Knowledge Spillovers, Congestion Effects, and Long-Run Location Patterns

Abstract

Abstract.We introduce an evolutionary two-country model to characterize long run location patterns of the manufacturing activities of competing multinational enterprises. Firms located in country 1 can decide to offshore their manufacturing activities to country 2. The profitability of production in a country depends on several factors: unitary costs of production, the number of firms that are located in each country, within-country spillovers, and cross-border spillovers. Furthermore, profits in country 2 are influenced by congestion costs. Country 1 is assumed to be technologically advanced and has an advantage in terms of internal spillovers. In contrast, country 2 offers lower production unit cost which, however, may be offset by congestion costs. The firms' (re)location choices are based on a simple comparison of current production costs obtained in the two countries and the dynamics of switching is modeled by a simple replicator dynamics. The global analysis of the resulting one-dimensional dynamical system reveals that a large advantage in terms of unitary production costs encourages the firms to off-shore manufacturing activities to country 2. This off-shoring process stops when congestion costs offset this advantage of country 2, even though congestion costs do not cause all manufacturing activities to be re-shored to country 1. The re-shoring process can be accelerated by an increase of within-country spillovers in country 1, while cross-border spillovers tend to favor a geographic dispersion of manufacturing activities and make location patterns that lead to suboptimal long run outcomes less likely.

Offshoring, Reshoring, Unemployment, and Wage Dynamics in a Two-Country Evolutionary Model

“…Following this stream of research, in Bischi et al (2018), manufacturing location patterns are described by a dynamic model that combines together endowment drivers and agglomeration drivers for the first time. It is an evolutionary model, based on replicator dynamics, that describes the location patterns of a manufacturing activity which is originally located in a technological-leader country.…”

“…In summary, the model in Bischi et al (2018) is developed to describe the offshoring of manufacturing activity by MNEs, operated to take advantage of lower-cost workers only. We may think of the European automotive industry that (to satisfy the European Single Market) decentralizes the manufacturing activity in the Eastern Europe; for the sole purpose of enjoying lower labor costs.…”

“…The diversity in the economic issue at stake justifies the differences between the two modeling frameworks. The one proposed in Bischi et al (2018) is a partial equilibrium model; manufactured goods are sold in a single common market and only supply-side factors drive the location pattern. In these aspects, the modeling setup in Bischi et al (2018) is similar to the one in Maurer and Walz (2002), where two regional governments compete (providing local infrastructures) to attract two mobile oligopolistic firms.…”

“…The one proposed in Bischi et al (2018) is a partial equilibrium model; manufactured goods are sold in a single common market and only supply-side factors drive the location pattern. In these aspects, the modeling setup in Bischi et al (2018) is similar to the one in Maurer and Walz (2002), where two regional governments compete (providing local infrastructures) to attract two mobile oligopolistic firms. On the contrary, the NEG models are general equilibrium models, heterogeneous local markets are considered, and market demands as well as remuneration of productive factors guide the capital mobility; see the Core Periphery model in Trionfetti (1997), the original Krugman's framework developed in Krugman (1991), as well as the recent variants such as the Vertical-Linkages version of the Core Periphery model in Trionfetti (2001), the Footloose Capital model in Martin and Rogers (1995), and the Footloose Entrepreneur model in Brakman et al (2008).…”

“…Despite these differences, similarities between the two approaches are present. In Bischi et al (2018) the spatial distribution of the manufacturing activity is modeled according to evolutionary game theory (with a discrete time specification to account for delays in firms reallocations) as in recent NEG models [see, e.g., Agliari et al (2014) and Commendatore et al (2014)]. The setup in Bischi et al (2018) accounts for heterogeneous endowment drivers in terms of public goods among countries that reflect in different transportation costs as well as manufacturing costs.…”