Chapter Seven

Local and Regional Economic Development

7.1 Background and definition

Regional economics try to address the economic aspects of the regional problems that are spatially
analyzable and hence policy implications can be derived with respect to regions whose
geographical scope ranges from local to global areas. It attempts to establish a methodological and
procedural foundations for the systematic comparison and improvement of different regions, and
hence strive for the betterment of the community by ensuring sustainable local and regional
economic development.

As a sub field of economics, regional economics tries to identify the causes, effects, and suggests
possible policy interventions for local and regional development disparities. This process of
economic analysis starts with the classification of regions based either on their homogeneity or
political characteristics. And then, it proceeds to identifying the economic performance and
challenges across regions.

The origin of local and regional economic development as academic interest is the early
contributions from sociology and political science, and to lesser degree economics. Local and
regional economic development comprises two separate but interchangeably used locational based
development concepts: regional development and local development.

Regional development refers to the process of economic development of a region through which
a region is capable to improve its overall wellbeing; and can be seen as a general effort to reduce
regional disparities by expanding employment opportunities and building wealth generation
capacities in regions.

Local economic development on the other hand is a particular form of regional development in
which endogenous factors occupy a central position. It is an approach towards economic
development which allows together to achieve sustainable economic growth and development
thereby bringing economic benefits and improved quality of life for all residents in a local area. It
considers the endogenous potentialities of a community within specific territories.

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Local and regional economic development is therefore, the process of economic development of a
region through which a region is capable of improve its economic, political, and social welfare.
The term local and regional economic development is used by academicians, policy makers, and
regional development agencies to indicate the growth of a region. Its purpose is to build the
capacity of a defined area to improve its economic future and the quality of life for habitants. The
process of local and regional development is highly influenced by availability and quality of
human resources, physical and human capital, natural resources, technology, and governance.

7.2 Local and regional economic development; initiatives and actors

A. Local and regional economic development initiatives

Local and regional development aims at promoting local and regional wide;

 Sustainable economic development

 Growth and competitiveness of the region
 Wellbeing of residents
 Quality of the living environment

It seen as one of the most important ways of;

 Reducing regional disparities and poverty

 Creating jobs
 Realizing full potential of region’s resources and its habitants

In general, local and regional economic development encourages economically disadvantaged

communities and regions to improve their economic, social, and environmental wellbeing. And
thereby, assures the core values of development for the local community; that is, local and regional
economic development seeks to realize;

 Sustenance: ability to meet basic needs

 Self-esteem: sense of worth and self-respect and feeling of not being marginalized
 Freedom: ability to make decisions and free from servitude. It involves expanding range of
economic, political, and social choices.

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As a regional economy developed and advanced, that region and its community become less
dependent and increasingly affluent and more innovative.

B. Local and regional economic development actors

Local and regional economic development is a bottom up development process and is based on
interactions among different development actors or stakeholders.

 Local, regional, and central governments: they formulate, coordinate, and monitor
development strategies and implementations
 Local, national, or international institutions and/or organizations, and other agencies and
donors: they facilitate development process in collaboration with governments and local
community through provision of financial and material support and coordination
 Individual persons or business entities: they can engage in development by making their
private business and create job opportunities for the local community thereby
 Local community: local and regional development requires the active participation of local
community and are the main actors (they need to identify their local and regional challenges
and also be part of the solution)
 Ordinary citizens and civic societies: NGOs, entrepreneurs, research centers, universities,
etc also play a great role in local and regional economic development. They facilitates
development process by;
 Identifying local and regional based development problems, focus areas, or priorities
 Providing remedial solutions and policy recommendations for the problems
 Participating in or contributing for development activities

7.3 Theories of local and regional economic growth and development

Different economists, geographers, and social scientists have developed many theories and
concepts that attempt to systematize the mechanisms of regional development and explain spatial
inequalities in the economic development of regions. Based on different methodological
orientations, these theories and concepts explain the diverse spatial dynamics of socio-economic
processes in various ways.

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Theories of regional development arose evolutionary and in terms of general assumptions of
regional development, they are based on the path of sustainable growth. In this respect, the issues
of the layout of agricultural zones for a given area are analyzed, and elements of the theory of
location can already be found in the works of the creators of classical economics.

7.3.1 Paradigms and schools of thought of regional development

As it stated above, a number of different local and regional economic development theories have
been developed where some of them are derived from the nation-level development theories, and
others focused particularly on the regional context. It is possible to identify and categorize these
theories into nine main theoretical frameworks, each one giving rise to different theories and
models of regional development. Namely: firm location theory, traditional neoclassical theories,
Keynesian theories, core-periphery theories, functional development theory, stage theory,
disequilibrium theories, endogenous growth theory, and new economic geography theory.

