Web Book of Regional Science Regional Research Institute

2020

Regional Development: Challenges, Methods, and Models

Randall W. Jackson
West Virginia University

Geoffrey J.D. Hewings

University of Illinois at Urbana-Champaign

Serge Rey
University of California, Riverside

Nancy Lozano-Gracia
World Bank

Follow this and additional works at: [Link]

Recommended Citation
Jackson, R.W., Hewings, G.J.D., Rey S., & Lozano-Gracio, N. (2019). Regional Development: Challenges,
Methods, and Models. WVU Research Repository, 2020.
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The Web Book of Regional Science
Sponsored by

Regional Development:
Challenges, Methods, and Models
By

Randall W. Jackson, West Virginia University

Geoffrey J.D. Hewings, University of Illinois
Serge Rey, University of California-Riverside
Nancy Lozano-Gracia, World Bank

Published: 2019

Editor: Randall Jackson

Director, Regional Research Institute
West Virginia University
<This page blank>
The Web Book of Regional Science is oered as a service to the regional research community in
an eort to make a wide range of reference and instructional materials freely available online.
Approximately 30 books and monographs have been published as Web Books of Regional Science.
These texts covering diverse subjects such as regional networks, land use, migration, and regional
specialization, include descriptions of many of the basic concepts, analytical tools, and policy issues
important to regional science. The Web Book was launched in 1999 by Scott Loveridge with
Regional Research Institute directors serving as Web Book editors. Scott Loveridge performed that
role through 2000 and Randall Jackson served as editor from 2001 through 2022.

Web Book material, including text and graphics, is available to users for personal use and may not
be redistributed in whole or in part, in print, online, or on electronic media (e.g., CD). Permission
for reprinting images and text from the Web Book of Regional Science must be obtained from the
Regional Research Institute to which all users must comply.

When citing this book, please include the following:

Jackson, R.W., Hewings, G.J.D., Rey, S., & Lozano-Gracia, N. (2019). Regional Development:
Challenges, Methods, and Models. WVU Research Repository, 2020.
<This page blank>

4
Contents
1 How Regional Economies Work 2
1.1 An overview of policy proposals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
The Early Regional Policies-Sticks and Carrots . . . . . . . . . . . . . . . . . . . . . 5
Growth Poles and Growth Centers . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Portfolio Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Industrial Complexes and Cluster Strategies . . . . . . . . . . . . . . . . . . . . . . . 6
The Role of the Creative Class: A New Take on Key Sectors . . . . . . . . . . . . . . 7
Smart Specialization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
1.2 Avoiding one size ts all pitfalls in terms of diagnosis and policy prescriptions . . . 9

2 What Have Regional Policies Missed? 9

2.1 Critical nature of internal heterogeneity . . . . . . . . . . . . . . . . . . . . . . . . . 9
2.2 Identifying spatial interconnections-trade in goods and services, trade in people, in-
novations, interregional income transfers . . . . . . . . . . . . . . . . . . . . . . . . . 9
2.3 Addressing socio-cultural barriers and increasing concerns about increased inequality 10
2.4 Challenging the regional equity-national eciency trade-o  solutions to some re-
gional problems may enhance national eciency . . . . . . . . . . . . . . . . . . . . . 11

3 Exploring Regional Structure 11

4 Regional Economic Analysis Methods: Introduction and Selective Overview 15
4.1 Regional Economic Systems Inventorying . . . . . . . . . . . . . . . . . . . . . . . . 16
The Location Quotient . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Related Measures of Concentration . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Industrial Diversity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
Common Diversity Indices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
Key Industries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
4.2 From Individual Key Sectors to Industrial Clusters . . . . . . . . . . . . . . . . . . . 20
Melding Clustering and Diversication Strategies . . . . . . . . . . . . . . . . . . . . 20
4.3 Identifying Supra-Regional Trends . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
4.4 Industrial Restructuring Challenges . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24

5 Regional Accounts and IO Software 24

Regional Accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
IO-Snap . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
REAL I-O Software . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25

6 Spatial Analysis of Regional Economies 26

6.1 Inequality, Lorenz Curves and Convergence . . . . . . . . . . . . . . . . . . . . . . . 26
6.2 Spatial σ -convergence and Spatial Gini . . . . . . . . . . . . . . . . . . . . . . . . . . 27
6.3 Theil Interregional Inequality Decomposition . . . . . . . . . . . . . . . . . . . . . . 27
6.4 Exploratory Spatial Data Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
6.5 Global Autocorrelation Measures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
6.6 Local Autocorrelation Measures (Spatial Clusters/Hot-Cold-Spots) . . . . . . . . . . 28
6.7 Markov and Spatial Markov/Distribution Dynamics . . . . . . . . . . . . . . . . . . . 29
6.8 Mobility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
6.9 Integrating equity, eciency and mobility . . . . . . . . . . . . . . . . . . . . . . . . 30

