Economic Effects of Location Choice on Regions Faculty of Geography University of Tartu

1. Economic Effects of Location Choice on RegionsFaculty of GeographyUniversity of Tartu Prof. Dr. Dr. h.c. Peter Friedrichsenior researcher Exercises: Raigo Ernits, ma, lecturer

2. I. Modern Economic Location Theory and Location Choice Concepts as Basis of Regional Policies1) Which approaches exist to regional evolution theory? • The evolutionary economic geography deals with regional and location processes that are not based on assumptions of full information, static equilibrium, and constant returns to scale. • Regional evolution theory points to cumulative processes based on the survival of the fittest. • There are three main branches. One is based on the notion of natural selection. Another is based on analogies to biology why species survive. • A third branch of investigation takes the Darwin principles of evolution broadly but specifically to geographically important issues such as development of technological change, the search processes, the survival and developments of firms, clusters and the life cycle of regions, the change of institutions, the path dependency of regional and location development .

3. 1) Which approaches exist to regional evolution theory? Start Stochastic initial distribution Account values of a goal function New population Optimization criteria Chose the fittest no Choice Recombination Mutation yes Artificial neural networks are information processing systems that are oriented to the structure and functioning of the human brain (Constantin May 1995) Neuronal networks NN Best solution, result Connected neurons Channels Developments

4. 2)Describe the main features of new economic geography! • Economic geography (NEG) seeks to explain unequal spatial development • Before NEG transport costs got almost ignored in trade models. In new economic geography trade also external trade is stressed. • The NEG concerns spatial differentiation and the home marketeffect. Using labor and capital, sectors operate under increasing returns, monopolistic competition and positive trade costs. The home market effect signalsthat a region larger in terms of population and purchasing power attracts a more than proportional share of firms. An initial size advantage is enforced by trade liberalization • There is a circular effect: Manufactures production concentrates where there is a large market, but the market will be large where manufactures production is concentrated. • Agglomeration of the final sector in a region occurs because of the concentration of the intermediate industry there. However, as urban costs of spatial concentration react there are first increases then decreases of agglomeration.

5. 3) How develops growth according to Krugman? Home market effect Consumption demand Factor demand Intermediate products Low factor prices Price effect Final product

6. 4) What are the contributions of Romer, Nelson and Winter? • Romer points to the productivity of infrastructure and possibilities of increasing returns to scale • Nelson and Winter have turned to the competition among firms and stressed their capabilities and their strength, their attitudes to search internal technical solutions and new technical solutions, to imitation, the selection through market success, and the reinvestment of profits due to increasing returns to scale. They showed in simulation models that evolutionary processes take place. This ideas are also transferred to economic agents in regions and at locations and thus give rise to an evolutionary economic geographic theorythat can be integrated with new economic geography.It is more a regional development theory than a pure location theory.

7. 5) How explain the polarisation theories by Hirschman, Myrdal and the cumulative approach regional growth and development? Polarization theories: • Myrdal: Regional inequality especially in underdeveloped countries • Hirschman:Unbalanced sectors, leading sectors with forward and backward effects • Kaldor:Cumulative processes:, Rate of growth of productivity P is a function of production. The relation of wage W to productivity P is low if productivity is high. If this relation is low then income is high. P W/P Y Y Y

8. 6) How argues Richardson? • Richardson bases on neoclassical growth. • His main relation is that • Growth of income = (proportion of capital income of income + proportion of labor income of income)α + rate of technical progress. α expresses returns to scale, which can be diminishing, constant or increasing. The equation notes the growth of income of a region not the income at a location. If the region becomes small enough it comes near to a location. • αis determined much by agglomeration effects.

9. 7) What stresses the modern stage theory? • Modern stage theorists combine innovation with the idea of stage development. Modern stage theorists determine the life-cycle of leading industries of a country. A developing country industrialises and goes through industrial upgrading, by learning through its external relation with the more advanced world. • In combination with two kinds of markets (i.e. domestic and export markets) and five types of industries (i.e. R&D-intensive and easily imitable high-tech industries, as well as capital-, labour- and natural resource-intensive industries), the stages of economic development are divided into three phases, through which countries progress: • stage 1: natural resource and labour driven, • stage 2: capital and imported technology driven, and • stage 3: R&D and innovation driven.

