Module OneNFD26

Public Service College of Oromia
Regional Growth and Local Development
Course Introduction
Dear learner, welcome to the course Regional Growth and Local Development. The course has
been designed to acquaint you with fundamental concepts of regional and local development, the
rationales of focusing on development of regions and localities in the era of globalization,
emerging theories and policies in regional and local development and approaches to regional and
local economic development planning. Thus, the course is meant to help students to understand
the challenges of development and the roles of different stakeholders (government, private
sector, community based organizations…) to mitigate regional imbalances and poverty at local,
regional and national levels.
The course has been organized into five chapters in two modules. The first three chapters have
been included in this first module whereas the remaining two chapters will be addressed in the
second module.
Of the three chapters contained in this module, chapter one discusses conceptual foundations of
regional growth and local development together with such concepts as goals of regionalization
and preliminary concepts on local economic development (LED). The second chapter builds on
the concepts addressed in the first chapter and further extends to the relationships among
decentralization, globalization and regional and local development. The third and the final
chapter included in this first module deals with theories of regional and local economic growth
and development. Here, theories based on resources/supply, theories based on demand or market,
theories based on space, the neo-classical regional growth theory, staples theory of regional
growth and recent theories of regional development will be discussed under separate sections.
Brainstorming questions have been provided throughout the modules to stimulate critical
thinking and rouse interest in you as you read. Review questions are provided at the end of each
chapter to help you evaluate your understanding of contents of the chapters.
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Course objectives
After the successful completion of the course, you should be able to:
 Understand the concepts ,issues and problems of regional growth and development;
 Contrast different paradigms and theories on regional growth and local development;
 Identify and explain the basis of regional growth and development;
 Clarify the concept of local economic development and local determinants of growth;
 Explain the importance and techniques of planning for local economic development;
 Discuss the impacts of decentralization and globalization on regional growth and
development
Course Content
Chapter One: Conceptual Foundations of Regional Growth and Local Development
1.1 The concept of region and Regional development: regionalization and development
1.2 Goals of regionalization
1.3 The Issues/Problems of Regions
1.4 Local Economic Development (LED)
Chapter Two: Decentralization, Globalization and Regional Development

2.1. The Link between Globalization, Decentralization and Regionalization
2.2. Globalization and Regional and Local Economic Development
Chapter Three: Theories of Regional Economic Growth and Development

3.1. A Review of classic theories of development
3.2. Conceptual foundations of regional economic development theories
3.3. Alternative theories of regional economic development
3.3.1. Theories based on demand
3.3.2. Theories based on supply
3.3.3. Theories of regional economic divergence
3.3.4. Structuralist theories
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3.3.5. Theories that focus on political institutions

3.4. Emerging neoclassical perspectives
Chapter Four: Regional and Local Development Strategies and Policies

4.1 Regional development policy: rationale and foundations
4.2 Theoretical approaches to regional policy
4.3 Place based approaches to regional development policies
4.4. Objectives of regional development policies
4.5. Instruments of regional policy
4.6. Policy areas for promoting regional development
4.7. Strategies for regional economic development
Chapter Five: Local and Regional Planning
5.1 Regional development planning concepts and models
5.2 The role of regional planning for development
5.3. Principles and approaches to local economic development planning
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Chapter One
Conceptual Foundations of Regional Growth and Local Development
Introduction
Dear learner, welcome to the first chapter of this module. This chapter provides
conceptual foundations of regional growth and local development: its definitions, rationales and
goals; the difference between national, regional and local approaches to economic development
and introductory ideas on the concepts of local economic development. First you will be
introduced to various definitions of the terms region and local. You will then see the goals of
regionalization and localization of development policy and planning. Finally, the chapter ends
with a brief introduction to concepts and strategies of local economic development (LED) which
will be further elaborated in subsequent chapters.
Objectives
At the end of this chapter you should be able to:
 Define the concepts of region and regional development
 Distinguish between national, regional and local development
 Describe goals of regionalization
 Explain the causes of Regional inequality and how regionalization helps income
equalization
 Discuss the rationales of local and regional approaches to development
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1.1. The Concept of Region and Regional Development
Dear learner, from your experiences so far, what concept do you think does the term
“region” stand for?
Although all regional development studies are focused on understanding the process of regional
growth and decline, there is surprisingly little agreement among scholars as to how regions
should be defined. Some scholars merely presume the a priori existence of a cohesive geographic
and economic entity known as a region, whereas others base their theories on more explicit
definitions. A few of the most common approaches to defining regions are reviewed below.
In economic terms, the concept of region can be defined as an open spatial system which is under
the authority of a central government (for purposes of general economic policy such as currency,
trade, taxation, and so forth), and which is situated within the context of a larger national entity
within which products and factors of production circulate freely. This definition enables a region
to be delineated in various forms and dimensions, according to the needs of a particular analysis.
Regions may also be defined in terms of natural resource, ecosystem, or other geographic
boundaries. A few authors suggest an interesting approach to defining regions in terms of the
interdependencies between natural resource systems and human populations.
Markusen (1987) defines a region as a “historically evolved, contiguous territorial society that
possesses a physical environment, a socioeconomic, political, and cultural milieu, and a spatial
structure distinct from other regions and from the other major territorial units, city and nation”.
This definition recognizes that regions are historically determined entities that emerge largely
due to the interaction between humans and local natural resources. Although improvements in
transportation have removed many of the constraints imposed by geography, the historical
patterns of regional formation still affect the evolution of modern regions.
Other more recent theorists define a region in terms of a spatially interdependent, or “nodal,”
labor market.
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According to Hoover and Giarratani, nodal regions have two characteristics:
(1) they are functionally integrated internally to the extent that labor, capital, or commodity
flows are more common within the region than with another region, and
(2) within the region, activities are oriented toward a single point, or node, where there is the
presumption of dominance or order of the node over the surrounding peripheral area.
Richardson extends the nodal concept to include polycentric regions that have several nodes and
several peripheries but that exhibit high degrees of internal functional integration. The functional
economic area concept is a variation on the nodal approach that is based on the view that the
dominance of a central node over the surrounding periphery is attributable to the spatial
dependence of workers on adjacent employment centers. This approach provides a conceptual
basis for the delineation of economic areas.
Theorists have found this conceptualization of “functional economic area” to be quite useful for
several practical and theoretical reasons. First, since labor is the unit of measurement, there is a
clear correspondence between regional analysis and social welfare analysis. If regions were
defined in terms of geographic units that did not correspond to the location of the population, it
would be difficult to determine the human impacts of changes within particular regions,
especially if some regions had little or no population base. Second, unlike other definitions
discussed later, the functional economic area concept explicitly incorporates space and spatial
integration among economic units into the definition of a region. In the functional economic area
definition, space is incorporated via worker transportation costs. Third, there is a clear economic
rationale for the delineation of regions based on functionally integrated labor markets. Because
workers desire to minimize transportation costs of commuting to work and employers wish to
minimize the cost of compensating labor for high commutes, functional economic areas are more
likely to correspond to the economic boundaries that firms and workers face in a spatial
dimension. This allows regional analysts to examine regional problems in a manner similar to the
way the problems are encountered by economic agents. Finally, large labor markets also serve as
large consumer markets. Thus, a significant local labor market serves both as a resource for firms
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that employ local workers and as a consumer market for firms that wish to sell their products to
workers. Relying on labor as the unit of analysis reinforces the patterns of interdependency
among firms and workers in the region.
The problem with this approach to defining regions is that advances in communications and
transportation technology have weakened many of the centripetal forces that tie suburban labor
markets to central city business districts for employment needs. If telecommunications are a
substitute for face-to-face communication, then workers can live in virtually any location and
conduct economic activities from their homes. Similarly, if it is virtually costless to commute to
work, due to improvements to the land-based transportation network or declines in the cost of
airline travel, workers can live farther from their employers. When the bounds imposed by
transportation costs are lifted, workers are more likely to migrate to rural areas or commercial
centers that offer service and/or quality-of-life benefits. The implications of these changes for the
definition of a region are that regional boundaries become more difficult to define and may not
represent the spatial dependencies between labor and employment centers.
Another limitation of the functional economic area concept and the related concept of a nodal
economic region is that local political boundaries rarely correspond to functional economic areas
or other nodal definitions, suggesting that there may rarely be a one-to-one correspondence
between a particular regional problem and the tools that a planner may employ to resolve the
problem. Similarly, since geographic or ecological boundaries rarely correspond to functional
economic areas, planners may incorrectly estimate the ecological impacts of regional economic
development using the functional economic area definition.
Alternative definitions of regions have been proposed to account for the shortcomings of the
traditional functional economic area approach. For example, regions have also been defined in
terms of the degree of internal homogeneity with respect to some factor. Using the example of a
region defined in terms of the size of a labor market, a regional boundary would emerge in places
where differences appear in the characteristics of the labor force. Using income as an example,
one could define low, medium, and high-income regions with relatively similar per capita
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incomes within regions and different per capita incomes across regions. Similarly, regions may
be identified on the basis of the sectoral specialization of labor (e.g., manufacturing-based
regions versus service sector regions). Using this approach, regions are treated much like
homogeneous nations and can be analyzed using modified methods from international trade
theory.
A more relevant definition from the perspective of regional and local development that views
regions as political or administrative units or “planning regions” that correspond to units of
political or administrative control has also been suggested by scholars The advantage of this
approach is that political and administrative boundaries directly correspond to the boundaries
over which planners and politicians design and implement policies. Its disadvantage is that
economic and/or environmental regions rarely conform to political boundaries. Thus, in the case
of an environmental region, a policy designed for a particular political region may have spillover
effects on adjacent environmental regions. Both the new institutional economics and the growth
machine literature rely on this approach to define regions.
How (on the basis of what factor) are the regions in Ethiopia defined?
The preceding discussions indicate that regions can be defined by socio-cultural factors with
emphasis on questions of identity and attachment to place (Quebec, Basque territories) - Identity
is a powerful force in development of notions of regions and regionalism. Regionalism is a
process of creating or reinforcing regions, most notably through the cultural and social
characteristics which go to identify and reinforce regions. Regionalism is the political
manifestation of regional identity. It is the agency factor; it is the ‘voice’ of regions at the
political level. The processes which contribute to regional identity are significant and may be an
important reinforcement for policy prescriptions. It is worth considering the extent to which
regional identity can act as a constraint, limiting alternatives and maintaining an inward looking
view. This point draws attention to the benefits and/or costs of regional identity, as positive
forces regional identity can act as catalysts for ongoing development from within through the
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development and pursuit of grassroots initiatives. As a negative, it can stifle innovation and
reinforce negative stereotypes.
For the purposes of this course, a region will be defined as a spatially contiguous population (of
human beings) that is bound either by socio-cultural and historical necessity or by choice to a
particular geographic location. In other words, regions are defined as political or administrative
units that have political and administrative boundaries directly corresponding with the
boundaries over which planners and politicians design and implement policies.
Countries, Regions and Localities

The difference between regions and countries is not always very clear (for instance, some of the
regional states in Ethiopia and several US states are larger than many countries in Europe), but
the major distinction in most cases is the fact that regions are open spatial entities (in contrast to
countries), while the competence of a region may normally be superseded by the nation. Regions
display a spatial subdivision of a country and are characterized by a distinct cultural, socio-
political or spatial diversity.
While the concept of a "region" in relation to that of a "nation" appears to be relatively clear, the
conceptual difference between a "locality" and a "region" seems difficult to establish, apart from
the criterion of size. According to its current usage, the adjective "local" indicates any action,
event, or process which concerns an individual place or territory; in other words, a locality. Used
in this fashion, the term "local" can serve as a synonym for "regional" although by tradition the
former refers to a territory relatively limited or confined. The definition of local development
that follows from this interpretation thus implies the self-development of small regions -- the
development of localities.
The adjective local has traditionally also been used to refer to sub-national areas which possess
their own government; while this distinction can serve as a useful criterion, it can add to the
confusion in countries which possess several levels of government. In the absence of a distinct
concept of "locality" the difference between regional development and local development is
largely reduced to a difference of degree, according to the size of the area in question, and does
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not necessarily reflect a difference in the nature of the process. In addition, the territorial limits
of that which is "local" (in relation to that which is "regional") will likely vary from author to
author and from one country to another. The framework of local development defined in this
manner thus rests upon examining the relation between the variable "size" and the variable
"development" i.e., upon examining the development problems of micro-regions.
Thus, the term "local" can also indicate an event, action, or process the impetus for which is
found principally within the region in question, as opposed to being provided from external
areas. Interpreted in this manner, the adjective "local" suggests terms such as "endogenous" or
"native."
Local vs. Regional Development

Regional development is a multidimensional concept with a great socioeconomic variety that is
determined by a multiplicity of factors such as natural resource endowments, quality and
quantity of labor, capital availability and access, productive and overhead investments,
entrepreneurial culture and attitude, physical infrastructures, sectoral structure, technological
infrastructure and progress, open mind, public support systems, and so forth.
The adjective "local," when added to the term "development" lends itself to an interpretation
whose connotation is not purely spatial and which presents a different perspective on the very
nature of the process of development. This view of "local" within the development process
stresses the role of endogenous elements which can be applied to large regions as well as to
micro-regions. One often finds expressions such as "development from below" or "bottom-up
development" used to express similar processes.
The concept of local (or endogenous) development thus defines a particular form of regional
development in which "local" factors and the local spirit of entrepreneurship, local firms or local
financial institutions constitute the principal bases for regional economic growth. This
formulation of the concept thus requires a definition of local factors, as distinct from external
factors. Local factors as used here refer to the socio-cultural and behavioral attributes of the local
population related to the development process. It is the identification and analysis of such local
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factors which constitutes the principal methodological and conceptual challenge to the
elaboration of a model of endogenous regional growth.
1.2. Goals of Regionalization

The discipline of regional development emerged in the 1950s with a strong economics basis and
a focus on what firms did in regions and how their performance influenced a range of economic
indicators: employment, profit, GDP and growth. Towards the end of the 20th century, regional
development became far more multi-disciplinary in its approach. Political science, public policy
and sociology became critical disciplines alongside economics focusing more on the notion of
what a region might be and how a range of factors – not just economic – shaped the idea of a
region. In the 21st century economic geography has joined the disciplines and the focus of
regional development is more on the spatial dynamics of regions – as places to live, work and
invest. The focus for the discipline is just as much on people as drivers of regional development
as smoke stack industries, regional development agencies and firms.
Whilst the way we look at regions has changed the focus, purpose and objectives around regional
development haven’t changed that much, but the context for that analysis has changed
dramatically.
A common thread for regional development concerns some kind of economic and social
improvement:
• More and better quality infrastructure (soft and hard);
• Improved community services;
• Greater and more diverse volume of production;
• Lower unemployment;
• Growing number of jobs;
• Rising average wealth and improved quality of life
Studies on regional development have usually centered around two dominant issues: how is
regional welfare created and how can we cope with undesirable interregional welfare
discrepancies?
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The first question is normally referred to as ‘allocative efficiency’ and addresses the economic
issue of an optimal spatial-economic use of scarce resources (i.e., inputs such as capital, labor,
physical resources, knowledge etc.) so as to generate a maximum value of output. The second
question is more of a socio-political equity nature and addresses the mechanisms and conditions
(economic, policy interventions) that may help to alleviate undesirable development disparities
in the space-economy. Normally, efficiently operating regions tend to grow faster than regions
with less favorable development conditions, so that there is an inbuilt tension between efficiency
and equity among a system of regions, at least in the short run. It goes without saying that the
efficiency-equity dilemma is one of the most intriguing issues in regional development policy
which has extensively been discussed in the literature.
1. Regional Inequality and Regional Income Equalization

The motives to measure regional development are manifold. But a prominent argument all over
the years is that welfare positions of regions or nations may exhibit great disparities which are
often rather persistent in nature. These in turn translate into large disparities in living standards.
For example, in 1960, the world’s richest country had a per capita income that was 39 times
greater than that of the world’s poorest country (after correcting for purchasing power), while by
the year 2000, this gap had increased to 91. Areas in our world do not only have significant
differences in welfare positions, but it takes also sometimes decades or more to eliminate them.
As an illustration we take here Tanzania (the world’s poorest country in 2000), which
experienced on average a modest growth rate of 0.6 percent per annum over the period 1960-
2000. In order to reach the world’s average per capita income of 8,820 US dollars per annum at
its current rate of growth, it would need another 485 years. Even if the annual growth rate were
to increase to 1.8 percent (i.e., the world’s current average), it would need 161 years to close the
gap. And if it were to grow at the rate of South Korea (the fastest grower over the period
concerned), it could close the gap in just 49 years. Persistent spatial welfare disparities are a
source of frustration for both economists and policymakers.
Changing regional welfare positions are often hard to measure, and in practice we often use
Gross Domestic Product (GDP) per capita (or growth therein) as a statistical approximation.
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Sometimes alternative or complementary measures are also used, such as per-capita

consumption, poverty rates, unemployment rates, labor force participation rates or access to
public services. These indicators are more social in nature and are often used in United Nations
welfare comparisons. An example of a rather popular index in this framework is the Human
Development Index which represents the welfare position of regions or nations on a 0-1 scale
using quantifiable standardized social data (such as employment, life expectancy or adult
literacy).
2. Regional Economic Growth

Location matters for economic development in the sense that forces that lead to innovation and
growth are rooted in specific places or regions (rather than countries) and they cannot be easily
moved elsewhere or replicated in different contexts. Hence, regional economic development
focuses on the processes that favor learning and new knowledge creation at the local level. A
particular relevant role is played by the cultural and socio-institutional characteristics of regions,
which basically drive the economic behavior and attitudes of local actors by providing the
appropriate structural relational assets to the regional economy. This makes innovation and
development no longer a linear but a multidimensional process by affecting local relations, rules,
absorptive capacity and the capability to re-use knowledge.
3. Political Stability
Regionalization (or decentralization) may also serve to bring about political stability. People
around the world due to diverse group interests demand greater self-rule and want to influence
the decisions of their governments. In this regard regionalization enables sharing of political
power among different people within a country and creates a situation where people may agree
to share a common country/state while retaining substantial degree of self-government over
matters essential to their identity as people.
Regionalization/decentralization helps as a means to resolve ethnic tension or conflict between

different groups of society because it gives more space for people to exercise develop their
culture and exercise their customs and religious beliefs with freedom.
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Thus regionalization (decentralization of power to regions) is becoming a panacea to

accommodate diversities and resolve problems and conflicts arising from ethnic and other forms
of diversities and the demand for local autonomy both in developing and developed countries. It
also has advantages of better information flows and expands opportunities for political
representations. In short it is being practiced as a strong means for resolving conflicts,
empowering regions and helping to promote national unity by accommodating diversity.
However, scholars warn that regionalization is not an end but a means to the end. What matters
most is not the introduction of it but it is whether it is successful or not. Decentralization to
regions is successful if it improves administrative efficiency and responsiveness by
accommodating potentially violent political forces. On the contrary it is unsuccessful if it
threatens economic and political stability.
1.5 . The Issues/Problems of Regions
Regional Pathology: The Emergence of "Problem Areas"

When a region is enjoying growth-euphoria and reasonably full employment, there is no great
disposition to examine its situation and prospects in detail and search for ways to gild its robust
health. National attention is directed only to those regions that are in trouble, and there always
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are enough of them to worry about. We assume, in other words, that in healthy regions the
workings of the market economy under existing constraints are relatively satisfactory.
To focus on regional pathology is both politically and economically rational. Our diagnostic and
therapeutic resources are limited enough, and we are more likely to find something helpful to do
for regions with obvious ailments than to improve comparably an already good situation. The
only risk is that we may thus overlook opportunities to nip unwelcome developments in the bud.
Regional economic growth is not a smooth, straightforward process. The persistence of efforts to
explain development in terms of successive "stages" attests to the existence of important
discontinuities. We do not by any means know what all these are, how to foresee them, or how to
deal with them. But we do know that the development of a region, like that of a nation,
encounters from time to time crucial situations in which its future course can be significantly
influenced by major planning decisions and policies. Alternative paths appear; one of the
alternatives may be a further growth along some new line, and the other may be stagnation,
arrested development, or even regression.
These crucial situations present the biggest challenge to our insight into growth-determining
factors. The stakes are highest and the rewards for correct decisions, in terms of economic
progress, are at a maximum.
Backward Regions
A familiar case is that of underdeveloped nations poised on the threshold of industrialization and
threatened by a genuine Malthusian peril of overpopulation. Much effort has gone into defining
the conditions necessary for a successful surmounting of the threshold, the so-called "takeoff into
self-sustaining growth" process.
Most if not all of the advanced countries also include one or more backward regions, which seem
to be hung up at a threshold on the road of development and not to have kept pace with the
structural changes and the rising income and opportunity levels of the more fortunate regions of
the country.
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Developed Regions in Recession

