0. George Horváth Department of Environmental Economics george@eik.bme.hu
Regional Economics
George Horváth
Department of Environmental Economics

1. The theory of regional development (regional macroeconomics)
So far we have generally looked at the location and behaviour of microeconomic actors in space.
Even when these formed a part of a system (such as in the Theory of Central Places), their behaviours could be explained using the toolkit of microeconomics.
Hereon, we will look at the development of whole regions and the factors that contribute to this. This is known as the macroeconomics of regional economics.
But what exactly are regions? 1

2. Regions – homogenous regions
Homogenous regions are smaller territories which, together with their neighbours constitute a larger territory, and which share similar properties (geographic, economic, historical, political, etc.)
Advantages: we can investigate and research the effects of government interventions.
Disadvantages: the homogenous traits may disappear over time, and the region may not be functional as a unit of government 2

3. Regions – functional or nodal regions
Functional or nodal regions usually comprise a large city and their wider environs
Advantages: it is ‘self-contained’, the city and rural areas complement each other, its internal cohesion is strong, suitable as an administrative unit, it can carry out functions efficiently
Disadvantage: tensions and problems may arise between city and rural countryside 3

4. Regions – planning or programming regions
Planning regions need to conform to some requirements:
Adequate size and scale
Ideally, resultant regions should be of equal size
They should be created by joining together previously existing smaller regions (no splitting allowed)
All required data should be available
Region must fall under the management of a single directing authority (which does not have to be a government administrative unit) 4

5. Theories of regional economic growth
There is a distinction between regional development and regional growth.
Regional development is a broader context, while regional growth is a much narrower one, but only this latter one can be quantified.
Quantification can be done by several methods
Theory of Phases of Development
Structural analyses (shift-share analyses)
Centre-periphery analyses
Export base model
Importing region model (Harrod-Domar model) 5

6. Theory of Phases of Development
Developed by J. G. Williamson
As regions go through various stages of development, their economies grow and the regions become richer. He noticed that regional economic development starts at the centre of the region.
Therefore, differences within and between regions first increase, and then they decrease.
Development in some remote areas only begins after reaching a certain level of national development. 6

7. Reasons for growing differences
Better-trained workers will move from less developed to more developed
Capital investments are generally made in the more developed areas (since demand is greater, infrastructure and services are better)
State investments are also more likely to happen in more developed regions
Limited inter-regional trade, which means that richer regions will not have development effects on poorer regions 7

8. Phases of development
Autarchy: consumption of locally produced goods is dominant
Specialisation: as soon as transportation networks are established, regions will specialise in producing certain goods
Transformation: agriculture is superseded by industry
Diversification: development of the industry provides a more diverse economic structure and specialised skills
Tertierisation: services become the dominant driving force ahead of agriculture and industry in providing jobs and goods 8

9. Critiques of the phases of development
The increase in differences in development between and within regions is always certain, whether other areas catch up with the centre is more uncertain.
We need additional measures to overcome differences:
Job creation in less developed regions
Shifting of state development programmes to poorer areas
More developed regions will get saturated, their costs will increase and its advantages will gradually turn into disadvantages
Richer regions need to be encouraged to help develop poorer regions 9

10. Structural (shift-share) analyses
A region’s development is largely defined by its economic structure, the share of sectors (agriculture, industry, services) in employment and in GDP.
The dynamics of a sector may be different between regions, as a consequence of demand, particularities and differences in productivity.
We need to differentiate between growth effects arising from structural and other factors. 10

11. MIX and DIF effects
MIX effects are those that arise from the composition of the economy (or the ‘mix’ of sectors) in the region
DIF effects are those arising from differences in competitiveness
If E denotes the employment in a sector/region, i is the industry (sector), n denotes the country and r denotes the region, then 11

12. What this tells us
MIX shows us how quickly (or slowly) an industry i is growing compared to the national economic growth, multiplied by the share of that industry in the regional economy.
This is called a MIX effect.
DIF shows us how quickly an industry i is growing in a region compared to the national growth rate, multiplied by the share of that industry in the regional economy.
This is what we call competitveness or differential effects. 12

