infrastructure such as roads, modernization of airports and the improvement of local universities. These features of industrial clusters create an environment in which firms can benefit, potentially greater than their direct costs.