5
 6.10 Spatial Counterfactuals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
6.11 Machine Learning and Big Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31

7 Conclusion 31
References 33
Annex 39
IO-Snap Software . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39
REAL-IO Software . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40

6
The recognition that aspatial macroeconomic perspectives can prove to be misleading is far from
new, but there has been a recent and welcome increase in attention to the spatial dimensions of
economic development. Beveridge (1944) was among the rst to introduce a spatial dimension by
examining the role of full employment in a society with a special focus on the spatial distribution
of employment and unemployment. Readers were startled to nd that during the Great Depression
(1929-1937), unemployment rates varied by a factor of two to two and a half times between the
Southeast of the UK (London-centered region) and Wales, Scotland, and the North of England. The
impact of the Great Depression turned out to have been very uneven over space; the Beveridge book
sought to understand the causes and the outcomes. Eighty years later, during a period in which a
variety of initiatives had been undertaken, the regional disparities have persisted notwithstanding
the introduction of signicant initiatives by the national government to address these disparities.
For the three months ending in July 2017, the highest unemployment rate was still in the Northeast
(6.0%) with the lowest recorded in the Southeast of the UK (3.2%).
1 Many other places around

the World have experienced similar deep regional inequalities, with disparities between rural and
urban areas playing a central role in such inequalities (World Bank, 2014; Deuskar et al., 2015). In
China for example, the rural-urban divide is estimated to account for 45 percent of overall inequality
(Kanbur et al., 2014).

Much of the disappointment with the outcomes from spatial interventions may be traced to a
lack of understanding of how regional economies work. In retrospect, it would appear that many
of the initiatives aimed at reducing regional disparities have been proposed with an incomplete
understanding of how they might work; in many cases, there was little or no attempt to measure
the ecacy of the initiatives. In other cases, the lack of consideration of spatial/regional disparities
may have compromised the ecacy of broader development policies. Too often, there is a naïve
assumption that investment in a region can only generate benets or costs in that region; spatial
spillovers are, more often than not, ignored. A distinguishing feature of regional economies is their
openness, which leads to complex webs of interregional linkages that tie the fortunes of individual
regional economies together. This means that one region cannot be studied in isolation from the
broader interregional system, and that measurements of interregional linkages and the impacts of
these linkages on regional economies are required.

There have been signicant changes in the structure of national and regional economies in recent
decades that have challenged some of the assumptions on which many regional policy interventions
were once proposed. All the while, regional disparities in levels of welfare, growth rates, employment
and unemployment have persisted, and one of the major challenges in most countries centers on
addressing this persistence. However, earlier views that there is a negative trade-o between national
eciency and regional equity remains current, leading many policy analysts to view attention to
regional problems as a cost to overall national growth and development.

The spatial dimensions of economic activity have received increasing attention in the last 20 years
(Fujita et al., 2001). Parallel to these developments in economics has been the widespread adoption
of geospatial analysis and technologies across the wider social sciences (Goodchild et al., 2000),
which reects the ability of these methods to provide insights as to the role of spatial processes and
structure in the operation of many socioeconomic phenomena, and in turn, more comprehensive
understanding of the world.

1
[Link]
bulletins/regionallabourmarket/september2017. Accessed 12/04/2018.

1
In this paper we review the challenges that the consideration of regions brings into economic analysis
and provide an overview of some of the key methods and tools that can be used to gain a better
understanding of how regional economies work, and through that, identify both the challenges and
opportunities that they face. In the next section, the exploration of these challenges begins with
some consideration of the ways in which regional economies work to set the stage for subsequent
sections that summarize a toolbox of methods and strategies that might be considered for both ex
ante and ex post evaluation of regional development initiatives. In contrast to past reviews of this
eld, this report presents an integration of more traditional regional macroeconomic modeling with
new developments in spatial data analysis.

1 How Regional Economies Work

Brakman et al. (2010) suggest that regional economics  . . . analyzes the spatial organization of
economic systems and must somehow account for the uneven distribution (of economic activities)
across space... In contrast, regional growth and development theory attempts to answer three main
questions:

ˆ Why and how do regions grow?