A second and quite different type of problem area is the mature industrialized urban region
afflicted by stagnation. Symptoms of this particular syndrome are easily recognizable. The ailing
region’s rate of growth has been increasingly subnormal for many decades. Unemployment is
high and chronic. Out-migration is heavy. The area appears to have somehow lost the dynamic
growth character that had brought it to its peak importance in days gone by. There is a feeling
that unless something really decisive happens, stagnation will prevail indefinitely.
Such a situation can arise in a region whose economy is heavily based on a few activities that
have themselves ceased to grow or have begun to decline. They are the activities of yesterday
and today, but not those of tomorrow. But arrested growth in a region may also mean simply that
the factors of interregional competition, in specific activities, have taken a trend adverse to that
particular region. The region’s difficulties are compounded if both of the above conditions apply,
so that it finds itself with shrinking shares of declining activities.
But in diagnosing the ills of such a region, it is not enough to determine the extent to which it is
losing ground to other areas in major activities, or the extent to which its activities are no longer
of the growth-industry type. After all, we could hardly expect that every activity would continue
to grow forever, or that any given region could forever retain or increase its relative position in
its principal activities. A healthy regional economy can absorb losses in its stride and shift its
resources into new fields, getting a share of the emerging new rapid-growth activities to balance
the inevitable decline of other activities.
It is important to keep this in mind when trying to determine the proper role of federal and local
policies in regional development. Change is a necessary aspect of growth, and it is as inevitable
that some regions will prosper and others will not as it is that some individuals will fare better
than others.
Excessive Growth and Concentration
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In both types of problem regions thus far mentioned, a basic symptom is that employment
opportunities have not developed (in amount, in variety, or in both) fast enough to keep pace
with the size and aptitudes of the labor force. Resources are underutilized. Somewhat the
opposite situation prevails in regions that undergo extremely rapid growth involving massive
inward migration. The growing pains of such regions are felt as impairment of the quality of
services, destruction of local resources and amenities through overuse, a high rate of
obsolescence of facilities, neighborhoods, and institutions, and a general deterioration of the
quality of life. The forestalling or mitigation of these effects through analytical foresight and
advance planning poses a major challenge to regional specialists.
The most widespread and obvious present-day examples of the perils of too rapid development
appear in two types of areas. One is the suburban fringe of metropolitan areas, where many
factors have combined to produce sudden and often unforeseen growth. The other type of area
comprises zones of special recreational amenity such as beaches. The growth of population plus
its increased mobility, leisure, and taste for outdoor pleasures add up to a formidable threat to our
basically non-expansible resources of open space, clean water, and privacy.
Related to, but distinct from, the question of too rapid growth is the problem of excessive spatial
concentration of development, specifically in gigantic metropolitan centers. Concern on this
score is felt in nearly every country. In the less developed countries, the problem is seen as
exclusive concentration of modern industrial development, business, and population in the chief
city. In France and England, the concentration of growth in Paris and London has been officially
deplored, and attempts have been made to combat associated problems for a generation or more.
The question whether our large metropolitan areas are "too big" defies any easy answer. Part of
the difficulty lies in the variety of possible criteria. Large cities have been variously assailed as
hotbeds of vice, breeders of psychological and political disorder, and hazards to health and
safety; and they have been extolled for equally diverse virtues. With respect to economic criteria,
it is often argued that the rising costs of housing, public services, and similar items make large
cities uneconomical as places to produce or to live. These diseconomies of size are said to
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outweigh, in very large cities, the positive advantages of urban agglomeration that we discussed
earlier.
A strong substantial body of empirical evidence suggests that there are strong net economies in
the provision of infrastructure and public services of middle-sized cities as compared to small
ones. There are difficulties with this approach, however, in that expenditures reflect differences
in the quantity and quality of services provided as well as costs. Thus persons in large cities may
have demands for public services that are different from those of persons in smaller cities, and
this will affect per capita expenditures.
However, costs of public services are only one element in the comparative economic advantages
of different sizes of cities. A more accurate approach to this problem would recognize that the
activity of cities includes the production and consumption of private as well as publicly provided
goods and services. In order to make valid comparisons, one must account for the incremental
benefits and costs associated with each as city size increases.
Many regional economists see hidden disadvantages in very large cities, justifying a public
policy of diverting growth from such cities to medium-sized ones. They argue that there are
important external diseconomies (such as added costs of housing, congestion, and environmental
spoilage) that do not enter into the calculations of the firms or individuals who contribute to city
size by establishing themselves there—in other words, these costs should, but do not, work to
limit urban growth. For example, an additional urban freeway commuter adds to congestion and
causes losses to all the other commuters whom he slows up, but he does not have to pay for the
added costs inflicted on the others and is not deterred from rising the freeway.
1.4. Local Economic Development (LED)
Defining LED
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Literal definition of Local Economic Development (LED) seems straightforward, which is about
economic development that happens at local level; however, as the multitude of issues, actors,
instruments and activities involved in LED processes is considered, the concept of LED would
be a bit complicated.
The World Bank defines LED “as a development initiative of local stakeholders aiming at
building local economic capacity, strengthening competitive advantage of a locality, enhancing
opportunities for job creation as well as improving quality of life of local population.
According to the UN Habitat “LED is a participatory process in which local people from all
sectors work together to stimulate local commercial activity, resulting in a resilient and
sustainable economy. It is a way to help create decent jobs and improve the quality of life for
everyone, including the poor and marginalized.
The ILO also defines LED as a participatory development process that encourages partnership
arrangements between the main private and public stakeholders of a defined territory with the
final objective of creating decent jobs and stimulating economic activity. As a policy approach
the LED evolved in the late 1960s as a response to the growing competition among local
governments for businesses and capital.
The above definitions indicate that there is not one standard definition of what LED is, but in
general local economic development approaches tend to have the following characteristics:
1) It is a territorial-based approach that aims to empower stakeholders to shape the future of the
place they live in. Although other actors are and indeed need to be involved as well in order for
LED to be successful, it is a locally owned approach that is, to a large extent, shaped and
implemented by local actors.
2) LED is a participatory approach to development where a wide range of local stakeholders

work alongside regional and national governments and international organizations in an effort to
realize a locality’s full economic potential. Through this focus on participation, LED creates
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incentives and opportunities for partnership between local private and public sector stakeholders
as well as other societal and political groups.
4) LED does not ignore or reject globalization, but rather focuses on new social and economic
opportunities that local, national and international markets may provide for its people and
enterprises. This focus enables the formulation and implementation of locally tailored
development strategies that make better use of and building on existing local resources and
competitive advantages.
5) The LED approach ultimately aims to create sustainable economic development. Through the
involvement of a range of stakeholders, it aims to find solutions that will combine the goal of
economic development and employment creation with the objective of poverty reduction and
maintaining and increasing the quality of locally available jobs.
As these characteristics show, LED presents a number of core values that are not necessarily
found in other development approaches. The approach seeks to promote a truly inclusive policy
process, valuing the opinions of a wide range of local stakeholders and promoting equality
among them. It encourages the creation of new opportunities for voice and social dialogue, both
in the shape of formal processes, such as elections, and more informal local meeting and forums.
Such inclusive processes are crucial sustainable, pro-poor development and the creation of
decent employment opportunities.
Practicing Local Economic Development

The success of a community today depends upon its ability to adapt to the dynamic local,
national and international market economy. Strategically planned LED is increasingly used by
communities to strengthen the local economic capacity of an area, improve the investment
climate, and increase the productivity and competitiveness of local businesses, entrepreneurs and
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workers. The ability of communities to improve the quality of life, create new economic
opportunities and fight poverty depends upon them being able to understand the processes of
LED, and act strategically in the changing and increasingly competitive market economy.
Building a Strong Local Economy

Each community has a unique set of local conditions that either enhance or reduce the potential
for local economic development, and it is these conditions that determine the relative advantage
of an area in its ability to attract, generate and retain investment. A community’s economic,
social and physical attributes will guide the design of, and approach to, the implementation of a
local economic development strategy. To build a strong local economy, good practice proves that
each community should undertake a collaborative process to understand the nature and structure
of the local economy, and conduct an analysis of the area’s strengths, weaknesses, opportunities
and threats. This will serve to highlight the key issues and opportunities facing the local
economy.
Who Does Local Economic Development?

Successful private enterprise and productive public-private partnerships create wealth in local
communities. Private enterprise however, requires a positive business enabling environment to
deliver prosperity. Municipal government has an essential role in creating a favorable
environment for business development and success. By its nature, local economic development is
a partnership between the business sector, community interests and municipal government.
LED is usually strategically planned by local government in conjunction with public and private
sector partners. Implementation is carried out by the public, private and non-governmental
sectors according to their abilities and strengths.
Rationales of LED
The rationale for local economic development (LED) can be economic, political and social. One
example of economic rational could be linked to the problem of market failure. In the real world,
there is no perfect market, Markets never fit into the ideal assumptions of simple neoclassical
models; and thus, market failures should have to be accepted. One typical market failure, which
21
often prevails at local level is information gap. For instance, new companies which offer all sorts
of goods and services may enter into a given locality, but potential local customers may not be
aware of this and continue to rely on their long-time suppliers and providers (may be external).
This market failure sets in a serious economic inefficiencies and barriers to entry for new
suppliers. Overcoming such market failures or gaps can be possible in LED through business
development services such trade fairs exhibitions or effective market information infrastructure
including the information and communication technology (ICT), as well as an efficient system of
promoting and delivering the service.
The needs to reduce unemployment and poverty reduction are the political concerns of local
authorities to initiate a local economic development strategy. Since most local elections are
fought on the platform of job creation, crime reduction and other social issues, the rationale for
LED goes beyond economic development alone.
Since most economic development constraints are found at the local level such as access to land,
development of industrial zones, skills development and other infrastructure, the rational for
LED becomes imperative. Thus an all inclusive, participatory LED with the effective leadership
of local officials would be necessary.
LED evolved as a policy approach in the early 1970s in response to municipal governments
realizing that businesses and capital were moving between locations for competitive advantage.
By actively reviewing their economic base, communities gained an understanding of the

opportunities for, and obstacles to, growth and investment. With this newfound understanding,
communities attempted to expand their economic and employment base by devising and
undertaking strategic programs and projects to remove obstacles and facilitate investment.
Today, local economies face an even greater set of challenges. These include:
International
Globalization increases both opportunities and competition for local investment. It offers
opportunities for local businesses to develop new markets but also presents challenges from
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international competitors entering local markets. Multi-site, multi-national manufacturing,

banking and service corporations compete globally to find cost efficient sites in which to locate.
Technologically advanced growth industries require highly specialized skills and a supporting
technology infrastructure, but increasingly all industrial and service sectors needs highly
specialized and specific skills and business environments. Local conditions determine the
relative advantage of an area and its ability to attract and retain investment. Even small towns
and their surrounding rural regions can develop local economic opportunities at a national or
international level by building on their local economic strengths.
National
At the national level, macro-economic, fiscal and monetary reforms have directly impacted the
economy at the local level. National regulatory and legal frameworks such as tax reform,
telecommunications deregulation and environmental standards directly influence the local
business climate, either enhancing or reducing the potential for local economic development. In
many countries, national government functions continue to be decentralized thereby increasing
the responsibility of municipal governments to retain and attract private industry.
Regional
Communities within and between regions often compete to attract external and local investment.
Opportunities exist for communities across regions to collaborate with each other to help their
economies grow, for example, by supporting infrastructure or environmental improvements that
demonstrate a broad regional impact. An association of local municipalities or regional
governments can serve to facilitate these types of LED effort by acting as an intermediary
between national and municipal governments.
Metropolitan and Municipal

Businesses, both large and small, often choose to locate in urban areas because of agglomeration
economies (i.e., the benefits derived from sharing markets, infrastructure, labor pools and
information with other firms). The economic advantage of urban areas depends significantly on
the quality of urban governance and management, and on the policies affecting the availability,
23
or lack, of electricity, transport, telecommunications, sanitation and developable urban land.

Factors affecting labor productivity in the local economy include the availability and quality of
housing, health and1 education services, skills, security, training opportunities and public
transport. These ‘hard’ (physical infrastructure incorporating roads, rail, water, sewerage and
drainage systems, and energy and telecommunications networks) and ‘soft’ (infrastructure of
social, cultural and community facilities and capacity that enhance the quality of life and
encourage industry and business development) infrastructure factors are major determinants of a
community’s relative advantage. The quality and provision of ‘hard’ and ‘soft’ infrastructure
forms the cornerstone of a successful local economy.
Metropolitan areas can offer increasing opportunities through economies of scale and effort as a
result of the size of the physical and human capital available, as well as the size of its services
and internal market. Uncoordinated and disparate institutional frameworks and planning bodies
in metropolitan areas can serve to undermine area-wide economic growth. Metropolitan-wide
LED agencies, consortia and networks can be created to address these constraints. These
innovative institutional frameworks, which represent the interests of different municipalities and
partner agencies in the same metropolitan area, can bring benefits to the key actors of each
municipality (public departments, business and civil society organizations). These frameworks
can serve to unite the efforts of different localities and increase LED results, and can strengthen
representation in higher levels of decision-making.
The most important and effective local economic development activity that a municipality can
undertake is to improve the regulatory processes and procedures to which businesses are
subjected by the municipality itself. A survey of most municipalities would reveal a number of
complex, poorly managed, expensive and unnecessary business registration systems. By
reducing these, a municipality can quickly improve its local investment climate.
Disadvantaged Populations and Informal Economy

In many countries, economic growth is determined not only by the formal economy (the
economic sectors that are legally registered and pay taxes) but also by the informal economy
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(those activities that are not legally registered). In some cases the size of the informal economy is
greater than the formal economy, and it interacts with the formal economy by supplying certain
goods and services. The linkages between the formal and informal sectors of the economy need
to be understood and considered in the devising of a local economic development strategy.
Communities and businesses increasingly recognize that a successful local economy requires
social, as well as economic, environmental and physical renewal. In many cities, large numbers
of low-income families work within the informal economy. However, these informal activities
are often low-growth activities as a result of a lack of access to proper infrastructure and services
(i.e., electricity, water and roads), regular means of financing, information and skills. The
development of an LED strategy should recognize and accommodate the constraints and
opportunities of the informal economy so as to broaden the appeal of a strategically planned
LED strategy. It should also encourage wider social benefits for all a community’s economic and
social sectors, formal and informal, disadvantaged and excluded.
What is local in LED?

LED is a territorial approach to development. This begs the question of which territorial scale the
local in local economic development is referring to. Unfortunately there is no general answer to
this question. The geographical dimension and population size of the “ideal” policy territory will
differ from context to context and policy to policy. Defining the concept of local too rigorously
would therefore hinder the flexibility that is inherent to the LED approach.
There is a trade-off between coordination and economic potential in choosing the size of the
territorial unit at which the LED approach will be implemented. In other words, the size of the
locality will influence both the ease with which joint decisions and broad participation can be
achieved and the degree to which effective and efficient policies can be developed and
implemented.
As a rule, defining narrowly-bounded territories has three key advantages. First, within smaller
localities, the local stakeholders will generally have a stronger and more comprehensive
knowledge of the local conditions, problems, and needs. Second, reaching a consensus on the
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goals of LED and the actions that need to be taken will tend to be easier in smaller areas, where
the number of stakeholders is lower and their preferences tend to be more similar. As territories
become larger, the increase in the number of stakeholders and the greater diversity of interests
may make it difficult to reach an agreement. Finally, when territories are not too large, it will, in
general, be easier to coordinate and oversee the implementation of the LED strategy.
Choosing a larger territorial unit, on the other hand, may have a number of advantages too.
Firstly, larger territories may be able to take advantage of economies of scale that are not
available to their smaller counterparts, making them more efficient at implementing LED
strategies. Secondly, larger territories will tend to have a stronger ability to lobby the central
government. This may put them in a better position to secure resources and defend the interests
of the locality in the national arena. Finally, bigger areas will be better able to engage in
international competition with territories or cities in other countries.
Apart from these more theoretical considerations, the existing governmental structure plays an
important role. The territorial scale chosen will generally correspond to the division prevalent in
the pre-existing governmental structure, since local governments are very well positioned to
champion the LED approach locally and guide the formulation and implementation process.
However, it is important to remain aware that this geographical scale does not necessarily
correspond to the functional economic area in terms of regional commuting, shopping, and
supply chain patterns. Therefore coordination of activities between localities remains crucial if
administrative units are chosen as the main scale of delivery for LED.
What is different about LED?

Having roughly defined what LED is and which territorial scale it refers to, the remainder of this
section will seek to clarify its distinctive properties by contrasting the approach with two other
common development approaches, namely top-down and community development approaches.
There are three main differences between top-down development approaches and strategically-
planned LED.
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1. Level of intervention: Traditionally, development strategies have been largely top-down

strategies devised by the central government. Central officials decide where to intervene and in
what way with little or no input from local actors. In contrast, LED seeks to give localities the
tools to promote development from below. It is based on the idea that national institutions are
often too remote to respond to the rapid changes local and regional needs effectively. Local
institutions can be much more flexible and are better positioned to interact with other local
economic and social actors. This allows the formulation of strategies which are better tailored
towards local needs.
2. Locus of development: top down approaches to development tend to adopt a sectoral focus;
they attempt to increase growth and employment through devising policies aimed at promoting
industrial sectors that are seen to increase economic dynamism. LED, on the other hand, takes a
territorial approach, focusing on the development of a region or locality rather than an industrial
sector. From this perspective, economic development and employment is achieved through a
thorough diagnosis of local economic, social and institutional conditions and through the
formulation of a tailored strategy aimed at allowing each territory to reach its economic
potential.
3. Type of instruments: top down approaches often focus on the development of large industrial
projects, in the hope that such project will generate additional economic activity in the area. In
this approach, infrastructural investments and financial incentives are often the preferred
instruments for attracting firms to a given locality. LED, on the other hand, sees development as
related primarily to the ability of the locality to exploit and build on its comparative advantages
and local economic potential. It therefore tends to rely more on improving the basic local
conditions for development and reducing the dependence of the local economy on one or a
limited number of local employers. To achieve these goals a variety of instruments, including
business support systems, educational programs, and micro finance, will usually need to be used
in tandem with more traditional instruments.
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As stated earlier, LED is a collective initiative of development actors who have stakes in
development of a given locality and which aim at building economic capacity and competitive
advantage of a locality and enhancing opportunities for job creation as well as improving living
conditions of local population.
LED is designed and executed in the context of national economic policy frameworks and
development agendas. The national monetary and fiscal policies, employment laws, investment
laws, customs regulations, five years development plans, urban development polices, MSE
development policies and programs are some of the key national frameworks determining the
context for LEDS. However in terms of determining policy instruments and the role of key actors
LEDS can also have their own distinct frameworks.
Accordingly, LED differs from other development programs either by its spatial scale or sectoral
focus since territorial limit of LED is local and its main focus refers to economic development.
On the other hand, spatial limit of LED could hardly be equated with geographical coverage of
national or regional economic development programs. Indeed, the distinction between local and
regional in terms of geographical limit can be blurred, and is very much case specific. For
instance one may identify local economic development with cities or municipalities, and regional
economic development with aggregates of cities. However, different countries define
municipalities in different ways. Sometimes an urban agglomeration in economic terms is a
functional entity consisting of several municipalities. In other cases, a municipality encompasses
a set of cities without particularly strong economic interaction.
In general, definition of local and regional geographical unit very much depends on specific
cases. The only thing that we can certainly say is local economic development program
addresses a smaller geographic aggregate than regional. Moreover, LED and Local Development
Program of a given locality cannot be identical, even if both refer to the same spatial unit. LED
specifically refers to economic issues, while local development program could encompass other
noneconomic goals, such as social, environmental, physical and institutional developments.
Accordingly, LED should not be confused, conceptually, with other development programs that
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take place at local level. In other words, all development programs undertaken at local level are
not LED. LED has its own peculiar features and specific focuses; it is about,
• Creating favorable environment for business improvement,

