Industrial Clusters: Equilibrium, Welfare and Policy

Abstract

This paper studies the size and number of industrial clusters that arise in a multi-country world in which one sector has a propensity to cluster because of increasing returns to scale. Equilibrium will generally have smaller clusters than the world welfare optimum, and possibly too many countries with a cluster. Countries have an incentive to use policy to attract an industrial cluster, but the equilibrium of the policy game between governments coincides with the world optimum so there is no "race to the bottom". Capping subsidy rates would lead to a proliferation of too many and too small clusters.