Supply Based Regional Growth Analysis

Long-run regional growth models concentrate on factors that shift the production
possibilities curve outward. The changes in employment analysis in capther 7
could result from a shifting production possibilities curve, but short-run theories
give no reason for such a shift to take place.
How can an economy prepare itself for long-run sustainable growth? Two
macroeconomic model underline long-run regional economic growth analysis :
the neoclassical growt model of Solow and Swan, and the new or endegenous
growth theory. The two models are not only the foundations for different
concepts of long-run sustainable growth, but they also support different policy
prescriptions for achieving this growth. The neoclassical model analyzes regional
growth as if all economic activity were located at a point, as do most
macroeconomic models, but the new growth theory acknowledges, among other
things, that a location relative to some focal point is important in determining a
regions growth potential. These theories are characterized by their focus on the
dynamics or the process of change more than on the change itself
This chapter will first review the neoclassical growth model and evaluate its
policy implications. We will then focus on the endegeneous growth theory. This
theory highlights the importance of innovation and the diffuson of thecnology as
the factor determning growth. Finally, we will explore how agglomeration
economics can foster innovation and how capital, entrepreneurship, and labor
combine to create innovation and transmit technological advances.
NEOCLASSICAL GROWTH THEORY
Slow and Swan neoclasical growth theory applies production theory to an entire
region or country as if it were a firm producing only one type of output
Output is function of labor, capital, and exogeneously acquired technology that is
Where Y, K, L are the level output, capital, and labor respectively. The production
function exhibits constant return to scale. The level of technical progress, x, does
not vary across space. The technology available to cities and develop economies
is immediately available to rural, low income areas. Capital and labor are equally
productive everywhere. The rate of return to capital is constant and equal to the
national interest rate. The marginal product of labor equals the wage paid in a
perfectly competitive market.
According to the aggregate production function models, regional output is a
function of aggregate capital and labor. Researchers have also added spending
on energy or government spending on infrastructure as inputs. Growth occurs
when the amount of resources increases or when technology changes shift the
production function upward. If labor is the input under consideration, increasing
the amount of capital shifts the aggregate production upward because labor is
more productive if the capital/labor ratio is high.

Increases in regional productivity come about (1) b technological progress, (2)

from an increased amount of capital per worker, or (3) from correcting a
missallocation of resources (spatial mismatch). In equilibrium, overtime, the
growth of wages as well as the growth of the rate of return to capital is
everywhere equal to the nation average rates.
Unlike the keynesian model, theree is no investment function per se in th
neoclassical growth theory. Instead, regional savings are constant proportion of
regional output and all savings are invested in capital. The marginal propensity
to save is the same in every region.
The market corrects any resource missalllocation. An increase in region output
can exceed the national average because of variatiions in the growth of regional
labor force. When this happens, the rate of return to capital will be higher than
normal and the region will import capital. This influx capital (firm), will increase
the ratio of capital to labor, decrease the rate return to capital, and increase the
wage rate until the entire economy again in equilibrium.
Neoclassical firms always sell their outputs in perfectly competition market.
Perfect competition implies that the firms are input oriented footlose, but never
market oriented. This is because market oriented firm are by nature imperfectly
competitive. Therefore in the neoclassical model, entrepreneurs maximize profits
by minimizing cost as in webers location model.
The neoclassical theory asserts that the free movement of capial are labor
corrects any misallocation of resources, causing a convergence income, growth
rates, capital intensity among regions. The logic is follow : say urbania and pine
grove are two subareas of economy. Urbanis has greater employment and
population density, more capital and higher wages because of the greater labor
demand. Pine grove is agraria with fewer workers earning relatively low wages
and large amounts inexpensive land.
Under these conditions, firms from urbanis want to relocate in pine grove,
bidding up factor price there while depressing factor prices quickly than) urbania.
Firm stop moving to pine grove ehn the cost of inputs in both areas is the same.
Demonstrate this scenario for the labor market in urbanua and pine grove.
If, for some reason not enough firm (therefore capital) relocate in pine grove, the
high wages of urbanisa will attract workess from pine grove, increasing both
labor supply and the demand for land in urbania while decreasing them in pine
grove. As labor supply increases, wages plummet. As the demand for land
increases, land rent rise, further decreasing the real wage of workers in urbanis.
In pine grove, the opposite occurs. The process will continue unti real wages in
both the areas convergence,.
Because there is no standardized measure of technology, in this model, the share
of growth due to technological progress is measured as residual after explaining
the growth due to the other production factors. According to dension, this solow

residual representative more than 33% of the economic growth in the US

between 1929 and 1982