Resources and regional development

The types and amounts of resources in a region determine its growth. Industries that depend on
natural resources provide more jobs and income in metro than non-metro counties. Global and
national economies, policies regulating natural resources and the environment, as well as technical
changes affect the growth and stability of jobs and income in these industries. Lower incomes in
the fishing industry and unemployment in forestry, energy, and mining illustrate the instability of
natural resource industry. The survival of these regions depends on the availability of alternative
industries in the area. Similarly, regulations that affect the periphery also affect its core.

Staple Theory of Economic Development: Focus on natural resources

The staple theory of economic development, formulated by Canadian economist Harold Innis
(1956), affirms that regional economic growth (and hence, employment opportunities) are largely
determined by the growth of the staple (resource-based) industries in each region. According to
Innis, the prosperity of the staple industries determines regional prosperity, which attracts people
from depressed regions.

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Although abundant natural resources are an essential ingredient in world economic growth, they
are neither necessary nor sufficient for a region’s economic growth. Hong Kong, for instance, has
few natural resources, but Hong Kong’s per capita income is the highest in Southeast Asia.
Alternatively, many countries in Africa, Latin America, and Asia have abundant natural resources
but political instability and inefficient bureaucracies prevent their growth.

Yet, natural resources played an important role in the early development of many regions. Current
literature concerning the staple theory deals with the history of economic development in western
North America. Low-cost farmland, minerals, timber, oil, and fishing first brought people and
economic development to this area.

The economies of regions that depend on natural resources are extremely volatile because they are
at the mercy of the world market. The quantity of the resource extracted or harvested is more
responsive to earlier investments in machinery than to current resource prices. An increase in the
price of the resource, especially if it is expected to persist, signals an increased market value of
that resource and therefore quite lucrative profits. Profit increases spur investment and
employment growth, thus increasing incomes.

Over time, new industries surface to support primary resource industries by providing services or
equipment (indirect effect). Increased wages and possibilities for wealth attract migrants who
create a demand for consumption products and residential construction (induced effect). Resource-
based industries cannot easily expand production, so wealth created in the industry diversifies
through acquisitions. Equally, when resource prices fall, migration and outside investment slows.

The sustainability of economies that depend on natural resources is precarious. First, the national
income accounts list neither the natural resources as assets nor their extraction as a debit, and thus
they only give a partial representation of potential future growth. For example, the value of
pulpwood boosts gross regional product, but the value of the stand of timber that is cut down to
produce pulp is not subtracted.

Second, as regions grow, they should diversify, creating industries independent of natural
resources. However, that time, this strategy seems unsound because profit rates in the resource
industries are close to their peak and significantly higher than any alternative investment.

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Nonetheless, those economies depending on natural resources that have the astuteness to diversify
while the resource prices are high will become more stable.

Firm Location Theory

Models of regional development inspired by firm location theory assume that regional
development is largely dependent upon the existence of firms in the region. In such models,
regional development is, therefore, a function of the factors firms consider when choosing where
to locate.

In its traditional formulation – largely influenced by the pioneer works of Alfred Weber in the
1910s, Andreas Predohl in the 1920s, and August Losch in the 1940s – the firm’s location decision
problem is modeled as a simple transportation costs minimization problem. Therefore, the distance
to customers, the distance to inputs, and transportation costs are central elements of a firm’s
decision location model. The firm’s location, then, is the place where total transportation costs are
minimized. Most of the regional development models, inspired by location theory and developed
prior to 1960, adopted a transportation cost minimization framework.

In regional economics location theory evolved from simple transportation cost minimization
models to more realistic location decision models incorporating a myriad of additional factors that
empirical evidence has demonstrated to be significant locational factors. The extensions have
included, among others, spatial variations in market size, production cost differentials, availability
(and cost) of labor, technical competence of the labor force, technological capabilities, regional
amenities and quality of life, regional business climate, and local taxes. As the realism of location
theory increased so too did the complexity of the location decision models, which are increasingly
less theoretical deterministic models of where firms decide to locate. More recent models of
regional development inspired by firm location theory admit that other factors such as inertia,
agglomeration economies, chance, and institutional framework can play a role in where firms
choose to locate as well.

Traditional Neoclassical Theories

Broadly speaking, the theories of regional development rooted in a traditional neoclassical

framework assume that the key determinants of regional development are factors endowment and

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productivity because these are the determinants of long-run growth of the supply capacity. These
models also assume free trade among regions, perfect competition, perfect information,
technological progress exogenously determined, and an equilibrium growth path leading to a
convergence of growth rates among regions (Cheshire and Malecki 2004). Among the theories of
regional development emerging from this framework are (1) the Borts and Stein model and (2) the
factor price equalization theory.

