Incorporating Space in the Theory of Endogenous Growth: Contributions from the New Economic Geography

Abstract

We describe how endogenous growth theory has now incorporated spatial factors. We also derive some of the policy implications of this new theory for growth and economic integration. We start by reviewing the product variety model of endogenous growth and discuss similarities with modeling techniques in the new economic geography. Both use Dixit-Stiglitz competition. Increasing returns provide an incentive for innovation in endogenous growth theory, and in combination with transport costs, increasing returns provide an incentive for firm location decisions in the new economic geography. Since innovation is the engine of growth in endogenous growth models and knowledge spillovers are a key input to innovation production, we also explore how innovation and knowledge have distinctly spatial characteristics. These modeling similarities and the spatial nature of knowledge spillovers have led to space being incorporated into the theory of endogenous growth. We guide the reader through how space is modeled in endogenous growth theory via the new economic geography. Growth by innovation is a force for agglomeration. When space is included, growth is enhanced by agglomeration because of the presence of localized technology spillovers. We consider the many other spatial factors included in models of space and growth. We explore the spatial effects on economic growth demonstrated by these theoretical models. Lastly, we consider policy implications for integration beyond lowering trade costs and discuss how lowering the cost of trading knowledge is a stabilizing force and is growth enhancing.