10. 8) What is the economic core concept of Predöhl? • A Predöhl introduced the concept of an industrial core called Wirtschaftskreis • He considers a cluster ofsteel, iron, coal and energy producing firms as well as infrastructure consisting of ports, pipelines, water provision, railways, canals, etc. producing the most important goods for economic development.(On the background of technological circumstances in the 30th, today he would choose other goods as well) • He identified cores in Germany, France, Belgium, Great Britain, USA and Japan.

11. 9) Which kinds of agglomerations got defined? • Agglomeration implies clustering. If firms of the sameindustries are clustering we have localization economics. If firms of different industries cluster then urbanization economics prevail • There are examples such as delivery of intermediate goods between supplier and user just in time. There is a cemetery near a hospital. There can be vertical and horizontal integration (also localization economics). Firms use the same pre-services, the same infrastructure, and facilities they rely on the same labor market of high skilled labor. They settle close to customers,to hotels, to entertainment, to service centers. • They concentrate in Christaller places or in nodes of traffic networks.

12. 10) How to explain agglomerations? • Weber model • Hakamiri Gülicher effect • Lösch model • Christaller model • Other central place theories • In cost minimization models firms concentrate if savings in production costs (and other costs) are higher than higher costs of transport to customers. • NEG models explain agglomeration

13. 11) How does utility from cooperation develop with increasing distance between partners? (less agglom-eration) Utility of y Utility of z Result from cooperation between partner y with time input y and z with time input z Optimum conditions Opportunity costs of time of patner y Opportuniy costs of time of partner z Time consumption because of distance kr With higher distance shrinks utility ofcooperation / dy dUy/dy = dUy= bh-kru)y = (bh-kru)y dUy /dy = (bh-kru)y = (bh dUy increases Constant

14. 12) What are clusters and what types of clusters should one distinguish? • Clusters are sets of private (firms), public and mixed enterprises and public offices characterized by close interrelations and a close regional dimension. They form a network and want to make use of synergy effects and advantages in competition.There are: • Leading firm clusters (few companies lead a cluster all links to other economic units are directed to them) • Net-work clusters (They comprise similar firms and other economic units with multidimensional - in particular -horizontal links,e.g. members of the same industrial district) • Sub-supplier clusters (A leading firm shows vertical links along the value chain, e.g. car industry) • Cluster underlie regional product life cycles and some are aging, thus not achieving desired goals.

15. 13) Which are the differences between socialist clusters and clusters in western market economies? • Market oriented clusters come into being by market processes and by public co-ordination. The cluster members are profit oriented or service oriented to achieve public goals • Socialist clusters consist of combines and linked people owned firms and integrated public offices. They were coordinated by a central organization such as a sector ministry and show very tight vertical and horizontal links, and a top down and bottom up planning process

16. II. Regional Location Policy14) Who are the actors of regional location policy? • Regional policy concerns measures to influence the regional distribution and magnitude of human activities in and among regions • The actors are primarily: • Jurisdictions and public offices: EU, national member state, states (provinces, regions), municipalities, • Interest groups represented by chambers of commerce, chambers of handicraft, trade unions, associations of firms, of sectors of industries • Big firms (national and international) • Political groups organized in parties, religious organizations, groups of households organized of same language, ethnical roots, same life style

17. 15) Who are the actors of regional location policy? • Regional policy concerns measures to influence the regional distribution and magnitude of human activities in and among regions • The actors are primarily: • Jurisdictions and public offices: EU, national member state, states (provinces, regions), municipalities, • Interest groups represented by chambers of commerce, chambers of handicraft, trade unions, associations of firms, of sectors of industries • Big firms (national and international) • Political groups organized in parties, religious organizations, groups of households organized of same language, ethnical roots, same life style

