IAS-WP98.Pdf

UNU/IAS Working Paper No. 98 An environmentally based approach for industrial location decisions and its application in Punjab Province, Pakistan Awais Latif Piracha 1 ABSTRACT Analyses of decisions pertaining to the spatial distribution of industries have long been the domain of economists or economic geographers. “Location Theory” is considered to be a part of both economic geography and microeconomics. Location decisions of firms, including those of secondary industries, have mostly been looked at in terms of cost minimization, profit and market maximization, cost reduction and comparative advantage. A more recent concern has been the link between innovations and industrial locations. At times welfare concerns have entered into the study of industrial locations but again these issues have been taken from an economic viewpoint with income generation and employment creation being the main focus. There has been a noticeable absence of interest in environmental issues in planning methods pertaining to normative influences on industrial locations. This lack of emphasis, however, begs the question of how would public regulators decide on the optimal location of industries so as to safeguard natural environments as well as achieve the social equity goals. In present climate of market-oriented reforms and privatization, it is unlikely, that in foreseeable future, governments will directly invest in the industrial sector. In most countries the future public sector’s role will be limited to safeguarding the natural environment and welfare of its people. Thus, economics based theories and concepts of industrial location will not be of much help for government officials. In this context, it makes sense for governments to look for new approaches to strategic industrial location policies that will help to both preserve the environment and achieve social goals. In this paper the author has attempted to formulate one such approach. The approach formulated contains certain steps, guided by flexible principles to accommodate regional environmental variations. As environmental concerns vary from place to place, it was therefore imperative to provide an in-depth case study to highlight the salient features of the approach. Punjab Province in Pakistan was selected as it is likely to see rapid industrial development in the future and its environment is sensitive to perturbations. The paper has two parts. The first part is subdivided into two sub-sections; the first discusses the existing approaches for industrial location and the second presents the new environmentally based approach. The second part presents the results from the application of the new approach to Punjab Province in Pakistan. The details of the research necessitate the subdivision of this section into four sub-sections, pertaining to different modules of analysis. The first three sub-sections present different scientific inputs needed to carry out the evaluation and the fourth sub-section discusses policy implications for industrial locations based upon this approach. 2 PART - A: ENVIRONMENT-BASED APPROACH I - Existing approaches of industrial locations The study of industrial location is considered a part of “location theory,” which in itself is a part of the field of Economic Geography or Spatial Economics. Location theory addresses the questions of what economic activities are located where and why? It uses economic analyses to study the distribution of economic activities. It focus is the microeconomics of space, with the goal of allocation and equilibrium achieved through the price mechanism. The German economist Beckman (1968) has provided a comprehensive overview of location theory. The first major work in location theory was that of Von Thünen (1826). He explained the geographic distribution of activities in and around towns. He suggested a model that predicts agriculture development in concentric zones around cities, based upon the weight and shelf life of the products. In his model, heavy products, in proportion to value, and perishables are produced close to the town; lighter and durable goods, produced further away on the periphery. Land rent and transport costs are related such that, as transport costs to the city increased with distance, the returns to the land would diminish until, at a certain distance, land rent would become zero. Moreover, methods of cultivation would vary - with land cultivated more intensively near the city, where it was more valuable. Von Thünen’s model has provided fertile ground for geographers. Researchers have ever since been building on his work. A major extension of Von Thünen’s model was done by William Alonso (1964) in his work titled “Location and Land Use: Towards a General Theory of Land Rent”. The next major contribution to location theory was related to predicting industrial locations. In 1909, the German location economist Alfred Weber formulated a theory of industrial location in his book entitled Über den Standort der Industrien (Theory of the Location of Industries, 1929). Weber's theory, called the location triangle, sought the optimum location for the production of a good based on the fixed locations of the market and two raw material sources, which geographically form a triangle. He sought to determine the least-cost production location within the triangle by calculating the total costs of transporting raw material from both sites to the production site and the product from the production site to the market. A number of variations to Weber’s theory have been attempted all striving at optimizing location for a production activity where profit is maximized. Advancement to the theory of industrial location was achieved through several interdependent activities. The first and most important was the work of Walter Christaller (1933) in terms of his theory of Central Places. According to him the primary purpose of a town is to provide goods and services to surrounding market areas. Such towns therefore must be centrally located in terms of maximizing their market share and may be called central 3 places. Further, settlements could be characterized, in ascending order, by the amount and type of goods and services they provide. There are three such levels of towns in Christaller’s hierarchy that follow a hexagonal geometry. Hence, Christaller’s theory consists of two basic concepts: 1) threshold - the minimum market needed to bring a firm or city selling goods and services into existence and maintain business; and, 2) range - the average maximum distance people will travel to purchase goods and services. The German economist August Lösch (1940) expanded Christaller’s work in his book titled The Spatial Organization of the Economy. Most work on the subject since that time until approximately 1960 extended the notions related to the above mentioned classical location theories. In the case of industries, location theory remained concerned primarily with profit maximization, through transport cost reduction and market share maximization. Thereafter, it was increasingly recognized that the location of individual factories could only be understood through the individual firm’s relation to wider corporate systems to which they belong. This understanding went hand in hand with the increase in importance of multinational corporate strategies, discussions or globalization and foreign direct investment. A recent contribution in this direction is from Paul Krugman (Krugman, 1993, 1997: Fujita and Krugman, 1999). Others, such as Chapman (1991) and Harrington (1995) have elaborated on two new themes, the role of multinationals and the role of governments. Benjamin Higgins’ (1995) work that reviews regional development policy includes interesting references to the role of location theory. From the literature on industrial location six different approaches to industrial location decision-making can be identified. 1. Normative industrial location approach The normative approach concerns minimizing cost or maximizing profits. This approach is based upon Alfred Weber’s work (1909) on least-cost industrial locations. Weber considered demand to be constant. Other researchers varied demand and emphasized the location strategy of competitors, but they kept cost constant. August Lösch (1944) combined the two in “The Economics of Location”. He argued that an entrepreneur should select a location at which profits are maximized. Lösch realized that, in reality neither demand nor costs are spatial constants as assumed by the least-cost and locational interdependence schools respectively. However, he maintained that such a model was impossible to construct. Despite his pessimism, however, other researchers have since been trying to build such model. The normative approach is based upon the existence of an “Economic Man” (Chapman, 1991). An “Economic Man” is a rational decision-maker with the single-minded pursuit of 4 profit maximization. He also possesses complete knowledge of all relevant economic information, including the ability to predict the actions of competitors and future events. As such a person does not exist, it is necessary to see how decisions are actually made. This deficiency of the normative approach along with rapid economic growth of the 1960s and the associated construction of new manufacturing establishments in the developed countries provoked interest in so-called behavioral approach. 2. Behavioral approach Researchers in the field of industrial location realized that decision-makers do not possess either the level of knowledge

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