However, World Bank researchers Deichmann, Kaiser, Lall, and Shalizi find that, in practice, firms often make their location decisions based on a range of factors—including the benefits of clustering in areas that offer both natural and production-related advantages.
This finding is part of a broader World Bank development research effort to examine the effectiveness of government interventions in lagging regions, and the policy tension between the market solution of out-migration or “moving people to jobs”, and the intervention of promoting capital flows, including fiscal transfers designed to support incomes or to subsidize the creation of jobs and the extension of credit –“moving jobs to people”.
“Roads are necessary for the expansion of production and trade, but they do not always facilitate the movement of jobs to people,” says Zmarak Shalizi, who heads the Infrastructure & Environment Research Team at the World Bank. “Our research in Indonesia shows that investing in transport infrastructure to attract industry to secondary centers outside of Java will have limited success without complementary investments, especially in sectors that benefit from clustering and are already established in other leading regions.”
The broader conclusion from the Indonesia research study is that authorities need to better understand the factors that influence location decisions for manufacturing firms, and also need to view the outcomes of potential policy interventions in a new ‘economic geography’ context.
Given that governments in both developed and developing countries have widely undertaken spatially targeted programs that include public expenditure on transport infrastructure to improve market accessibility, the research presents new evidence that could influence future policy decisions.
In Bihar, India, for instance, standardized manufacturing development is not likely to be very successful, where production is already clustered elsewhere in India because of increasing returns from clustering. In the absence of investment focused in a few centers, the state is more likely to benefit from an agro-based industrial strategy, since agriculture is likely to be the mainstay of Bihar ’s economy for the foreseeable future.
What firms want
‘Localization economies’ partly explain the location decisions of some firms. These clusters of firms located in the same area share sector-specific inputs, skilled labor and knowledge. Opportunities for intra-industry linkages such as buyer-supplier relationships, and subcontracting are higher when firms are located near one another.
Firms also look for the benefits offered by ‘urbanization economies’, where a larger overall size of urban agglomeration and its diverse industry mix enables innovative firms to access a large pool of potential buyers and complementary services.
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Larger cities provide a larger home market for products; attract skilled employees looking for urban amenities; and offer financial, legal, real estate, advertising and services not available to such an extent in smaller towns.
In addition, firms look at various aspects of the local business environment, ranging from quality and cost of complementary utility services to the nature of the regulatory environment.
The limited success of regional incentives
Evidence from research is mixed on whether regional incentives—such as interest rate subsidies, tax breaks and industrial estate development—succeed in attracting industries or transforming the fortunes of lagging regions within a country.
In India , evidence shows that the government’s policy of influencing industry location toward backward areas using licensing regulations was neither successful in stimulating industrialization in these areas, nor sustainable in the long run, as new investments moved out of these regions as soon as regulations were relaxed.
In Brazil , research suggests some regional incentives are effective where the need for complementary factors have been addressed.
Developing an “intervention package”
“Clearly, large-scale transport improvements and regional incentives, without other forms of public service provision and amenity creation, are not enough to induce firms to locate production facilities in spatially disadvantaged areas,” says Somik V. Lall, Senior Economist with the Bank’s Infrastructure & Environment Research Team.
Lall advocates that governments seeking to woo firms into lagging areas invest first in finding out more about what firms want, and then develop a comprehensive package of strategic complementary interventions.
Finding out more about what firms want can be done both through surveys of firm representatives, as well as by econometric analysis that can establish the probability of a firm in a specific sector establishing production in a particular location.
A survey that attempts to find out what firms want should gather information on several aspects of the business environment. For instance, measures of the quality of utilities, such as frequency and duration of electricity cuts, can directly affect firms’ performance.
Measures of the regulatory environment are also very important – firms’ decisions could be influenced by the time taken to start a new business, time taken to hire or lay off employees, and the existence of corruption among officials.
World Bank Development Research Group
Uwe Deichmann is a Senior Environmental Specialist in the Development Research Group and coordinator of its Spatial Analysis Team. His research interests are in the geographic aspects of development. He is currently working on approaches to information based urban management in rapidly growing cities and on poverty-environment linkages.
Somik V. Lall is a senior economist with the infrastructure and environment team of the Development Research Group. His current research includes (1) examining the impacts of programs to assist the urban poor, (2) implications of strengthening local government fiscal capacity, and (3) influence of local and regional policies on sub national growth. Lall has recently initiated a policy research program with IPEA in Brazil to examine the determinants of growth and slum formation in urban areas, and is also working with the Indian National Institute of Public Finance and Policy (NIPFP) to examine the consequences of improving local tax handles on revenues and provision of services and local public goods in selected Indian cities.
Zmarak Shalizi is Senior Research Manager for Infrastructure and Environment in the Development Research Group. His current research interests include (1) urban and regional development, including evaluating pricing and non-pricing approaches to reducing the negative externalities associated with motorization in rapidly growing cities in Asia; (2) Mitigation and adaptation issues associated with climate change, particularly problems of lock-in and path dependency in the use of different types of energy in China and India; (3) evaluating institutional reforms and economic instruments to facilitate Forest and Biodiversity conservation.
World Bank Poverty Reduction and Economic Management Unit
Kai Kaiser is an Economist with the Public Sector Group at the World Bank. His current work focused on decentralization and sub-national economics, public finance, and institutional constraints to government performance and reform. Previously he was based in Jakarta, Indonesia. He remains engaged in a research project to assess the impact for Indonesia's 2001 Big Bang decentralization on households and firms. Recently he has also worked on decentralization reforms in Africa and South Asia.
Professor Christopher Timmins (Duke University )
Professor Sanjoy Chakravorty (Temple University )
Dr. Alexandre Carvalho (IPEA, Brazil )
Agglomeration, transport, and regional development in Indonesia. Uwe Deichmann, Kai Kaiser, Somik V. Lall, Zmarak Shalizi. World Bank Policy Research Working Paper 3477, January 2005
Public Interventions for improving economic prospects of lagging regions: review of experience. Somik V. Lall. The World Bank and NIPFP, October 2005
Regional Subsidies and Industrial Prospects of Lagging Regions. Alexandre Carvalho, Somik V. Lall, and Christopher Timmins. World Bank Policy Research Working Paper, forthcoming.
Industrial Location and Spatial Inequality: Theory and Evidence from India . Somik V. Lall and Sanjoy Chakravorty, Review of Development Economics, 9, 47-68, 2005.