Borts and Stein Model

The model of regional development developed by George Borts and Jerome Stein in the 1960s is
a simple adaptation of Solow’s (1956) neoclassical growth model to a regional context by allowing
for production factors mobility. According to this model regional development is determined by
the long-run growth rate of the supply capacity which, in turn, is determined by the combined
growth of the capital stock, labor supply, and productivity which depends on technical progress.
Technical progress is considered exogenous to the development process and determined largely
by non-economic forces. The production factors labor and capital are mobile among regions.
Therefore, investment from outside and migration are the only inducing factors that can stimulate
regional development since technical progress, the source of productivity growth, is determined
by exogenous factors (Borts and Stein 1964, Cheshire and Malecki 2004).

Factor Price Equalization Theory

The regional development theory of factor price equalization derived from the works of Eli
Heckscher (in the 1910s), Bertil Ohlin (in the 1930s), and Bela Balassa (in the 1960s) suggests
that regional development occurs as a process of factor prices equalization among regions.
According to this theory, investment tends to flow from leading to lagging regions where the lower
prices of production factors (e.g., labor, land, or energy) allow greater returns on investment. As
investment in lagging regions increases, so does the competition for production factors, which
results in increasing factor prices and decreasing returns on investments. Over time, factor prices
and return on investments tend to equalize over regions (Nelson 1993).

The major strength of the regional development theories grounded in a traditional neoclassical
approach is the emphasis on productivity and technological progress as major sources of economic

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development. Their major limitations derive from the strong hypotheses these models are built
upon which are not verifiable in most regional economies. Of particular relevance for regional
development are the (unrealistic) assumptions of (1) the exogenous nature of technological
progress and (2) constant returns to scale, which imply that agglomeration economies and
economies of scale are assumed not to exist or not to matter for regional development.

Keynesian Theories

By contrast to the neoclassical view, which puts the emphasis on factors affecting supply capacity
as the major determinants of regional development, Keynesian theories assume that regional
development is largely demand driven. Two main regional development theories fall into this
framework: (1) export-base theory and (2) input-output theory.

Export-Base Theory

The export-base theory, developed by John Alexander, Douglass North, and Charles Tiebout in
the 1950s, assumes that regional economic activity can be divided between activities producing
goods and services for export to other regions (basic activities or export base) and activities
producing goods and services for local consumption (non-basic activities). The key feature of this
theory is that it considers exports the major driver of regional development because exports have
a regional multiplying effect. The expansion of the regional export base means that funds flow into
the regional economy from the sale of locally produced goods and services to customers outside
the region. These externally generated funds boost local demand for local-oriented (non-basic)
activities. The initial and subsequent rounds of spending (indirect and induced effects) derived
from the initial expansion in the export base have a multiplier effect on the non-basic activities
thereby creating economic development.

Therefore, according to this theory the economic development of a region depends on the region’s
ability to develop and sustain an export base capable of producing goods and services in demand
outside the region. Non-basic activities are largely dependent on export activities and thereby play
a minor role in regional development.

The major strength of the economic-base theory is the emphasis given to regional competitive
advantages as the ultimate fundamental source of regional development. The profit opportunities

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offered by the region’s competitive advantages in activities capable of producing goods and
services in demand outside the region attract capital and labor into the region from outside which,
in turn, boost the economic development of the region (North 1956).

The export-base theory has some limitations as well. First, as a demand-driven theory it pays little,
if any, attention to the supply-side conditions a region must offer in order to be able to fully exploit
its competitive advantages and/or to create new competitive advantages. Such supply-side
conditions include, among others, physical infrastructure, accessibility to external markets,
financial resources, labor force skills, entrepreneurial capacity, local amenities, and institutional
framework. Second, it assumes that all export activities are equally important in boosting regional
development because they all have similar multiplier effects on non-basic activities.

Input-Output Theory

The demand-driven input-output theory, developed by Wassily Leontief in the 1940s, differs from
the export-base theory by assuming that different activities have different multiplier effects in the
local economy. This implies that not all export-oriented activities have the same effect on regional
development. The distinct local multiplier effects depend, according to the input-output theory, on
the local industrial mix and on the local inter-industry linkages. Therefore, regional economic
development depends on the region’s ability to develop and sustain (1) export activities with dense
local inter-industry linkages, and/or (2) import substitution activities that limit the income leakage
to other regions and simultaneously strengthen the local inter industry-linkages, and/or (3)
intermediate activities with backward and forward linkages to both export-oriented and local-
oriented activities.

The input-output theory has the major advantage of highlighting that regional development can be
enhanced if, in parallel with developing an export base, the regional economy is able to develop
local intermediate suppliers which may or may not be export-oriented per se. This will generate
stronger and more complex backward and forward intra-industry linkages thereby expanding the
local multiplier effect of exports.

Like the export-base theory, the major drawback of the input-output theory is that it is not
concerned with the supply-side conditions a region must have in place to be able to develop and

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sustain a dense network of local activities that includes export-oriented activities, local-oriented
activities, and intermediate suppliers to both exports and local activities.