ˆ Why do some regions grow more rapidly than others?

ˆ Why do some regions decline?

Unevenness in the neoclassical view of Borts and Stein (1964) would not be a problem since mo-
bile factors (such as labor and capital) would move to extract their maximum rents, leading to a
world in which an equilibrium distribution would see no dierences among regions. For example,
workers would move to regions with higher wages  causing labor market adjustments in origin and
destination regions  until wages equalize across regions.

Many of the neoclassical regional models were based on a Ricardian notion of comparative advantage,
in which a region exports those goods that it produces at relatively lower production costs that
result from diering relative productivities of the factors used to manufacture the goods. It is
trade in goods or factors, adjusting through their relative prices and increased productive capacity,
that results in the achievement of full employment. In this world, diering remunerations of the
production factors reallocate resources in space, and thus generate a higher rate of growth and
eventually, in equilibrium, equalized factor returns.

However, factors are neither innitely divisible nor homogenous and certainly not perfectly mobile.
This leads to non-equilibrium outcomes in which dierences in levels of welfare between regions can
arise and persist. So, what happens when mobility is limited, and instead of constant, there are
increasing returns to scale, with diering initial endowments and number of sectors in each region?

According to Richardson (1978), regional growth economics diers from aggregate growth theory
by its emphasis on interregional factor mobility as a key growth determinant; neoclassical regional
growth models simultaneously oer explanations of endogenous system of growth and interregional
factor ows with a single model. However, as regional economics developed, it became clear that
many of the assumptions in neoclassical theory were dicult to envisage operating in reality; in
fact, Armstrong et al. (2000) advance the notion that one of the reasons that regional development
policy can be justied is to address market failures.

Among the many critical assumptions of traditional neoclassical models, is the one that a common

2
wage level prevails in ALL regions because of perfect adjustment on the demand side due to dieren-
tials in labor supply growth. However, frictions to the mobility of labor are common in many parts
of the world. Further, in some regions, labor supply grows faster because of a faster rate of natural
increase and/or net migration, and this faster increase in labor supply or barriers to mobility of
factor markets can have a dampening eect on wage rates and can prevent equalization of wages.

Under the assumptions of the neoclassical model, even if a region produces all goods at higher
prices, so that it is generally more inecient in its production processes than any other region in
the country, it may nevertheless be relatively less inecient in producing one particular good. The
region will thus be able to obtain a role for itself in the international division of labor by specializing
in the production of the good in which it is relatively more ecient. As Capello (2015) has noted,
this argument has major normative implications, for it asserts that there is always an automatic
mechanism guaranteeing the existence of some specialization, regardless of productive eciency,
and therefore economic policy measures to foster development are unnecessary.

However, it is the imbalance in interregional factor endowments, and dierences in levels of factor
productivity, that account for the advantage enjoyed by a local system in its relations with the rest
of the world. These are the elements that underlie a region's growth path and condition its timing
and the form that it takes. Capello (2015) notes that there are numerous sources of territorial
competitiveness: one of the main foci has been on role of dierences in factor endowment as the
main source of territorial competitiveness.

More generally, many of the limitations of the neoclassical model and its reliance on automatic
equilibrating mechanisms stem from two assumptions: that (1) the capital market is perfect; and
(2) technical progress is available to all regions  no one region has an advantage. Under these
assumptions, the outcome is convergence in regional incomes. However, empirical evidence refutes
the conclusion that capital ows to regions with low income levels. And instead, most countries end
up divided into leading regions where investment and economic activity concentrate, and lagging
areas where investment remains low, economic activity is incipient, and basic living standards are
lacking.

An alternative approach that would furnish a better interpretation of the real movement of the
factors would conrm the tendency of capital to shift to areas with higher wage remunerations;
in this alternative approach, often referred to as the Two-Sector model, subsequent reallocation
of resources, due to an external shock that moves the regions far from the initial steady-state
equilibrium, pushes local economies towards permanently dierent growth rates.
2

Consider a two-region case and assume an initial equilibrium, with the growth rate stable and
uniform between the regions and in which capital and labor grow in each of them at a constant
rate equal to that of income. Now consider an exogenous shock, for example, wherein the demand
for the good exported by one of the two regions increases. The price of the good rises as a direct
consequence and this eect has a positive impact on the value of the marginal product of the factors
in the region. The outcome is an intra- and interregional reallocation of production resources. The
amount of capital stock increases in the producing sector to meet the increased export demand
because of the inow of external capital attracted by greater returns. However, labor demand by
local rms will also increase because of the increase in the value of the marginal product of labor
(generated by the rise in the exported good price). There will be two further eects, one generated
by in-migration and the other by labor switching. The greater demand for labor will attract workers

2
Recall that the neoclassical model has production factors migrating because they are attracted by higher remu-
nerations.

