Essays on Agglomeration and Inter-Jurisdictional Competition Inaugural-Dissertation zur Erlangung des Grades Doctor oeconomiae publicae (Dr. oec. publ.) an der Ludwig-Maximilians-Universität München Volkswirtschaftliche Fakultät im Jahr 2009 vorgelegt von Hyun-Ju Koh Referent: Prof. Dr. Rainald Borck Korreferent: Prof. Dr. Michael Pflüger Promotionsabschlussberatung: 10. Februar 2010 Acknowledgements First I want to thank my supervisor Rainald Borck for his academic guidance and encour- agement. He gave me the freedom to pursue my research interests and was always willing to discuss new ideas and thoughts with me. His comments and suggestions improved every paper of the dissertation. I am also grateful to my second supervisor Michael Pflüger. His fascination for regional and urban economics spilled over and became my favorite research interest. I am also thankful for his efforts to arrange a research stay abroad. I thank Andreas Haufler who completes my thesis committee for valuable comments on my research. I am also indebted to Gilles Duranton who served as a local supervisor during my stay at the University of Toronto. I much enjoyed doing research in such an inspiring environment. I gratefully acknowledge financial and academic support from the Bavarian Graduate Program in Economics and the Elitenetzwerk Bayern. Special thanks go to my co-authors for the rewarding experience that doing research together is much more fun. Part of the chapters were presented at conferences: the meeting of the Austrian Economic Association (NoEG) in Vienna, 2008, the Annual Meeting of the European Economic Asso- ciation (EEA) in Milan, 2008, the IIPF Meeting in Maastricht, 2008, the Public Economic Theory (PET) Meeting in Seoul, 2008 and the Annual Meeting of the German Economic As- sociation (VfS) in Magdeburg, 2009. I thank all participants for their comments. I also thank all seminar participants of the BGPE Workshop, Public Economics Seminar and participants of the Trade Seminar at the University of Toronto for their remarks. Special thanks go to my colleagues at the department: Wolfgang Habla, Ferdinand Mitter- maier, Ines Pelger and Nadine Riedel for enjoyable conversations especially those beyond economics. Wolfgang Habla and Mohammed Mardan for research assistance and Anita Hof- mann for handling all administrative affairs. Most importantly, I am deeply indebted to my family. Their love and support helped me to endure especially difficult times during my years of studies. Hyun-Ju Koh Munich, 25 September 2009 Contents Introduction 1 1 Assessing the Localization Pattern of German Manufacturing & Ser- vice Industries - A Distance Based Approach 9 1.1 Introduction . 10 1.2 Data . 13 1.3 Estimation Methodology . 15 1.3.1 Step 1: Calculation of Kernel Density Estimate . 15 1.3.2 Step 2: Constructing Counterfactuals . 16 1.3.3 Step 3: Global Confidence Bands . 17 1.3.4 Step 4: Identification of Localized Industries . 17 1.4 Results: Industrial Localization in Germany . 20 1.4.1 Geographical and Sectoral Scope of Localization . 27 1.5 The Ellison and Glaeser (1997) Approach . 30 1.5.1 Methodology . 32 1.5.2 Results with the EG index . 34 1.6 Conclusion . 39 Contents ii 2 Taxing Agglomeration Rents: The importance of localization and urbanization for local business taxation 41 2.1 Introduction . 42 2.2 A Simple Theoretical Model . 46 2.3 Data . 50 2.4 Empirical Methodology . 52 2.5 Results . 58 2.5.1 Baseline Results . 58 2.5.2 Robustness Checks . 63 2.6 Conclusion . 65 3 Inefficient Lock-in and Subsidy Competition 85 3.1 Introduction . 86 3.2 The Model . 91 3.2.1 Basic Set Up . 91 3.2.2 Preferences and Demand . 92 3.2.3 Production . 93 3.2.4 Long run equilibrium and welfare: the symmetric case . 