Core-Periphery Theories

The core-periphery theories of regional development depart from the assumption that there are
advanced (leading) regions and underdeveloped (lagging) regions. In a clear contrast with
traditional neoclassical approach which assumes that regions tend to converge to similar long-run
growth rates, core-periphery theories see regional development as inherently uneven. The several
core-periphery theories differ in the assumptions they make with respect to the linkages between
leading and lagging regions. It is possible to identify three major theories within this approach: (1)
theory of cumulative causation, (2) growth pole/growth center theory, and (3) central place theory.

Theory of Cumulative Causation

The theory of cumulative causation, developed by Gunnar Myrdal in the 1950s, emphasizes the
polarizing effects of leading regions over lagging regions. Some places (leading regions) possess
initial comparative advantages due to, for example, location, infrastructure, and size.
Agglomeration economies reinforce these comparative advantages and pull in capital, skills and
expertise, with backward effects preventing the lagging regions from developing the internal
capacity to compete and prosper. Skilled workers, educated people, business leaders, and capital
that may emerge in lagging regions will flow to leading regions where the returns are higher. Little
investment moves from leading regions to lagging regions. Investment that occurs is controlled by
leading region elites to assure economic dominance. In addition, goods and services produced in
the leading regions are sold to the lagging regions at such low prices that local industries cannot
compete. This theory also concedes that leading regions can spread out into lagging regions that
have some comparative advantage. Lagging regions can have some comparative advantage, e.g.,
natural resources or a large labor pool, which can cause a positive investment flow into the region.
The lagging region will develop when the spread effects become stronger than the polarizing
effects (Myrdal 1957, Nelson 1993, Stimson et al. 2006).

The theory of cumulative causation has the merit of offering one possible explanation why regional
convergence is far from being a natural long run outcome of the development process. As the

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theory suggests, agglomeration economies can reinforce the competitive advantages of leading
regions and the polarizing effects can inhibit the development of lagging regions. One of the
shortcomings of this theory is the limited role given to the spillover effects of leading regions into
lagging regions. They seem to occur just through investments seeking to exploit a comparative
advantage the lagging region might have.

Growth Pole/Growth Center Theory

The growth pole theory, first introduced in regional economics by Perroux in the 1950s, argues
that by concentrating its efforts on a specific sector or a limited number of sectors with high
potential for growth, the growth pole, a region can initiate propulsive development. As the “pole”
expands, the local inter-industry linkages are intensified through import substitution thereby
causing regional economic development. Usually, the selected growth pole is a region’s leading
export industry because it has larger spillover and multiplier effects on other industries.

Largely as a result of the works of Albert Hirschman also in the 1950s, the growth pole theory has
also been applied to urban nodes, which is termed in the literature as growth center theory. In this
context, the theory argues that regional development efforts should be concentrated in a few urban
nodes, those with greater growth potential. As these urban nodes expand, economic growth spills
over to adjacent regions through a process of de-concentration of economic activity and/or
population from the growth center to the peripheries.

The growth pole/growth center theory has the merit of highlighting that scarce resources have the
potential of generating greater returns in terms of economic development if concentrated in
sectors/urban nodes that have greater growth potential.

Like the theory of cumulative causation, the growth pole/growth center theory assumes that growth
and development can be unbalanced, either over region or over sectors. By targeting particular
poles (sectors or urban centers) this theory is assuming that the benefits accrue initially to that pole
enhanced by polarizing effects. The trickling-down benefits come later to the other sectors or parts
of the region. Although the theory assumes that the trickling-down effects will occur later and
eventually will surpass the polarizing effects, in practice nothing guarantees that this is the case.

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Polarizing effects can be stronger than the trickling-down effects over time and, as a result, the
initial unbalanced growth can become the norm or be even aggravated.

Central Place Theory

The central place theory, developed by Walter Christaller and August Losch in the 1930s and
1940s, argues that the development efforts and investments should be concentrated in a limited
number of growth points organized in a hierarchical and functionally integrated way. In this view,
regional development occurs in a matrix of growth points which are the building blocks around
which the regional economic base will cluster.

In identifying a hierarchical system of growth points three things are necessary. One is to define
the minimum population size an urban region must have to qualify as a candidate for a growth
point. The second is to select as major growth points those candidates having the greatest potential
for future economic growth. The third is to establish a hierarchy among the selected growth points
based on their different sizes and thereby different areas of influence. Higher-order growth points
should be assigned a higher number and order of critical service functions and thereby higher
developmental efforts and investments on the basis of estimated population-service ratios. Critical
services may include: (1) secondary schools, (2) vocational training schools, (3) technical research
facilities, (4) health facilities, (5) housing, (6) utilities (e.g., sewerage and water supply system,
energy system, and telecommunications system), and (7) information and communication services,
and (8) recreational and cultural facilities. The several hierarchical levels of growth points must
be connected by a transportation network to provide for the maximum access of population to the
different growth point levels and thereby different levels of critical services.