3
both from the local agricultural sector and from other regions, given the higher remunerations that
will be available. Expansion of production and employment in the sector producing for export will
thus have a backwash eect on the agricultural sector. The main outcome is regional divergence 
the persistently higher growth rate in the region for which export demand is increasing generates
attractive forces  for both labor and capital  that make it dicult to envision a situation in
which the agricultural sector will catch up in terms of income convergence, without additional
interventions. While the less prosperous regions oer advantages due to their relatively lower wages
and unit labor costs, these are often not suciently attractive for signicant relocation of economic
activity.

Persistence of marked regional disequilibria suggests that these locational advantages are not enough
to close the gap between advanced and backward regions. The more prosperous areas are able to
absorb the decreasing returns that accompany industrialization and high capital intensity, while the
less prosperous regions of the advanced countries (such as those regions in the new accession countries
of the EU) have to compete with the low unit labor costs characteristic of the developing countries.
These issues highlight an emerging problem in regional analysis  the existence of dierences at
dierent spatial scales (e.g., EU versus the developing world at one level, dierences between regions
within the EU and even important heterogeneity within regions, for example between urban and
rural areas, and even within neighborhoods in a city).

Further, within a country, the economic performance of a region depends largely on its absolute
rather than its comparative advantage. A negative shock in a national sector is often met with
real depreciation, which continues until other sectors become competitive. Within a country, labor
markets are often more integrated than across countries, and hence if a region suers a negative
shock, exibility of adjustment of relative wages will be lower making equalization of wages harder.
Prices of immobile factors like land and housing may decline but this may not be enough to bring
the local economy to competitive levels, suggesting persistent regional disparities and possible loss
of labor rather than the convergence mechanism often expected at the national level (Duranton and
Venables, 2018).

Another issue not addressed by the neoclassical model is the diculties of factor ow movements,
since the model assumes that the costs of migration are zero, when migration costs can often be
high. This will be true not only of labor, but also for rms - especially those whose production
systems require signicant investment in buildings and associated infrastructure. In addition, full
information may not be available and even when available, Basile and Lim (2017) have identied a
non-linear relationship between migration and wage dierentials, with an inertia range in which
little migration is observed until the dierentials become large enough that people do move. One
might appeal to the role of assets or access to credit as an important part of the decision-making
process in making a move. Capital, even if mobile, may remain in more prosperous regions because
of cumulative processes, information spillovers relating to innovation and other factors that the
New Economic Geography (NEG) groups into agglomeration forces. Further, labor may not be able
to move from agriculture to industry because of lack of skills generating the possibility of wages
increasing in one sector even with high unemployment in the other. While the two-sector model has
still some limiting assumptions, it does move the discussion closer to empirical realities and toward
a better understanding of the specicities of regional economics.

Regional analysis has reached a stage in which theory has formed the foundation for a better
understanding of how spatial development happens, incorporating some of the frictions that we
see in reality and that neoclassical theory ignores. Yet, regional economic development theory still
falls short of complete spatial-awareness  of explaining both why and where things are happening.

4
Policy proposals for regional development have followed a similar process of evolution, sometimes
developing hand in hand with theory and sometimes despite it. In the next section, a brief review
of some past and current policies will be provided, all premised on the notion that market failure,
in the form of uneven development, requires some form of intervention.

1.1 An overview of policy proposals

In the 80 years since the publication of Beveridge's monograph there has been a variety of regional
policy proposals aimed at the reduction of interregional disparities. Many of these have focused on
limited development in more prosperous areas while others focused on enhancing the competitive
potential of the least prosperous regions of a country. An excellent but somewhat dated overview
may be found in Armstrong et al. (2000) with some of the more recent policies reviewed by McCann
(2015), with a special focus on the United Kingdom and the European Union.

