Describing industry location: theory and empirical evidence Travis P. Dunn 1.284/11.481 Professor Karen Polenske Wang Xiaodong Assignment #1/Question #1 February 20, 2004 Dunn 1
1. Introduction New Orleans, humidly located below sea level in a swamp near the southeastern tip of Louisiana, is a major center for the oil and gas industry. Phoenix rose from the Mojave Desert to become one of America s fastest-growing cities, supported in large part by the semiconductor industry. Neither of these cities locations seems particularly suitable for human habitation, at least not prior to the advent of large-scale irrigation and air conditioning. Nevertheless, similar examples of urban agglomerations and industry abound, leading observers to pose the question, Why does that city exist? In hindsight, historians can easily trace the impetuses for growth. For example, New Orleans served as the primary port for trade between Mississippi River settlements and points east in the 18 and 19 th centuries, while 20 th century oil exploration in the Gulf of Mexico led to its development as an energy city. Building a general model for understanding industry location, however, is a much more difficult question, one that has been worthy of the efforts of regional economists for many decades. Neoclassical theorists offer some insights into the spatial nature industrial location. Likewise, the more recent contributions of alternative location theorists explain the reasoning for such phenomena as clustering and decentralized production systems. In the following sections, I present relevant pieces of these two sets of theories, based on the analysis of contemporary scholars, to address the questions of industrial location and decentralization. Additionally, anecdotal evidence occasionally supports these theories. Finally, using this empirical evidence, I offer a few observations on the shortcomings--and the aspirations--of theoretical attempts to describe location. It appears that the work of theorists has both anticipated and responded to observed realities; yet, the task of developing a comprehensive model or framework to describe firm location remains. Dunn 1
2. Theories respecting the location of firms Parr summarizes the framework, known as central place theory, built by early location theorists like Weber, Christaller, and Lösch (2002, pp. 32-82). Central place theory carries the assumptions that population and resources are uniformly distributed over a homogeneous plane, firms have free entry into the market, all firms have constant returns to scale, and perfect competition exists. In this model, production factors--labor and capital--and transportation costs represent the keys to understanding firm location: firms locate in such a way as to maximize profits. In many ways, the models developed by these early location theorists fit reasonably well with observed reality, especially in their native southern Germany. Yet, even with the added complexities of hexagonally-shaped markets to capture the entire market space and a nested hierarchy of variably-sized central places, central place theory cannot be regarded as a general theory of the urban system (Parr 79). Adding a provocative perspective, Krugman points out that central place theory is more of a geometrical accomplishment than one of economics. While lauding the efforts of the German theorists, he describes the Lösch model as an optimum rather than a market outcome, and maintains that Christaller failed to define a market structure (1995, p. 40). The general lack of formalization is, in Krugman s view, one of the primary reasons for the inability of central place theory to garner broad attention within economics. As alternatives, Krugman offers four explanations of firm location. First, the notion of social physics is helpful in constructing economic relationships that are analogous to observed laws of physics. For example, firms will locate at points of high market potential, where the computation of market potential is some measure of market access divided by distance (the gravity model). Secondly, cumulative causation suggests a circular relationship, whereby a region attracts firms whose presence Dunn 2
attracts other firms, who attract still other firms, and so on. This is similar to the alternative location theory of clustering. Third, positive local externalities promote concentration of production, and analysis of these externalities can provide insights into optimum city size. Finally, the land rents theory of von Thünen assumes a gradient of land values as one moves away from an urban center. This model explains centrifugal forces quite well, but it has little explanatory power with respect to the existence of economic centers (Krugman, pp. 38-55). 3. Alternative theories respecting the location of firms In the latter half of the 20 th century, alternative theories of location emerged. The principal features of these attempts to explain firm location are emphasis on the importance of spatial diffusion and consideration of political and social interactions. In addition, as Storper and Walker argue, the basic patterns of industry location and regional growth can be processes endogenous to capitalist industrialization, rather than exogenous placements of resources and consumers (1989, p.70). In other words, firms can create economic space. This contrasts with the neoclassical theories, in which firm location occurs more or less as a response to economic conditions in a region. Among alternative theories, several stand out as particularly noteworthy: localization, urbanization, and dispersal. Discussion of dispersal is reserved for the following section, which deals with decentralization of industry processes. Localization asserts that similar industries will tend to grow together in particular regions. There is no shortage of empirical evidence of this; among the prominent examples are the automobile industry in Detroit and the high-tech agglomerations in Silicon Valley, California. Such agglomerations owe their self-perpetuation in large part to social and economic factors. As for social factors, The community is the repository of social practices and attitudes Dunn 3
that facilitate socialization of the labor force and provide important cues to workers about legitimate expectations and habits (1982 Storper & Walker, p. 82). Likewise, economic factors that support localization include development of a labor supply and of a network of intermediate buyers and sellers, users and suppliers On a larger scale, the growing cluster attracts sellers, merchant intermediaries, and labor from afar (pp. 80-81). Urbanization, contrasted with localization, says that firms of different types will cluster together in an urban region. This theory relies on the assumption that firms of different industry types will form an inter-reliance as the size of the region becomes large. Consequently, interdependent social and economic links create a similar effect for regions as localization economies. 4. Decentralization of firms Another alternative location theory is that of dispersal economies, which postulates that firms may relocate and decentralize in order to separate from the dwindling profits of an overinvested core and to extend into new growth peripheries (Storper & Walker, p. 88). Firms are also motivated by the prospect of cheaper labor pools and rents. Such movements may be linked with the product cycle, which can lead to broad decentralization. The product cycle describes that industries, after experimentation with a new product, will experience a period of tremendous growth; however, these high growth rates will eventually decline, leading to a final period of stability or declining growth (1979 Norton & Rees, p. 145). Through shift-share analysis, Norton and Rees quantify the economic losses of the traditional industrial core of the United States and the concomitant expansion of industry elsewhere, particularly in the Sun Belt. In terms of the product cycle, new high technology enterprises Dunn 4
