Geographical Concentration, Comparative Advantage, and Public Policy

This paper analyzes the geographical concentration and diversification of industries in the Continuum-of-Goods Trade Model in the presence of labor migration, comparative advantage, and external increasing returns to scale. In the model, higher transportation costs lead to concentration in one region, and lower transportation costs lead to diversification between the regions. For intermediate transportation costs, asymmetric diversification becomes a stable equilibrium through a reduction in the range of nontraded goods due to external increasing returns to scale and transportation costs. However, asymmetric equilibrium is an inefficient outcome: Pareto dominated by the other equilibria. To prevent this inefficient equilibrium, subsidies may be useful to sustain symmetric diversification.