• Promoting competitiveness of local firms,
• Creating opportunities for start up of new businesses,
• Job creation, and
• Improving quality of life for all inhabitants in a given locality.
Purposes of LED
The purpose of local economic development (LED) is to build up the economic capacity of a
local area to improve its economic future and the quality of life for all. It is a process by which
public, business and non-governmental sector partners work collectively to create better
conditions for economic growth and employment generation.
As discussed earlier, the growing pressure of global competition on domestic producers is one of
the key factors that forces local government to engage in LED undertakings. However, LED is
not only about integration into external markets. In fact, this is often the main preoccupation and
rational for local economic development. But local economic development ought to be more than
that; it can also refer to a location, which is hardly touched by forces of globalization. In such
cases, the rational for local economic development would be to close local gaps. This is true
because, it is not a rare case that local economies are fragmented; business opportunities are not
exploited due to their invisibility and local companies look for external suppliers and customers,
rather than local ones. Thus, in such cases, the focus of LED would be stimulating interactions
between local businesses so as to enable them to create new business opportunities among
themselves.
Moreover, LED is also about enhancing local potentials. It is not rare to find local economic
development actors with just one thing in their mind: how to attract big external investor who
brings thousands of jobs. But these investors are rare in the sense that the possibility of getting
big investors is through stiff competition. These competitions are between cities nationally and
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internationally. Since investors are likely to invest in a more favorable environment cities and
towns in the poor countries in Ethiopia must work hard to create a competitive investment
environment, regionally, nationally and internationally. Thus it is necessary to recognize that one
purpose of LED is to progress the local economy into a competitive investment environment.
Therefore, it is more promising to enhance the competitiveness of companies, which are already
there, and to stimulate and support the emergence of new companies by harnessing local
potentials and enhancing entrepreneurship development.
Here, it seems important to note that competitive advantage refers not only to competitiveness of
local firms, but also competitive advantage of a locality as a whole. Attracting investment which
otherwise would go elsewhere and create jobs and income in another city, is as important as
retaining existing firms by creating more favorable conditions to do business in the locality as
compared with other locations.
Although it is not possible to divide the LED process it into clearly distinguishable,
chronological steps or phases, a successful LED process will usually contain six stages:
a) territorial diagnosis;
b) sensitizing of stakeholders;
c) promotion of a local forum;
d) design of a strategy;
e) implementation; and
f) evaluation and monitoring.
In reality, these phases tend to be blurred and will feed into each other. For instance, problems in
defining a strategy may lead to a return to the diagnosis phase in order to gather further
information that can inform the strategy formation process.
Due to its focus on bottom-up, participatory development and the tendency to combine social
and economic roles, LED is often confused with community development approaches that seek
to move away from top-down, economic growth focused development strategies. Although LED
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shares some of the same methods and goals as such community development approaches, it is
important to distinguish between the two.
Community development strategies can be regarded as fundamentally pro-poor strategies which

are essentially about achieving social rather than economic goals. They address important
problems, but tend to concentrate on short-term survival and on the alleviation of social
problems, leaving many of the economic issues that lie at the basis of underdevelopment
virtually untouched. The initiators of community development projects are generally agents from
outside the locality, such as NGO‟s, international donor agencies, national governments, or
international organizations. Rarely are community development strategies initiated within the
community itself, with local governments, and local social and economic stakeholders often
taking a rather passive role in the back seat of these processes.
LED strategies, in contrast, are primarily aimed at increasing economic growth, but also share
the goals of poverty alleviation or the greater inclusion of previously excluded groups in social
and economic life with community development strategies. Both sets of goals are clearly
compatible, but LED has the overall advantage over community development that it not only
aims at alleviating poverty and encouraging a greater inclusion of previously excluded groups in
social and economic life, but also at generating greater welfare for all. This is the principle that a
rising tide raises all boats.
The actors involved in both sets of strategies also vary. While, as mentioned above, external
actors are the key backers of community development strategies, LED necessarily emerges from
and is driven by internal actors. LED is based on the formation broad coalitions of actors,
including local stakeholders, international organizations and NGO‟s, but with local stakeholders
owning and taking the leading role in the process. Local governments are essential in the
formulation and implementation of the LED strategy. During all phases of the project, the
initiators will seek to adopt an all-encompassing approach, involving local firms as well as
residents and social and political groups.
How does the LED approach fit within the general development agenda?
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Although the LED approach differs from both top down and community development strategies
in important ways, it is not incompatible with them. Rather than being a substitute to existing
approaches, local economic development initiatives can complement existing development
efforts.
Localities do not exist in isolation. Policies formulated at the national level greatly affect the
strategies open to them. Territories need to actively engage with such top down national
strategies for development, in order to devise strategies that are both effective and feasible. By
balancing this focus on the national framework with a strong local dimension, LED allows
territories to find new ways to exploit local strengths, and minimize the negative effects of
weaknesses.
Similarly, LED initiatives can build on and strengthen community development projects. The
social capital and formal and informal organization created by community development form an
invaluable asset for emerging LED efforts. Through its focus on the poor and socially excluded,
community development projects can lay the ground work for a more inclusive LED project that
marries economic and employment goals with poverty reduction and social inclusion.
An enabling environment for LED

The likelihood of LED making a valuable contribution to creating sustainable and decent
livelihoods within a locality is influenced by local, regional, national, and international factors
alike. This is true at every stage of the process, from creating a local forum, to gathering data,
formulating and implementing a strategy, and evaluating and monitoring the efforts.
As discussed, a successful LED process includes a wide range of stakeholders in the decision-
making process. Especially in conflict-prone areas, creating social dialogue may be a complex
task, which requires specialist training and strong institutional structures. National governments,
NGOs, and international organizations can all play a role in facilitating this process by creating
the right incentive structures, helping localities to acquire the necessary skills, and providing
technical assistance where needed.
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Once a functioning local forum is created, it needs to posses the necessary powers, resources,
and skills to be able to formulate and implement an LED strategy that can truly address local
issues. By decentralizing powers and resources and helping localities acquire the necessary skills
to effectively use those powers, national governments can greatly facilitate this process. In
addition, higher levels of government can assist local actors to acquire the data they need in
order to formulate a successful strategy. In the absence of such government action, international
actors and NGOs can often help to fill the gaps.
Finally, in order for an LED strategy to develop and evolve, local stakeholders need to have the
ability to monitor and evaluate projects adequately. This requires both local capacity and the
creation of appropriate institutions for monitoring and evaluation from above. Again regional,
national, and international actors can all potentially play a role in this process. In other words,
every phase of the LED process is influenced by local capacities as well as national and, at times,
international factors. The subsequent section will discuss the influence of the wider environment
on the likelihood of success.
Two key elements in the viability and success of LED strategies are the national and the
international environment.
The International Environment

The international environment can play are role in LED process in two primary ways. First,
international markets, trade, and investments can shape the opportunities and threats faced by
localities. Secondly, NGOs and international organizations may play a role in the LED process in
terms of initiating and (co-)financing a project as well as providing technical assistance and
training.
Let us start by briefly considering the effect of the international environment on the opportunities
and threats faced by a locality. The extent to which globalization and the related changes in
trade, investment, and production will affect a territory depends on the position of the locality
within the global economy. A territory that competes mainly on a national or regional scale will
only be indirectly influenced by these trends through the effects they have on the economy of
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other territories within the country. A territory that is able to compete with localities in other
countries, by contrast, will be much more directly affected.
In both cases, local actors will need to take care to consider developments in all relevant areas
when they devise an LED strategy for the territory. LED projects that ignore relevant trends
outside the locality run the risk of developing strategies that do not materialize on potential
opportunities or fail to address important threats. On the other hand, unrealistic expectations
regarding the ability of a locality to become a national or international player can lead to
unnecessary data gathering and overly ambitious development strategies.
Aside from the influence of international markets, trade, and investment on the development
opportunities open to a locality, the international environment can also influence LED projects
through the involvement of international actors like NGOs and international organizations.
Especially in the absence of government decentralization, such actors are often crucial in
supplying local communities with the impetus, expertise and resources necessary to initiate a
successful LED project. Through providing technical expertise, practical training, and support in
building the needed institutional capacities, they can play an important facilitating role.
The involvement of international organizations aids the spread of the LED approach to areas
countries where national policies are not conducive to the approach. In addition, these
organizations have an important role to play in filling local capacity gaps. However, localities
that start a LED project on the basis of short-term external support, whether international or
domestic, will need to work hard to internalize the process and find alternative sources of finance
in order to ensure the long-term sustainability of the project.
The National Environment

National policies also have an important role to play in promoting economic growth and
employment. However, most of the policy options open to national governments have an impact
on overall economic growth. Though they can improve the general development prospects within
the country, they do not address the problems of specific territories. Where national development
policies do target a specific region or locality, they are often focused on improving infrastructure
34
or diverting economic activity away from one area in favor of another. Often such policies do not
match local capacities very well and as a result territories have failed to use them to their full
advantage.
By providing localities with the powers and the resources to develop targeted projects at a
smaller scale, national governments can help communities to exploit potential competitive
advantages and increase local employment opportunities in a more fruitful and sustainable way.
However, this does not mean that the national environment no longer plays a role in a territory’s
development. Both the quality of governance and the economic situation in a country will have
an impact upon how the LED approach can be used and implemented. It is now widely accepted
that the quality of governance has an important effect on the development prospects of a country
as a whole and the territories within it. The traditions and institutions by which authority is
exercised profoundly affect citizens and private actors alike. The way in which a government is
selected for instance determines who has an input in the decision-making process and how public
resources are allocated across social groups. The capacity of government actors to formulate and
implement sound policies in turn influences both the quality of public goods and services and the
degree to which the regulatory environment facilitates or hinders private sector development.
Likewise, the political stability of a regime, the incidences of violence in a polity, and the
enforcement of the rule of law affect both the security and rights of citizens and the
attractiveness of a market for domestic and foreign investors.
In addition to the governance setting, the economic environment within which a locality needs to
shape its future also influences the development opportunities open to them. Here too national
governments have an important role to play in providing localities with the opportunities and
incentives to pursue productive and sustainable development strategies. At the most basic level,
key macro-economic variables, like inflation, exchange rates, interest rates and the extent of
government borrowing, shape the development prospects open to a territory. Central government
actions influence these variables and thereby shape the risks in doing business, the cost of capital
and the attractiveness of the national market for domestic and foreign investors alike. In addition,
economic policies like deregulation, privatization, and trade and capital market liberalization can
35
create both opportunities and threats for localities. Through taxes, tariffs, and penalties, and
subsidies, central government can further influence these opportunities and threats and provide
more favorable conditions for some economic activities than others.
Although a favorable setting in terms of economics and governance clearly enhances both the
opportunities and the resources available to territories, it is not a prerequisite for successful LED.
In fact, local economic development can even provide a pathway to sustainable and quality
employment, community reconciliation and increased equality for territories in post crisis
situations. Hence, the economic and governance environment shapes the type of LED project
that is feasible, rather than the applicability of the approach in general. In a favorable governance
setting, the local government may for instance be in an excellent position to champion the LED
initiative and take a leading role in the process. Where governance is poor, the constitution of a
new body is usually needed in order to provide a neutral and reliable forum for dialogue between
local stakeholders. Where the economic setting is favorable, LED can focus on exploiting the
available opportunities to foster economic growth and job creation. As the economic situation
deteriorates and the opportunities for productive growth diminish, the focus may shift towards
finding ways to minimize the negative effects this has on the territory. The LED strategies
developed in these areas are likely to have a stronger focus on combating poverty and inequality.
Overall, the role of governance and institutions is crucial. “Markets are not free floating
phenomena described in neo-classical theory”, but they are “social constructs made and
reproduced through frameworks of socially constructed institutions and conventions”. Correcting
for market failures requires collective institutions “for instance to underpin investment in public
goods, new generic technologies, or patient capital markets for smaller firms”. However, while it
may be accepted that collective informal and formal institutions thickness is important in
development strategies and there is little known about what improving institutional quality
means on the ground for those localities diagnosed with institutional inefficiency. For example,
there is a lack of consensus as to whether institutions may be a natural outcome of development,
or a prerequisite. It is much easier to attribute success of regions to adequate institutions than to
36
prescribe a formula to least favored regions as to how they can develop their institutions to foster
growth. Thus, there may be relatively little a government can do in correcting for a deficiency.
Furthermore, lagging regions diagnosed with insufficient institutions will suffer opportunity
costs in order to „create institutions‟. This may not be the best use of funds for a lagging region
with potential challenges in other aspects of development such as infrastructure and human
capacity. A development plan in an institutionally deficient region should focus on their
strengths and move forward with the growth strategy, while at the same time using the strategy
in order to encourage capacity building and the improvement of institutions.
There are also other factors influencing a countries development trajectory. Adequate local
institutions in lagging regions may not be sufficient to counter powerful forces of agglomeration
in economically thriving regions and attract investment in the lagging regions. Institutional
development is a slow process and other factors, such as investment and human capital can
determine the evolution of institutional design. Adequate institutions may not be sufficient to
bring investment to the region. For example China has yet to adopt formal private property rights
but enjoys major investments as the world’s fastest growing economy over the past two decades,
while Russia has a private property rights regime in place but investment remains low.
Thus, prioritizing institutional quality as a prerequisite for a development strategy may have
important implications for growth because little is known about how to build institutions,
opportunity costs are also associated with institutional building, and other factors may be more
influential for growth. In the end capacity and institution building should come hand in hand
with the strategy, with development strategies including a capacity building dimension and the
emerging improved institutions revitalizing the strategy in a dynamic virtuous cycle of
development.
The local setting and the likelihood of success

As we have seen, the national and international roles shape the LED process in important ways.
LED is however primarily a locally owned and managed development process. Though local
actors need to take account of the wider environment and coordinate actions with other local,
37
regional, and national actors, they are ultimately responsible for formulating and implementing
the LED strategy. In doing so, they set the goals of the exercise and greatly influence the
likelihood of its success.
Just as success in LED is a multifaceted concept, so are the local factors that increase the
likelihood of its success. The local economic development process itself, the resulting strategy
and the attention paid to sustainability all play a role in making the LED approach work for a
territory or locality. Although a simple recipe for success does not exist, this section will discuss
these features of the LED approach in turn, in order to uncover some best practices and common
pitfalls.
Chapter Summary
A region can be defined on the basis of economic, ecological, socio-cultural and political factors.
In economic terms, a region can be defined as an open spatial system which is under the
authority of a central government for purposes of general economic policy and which is situated
within the context of a larger national entity within which products and factors of production
circulate freely. A more relevant definition from the perspective of regional and local
development is the one that views regions as political or administrative units commonly referred
to as “Planning regions”. The advantage of this approach is that political and administrative
boundaries directly correspond to the boundaries over which planners and politicians design and
implement policies.
The major goals of regionalization are reducing regional inequalities, promoting economic
development, and bringing about political stability. The first goal has a socio-political equity
nature and addresses the mechanisms that may help to alleviate undesirable development
disparities in the space-economy. The second goal refers to ‘allocative efficiency’ and addresses
38
the economic issue of an optimal spatial-economic use of scarce resources so as to generate a

maximum value of output. In addition to these economic goals regionalization (or
decentralization) can also serve to bring about political stability because it enables sharing of
political power among different people within a country and creates a situation where people
may agree to share a common country/state while retaining substantial degree of self government
over matters essential to their identity as people.
The concept of local (or endogenous) development defines a particular form of regional
development in which "local" factors and the local spirit of entrepreneurship, local firms or local
financial institutions constitute the principal bases for regional economic growth. Accordingly,
Local Economic Development (LED) can be defined as a development initiative of local
stakeholders aiming at building local economic capacity, strengthening competitive advantage of
a locality, enhancing opportunities for job creation as well as improving quality of life of local
population.
Review Questions
1. Define the concepts of region and regional development.
2. Distinguish between national, regional and local development.
3. Describe goals of regionalization.
4. Explain the causes of regional inequality and how regionalization helps income
equalization.
5. Discuss the rationales of local and regional approaches to development.
39
Chapter Two
Decentralization, Globalization and Regional Development
Introduction
Dear learner, in this second chapter, we will build on the concepts addressed in the first chapter
and further extend to the relationships among decentralization, globalization and regional and
local development. We will particularly see details of the rationales of focusing on development
of regions and localities in the era of globalization and how regionalization and decentralization
of development efforts square with the unfolding globalization.
Objectives
After studying this chapter, you should be able to:
 Explain how globalization has impacted on the process of development
40
 Discuss how and why globalization has necessitated regionalization and localization of
development
 Identify and explain main factors for regionalization and localization of development
that are brought about by globalization
 Explain the relationship between the revolution in ICT, globalization and regionalization
 Describe the implication of the advent of knowledge economy for regional growth and
development;
2.1. The Link between Globalization, Decentralization and Regionalization

Over the past three decades the process of globalization has brought forward major changes in
the economic landscape. Since the 1980s, the unprecedented expansion in volumes of
international trade and capital mobility across countries has dramatically altered pre-existing
equilibria based on the strong role of nation states in regulating, orienting and/or restricting such
flows. Therefore, globalization has gradually frayed nation-state level economic institutions as
they were known in the post-WWII period. At the same time, globalization has contributed to the
progressive evolution of the industrial organization paradigm of mass production towards more
flexible and successful production systems as a way to respond to the increasing competitive
pressure of international markets. As a result, 'standardized' production became progressively
obsolete in favor of a specialized and more flexible-to-demand-changes system, which allowed
firms to survive to the uncertainty of global challenges.
Besides, the importance of Multinational Enterprises (MNEs) has risen and contributed further in
the weakening of national borders and economic institutions in managing international flows of
goods and capital. The increased importance of MNEs appears to be a response to the changes
41
determined by the process of globalization as a way for firms to adapt their industrial governance
and competitiveness to the new economic environment. The magnitude of these processes has
encouraged some commentators to conceive the globalized world as a ‘flat world’ as well as to
evoke notions such the ‘end of geography’ and the ‘death of distance’. In this perspective
globalization has basically eroded differences between places through the international reach of
its technological and socio-economic forces. As such, locations seem to be emptied of their
particular characteristics and local actors fundamentally lose the capacity to shape regional
destinies.
Further, improvements in communication technologies and the fall in transportation costs reduce
the importance of physical distance in the location of productive activities. Consequently,
economic development may virtually occur everywhere without any role being played by local\
spatial factors. Convergence in incomes across regions and countries would thus be the ultimate
result of globalization.
This conceptualization of both the nature and trajectory of the process of globalization is in sharp
contrast with the theoretical insights and empirical evidence produced by a large (and growing)
body of literature in the fields of institutional and evolutionary economics, internal business
studies and economic geography. In all these disciplines there is increasing awareness that the
process of globalization is progressively increasing the importance of regional processes and the
role of local actors in shaping development trajectories. Since the 1980s it is apparent that some
regions (and not others) have followed successful post-Fordist development paths.
The implication of the above discussions is that, the importance of local specificities has
increased rather than being marginalized in a context of increasing globalization and functional
economic integration: development processes unfold at the local level and globalization
reinforces such patterns. In other words, the emergence of a ‘regional world’ is essentially
underpinned by the spatially-bounded localized forces that trigger economic development and
push welfare to agglomerate in specific locations within countries. Hence, economic
development stemming from industrial renovation after mass production also seems to coincide
42
with territorial development. As such, in spite of some evidence in favor of convergence between
countries in the last decades, disparities within countries have increased in a number of cases,
suggesting that economic development patterns are characterized by strong spatial concentration
at the regional level and that distance and geography do matter in a global world.
In addition, such insights also suggest that national economic growth tends to be driven by the
performance of a limited number of local economies within nation-states. Particularly, urban
areas appear to be the physical loci where economic growth most likely concentrates. Indeed,
most industrial production, skilled labor and higher wages tend to agglomerate in cities where
geographical proximity between economic agents facilitates communication and creates an
environment which favors frequent interactions and flows of ideas. This basically consists of the
Marshallian idea of agglomeration economies related to knowledge diffusion. The importance of
such interactions that give rise to positive externalities in the form of technological or knowledge
spillovers is particularly crucial for economic development. Moreover, empirical evidence
suggests that knowledge externalities provide relevant explanation for spatially uneven economic
and innovative performance.
Following this line of reasoning, knowledge-intensive activities become fundamental for

economic performance, following distinctive patterns of geographical distribution and
contributing to generate localized sources of competitive advantage. As such, cumulative and
path-dependent processes of accumulation of knowledge shape the distribution of welfare across
space, suggesting the existence of a more complex economic geography than that of a flat world.
In other words, economic development is ultimately spurred at the local level where knowledge
externalities are generated.
While codified knowledge becomes largely available and accessible as a result of improvements
in communication technologies, tacit knowledge remains spatially bounded and its economic
value has even increased as a consequence of its relative scarcity in respect to codified
knowledge. Similarly, while globalization has determined a net fall of the transmission costs of
43
codified knowledge, economically valuable knowledge which is tacit and complex by nature
increasingly requires spatial proximity to be transmitted, absorbed and successfully re-used.
As mentioned, in combination with highly localized drivers of economic performance, the

process of globalization has also emphasized the developmental impact of the international reach
of firms which determine the degree of global connectivity and international competitiveness of
their host regions. What emerges from this picture is basically that increasing international trade
and capital mobility crucially sharpen the regional character of development processes,
emphasizing the role of geographical proximity in shaping successful economic performance.
In summary, rather than reducing the importance of place, globalization has made localities more
important for economic growth and prosperity. Space is becoming increasingly “slippery‟, in the
sense that capital, goods, people, and ideas travel more easily. In this context, the unique aspects
of a locality and the ability to create and strengthen a comparative advantage are becoming more
and more important. By successfully rooting economic activity in the local social and economic
fabric, territories have the potential to become a source of vitality and strength within the
national economy. However, if a locality fails to engage with the challenges posed by
globalization, it runs the risk of being marginalized.
The next sections will discuss the main effects of globalization and the opportunities and threats
they pose to territories. We will start by examining the direct effects of the increased mobility of
goods, capital and labor on local economies. After this we will turn our attention to two related
trends; the trend towards the decentralization of governance and the increase in interpersonal and
spatial inequality.
The increasing interconnectedness of the world