13. Representing findings
Shift-Share analyses may be represented in a coordinate system, where national data are represented on the X-axis, and regional data on the Y-axis.
Each industry will be marked by a dot, showing national and regional growth rates.
A straight line at a 45° angle shows the deviance between national and regional data. 13

14. Graphic representation
Regional sectoral growth rate
Average regional growth rate
National sectoral growth rate
Sectors in crisis
Dynamic sectors
Average national growth rate D A B E C F G 14

15. Centre-Periphery approach
The Centre-Periphery approach takes the distance from the centre as a factor of development.
This method was first applied by Walter Isard, the creator of regional economics.
His observations are correct, as development is hindered by the greater transportation costs of final and intermediate products on the peripheries.
The Centre-Periphery approach can be applied well to Europe, where such a centre does exist, in a pentagon bounded by London-Hamburg-Munich-Milan-Paris.
This central area covers 15% of Europe’s territory, houses 35% of Europeans, and produces 55% of Europe’s GDP.
This model is poorly applicable to other countries (e.g.: the United States), where the peripheries are more developed, and the centre is largely underdeveloped. 15

16. Other approaches: export based models
Generally, these methods focus on the (export) demand for a region’s products.
A small country or region cannot develop every industry, therefore they must become a part of the international system of division of labour.
This external demand is what drives the dynamics of growth.
The region must be able to produce a specialised product which can be exported. 16

17. Other approaches: Homer Hoyt’s model
In 1930, Homer Hoyt was commissioned by the United States Federal Housing Administration to devise a simple model which can predict population growth in large cities.
According to Hoyt, the working population (Lt) of a city consists of two groups:
A base population Lb producing goods for export
A population Ls providing goods and services to the whole domestic population
The population providing services can be expressed as a fraction of the total population: Ls = a Lt
Total working population
Total population as a multiple of working population 17

18. Harrod-Domar model of importing regions
An underdeveloped region will not be able to export at first: it will have to import, defining its development trajectory.
Capital imports are the driving force behind growth: yi = s/v , where s is the proportion of savings, and v is the ratio of capital needed for the creation of an additional unit of wealth
In the beginning, a lot of capital investments are needed, which decrease later on.
An equivalent s may induce different rates of growth based on the capital intensity of the investment.
It maintains a better balance than export does, provided that ultimately the importing region also becomes an exporting region (after a while, at least) 18

19. Resource endowment and regional growth
Previously we’ve considered exports to be the driving force behind economic growth.
What do exports and export potentials arise from?
An exporting state is endowed with better or cheaper factors of production than an importing state.
An export-based growth depends on a sufficient quantity and quality of production factors.
Exports may consist of
Factors of production (capital and labour) exported
Products are exported (theory of international trade, Ricardo and Heckscher & Ohlin) 19

20. Neoclassical model of flow of resources
We will now consider a single sector: there is only one product and one perfect market.
The factors of production (capital and labour) are also exchanged on a perfect market, i.e. they are completely exploited and are priced at marginal values.
Products and factors of production are perfectly mobile
If there exists a poorer and a richer region, with the richer region posessing more capital, and the poorer one more labour…
…the outcome will be optimal if some of the workers in the poorer region migrate to the richer region, and the surplus capital moves to the poorer region.
This exchange contributes to the greater efficiency and increased incomes in both regions 20

21. 21 Graphically Capital Poor region Rich region – capital + capital
– labour
at first
Poor region
– capital
+ labour
at first
Labour 21

22. The model in practice
Contrary to the theoretical model, experience shows us that both capital and labour will flow in the same direction.
Two-sector model: both regions have two sectors, e.g. industry and agriculture. One produces for export, the other for domestic consumption. Capital is only used by the industrial sector.
Hypothesis: the external demand for one region’s industrial products will increase
The demand for labour will also increase. The industrial sector’s growth will trigger an increased demand for agriculture in this region. 22

23. Graphically
Capital
Region where demand for exported goods increased
Poor region
Labour 23

24. Specialisation and comparative advantages
David Ricardo ( ) formulates the theory of comparative advantages. Free competition is idealised, the system of tariffs is debated in England.
Division of labour is mutually beneficial for all parties.
A pre-requisite of division of labour is that everybody produces where their comparative advantages are greater, or disadvantages smaller.
Example: England and Portugal 24

