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Chapter 1

Introduction
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When we analyze economic issues by treating explicitly the spatial

dimensions of those issues, we basically deal with ‘regional economics.’
In terms of semantics and detailed features, ‘regional economics’ may
not be the same as ‘regional science’ or ‘spatial economics.’ Yet, they all
basically share a common interest: how space affects — and is affected
by — the economic behavior of agents (consumers, producers, government,
and others). For practical purposes, therefore, we treat those three terms
equivalently and use them interchangeably throughout this book; hence the
title of Chapter 2.
In general, regional economics focuses on the concepts, economic
theories, and policy applications related to regional and spatial problems.
Like in standard economics, in regional economics any spatial phenomena
can lead to an outcome that reflects private optimum as well as non-private
or social optimum. When the two do not coincide, and in most cases they
don’t, the system creates ‘externalities.’ For example, due to agglomeration
economies, a spatial pattern emerges where activities tend to cluster in
certain areas or regions, creating interregional inequality and urban centers.
If left unattended, that pattern can create a series of ‘externalities’ such as
congestion, pollution, social tensions, instability, and spatial inefficiency.
This is where policy intervention is justified.
This book explains the concepts and policies surrounding such issues,
and how institutions can be the determining factors in generating the
outcome. More specifically, it discusses how spatial dimension interacts with
behaviors of agents. In the next chapter, for example, the discussions are

1
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2 Regional Economics: Fundamental Concepts, Policies, and Institutions

intended to expose how the treatment of ‘space’ distinguishes regional eco-

nomics or regional science–spatial economics from conventional economics.
The typical questions to be addressed throughout the book are: how
space and location influence the economic behaviors of agents, and how
these behaviors affect their locational configuration that could shape the
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spatial patterns of economic development. The spatial patterns of most

interest are as follows:

(1) Emergence of activities concentrating in certain locations (agglomera-

tion of industries, formation of cities, congestion of urban centers, etc.);
(2) Persistent imbalances in regional growth where output and incomes
in some regions are growing faster than in others (interregional
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inequality).

To the extent ‘space’ and location is the primary factor distinguishing

regional science–spatial economics from conventional economics, the start-
ing point is to understand how space and location matter. In particular,
how they explain the phenomena of spatial concentration and dispersion,
including the impact of a specific policy such as infrastructure development.
This is the subject of Chapter 2. I also discuss what is the relevance of
regional science–spatial economics as the foundation of regional economics
in the development of other fields and contemporary development issues
in that chapter. In terms of market structure, the unique characteristic
of spatial economics is the dominance of limited competition from which
spatial concentration and dispersion could arise. How such a market
structure influences the spatial configuration of activities is the main
question of interest.
One of the most fundamental matters associated with the concept of
equilibrium is determining the production–location optimum. In a standard
partial equilibrium analysis, the production theory helps us understand how
much a firm will produce and what combination of inputs they will choose.
It is assumed that the optimum production can take place anywhere in any
location so long as the information on inputs and their costs are given in
each of the locations. This assumption is critical in distinguishing spatial
economics from conventional economics. Location is hardly discussed in
the latter, let alone analyzed with some degree of clarity. In a standard
microeconomics, for example, location is unstated and treated as exogenous.
What it essentially says is that, different locations will have different
inputs and corresponding prices, each can be analyzed separately using
the standard production optimization to reach Pareto efficiency. Hence,
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Introduction 3

there is no need to analyze the optimum location. In contrast, regional

science takes location as endogenous with far-reaching implications, that
is, the production solution from standard microeconomics may be neither
equilibrium nor Pareto efficiently, because firms may have incentives to
relocate and consequently alter significantly their production schedule.
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What is then the optimum production–location schedule? In some

cases, given a vast number of producers and markets, no equilibrium
is possible especially when the transportation costs are not negligible.
In regional science and spatial economics, this is known as the Spatial
Impossibility Theorem (SIT). From this perspective, the treatment of spatial
interdependence across markets in a general equilibrium setting will indeed
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have significant implications. In other cases, the sequence matters: whether