Globalization has increased the mobility of goods, capital, and labor. These developments pose
both opportunities and threats to localities seeking to advance the working and living conditions
in their territory. Though they are interrelated, we will discuss these three trends and their
impacts independently.
44
Goods
Trade liberalization and the decline in transportation costs have dramatically increased
international trade. Since 1970 world trade has been multiplied by a factor of ten in real terms
and, as a percentage of GDP, world trade has risen from a mere 27 per cent of global GDP to
more than 55 per cent in 2006. Although most cross-border trade still takes place among
developed nations, the trend is increasingly affecting all parts of the world, with East Asia and
the Pacific, Latin America, and South Asia as the regions of the world witnessing the greatest
expansion in trade.
Globalization has not only increased the volume but also the nature of international trade. Firstly,
the kind of goods that are being traded has changed. The rapid expansion of manufacturing trade
in the last decades has in many cases occurred at the expense of trade in agricultural goods. As a
result the proportion of agricultural goods in the composition of trade has fallen. The increase in
trade may therefore favor the, often urban, areas hosting manufacturing industry over the more
rural areas specializing in agriculture. Until 2000, the decline in prices of primary commodities
relative to manufacturing goods since the 1970s and the related deterioration in the terms of trade
reinforced this trend.
Taken together, these trends offer both opportunities and threats to localities in low and middle-
income countries. The increase in trade makes it possible for territories in countries with
relatively small economies to serve larger markets and capitalize on their competitive advantage
more fully. On the other hand, the drop in transportation costs and trade barriers also reduced the
protection enjoyed by the more vulnerable sectors and enterprises and people employed within
them. Localities therefore need a way to engage with the increased openness to trade that will
allow them to benefit from these developments.
Capital
Not only trade, but also investment has become increasingly footloose. Foreign Direct
Investment (FDI), which accounted for a mere 0.5 per cent of global GDP in 1970, now
represents almost 3 per cent, almost six times as much in less than forty years . The biggest rise
45
in FDI took place from 1990 onwards, with East Asia as the main driver of the process, followed
shortly afterwards by Latin America and the Caribbean. Again this trend is not universal. In large
areas of Sub-Saharan Africa and South Asia, formal aid still far outweighs FDI as a source of
external finance. In the higher income countries in Asia and Latin America, by contrast, FDI
often accounts for 70 to 80 per cent of total capital inflow. This reflects both geographical
differences and the general finding that FDI inflows and stocks tend to be lower in poorer areas,
especially if incidences of absolute poverty are relatively high.
As foreign aid has tended to stagnate over recent decades, FDI is usually seen as a welcome new
source of capital. In addition, such direct investments add know-how and technology as well as
channels for marketing products internationally to the local economy. FDI therefore has an
important role to play in disseminating best-practices and technological advantages developed in
high income areas to low and middle income countries.
In search of these benefits, many countries have opened up their markets to foreign investors and
are actively trying to attract FDI. However, the effects of FDI differ from territory to territory. In
some cases, it is feared that foreign investment is „crowding out‟ domestic investment, in the
sense that it pre-empts investment by local entrepreneurs or displaces existing domestic
producers.
People
In addition to goods and capital, people have also become increasingly mobile. As a result of
lower transportation costs and better infrastructure, both internal and international migration has
risen significantly in recent decades.
In terms of percentage of the global population, international migrants are still very much a
minority. In 2005, the migrant stock was estimated at close to 190 million, or 3 per cent of the
global population. However, if we look beyond the migrant stock, to measures such as inflows of
working-age immigrants as a percentage of new additions to the working-age population, it is
clear that migration is becoming increasingly important. This trend has notable effects on
recipient and sending countries alike.
46
For the, mainly high income, countries that are net recipients of migrants, migration offers an
opportunity to fill gaps in the labor market and deal with the problems associated with an ageing
populations. On the other hand, large scale migration from low and middle income countries is
often feared to have a negative effect on the employment opportunities and wages of the native
population. Although little evidence is found of such an effect overall, this may be the case in
sectors that have a large migrant workforce, i.e. low skilled service and manufacturing sectors.
Regardless of the true economic effects of migration, rising migrant flows have been
accompanied by increases in xenophobia in many western societies. In response to such
pressures, the main destination countries have considerably tightened general immigration rules.
Simultaneously, policies are put in place to attract individuals with specific skills that are needed
in the local labor market.
In contrast to high-income countries, many low and middle income countries are experiencing
net out migration of their nationals. Given the changes in the migration policies of many high
income countries, legal economic migrants are now increasingly high skilled. Especially in
regions that are relatively far from the main destination countries, such as Sub Saharan Africa,
low skilled emigration as a percentage of low-skilled workers is very limited. If we look at
emigration rates amongst those with tertiary education as a percentage of total tertiary-educated
people, this picture changes dramatically. With an average of 15 per cent, Sub-Saharan Africa
faces the highest rate of emigration as a percentage of tertiary-educated people. Other low and
medium income areas have seen a similar trend, with the increases in the percentage of skilled
people in the emigrant population outweighing the increase in skills in the population as a whole.
Even though international migration is increasing, migration between regions and localities
within a country is still far more prevalent. One expression of this type of migration is the rapid
growth of urban populations to the detriment of rural areas. Although natural population
increases and reclassification of areas as urban zones account for a large part of the rapid
increase in the urban population, migration from rural to more urbanized areas plays a significant
role too. Apart from rural-urban migration, rural-rural migration is still occurring in low and
middle income countries.
47
Both rural-urban and rural-rural migration can benefit individuals and households in numerous
ways. Most importantly, migration can enhance employment opportunities, by giving individuals
access to more vibrant and promising labor markets. In many cases, migrants also shift from one
sector or activity to another, giving them opportunities to acquire new skills and engage in more
productive and higher income activities. In addition, the spread of family income over differ
kinds of economic activities has an important risk-spreading effect.
However, migration does not always have such positive effects. Areas experiencing net out and
net inward migration both face important social and economic problems. Territories of out
migration often face the problems associated with an increased dependency ratio. As young
adults emigrate in search of a better future, they leave behind the children and the elderly. This
decrease of the working age population poses a real development challenge to areas of net out
migration.
Net receiving areas, on the other hand, will face another set of problems. Overcrowding of both
the labor market and the physical infrastructure can pose real development issues. In devising
policies to deal with these issues, local authorities need to balance the concerns of migrants with
those of existing residents. To deal with the challenges posed by internal and international
migration, territories will have to devise active strategies to provide their populations with
productive employment opportunities and decent living conditions.
Decentralization
Together with the increasing rise in the mobility of goods, capital, and people, globalization has
been associated with another important change, that of the decentralization of governance. The
move towards decentralization, or the transfer of power and resources to regional or local of
government, has been evident since the 1970s. Although most pronounced in high income
countries, low and middle income countries are also becoming progressively more decentralized.
In the early 1990s, sixty-three out of seventy-five low and middle income countries with a
population in excess of five million were already actively pursuing decentralization policies.
Since then, the trend towards regional devolution and decentralization has even accelerated.
48
Decentralization can have a number of benefits. By bringing government closer to the people,
decentralization can enhance the transparency, responsiveness and accountability of government.
The simple and directly relevant nature of especially the local policy agenda can encourage
groups that were previously less active in the democratic process to participate. In addition,
decentralization can lead to innovation in the way the government provides public goods and
services. By transferring resources and responsibilities to the local level, public spending can be
adapted to local preferences. If a new method proves to be effective in one context, it can also be
applied in other areas. Therefore decentralization can improve both the allocation of public funds
and the efficiency with which they are used.
However, the ability of decentralized systems to deliver these benefits has been far from
universal. In many cases, regional and local governments still lack the de facto powers to make a
real difference to the lives of people in their territory. Where substantial powers are
decentralized, these are often not accompanied by adequate resources. In addition, regional and
local governments are often the first to feel the pinch when economic crises affect the national
budget.
Where sufficient powers and resources are available, capacity constraints at the local or regional
often form an obstacle to the successful formulation and implementation of policies. As Figure 5
shows, low and middle income countries generally perform less well than high income countries
in terms of the quality of policy formulation and implementation. These capacity constraints tend
to increase as we move from the national to the regional and the local scale. These capacity
constraints can limit the benefits decentralization.
On top of this, decentralized systems have not always succeeded in increasing the involvement
of previously excluded groups and in particular the poor. The desire of national elites to create
and sustain their power base plays an important role in creating systems of decentralization that
reinforce vested interests and existing patterns of patronage. As a result, the allocation of
resources may not represent the preferences of all groups in society equally, diminishing the pro-
poor effects of decentralization.
49
Decentralization offers territories real opportunities to shape their future and deal with the
challenges of globalization in a productive way. However, the design of the decentralized system
and way powers and resources are managed locally will have implications for the effects of
decentralization. National, regional, and local actors alike have an important role to play in
making the system work better. By providing adequately funded mandates and increasing
accountability at every level, national governments can create an environment that is conducive
to success. By ensuring that wages levels are competitive and improving the training of regional
and local governments, the capacity of civil servants, and with it the effects of decentralization,
can be further improved.
Rising inequalities
The combination of the process of globalization – and specifically the opening of countries to
trade – with the decentralization of governance processes has coincided with a rise in inter-
personal and inter-territorial inequalities. Although the evolution of inequalities across the world
is still the subject of heated debates, there is increasing consensus that both inter-personal and
inter-territorial inequalities are increasing. The general trend has been for a moderate rise in
inequalities. Most countries around the world for which sub-national data are available fall into
this category. Places like central and Eastern Europe have witnessed a very rapid increase of
inequalities, as has been the case in countries like Sweden or Ireland. In a small number of
countries – such as the US, Canada, or South Africa – regional inequalities have remained stable,
while the number of countries observing a decline in regional inequalities can be counted with
the fingers of one hand (Brazil seems to be the only case in Latin America over the last two
decades).
The dimension and evolution of inequalities, however, tend to differ according to income level.
The dimension of inter-personal inequalities and regional disparities within countries is, in
general, considerably larger in low and middle income countries than in the high income areas of
the world. In addition, inequalities have also been rising faster in low- and middle-income
countries than in wealthier countries. This trend can be linked to a number of interrelated
changes in the way people live their lives.
50
The rise of a new territorial structure

The combination of globalization, decentralization, and rising inequalities are leaving an
important territorial imprint with which many nation-states are struggling to cope. This new,
more heterogeneous and fragmented territorial structure is characterized by the emergence of
three types of spaces with very different development needs and often within the same national
framework.
The key spaces in this three-tier structure are:

a) Primate cities: Large urban agglomerations that have not only managed to attract massive
rural-urban migration, but also a greater concentration of economic activity. This is mainly
because of their greater accessibility, their larger economies of scale, scope, and agglomeration,
their greater presence of skilled labor and markets and their better capacity to compete in open
markets. These growing urban conurbations – in many cases becoming true megalopolis – attract
large numbers of rural and small-town workers seeking to improve their personal conditions.
However, as mentioned earlier, the other side of the coin, in these cities there are serious
problems of poverty and social exclusion, as well as violence and the rise of large slums.
b) Intermediate city-regions: Medium-sized cities, outside the direct area of influence of the
primate city that often articulate large rural hinterlands. These cities are generally growing
(especially in the developing world) and attracting population from rural areas. But, given their
size and frequent endowment deficiencies, they frequently struggle to find market niches and
become competitive. In the developing world, many of these intermediate city regions are often
becoming increasingly dependent on international aid.
c) Rural areas: Generally remote, with poor accessibility, and with weaker endowments in
human resources and firms, the problems of rural areas differ significantly from those of urban
51
areas. Across the developing world, many of the problems of rural areas are exacerbated by
global restrictions to trade in agriculture and by the greater volatility in the price of agricultural
produce and raw materials
This emerging more heterogeneous and complex territorial structure is undermining the ability of
the nation-state to manage national economies. The needs of large urbanized areas and primate
cities – with their incentives to compete in a more globalized arena – vary with respect to those
of intermediate city-regions and to those of remote rural areas. This makes one-size-fits-all
policies increasingly inadequate to tackle development problems rendering traditional top-down,
supply-side development policies, which are often based on the promotion of industrial sectors or
on improving accessibility, less and less efficient.
Traditional development policies have normally been cut from the same cloth in different parts
of the world. These were normally supply-side strategies, based on a sectoral rather than a
territorial dimension. Decision-making was mainly top-down, with mixed or bottom-up
approaches virtually ignored and with a tendency to rely on financial support, incentives, and
subsidies as key elements of the strategy. Frequently, these policies relied on the imitation of
successful development strategies applied in very different contexts.
Most strategies were based on two axes. On the one hand is the development of transport
infrastructure. Infrastructure has frequently been perceived as the panacea for economic
development. Solving the accessibility problem of remote areas or addressing congestion in core
ones has traditionally been popular with politicians and the public at large and generally regarded
to yield high returns to investment. Development policies thus often relied almost exclusively on
the provision of roads, railways, sanitation, and water, at the expense of other policy areas that
required intervention. While the provision of these public goods is necessary to trigger
development, it is not sufficient when other development bottlenecks are not addressed. Hence,
many of these policies have not delivered the expected returns. One such example has been the
case of the Italian Mezzogiorno, where a strategy based on infrastructure and the attraction of
52
inward investment did not manage to cut the development gap between the Mezzogiorno in the
South of the country and the rest of Italy.
On the other hand, many policies have aimed at promoting industrialization and attraction of
inward investment. Industrialization strategies and the attraction of large firms to territories with
a weak industrial fabric have been as popular a strategy as infrastructure investment. However,
setting up or importing firms to areas where few or no synergies with the local economy can be
established may create a situation is which many of these industries remain detached from the
local environment, yielding little or no direct benefit to the local population and often relying on
subsidies or incentives to remain active.
The desire to attract foreign investment has also in many cases derived in locational tournaments,
where different governments try to outbid each other to attract multinational companies,
generally with pernicious effects for the local economy.
Hence, traditional top-down, supply-side development policies have been, and are still, popular
because of their simplicity and popularity, but tend to be unbalanced, only relevant to the formal
sector, and ultimately incapable of delivering sustainable development and decent work. In
addition, these policies are struggling to cope with the more heterogeneous economic reality
emerging from globalization and, in some cases may be even contributing to enhance economic
agglomeration and regional inequalities.
2.2. Globalization and Regional and Local Economic Development

The general failure of traditional top-down, supply-side development strategies to deliver
sustainable development demonstrates that there is no simple and universal way to tackle the
challenges posed by globalization. They also show that there is no unique general solution to the
development problems of every area or region, regardless of the local context.
This failure of traditional strategies in an increasingly globalized context has triggered a

thorough rethinking of how development problems can be addressed. As a result, a series of
tailor-made approaches for the development of sub-national areas has emerged. These
53
approaches, generally grouped under the name of local and regional development or local
economic development (LED), highlight the advantages of focusing on the territorial, rather than
on the sectoral dimension and of integrating different development axes in one strategy. They
also put a greater emphasis on governance structures and institutions in order to achieve greater
sustainability and generate not just work, but quality work.
In short, LED champions a development approach aimed at increasing local economic potential
and sustainable employment through giving local governments the tools to devise locally tailored
strategies in cooperation with local, regional, and international stakeholders and actors. It has
surfaced as a complementary development strategy that could potentially offer opportunities for
growth to all areas.
In low and middle-income countries, LED has gradually been introduced for similar reasons. The
changes in the national and international economic environment, combined with the persistence
of problems of slow economic growth and poverty in many areas, fostered a reconsideration of
top-down strategies. Globalization and the effective inability of many central states to intervene
at the local level have created a need for more locally based initiatives.
54
Chapter Summary
Regionalization has become increasingly important for economic development because
geography matters for economic development in the sense that forces that lead to innovation and
growth are rooted in specific places or regions (rather than countries) and they cannot be easily
moved elsewhere or replicated in different contexts.
The importance of local specificities has increased rather than being marginalized in a context of
increasing globalization and functional economic integration: development processes unfold at
the local level and globalization reinforces such patterns. In other words, the emergence of a
‘regional world’ is essentially underpinned by the spatially-bounded localized forces that trigger
economic development and push welfare to agglomerate in specific locations within countries. In
short, globalization sharpens the localized nature of innovation and development rather than
alleviating it, since successful regions become able to exploit external knowledge as well as to
serve international markets. On the other hand, the growing awareness about the relevance of
local forces in shaping regional economic development path is reinforced by the increasing
demand for power decentralization from national to regional governments in the last decades.
Decision-making at the local level could be extremely positive for regional development by
encouraging collective action and tailoring strategies to local needs, although some drawbacks
also exist in terms of equity and efficiency. In general, regional economic development theories
highlight that development potential and competitive advantage are strongly localized elements.
55
Review Questions
1. Explain how globalization has impacted on the process of development.
2. Discuss how and why globalization has necessitated regionalization and localization of
development.
3. Identify and explain main factors for regionalization and localization of development that
are brought about by globalization.
4. Explain the relationship between the revolution in ICT, globalization and regionalization
5. Describe the implication of the advent of knowledge economy for regional growth and
development.
56
Chapter Three
Theories of Regional Economic Growth and Development
Introduction
Dear Learner, do you remember the various economic development theories and
models you studied in the course Development Economics?
Most of the theories of regional and local economic growth we are going to study in this chapter
are spatial extensions of the neoclassical economic theories you studied in that course. Hence,
refreshing your memory of those theories and models will help you in studying this chapter as
they have some concepts and assumption in common though not the same.
Besides, the ideas discussed in chapters one and two of this module will also lay the background
for studying this chapter. In chapter one, we discussed conceptual foundations of regional growth
and local development. We also noted that the concept of region in relation to our present study
stands for political and administrative units that serve as “planning regions”. Further, in chapter
two, we saw the rationales for and the relevance of regionalization and localization of
development efforts (initiatives, policies, planning…) in the era of rising globalization.
Against the above conceptual backgrounds, this chapter attempts to give you an overview of the
major theories on regional economic growth and examines its conceptual foundations, major
competing paradigms and recent developments.
57
Objectives
After studying this unit, you should be able to:
 explain the conceptual foundations of theories of regional economic development
 enumerate place based theories of regional economic development
 explain resource based theories of regional economic development
 describe the neo-classical regional growth theory
 explain the role of clusters and agglomerations in regional economic development
 discuss the role of entrepreneurship, knowledge and innovation for regional and local
economic development
 contrast the different theories of regional development and identify their strengths and
limitations
Dear learner, try to remember the major economic development theories you studied in
development economics.
List and describe at least four of the major theories.
Before discussing theories of regional economic development, the following section will provide
you with a short review of the major theories of economic development in general as it will lay a
good background for understanding subsequent sections.
3.1. A Review of Classic Theories of Development

Economic development theory since the mid 20 th century has been dominated by four major and
sometimes competing strands of thought. These four strands were:
(1) the linear-stages of- growth model,

58
(2) theories and patterns of structural change,

(3) the international- dependence revolution, and
(4) the neoclassical, free-market counterrevolution.
1) The Linear-Stages Theories

Theorists of the 1950s and early 1960s viewed the process of development as a series of
successive stages of economic growth through which all countries must pass. It was primarily an
economic theory of development in which the right quantity and mixture of saving, investment,
and foreign aid were all that was necessary to enable developing nations to proceed along an
economic growth path that historically had been followed by the more developed countries.
Development thus became synonymous with rapid, aggregate economic growth.
Rostow’s Stages of Growth

Out of this somewhat sterile intellectual environment, fueled by the cold war politics of the
1950s and 1960s and the resulting competition for the allegiance of newly independent nations,
came the stages-of-growth model of development. Its most influential and outspoken advocate
was the American economic historian Walt W. Rostow. According to the Rostow doctrine, the
transition from underdevelopment to development can be described in terms of a series of steps
or stages through which all countries must proceed. The advanced countries, it was argued, had
all passed the stage of “take-off into self sustaining growth,” and the underdeveloped countries
that were still in either the traditional society or the “preconditions” stage had only to follow a
certain set of rules of development to take off in their turn into self-sustaining economic growth.
One of the principal strategies of development necessary for any takeoff was the mobilization of
domestic and foreign saving in order to generate sufficient investment to accelerate economic
growth. The economic mechanism by which more investment leads to more growth can be
described in terms of the Harrod-Domar growth model today often referred to as the AK
model. In one form or another, it has frequently been applied to policy issues facing developing
countries.
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The Harrod-Domar Growth Model