The central place theory shares with the growth pole/growth center theory the principle that some
urban agglomerations are the engine of development and this development impacts surrounding
lagging regions through a combination of trickling-down and polarizing effects. It adds to the
growth pole/growth center theory the important notion that not all growth points are equally
important in promoting regional development. Regional development is maximized if the
developmental efforts, functions, and services provided by the growth points are hierarchically
organized.

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Agropolitan theories are the strategies that focus on restructuring rural areas by adopting
appropriate urban idea to the rural environment based on agriculture. Such cocept prioritize the
development of much lower level and aims to improve the socioeconomic community in rural area
by adopting urban ideas. Urban hierarchy theories are also theories that focus on the development
of urban regions based on their population size and number of their functions or activities. Such
theories give priorities to the larger cities that can also generate positive spillover effects for the
development of surrounding areas.

Functional Development Theory

The functional development theory suggested by John Friedmann, Clyde Weaver, and Walter
Stohr, in the 1970s departs from the assumption that regional development can be achieved by
harnessing selected regional resources to create generative growth. This theory assumes that it is
possible to move a region to higher stages of development by organizing it around a principal
function closely related with its resources endowment. For that, the lagging region relies on
investments funds originated in leading regions. In addition, several efforts should be made to
reduce imports of goods and services and to reinvest locally the regionally created savings. This
theory envisages the existence of a decentralized regional administrative organization to
coordinate such efforts. This organization should be supported by local and state governments and
by local business groups. The Tennessee Valley Authority and the Bonneville Power
Administration are considered two U.S. examples of regional development strategies based on the
functional development theory (Friedman and Weaver 1979, Nelson 1993).

One of the strongest points of this theory is the idea that regions themselves must play an important
role in influencing the character of their own development. The functional development theory
assumes that regional development should fit regional character. For that, regional communities
must be involved in both defining social and economic goals and objectives and tailoring the
development patterns. One of its weaknesses is that it is just applicable in regions that have at least
one resource endowment economically relevant enough to become the engine of local
development. Such a resource can be (1) a natural resource (e.g., land, water, oil, or wood), (2) a
strategic geographic location, (3) climate, (4) a pool of cheap labor, (5) a pool of skilled labor, (6)
a knowledge pool (e.g., a pool of universities and research facilities), or (7) a pool of specialized

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skills and expertise on a particular industry that can be leveraged to higher value added activities
(for example, expertise in the clock industry can be leveraged to high-precision surgical
instruments).

Stage Theory

The stage theory developed by Walter Rostow in the 1960s assumes that regional development
occurs through stages of growth. According to this theory, there are five stages of regional
development: (1) traditional, (2) preconditions for takeoff, (3) takeoff, (4) maturity, and (5) mass
consumption. A region develops by evolving from lower stages to higher stages of development.
The progression from one stage to another is not automatic. It may be delayed or rendered
unachievable for a variety of reasons.

A region in the traditional stage of development is one in which there is limited availability of
technology relative to other regions and probably a rigid and hierarchical social structure. The
region enters the second stage of development when investments flow into the region for the
purpose of exploiting its natural resources. Industrial investments are accompanied by investments
in basic physical infrastructure such as transportation and communication. In addition, managers
and skilled labor are transferred to the region to lead the new industrial investments. As a result,
the region’s economic and social structure begins to change and a new social and political elite
emerges. Takeoff occurs when an external stimulus, such as a development program or a major
private investment, brings investment into the region and the new local social and political order
is able to sustain that investment. A region enters the maturity stage when it achieves a diversified
economic base and complex local inter-industry linkages. As a result, the region is able to produce
locally many formerly imported goods and services. Finally, the mass consumption stage occurs
when a region exports many goods and services that it formerly imported. In this stage the local
economic base has to be both diversified and sophisticated enough in order to produce goods and
services that can compete in the external markets (Nelson 1993, Rostow 1960).

The stage theory has the important advantage of making clear that the magnitude of the multiplier
and spillover effects predicted by other theories of regional development depends upon the
region’s stage of development. One corollary of the stage theory is that in lower stages of
development the regional industrial mix is less diversified and sophisticated and the local inter-

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industry linkages are weaker. As a result, the magnitude of the multiplier effects predicted by the
export-base and input-output theories, as well as the multiplier and spillover effects predicted by
the growth pole/growth center theory and central place theory, are likely to be smaller in lower
stages than in higher stages of development. Ultimately, the stage theory suggests that strategies
and programs seeking to promote regional development should be tailored to fit the region’s stage
of development.

One important limitation of the stage theory is its deterministic nature. This theory assumes that
the process of regional development always follows the five stages identified above. It does not
consider the possibility that some regions can skip some stages and, for example, move from the
traditional stage to the takeoff stage without experiencing the takeoff preconditions stage. A
second limitation of this theory is its non-reverse nature. The stage theory provides a framework
explaining how regions progress. It assumes that a region can either progress from lower stages to
higher stages or stagnate in one stage of development. It fails to explain declining regional
economies as a result, for example, of an obsolete economic structure.