The Early Regional Policies-Sticks and Carrots

In the 1960s, especially in the United Kingdom, regional policies oscillated between those termed
Carrot and those characterized as Stick. The former provided incentives for rms to locate estab-
lishments in less prosperous regions; these incentives ranged from outright grants to tax abatements
and funds for the training/retraining of employees. In analysis of the Department of Regional Eco-
nomic Expansion policies in Canada, Woodward (1973, 1974, 1975) characterized these policies as
windfalls; in many cases, the rms had already decided to locate in less prosperous areas (especially
in the Atlantic provinces) and so the incentives provided little benet to these economies but were
clearly attractive to the rms (see a more recent comprehensive evaluation by Schoeld (1989) and
Polèse and Shearmur (2006a,b). In contrast, the stick policies were focused on restricting devel-
opment in the most prosperous parts of the country (e.g., London in the United Kingdom). The
argument advanced was that without such restrictions, rms would continue to place establishments
in these regions and thus exacerbate the already profound existing disparities. Neither policy was
particularly eective, and few countries adopted the restrictive policies, but many continue to oer
subsidies and incentives for rms to locate facilities in their region (referred to globally as scal
wars such as the one recently visible in the US for the location of Amazon's second major headquar-
ter facility). Rarely, does one nd careful project appraisal techniques being used to evaluate the
expected return on investment by public agencies although US states are becoming more assertive
in tying incentives to a set of demonstrable metrics (e.g., numbers of jobs created).

Growth Poles and Growth Centers

The fascination with Perroux (1955) concept of pôles de croissance (growth poles) generated a
new wave of interest in the creation of innovative policies that address regional disparities. Since
Perroux's concept was aspatial, proposing to exploit the dynamics of critical linkages in an economic
system, it was quickly translated to the term growth centers. However, like Perroux's original
concept, denition proved elusive to the point that growth centers were often designated ex post.
What was retained was a sense of the role and importance of sectoral linkages, building on some of
the early ideas of the notion of keys sectors (Hirschman-Rasmussen). One of the main problems of
this set of ideas is that they looked to the past rather than providing indicators about the future
growth and development potential of a region (on this see Diamond, 1974).

5
Portfolio Theory
For a number of years, regional development strategy became enamored with an industrial policy
analogous to nancial portfolio theory in which the explicit trade-o between risk  unemployment
volatility in the industrial case  and return  employment growth by industry  was applied to
regional economic systems. The region's industrial portfolio was to be viewed as though it were a
stock portfolio, which was then evaluated in terms of two dimensions  the expectation for growth
and the risk associated with public capital investment in the sense that a faster growing sector
might also be one that experiences signicant cyclical behavior (e.g., boom followed by bust). The
mathematical programming portfolio variance techniques already in application in nance could
then be applied to seek a mix of industries that would provide an acceptable balance between
risk (economic uctuations) and return (growth rates). Policy makers could indicate preference
for risk minimization by supporting the development of industries whose employment uctuations
were countercyclical and osetting, or for more rapid growth with less concern for employment
or unemployment volatility. Following its introduction by Conroy (1974), the approach attracted
support from early proponents such as St. Louis (1980) along with some additional commentary
and criticism oered by Jackson (1984). The idea seemed to have experienced a modern renaissance
with work by Chandra (2003) and Chiang (2009) but has been eclipsed by the cluster-based strategy
most closely associated with the work of Porter (1990).

Industrial Complexes and Cluster Strategies

In regional science, there had been an emerging tradition in industrial complex analysis in which
attention was directed to the interconnections between industries within some a priori dened
geographic space (see Czamanski, 1971; Czamanski et al., 1974; Czamanski and Czamanski, 1976
and Czamanski and Ablas, 1979). The inuence of Marshallian ideas of industrial districts and
the externalities they generate was also inuential but, as Martin and Sunley (2003) have noted,
Porter was perhaps not as generous as one might have wished him to be in acknowledging the
intellectual foundations of his proposals. Porter's initial ideas centered on a diamond of interactions
within a local context  rm strategy and rivalry, factor inputs, demand conditions and related
and supporting industries. The latter three components could be found in Czamanski's work,
for example, while Porter's addition of rm strategy and rivalry clearly dierentiated his work
from traditional academic endeavors and positioned him to command the attention of national and
regional governments eager to embrace a new strategy for enhancing competitiveness. Martin and
Sunley (2003) also reect a growing sense concern about a concept that has not been rigorously
evaluated. While this is a valid concern, it applies equally to virtually all development strategies.
While the relationships between structure and performance can be assessed, on this basis alone
one cannot really conclude anything about whether there was an explicit development program that
had consequences consistent with the observed relationships or changes. In fact, extensive searches
of the literature fail to produce evidence of rigorous evaluations  for example, the adoption of
some quasi-experimental design in which two similar regions, one with and one without a cluster-
based development strategy, could be compared in terms of some appropriate metrics of economic
performance.