18. 16) How do they influence location decisions of economic units? • The goals of jurisdictions that are bodies responsible for regional policy concern: • Supply-oriented (equal conditions of life) and development oriented objectives of regional policy, many times to reduce disparities achievement of these goals • The measures are fixed in regional plans of the EU, the member states, the states and the municipalities, and concerned in regional planning processes for projects and environmental tests. Other policies such as social and employment, immigration policies and sector policies show regional effects as well as intergovernmental fiscal relations

19. 17) What is meant by economic milieu? How can it be influenced? • The economic milieu shows the economic social embedding of an economic unit in a region • There are different economic milieus, e.g. milieus of creative cities, innovative milieus • The milieu is characterized by intensive cultural and economic contacts concerning the exchange of goods, the evaluation of economic results and behavior, special closeness, common institutional arrangements, types of firms and production factors, infrastructure and political regional governance. From this factors synergy effects should result.

20. 17) What is meant by economic milieu? How can it be influenced? • There are different views on the economic milieu. One chain of arguments stresses that a changing economic milieu, e.g. by immigration, new economic units, cultural and political changes createsuncertainty and forces to new ideas, new ways of behavior, products, coordination,etc.(innovative city). Other arguments are that a regional milieu reduces uncertainty in a region and enables collective search for solutions, a signaling of product image, collective learning, common decision situations, and the adaptation of factor qualities to common requirements (innovative milieu) • However, economic milieu can also prevent change, e.g. if regional interest groups form coalitions to conserve old industrial structures

21. 17)What is meant by economic milieu? How can it be influenced? • Economic milieus can be changed especially of old industrial areas by policies of a higher rank jurisdiction by legal measures, e.g. market liberalizations for products and factors, settlement assistance for firms of new sectors through allowed subsidization, The establishment of new public firms, new public offices, by creation of new industrial parks and clusters, improvement of infrastructure, innovation policies, population policies. • Such policies can be enforced by municipal policies such as real estate provision, infrastructure improvements, vocational training possibilities, skilled workers mediations, information policy, urban planning and financial or fiscal assistance, housing, etc. • The change of economic milieu can be also too drastic, e.g. through immigration, social and cultural clashes, changes of working attitudes, changes in evaluation of property rights, negotiation behavior, loosing of common religious and social values, tax moral, corruption, groups egoism, enforced brain drain, etc. or commuting and outmigration and import pressure.

22. 18) Which roles can entrepreneurship play for location decisions of households, firms, and public economic units? • Entrepreneurship refers to an actor who recognizes entrepreneurial (profit) opportunities, undertakes (moderately risky) investment decisions with a view to innovating, and takes action by using resources to implement a differentiated vision that adds value • Political entrepreneurshiprefers to political innovations, e.g. new types of cooperation, new tasks in relation to the public and private sector, etc. • Social entrepreneurshipshows an economic unit acting in the public benefit to achieve social goals, e.g. new forms of homes,etc. • Knowledge entrepreneurship concerns activities in knowledge creation, distribution and application, e.g. science, education, etc. • Technology entrepreneurship deals with an innovative actor who develops new technical processes, new goods, knowledge transfer and technological development in administrative sectors. • Sector-specific entrepreneurship takes place in public sectors such as military, health, transportation, communication, services, internal security, agriculture, environmental preservation, energy, law and justice etc.and in private sector mainly by firms.

23. 18) Which roles can entrepreneurship play for location decisions of households, firms, and public economic units? • It can influence the goals, alternatives and evaluations concerning location choice. • Goals for private firms or public offices in industrial location theory, in location competition models, political location models, etc. • Alternativesas transport costs may change, production function and agglomeration change goods change in industrial location theory, in location competition models, in models of economic landscape, etc. • The evaluation of alternatives change in models of industrial location theory, location theory of public offices, political location theory, cluster development, etc. • The households are influenced in their consumption patterns, work attitude, risk taking and skills thus changing their location decisions and factor supply. • Entrepreneurship is part of the economic milieu that can be more favourable for development if entrepreneurship prevails.

