Regional Economics, Theories of local development (Diversified relational space) - Part 3

Regional economics: Part III - Theories of local development: Diversified-relational space

Chapter 7. Territorial competitiveness and exogenous development

7.1. Diversified space: The components of territorial competitiveness

Study of regional development change in the conception of space which now is diversified. In a region now we have spatial heterogeneity of economic activities, production factors, demand, and sectorial structure. — New territorial relations that allow identification of highly distinct polarities, all the activities structured around these polarities generate a cumulative process of territorial agglomeration and a virtuous circle of development!

Inspiring principle of agglomeration economies as source of local development — Now applied on regional development! (Cambio naturale delle teorie che passano da macro a micro behavioural and micro territorial.)

Individual economic actors' behaviour is studied in relation to location choices, productive and innovative capacity, competitiveness, and relations with local systems and the rest of the world. Period: Mid-1970s. The theories analysed in this chapter resemble those discussed in the previous one in that they conceive development as a process generated and sustained by supply-side elements. But development is no more seen on a short-run view, but assumes a longer-term perspective.

They identified all the tangible and intangible elements in a local area that determine its long-term competitiveness and enable it to maintain that competitiveness over time. The theories analysed here try to identify the factors that render the costs and prices of production processes lower than they are elsewhere. These factors are:

• Exogenous elements to the local context: which originate externally to the area and are transferred into it either fortuitously or deliberately. Exogenous elements that may catalyse new economic activities and development are:
  • The fortuitous local presence of a dominant firm or a multinational company
  • The diffusion in an area of an innovation produced elsewhere
  • The installation of new infrastructures decided by external authorities
• Endogenous elements to the local context: which arise and develop within the area and enable it to initiate a process of self-propelling development. Endogenous elements are:
  • Entrepreneurial ability and local resources for production (labour and capital)
  • The decision-making capacity of local economic and social actors able to control the development process, support it during transformation and innovation phases, and enrich it with external knowledge and information.

All these factors generate local processes of knowledge acquisition and learning; networks of economic and social relations that support more efficient and less costly transactions; and advantages of economic and physical proximity among economic actors.

7.2. The growth-pole theory

7.2.1. The economic approach: Perroux’s contribution

1955 - François Perroux: The growth-pole theory first abandoned the notion of uniform-abstract space to conceive of a diversified relational space. “Development does not appear everywhere at the same time: it becomes manifest at points or poles of developments, with variable intensity; it spreads through different channels, with various final effects on the whole of the economy.”

Perroux formulated a theory of local development that envisaged selective growth at certain points in space where a “propulsive unit” triggered the development process. Perroux identified this element as a fortuitous presence in the area of a dominant firm, which he called the industrie motrice owing to its capacity to influence through its investment decision the levels of investment undertaken by the firms connected with it. This industrie motrice responds to the needs of an external market (influence of the export-base model).

Thanks to its dominant position in the sector and in the economy, the industrie motrice generates a series of positive effects on the sector to which it belongs and on the economy as a whole. A technological innovation by the dominant firm that reduces the price of a good or enhances its quality increases external demand for that good. — This brings a greater production of the good which generates a growth pole through a series of positive effects:

• Keynesian multiplying effect on income: that horizontally pervades the entire economy.
  • Increased production by the dominant firm increases employment in both the firm itself and those connected with it, with a consequent increase in incomes and consumption (effetto moltiplicativo Keynesiano sul reddito).
• A multiplying effect à la Lentief: connected with inter-sectoral input-output effects, which vertically pervades the dominant firms’ filiere.
  • Firms and sectors upstream from the dominant firm see their production and outlet markets expand.
  • Relations among firms act as channels transmitting development without which the growth-pole could not exist (the theory thus closely reflects a conception of diversified relational space) (effetto moltiplicativo leonteviano).
• An acceleration effect on firms’ investment (effetto di accelerazione sugli investimenti delle imprese).
  • Growth of demand for the dominant firms’ good and those of the firms connected with it stimulates investments (there is an evident reference here to the Harrod-Domar model). These investments are facilitated by higher profits which generate higher levels of reinvestment of those same profits.
  • Like the input-output effect, this acceleration effect operates vertically along the dominant firms’ filière — this leads to selective development because it is confined to firms’ sector and to those connected with it.
• A polarisation effect that produces the Growth-pole. Increased demand for intermediate goods and services generated by the dominant firm induces other firms to:
  • Locate close to it in order to minimise their transportation costs in serving the propulsive firm
  • Exploit the infrastructures and fixed social capital activated by the pole
  • Improve local managerial or entrepreneurial skills produced by the economic activities generated by the dominant firm
  • Exploit the greater demand produced by higher employment (effetto di polarizzazione).

