in the Context of Regional Development

BOX 5.4 Not All Places Are Equal: The Coexistence of a Low and a High Equilibrium in the Context of Regional Development

Being able to move from a low equilibrium to a high one through place-based policies sounds attractive because a temporary intervention may be able to bring about a permanent change for the better. To this end, policy makers combine some place-based interventions with efforts to develop individuals’ and firms’ capabilities, such as support for higher education, and incentives to technology firms to relocate in hopes of creating a “transformative” high-tech cluster. Yet such interventions can also produce multiple equilibria—that is, the coexistence of a low and a high equilibrium—with some places benefiting, and others not so much, or at all. Moreover, the knowledge needed to design effective interventions far exceeds what is currently known. Extant research still struggles to offer solid conclusions regarding the existence of multiple equilibria in regional development and the ability to move from one equilibrium to another.

Multiple equilibria involve some form of increasing returns. It is useful to distinguish between three forms of multiple equilibria. 1. Although leading and lagging regions coexist, which region will lead is not a foregone conclusion. While Silicon Valley emerged around Palo Alto and Stanford University in California, New Jersey—with its high concentration of human capital—was also a strong candidate. Naturally, the lagging region wants to change the equilibrium it faces to become the new winning region. However, any policy to redirect development is of no overall net social value unless the concentration of economic activity initially occurred in the “wrong” region: one that was not predisposed to a higher equilibrium because of the first, second, or third nature factors discussed in chapter 2 of this volume. 2. Multiple equilibria are possible with numerous configurations. There is no general result about which configuration is more desirable. Multiplicity arises when both concentration of economic activity in one region and an even distribution of economic activity across both regions can be in equilibrium (Krugman 1991b). Concentration of economic activity may be in equilibrium if no firm wants to leave the leading region, where it benefits from agglomeration effects, and serving the leading region from the peripheral region would be too costly. An even distribution of economic activity may also be in equilibrium because the benefits for firms of increased concentration in one region would not compensate for the higher cost of serving the equally large market in the other region. The efficiency of a given configuration depends on the fine details of the exact model at hand and the situation on the ground (Baldwin et al. 2005). 3. Policy interventions are justified in a situation of multiple equilibria in the absence of factor mobility and reallocations across regions. These situations are often referred to as poverty traps. While there are many ways to justify the existence of poverty traps, a first classic motivation is the existence of an equilibrium characterized by low human capital and low productivity, which can persist when a region cannot finance its initial growth in human capital (Azariadis and Drazen 1990). Another classic example involves the existence of a persistent agrarian equilibrium: in a predominantly agrarian economy, the viability and expansion of the industrial sector is limited by the local demand (Murphy, Shleifer, and Vishny 1989).

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BOX 5.4 Not All Places Are Equal: The Coexistence of a Low and a High Equilibrium in the Context of Regional Development (continued)

A key question with multiple equilibria is how to move from one equilibrium to the other. In the absence of any type of disequilibrating frictions, a shock is needed to take the economy away from the low equilibrium into high equilibrium. With transitional frictions such as the cost of ruralurban migration or the inability of an industrial sector to quickly absorb new workers, the situation is more complicated. The frictions may be large enough to trap the economy in the low equilibrium. When frictions are not as large, expectations about future development are key in deciding the destiny of the place (Krugman 1991a; Matsuyama 1991).

Development Program. Having provided infrastructure, social services, and job creation projects in the past, it piloted a new integrated approach to provide two sets of missing complements. First, it supports firms by improving their business environment. Key components include improving the efficiency of government-tobusiness services, technological support to upgrade clusters, access to serviced land, and investment services through better industrial zone management and infrastructure. Second, it supports local governorates in planning and implementing policies and expenditures that improve access to infrastructure and services. Key components include better capital investment planning, improved service delivery, and better financial management. The operation is still being implemented, but early results are promising. Since implementation, the occupancy rate in the industrial zone has increased from 13 percent to 34 percent in the Qena Governorate, and more than 5 million people and 3,000 local firms have benefited from improved access to infrastructure and services. Evaluation of combinations of such policies is still challenging, but an accurate valuation of the expected gains from the (indirect) scale effects of a big push approach is not necessary either.

With any multidimensional program, when government capabilities are limited it may not be possible to diagnose and implement the full range of necessary complementary policies, including coordinating them across ministries and levels of government. This necessarily reduces the expected return to investments in a region and can relegate it to de facto nonviability. The case of Integrated Rural Development programs of the 1970s and 1980s in Colombia offers an illustrative example. These programs sought to bring together agricultural credit, technical assistance, supply of inputs, and marketing integration assistance in a coordinated fashion, precisely to resolve multiple market failures at once while creating a modern farmer. In an early pilot in the municipality of Cáqueza, the technology assistance and input components substantially increased yields, but the market integration component, in particular roads was neglected, leading to a dramatic fall in local prices that offset the productivity gains. Hence, the lesson was