96 3.2.5 Long run equilibrium and welfare: the asymmetric case . 101 3.3 Subsidy Competition . 105 3.3.1 Basic Setup . 105 3.3.2 Equilibrium . 109 3.4 Conclusion . 114 3.5 Appendix . 116 Contents iii 3.5.1 Break point . 116 3.5.2 Sustain point . 116 3.5.3 Locational Forces . 117 3.5.4 Proofs . 118 4 The winner gives it all: Unions, tax competition and offshoring 121 4.1 Introduction . 122 4.2 The basic model . 125 4.2.1 Preferences . 125 4.2.2 Industrial production . 127 4.2.3 Mobile factor’s reward . 128 4.2.4 Union wage setting . 130 4.3 Tax competition . 133 4.3.1 Second Stage: Periphery’s government . 136 4.3.2 First Stage: Core’s government . 137 4.4 Winners and losers of the subsidy race . 140 4.5 Discussion . 144 4.6 Conclusion . 146 4.7 Appendix . 147 4.7.1 Proof of Proposition 2 . 147 4.7.2 Proof of Proposition 3 . 147 4.7.3 Proof of Proposition 4 . 148 5 The merits and pitfalls of co-agglomeration: Contents iv Vertical linkages and regional competition 149 5.1 Introduction . 150 5.2 The Model . 153 5.2.1 Basic Set Up . 153 5.2.2 Preferences and Demand . 154 5.2.3 Production . 155 5.3 Locational equilibria . 159 5.4 Competition for a key industry . 164 5.4.1 Stage 2 - Periphery’s decision . 166 5.4.2 Stage 1 - Core’s decision . 168 5.5 Conclusion . 171 5.6 Locational forces of the model . 173 5.6.1 Final goods sector . 173 5.6.2 Intermediate goods sector . 173 5.7 Proof of Proposition 1 . 174 5.8 Derivation of ÁB .............................. 175 5.9 Cost-of-living indices . 175 5.10 Proofs . 176 5.10.1 Proof of Proposition 2 . 176 5.10.2 Proof of Proposition 3 . 176 5.10.3 Proof of Proposition 4 . 177 Bibliography 189 List of Figures 1.1 Kernel Density Functions and Global Confidence Bands . 19 1.2 Industry location pattern for four illustrative industries . 21 1.3 Kernel Density Functions for Cutlery (WZ2861) and Motion picture, video distribution activities (WZ9212) . 26 1.4 ¡m and ªm by distance . 28 1.5 Distribution of γEG ............................ 34 2.1 Raumordnungsregionen ............................ 83 3.1 Locational equilibria . 97 3.2 Bifurcation diagram . 97 3.3 Social welfare: symmetric region size . 101 3.4 Bifurcation diagram for asymmetric region size . 103 3.5 Agglomeration rent for asymmetric region size . 103 3.6 Social welfare: asymmetric region size . 104 d 3.7 Govt 2’s Decision (z2 > 0) . 113 4.1 Stability of core-periphery equilibria under asymmetric unionization . 132 4.2 Core’s welfare function for different union wages . 136 4.3 Foreign workers’ welfare differential . 141 Contents vi 4.4 Welfare of h’s union workers . 142 4.5 Welfare of h’s non-union workers . 143 4.6 Home’s welfare difference for different union wages . 145 5.1 Upstream industry (X)........................... 162 5.2 Downstream industry (M) . 162 5.3 Core’s subsidy necessary to defend industry core . 170 List of Tables 1.1 Descriptive statistics . 14 1.2 Plant Size Distribution (DO index) . 14 1.3 Industry Size Distribution . 15 1.4 Most Localized Manufacturing Industries (DO index) . 23 1.5 Most Localized Service Oriented Industries (DO index) . 24 1.6 Most Dispersed Manufacturing Industries (DO index) . 27 1.7 Location of Plants in the Weaving Industry (WZ1722) . 30 1.8 Intra-Industry Localization . 31 1.9 Geographical and Industrial Concentration for Different Administration Units . 36 1.10 EG index for different administration units . 36 1.11 Most Localized Industries with EG index . 37 1.12 Most Dispersed Industries: EG index . 38 2.1 Descriptive Statistics . 69 2.2 Number of Employees - Localized Industries at 0km . 71 2.3 Number of Employees - Localized Industries at 10km . 72 2.4 Sum Localized Industry Shares - Localized Industries at 0km . 73 Contents viii 2.5 Sum Localized Industry Shares - Localized Industries at 10km.