The Idea of Agglomeration Economies for Attracting New Foreign Plants - Literature review Example

LOCATION ANALYSIS INTRODUCTION Since ages, land and property have influenced the growth and prosperity of a location or area. The land attributes or the physical landscape, the materials and natural wealth of an area has been mainly responsible for the economic growth of a region. Thus economists have been studying the effects of resources of space and location on the economic activity and economic growth and this is known as the spatial economics. Usually, the spatial economics is concerned with the location analysis which in turn is dependant on the location choice. But this is only one of the many factors affecting economic activity and growth. (Duranton, 2005). But though some experts such as Debreu (1959) argue that spatial economics is only about space, it is not true. Others such as Ricardo (1821), believe that other factors can also be taken into consideration when discussing location choices. He developed a theory of land use based on relative fertility. This and others finally led to the theories of location and trade that are based on the concept of comparative advantages across locations. As of today, there are two main approaches of spatial economics -- the first is the urban systems approach as given by Henderson (1974) which focuses on cities and areas growing because of combination of agglomeration economies and urban crowding. And the second is the New economic geography given by Krugman (1991). According to this approach, the cost of trading is more important than the transportation costs in urban systems. Moreover, workers want to be in the area where there is larger market due to agglomeration as it gives them better access to consumers. Basically, location choices by companies, businesses and individuals are based on the information they have on that location. Thus, a major issue in the development of land and property markets is the non availability of timely and accurate market data and the inability to interpret that data in an appropriate fashion. And thus markets and areas that are able to possess such information certainly have the competitive advantage and are able to attract better companies and investment to their location. Another important area of investigation is the role of agglomeration economies in the choice of location by businesses in the regional and international economics. Many experts have shown that by clustering together the same kind of economic activities, the businesses are able to cut costs and gain profitability and productivity and thus many companies go for locations which already have the same kind of economic activity. But it has also been seen that the location decisions of foreign firms are different from their domestic counterparts and thus these need to be investigated separately. And as pointed out by Caves (1996), foreign firms face more uncertainty on account of quality of location and it has to bear higher costs for information search as compared to the domestic firms. CHOSEN AREA For our study, we have chosen the area of Leeds in UK as the study location. Leeds have been chosen because it is one of the prime areas in UK which has been attracting businesses since long. It has recently been named one of the best places in Europe to locate a business (as per Cushman & Wakefield ‘European Cities Monitor’). Some of the other key facts about the region are : 1. There has been a lot of investment in the area for commercial property development over the last 10 years and much more is in the pipeline. 2. Around 457,400 people work in the Leeds making it one of the major employment regions in UK. 3. As one of the UK's largest centers for financial and business services, it has over 30 national and international banks based in the city. 4. Leeds city centre has over 1,000 shops and it is considered one of the best shopping destinations of UK. 5. Leeds is linked via Leeds Bradford International Airport to many European destinations. 6. The city is also scenic with two-thirds of land being the green belt land and is home to the Yorkshire Dales National Park. 7. Leeds economy is estimated at £13.6 billion (2006) and is projected to grow by a third in the next ten years And it has the third biggest manufacturing sector in the UK. 8. It is also one of the top retail destinations in UK . (Locate in Leeds, nd) LITERATURE REVIEW Lot of literature exists on the location choices and preferences of firms and businesses. Some of the studies have focused on the foreign versus domestic firms and found that foreign companies value various location factors different than domestic firms (e.g., Glickman and Woodward, 1988 and 1989). But generally, the earlier studies have focused on developed countries such as the United States. For e.g Coughlin et al. (1991), Woodward (1992) and Wheeler and Mody (1992) studied the importance of agglomeration economies for the location