How does location affect growth?

This article builds an understanding of regional innovation specialisation by developing a multi-sector model with endogenous growth through quality improving innovations and spillovers from related technologies. The model provides an approach to incorporate the relatedness literature within the mainstream theoretical frameworks of endogenous growth and economic geography. Each firm’s technology sector and the location of other firms play a role in each firm’s ability to improve its own technology. As a result, firms prefer to co-locate in technologically compatible clusters. Without relying on scale assumptions, the model for the first time coherently links related variety knowledge spillovers to mainstream urban economic frameworks and demonstrates that clustering is possible in both core and peripheral areas.

In this paper we model growth using a scale-neutral approach to innovation allowing differences between regions to emerge due to regional mechanisms. In this model, agglomeration is growth enhancing as the scale effect for innovation arises from greater access to knowledge rather than any assumed scale effects in growth-modelling techniques. Furthermore, entrepreneurs are assumed to choose the location of firms endogenously so as to minimize the costs of innovation, transport and living. The effects of such mechanisms are such that any policies that increase knowledge spillovers between locations will enhance growth and equality, but may be destabilizing for agglomeration.

We describe how endogenous growth theory has now incorporated spatial factors. We also derive some of the policy implications of this new theory for growth and economic integration. We start by reviewing the product variety model of endogenous growth and discuss similarities with modeling techniques in the new economic geography. Both use Dixit- Stiglitz competition. Increasing returns provide an incentive for innovation in endogenous growth theory, and in combination with transport costs, increasing returns provide an incentive for firm location decisions in the new economic geography. Since innovation is the engine of growth in endogenous growth models and knowledge spillovers are a key input to innovation production, we also explore how innovation and knowledge have distinctly spatial characteristics. These modeling similarities and the spatial nature of knowledge spillovers have led to space being incorporated into the theory of endogenous growth. We guide the reader through how space is modeled in endogenous growth theory via the new economic geography. Growth by innovation is a force for agglomeration. When space is included, growth is enhanced by agglomeration because of the presence of localized technology spillovers. We consider the many other spatial factors included in models of space and growth. We explore the spatial effects on economic growth demonstrated by these theoretical models. Lastly, we consider policy implications for integration beyond lowering trade costs and discuss how lowering the cost of trading knowledge is a stabilizing force and is growth enhancing.