Every economy must save a certain proportion of its national income, if only to replace worn-out
or impaired capital goods (buildings, equipment, and materials). However, in order to grow, new
investments representing net additions to the capital stock are necessary. If we assume that there
is some direct economic relationship between the size of the total capital stock, K, and total
GNP, Y—for example, if $3 of capital is always necessary to produce a $1 stream of GNP—it
follows that any net additions to the capital stock in the form of new investment will bring about
corresponding increases in the flow of national output, GNP.
The Solow neoclassical growth model, for which Robert Solow of the Massachusetts Institute
of Technology received the Nobel Prize, is probably the best known model of economic growth.
Although in some respects Solow’s model describes a developed economy better than a
developing one, it remains a basic reference point for the literature on growth and development.
It implies that economies will conditionally converge to the same level of income, given that
they have the same rates of savings, depreciation, labor force growth, and productivity growth.
Thus, the Solow model is the basic framework for the study of convergence across countries.
The key modification from the Harrod-Domar (or AK) growth model is that the Solow model
allows for substitution between capital and labor. In the process, it assumes that there are
diminishing returns to the use of these inputs.
Unfortunately, the mechanisms of development embodied in the theory of stages of growth did
not always work. And the basic reason they didn’t work was not because more saving and
investment isn’t a necessary condition for accelerated rates of economic growth—it is—but
rather because it is not a sufficient condition. The Rostow and Harrod-Domar models implicitly
assume the existence of these same attitudes and arrangements in underdeveloped nations. Yet in
many cases they are lacking, as are complementary factors such as managerial competence,
skilled labor, and the ability to plan and administer a wide assortment of development projects.
But at an even more fundamental level, the stages theory failed to take into account the crucial
fact that contemporary developing nations are part of a highly integrated and complex
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international system in which even the best and most intelligent development strategies can fail
to be effective by external forces beyond the countries’ control.
2) Structural-Change Models
This linear-stages approach was largely replaced in the 1970s by two competing economic (and
indeed ideological) schools of thought. The first, which focused on theories and patterns of
structural change, used modern economic theory and statistical analysis in an attempt to portray
the internal process of structural change that a “typical” developing country must undergo if it is
to succeed in generating and sustaining a process of rapid economic growth.
The major hypothesis of the structural-change model is that development is an identifiable

process of growth and change whose main features are similar in all countries. However, the
model does recognize that differences can arise among countries in the pace and pattern of
development, depending on their particular set of circumstances. Factors influencing the
development process include a country’s resource endowment and size, its government’s policies
and objectives, the availability of external capital and technology, and the international trade
environment.
Empirical studies on the process of structural change lead to the conclusion that the pace and
pattern of development can vary according to both domestic and international factors, many of
which lie beyond the control of an individual developing nation. Yet despite this variation,
structural-change economists argue that one can identify certain patterns occurring in almost all
countries during the development process. And these patterns, they argue, may be affected by the
choice of development policies pursued by LDC governments as well as the international trade
and foreign-assistance policies of developed nations. Hence structural-change analysts are
basically optimistic that the “correct” mix of economic policies will generate beneficial patterns
of self-sustaining growth..
3) The international- dependence revolution

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The international dependence revolution was more radical and political in orientation. It viewed
underdevelopment in terms of international and domestic power relationships, institutional and
structural economic rigidities, and the resulting proliferation of dual economies and dual
societies both within and among the nations of the world. Dependence theories tended to
emphasize external and internal institutional and political constraints on economic development.
Emphasis was placed on the need for major new policies to eradicate poverty, to provide more
diversified employment opportunities, and to reduce income inequalities.
Advocates of this theory reject the exclusive emphasis on traditional neoclassical economic
theories designed to accelerate the growth of GNP as the principal index of development. They
question the validity of Lewis-type two sector models of modernization and industrialization in
light of their questionable assumptions and recent developing-world history. They further reject
the claims that there exist well-defined empirical patterns of development that should be pursued
by most poor countries on the periphery of the world economy. Instead, dependence, false-
paradigm, and dualism theorists place more emphasis on international power imbalances and on
needed fundamental economic, political, and institutional reforms, both domestic and worldwide.
In extreme cases, they call for the outright expropriation of privately owned assets in the
expectation that public asset ownership and control will be a more effective means to help
eradicate absolute poverty, provide expanded employment opportunities, lessen income
inequalities, and raise the levels of living (including health, education, and cultural enrichment)
of the masses. Although a few radical neo-Marxists would even go so far as to say that economic
growth and structural change do not matter, the majority of thoughtful observers recognize that
the most effective way to deal with these diverse social problems is to accelerate the pace of
economic growth through domestic and international reforms accompanied by a judicious
mixture of both public and private economic activity.
While the international-dependence revolution in development theory was capturing the

imagination of many Western and LDC scholars, a reaction was emerging in the late 1970s in the
form of a neoclassical free-market counterrevolution. This very different approach would
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ultimately dominate Western (and, to a lesser extent, LDC) development writings during the
1980s and early 1990s.
(4) The neoclassical, free-market counterrevolution

Throughout much of the 1980s and early 1990s, a fourth approach prevailed. This neoclassical
(sometimes called neoliberal) counterrevolution in economic thought emphasized the beneficial
role of free markets, open economies, and the privatization of inefficient public enterprises.
Failure to develop, according to this theory, is not due to exploitive external and internal forces
as expounded by dependence theorists. Rather, it is primarily the result of too much government
intervention and regulation of the economy. Today’s eclectic approach draws on all of these
perspectives, and we will highlight the strengths and weaknesses of each.
Like the dependence revolution of the 1970s, the neoclassical counterrevolution of the 1980s had
its origin in an economics-cum-ideological view of the developing world and its problems.
Whereas dependence theorists saw underdevelopment as an externally induced phenomenon,
neoclassical revisionists saw the problem as an internally induced LDC phenomenon, caused by
too much government intervention and bad economic policies. Such finger-pointing on both
sides is not uncommon in issues so contentious as those that divide rich and poor nations.
On strictly efficiency (as opposed to equity) criteria, there can be little doubt that market price
allocation usually does a better job than state intervention. The problem is that many LDC
economies are so different in structure and organization from their Western counterparts that the
behavioral assumptions and policy precepts of traditional neoclassical theory are sometimes
questionable and often incorrect. Competitive markets simply do not exist, nor, given the
institutional, cultural, and historical context of many LDCs, would they necessarily be desirable
from a long-term economic and social perspective. Consumers as a whole are rarely sovereign
about anything, let alone about what goods and services are to be produced, in what quantities,
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and for whom. Information is limited, markets are fragmented, and much of the economy is still
non-monetized.
Questions for brainstorming
Dear learner, have you ever pondered over questions like the following?
 What are the implications of the general theories of economic development discussed in
the above section?
 “How do regions grow or why do some regions grow more rapidly than others?”
 “Why are regional inequalities (differences in development across regions) so
persistent?”
Now take some ten minutes to ponder over these questions before reading further. Jot down
some of your reflections on these questions.
These are central question in the study of regional economic development. And these central
questions have attracted the attention of a diverse group of scholars during the past fifty years.
Topics that were initially of interest only to economists and geographers are now being
investigated by sociologists, political scientists, and researchers from other social science
disciplines. This growing interest in regional development studies is due in part to the
recognition that the processes driving innovation and national economic growth are
fundamentally spatial in nature. In short, “space matters.” The following sections discuss the
major theories on regional economic growth. Given that this field of inquiry spans several
disciplines, the discussion here is not meant to give a comprehensive survey of all theories in the
field. Instead you will be provided with comprehensive overviews of the most important
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theoretical concepts. But we will first explore the conceptual foundations of theories of regional
economic development.
3.2. Conceptual Foundations of Regional Economic Development Theories

Regional development theory emerged from several different intellectual traditions. Neoclassical
trade theory and growth theory provide the conceptual basis for understanding whether regional
economies will become more similar or more differentiated over time.
The spatial dimension of modern regional growth theory can be traced to several sources.
Location theorists provide a framework for understanding the role of transportation costs in
regional growth and decline. The idea of external scale economies has been rediscovered by
more recent neoclassical theorists and those writing in the flexible specialization tradition.
Finally, ideas from central place theory resurface throughout the regional development literature,
especially in the growth pole theory and in many recent structuralist approaches.
The Interregional Convergence Hypothesis

Most early theories of regional economic growth were spatial extensions of neoclassical
economic theories of international trade and national economic growth. Together, these early
neoclassical theories predict that over time, differences in the price of labor and other factors
across regions will diminish and tend toward convergence. This prediction has generated
considerable controversy among theorists, particularly in light of the apparent tendency toward
international divergence between the per capita incomes of industrialized nations and less
developed nations. Early theories of regional economic development emerged out of this
controversy and can be distinguished from one another in terms of differences in the theoretical
predictions regarding interregional convergence or divergence in per capita incomes and factor
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prices over time. These theoretical responses are examined in more detail in the next section.
First, it is important to look at the interregional convergence hypothesis.
Neoclassical trade theorists draw on the Heckscher-Ohlin-Samuelson (HOS) theorem to explain

international factor price convergence using static equilibrium trade models. This well-known
theory of international trade begins with the following simplifying assumptions:
1. Two regions (1 and 2) trade two commodities (A and B) using two factors of production.
2. The production of A is labor-intensive, and the production of B is capital-intensive.
3. Both regions rely on the same technology in production and have the same production
functions.
4. There are constant returns to scale in the production of A and B.
5. Both regions produce some of A and some of B.
6. Tastes are homogeneous across regions.
7. Commodity and factor markets are perfectly competitive.
8. Factors are mobile within nations but not mobile across nations.
9. There are zero transportation costs.
10. All resources are used up in the production of A and
11. Trade between 1 and 2 is balanced such that the value of regional exports is equal to the
value of regional imports.
With these assumptions, Heckscher (1919) and Ohlin (1933) demonstrate that a factor-abundant
region will have a comparative advantage in the production of goods that require the intensive
use of that factor. This region will then specialize in and export the factor abundant good and
import goods for which factors of production are scarce. This result can be explained as follows:
If the assumption is made that the markets for factors and commodities are perfectly competitive,
the relative abundance of a factor in a given region can be expressed in terms of the ratio of
prices for the two factors. Labor abundance, for example, can be expressed in terms of the ratio
of wages to interest rates. If labor is relatively more plentiful in a given region, then this implies
that the relative price of labor (wages) is lower, which further implies that the region will have a
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comparative advantage in the production of labor-intensive goods, because the production of

labor-intensive goods is relatively cheaper for that region. If regions specialize in the production
of goods for which relative factors are abundant and export those goods, importing goods for
which factors are scarce, both regions gain from specialization and trade. In 1950s, Samuelson
elaborated on the Heckscher-Ohlin result to demonstrate how free trade and/or factor mobility
equalizes the relative and absolute long-run prices of factors of production among regions
involved in trade. Assume that region 1 specializes in the production of A, the labor-intensive
good, whereas region 2 specializes in the production of B, the capital-intensive good. Once trade
opens between the two nations and specialized production begins, the relative price of labor in
the labor-abundant region rises due to relative increases in the demand for labor. Conversely, the
relative price of capital rises in the capital abundant region due to relative increases in the
demand for capital. Even if capital and labor are immobile, the aggregate effect of these market
forces is to equalize relative factor prices across regions. With factor mobility, less trade is
required to equalize relative factor prices. Furthermore, with our assumptions of perfect
competition, homogeneous production technologies, and constant returns to scale, trade also
equalizes the absolute prices of labor and capital. In other words, real wages and real interest
rates for similar types of labor and capital will be the same in both regions following trade and
specialization.
The HOS theorem is complementary to David Ricardo’s theory of comparative advantage in that
the Heckscher-Ohlin model explains why comparative advantages exist (differences in initial
factor endowments), whereas Ricardo’s theory only establishes why comparative advantages
may lead to specialized production. The HOS theorem also has obvious implications for regional
trade and development. In its simplest form, the model suggests that specialization in factor-
abundant production combined with free interregional trade will result in equal per capita
incomes across regions for workers with similar skills. This hypothesis is a comparative statics
version of the interregional convergence hypothesis.
Dynamic versions of the convergence hypothesis draw on neoclassical growth theory,

particularly the models proposed by Solow and Swan. In neoclassical growth theory, there are
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two different types of convergence. Conditional convergence refers to the convergence toward a
steady state growth rate resulting in constant per capita incomes, consumption levels, and
capital/labor ratios. This is termed conditional, because savings rates, depreciation rates, and
population growth rates are allowed to differ across countries. Therefore, conditional
convergence need not necessarily result in equal per capita income levels across countries.
Absolute convergence occurs when growth model parameters are equal for all countries, which
in turn implies that richer countries will grow slower than poorer countries, and per capita
incomes will become equalized across countries over time as in the HOS model of international
trade.
There are several reasons why it is important to distinguish between the convergence hypothesis
of the HOS-model and the convergence hypotheses from neoclassical growth theories. First,
neoclassical growth models are, by definition, dynamic models, so their convergence hypotheses
refer to the convergence in growth rates rather than the static convergence of factor prices.
Although both models predict the eventual long-run convergence of per capita incomes across
regions, the process that brings about convergence differs between the neoclassical trade and
growth models.
Since most neoclassical growth models typically assume away trade by modeling growth within
closed economies, convergence occurs not through trade or factor mobility but through
diminishing returns to capital investment. In neoclassical growth theory, regions with less capital
per unit of labor will tend to have higher rates of return and higher initial growth rates than
regions with high levels of capital per worker. Although a regional version of the neoclassical
exogenous growth model considers interregional factor mobility, most neoclassical growth
models assume perfect intraregional factor mobility but assume zero interregional factor
mobility. Finally, neoclassical growth models often allow for differences in production
technologies and/or savings rates across regions. If these parameters are assumed to be
exogenous, then regions will only conditionally converge toward a steady state constant rate of
growth. In neoclassical growth models that allow for variability in growth parameters, the steady
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state may differ across regions, but all regions eventually reach constant per capita income,
consumption, and capital/labor ratio values.
The possibility of dynamic or static interregional convergence has obvious implications for
regional development theory: trade and investment will eventually lead to an equalization of
wages across regions. It is important to note, however, that this does not necessarily imply
equalization of per capita incomes, since per capita incomes depend on additional factors such as
the skill level of the population and the percentage of the population that is in the labor force.
Thus, although the HOS-model implies convergence in wages across countries, it does not
necessarily imply convergence in per capita incomes, a point that is often ignored by critics of
neoclassical trade theories. Also, since growth parameters may differ across countries, we may
only observe the weaker form of conditional convergence over time and per capita incomes may
differ due to differences across regions in production technologies or savings rates.
The Convergence Debate

Regions and nations in our world show complex development patterns. Textbook economics
would teach us that under conditions of free competition, homogeneity of preference and
technology parameters, and mobility of production factors all regions in the space-economy
would tend to a converge to the same per-capita income growth rate. In neoclassical economic
growth models, convergence between regions takes place through capital accumulation. Regions
that are further away from their state states grow faster in the short run, but in the long run
diminishing returns to capital set in and the growth rate drops to the exogenous growth rate of
technological progress. This tends towards a situation where the growth rate of GDP per capita
falls and becomes constant (i.e., it becomes equal to the exogenously-determined technological
growth rate). The neo-classical growth models therefore predict that in the long run countries and
regions will converge in terms of per-capita income levels, if one controls for the effects of
differences in initial conditions.
A basic problem in the above neo-classical explanation of the world is that technological
progress is not exogenous ‘manna from heaven’. It is part of the complex architecture of a
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regional economy and is determined by internal and external R&D investments, on-the-job
training, learning by doing and spillovers from university research. Spillovers resulting from
R&D expenditures and other activities generate increasing returns to scale for reproducible
production factors, the existence of which implies the possibility of long-run divergence in per-
capita income levels.
The conflicting predictions of the neoclassical and endogenous growth models have generated
intense scrutiny and a plethora of empirical studies, known collectively as the ‘convergence
debate’. The literature has generally found that while per-capita income levels between the
poorest countries (of Sub-Saharan Africa) and the richest countries (Europe and the United
States) have diverged over the past few decades, there is convergence among countries that are
similar in terms of initial conditions and policies, for instance, among the countries of the
European Union or the fast-growing East Asian economies (a phenomenon known as
‘conditional convergence’). The evidence also suggests that per-capita income levels among
regions within countries have diverged markedly in recent years, particularly in large, diverse
countries such as India and China. An increase in regional disparities in fast growing regions
such as India and China is not necessarily bad news, however. Improvements in living standards
in vast countries such as these implies that global inequality as a whole may be decreasing (in
tandem with improvement in living standards in these countries), and economic theory suggests
that an increase in agglomeration may lead to further improvements in the long run, as
knowledge spills-over into other regions and sectors of the economy. The findings of the
convergence literature therefore highlight the key role of regional development policies in
promoting economic growth and human development.
Location Theory: Location of Human Activity and Regional Development

The history of mankind has exhibited an interesting geographic pattern, where accessibility (e.g.,
river banks, coastal areas) and favorable physical-geographical conditions (e.g., climate) were
decisive factors for settlement. These areas created the foundations for large agglomerations.
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Regional development appeared to be contingent upon the existence of large economic attraction
poles. Thus, location of economic activity created the foundations for regional welfare. Even
nowadays, persistent discrepancies in regional welfare have historical roots in locational
conditions of these high-potential areas. The present figures of our world are still striking:
approx. 1 billion people live on less than a dollar per day, while more than 2 billion people have
no access to adequate sanitation. And the gap between poor and rich is formidable and even
increasing.
The location patterns of people and economic activity in our world show apparently a great
variation. And hence, location theory has played a central role in explaining not only the
dispersion of economic activity, but also the dispersion of welfare among regions. Consequently,
regional development theory is deeply rooted in location theory.
Location theory has already a long history in regional economics and economic geography.
Modern location theory has moved into a strong analytical framework for regional economics
and economic geography. Cost minimization and profit maximization principles are integrated in
a solid economic setting, in which both partial and general spatial equilibrium studies on the
space economy can be found that highlight the geographical patterns of industrial and residential
behavior. Furthermore, the theory is also able to encapsulate the impact of public actors (e.g.,
regional development policy). Thus, the fundamentals of classical location theory are made up of
a blend of physical geography (determining the accessibility of a location and the availability of
resources) and smart economic behavior (through a clever combination of production factors and
market potentials in space).
However, location patterns are never static, but have an endogenous impact on newcomers.
Thus, incumbent firms may attract others through scale, localization and urbanization advantages
(e.g., in the form of spatial-economic externalities in a Marshallian district). Consequently,
agglomerations tend to become self-reinforcing spatial magnets impacting on the entire space-
economy. Such concentrations of economic activity create welfare spin-offs for a broader
regional system and thus determine the geographic patterns of welfare and regional development.
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In this context, we may also observe a blend between location theory and urban economics or
urban geography.
In recent years, the emergence of the digital economy has enabled actors to be networked world-
wide. As a consequence, the interaction between industrial networks and location as well as the
access to telecommunication networks has gained much interest. Locations that offer the best
available network services are the proper candidates for many firms in the ICT, high-tech and
high services sectors and are able to generate a high value added to regional development.
The availability of and access to infrastructure is another critical success factor for regional
development. In addition to the presence of labor as capital on traditional factor inputs, we
observe an increasing interest in measuring the impact of infrastructure on regional development.
Especially in a world with shrinking distances, space-time accessibility of regions becomes a
critical determinant of relative regional economic positions. Transport economics and transport
geography have offered an abundance of theoretical and empirical evidence on the importance of
physical infrastructure for regional growth. The uneven provision of infrastructure have also
been identified as a key determinant of regional income disparities in less developed countries,
as is witnessed in various World Bank studies.
Location theory was developed as an early response to the ignorance of space in traditional
economic analyses. Location theory has focused primarily on developing formal mathematical
models of the optimal location of industry given the costs of transporting raw materials and final
products. Simply stated, firms will tend to locate near markets when the monetary weight
(defined as the shipping costs per mile times the physical weight of the item shipped) of the final
product exceeds the monetary weight of the inputs required to produce that product. Conversely,
firms will tend to locate near primary input sources when the monetary weight of raw materials
is large relative to the weight of the final product. Firms may also weigh the relative production
cost savings from particular locations with the increased transportation costs to minimize the
total costs of production and transportation.
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Although location theory alone does not provide a theory of regional economic development, the
explicit models of transportation costs have been highly influential in later theories of economic
growth and development, particularly the new economic geography. Scholars eventually drew on
concepts from location theory to develop the field now known as regional science, a branch of
the social sciences that examines the impact of space on economic decision making.
External Economies
One problem with traditional location theory is that the cost advantages of spatial proximity to
inputs and markets are modeled purely in terms of internal transportation cost economies.
Industries may cluster together for reasons unrelated to internal cost considerations. Instead,
firms may cluster to take advantage of external economies that result from close proximity to a
large number of other firms. These external economies may include
(1) localization economies that result from the firms in the same industry co-locating in the same
area and
(2) urbanization economies, which result from the co-location of firms in different industries.
Since these external benefits tend to increase with the number and output of co-locating firms,
they are usually referred to as external scale economies or agglomeration economies.
Economists continue to disagree over the nature and cause of these external economies, but
broadly speaking, knowledge spillovers, labor pooling, and economies in the production of
intermediate inputs have all been cited as contributing factors. Because external scale economies
are characterized by both positive externality effects and increasing returns to scale, traditional
competitive market models have tended to ignore these effects.
Models of Spatial Competition