This is not to suggest, however, that there is evidence suggesting the failure of cluster development
strategies. Indeed, cluster strategies themselves are often not formally dened (Yu and Jackson,
2011), and can include any combination of state-sponsored eorts, groups composed of private en-
trepreneurs working to enhance interindustry linkages, actively promoted cluster initiatives, and
clusters that have developed essentially organically, with the most prominent example of the latter

6
kind being Silicon Valley. Woodward (2012) describes the success of the South Carolina auto clus-
ter, which continues to gain momentum, and there is anecdotal evidence that many other cluster
initiatives have been successful. Cluster initiatives vary from case to case, of course, complicating
their evaluation and assessment. The most substantial contributions from some cluster initiatives
can simply be the establishment of and focus for networks of like-minded individuals working to-
ward a common goal. Cluster-based initiatives that engage more and more diverse actors in their
networks, such as academic institutions, chambers of commerce, governmental bodies, and private
entrepreneurs would be expected to be more eective than those that engage fewer, but again,
empirical assessment is lacking.

The Role of the Creative Class: A New Take on Key Sectors

Similar criticisms surrounding a lack of evidence-based support might be directed towards Florida's
(2005a) exposition of the role of the creative class; in his book, he proposes that while . . . the role of
creativity in city formation and growth is new, . . . with the decline of physical constraints on cities
and communities in recent decades, creativity has become the principal driving force in the growth
and development of cities, regions, and nations. As with many concepts that focus on a subset of a
regional or urban economy, there is always going to be criticism directed to ignoring or downplaying
the role of the rest of the economy. As Diamond (1974) once commented in connection with the
concept of key sector analysis (of which the creative class idea shares many conceptual similarities),
a case may be made that non-key sectors may be more critical since, without them, the key sectors
would not be so prominent. A more nuanced vision of an economy might appeal to the one proposed
much earlier by Leontief who highlighted the roles of circulation and interdependence and drew
attention to the notion of complexity generated by consideration of not only direct relationships
but the importance of indirect ones (something not considered in Porter's work).

Smart Specialization
More recently, there has been interest in capturing some of the characteristics of earlier policies
within a more comprehensive framework that is referred to as smart specialization (see McCann,
2015). Conceptualized as a new way to integrate innovation and development policy, the proposed
strategy was motivated by concerns about the productivity gap between the European Union and
the United States that could be traced to the former's weakness in the diusion of new knowledge
and technologies across sectors. The causes postulated included (1) dierences in labor markets;
(2) management performance; (3) organizational issues and (4) market deregulation. According to
McCann (2015), the key turned out to be the critical role played by new information and communi-
cation technologies (ICT)since it was ICT-producing sectors that were driving the productivity gap.
Smart specialization was originally a non-spatial construct  focused on the idea of a knowledge
ecology  the endogenous context in which technological evolution takes place, focusing on pathways
for innovation, the evolutionary experience of the system, inherited structures, institutions and ac-
tors and their interrelations. In addition, it focused on the role of entrepreneurial search processes
and the domain in which innovation takes place especially its connectedness, thus highlighting the
role of R&D in the broadest sense.

Further, smart specialization highlighted the role of domain, relevant size (scale economies) and
level of connectedness and in this sense drew on ideas from NEG  but with much greater focus
on the relatedness of varieties. It appealed to the attraction of Marshallian externalities, namely
that it would be easier to switch between related than between unrelated activities (in response to
changes in demand). All these attributes needed to be embedded in the domain  with a focus on

7
local linkages, dependence on local skills or local institutions.