25. Autarchy vs. Trade in Ricardo’s analysis25

26. Criticism of theory of comparative advantages
There are sectors which grow dynamically, and there are sectors which grow more slowly, or not at all.
If a region has a comparative advantage in a stagnating or slowly growing sector, it will develop more slowly and lag behind.
It isn’t only labour that defines comparative advantages.
The spatial dimension is completely absent from this theory. 26

27. Heckscher-Ohlin Model
Comparative advantages are determined by the relative endowment of factors of production.
These differences are counteracted by foreign trade, and not by migration.
As prices of factors of production come to an equilibrium, differences in development are reduced.
The model is only partially backed up by real-life evidence: a number of countries show very different trajectories.
Leontieff-paradox: the export and import trends in the United States do not behave like the model suggests it. Instead of exporting capital-intensive goods, the US exports labour-intensive goods.
Trade between the Italian North and South also does not back up this model. 27

28. Theory and spatial effects of customs unions
Customs unions break down economic and institutional obstacles between countries and regions, therefore they have positive economic effects:
Competition between markets increases.
Economies of scale achieved in production and on markets.
Additional investments in anticipation of growing demand
Greater variety of products
Technology and knowledge transfer to poorer regions
All but the last effect benefit more developed regions.
New stores and shopping centres are established by developed countries.
Increased trade in border regions and capital area only.
Shopping centres do not generate new demand, but funnel existing demand away from local producers and vendors 28

29. Theory of Poles of Growth
So far we supposed that regions were homogenous internally, i.e. the whole region has the same properties internally
In the following models, regions are diverse internally too
Internal development of regions is affected by:
Exogenous factors, e.g.:
a large multinational company appears,
technology transfer to the region,
large-scale infrastructure development by outside decision
Endogenous factors, e.g.:
the willingness to enterprise,
availability of factors of production (capital and labour),
willingness and ability to study, firm local governance.
These collectively form the conditions of Poles of Growth 29

30. Theory of Poles of Growth
This model was first formulated by François Perroux in 1955.
He observed that development didn’t occur simultaneously everywhere.
First, it occurs in nodes or poles with varying intensity, and then it is channeled outward to the rest of the economy, causing various effects.
Essentially, the theory of local economies arose at the same time as the theory of Poles of Growth. 30

31. What sort of poles might there be?
There exists a dominant company, which triggers development, and causes certain effects:
Keynesian multiplicator effect, through the workers and the consumption of the increased number of workers.
Leontieff multiplicator effect, through intersectoral relations
Accelerator effect, through additional investments
Polarising effect, through new plants established or moved nearer the pole 31

32. From Perroux to Boudeville
According to Perroux, multiplicator effects propagate through sectoral input/output connections, and may spread over large distances.
His student, Jacques-Robert Boudeville developed Perroux’s model to a theory of space.
According to Boudeville, propagating effects can be
Effects within the factory/plant and the immediate cluster surrounding it
Effects in the city where the company generating the driving force is
Effects in the closest local economy
Boudeville’s most important finding was that propagating effects don’t need sectoral input/output connections. Geographic proximity can have an effect in numerous other ways (including education, aid, assistance, cooperation, joint institutions, etc.) 32

33. The multiplier effect
Catering for each new factory worker and their family at the factory and their homes generates m new jobs (m < 1).
The sum of propagating multiplier effects is 1 + m + m2 + m3 … + mn ….∞ = 1/1-m
Local multiplier Lm will be dependent on how much of the demand will be satisfied locally or from the vicinity.
It is also possible that the development of a nearby city has more influence on the development of our own city, as the nearby city may have a greater regional multiplier.
Correctly choosing poles of growth is therefore crucial.
Perroux has made a distinction between push and pull effects.
Hirschman and Myrdal described spread and backwash effects. 33

34. Spread and Backwash effects
Positive spread effects
time
Negative backwash effects
time
Net spillover effects
time 34