Another benefit of spatial proximity from a firm’s perspective is the ability to charge higher
prices to customers that are located within close proximity of a given distribution point. This
means that spatial proximity gives firms market power, because nearby customers would be
willing to pay more for goods that can be consumed without incurring substantial transportation
costs. In the simplest case with two firms competing along a straight line, monopolistic
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competition in space produces a tendency toward concentration with firms splitting the market
along the line segment. This optimum location is not socially efficient, however, since customers
at either end of the line must incur higher transportation costs.
Later, scholars extended this original model to incorporate the threat of entry by competitors,
demand elasticity, and competition along a plane. These extended models demonstrate that
concentration is not always the equilibrium outcome and that the threat of entry may or may not
always drive profits to zero.
Central Place Theory

Central place theory was formulated as an early attempt to bring some of the above perspectives
together in a more general theory of the spatial location of firms. The basic idea of the theory is
that the relative size of a firm’s market area, defined as the territory over which it sells its
product, is determined by the combined influence of scale economies and transportation costs to
markets. If scale economies are strong relative to transportation costs, all production will take
place in a single plant. If transportation costs are large relative to scale economies, firms will be
scattered around the region. For any given market, free entry among firms drives profits to zero
and causes all spaces to be occupied by equally spaced firms with hexagonal market areas.
However, due to differences in transportation costs, scale economies and demand for different
products, the size of the individual hexagons will be different for different markets.
Central places emerge in locations where market areas for different products overlap. As
indicated in the previous section, this process of monopolistic competition in space produces a
hierarchically structured system of cities of different sizes and different levels of product
diversity.
Although location theory and central place theory have each contributed considerably to the
understanding of the spatial pattern of firms, their static perspective and ignorance of many
important dimensions of regional economic growth, particularly labor migration, has impaired
their use as a general theory of regional economic development. Theories of regional economic
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development incorporate these concepts into more formal expressions of regional growth
dynamics.
Demand and Supply as Determinants of Regional Development

The various kinds of linkages represent ways in which some impetus to regional change is
transmitted from one activity to another within the regional economy, leading to overall growth
or decline. The next question, then, is where can such impetus originate? What really initiates
change?
Here as in almost every economic problem, the dichotomy of supply and demand appears.
Regional activity requires both inputs and a market for outputs, and it does not make sense to
argue that either supply or demand is the sole determinant of growth.
If we look to demand for the explanation of regional growth, we first inquire where the demand
comes from and then trace its impact through the regional economic system. This approach will
emphasize backward linkages among regional activities, since such linkages are the way in
which a demand for one regional output (say, automobiles) gives rise to demand for other
regional activity (say, the making of automobile parts or paint, the generation of electricity, or
the employment of labor).
If we look to supply for the explanation of regional growth, we inquire where inputs come from
and in what way the supply of, say, mineral resources, capital, or labor in a region leads to
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regional activity generating a regional supply of, say, coal, electricity, automobile parts, or
automobiles. The approach from the supply side will emphasize forward linkages.
Clearly, both approaches are relevant and necessary parts of an adequate theory of regional
change and development. Complementary linkages and external economies of agglomeration, as
we have seen, involve both backward and forward vertical linkages; and in evaluating the factor
of competition for scarce local inputs, both demand and supply have to be considered.
3.3. Alternative Theories of Regional Economic Development
3.3.1. Theories Based on Demand
Economic Base Theory

One approach to an explanation of regional growth is that of the so-called economic base. The
essential idea is that some activities in a region are peculiarly basic in the sense that their growth
leads and determines the region’s overall development; while other (non basic) activities are
simply consequences of the region’s overall development. If such an identification of basic
activities can really be made, then an explanation of regional growth consists of two parts: (1)
explaining the location of basic activities and (2) tracing the processes by which basic activities
in any region give rise to an accompanying development of non-basic activities. The usual
economic base theory identifies basic activities as those that bring in money from the outside
world, generally by producing goods or services for export.
The argument advanced for this approach is that a region, like a household or a business firm,
must earn its livelihood by producing something that others will pay for. Activities that simply
serve the regional market are there as a result of whatever level of income and demand the
region may have achieved: They are passive participants in growth but not prime movers. A
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household, a neighborhood, a firm, or a region cannot get richer by simply "taking in its own
washing"; it must sell something to others in order to get more income. Consequently, exports
are viewed as providing the economic base of a region’s growth.
A regional economic base study generally seeks (1) to identify the region’s export activities, (2)
to forecast in some way the probable growth in those activities, and (3) to evaluate the impact of
that additional export activity on the other, or non-basic, activities of the region. The result is not
only a projection of the region’s prospective growth and structural change but also a model that
can be used in evaluating the effects of alternative trends of export growth.
A region’s export activities can be determined with various degrees of precision. The simplest
and crudest procedure is simply to assign whole industries or activity groups to the export or
non-export category without making a specific local investigation. Thus retail trade, utilities,
local government, and services may be classed en bloc as non-export, while manufacturing is
considered wholly an export activity.
Projection of the future trend of exports from a region involves a series of studies of the
prospective national growth and interregional location trends of each of the activities concerned,
and an evaluation of whether the region’s competitive position is likely to get better or worse.
The kinds of location factors to be taken into account in such studies have already been discussed
in earlier chapters.
Given some prospective change in the level of export or basic activity in the region, how much
overall regional growth in income and employment is implied? This determination requires the
tracing of linkage effects. Specifically, it involves the estimation of a regional multiplier, which
tells us how much increase in total regional income (or sales, or employment) to expect as a
result of each additional dollar of export sales or income, or each additional person employed in
producing for export.
At this stage too, there are alternative procedures of varying degrees of sophistication. The
simplest method is to derive the multiplier from the "basic ratio." If, for example, one-third of
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the region’s employment is in basic activities, we simply assume that that proportion will be
maintained. Accordingly, every worker added to basic employment will directly lead to the
employment of two additional workers in nonbasic activities: the multiplier is 3.
Such a procedure is too easy to be convincing. There is really no reason to assume that the ratio
will remain unaffected by export growth, and such ratios vary rather widely. There is a
discernible tendency for export multipliers (whether derived by this or by more sophisticated
analysis) to be larger with increasing regional size and diversity.
The view of export demand as the prime mover in regional growth raises some interesting
questions that indicate the need for a more adequate explanation. Consider, for example, a large
area, such as a whole country, that comprises several economic regions. Let us assume that these
regions trade with one another, but the country as a whole is self-sufficient. We might explain
the growth of each of these regions on the basis of its exports to the others and the resulting
multiplier effects upon activities serving the internal demand of the region. But if all the regions
grow, then the whole country or "super-region" must also be growing, despite the fact that it does
not export at all. The world economy has been growing for a long time, though our exports to
outer space have just begun and we have yet to locate a paying customer for them. It appears,
then, that internal trade and demand can generate regional growth: A region really can get richer
by taking in its own washing.
Let us next look at the role of imports. In the mechanism of the regional export multiplier,
expenditures for imports represent demand leakage from the regional income stream. The greater
the proportion of any increase in regional income that is spent outside the region, the smaller is
the multiplier.
It follows that if a region can develop local production to meet a demand previously satisfied by
imports, this "import substitution" would have precisely the same impact on the regional
economy as an equivalent increase in exports. In either case, there is an increase in sales by
producers within the region.
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It is quite incorrect, then, to identify a region’s export activities exclusively as the basic sector. It
would be more appropriate to identify as basic activities those that are inter-regionally footloose
(in the sense of not being tightly oriented to the local market). This definition would admit all
activities engaging in any substantial amount of interregional trade, regardless of whether the
region we are considering happens to be a net exporter or a net importer.
This necessary amendment to the export base theory, however, exposes a more fundamental
flaw. We are still left with the implication that a region will grow faster if it can manage to
import less, and that growth promotion efforts should be directed toward creating a "favorable
balance of trade," or excess of exports over imports. Let us examine this notion.
If a region’s earnings from exports exceed its outlays for imports, on net there is an exodus of
productive resources from the region (as embodied in goods and services traded). In this sense
the region is loaning its resources to other areas and its people and businesses are building up
equities and credits in those areas. Thus the region is a net investor, or exporter of capital. By the
same token, if imports exceed exports, the region is receiving a net inflow of capital from
outside.
Other theorists expanded the theory of the economic base to explain the development of a region
by dividing the economy into two types of activity (egzogenous and endogenous) and by
determining the causal relations occurring in the process of the development of a region.
According to this line of argument, the egzogenous (export) activities are fundamental and
constitute the economic basis of the region as the demand for goods and services stimulates the
region’s economic development and shapes its role and distinctive features in the social and
spatial division of labor.
Sectors of economy and companies involved in export activities initiate a multiplication

mechanism among cooperating companies and related sectors active in the domestic market.
Therefore, the egzogenous sector stimulates other internal elements of the regional economy, the
so called endogenous sector, strictly related to the basic (egzogenous) one. This theory proposes
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actions to attract investors competitive in domestic and international markets that operate in the
economy or service sectors supporting technological modernization.
The simplicity of the assumptions of the theory of the economic base has influenced its
popularity, but it has also led to criticism questioning the possibility to describe the development
of a region using a model with only few variables. Additionally, the concept does not form a
homogenous theoretical system as it has been simultaneously developed in many countries;
therefore, it is rather a mixture of various ideas whose interdependencies are difficult to explain.
Other Theories Related to the Concept of Economic Base

Staples theory
This theory sees the concept of the staple as a key factor in the development of regions. A staple
is a dominant commodity which provides the basis for the regional economy and society. Good
examples would be wool, as a staple for regional Australia for the latter 19 century and in the
post war period till the 1980s.
Staples theory was greatly influenced by the work of Canadian scholar Harold Innis who studied
the impact of the fur trade and fisheries, among other commodities on the growth of Canada.
These studies showed how exploitation of a staple provided regional growth, but when the staple
declined or was replaced the region declined.
Staples theory provides a useful historical frame of reference but has been criticized for its lack
of predictive ability. It does however indicate how commodity based economies are subjected to
cyclical growth patterns, dependent on changing commodity prices.
The economic, political and social actions of regional authorities are strongly influenced by the
orders and suggestions formulated on the basis of geographical regional development (different
scales: global, national, regional and local), pointing to the economic benefits coming from the
spatial concentration of economic activities.
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Another related concept, the basic product theory, explains long-term factors of economic
growth and essentially compliments the concept of economic base. According to the theory,
regional development is achieved through gradual specialization of selected products,
competitive on the foreign markets. The profits from product specialization are achieved through
improving the organization of production and lowering the cost of economic transactions. The
tasks that this theory envisages for all administrative authorities involve strengthening the
specialization trend, investing in infrastructure (telecommunication, transport), supporting
financial and consulting institutions, and providing services for business and education.
It is plausible to infer that a region’s growth is enhanced if its capital stock is augmented by
investment from outside—which means that the region’s imports exceed its exports.
Furthermore, regional development is normally associated in practice with increases in both
exports and imports. The important point here is that explanations of regional growth based
exclusively on demand lead to absurd implications, so that a broader approach is called for.
Export Base Theory

Developed in the 1950s, export base theory has remained one of the most influential theories of
regional economic development. Proponents of this theory argue that regional growth in local
political, economic, and social institutions is largely determined by the region’s response to
exogenous world demand. This response produces growth in both the economic base, or export
sector, and the “residentiary,” or non-basic sector which exists only to serve the basic sector.
Furthermore, the theory argues that regions need not necessarily industrialize to grow, since a
region’s exports may consist of either manufactured goods, service-based goods, or agricultural
goods. As regions grow, their economy becomes more diversified, due to increases in local
production to serve increasing local per capita incomes and the emergence of new industries
serving export markets. Over time, regions will tend to “lose their identity as regions”. With the
increasing diversity of regional export bases and the mobility of factors of production,
production will tend to disperse across regions over time, and per capita incomes will tend
toward interregional convergence as in the HOS-model of international trade.
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The modern version of the theory argues that the earlier model ignores the importance of many
important supply-side factors that ultimately affect a region’s ability to support an emerging
export base. This later version points to other instances when exports are not the sole
determinants of regional economic growth. For example, in regions with populations large
enough to affect the worldwide demand for exports, regional growth in per capita incomes may
be affected by an increase in export demand and may affect world demand for exports. This
bidirectional causality implies that there are significant feedback effects between regional per
capita income growth and export market demand.
On the other hand, scholars who defend the earlier version suggest that the model should be
viewed as a long-run model of economic growth that may not always be applicable in the short
run when certain factors of production are fixed and immobile. In the long run, however, the
model still holds as an adequate account of regional economic growth.
The new theory of trade also stresses the role of export activities in regional development and
explains the mechanisms of benefits in the global economy coming from trade between countries
at different stages of development. Answers are sought in the specialization of production in
various regions concerning their time and capital consumption. Hence, regions rich in capital,
export capital consuming products while regions rich in labor force export time-consuming
products. The theory suggests that potential trade exchange between such regions is more
advantageous for the capital consuming ones. Therefore, local governments in poorer regions
should support not only export and free international trade, but also their infrastructural and
institutional investments (especially financial institutions) and specialized education.
3.3.2. Theories Based on Supply

The demand-driven model discussed above emphasizes final demand, backward linkage, and
output orientation of activities. Now let us reverse the emphasis to focus on the roles of primary
supply, forward linkage, and input orientation.
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When considering the effects of demand on regional activity, we implicitly assumed that supplies
of inputs would automatically be forthcoming, at no increase in per-unit cost, to support any
additional activity responding to increased demand. In other words, supplies of inputs, such as
labor, capital, imports, and public services, were taken to be perfectly elastic and consequently
imposing no constraint on regional growth. If export demand for a region’s steel output
increased, the region could freely import as much additional fuel or iron ore as might be needed;
if the demand for labor exceeded the region’s labor force, more workers would join the labor
force or move in from other areas.
Conversely, a supply-driven model of regional growth takes demand for granted (that is, it
assumes that there is a perfectly elastic demand for the region’s products) and thus makes
regional activity depend on the availability of resources to put into production. Accordingly, the
starting point in the process of change now becomes primary supply rather than final demand.
Availability of labor, capital, imported inputs, and government services (infrastructure) makes
possible, through forward linkage, certain intermediate activities oriented to such primary inputs.
Increase in output by an activity that sells in the region can encourage, through further forward
linkages, increases by other activities, giving rise to what may be called a "supply multiplier"
effect. This effect is limited by the existence of supply leakages. At each stage, some of the
increase in regional outputs is drained off into exports, investment, deliveries to governments,
and household consumption—in other words, to the final demand sectors.
This supply-driven process sounds very much like the converse of the demand-driven process
discussed earlier, whereby an initial increase in final demand gives rise to indirect growth of
income and employment in the region and increased drafts upon primary supply. Conceptually,
the symmetry is complete.
There is, however, an important operational difference. In practice it would not be feasible,
except under quite special circumstances, to calibrate a supply-driven regional model simply on
technical coefficients derived from the basic input-output table. The reason seems to lie in
technology itself. Goods normally become more specialized in character as they pass through
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successive stages of processing and handling. We can legitimately use such input coefficients as,
say, the amount of steel needed to make a pound of nails, because there is not much flexibility in
the nature and amount of input required for a given output.
The demand-driven and supply-driven models should be viewed as complementary rather than as
conflicting or rival hypotheses about regional economic change. Each of the two model types in
itself is one-sided and can be seriously misleading; for full insight into real processes, both need
to be combined. As yet, however, there is no analytical model that adequately incorporates this
union of the two complementary approaches.
Interregional Trade and Factor Movements

A region’s growth involves at least three kinds of external relationships of the region: (1) trade,
or the import and export of goods and services; (2) migration of people, both in their capacity as
consumers and in their capacity as workers; and (3) interregional "migration" of other production
factors, notably investment capital. A fourth external influence, to which some attention will be
paid in the next chapter, is the national government’s revenue collection and expenditure in the
region.
Trade among regions has, as David Ricardo noted a long time ago with respect to nations, the
beneficent effect of allowing each region to specialize in those activities for which it is best fitted
by its endowments of resources and other fixed local input factors, with all regions sharing to
some extent in the economies of such specialization. Recognition of this effect helps to place the
value and limitations of the export base theory in better perspective. When the local market is so
small as to limit seriously the productivity gains that can be realized by specialization, exports
may be necessary for growth. Thus the weakness of the export base theory lies not in recognizing
exports as being important for growth, but rather in focusing on exports exclusively and failing
to recognize that it is trade (imports as well as exports) that permits the realization of economies
due to specialization.
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This specialization of regions is limited by interregional transfer costs as well as by ignorance,

inertia, and the like, and the simplified model implied here fails to take into account the
economies of scale and regional agglomeration. But so far as it goes, the effect of freer
interregional trade is likely to be in the direction of equalizing not only commodity prices among
regions but also wages, incomes, and the rates of return to capital. The reason for this is that a
region in which capital is scarce relative to labor can, with interregional trade, specialize in
"labor-intensive" lines of production requiring much labor and little capital while importing the
products of "capital-intensive" activities from regions better endowed with capital or less well
endowed with manpower.
This substitution of trade for production-factor mobility is of course only partially effective.
Considerable differentials persist in the rewards of labor and the returns on capital among the
regions, leaving an incentive to further equalization by migration of those factors of production.
Consideration of the factors influencing regional income inequalities leads to an interesting

hypothesis relating convergence and divergence systematically to the stages of the development
process. Specifically, the early stages of national economic development are associated with
increasing regional income disparities, while regional income levels tend to converge in a more
maturely developed national economy.
In the present age, the crux of what we call development and attainment of self-sustaining
progress is the transition from an agrarian economic basis to a basis of secondary and tertiary
activities, with accompanying urbanization. A wide gap exists between the new and the old in
terms of income levels, ways of life, and location factors.
When industrialization is in its early stages, most of the rise in overall productivity and per capita
income comes from the change of mix—that is, the increasing importance of the nonagricultural
sector relative to the agricultural. The new activities cannot take root everywhere at once but are
highly concentrated at first in a few key cities—generally the places with the most active contact
with more advanced countries and the largest and most diverse populations. At this stage of
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development, most regions still lack the necessary local market potential and the necessary local
inputs to engage in the new and unfamiliar types of activity. Migration is likely to be heavy from
the backward areas to the industrializing cities. This migration is highly selective, and on the
whole this selectivity is prejudicial to the areas of out-migration. The result is the next stage:
progressive agglomeration of modern industry in the principal urban areas and an accentuation of
regional differences in economic structure, productivity, and income. Such conditions appear to
have prevailed in the United States during the divergence period 1840-1880, which was
lengthened by the destructive effects of the Civil War upon the economy of the South; and they
prevail today in many Third World countries of Asia, Africa, and South America.
As development proceeds, more and more regions acquire the market potential, attitudes, and
access to capital and know-how required to surmount the threshold of industrialization. A stage
of interregional convergence in economic structure, productivity, and income sets in. This
convergence may be made cumulative because migration is likely to become less selective, and
national government policies will be less preoccupied with the objective of getting
industrialization started in the country as a whole and more sensitive to the political pressures
arising from regional inequality.
Neoclassical Exogenous Growth Theory

In contrast to the demand-side approach of export base theory, neoclassical growth theory
models regional growth using supply-side models of investment in regional productive capacity.
Early versions of this theory are often referred to as exogenous growth theory, because savings
rates, population growth rates and technological progress parameters are all determined outside
the model. The models developed by Solow and Swan in the 1950s have been the most
influential in modern growth theory, primarily due to the more general form of the regional
production function which allows for substitutability among production inputs in accordance
with production functions that assume constant returns to scale and a positive elasticity of
substitution among inputs. These features generate predictions of conditional convergence of
growth rates over time across countries and the leveling off of per capita incomes within
countries. If growth parameter values are the same across countries, then neoclassical exogenous
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growth theory also predicts absolute convergence in per capita incomes, as discussed in the
previous section.
The neoclassical growth model has since been modified for the regional context by allowing for
open regional economies with net exogenous labor and capital inflows. Under these assumptions
it is argued that interregional convergence is more likely than international convergence because
factors of production are more highly mobile across regions. Furthermore, absolute convergence
in per capita incomes across regions within a country is more likely due to the homogeneity of
savings rates, depreciation rates, population growth rates, and production functions within
countries.
This argument has even been modified further by suggesting several reasons why interregional
convergence maybe more likely during the later stages of a nation’s development. First, labor
migration rates in relatively underdeveloped nations are unequal due to differences in the costs of
migration and differences in the way migrant workers are perceived vis-à-vis indigenous
workers. Second, initial endowments or constraints, external economies of scale, and immature
capital markets in some regions may impede equal capital flows across regions. Third, central
government policies may be biased toward regions that are more politically mobilized or where
economic growth creates the need for additional capital investments. Finally, there may be few
interregional linkages in the early stages of national growth.
3.3.3. Theories of Regional Economic Divergence

