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What are the main determinants of industrial location?

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Introduction

T H E E U R O P E A N S P A T I A L E C O N O M Y E C 5 5 5 What are the main determinants of industrial location? Introduction The last years have seen a strong increase in the study of industrial location and economic geography. The deepening economic integration within so called tax and customs unions such as the European Union has fuelled new interest in the field of industrial location. The fact that industrial production has a tendency to agglomerate in central regions has been a major concern to policy makers not just within the EU. Recent findings by researchers such as Fujita, Krugman and Venables (1999) identifying new modelling tricks to compare industrial organizations, international trade and economic growth more accurately has led to an increasing number of studies being conducted. The Three Main Schools of Industrial location Developments of the theory of industrial location can be tracked down by following the evolution of the three main schools of thought as outlined below. For a tabular illustration, please refer to the Appendix. One of the first studies of trade and location is Ricardo's classical theory of comparative advantage (1817), which was later on linked with the Heckscher-Ohlin (H-O) model. The H-O model predicts that the patterns of trade between countries are based on the characteristics of the countries. The H-O model says that a capital-abundant country will export the capital-intensive good while the labour-abundant country will export the labour-intensive good. ...read more.

Middle

in turn determines profitability of firms. Depending on the starting point, they either predict convergence or divergence. At high values of T it is most profitable to produce in both locations, leading to divergence. At low levels of T, production will tend to locate in a single location (the core). Bifurcation Core Periphery Model In view of the multiple outcomes which can be accommodated in this theoretical framework, empirical evidence is limited. In these models, agglomeration mechanisms are confronted with increases in the prices of the immobile factors. The outcome may be high agglomeration levels resulting in the centre-periphery structure, which in turn lead to higher economic integration. The new economic geography literature extends this line of research by showing that international or inter-regional demand differences are themselves likely to be endogenous - either because of mobility of workers (Krugman, 1991) or because of mobility of firms which demand intermediate goods (Venables, 1996). In industries, which are linked through an input-output structure, the downstream industry will form the market for upstream firms. The home-market effect1 then means that upstream firms are drawn to locations where there are relatively many. In addition to this demand (or backward) linkage there may also be a cost (or forward) linkage. Having a larger number of up-stream firms in a location benefits downstream firms who obtain their intermediate goods more cheaply - by saving transport costs, and perhaps also benefiting from a larger variety of differentiated inputs or more intense competition in the upstream industry. ...read more.

Conclusion

In the second part we have seen that in theory firms should only be competing on comparative advantage, once trade barriers have been removed. However, continuing integration means that at intermediate levels of transportation cost, geographical advantage becomes of strong importance leading to concentration of businesses. At high levels of transport cost, firms in custom-unions are likely to move to the periphery as the trade-off becomes more favourable. Towards the end of the essay we have seen that a number of industries that were initially spatially dispersed have become more concentrated on the periphery of the European union, especially in high technology 'footloose' industries in countries like Ireland. Appendix 1: Traditional Trade Theory New Trade theory New Economic Geography Market structure Perfect competition Monopolistic competition Monopolistic competition Plant level effects Generally constant returns to scale but with technological differences Natural resource endowments Factor endowments and intensities Generally increasing returns to scale Substitutability of differentiated goods Home market dominates Trade costs typically ignored IRS and pecuniary externalities (labour market, backward and forward linkages) Technological externalities Positive trade costs Industrial concentration Location of industry determined by endowments Inter-industry specialisation according to comparative advantage and H-O theory Unique equilibria Location of industry determined exogenously Inter- and intra-industry specialisation Unique equilibria Location of industry determined endogenously through labour market, backward and forward linkages and migration Tendency to centripetal agglomeration Inter- and intra-industry specialisation Multiple equilibria Trade Inter-industry Inter- and intra-industry Inter- and intra-industry Welfare effects of reducing trade barriers Net gain according to trade creation and trade diversion All countries gain Owners of scarce factors lose Net gains Large countries benefit more than small (i.e. ...read more.

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