Connectivity highlights the degree to which rms are linked within the domain via transport, inter-
personal and nancial links. The policy implications stress the proposition that in order to foster
innovation and growth, regions should prioritize those activities enhancing entrepreneurial search
activities to diversify those that are highly embedded in the region. There should be a concerted
attempt to build on existing dominant technological and skills proles and capabilities but then
diversify around this core base. While this proposal might be appropriate for those regions that
actually have dominant tech and skills proles and capabilities, it would be dicult to translate
into action in places that lack them  such as NE Brazil, perhaps, or even a state such as West
Virginia in the US. Empirical evidence suggests that regions grow more successfully and are more
resilient if their growth patterns are more related to their historical trajectories. Hence, in contrast
to portfolio theory, the diversication strategy is more nuanced in that it does not posit a sharp
break with prior specialization. Smart specialization does not imply regions should become more
specialized because this will make regions more vulnerable to shocks. In essence, regional policies
should promote not just diversication but specialized diversication. Particularly astute are the
obvervations of Malizia and Feser (1999), who note that, The economic diversity of a city can
be dened in reference to its specializations. As additional relatively independent specializations
co-locate, the area becomes more diverse. Economic diversity is the presence of multiple special-
izations. In response, Jackson (2015) developed a method designed to identify new activities that
move the regional economy toward specialized diversication. This approach contrasts with some
earlier attempts to explore diversication to provide some pro-active counter-cyclical resilience in
regions that were characterized by a relatively narrow economic base. For example, in an evaluation
of a diversication policy for Appalachia, there was no consistent superior performance in counties
that were more diversied than others. In many cases, the more diversied counties had become
that way as a result of the loss of specialized industrial activity rather than through the addition of
rms in other sectors. Indeed, Chinitz (1961) urged the careful assessment of how changes in one
industry might impact regional suitability for others. Chinitz fell just short of explicitly identifying
a paradox for the structure to performance relationship. Namely, should an anchor industry in a
region suer a sharp decline, the region by most measures would as a direct consequence become
more diversied, though certainly not better o  (Jackson, 2015, p. 119).

Whatever polices that are proposed, there is a concomitant need to provide an analytical framework
that can be used for evaluation. Evaluation is signicantly underrepresented in the literature in
large part because of the diculty of demonstrating that policy x has made a dierence. Single-
equation analysis (e.g., Moore and Rhodes, 1974) is clearly not complete and the diculties of
comparative analysis remain. Further, as regions become more interconnected, comparison based
only on internal structure fails to highlight potential dierences in external linkages. In subsequent
sections, a set of available models and approaches that could be used for policy analysis will be
identied.

Academics and policy makers are reluctant to highlight failures  and as a result, many policies
continue to be recycled despite their often-limited ecacy. Additional work is needed to assess what
has been learned from previous policies about what did and did not work. What made a dierence
and in what ways? How did the outcome vary by the type of intervention, such as a direct impact
(e.g. a grant or subsidy) or an indirect one (infrastructure, investment in human capital etc.)? What
were the positive and what were the negative impacts of demographic changes (aging, composition
of the labor force, migration, occupational/skill capital) and economic development? An example
of such assessment is done in recent work by Rodríguez-Pose and Wilkie (2018) where a series

8
of policies to promote growth and development in underperforming, lagging areas is reviewed and
evaluated through a critical discussion of the impacts of such policies. However, much more empirical
evidence is needed to build a body of work that can suggest with condence which policies have
had the desired impacts and which have not.

1.2 Avoiding one size ts all pitfalls in terms of diagnosis and policy prescrip-
tions

One major theme that has emerged from the regional policy literature is that there are no uni-
versal approaches that seem to work in all places. In large part, this problem can be traced to
the idiosyncratic nature in which national and regional economies interact, their history and tradi-
tions, the nature and strength of government institutions and the degree to which notions of scal
decentralization have been adopted.

One common suggestion could be advanced, namely that before any policy is adopted, a careful
appraisal of the structure of the regional economies would be necessary. While this might seem
self-evident, there are many cases of policies being adopted prior to a diagnosis of the structure of
the regional economy. In the next section, a rational for this diagnosis will be presented; thereafter,
the discussion will move to a consideration of regional structure and some of the methods that can
aid in diagnosis and interpretation.

2 What Have Regional Policies Missed?

2.1 Critical nature of internal heterogeneity

Beveridge (1944) identied the nature of the internal heterogeneity of the United Kingdom economy,
a phenomenon that has persisted in almost all countries. The enormous expenditure of funds
provided by the European Union for cohesion policies provides further testimony to the critical
nature and persistence of inequalities in the level of welfare both across and within countries. As
noted in the previous section, it makes little sense to discuss the development of a country such
as Brazil without providing concomitant detail on the internal spatial distribution of economic
activity and population. To gain a deeper understanding and appreciation of heterogeneity within
countries and across regions, it is key to look at dimensions such as the trade of goods, services and
people as that provides a sense of the strength of linkages among interconnected regional economies.
Innovations and income transfers will also reveal critical aspects of interregional knowledge and
resource linkages. Further, assessing geographical, cultural, social, and infrastructure availability
dierences can also shed light on where disparities in living standards stem from and provide an
avenue for breaching existing gaps.