Disequilibrium Theories

The disequilibrium theories of regional development depart from the assumption that regional
development is boosted by disequilibrating forces. Three major theories of regional development
fit within this approach: (1) Schumpeterian dynamic disequilibrium, (2) regional life cycle theory,
and (3) product life-cycle theory.

Schumpeterian Dynamic Disequilibrium Theory

The Schumpeterian dynamic disequilibrium theory of regional development builds upon Joseph
Schumpeter’s view of the market system as a process of “creative destruction” where old systems
are destroyed and replaced by new ones. This theory, set forth in the 1930s and 1940s, assumes
that regional development is the result of dynamic disequilibrating forces that render obsolete the
productive structure of leading regions and favor the competitive advantages of lagging regions.
Market dynamics cause obsolete products and processes to be replaced by more timely and
efficient ones. Technological developments may render the existing infrastructure of leading
regions obsolete. On the other hand, investment in new industries may be more profitable in

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lagging regions. In addition, building new infrastructures may be more efficient in the lagging
regions relative to tearing down and rebuilding new ones in leading regions. This dynamic process
of “creative destruction” explains the development of regions over time (Nelson 1993, Schumpeter
1939).

Regional Life-Cycle Theory

Following a rather similar perspective, the regional life-cycle theory offered by Bernard Weinstein,
Harold Gross and John Rees in the 1980s assumes that the development of any region evolves in
waves of boom and bust in a way resembling Nikolai Kondratieff’s long waves of development.
New enterprises emerge in lagging regions because leading regions are strapped with obsolete and
unprofitable infrastructure and productive structure. Over time, newly developed regions will
themselves decline and by that time bypassed regions will have reemerged (Hall 1990, Rees 1979,
Weinstein et al. 1985).

Product Life-Cycle Theory

The product life-cycle theory introduced in the 1960s by Raymond Vernon and Seev Hirsch
assumes that the different patterns of development among regions can be explained by the different
stages of the product life-cycle in which they are specialized. According to the product life-cycle,
a concept borrowed from marketing and international trade literature, a typical product evolves
through three distinct stages in its life cycle: innovation, growth, and standardization. During the
innovation stage the new product is both developed and manufactured in its home region since
incremental innovations in the characteristics of the product are frequent and the production
processes have not yet been standardized. The growth stage is characterized by significant growth
in sales, the use of larger production facilities, and the occurrence of some incremental process
innovations. The standardized stage is when the production process becomes standardized, no
innovations take place either in the product or in the production process, and the sales either
stabilize or start to decline. At this stage the production can be shifted to lower cost locations.

Using the product life-cycle framework regions can be designated as innovation-phase, growth-
phase, or standardized-product regions corresponding to their tendency toward a particular phase
in the product cycle. The innovation stage needs a high input of R&D and specialized skills. It is

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usually carried out in large urban areas of developed countries. The standardized production phase
of the product life cycle can be transferred to low cost locations abroad or down the urban hierarchy
to rural areas.

According to the product life-cycle theory of regional development, regions can change their roles
over time. As production concentrates in lagging regions, human capital accumulation through
learning by doing, personnel mobility, the development of local linkages and other external
economies can build up there. As the region expands, regional demand can increase to a critical
threshold where an industrial seed bed effect can develop rapidly with the spin-off of small firms
or through the immigration of entrepreneurs. This will cause lagging regions to develop and
eventually to become an innovation-stage region (Capello 2007a, Malecki 1981, Rees 2000).

These three disequilibrium theories of regional development aim at explaining why regions
prosper and decline over time. In contrast with other theories of regional development, which
implicitly or explicitly assume that leading regions will either develop or stagnate, e.g. the stage
theory, the disequilibrium theories set forth the idea that over time lagging regions can bypass
leading regions. The major flaw of disequilibrium theories is that they do not provide insights on
what prerequisites lagging regions should have in place to become leading regions. These theories
seem to assume that moving away from lagging to leading and vice-versa is a deterministic process
that any region sooner or later will face and little if anything can be done to change this process.

Neoclassical Endogenous Growth Theories

In the late 1980s and early 1990s a large body of theoretical developments emerged in the literature
as an attempt to introduce more realism in the traditional neoclassical theories. Many theorists
have contributed to these developments, termed in the literature as “endogenous growth,” namely
Paul Romer, Gene Grossman, Elhanan Helpman, Robert Barro, and Robert Lucas. As expected,
there have also been attempts to introduce endogenous growth concepts into the neoclassical-
inspired theories of regional development. One of the first steps in that direction was the work of
Stefano Magrini in the late 1990s.

