The Percolation of Knowledge across Space

This paper sheds new light on the negative effect of spatial distance on knowledge flows. We show that it is rooted in the dynamics of the innovation network formation over firms' life-cycles: young and small firms have contacts near them, and progressively expand their network. Using patent citations, we show that knowledge percolates: firms disproportionately cite new patents from prior contacts, and form links with contacts of their contacts. A network formation model that builds on these facts yields two predictions which are met in the data: firm sizes follow a Pareto distribution, and larger firms cite further away. Combining these two facts naturally explains an effect of distance and implies that small firms are its main contributors.