35. The spread of innovation in space
In the beginning, researchers took it for granted that innovation is uniformly and simultaneously available for everybody.
Instead, Torsten Hägerstrand reviewed this claim, and found that innovations spread, in certain directions, at a certain pace.
According to Hägerstrand, three phases of spread exist:
Adoption, when innovation spreads out from the core city along the network hierarchy of cities (see: Christaller’s model)
Diffusion, when innovations already go beyond the network hierarchy, and spread out in space (i.e. to smaller towns and settlements between the cities)
Saturation, when an innovation can be found everywhere.
These effects are called „spread along geographic space” 35

36. The spread of innovation in space
Total number of users
Saturation point
Innovation, discovery
Time 36

37. The spread of innovation in space
Zvi Griliches & Edwin Mansfield: economic distance
Innovations do not propagate at the same speed in every region.
The speed of propagation depends on the number, density, preparedness and receiving capalbility of potential users.
Examples:
Hybrid cereals – propagation depends on geographic distance
Mobile phones – propagation depends on socio-economic factors, rather than geographic factors 37

38. Alfred Marshall’s industrial districts
In the previous models, space and location were important factors of production, but they did not predestine the fate and economic performance of an enterprise.
In his work “The Principles of Economy” (1890), Alfred Marshall writes about industrial districts having more of an effect on the performance of corporations than other factors of production, including raw materials and labour force. 38

39. Alfred Marshall’s industrial districts
An industrial district is a concentration of small businesses in a given location, which have very important social connections.
Properties:
Spatial proximity, geographic continuity
Social proximity: institutions, codes and practices, rules are homogenous throughout the area, which triggers cooperation
Concentration of small firms, which are capable of speedy adaptation to changing conditions and demands
Such areas are known today as clusters. 39

40. Benefits of district economies
Lower production costs: intermediate products, parts, etc. do not need to be transported, work force is more flexible and adaptable
Lower transaction costs: management and organisation is much simpler because of the shared values
Higher efficiency of factors of production
Example: Northeastern Italy’s Veneto and Emilia-Romagna regions 40

41. Myrdal and Kaldor’s circular processes
Gunnar Myrdal and Nicholas Kaldor worked on a new model of regional development.
According to them, economic processes are self-enforcing, cyclical events, regardless of being positive or negative.
There are virtuous circles and vicious circles.
Virtuous circles are driven by increasing returns to scale (compare this to the mainstream concept of diminishing returns to scale)
The other driving force behind virtuous circles is the accelerator effect. 41

42. Myrdal and Kaldor’s circular processes
Gunnar Myrdal and Nicholas Kaldor worked on a new model of regional development.
According to them, economic processes are self-enforcing, cyclical events, regardless of being positive or negative.
There are virtuous circles and vicious circles.
Virtuous circles are driven by increasing returns to scale (compare this to the mainstream concept of diminishing returns to scale)
The other driving force behind virtuous circles is the accelerator effect. 42

43. Paul Krugman’s New Economic Geography
Towards the end of the 20th Century, the geographic dimension of the economy was fading from view
Paul Krugman’s greatest merit is the bringback of the economic dimension into mainstream economics.
Krugman’s works had a profound and detrimental effect on the one-point economy that was (and still is) dominant in economics.
His starting points were the same as Weber’s.
He began investigating factors of production in light of transportation, work force and economies of scale, but he comes to a radically different conclusion than Weber does. 43

44. Paul Krugman’s New Economic Geography
To start out, he rejects the principle of diminishing returns in the case of economic concentration: let us not forget that the entire classical economic theory rested on this principle.
Why does the principle of diminishing returns not hold in larger agglomerations?
Weber and Lösch’s theorems on having to serve increasingly distant consumers with ever increasing transportation costs do not hold, because as production concentrates, so do consumers.
Transportation costs do not increase (as dramatically) because of the improving transportation technology and the information revolution
Large agglomerations permit mutual specialisation of economic activities, strong interdependences form, and a dramatic increase is achieved in efficiency.
The use of tacit knowledge is only possible in geographic proximity. 44

45. Paul Krugman’s New Economic Geography
According to Krugman, failing to start development in time has permanent detrimental effect on late starters.
He found that if a progression towards greater concentration and efficiency begins in a point in space, this will be unstoppable, and this will present an advantage (and a disadvantage for competitors, who will not be able to catch up with it).
This sends a very pessimistic message to developing regions. 45