24. 19) Does enterprise culture influence location decisions? • Enterprise culture can refer to one economic unit in the sense of Schumpeter of being pioneering, imitating, reactive, immobile. Then the location decisions with respect to goals, alternatives, and choices turn out differently. Locations become developed. • Enterprise culture can refer to entrepreneurship prevailing in a region if it is dynamic the new locations, industries etc. get created or in the sense of conservative entrepreneurs the actions are to prevent and defend the use and existence of locations. Different milieus prevail that allow individual economic units or clusters to develop and use locations • The culture might be related to private and public enterprises, public offices and their management as wells as to households and their associations

25. 20) Which location policy measures are available to different types of government? • That depends on the kind of fiscal federalism prevailing in a country • EU defines its goals and tasks for its activities of regional policy and approves the national regional policies. The regional goals to allocate structural funds are defined as follows • Objective 1: to promote the development and structural adjustment of regions whose development is lagging behind; • Objective 2: to support the economic and social conversion of areas experiencing structural difficulties; • Objective 3: to support the adaptation and modernization of education, training and employment policies and systems in regions not eligible under Objective 1. EU also influences regional development through cohesion funds and its sector policies from which regions benefit differently. The regional policy refers to major socio economic regions Nuts 1 (3 to 7 millions inhabitants), Nuts 2 basic regions for application of regional policies (800,000 to 3 million) and Nuts 3 regions of specific diagnosis(150,000 to 800,000).

26. 20) Which location policy measures are available to different types of government? • In Estonia the whole country is Nuts1 and Nuts 2, there are only Nuts 3 regions. Some programs for Estonia exist approved by the European Union: Development of Living Environment, Development of Economic Environment, Estonia Latvia, Central Baltic and Baltic Sea Region. They concern project development and finance and influences the national policies through co-financing, etc. • In Germany there is a program for transportation, one for the region Lüneburg, and 16 programs for the states (Länder) and 19 cross boarder programs. • For the country exists a national regional planning that consist of the Federal regional planning program, State (Land) regional plans, and the municipal regional plans consisting of a territorial plan and a building plan. The higher level plan binds partly the plan of the next lower level. There are also project oriented regional policy process.

27. 20) Which location policy measures are available to different types of government? • In Germany all levels of government use information, consulting, infrastructure, incentive policies, e.g. fiscal, and administrative measures (orders and prohibitions). The fiscal measures are more on the federal level, the infrastructure level is mostly with the states and information, consulting, incentive policies (real estate) and administrative measures with the municipalities. • Important are also the project, sector and procurement policies of the governments. • All three level of government and their policies play a role in regional competition.

28. 20) Which kinds of regional competition exist? • Many competitive relations among regional competitors exist. Single public offices, public firms and the jurisdictions they belong to, may act as public competitors in regional competition. • ** They may act as a single competitor in microeconomic competition. • ** Should they be considered as a group, or if a public office, acts as representative a region, we are confronted with macroeconomic competition. • ** Economic units act either in isolation or in cooperation in the course of regional competition. • ** The aimsof the public institutions may be either regionally or nationally oriented. • ** Apart from horizontal competition among regions, vertical competition also exists.

31. III. The Effects of Regional Choice21) Distinguish questions of location choice from questions concerning location effects of location choice • In this lecture we look for effects which stem from location choice. When dealing with location theory one looks for statements on optimal locations. In location theory the effects are mostly assumed, e.g. distance dependent costs, weights, voting reactions. • Effects differ according to establishment, resettlement, expansion, shrinking,closing down of one or more economic units • With one economic units effects differ according to the spheres of activities which are touched, e.g. service provision sphere (procurement, production, and marketing) or financial sphere

32. 21) Distinguish questions of location choice from questions concerning location effects of location choice Launhardt problem: R1 √(R1C- R1)2 + (R2C- R2)2 MC R1C R1 MA ∂TC/∂ R2 = MB R2 R2 R2C Transportation costs = f*(MC*√ (R1C- R1)2 + (R2C- R2)2 +MA*√ (R1A- R1)2 + (R2A- R2)2 + MB*√ (R1B- R1)2 + (R2B- R2)2 ) ∂TC/∂ R2 = -f* MC(R2C- R2)/ √ (R1C- R1)2 + (R2C- R2)2 - f* MA* (R2A- R2)/ √ (R1A- R1)2 + (R2A- R2)2 - f* MB* (R2B- R2)*/√ (R1B- R1)2 + (R2B- R2)2 = 0 ∂TC/∂ R1 = ∂TC/∂ R2 Marginal transportation cost are in both directions the same