The concept of convergence, even in its weaker formulation as long-run constant per capita
income growth rates, or conditional convergence, has come under attack from many sides. One
criticism is largely empirical. The field of development economics emerged in the post–World
War II period in recognition of the growing economic disparities between industrialized nations
and less developed countries (LDCs). Although empirical studies supported a trend toward
economic convergence at the regional scale in countries like the United States, critics pointed to
the persistent poverty in most LDCs as evidence that some regions of the world were not
conforming to the predictions of the neoclassical growth models.
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Another criticism focuses on the unrealistic assumptions underlying neoclassical growth

theories, particularly those having to do with the assumption of constant returns to scale, zero
transportation costs, and identical production technologies across regions, perfectly competitive
markets, identical preferences across regions, and the assumption of homogeneous labor and
capital inputs. Although there have been attempts to incorporate more realistic assumptions into
extant models of exogenous growth, most neoclassical theories still tend to generate predictions
of conditional convergence even when labor or capital is heterogeneous across space.
One response to the convergence critique has been to directly incorporate a prediction of
divergence into extant theories of regional economic growth. Here two such theories are
examined: cumulative causation theory and growth pole theory.
Cumulative Causation Theory

Cumulative causation theory argues that increasing returns to scale produces clustering of
economic activity within those regions that are first to industrialize. Moreover, the process of
growth tends to feed on itself through a process of cumulative causation. Although
underdeveloped regions offer the advantage of low-wage labor, these benefits tend to be offset
by the agglomeration economies found in the industrialized regions.
Proponents argued that underdeveloped regions may benefit from growth in developed regions
through “spread” effects resulting from the diffusion of innovations into a “lagging” region and
the growing export markets for lagging region products. However, these benefits will tend to be
offset by the “backwash” effects resulting from the flow of capital and labor from the lagging
region into the developed region. Free trade results among regions only serve to reinforce this
process of cumulative causation by further catalyzing growth in developed regions at the expense
of lagging regions.
This theory of cumulative causation has been elaborated by introducing ideas from export base
theory and the concept of an efficiency wage. Accordingly assuming that increasing returns to
scale give early industrializing regions the advantage in international trade it is suggested that
cumulative causation sets in when an exogenous shock increases the worldwide demand for an
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industrial good. Actual monetary wages may be the same in all regions, but efficiency wages,
defined as monetary wages divided by a measure of labor productivity, tend to be lower in
industrialized regions due to scale economies. Since regions with lower efficiency wages can
produce more output, which in turn leads to further reductions in the efficiency wage (and so on),
growth may build on itself without bound.
Growth Pole Theory

The growth pole theory of regional economic growth places the theory of cumulative causation
into a spatial context. The “space as force” view of spatial interaction, which defines space as a
type of network that is held together by centripetal forces, has formed the basis of most growth
pole theories. Although this view of space is not unlike that which is advocated by those in the
flexible specialization/network theory tradition, the two theoretical perspectives have largely
developed in isolation from one another. In the original formulation, a growth pole referred to
linkages between firms and industries. “Propulsive firms” are those that are large relative to
other firms and generate induced growth through inter-industry linkages as the industry expands
its output.
A growth pole has also been defined in terms of the presence of propulsive firms and industries
that generate sustained regional growth through linkages with other firms in a region. Under this
perspective scholars like Hirschman (1958) argued that growth in a developed region produces
favorable “trickling-down” effects within a lagging region as the lagging region’s goods are
purchased and labor hired by the developed region. Growth may also produce unfavorable
“polarization” effects resulting from competition and trade barriers erected by the developed
region. Despite these similarities, Hirschman rejects Myrdal’s cumulative causation approach as
overly bleak due to the fact that it hides “the emergence of strong forces making for a turning
point once the movement towards North-South polarization within a country has proceeded for
some time”. In the end, Hirschman has faith that trickle-down effects will outweigh polarization
effects due to increased pressure to enact economic policies to combat the latter.
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Originally the concept of growth poles was more economic than spatial as it assumed that
economic growth was stimulated by the most developed sectors and branches of industry and by
specific enterprises which constitute a kind of growth poles of the whole economy. These poles
are characterized by a significantly high rate of economic development and numerous
cooperative connections, as well as the strongest position in world markets. They generate
development of economy and make weaker enterprises depend on them.
A growth pole and its relations with the environment create a spatial system called the polarized
system. The application of the concept and further research led to its usage to explain the spatial
polarization of regional development, where highly developed regions are the growth poles
treated as reference points for the environment. Sectors and branches innovative and competitive
in foreign markets are located there. In this way metropolitan areas are created or strengthened;
as the growth poles of the region, they dominate over weaker centers and regions. They become
competitive for peripheral regions and make them dependent on their economic policy.
According to this theory, the task of local authorities in the polarized system is to create new
growth poles and to strengthen the relations (new investments in communication and transport)
between metropolis and the region in order to intensify diffusion and stimulation of economic
growth.
Some proponents of this theory argue that regional development is irregular and concentrated in
the so called geographic centers, from which a diffusion wave of developmental impulses
gradually spreads onto the surrounding area. Others assume that irregular economic growth is the
result of long-term historical, cultural and economic conditions. Hence, developed regions
become more progressive as a result of the accumulation effect and poor ones remain passive.
The center-periphery model

The center-periphery model includes elements of unbalanced regional growth and export base
theory. Like export base theory, it recognizes that growth may be externally induced. It also
points to the impact of interregional labor migration on the convergence of incomes across
regions. However, it departs from traditional export-based theories of economic growth by
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pointing out that local political and economic entrepreneurship and leadership may affect the
translation of export demand into growth in the non-basic residentiary sector. The quality of
local leadership is in turn affected by the region’s development history. The theory also points
out that regions may vary in the extent to which supply constraints limit a region’s ability to
respond to increased demand for exports. Finally, large urban areas have the initial advantage in
the competition for new growth because of the decreasing cost benefits of urbanization
economies. All these factors tend to work to the advantage of core regions, which are incumbents
in the economic development game. Outside of the core, regions are differentiated by their
relative degree of regional economic autonomy. “Resource frontiers” are undeveloped regions
whose primary draw is the plentiful supply of untapped natural resources. “Downward-
transitional areas” are rural areas trapped in a stage of structural poverty, primarily due to their
structural dependence on adjacent core regions.
This model argues that the center with capital, authority and knowledge potential and high
cultural standards dominates over the peripheral regions not only in the technological but also in
the political and cultural spheres. The peripheries are hierarchically subordinated to the center in
technological, economic, political, cultural and service terms. The relations between the core and
the peripheries are neither balanced nor equal.
The core and peripheries models appeared in economic literature at the same time as the
polarized concepts (the theory of growth poles). The main difference between them concerns the
economic category of the points of reference. The authors of the core and peripheries models
referred to disproportions in development on a global scale (concerning especially poorly
developed regions), while the authors of the polarized concepts concentrated on differences in
development of highly developed regions.
The approach proposed by some of the theoreticians in this category suggests that the flow of
technological and cultural innovations, controlled by the center, is the main factor contributing to
disproportions in development. Core regions are defined as economic centers with the greatest
potential for change and they are located in places of strong influence, while development is
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treated as an innovative process (production and services provided by the most competitive
enterprises), located in large metropolitan centers. The centers dominate the peripheries.
Followers of this approach continue discussing the process of centers formation. They believe it
to be very dynamic because it is determined by innovation trends (new technologies and
industrial branches). Hence, the dialectics of the relation between center and peripheries
demonstrates that in a historical context at a specific stage of development of civilization, the
centers may be downgraded to the peripheral role. Also, in favorable conditions, peripheries may
gradually take on the features of an economic center and in the distance from the center may
acquire a transitional, semi-peripheral (borderland) character. This line of argument emphasizes
that the system with leading regions (centers) and slower developing peripheries is dynamic and
cannot be treated as something given and unchangeable.
Moreover, attention should be paid to the geographical relativity of the concepts of center and
periphery, which makes their identification dependent on the spatial scale. What appears as a
periphery on the national scale may be seen as the center in the local or regional scale, and vice
versa: a national center may be the periphery of world economy. Modern economy is a system of
complementary structural components such as: core – world center, semi peripheries and
peripheries.
3.3.4. Structuralist Theories

Another body of theory examines regional economic development as a process of structural
adjustment both within and outside the region. Rather than view regional economic growth in
terms of the factors pushing regional economies toward or away from some equilibrium rate or
distribution of growth, these theorists view economic growth as a path-dependent evolution
through various stages of economic maturity.
Stage/Sector Theories
Early perspectives in the structuralist tradition include several different “stage” theories of
regional economic growth. Since many of these theories also include a focus on sectoral change,
some are also referred to as “sector” theories.
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An early theory of sectoral change were explained through various stages of regional growth. In
the early stages of regional growth, agricultural production predominates and the economy is
largely self-sufficient. As transportation improves, producers begin to specialize and engage in
outside trade with other regions. As diminishing returns begin to occur in the production of the
region’s primary extractive and agricultural industries, the region enters a phase of
industrialization. At the most advanced stage, the region specializes in export production. In this
theory, the progression from self-sufficiency to export producer is largely seen in terms of the
internal changes in the division of labor that produce economic specialization.
Other early stage theories developed to explain national economic growth have also been used to
explain regional economic growth and development. For example, Schumpeter (1934) sees
economic development as occurring from within the region. Regional economic change can be
viewed as a progression through long waves of growth and decline that are distinguished from
one another through the differences in the nature of the innovations that characterize each period.
New innovations emerge through a process of “creative destruction,” where old ideas are
constantly replaced by new ones. Rostow provides a related view in his description of a “take-
off” period, where a rapid revolution in the means of production leads to a relatively long-term
wave of sustained growth.
Another stage theory of urban/regional economic growth was presented by Thompson (1968).
According to Thompson, urban areas grow by progressing from an early stage where the local
economy is largely equated with a single large industry or firm through various phases of export-
led growth until the export of services becomes the major function in the final stage. At some
point during this development process, a “ratchet” effect occurs, where growth patterns become
locked into place and future contraction becomes unlikely. Thompson gives several possible
explanations for this effect:
1. In diverse urban economies, small firms have multiple local linkages that are difficult to
reproduce if the firms relocated to another region.
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2. Cities with larger populations are more successful in garnishing political spoils from state and
national government entities.
3. Per capita public service costs are significantly lower due to economies of scale.
4. A large local population base is valuable as a labor resource and a potential consumer market
for locally oriented industries.
5. Large areas give birth to more local industries than small areas, which in turn increases the
probability of local innovations.
Thompson concludes by pointing out that diseconomies of scale associated with congestion and
bureaucratic costs may set in to counter the ratchet effect. Pred (1977) discusses how the
structure of information flows between economic agents affects the economic development of
city systems. A central premise of the work is that “spatial biases” in the flow of information
tend to give incumbent urban centers an advantage in economic growth. Furthermore, the flow of
information across the landscape occurs primarily among the system of large metropolitan
centers, thus reinforcing the stability of the system of cities. Pred relies on this basic idea to
account for the historical development of urban areas. During the “pre-telegraphic” period of
urbanization, when urban centers emerged primarily to facilitate trade, the spatial bias was most
pronounced due to the importance of face-to-face communication within cities and among large
trading centers. Due to spatial biases, trading centers established in the pre-telegraphic centers
were more likely to become the sites of initial industrialization.
Once established, multiplier effects gave these initial industrial centers a cumulative advantage
in economic growth as innovations in production technologies diffused among local factory
owners. During the postindustrial period, “multi-locational” corporations emerged to transform
cities. Unlike growth pole theorists, Pred concludes that inter- and intra- organizational linkages
between the administrative hubs found in large metropolitan areas are self reinforcing and not
likely to result in a “spread” of growth into lower-level urban centers or surrounding hinterlands.
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It has also been argued by later advocates of the theory that the relationship between the utility
of any given city resident and city size can be represented by an inverted U, which captures
external economies of scale on the left side and diseconomies of scale on the right. The link
between this argument and industry structure is the twist that whereas diseconomies are
predominantly associated with population size, external economies are industry specific. Thus, it
only makes sense to group firms that share the same external economies within the same city.
This suggests that the optimal size of any given city over time will depend on its role, which is a
function of the industry structure that dominates the city.
Profit/Product Cycle Theories

Product cycle theory views regional development and change in terms of the evolution of
regional industry structures required to sell export goods. Due to low price elasticity of demand
for new products, an innovating firm cares less about small initial cost differences between
regions than about future cost considerations. Furthermore, in the early stages of a product’s life,
locational proximity to suppliers and research and development firms is important to facilitate
the flexible incorporation of product changes and process innovations. Thus, large urban areas
will be preferred locations for firms producing new immature products. As the product matures
and becomes more standardized, the need for flexibility diminishes, and the need to focus on
economies of scale increases. Once production has been standardized, the firm can employ cheap
low-skilled labor, so underdeveloped regions become preferred locations.
The theory of production cycle combines economic development with the process of new
products manufacturing, their improvement and standardization of production. According to this
theory, regional development is stimulated by technological innovativeness or creative series of
goods and services. The theory assumes economic polarization between developed and
underdeveloped countries. Obviously high quality goods, services and standards are created in
the former countries and then they are transferred to the latter ones. The degree to which
peripheries depend on developed regions (centers) increases when production of standard
products is located in their area.
95
On the other hand, technologically advanced components are rarely produced in the peripheries.
The majority of economists treat technological innovativeness as a basic factor of region’s
economic development as technological development stimulates economic efficiency, functional
modernization and competitive domination in international markets. Hence, knowledge,
technological and technical progress become a factor of regional development.
Some of the major criticisms to this approach are :
1. The model provides an ambiguous treatment of the internationalization of production and the
ownership dimensions of internationalization.
2. The model is at odds with more conventional incremental views of product invention and
innovation.
3. The model ignores product differentiation.
4. The assumption of shifts to low-cost labor locations in the final stage of the product cycle
implicitly assumes that cheap labor is the primary cost consideration, an assumption that is not
always true.
5. The model assumes a homogeneous geographic plane on which firms compete.
6. Market cycles may not always be consistent with international product cycles.
The profit cycle theory is one modification of the product cycle approach that responds to
several of these criticisms by incorporating a focus on industry structure at various stages of a
product’s history. Accordingly it was suggested that sectoral change within regions corresponds
to one of five “profit cycles” that are determined by the structure of competition at various stages
of product development. Initially, sectoral development proceeds from a period of zero profit
toward a period of super-profits, where initial innovators earn monopoly profits. The sector then
enters a normal profit stage as new firms enter the market. Eventually, the market becomes
saturated, and destabilizing factors set in. During this phase, firms either tend toward
96
oligopolistic forms of organization to gain additional profits or the firms enter a stage of decline,
as substitute or imported products take over the market. The final “negative profit” stage is one
of sectoral decline and disinvestment.
Each stage in this profit cycle is characterized by unique spatial relationships. In the initial stages
of a product’s life, the location of firms is largely determined by historical accident or by the
physical location of the innovation. Entrants into the market may be drawn to the location of the
initial innovation or to regions whose resources are favorable to the industry. During the
“superprofit” stage, industries collocate to benefit from knowledge spillovers and a localized
skilled labor force. Eventually, firms grow in size, diminish in number, and become increasingly
oriented toward the location of consumer markets. If the industry tends toward an oligopolistic
structure, firms will tend to concentrate to take advantage of market power resulting from
proximity to consumer markets and location-oriented political supports. During later periods,
oligopolies seeking to minimize labor costs may relocate to escape unionization. If firms enter a
final stage of decline, the spatial tendency will be one of divestiture and gradual abandonment of
location specific facilities.
Industrial Restructuring Theories

Several new empirical realities began to emerge in the late 1970s and early 1980s that led to the
emergence of new structural explanations of regional growth and development. Among these
trends have been the decline of manufacturing and the emergence of the service sector in the
industrialized world, the increasing international mobility of capital and labor flows, and the
growing interregional disparities in labor conditions across gender and ethnic lines. These and
other studies suggest that fundamental shifts in the organization of industry and labor have
resulted in a relative decline in the proportion of workers earning middle-income wages, and a
spatial stratification of the workforce.
One response among regional development theorists was to look for explanations for these trends
within the changes that were occurring in industrial organization. The “industrial restructuring”
97
perspective examines how structural changes in the organization of industry have affected
regional capital and labor markets.
Several studies in this tradition point to the internationalization and mobility of capitalist
production and its effect on workers. For example, it has been suggested that in the developing
world, frequent layoffs resulting from insecure manufacturing jobs have created a large supply of
female migrant workers, many of whom were previously employed in the nonwage household
sector. In the United States, the internationalization of capital flows resulted in the disinvestment
in many U.S. industries. This disinvestment in national productive capacity has in turn resulted
in the destruction of social and community ties in many regions of the United States.
Further studies have identified three different corporate strategies that typically lead to job loss.
 Intensification strategies seek to improve labor productivity without substantial new

investments.
 Investment and technological change strategies result in changes to productive
technology.
 Rationalization strategies are those focused on the simple reduction of labor capacity.
Since each of these strategies may lead to differences in the number of plant closures and
investments in new capacity researchers argue that regions are affected in different ways
depending on the nature of the strategy leading to employment decline.
Another trend has been the transformation from a manufacturing-based to a service-based

economy among advanced industrialized nations. This rise in the service sector is attributed to
the increased geographic size of markets, innovations in transportation technology, the increased
importance of public and nonprofit sectors and the rise of the multinational corporation.
Regarding regional development, the transformation to a service-based economy is said to have
fostered increased centralization among corporate activities accompanied by the decentralization
of many low skilled white-collar jobs.
98
Labor is also an important factor in the location decisions of industries. Labor, unlike other
factors of production, is inherently heterogeneous across space due to differences in culture,
social institutions, and production requirements across that same space. Furthermore, unlike
other commodities, labor is not purchased outright. Instead, it is bought and sold subject to
uncertain expectations about future performance and reproducibility. Firms respond to and take
advantage of the spatial heterogeneity of the labor force as a way to exert control over their
workers. For example, firms can easily escape unionization by relocating to another region.
Similarly, firms can exploit the spatial relationships between workers within individual plants to
reduce the tendency toward worker solidarity. Workers, on the other hand, may also take
advantage of the mutual dependency between the firm and the worker and successfully capture
concessions if their skills are sufficiently scarce outside the region.
Flexible Specialization and Network Theory

Another theoretical response to the recent changes in the structure of industry has been the
development of a new theoretical approach that focuses on the patterns of interrelationships
found in new industrial districts. Advocates of this view state that increasing social unrest,
floating exchange rates, oil shocks, the international debt crisis, the saturation of industrial
markets, and the diversification of consumer demands have produced a new form of production
designed to permanently respond to change through innovation. This new “flexible
specialization” is based on the use of flexible labor and capital that can easily be tailored to the
needs of changing markets. Firms engaged in flexible specialization are bound together through
highly localized networks where knowledge and information are shared. These networks are
bound by trust rather than hierarchical authority relationships found in vertically integrated forms
of organization.
Theorists argue that geographic clustering can be viewed as an organizing force for national
industrial competitiveness. Domestic rivalry combined with discriminating local demand helps to
prepare firms for global markets. Geographic concentration magnifies the impact of domestic
rivalry, and local discriminating demand serves as a catalyst for innovation. Geographic
concentration also helps to spur local investment in specialized infrastructure and other local
99
factors, especially by governmental and educational institutions that depend on the health of a
local industrial cluster.
Finally, geographic clusters facilitate intra-local information flows and help to spread ideas and
innovations especially when firms share similar local business cultures, interact in local business
organizations, and share similar local or national norms and values.
This theory has been expanded to define different stages of competitive development. In the
factor-driven stage, internationally successful industries draw advantages from basic production
factors. Eventually, nations may enter an investment-driven stage, where firms and the national
government invest locally to transform local basic factors into more advanced factors of
production, eventually reaching the innovation-driven stage of national development, when all
determinants of competition are working at their strongest. The final wealth-driven stage is the
beginning of a period of decline, caused by a reduction in the number of successful rivals and a
trend toward capital preservation rather than capital accumulation.
Further, it has been suggested by theorists of this group that networks offer the control
advantages of hierarchical forms of transaction governance while maintaining the flexibility
advantages of markets. Networks rely on locational proximity to reinforce trust relationships
between those involved in economic exchange. The key features of a networked region are
strong public and private industrial support institutions, channels for the rapid diffusion of
technology, a high degree of inter-firm interactions, and a critical mass of innovation-focused
firms.
One criticism of the network-flexible specialization school is that theorists in this tradition tend
to oversimplify network relationships and ignore fundamental structural relationships within and
outside regional networks. Many also fail to acknowledge differences across networks in the
structure of competitive relationships among firms. For example, Porter places much more
emphasis on the importance of local competition among similar firms in the same industry.
Others in the network tradition place less emphasis on local competition and focus instead on the
collective sharing of knowledge and information among local firms.
100
Other critics add additional complexity into the common conception of the flexibly specialized
industrial district by emphasizing the role of large firms, state actors, local fixed capital, and the
active recruitment of skilled labor in district formation. For example, they point to the
importance of both local and global “embeddedness” within key intraregional and interregional
economic and political relationships. In their analysis of fifteen “second-tier” cities, the authors
identify four distinct types: (1) the traditional Marshallian industrial district based on small-firm
craft-based production; (2) the hub-and-spoke structure where suppliers are coagglomerated
around one or a few core firms; (3) state-anchored districts, where a governmental or nonprofit
entity predominates; and (4) satellite industrial platforms, where branch facilities of large,
externally owned firms locate.
The Theory of Industry Clusters