The neoclassical endogenous growth theories of regional development which also called as new
growth theory modify the traditional neoclassical theories by making technical progress (and

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thereby productivity growth) endogenous to the economic process. Several models have been
developed many substantially altering the traditional neoclassical framework by assuming
imperfect competition and increasing returns to scale. They have also relied on distinct
mathematical formulations and have assumed different simplifying hypothesis in an attempt to
conceptualize the regional characteristics that can cause technological change. Such
conceptualization has included modeling technological change as a function of (1) human capital
– stock and/or accumulation over time, (2) R&D, (3) innovation, (4) knowledge spillovers, and (5)
technological spillovers.

In short, the endogenous growth theories of regional development see long-term regional growth
as a result of accumulation of capital and labor (traditional neoclassical view) but also as a result
of the regional characteristics in terms of human capital, R&D, innovation, knowledge, and some
sort of knowledge and technological spillover effects (Grossman and Helpman 1994, Magrini
1997, OCDE 2009, Romer 1990, Romer 1994, Solow 1994).

One of the major contributions of these theories to regional development is the emphasis given to
human capital, knowledge, and innovation as important drivers of long-term growth and
development. A second important contribution is the acknowledgement that technology and
knowledge generate spillover effects which, in turn, are important determinants of regional
development by themselves. Their major shortcomings stem from the underlying assumption that
regions always have in place the necessary conditions for the translation of human capital and
R&D into productive innovations and productivity gains, as well as the conditions for the diffusion
of knowledge and technology to occur.

New Economic Geography Theories

The new economic geography theories of regional development originated in the 1990s with the
works of Paul Krugman and Anthony Venables integrate within a formal (mathematical)
neoclassical framework the concepts of cumulative causation and agglomeration economies
developed by the core-peripheries theories in the 1950s (Fujita and Thisse 2009). In so doing, the
new economic geography theories of regional development change the traditional neoclassical
model by assuming increasing returns to scale and imperfect competition in a context of
interregional trade (Martin 1999).

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The new economic geography approach focuses upon the balance between centripetal
(agglomerating) and centrifugal (dispersing) forces in determining the extent and form of regional
concentration of economic activities. Centripetal (agglomerating) forces, which tend toward
spatial concentration, include, according to these theories, (1) market size, (2) transportation costs,
(3) cooperative and functional linkages between firms, (4) dense labor markets with a diversity of
skills, and (5) external economies of scale such as knowledge spillover. Centrifugal (spillover)
forces, those that tend toward spatial de-concentration, include (1) labor immobility, (2) lower land
costs, (3) and external diseconomies of various sorts such as congestion (Hudson 2009, Martin
1999).

Among the range of centripetal and centrifugal forces, many of the models developed within this
approach emphasize economies of agglomeration (modeled as increasing returns to scale) and
transport costs – variables easy to measure and as such consistent with the mathematical
formulation approach followed by these models. According to these theories, the tendency for
spatial clustering of economic activities is positively correlated with agglomeration economies and
negatively correlated with transport costs. In this view, growing regional divergence and a core
periphery pattern of economic development is a result of agglomeration. Cumulative growth in
“core” regions occurs because firms benefit from cost savings and/or revenue increases there as a
result of mutual interaction and interdependencies which leads to increased efficiency and
comparative advantages.

More sophisticated models alter the traditional neoclassical framework by including more complex
agglomerating (centripetal) forces such as labor market pooling, technological spillovers,
intermediate goods supply and demand linkages, and market size. As centrifugal (dispersing)
forces they consider product-market and factor-market competition.

Recent variants of the new economic geography models incorporate elements of the endogenous
growth theory into the neoclassical model with increasing returns to scale. In so doing, they focus
either on interregional transfers of human capital or localized technological progress as the
mechanisms underlying the agglomeration of economic activity and the unequal development
among cores and peripheries (Fujita and Thisse 2009, Hudson 2009, Martin 1999, Krugman 1991,
Krugman 1996, Krugman and Venables 1996).

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Though many of the concepts introduced by the new economic geography theories are not entirely
new in the regional development realm, this approach has the advantage of refocusing the attention
of mainstream neoclassical economics to a different (and more realistic) set of determinants of
regional development. Instead of relying exclusively on the accumulation of production factors
capital and labor and exogenously-determined productivity growth (traditional neoclassical view),
this approach emphasizes the importance of agglomeration and cumulative causation for regional
economic development. As a result, it contributes to an explanation, under a formal neoclassical
framework, of why regions have different patterns of development over time instead of converging
to similar long-term growth rates as predicted by the traditional neoclassical theories of regional
development.

One important limitation of the new economic geography theories is that they have relied
extensively on mathematical modeling but are short on empirical testing and empirical application.
These models are mathematically very complex, typically quite abstract and over simplified
leaving several aspects held constant or simply ignored. Therefore, a meaningful application of
these theories to or test against the real world is a very challenging task (Brakman and Garretsen
2006).

The Missing Variables in Mainstream Regional Development Theories

Both recent empirical evidence and the lessons learned from major past regional development
programs suggest that several factors playing a crucial role in regional development have been
ignored by mainstream theories of regional development. Among them are: institutional
framework, local innovative milieu and technological competitiveness, and local entrepreneurial
capacity.