of Foreign direct investment in the United States. Based on the labor market conditions, there are many factors such as the wages, the labor-management environment, and the availability of labor which have been used in location studies. Common sense tells us that higher wages should deter firms from investing in a location, but the evidence does not say so. Studies by Bartik (1985) or Coughlin et al. (1991) revealed that higher wages make a location less attractive to foreign investors but research by Ondrich and Wasylenko (1993) and Guimaraes et al. (2000) shows that there is no statistically significant relationship between the two. Similarly, based on the unemployment rate -- high unemployment is more conducive to location choice as it indicates labor availability. (Head et al.1995 and Coughlin et al. (1991). Another factor affecting location choice is the land costs. Direct information on this factor is not available. Since population density affects the costs of land as people compete over land for both residential and industrial purposes , it has been used to conduct research on making location choices. (Guimaraes et al. (2000), Bartik, 1985). Another important factor which has been studied by experts is the availability of Infrastructure. Needless to say, that well-developed infrastructure always attracts businesses( Bartik, 1985; Coughlin and Segev, 2000) LOCATION THEORY Location theory has been going around for years now and many authors have added to it by their studies and researches such as Weber (1929), Hoover (1948) and Lösch (1954). Based on the traditional view, a business firm is an entity that focuses and thrives only on profits and hence all its activities including its location choice are undertaken to maximize profits. And this has proven to be true for most of the times. But of course, there are other important factors which need to be taken into consideration by the companies. Based on this scenario, the firm as an economic entity takes in various inputs and through its internal set of processes transforms those inputs into something more useful that sells in a market. Now these various inputs could be the raw materials, physical equipments, financial capital, and labor. So, typically, a location should be able to provide these inputs easily and cheaply to the firm. Certain inputs which are not available on the location are brought in from other places and transportation costs are taken into consideration. Obviously, the availability and cost of these inputs will vary from one location to other. Thus, a firm takes into account all these factors and by doing the cost benefit analysis, decided on the optimal location for its plant. . But it is not that easy to make a location choice. As per Cohen (2000) and Blair and Premus (1987) taking a decision on expansion or relocation of a firm is part of a big strategy of the firm and involves lots of planning and thinking at the topmost level of organizations. Moreover, it is not possible to evaluate each and every factor for the decision. Thus only the major and the most relevant indicators are taken into consideration. (Ritter, 1990). Although now a days . lot of data is available for companies to make sound decisions , generally the differences between alternate locations is sometimes so less variations in local incentives could potentially make the difference in final location choice. (Bartik, 1991) FACTORS AFFECTING LOCATION CHOICES Most of the early authors have worked on the minimization of transport costs (Blair and Premus, 1987) Moreover, the emphasis has been on the importance of direct cost factors and indirect cost factors have been neglected. Actually, any factor that can increase or decrease the cost of production at any location should be considered while making a location decision. Some of these factors that directly affect the cost of doing business are : Availability of cheap raw material, Land prices , State and local taxes, costs of construction, the local environmental regulations, local labor unions and their agendas and worker compensation laws or the labor wages. And some of the Indirect cost factors are : Efficiency of the local authorities and their business laws, availability of skilled personnel, quality and availability of infrastructure and government services, the educational institutions, Quality of life that is the recreational and cultural amenities etc. Actually, location decisions are not completely scientific or based on figures alone as data is not easily available. Thus companies usually bargain with local governments and base their choice on the area offering maximum sops or incentives. (Salvesen and Renski, 2003) AGGLOMERATION ECONOMICS As per Fujita and Thisse (1996), when some of the important factor combine or are favorable at a particular location, it gives rise to industrial clusters. These factors could be the easy availability of raw materials or presence of skilled personnel in the local market