According to Porter, industrial clusters are “geographical concentrations of interconnected
companies with close supply links, specialist suppliers, service providers, and related industries
and institutions (e.g. universities, standardizing units and branch associations)”. Hence, clusters
appear to be a system of integrated enterprises and institutions. The value of a cluster does not
comprise the sum of the values of particular elements only but it also takes “added value”. Then,
the cluster initiates numerous processes which increase the competitiveness of the location. At
first, Porter treated the cluster theory as a tool to analyze industry in whole countries (Sweden,
Switzerland, the United States), then, when gaining more research experience, he used it to
analyze given regions and towns (in New Jersey, in California, at the German-Swiss border). It
should be noted that the concept of industrial clusters is stable but not static, as it concerns a
development cycle with its beginning, evolutionary growth and decline.
Clusters differ from industrial regions by their range, i.e. they include even several branches or
types of industry, whereas industrial regions one branch or type. Further, what most
differentiates industrial clusters from similar concepts is the factor of competitiveness at every
level: local (between cluster companies), national (the whole cluster) and global.
101
Marxist Theory
Another response to the new structural changes in the international economy, especially the
persistent underdevelopment of regions in the third world, was the emergence of a Marxist
perspective on regional growth and decline. Marxists theories of uneven growth and spatial
differentiation place the roots of the uneven development crisis squarely within the nature of the
capitalist system. In contrast to theories in the convergence-divergence debate, authors in this
literature argue that neither perspective is correct. In fact, the Marxist perspective regards
regional growth and decline as neither convergent nor divergent but “episodic.” In other words,
capitalist accumulation proceeds through lumpy progressions, spurred forward by specific crises,
which in turn force capitalists to search for new spatial modes of production. The Marxist
perspective also examines urban and regional economic change as resulting from the historical
evolution in a society’s dominant mode of economic production. Social change and development
are viewed in terms of the inherent conflicts between the capitalist class and the worker class.
Accordingly, supporters of this theory argue that the modern problem of underdevelopment can
only be understood in terms of the historical development of the capitalist mode of production.
According to theorists in this category, the current trends of underdevelopment reflect the
exploitation of particular regions by previously developed capitalist regions, through colonial
domination, commercial domination, or imperialist industrial and financial domination. They
argue that we can only understand this process by looking at the history of political and social
relations within a region and the particular type of dependency relationship that has emerged
within the region.
Some supporters of the Marxist Theory argue that although there is always a tendency toward
“balanced growth” that is caused by competition for profits, this state can never be achieved due
to the unbalanced structure of social relations. This instability results in periodic crises in
capitalist accumulation and subsequent controlled waves of investment and disinvestment.
Neil Smith defines uneven development as the “geographic expression of the contradictions of
capital”. Smith developed a view of urban development that is based on the seesaw process of
102
investment and disinvestment at different spatial scales. The most pronounced scale is the urban
environment, whose rent value is manipulated, according to Smith, to ensure capitalist
accumulation.
In contrast to the neoclassical economic view, which sees development as progressing toward
equalization, Smith sees this tendency as an inherent paradox in capitalism that does not produce
even patterns of development but instead produces seesawing waves of development and
underdevelopment. Urban areas are initially developed to accumulate profits. However, due to
the spatial fixity of the investments and the increased competition from new entrants, these
profits are unstable. Once profits begin to fall, areas are completely abandoned for new locations
in the search for new profits.
Scholars in the Marxist tradition also focus on the spatial dimension of the division of labor.
They argue that distance and spatial differentiation are strategic devices employed by capitalists
to facilitate capital accumulation. The use of spatial strategies to take advantage of the
differentiation of the labor force results in patterns of uneven development across regions. For
example, the separation between headquarters and branch plants may result in substantial
leakage of profits from the branch region to the region housing the firm’s headquarters. The
branch region may also experience relatively weaker regional multiplier effects and regional
purchases.
Marxist Theory argues that the trend toward regional inequality results primarily from the
tendencies toward concentration among large-scale capitalist industries, which leads to the
geographic displacement of labor in both the manufacturing and the agricultural sectors. This
surplus of labor, which Marx refers to as the “industrial reserve army,” serves to impose
discipline on existing wage workers by reducing the company’s dependence on location-specific
labor.
According to the Marxist perspective emergent cities grow by enacting barriers that limit the
growth of smaller cities, thereby facilitating capital accumulation. However, as industrial
structure evolves from one epoch to another, the barriers erected by growing capitalist cities
103
become inflexible and may act to repel new emergent industries that no longer benefit from the
barriers erected during previous epochs. For example, in the United States, the erection of
substantial waterway and rail transportation infrastructure in the nineteenth century served to
drive commerce toward emergent urban market areas. With the onset of the industrial revolution,
new cities appeared in the Midwest, and older mercantilist cities became trapped by their
preindustrial ways of doing business. In the next wave of urbanization, federal investments in
infrastructure and military-industrial complexes helped to spur the disproportionate growth of
Sunbelt cities, which were then unencumbered by substantial fixed investments or patterns of
capital accumulation.
3.3.5. Theories that focus on Political Institutions

Aside from the works of Marxist theories discussed above, few theories account for the role of
politics and political institutions in economic development. Since local politicians and planners
directly attempt to influence the rate of growth and the location of industry through mixes of tax
incentives, land use regulations, and infrastructure provision policies, ignoring this dimension is
seen as a substantial weakness of existing theory. Here, two perspectives on the role of politics in
regional economic development are reviewed: growth machine theory and the new institutional
economics.
Growth Machine Theory

According to this theory, the impetus to pursue a strategy of regional growth comes not from
structural economic forces or from the equilibrating tendencies created by exports and trade.
Instead, it comes from political coalitions of land-based elites who stand to benefit from local
economic development. Since this perspective treats regional growth largely as the cause of local
political organization rather than the reverse, it is more accurately seen as a theory of local
politics; however, if one assumes that growth machine policies are effective, then they should
have an impact on the location economic activity.
Some recent writers argue that if the growth machine perspective is to be a useful contribution to
the theory of regional economic development, then growth machines must have an impact on the
104
interregional distribution of economic activities. The authors conclude that although the impact
of pro-growth policies is mixed, growth-control policies do not seem to significantly affect
population growth rates. This suggests that the growth machine perspective may be a more
useful theory of why political coalitions form than a theory of how growth coalitions affect
regional economic outcomes.
The New Institutional Economics

The new institutional economics is an attempt to incorporate institutions and institutional change
into theories of economic development. A seminal work in the new institutional economics is the
work of Ronald Coase (1937). Coase argues that various forms of internal economic organization
can be traced to the desire among owners to minimize the transaction costs of production. For
transactions that involve substantial uncertainties and for which contractual monitoring costs are
prohibitively high, vertically integrated nonmarket institutions may have cost savings over
market forms of organization.
In 1985, Williamson reintroduced the ideas of Coase to a more recent generation of scholars and
formalized the concept of transaction costs. Williamson argues that transactions arise from one
of two sources: bounded rationality and opportunistic behavior of contractual agents.
Furthermore, these conditions become more problematic for exchange relationships when parties
to an exchange use specific assets whose value is limited outside the scope of the immediate
exchange relationship. Williamson establishes a typology of organizational forms ranging from
market to hierarchy that each correspond to particular transaction cost dilemmas. The flexible
specialization theorists discussed above argue that networks are a form of hybrid organization
that lies somewhere between markets and hierarchies.
Other scholars applied the insights of Williamson, Coase, and others in the new institutional
economics to propose a theory of economic development that is based on institutional adaptation
and change. The essence of this argument is that political and economic institutions emerge
primarily to resolve transaction cost dilemmas. The institutions that emerge establish the “rules
105
of the game” for economic exchange and determine the expected private returns from
investments in the local economy.
The New Institutional Economics stresses the role of institutions in economic development.
Using a game theory analogy, theorists argue that institutions increase the social benefits of long-
term cooperation. The institutions of capitalism have grown increasingly more complex due to
the increasing complexity of economic exchanges. Institutional adaptation may either promote or
discourage economic development. If the institutions that evolve are incompatible with the
transaction cost demands of private investors, then a region may not grow. For example, if the
property rights structure of a society does not recognize private contracts among economic
agents, informal forms of governance may emerge to facilitate the capture of short-term profits
among established elites while also serving to exclude outside investors. Similarly, large
vertically integrated firms may emerge to monitor wage labor if contracts with external suppliers
are not recognized.
3.4. Emerging Neoclassical Perspectives
Concepts of Endogenous Development

Let us turn now to the concepts of endogenous development. As the assumptions of
modernization and dependence paradigm were tested in European, Latin American and African
research, and as the myth of universal modernity held by optimistic “modernists” and the
pessimism of “dependists” demonstrated in orthodox theories were passing into oblivion, there
appeared in the last decade of the 20th century new concepts of alternative development which
stressed the importance of social development, the growth of human capital, the role of local
communities and their activities in regional development. They were an answer to the
shortcomings of the classic theories of development and to the fact that, as subsequent research
revealed, technological changes alone turned out to be an insufficient explanation of economic
growth. Therefore, the concepts of endogenous development are an attempt at correcting the
theories by proposing models in which long-term growth effects are endogenous variables of the
model, based on assumptions related to investment in human and technical capital. Economic
106
growth is variously endogenized, either through competitive accumulation of capital or through

investment in human capital and exchange of information between companies. Therefore,
generating knowledge, innovation, learning by exchanging knowledge between companies,
towns and regions become a particularly important part of national and local government
policies.
It should be noted that endogenous development is not related to a specific spatial scale, and
therefore it cannot be treated as synonymous with local development. A characteristics feature of
endogenous development is economic growth based on creation, increase and usage of internal
resources at every spatial level: local, regional, national and even multinational groups.
Especially regions and towns of high concentration of production create conditions for
innovation and knowledge flow between enterprises in the process of people’s “learning” in the
same industrial sector. Such diffusion of knowledge and new innovative ideas within a region or
a town becomes a kind of local industry protection against external competition.
“Endogenous” theorists do not search for references to other theories (economic, social or
political) in their concepts because, according to the “separate development path” rule, their
visions are based on their own potential for spatial, economic and social development, on
communal tradition and civic maturity.
Economic policy is a very important factor in endogenous development and its role is
particularly significant nowadays when regional economy becomes more and more endogenous.
This determines the role of economic policy as it raises questions as to the possible combination
of national and regional policy. The answers to these questions lead to civilizational premises
since development in modern economy at the end of the 20th century is propelled more
successfully and efficiently by endogenous processes of self-adaptation and self-organization.
Entrepreneurship, Innovation and the Knowledge Economy
107
Entrepreneurship is a complex and multi-faceted phenomenon that finds its roots in risk-taking
behavior of profit-seeking individuals in a competitive economy. But its determinants have also
clear correlations with gender, age, education, financial support systems, administrative
regulations, risk tolerance and market structures.
Entrepreneurship lies at the heart of innovation as the art of doing creative things for the sake of
competitive advantage. The debate on entrepreneurship and innovation has – from a
geographical perspective – prompted the emergence of new concepts such as innovative regions,
innovative milieus learning regions, or knowledge-based regions.
Innovation has become the critical survival factor in a competitive space-economy and
determines the direction and pace of regional development. A key aspect of innovation in a
modern space-economy is the use of and access to the information and communication
technology (ICT) sector. Consequently, ICT infrastructure is increasingly seen as a necessary
resource endowment for regional development.
It goes almost without saying that ICT is a necessary ingredient of a modern knowledge-based
economy. And that also holds for regions. Clearly, knowledge is a composite good with many
facets, but from an economic perspective knowledge serves to enhance productivity and to
induce innovations. There is indeed an ongoing debate on the unidirectional or circular
relationship between knowledge and development, and this forms one of the central issues in
endogenous growth theory.
Endogenous growth theory has played a central role in the growth debate since the 1990’s. The
main idea of these new contributions is that technological progress is not exogenously given, but
an endogenous response of economic actors in a competitive business environment.
Consequently, in contrast to earlier macro-economic explanatory frameworks, the emphasis is
much more as individual economic behavior of firms. In this way, it can be demonstrated that
regional growth is not the result of exogenous productivity-enhancing factors, but rather the
outcome of deliberate choices of individual actors (firms and policy-makers).
108
The importance of knowledge for innovation and entrepreneurship is thus increasingly

recognized. The spatial distribution of knowledge and its spill-overs are considered as an
important success factor for regional development in an open competitive economic system.
Thus, the geographical patterns of knowledge diffusion as well as the barriers to access to
knowledge are decisive for regional development in a modern global and open space-economy.
Consequently, knowledge policy – often instigated by ICT advances – is a critical success factor
for regional welfare creation.
In recent years, it is also convincingly demonstrated that leadership and institutional qualities
have a great impact on regional welfare, in particular, when the role of leadership is linked with
innovation and knowledge-creation. To the same extent that innovative entrepreneurship is
critical for long-term regional welfare growth, governance and leadership are essential for a
balanced regional development. Leadership presupposes proactive behavior, visions for future
development, awareness of institutional and behavioral processes, responses and bottlenecks, as
well as acceptance by the population. The awareness of the importance of leadership and
entrepreneurship lies in with the recognition of creative actions and learning actors.
Chapter Summary
109
This chapter dealt with basic questions about regional growth and development and introduced
more than a dozen of theories that attempt to explain them from different perspectives.
The simple economic base approach identifies exports as the generator of growth in a region;
non-basic or local market-serving, activities are assumed to grow only in response to the local
demand generated by the export sector. The theory also explains the development of a region by
dividing the economy into two types of activity (egzogenous and endogenous) and by
determining the causal relations occurring in the process of the development of a region.
According to the theory, the egzogenous (export) activities are fundamental and constitute the
economic basis of the region as the demand for goods and services stimulates the region’s
economic development and shapes its role and distinctive features in the social and spatial
division of labor. The basic product theory, which explains long-term factors of economic
growth, is also related to the concept of economic base. According to this theory, regional
development is achieved through gradual specialization of selected products, competitive on the
foreign markets.
Theory of growth poles argues that economic growth is stimulated by the most developed
sectors and branches of industry and by specific enterprises which constitute a kind of growth
poles of the whole economy. These poles are characterized by a significantly high rate of
economic development and numerous cooperative connections, as well as the strongest position
in world markets. They generate development of economy and make weaker enterprises depend
on them. This theory explains the spatial polarization of regional development, where highly
developed regions are the growth poles treated as reference points for the environment.
The core and peripheries model, assumes the center with capital, authority and knowledge
potential, and high cultural standards dominates over the peripheral regions both in technological
and political and cultural spheres. The peripheries are hierarchically subordinated to the center in
technological, economic, political, cultural and service terms. The relations between the core and
the peripheries are neither balanced nor equal. The main difference between the core and
peripheries models and the theory of growth poles is the economic category of the points of
110
reference. The core and peripheries models refer to disproportions in development on a global
scale (concerning especially poorly developed regions), while the polarized concepts
concentrated on differences in development of highly developed regions.
The theory of production cycle combines economic development with the process of new
products manufacturing, their improvement and standardization of production. According to this
theory, regional development is stimulated by technological innovativeness or creative series of
goods and services. The theory assumes economic polarization between developed and
underdeveloped countries. The theory of industry clusters suggests that the value of a cluster
does not comprise the sum of the values of particular elements only but it also takes “added
value”. Then, the cluster initiates numerous processes which increase the competitiveness of the
location.
Overall, although study of theories of regional economic development is still an evolving field
with so much fragmentation among the theories, it should be readily apparent the reader that
there are areas of overlap among many of these theories and much potential for integration and
still something of significance can be gleaned from each of the theories that we have described.
111
Review Questions
1. explain the conceptual foundations of theories of local and regional economic growth
and development
2. enumerate place based theories of regional economic development
3. explain resource based theories of regional economic development
4. describe the neo-classical regional growth theory
5. and other contemporary models of growth and development
6. explain the role of clusters and agglomerations in regional economic development
7. discuss the role of entrepreneurship, knowledge and innovation for regional and local
economic development
8. contrast the different theories of regional development and identify their strengths and
limitations
112
References
 Andy Pike, Andrés Rodríguez-Pose and John Tomaney(2006),Local and Regional
Development, published by Routledge in the USA and Canada
 Casey J. Dawkins (2003) Regional Development Theory: Conceptual Foundations, Classic
Works, and Recent Developments, SAGE publisher,
http://www.sagepub.com/cc/faq/sageFAQ.htm,USA
 Fujita, Masahisa, Paul Krugman, and Anthony J.Venables. 1999. The spatial economy:
Cities, regions, and international trade. Cambridge, MA: MIT Press.
 Hoover, Edgar M., and Frank Giarratani. 1985. Introduction to regional economics. 3d ed.
New York: Knopf. Can be accessed online at the following URL:
http://www.rri.wvu.edu/WebBook/Giarratani/ main.htm.
 Johansson, Borje, and Charlie Karlsson. 2001. Theories of endogenous regional growth:
Lessons for regional policies. Berlin: Springer-Verlag
 Richardson, Harry W. 1978. Regional economics. Urbana: University of Illinois Press.
 Simon C. Parker (2004), The Economics of Self-employment and Entrepreneurship,
Cambridge University Press, UK
 Storper, Michael. 1997. The regional world: Territorial development in a global economy.
New York: Guilford.
 Stough, Roger R. 2001. Endogenous growth theory and the role of institutions in regional
economic development. In Theories of endogenous regional growth: Lessons for regional
policies, Borje Johansson
 Tegegne G/Egziabher (2006), Learning material on Regional Growth and
Development(unpublished), Addis Ababa University, Ethiopia
113

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Public Service College of Oromia

Regional Growth and Local Development

Chapter Two: Decentralization, Globalization and Regional Development

Chapter Three: Theories of Regional Economic Growth and Development

3.3.5. Theories that focus on political institutions

Chapter Four: Regional and Local Development Strategies and Policies

1.1. The Concept of Region and Regional Development

According to Hoover and Giarratani, nodal regions have two characteristics:

Countries, Regions and Localities

Local vs. Regional Development

1.2. Goals of Regionalization

1. Regional Inequality and Regional Income Equalization

Sometimes alternative or complementary measures are also used, such as per-capita

2. Regional Economic Growth

Regionalization/decentralization helps as a means to resolve ethnic tension or conflict between

Thus regionalization (decentralization of power to regions) is becoming a panacea to

1.5 . The Issues/Problems of Regions

Regional Pathology: The Emergence of "Problem Areas"

Developed Regions in Recession

Excessive Growth and Concentration

1.4. Local Economic Development (LED)

2) LED is a participatory approach to development where a wide range of local stakeholders

Practicing Local Economic Development

Building a Strong Local Economy

Who Does Local Economic Development?

By actively reviewing their economic base, communities gained an understanding of the

international competitors entering local markets. Multi-site, multi-national manufacturing,

Metropolitan and Municipal

or lack, of electricity, transport, telecommunications, sanitation and developable urban land.

Disadvantaged Populations and Informal Economy

What is local in LED?

What is different about LED?

1. Level of intervention: Traditionally, development strategies have been largely top-down

• Creating favorable environment for business improvement,

Community development strategies can be regarded as fundamentally pro-poor strategies which

An enabling environment for LED

The International Environment

The National Environment

The local setting and the likelihood of success

the economic issue of an optimal spatial-economic use of scarce resources so as to generate a

2.1. The Link between Globalization, Decentralization and Regionalization

Following this line of reasoning, knowledge-intensive activities become fundamental for

As mentioned, in combination with highly localized drivers of economic performance, the

The increasing interconnectedness of the world

The rise of a new territorial structure

The key spaces in this three-tier structure are:

2.2. Globalization and Regional and Local Economic Development

This failure of traditional strategies in an increasingly globalized context has triggered a

3.1. A Review of Classic Theories of Development

(1) the linear-stages of- growth model,

(2) theories and patterns of structural change,

1) The Linear-Stages Theories

Rostow’s Stages of Growth

The Harrod-Domar Growth Model

The major hypothesis of the structural-change model is that development is an identifiable

3) The international- dependence revolution

While the international-dependence revolution in development theory was capturing the

(4) The neoclassical, free-market counterrevolution

Questions for brainstorming

3.2. Conceptual Foundations of Regional Economic Development Theories

The Interregional Convergence Hypothesis

Neoclassical trade theorists draw on the Heckscher-Ohlin-Samuelson (HOS) theorem to explain

comparative advantage in the production of labor-intensive goods, because the production of