The availability of specialised inputs and services is another externality, assumed to cause agglomeration of firms belonging to the same industry (and therefore demanding the same kind of intermediate inputs). A geographically concentrated industry allows for a greater variety of, and more specialised, intermediate inputs, at a lower cost, at the same time as a substantial concentration of downstream firms provides upstream firms with a beneficial market access. In other words, cost, variety, and demand linkages all encourage agglomeration of vertically linked industries. That verticallinks trigger agglomeration, does, however, depend critically on an assumption of increasing returns to scale in production and imperfect competition.
Comparing the kinds of agglomeration economies elucidated in the "Core-periphery"
model with the one just described, we observe that in both cases the phenomenon
"market potential"
is central. They differ in the way the market-size is made endogenous. In the "Core-periphery" model, the size of the market at different locations was endogenous due to labour mobility. But if industries are vertically linked, it is the movement of the downstream industry that affects the market-size for the upstream firms,Economic geography and trade -A survey of the literature
Anthony Venables has developed a formal model considering the allocation problem of firms in an upstream and a downstream industry that are vertically linked (see Venables (1993». Since this model is basically quite similar to Krugman's "Core-periphery" model, we will not elaborate it in detail here, but just provide a brief description of framework and results.
Both industries are imperfectly competitive, and the interaction between the downstream and the upstream industry creates a force for agglomeration. Centrifugal forces are labour supply and final demand, which are spread across locations, and assumed immobile. Although the specific forces working for and against concentration are different from those in the "Core-periphery" model, the economies of agglomeration (positive externalities) are derived from the same, single source in both models, namely the market interactions. Technological externalities are neither considered by Krugman, nor by Venables.
A key parameter is the costs of ffi¥ket access.s? Similarly to the results regarding the sustainability of a core in the "Core-periphery" model, it turns out that the forces of agglomeration are greatest at the intermediate level of these costs. A reduction in transport costs from a high to an intermediate level, leads to agglomeration and divergence among regions. But a further reduction in transport costs to a very low level will, according to Venables' results, cause diversification and increased convergence of economic structure and income among regions.
It is interesting to note that, a reduction in costs affecting the incentives to cluster, and thereby the spatial equilibrium, may lead to reallocation in different directions,
40 Costs of market access are equal towhat we have earlier referred to as "transport costs". For the sake of simplicity, we will keep referring to these kinds of costs, as "transport costs" .
Economic geography and trade -A survey of the literature
depending on the characteristics of the industry in question and other vertically related industries. Furthermore, depending on initial conditions and industry characteristics, the effect of parameter changes may be small or large, incurring a slightly different equilibrium or a dramatic change from concentration to dispersion (or vice versa).
Venables also discusses the implications of a regional "industrial base": because a firm's choice of location depends on the allocation of other firms, like in the "Core-periphery" model, the possibility of multiple equilibria arises. Another consequence of this interdependence between firms is that, if one firm's (or several firms') locational choice is altered, the whole vertically linked chain of firms may be affected, and as a result we get a totally changed equilibrium.
Ultimately, we return to the crucial assumption of market imperfections. This assumption is critical to the results achieved by Venables. If,for instance, the upstream industry were perfectly competitive with all manufacturers producing the same homogenous goods, the downstream industry would probably always use its local supplier. But product differentiation (as Venables assumes in his model) ensures that all downstream firms use all upstream firms' products. Due to demand linkages, the firms in the upstream industry would, in this case, have an incentive to concentrate their production in one location, and the price for intermediate goods will be lower the more upstream firms there are in one location. This implies lower costs for the downstream industry and encourages agglomeration.
Technological spillovers
This is the very "common" externality that is (almost) always mentioned among the reasons for agglomeration in space. Silicon Valley and Boston's Route 128 are
Economic geography and trade -A survey of the literature
famous examples of industry clusters arising from knowledge spillovers between nearby firms, The difference between these kinds of externalities and the external economies rising from labour market pooling and intermediate goods supply, is that knowledge spillovers are, as Krugman describes them, invisible. In other words, technological spillovers are, difficult to measure and an economist needs to make several assumptions about their form and size before he can include them in a model.
Comparing the modelling of spillover effects with the models in which market interactions are responsible for agglomeration, the advantage of the latter models is clear: explicit assumptions about the externalities are not necessary. The external economies rise from interaction between increasing returns, factor mobility, and transport costs.f Currently, the modelling of knowledge spillovers relies totallyon the vague concept of external effects. As a consequence of the difficulties related to the models with these kinds of agglomeration economies, the issue of technological spillover effects has not received much attention within the new field of geography and economics.
41 As, for instance, from the interaction between internal increasing returns, factor mobility, and transport costsinthe Core-periphery model.