This theory comprises a number of key features for the interpretation of development already put forward by previous theories: the importance for the development process of infrastructure, services, and input-output relations among firms and sectors that balanced development models had already emphasised. The positive effects of growth in demand (real and expected) on the level of investments already highlighted by the Harrod-Domar model, and the Keynesian income multiplying mechanisms already present in the export-base model. So development is generated by the dynamism of a firm and by its links with other firms, and the cumulative growth process is the result of rational behavioural reactions by the various actors involved in the dominant firms’ activities.

7.2.2. The territorial approach: Boudeville’s contribution

In 1964 Jaques-R Boudeville endeavoured to emphasise precisely this spatial/territorial component of growth-pole theory, by imposing clear geographic boundaries on the positive development effects generated by the propulsive industry. Boudeville extended Perroux’s theory, identifying three ways to define the geographic boundaries of the polarisation effect, using three hypotheses on the geographic location of the actors involved in the development process:

• The propulsive industrie and the firms connected with it are geographically clustered.
• The propulsive firm is located in a city. Hence the input-output relations that generate development can be hypothesised as operating within the same urban area.
• The positive effects generated by the dominant firm impact only upon the local area. This amounts to hypothesising the absence of leakages/losses (perdite) in the income multiplying effects evidenced by the export-base theory, and to arguing that a growth pole comes into being when the positive effects of a dominant firm are confined to the local area.

These three interpretations have an important feature in common: the key factor in development is no longer sectoral interdependency alone (as in Perroux) but there must be a spatial concentration of production activities that determine the positive final effect exerted by the dominant firm on local development. Moreover, it emerges a new way to interpret regional development: the spatial concentration of economic activity is a territorial organisation of production that generates development more efficiently than does spatial dispersion. The growth-pole theory was the first step toward conceiving space as an active factor in development. It opened the way for analysing endogenous development. The spatial concentration of activities is the source of increasing returns in the form of agglomeration economies, localisation economies, technological externalities, and localised learning process. All of these factors are elements that enhance the competitiveness of local firms and foster local development.

7.2.3. Critical assessment of the theory

Defects (or shortcomings) of the theory include:

• Failure to explain the reasons for the initial presence of a propulsive “industrie motrice” in the area: this presence the theory assumes to be exogenous. The theory does not explain WHY the propulsive firm has located in that particular area so it is unable to distinguish the effect of a natural pole from those of a planned pole.
• It has deliberately ignored the negative effects “backwash effects” accompanying the formation of a pole, emphasising only the positive ones (spread effects) and stressing out expectations of success in the creation of a pole. It may easily happen that the location of a large firm in an area has an initial crowding-out effect on local firms, especially craft businesses, resulting from the shock on prices and wages generated by the advent of a large firm, with a negative impact on local employment.

The figure 7.1 shows the evolution over time of the negative and positive effects exerted on an area’s economy by the formation of a pole. The positive effects tend to appear in the long period, after initial resistance. The negative effects, which are very pronounced in the first period, subsequently attenuate when the local economy has reorganised itself around the large firm. The result is a pattern of net spillover effects which is initially negative but then positive.

• Close inspection of the growth-pole theory reveals a contradiction in its logic when applied for normative ends. If the aim is to develop a weak area, the dominant firm must require only a few local inputs; but for this reason, it is unable to generate large-scale spillover effects on the local economy. In general, the explicative development contribution is reduced.

7.3. Multinational companies and regional growth

7.3.1. The role of multinationals

The persistence of regional imbalances despite public interventions in favour of large firms in North of England, South of Italy, and Ireland has empirically belied the claims of this radical current of thought. The 1980s saw the advent of a more balanced school of thought that emphasised also the positive processes engendered in local economies by the presence of multinationals. The development of this school of thought was boosted in the 1980s by numerous technological innovations that altered the standard functional division of labour. The reprogrammable system made possible by CAM/CAD applications and the computerisation of numerous administrative and managerial procedures, gave rise to a new organisational industry characterised by functional integration (production, design, research, marketing, and strategy) de-verticalisation and reorganisation of the production cycle.

