A surprising and unfortunate characteristic of work on endogenous growth (or ‘new growth theory’) and the ‘new geography’ is that, despite their growing importance within economics, the two research agendas have so far been kept separate. The separation is surprising because the two literatures ask related questions, and unfortunate because, in the case of the new geography, it leads to the analysis of location dynamics which are based on the redistribution of a given amount of resources, while in the case of endogenous growth, the absence of a geographical dimension contradicts a point stressed by Lucas (1988), namely that the economic mechanism at the origin of endogenous growth requires social interactions or external effects which are mostly local in nature.

In Discussion Paper No. 1523, Philippe Martin and Gianmarco Ottaviano construct a model of endogenous growth and endogenous industry location where the two interact. They show that, with global spillovers in R&D, a high growth rate and a high level of transaction costs are associated with relocation of newly created firms to the south (the location with a low initial human capital). With local spillovers in R&D, this activity will be agglomerated in the north and the rate of innovation will increase with the concentration of firms in the north. This, in turn, implies that a decrease of transaction costs through, for example, trade integration, will increase the growth rate, because it leads to a higher industrial concentration of firms where the R&D is located. They show that industrial concentration improves welfare only for low enough transaction costs and high enough spillovers.

Growing Locations: Industry Location in a Model of Endogenous Growth
Philippe Martin and Gianmarco I P Ottaviano