Can Welfare Be Improved by Relocating Firms? The Case of the Constructed Capital Model

Abstract

In the literature of new economic geography several authors have shown that a benevolent social planner would choose a different spatial distribution of economic activity than the one achieved through market forces. So far little has been done to evaluate the welfare effects of specific redistribution policies. This is the main contribution of the paper. We look at two policy schemes: location permits policy and a tax-subsidy policy in the context of the constructed capital model (due to Baldwin 1999). It is shown that with a tax on final consumption expenditures and a capital subsidy there is more room for welfare improvement than under the location permits policy due to increased variety of goods. Nevertheless, relying on the numerical simulations, no situation is possible where the residents of both regions would gain from the policy. Also compensated Pareto improvements are unachievable.