Industrial clusters : equilibrium, welfare, and policy

Abstract

This paper studies the size and number of industrial clusters that will arise in a multi-country world in which one sector has a propensity to cluster because of increasing returns to scale. It compares the equilibrium with the world welfare maximum, showing that the equilibrium will generally have clusters that are too small, while there are possibly too many countries with a cluster. Allowing national governments to subsidize will move the equilibrium to the world welfare maximum, so there is no ‘race to the bottom’. If subsidy rates were capped then there would be a proliferation of too many and too small clusters.