finding the optimal production first before optimal location or the reverse,
the answer depends on a set of assumptions about the production features
and the technology being used.
The importance of monopolistic competition is paramount in regional
science–spatial economics. Intuitively, since the focus of spatial analysis is
on smaller areas (region, state, province, or district) compared to countries
or nations, the degree of competition is also more limited. This highlights
the need to focus on monopolistic competition. As discussed in Chapter 2,
through the interplay of centrifugal and centripetal forces, this could have
major consequences on the spatial patterns. Scenarios that lead to greater
centrifugal forces result in activities concentrating in certain locations or
regions, causing a wider gap between different locations or regions. Such
an analysis helps us understand better the growing interregional inequality
occurring almost everywhere around the world. The mechanism that puts
ahead the centrifugal forces could also explain how cities endogenously
emerge by way of the agglomeration process.
The relevant question then is, what are the elements behind the
centrifugal and centripetal forces, and what incentive mechanisms (policy
interventions) could change them? In the analysis of city or urban dynamics,
there is also a fundamental question pertaining to the configuration and
relations of the settlements that eventually lead to urban land use and the
distribution and size of market areas. The Central-Place Theory (CPT)
provides an important basis for understanding them.
A more recent approach in urban analysis has been developed, taking
advantage of computing technology and Big Data. Instead of starting with
a theory, the approach allows Big Data to form statistical patterns of
urban land use, infrastructure, and socio-economic activity. The premise
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4 Regional Economics: Fundamental Concepts, Policies, and Institutions

is, we would be in a better position to develop theory and think about the
necessary measures only after having a clear understanding about cities in
a scientific way. The information required, however, is huge and critical,
because much of the legitimacy of the statistical patterns depends on it.
A group of researchers with a wide range of disciplines (from geography,
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statistics, to economics) and loosely affiliated with the Santa Fe Institute

(SFI) was among those who took such an approach (see Bettencourt et al.,
2007). Exploring global urbanization by using data from two millennia
covering thousands of cities worldwide, they found that of the many factors
linked to urban growth, it was the size of population that had the closest
association with the physical as well as socio-economic dimensions of urban
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development.
While such conclusions are debatable, and in some respects also
too simplistic, the fact that they are derived from the mathematical
combinations of large numbers of cities with very different geographies and
widely separated in time suggests that there may be something important
and new for understanding urban growth and its development mechanisms.
But whether the conundrum of heterogeneous cities behaving identically
will open-up a new avenue for finding universal laws of urbanization,
it remains to be seen.
Operationally, the distinct concepts between conventional and spatial
economics described in Chapter 2 should be reflected in different results
and outcomes when a particular shock or policy is imposed in the system.
To see that this is indeed the case, Chapter 3 shows the difference between
the two types of models, one without and the other with an explicit
treatment of transport sector, transport rate, and different locations of
inputs. To capture the different results and implications numerically and
more generally, a computable general equilibrium (CGE) model is used.
The discussions and applications of the two models are intended to reveal
what happens when transport rate — reflecting location and distance —
and activities of the transportation sector are considered in the model. For
clarity, the model being used is relatively simple, and a computer program
using a specific language is shown in the appendix of Chapter 2 for readers
to experiment with different shocks in the model.
The so-called macro part of the analysis in regional science focuses on
the regional growth and development. The bulk of Chapter 4 is devoted
to a topic comprising two separate-yet-related subjects, regional growth
and productivity. Under the topic regional growth, the demand-driven and
supply-driven types of models are shown, both of which put the emphasis
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Introduction 5

on foreign demand (exports) as the driving force of regional growth.

The supply-side models look at the role of factor inputs, particularly capital,
as the key for regional output expansion.1
The demand-oriented models essentially show that if the economy of a
region can be divided into two producing sectors according to the location
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of markets for goods, those sold outside the region (basic) and those sold
within the region (non-basic), the main driver of regional growth is the
basic sector, the expansion of which calls for an increase of production in
the non-basic sector. But even if the basic sector becomes the main driver for
growth, the question remains how and in what way can the regional growth
path be explained? This is where the supply side takes center stage in
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identifying the sources of regional growth. The focus of the supply-oriented

