This paper elaborates on Baldwin’s (1999) New Economic Geography model allowing for capital accumulation and capital mobility between a “rich” and a “poor” region. A central government decides upon the level and the regional and sectoral allocation of productivity enhancing public investments. We derive results on how such policies affect the overall private capital stock and its regional allocation under alternative financing schemes. We show that the regional and sectoral distribution of public capital matters in determining the final impact of an increase in public capital on the level of private capital. Furthermore, we find that increasing public capital in the “poor” region does not always increase the share of manufacturing in that region as the final result depends on the relative strength of two effects which have been studied separately in the literature so far: the “productivity” and the “demand” effects. Finally, we show that in order to be effective regional policy must not confine itself to the expenditure side but has to take into account the financing side at the same time.
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Find related papers by JEL classification: F20 - International Economics - - International Factor Movements and International Business - - - General H5 - Public Economics - - National Government Expenditures and Related Policies R12 - Urban, Rural, and Regional Economics - - General Regional Economics - - - Size and Spatial Distributions of Regional Economic Activity; Interregional Trade (economic geography)