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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Specialisation and comparative advantages David Ricardo (1772-1823) 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

Autarchy vs. Trade in Ricardo’s analysis 25

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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