Agglomeration and human capital: an extended spatial Mankiw-Romer-Weil model for European regions

Over the last two decades a handful of very rich European regions have increased the gap separating them from the European average in terms of labour productivity. In this paper we extend a spatial version of the Mankiw, Romer and Weil model (MRW, 1992) as developed by Fischer (2011) to accommodate human capital spillovers linked to agglomeration. After modelling this specific spillover, we go on to test empirically whether its effect has been to stimulate labour productivity growth in those European regions with the greatest potential to benefit from agglomeration economies. The theoretical model leads to a cross-sectional spatial Durbin model specification. The empirical analysis is carried out for 121 European regions for the period 1995-2014. We find significant conditional b-convergence, positive impacts of investment in physical and human capital, and a negative impact of population growth. Our most notable result involves the specific spillover effect that enhances the impact of investment in human capital in the most highly agglomerated regions. We find this externality significant in explaining labour productivity growth and therefore also in increasing labour productivity disparities across European regions.