Agglomeration and Growth with Endogenous Expenditure Shares

We develop a New Economic Geography and Growth model which, by using a CES utility function in the second-stage optimization problem, allows for expenditure shares in industrial goods to be endogenously determined. The implications of our generalization are quite relevant. In particular, we obtain the following novel results: (1) two additional nonsymmetric interior steady states emerge for some intermediate values of trade costs. These steady-states are stable if the industrial and the traditional goods are either good or very poor substitutes, while they are unstable for intermediate (yet lower than one) values of the intersectoral elasticity of substitution. In the latter case, the model displays three interior steady states—the symmetric and the core-periphery allocations—which are stable at the same time; (2) agglomeration processes may always take place, whatever the degree of market integration, provided that the traditional and the industrial goods are sufficiently good substitutes; (3) the regional rate of growth is affected by the interregional allocation of economic activities even in the absence of localized spillovers, so that geography always matters for growth and (4) the regional rate of growth is affected by the degree of market openness: in particular, depending on whether the traditional and the industrial goods are good or poor substitutes, economic integration may be, respectively, growth-enhancing or growth-detrimental.