This study explores the relationship between spatial agglomeration and innovation, taking Chinese manufacturing data as an example. Tractable model is built to explain the mechanism through which spatial concentration of firms in a city affects industrial innovation. Then in the empirical analysis, new agglomeration and innovation indicators are used to test the theoretical conclusions at the city-industry level. Results show that the geographical concentration of firms has significant negative effects on industrial innovation and growth. These overall effects can be divided into positive and negative categories after considering the interaction between the industrial labor scale and firm’s spatial agglomeration. Industries with a higher labor scale will bear more crowding effects of firms’ spatial agglomeration. These findings mean that moving to a less concentrated area might be a good choice for the labor-intensive firms which aim at innovation.

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