and other sectors outside the traditional core had growth rates that overshadowed those of the traditional manufacturing regions. Traditional regions, by contrast, experienced the decline in growth predicted by the third stage of the product cycle. Though helpful and accurate, the product cycle explanation of industrial location in new regions is not complete. Markusen, for example, suggests that complementary policies at the national level helped to shape growth in the United States outside the Northeast and Midwest in the 20 th century. Spurred by an informal regional political mechanism of federalism and an informal industrial policy of Cold War-era military spending, the competitive region emerged as a major economic force. Although the more direct regional and industrial policies of other countries studied by Markusen did not achieve the same level of regionalization as their counterparts in the U.S., the effects of national policies on decentralization of industry is evident. * For example, American military spending was at least partly responsible for the development of the telecommunications and high-tech computing industries in the west. In Japan, nationally-endorsed technology poles attracted growth clustered around universities and R&D centers for advanced technology (Markusen 1999, pp. 65-94). Such policies, whether at the national or regional levels, represent significant political interactions with industrial location choices. For alternative location theory, recognition of the effect of political interactions is essential, albeit difficult to formalize in a comprehensive model. 5. Some Anecdotal Evidence Literature on industrial location also provides some anecdotal evidence for comparison against theory. As stated, southern Germany served as an immediate platform for observing central place theory in reality. The experience of regions with similar topographies tends to * The other nations studied were Japan, Korea, and Brazil Dunn 5
confirm the regional structure predicted by central place theorists. Heilbrun, for example, studied eastern Washington state and portions of Saskatchewan in order to test the predictive power of central place theory. While the results confirm to a large degree that the central place/city hierarchy framework could be observed, the manner of partitioning city sizes draws into question the ability to construct an accurate hierarchy from a system of cities (1981, pp. 96-100). Heilbrun further warns that application of the hierarchy of cities within a large metropolitan region for analysis is not sensible (p. 116). DiPasquale and Wheaton describe the decision process of General Motors for construction of a new Saturn Plant in the 1990 s. Ultimately, the company selected a site in Tennessee, removed from its primary manufacturing activities and suppliers in Michigan. In this particular instance, however, the availability of cheaper rents, lower taxes, and lower wages outweighed the transportation costs (1996, p. 173-174). The location of new industrial centers in South Korea under a national regionalization policy in the 1970 s resulted in a high concentration of development in the southeast portion of the country. Supposedly, these developments were due to the favoritism of many high-ranking government and military officials from that particular region (Markusen, p. 79). These cases illustrate two points, respectively: regional characteristics vary significantly enough to impact location decisions, and location decisions do not necessarily follow logical economic reasoning. 6. Commentary The value of central place theory is as a foundation on which to build more complex, accurate, and descriptive models. That central place theory alone cannot describe many regions with great accuracy is not surprising; the underlying geometrical assumptions preclude its ability Dunn 6
to do so. Given the complexities inherent in an urban or regional system system, however, especially in light of the variability and unpredictability of human decisions, building a comprehensive, descriptive model of location choice may never be possible. The advent of alternative theorists, who have pushed for inclusion of social and political interactions and considered spatial diffusion, are building on the central place foundation. The tools of analysis they bring may prove invaluable to the cause of understanding regional economies. 7. Conclusion From orthodox, central place theory to alternative theory, location models have evolved in at least two respects. First, theories have become more complex and somewhat more accurate in describing the factors that impact location decisions than earlier attempts. Secondly, they have responded to the observed realities around them. The inclusion of political and social factors in the writings of alternative theorists is a function of their observations, much as the design of central place theory was a function of the observations of the Germans who developed it. Perhaps the creation of a formal model, as Krugman suggested would be necessary for widespread appreciation of spatial economics, is not possible. But, even lacking a formal model, the qualitative tools together with the accumulated theory on the topic of industry location should inform the relevant actors in order to improve their likelihood of accomplishing corporate or regional goals through policy. Dunn 7
8. References DiPasquale, Denise and William C. Wheaton. 1996. Urban Economics and Real Estate Markets. Englewood Cliffs, NJ: Prentice Hall. Heilbrun, James. 1981. Urban Economics and Public Policy. 2nd Ed. New York: St. Martin's Press. Krugman, Paul. 1995. Development, Geography, and Economic Theory. Cambridge, MA: The MIT Press. Markusen, Ann R. 1999. National Contexts and the Emergence of Second-Tier Cities. In Second-Tier Cities: Rapid Growth Beyond the Metropolis, edited by Ann R. Markusen, Yong-Sook Lee, and Sean DiGiovanna. Minneapolis, MN: University of Minnesota Press. Norton, R.D. and J. Rees. 1979. "The Product Cycle and the Spatial Decentralization of American Manufacturing." Regional Studies, Vol. 13, No. 2. Parr, John B. 2002. The location of economic activity: central place theory and the wider urban system. In Industrial Location Economics, edited by Philip McCann. Edward Elgar, Cheltenham, UK & Northampton MA USA. Storper, Michael and Richard Walker. 1989. The Capitalist Imperative: Territory, Technology, and Industrial Growth. Oxford, UK: Basil Blackwell. Dunn 8