33. Theorem of Hakimi and Gülicher: Lij - x x ● ● i i j wi* x +wj *(Lij – x) If wi > wj → x = 0 If wi < wj → x = Lij

34. 22) In which regions occur effects? • A region is an area. Different regions concern homogenous regions (same climate, geographic structure,production, resources, population), functional regions (according to markets (labour market regions, commuting regions), administrative regions (territories of jurisdictions, administrative districts), centre hinterland regions, planning regions, economic regions • A region may be defined in economic terms as a group of neighbours whose relations with others are less conflicting than in the case of non- neighbouring economic subjects. An economic region refers to the distribution and activities of economic units in space • A region might be related to a linear, a two-dimensional area or a three dimensional space

35. 22) In which regions occur effects? • Regions according to economic policy aims: Objective 1 region (regions with too low income), objective 2 region (regions with structural problems),objective 3 regions (to develop human resources), objective 5b regions (rural areas), assistance regions of type A, B, distressed areas (peripheral regions, zonal border regions) • Competition regions • Effects can occur in homogenous regions, functional regions, and administrative regions • Functional regions show sometimes similar effects of location decisions • According to their size: Large, middle sized and small regions

36. 23) Which economic units get touched by a location choice? • Households: consumption, demand, labor supply, savings and finance, trips, movements, environment, utility, one household, settlements, other and several households • Private firms: goals (profit), owners, costs, factor demand, goods supply, spheres and sectors of one household its environment, other and several firms • Public enterprises (firms): Effects on public goals, effects such as with private firms, other economic units • Public offices: Effects on public offices, other public offices, other economic units

37. 24) Differs the identification of effects according to different economic units where the effects occur? • Depending on the kind of economic units the effects on goals and their indicators differ (ex ante effect assessment) • Different theoriesof household, private firm, public firm, and public office to detect effects exist • Depending on hypothesis, and indicators used for ex post assessment (accounting, statistical and econometric methods, ex post applied models of economy, environment, of coordination)

38. 25) To tackle which issues we need the knowledge of effects? • Achievement of goals • Change of landscape, settlements • Changes of coordination, external effects changes in production,allocation of goods and factors, transportation,budgets, etc. • Political changes • Comparison of locations • Changes of market areas • Changes ofdelivery and procurement, etc. New supplier 3 Market area 2 Market area 1

39. 26) State effects, which are assumed in location models! • Cost minimization models, e.g. Distance dependent costs, location dependent costs • Profit maximization models: e.g. Turnovers, costs, distances, delivery and procurement sites • Models with other goals, depending of goal indicators, outputs, jobs, incomes votes

40. IV. Kinds of Effects 27) Which kinds of effects are of interest in economic geography? • Effects on: • Structure of landscape • Infrastructure, • Development axes • Market areas • Networks, clusters, agglomeration • Environment • Distances, competition, • Individual economic units: households, private firms, public firms, public offices • Microeconomic effects: income, wages, taxes, output • Groups of economic units or economic sectors • Macroeconomic effects: Income, employment, migration, production, budgets

41. How does utility from cooperation shrink with increasing distance between partners? (less agglom-eration) Utility of y Utility of z Result from cooperation between partner y with time input y and z with time input z Optimum conditions Opportunity costs of time of patner y Opportuniy costs of time of partner z Time consumption because of distance kr With higher distance shrinks utility ofcooperation / dy dUy/dy = dUy= bh-kru)y = (bh-kru)y dUy /dy = (bh-kru)y = (bh dUy increases Constant

42. 28) Which kinds of agglomerations got defined? • Agglomeration implies clustering. If firms of the sameindustries are clustering we have localization economics. If firms of different industries cluster then urbanization economics prevail • There are examples such as delivery of intermediate goods between supplier and user just in time. There is a cemetery near a hospital. There can be vertical and horizontal integration (also localization economics). Firms use the same pre-services, the same infrastructure, and facilities they rely on the same labor market of high skilled labor. They settle close to customers,to hotels, to entertainment, to service centers. • They concentrate in Christaller places or in nodes of traffic networks.

