Endogenous Regional Policy in a Model of Agglomeration

Abstract

It is a widely observed fact that in many European countries, regions of low population density get subsidies that are not justified by their size. This paper throws some light on the effect of this phenomena on location of manufacturing activities. Considering a simple two-region economic geography model enriched to allow for endogenously determined regional policy, we find that, once the political economics of regional policy is explicitly considered, region size has an ambiguous effect in determining the equilibrium regional subsidy, while it still plays a key role in the determination of the equilibrium share of industrial activities. In particular the final allocation of firms will depend both on the relative economic strength of the two regions, as predicted by more orthodox economic geography models, and by their relative political weight.Agglomeration; Home Market Effect; Regional Aids; Political Economy; Swing Voter