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This paper examines the influence of internal and external knowledge on innovation activities of subsidiaries of multinational firms in an emerging market. We argue that many subsidiaries are under pressure to upgrade from manufacturing hubs to centers of innovation. Subsidiaries respond to this pressure by taking advantage of internal and external knowledge resources in the host country. Further, the relationship between these knowledge network resources and a subsidiary's innovation activity depends on the local market orientation of the subsidiary. The empirical test uses data on innovation activities of foreign subsidiaries and social-economic factors in Chinese cities from 1998 to 2005.