43. 29) How do cost savings enforce agglomeration? • Two firms deliver customers in m1 and m2 and space is a line. • m1 x m2 • By agglomeration their unit costs can be reduced from c1 to c12 and c2 to c21 and unit transportation costs: k1,k2 • q1 and q2 are quantities to be transported • Transport costs are k1q1(x-m1) + k2q2(m2-x)= • k2q2m2-k1q1m1 + (k1q1-k2q2)x, Minimization transport costs! • Joint location x is m1 if k1q1>k2q2 • m2 if k1q1<k2q2 • If k1q1=k2q2 any location from m1 to m2 is equally good.

44. 29) How do cost savings promote agglomeration? • If both are in x=m1 than under consideration of agglomeration savings this is better then for individual locations m1 and m2 if savings in production costs exceed transportation costs • (C1-c12)q1 +(c2-c21)q2 >(m2-m1) k2q2 • That firm 2 chooses m1 must prevail • (c2-c21)> (m2-m1) k2

45. 29) How do cost savings promote agglomeration? y • Also transportation cost from intermediary products may cause joint locations of firms. • m1 m2 • Firm1 uses a21 units of product2 for one unit output • Firm2 uses a12 units of product1 • Total transportation costs =k1q1(x-m1) +k2a2q1(y-x)+k2q2 (m2-y)+k1a12q2(y-x)= • K1q1m1+ k2q2m2 +(k1q1-k2a21q1-k1a12q2)x + (k1a12q2-k2q2+k1a21q1)y • The joint location is m1 if K1q1 > k2q2 and if • k2q2<k1a12q2+k2a21q2 • Firm 2 decides for m1 if k2q2 <k1a21q2. Then transport costs for intermediate goods are higher than for client deliveries (resource oriented). • If the only client of firm 1 is firm 2 and firm 2 transportation costs to clients k2q2 are higher than the transportation cost k1a12 q2 to firm 2 then • the firm 2 is market oriented and forces firm1 to follow. (leading firm cluster) x

46. 30) Explain the Tiebout model! When do people move because of location choice to built infrastructure in a community? Expenditures for x in i – tax payment of x in i Town Person Expenditure per capita in town i Tax rate in i Person’s income in i Number of persons in i 0‘ Total income in i EA EA tA

47. 30) Explain the Tiebout model! When do people move because of location choice to built infrastructure in a community? Poor people Moving to right of E especially to the first quadrant Average income people If tax rate increases poor people stay Average income people move less Migration frontier Migrate to quadrant I and II Rich people Rich people move Migrate to II and II

48. 31) Which kinds of microeconomic effects are to distinguish? • Microeconomic effects are effects on individual economic units • - one household • -- a household choosing a location • -- an already localized household • - several single households • - one private firm • -- choosing a location • -- an already localized firm • Several single private firms • - one public firm • -- choosing a location • -- an already localized public firm • -- several public firms

49. 31) Which kinds of microeconomic effects are to distinguish? • - one public office • -- choosing a location • -- an already localized public office • - several single public offices • Effects on goods and factor markets (prices volumes, market areas) and microeconomic coordination • Effects differ in case of establishment, resettlement (move), expansion, decline, and closing down • With one economic unit effects differ on financial and performance sphere concerning procurement, production and delivery

50. 32) How to show micro economic effects? • Household: • How large does a household chosehis location? • He produces a good x himself for consumption. There is a production function x=f(L,M); L Labor, M area • Utility from consumption U = a*x • Disutility from overcoming distance = ur*r*x • Disutility from work =uw*L • Total utility: UT = (a-ur*r)*f(L,M)- uw*L • UT/M = (a-ur*r)*f(L/M,1) - uw*L/M, i=L/M • d UT/M/di = (a-ur*r)*f’(i) – uw=0, f’(i) =uw/ (a-ur*r) • Intensity of land use gets zero if f’(i) →∞ then (a-ur*r) →0 • r=a/ur that means utility per consumption unit/ disutility of distance unit distance Disutility per distance unit