Such factors are particularly important when businesses have to choose among locations in higher
stages of economic development that already possess dense and sophisticated inter-industrial
linkages, a relatively skilled labor force, and a good level of physical and social overhead capital.
In addition, such locational factors are of particular relevance for the locational decisions of high-
value, sophisticated, and knowledge intensive services and industrial activities– those with higher
productivity levels able to sustain high and increasing standards of living for their populations.

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Some regional development researchers have claimed that a business-friendly institutional
framework play a determinant role in explaining different development patterns among regions.
In their view, successful regions are those that possess: (1) stable, predictable, and transparent laws
and regulations, (2) political stability, and (3) a favorable business climate (Gertler 2010, Hudson
2009, Pack 2004, Stimson et al. 2006).

Empirical studies highlighting the importance of an innovative milieu and local technological
capacity have stressed the relevance of factors such as: (1) untraded interdependencies (2)
management capacity, (3) organizational ability, (4) pro-market oriented technological and
innovative capacity, (5) knowledge and technology absorptive capacity, and (6) some sort of
“social capital” that creates rich patterns of supportive social relationships beyond the workplace
and the boundaries of the company that facilitate informal exchange of both codified and tacit
knowledge (Yglesias 2003, Rees 2001).

The role of entrepreneurial capacity in the process of regional development and how
entrepreneurial capacity might be cultivated at the regional level is a research area of growing
interest. Many regional development researchers argue that entrepreneurship plays a crucial role
in regional development, and substantial empirical research has been conducted in recent years
seeking to find evidence of such a role and the mechanism through which it operates. However, to
date researchers have been unable to set forth a theory of regional development that clearly
explains the role of entrepreneurship in regional development (Rees 2001, Malecki 1997 chap. 5,
Nijkamp and Abreu 2009).

Summary

The mainstream theories of regional economic development differ in the assumptions they make
with respect to the balance between agglomerating and dispersing forces, and the forces other than
agglomerating/dispersing forces influencing regional economic development they emphasize.

With respect to the balance between agglomerating and dispersing forces it is possible to group
the theories reviewed in this paper into three major groups. One group of theories assume that
agglomerating forces will ensure that dynamic places over a certain threshold will continue to
growth and that this positive dynamic does not necessarily spill over into surrounding and less

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dynamic areas. Among such theories are: the theory of cumulative causation, export-base theory,
input-output theory, and endogenous growth theories. Other theories consider that, at least in the
long-term, the spread effects over surrounding areas tend to be stronger than the agglomerating
effects. Such is the case of growth center theory and central place theory. A third group includes,
among others, the firm location theories and the new economic geography theories which consider
that the balance between agglomerating and dispersing forces is unclear depending on the strength
of the several distinct forces in place.

Different theories of regional development emphasize distinct factors other than

agglomerating/dispersing forces influencing regional economic development. For instance, the
traditional neoclassical theories emphasize the roles of local endowment (and relative prices) of
the factors of production (capital, labor, and land) and total factors productivity – viewed as a
function of technological progress which, in turn, is exogenous to the local development process.
The recent neoclassical endogenous growth-inspired models emphasize knowledge and
technological spillovers, two of the sources of technological progress (and thereby productivity
growth) identified by such theories. Other theories emphasize local competitive advantages based
on local characteristics as important factors influencing regional development besides the
agglomerating/dispersing forces. Among these theories are: export-base theory, theory of
cumulative causation, new economic geography theories, functional development theory, and
product life-cycle theory. Others emphasize the local industrial mix and the local inter-industry
linkages as relevant as well (input-output theory). Both the Schumpeterian dynamic disequilibrium
theory and the region life-cycle theory add the notion that technological developments and time
might create incentives for businesses, employment, and people to locate in lagging and less dense
places where investment in new industries and new infrastructures may be more efficient compared
to tearing down and rebuilding the obsolete productive structure and/or basic infrastructure of
some dense regions.

More recent empirical research suggests that several factors playing a crucial role in regional
development among regions already in higher stages of economic development have been ignored
by the mainstream theories of regional development. Among them are: institutional framework,
local entrepreneurial capacity, and local innovative milieu and technological competitiveness.

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The fact that these important intangible factors of regional development have been largely ignored
by mainstream theories of regional development suggests that such theories have some limitations
in explaining the regional development process of developed and sophisticated regions in
knowledge-intensive and innovation-driven economies. However, this does not necessarily mean
that such theories are rendered useless. Many of them, namely the firm location theory, the core-
periphery theories, export-base theory, input-output theory, and new economic geography theories,
still offer a valuable framework of analysis in the face of the rising importance of such factors.
The drawback of these frameworks is that they lack the consideration of variables that properly
account for such factors. Since these factors are highly intangible in nature, the challenge is,
therefore, to find appropriate methods and indicators to assess them.

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