models is on the relations between output and factor inputs as reflected in
the regional production function. Given the critical role of capital, especially
during the early stage of development, more emphasis has been placed
on factor input capital. Hence, the main issue of the supply-side models
discussed in Chapter 4 is related to the role of investment allocation and
interregional capital movements.
Before discussing regional development issues in Chapter 5, the last sec-
tion of Chapter 4 highlights the concept and trends of regional productivity.
The measure of per capita output as a result of growth is closely related to
productivity measure. At the global level, for example, more than 90% of
the differences in per capita income around the world can be explained by
differences in labor productivity. Conceptually, the growth and the level of
productivity could say a lot about the prospect and sustainability of the
regional growth trend.
Chapter 5 is devoted to the discussions on regional development and
policies. To put it in perspective, the chapter begins by focusing on the
interplay between regional and national government policies that affect the
incentives to promote regional growth as part of regional welfare. This is to
be followed by discussions on how to reduce regional inequality and improve
regional productivity; the latter is considered among the most relevant
indicators for sustainable development. In the last section of Chapter 5,

1 Forecasting and planning components are often embodied in regional growth theory,
and the two are ‘unified’ by models for impact analysis. Notable examples are the input
output and the CGE models. Together with various other optimization models, as shift-
share analysis, and spatial interaction or gravity model, they all can be useful for a means
of analyzing the process of regional growth.
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6 Regional Economics: Fundamental Concepts, Policies, and Institutions

we show a relatively simple approach to evaluate regional development

performance in which the concept of ‘sustainable development’ is used as
a guiding principle. More specifically, economic, social, and environmental
considerations are treated as inseparable goals.
Decades after theories of regional growth and development had been
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advanced, the gap between what the theories and the models predict and
the actual performance remained large. In some cases, it got even larger.
It soon became clear that the institutional factor could play a major role
in explaining the gap. It was Douglass North who emphasized the role of
institutions in economic growth and development. His work on this subject
was eventually acknowledged by the international community in 1993 when
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he was awarded the Nobel Memorial Prize in Economic Sciences (jointly

with Robert William Fogel).2 The main argument made by North and other
institutional economists is that the results of growth theory, especially the
neo-classical type that relies on efficient markets, can only be achieved when
transactions are costless during the process. When it is costly to transact,
institutions matter.
Indeed, the interplay of institutional factors is imperative for under-
standing the sources and mechanisms of growth and development at both
the national and regional levels. Chapter 6 takes up this last — but in no
way the least — important topic. The discussions begin with the concept
of decentralization, followed by the argument that regional development is
not only about the outcome of a process but also the process itself, and it
concerns economic and non-economic factors. These factors are interrelated
through complex chains of events that can reinforce themselves through a
feedback loop. In particular, when actors/players are multiple, and local
capture is present, the coordination among them can produce different
equilibrium outcomes under different scenarios of interactions.
The mechanisms showing how the interactions among institutional
factors can influence the welfare outcome at the regional level are sub-
sequently discussed by using the Institutional Model of Decentralization
(IMD). An application of IMD is shown using the case of a country that
has gone through a major shift in development strategy, namely from a
highly centralized to a decentralized system of regional development with

2 In the words of the Nobel Committee, North and Fogel “renewed research in economic
history by applying economic theory and quantitative methods in order to explain
economic and institutional change.”
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Introduction 7

open local elections. Other institutional factors, including education and

incentives to acquire knowledge, also determine the regional growth and
development outcomes. They can be affected by monetary rewards and pun-
ishments which, in turn, are influenced by a society’s tolerance of creative
developments. To the extent that much of the discussions on the role of
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institutional factors cannot be detached from the influence of society’s

culture, throughout the discussions in Chapter 5, the relations between
culture, institutions, and economic performance will also be touched upon.
The summary in Chapter 7 is followed up by the implications of all the
arguments made throughout the book, including the potential implications
of the development of the information-communication technology (ICT)
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and Big Data on the fundamental concepts of regional economics.

Reference
Bettencourt, L. M. A., Jose, L., Dirk, H., Christian, K. and Geoffrey, W. (2007).
“Growth, Innovation, Scaling and the Pace of Life in Cities.” Proceedings of
the National Academy of Sciences, 104(17), 7301–7306.