In general, the presence of multinationals has been associated with higher static efficiency of the entire area made possible by technological transfer and increased productivity. Advantages stemming from the presence of multinationals in an area have been classified into direct and indirect ones. The direct ones are:

• Job creation
• Increased managerial and technological expertise
• Increased wage levels thanks to the formation of higher quality occupations
• Change in the industrial and functional mix
• Increase in the productive capacity

Added to these benefits have been indirect advantages in the form of foreign direct investment (FDI) induced spillovers; this refers to the pecuniary and technological externalities that the local productive system receives from the presence of multinationals. The indirect advantages have been identified as rather numerous, namely:

• A strengthening of the productive system in areas with scant entrepreneurship;
• Enhancement of industrial agglomeration effects;
• The creation of new firms upstream and downstream from the multinational
• Localised technological spillovers
• Increase of managerial and technological know-how in the local area
• Cross-fertilisation between firms and local institutions in the provision of vocational training

These advantages or spillovers may be diffused in the area that hosts multinational through technological externalities; that is, labour force training and an increase in the quality of production processes of local firms due to the greater competition that the large multinational generates among potential suppliers. Advantages may be diffused through input-output linkages between multinational and the local firms. In this case, they take the form of pecuniary externalities since they are mediated by the market. The process intensity depends on FDI characteristics and on the area itself.

Modus operandi of multinationals affect the benefits that they generate for the local economy. Aspects of multinationals’ modus operandi are:

• Degree of the group’s vertical integration
• Technological intensity of the production process
• Site of the filiere
• The positioning in the filiere
• Type of investment (greenfield or the purchase of already existing firms)
• Extent to which production is outsourced

7.3.2. The determinants of a regional attractiveness for multinationals

A large number of studies have been devoted to identifying the sources of local FDI attractiveness with the aim of providing an explanation for their unequal spatial distribution. Generic reasons for the FDI location choices have been related to their strategies to become multinational. In particular:

• The presence of large final markets when the reason to produce abroad is a market-seeking strategy;
• The presence of low-cost labour, a limited distance to the final goods market, and limited international trade barriers when the reason of the firm to become a multinational is a cost minimisation-seeking strategy;
• Presence of high-quality assets and human capital when the choice to produce abroad is a strategic seeking strategy;
• The presence of natural resources and raw materials when the reason for the firm’s international production is oriented to a resource-seeking strategy.

The theory of FDI developed has been criticised for its a-spatial nature, since it has considered geography as highly stylised and unspecific, suggesting location factors applicable to a high number of regions and therefore being unable to explain real FDI location choices. During the 2000s, theories have started to look for determinants of specific local assets attracting FDI, by considering specific territorial elements of the region on the one hand and spatial interdependences in the location determinants on the other. As for territorial characteristics, the presence of large cities has been highlighted as an important aspect for FDI attractiveness: cities are the loci of qualified labour, amenities, knowledge, advanced and specialised services for industrial activities, and “urban atmosphere”. More recently, also social and relational capital, quality of local institutions, quality of life, quality of transport and infrastructures, and accessibility have been mentioned as important sources of attractiveness. Recent empirical analyses have shown that the location choices among countries and regions are strongly interrelated, demonstrating that multinationals take account of both aspects at the same time.

Location determinants: role of local assets of nearby regions in influencing FDI location choices. From the empirical perspective, this has been made possible by the development of spatial econometric techniques that allow in the estimation of location choices, inclusion of the characteristics of nearby regions, weighted by distance.

7.4. The spatial diffusion of innovation

7.4.1. Hagerstrand’s model: Geographical distance

Role of innovation in local development. Innovation comes about in entirely different ways in different areas and is thus a key factor in the explanation of the differing capacities of regions to grow. It accounts for the process of output growth, which cannot be directly attributed to an increase in the production factors, in equilibrium and with constant returns to scale. Innovation is therefore of key importance for the explanation of why local systems grow; and any thoroughgoing theory of regional development must be able to specify the sources of innovation and the factors that give a local system innovative capacity.

The best-known, and earliest, of these models of the spatial diffusion of innovation was developed by Torsten Hagerstrand. His pioneering work on innovation diffusion, on which numerous subsequent studies were based, maintained that the temporal development of an innovation displays an S-shaped pattern represented by a logistic function and a temporal phase of the cycle must be combined with spatial ones to depict a spatial-temporal diffusion innovation moving through the following three phases:

• Adoption stage. When the urban hierarchy canalises the course of diffusion: the innovation centre is often the primary city or some other metropolitan centre, the centres next in rank then follow.
• Diffusion stage. When the hierarchical effect and the neighbourhood effect act simultaneously, with different ...