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Contracting externalities and multiple equilibria in sectors: Theory and evidence

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Listed:
  • Neus Bover
  • Juan J. de Lucio
  • Diego Rodríguez

Abstract

We consider an economy where the production technology has constant returns to scale but where in the descentralized equilibrium there are aggregate increasing returns to scale. The result follows from a positive contracting externality among firms. If a firms is surrounded by more firms, employees have more opportunities outside their own firm. This improves employees' incentives to invest in the presence of ex post renegotiation at the firm level, at not cost. Our leading result is that if a region is sparsely populated or if the degree of development in the region is low enough, there are multiple equilibria in the level of sectorial employment. From the theoretical model we derive a non-linear first-order censored difference equation for sectoral employment. Our results are strongly consistent with the multiple equilibria hypothesis and the existence of a sectoral critical scale (below wich the sector follows a delocation process). The scale of the regions' population and the degree of development reduce the critical scale of the sector.

Suggested Citation

  • Neus Bover & Juan J. de Lucio & Diego Rodríguez, 1998. "Contracting externalities and multiple equilibria in sectors: Theory and evidence," Economics Working Papers 336, Department of Economics and Business, Universitat Pompeu Fabra.
  • Handle: RePEc:upf:upfgen:336
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    Keywords

    Incomplete contracts; development; multiple equilibria; delocation trap;

    JEL classification:

    • D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
    • J41 - Labor and Demographic Economics - - Particular Labor Markets - - - Labor Contracts
    • O18 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Urban, Rural, Regional, and Transportation Analysis; Housing; Infrastructure
    • R12 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - General Regional Economics - - - Size and Spatial Distributions of Regional Economic Activity; Interregional Trade (economic geography)

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