Evaluation of Regional Economic Policy in the New Economic Geography

In this paper we analyze the impact of a simple regional economic policy in the context of the core periphery model of the New Economic Geography. More specifically, we look at the welfare effects of a decrease in transport cost that is financed by a lump-sum tax on all inhabitants of the country. Our results are based on simulation. We compare the effects of traditional cost benefit analysis that measure consumer’s surplus on the basis of the partial demand curve for transport with the full general equilibrium effects. Since the manufacturing sector is characterized by imperfect competition, there is potentially a substantial difference between the change in consumer’s surplus and the true effects. We also consider the possibility that the investment causes a change in the long run development of the economy. In particular, we look at an investment that induces an economy that was converging to the dispersed equilibrium to move towards agglomeration. We compare the welfare effects of the redistribution of manufacturing workers and industries with those referring to a given distribution of economic activities.