or cheap land prices etc. Thus the natural advantages of a particular location may result in clustering of many organizations at a particular location. (Barriosi, Gorg and Strob, 2003) And the new setups will also prefer to move into same area to benefit from existing advantages and infrastructure. These leads to the phenomena called agglomeration economies. To avoid such conditions, the local authorities and state governments may thus offer other incentives for less naturally advantageous locations for their development. But the factors and situations are different for different industries. For example – the high tech industries such as IT etc will more likely locate in highly urbanized areas ( Jaffe et al., 1993) CONCLUSION Thus we see that location choice is dependant on many factors which have direct or indirect effects on profitability of firms. Most of firms rely on insufficient data and resort to bargaining at the site level to get maximum benefits. We have also seen that there is strong evidence for the idea that agglomeration economies are important for attracting new foreign plants but whether the tax benefits and other incentives actually make a difference is still debated. REFERENCES Barriosi, S., Gorg, H, and Strob, E. 2003, MULTINATIONALS’ LOCATION CHOICE, AGGLOMERATION ECONOMIES AND PUBLIC INCENTIVES, University of Nottingham Bartik, T.J. 1985 Business Location Decisions in the United States: Estimates of the Effects of Unionization, Taxes and other Characteristics of States, Journal of Business and Economic Statistics 3, 14-22. Bartik, T. J. (1991). Who Benefits from State and Local Economic Development Policies. Upjohn Institute for Employment Research Blair, J. P. and R. Premus 1987. “Major Factors in Industrial Location: A Review.” Economic Development Quarterly, 1: 72–85. Caves E.R. 1996 Multinational Enterprise and Economic Analysis. Cambridge: Cambridge University Press. Cohen, N. 2000. “Business Location Decision–Making and the Cities: Bringing Companies Back.” The Brookings Institution: Center on Urban and Metropolitan Policy Coughlin C.C. and Segev E. 2000 Location Determinants of New Foreign-Owned Manufacturing Plants, Journal of Regional Science 40, 323-351. Coughlin et al. 1991 State Characteristics and the Location of Foreign Direct Investment within the Unites States, Review of Economics and Statistics 73, 675-83. Debreu, G. 1959. Theory of Value. New Haven: Yale University Press. Duranton, G.. 2005. Spatial economies. In Handbook of Regional and Urban Economics, vol. 4,Amsterdam: North-Holland. Fujita, M. and J.F. Thisse, 1996. Economics of agglomeration, Journal of the Japanese and International Economies, 10 (4), 339-378 Glickman N.J. and Woodward D.P. 1988 The Location of Foreign Direct Investment in the United States: Patterns and Determinants, International Regional Science Review 11, 137-154. Glickman N.J. and Woodward D.P. 1989 The New Competitors: How Foreign Investors are Changing the U.S. Economy. New York: Basic Books. Guimareas et al. 2000 Agglomeration and the Location of Foreign Direct Investment in Portugal, Journal of Urban Economics 47, 115-135. Head et al. 1995 Agglomeration Benefits and Location Choice: Evidence from Japanese Manufacturing Investments in the United States,Journal of International Economics 38, 223-247. Henderson, J. 1974. The sizes and types of cities. American Economic Review 64, 640–56. Hoover, E.M. 1948. The Location of Economic Activity. McGraw–Hill, New York. Jaffe. A.B., M. Trajtenberg and R. Henderson, 1993. Geographic localization of knowledge spillovers as evidenced by patent citations. Quarterly Journal of Economics 63, 577-598. Krugman, P. 1991. Increasing returns and economic geography. Journal of Political Economy 99, 484–99. Locate in Leeds, Retreived from :http://www.locateinleeds.co.uk/leeds-news Lösch, A. 1954. The Economics of Location; Translated by Woglom, W.H., from Dieräumlich Ordnung der Wirtschaft (1940). Yale University Press, New Haven, Conn. Ondrich J. and Wasylenko M. 1993 Foreign Direct Investment in the United States. Kalamazoo, MI: Upjohn Institute. Ricardo, D. 1821. The Principles of Political Economy, 3rd edn. Homewood, IL: Irwin, 1963. Ritter, J. A. (1990). “The Industrial Location Decision: A Practitioner’s Perspective.” Economic Development Quarterly: 154–156. Salvesen, D. and Renski, H., 2003, THE IMPORTANCE OF QUALITY OF LIFE IN THE LOCATION DECISIONS OF NEW ECONOMY FIRMS Center for Urban and Regional Studies University of North Carolina Weber, A. 1929, Alfred Weber’s Theory of the Location of Industries; translated by Friedrich, C.J., from Über den Standort der Industrien (1909). University of Chicago Press Wheeler D. and Mody A. 1992 International Investment Location Decisions: The Case of U.S. Firms, Journal of International Economics 33, 57-76. Woodward D. 1992 Locational Determinants of Japanese Manufacturing Start-Ups in the United States, Southern Economic Journal 58, 690-708. . Read More