2.2 Identifying spatial interconnections-trade in goods and services, trade in

people, innovations, interregional income transfers

Modern production systems have become increasingly more fragmented in recent decades, with
dierent phases in production systems often allocated to dierent geographical locations. As a
result, interregional and international trade ows have been growing at rates in excess of the cor-
responding rates of growth of gross regional or national domestic product; further, this trade is
increasingly dominated by intra-industry rather than inter-industry trade, reecting the exploita-
tion of economies of scale in production of specied components and the signicant reduction in
transportation costs that facilitate spreading production across dierent locations along the value

9
chain (Krugman, 1991). This process has been propelled in part by a signicant spatial reorga-
nization of value chains over the past two or three decades, and the concomitant logistical issues
associated with the most ecient coordination of production systems has generated a complex
system of interdependent ows, linking regions in one country with regions in another.

This process of hollowing out (namely, the substitution of external sources of inputs and sales for in-
traregional transactions) has seen intra-economy multipliers decreasing while interregional spillovers
are increasing; this phenomenon is occurring at both the interregional and at the international scale.
Hence, one can no longer assume that a similar project would generate the same spatial and to-
tal impact wherever it was located within the nation at hand. The development of multiregional
inputoutput and computable general equilibrium models has revealed that, contrary to Friedman
(2005), the world inside nations is not at; space is spiky and it is uneven (see Florida, 2005b). Fur-
ther, projects generate dierent spatial distributive impacts depending on the nature (highway, new
business, investment in human capital) and on the location of the project. In addition, spillover ef-
fects are not necessarily symmetric: a project in Cataluña might generate larger impacts on Madrid
than a project in Madrid generates on Cataluña. Major projects can disturb the spatial equilibrium
as factors such as capital and labor respond to changes in opportunities and rents by relocating.

As the processes of fragmentation and hollowing out continue, interregional dependency will assume
even greater importance in explaining the growth and development paths of economies. The tragic
events in 2011 in Fukushima, Japan (earthquake and tsunami) and in Thailand (oods) revealed
risks associated with extensive supply chains that reach across many widely spread locations and
showed that disruptions in even the smallest components can generate severe stress on the whole
productive system.

Regional economies are becoming both more competitive and more integrated/complementary at
the same time, creating new challenges for policy analysts. To understand these new challenges
to economic development, it is essential to develop and maintain tools  such an interregional in-
putoutput models  that can assist in tracking these changes; focusing on just one region can
generate misleading outcomes. As in almost all formal economic modeling, the distinction between
endogenous and exogenous is very important; in constructing single-region models, it is often as-
sumed that the impacts of exogenous change are of a topdown nature with no feedback eects.
However, the changing structure of regional economies has resulted in greater role for interregional
trade and the possibility that feedbacks could prove to be important.

In this context, attention to trade needs to be expanded from attention to goods and services to
people, ideas and information ows. In many cases, movement of people (e.g., out-migration) can
often exacerbate the challenges of a less prosperous economy as Vanderkamp (1971) noted many
years ago.

The eld of spatial econometrics has developed an increasingly sophisticated set of tools to help iden-
tify the nature and strength of interregional spillovers to complement some of the more traditional
interregional models that can now be constructed relatively easily.

2.3 Addressing socio-cultural barriers and increasing concerns about increased

inequality

The publication of Capital in the Twenty-First Century refocused attention on the role of inequality
within nations (Piketty, 2017); but many prominent scholars, such as Stiglitz (2012) and Atkinson
(2015) have provided rigorous commentary on the impact of inequality. Piketty's major contribution

10
was to stress the role of the dierential between returns to capital in contrast to labor as a major
source of increasing inequality. However, these discussions usually focus on interpersonal inequality,
rarely mapping the outcomes into a spatial context. There is no consensus about how inequalities
should be reduced and the measurement of the cost of inequality is still not generally accepted.
Appeals to broader denitions of welfare that extend beyond monetary considerations are often
used to justify some form of intervention to address inequalities.

2.4 Challenging the regional equity-national eciency trade-o  solutions to

some regional problems may enhance national eciency

Regional analysts have been exploring the nature (and even the existence) of a trade-o between
attention to regional problems and the impact this might have on national economic eciency.
Archibald (1969, 1972) was one of the early contributors exploring this apparent trade-o, and
subsequent work by Thirlwall (1969, 1970), Mera (1967, 1973) and Thirsk (1973) found that the
simple expectation of a trade-o was often not conrmed in empirical work. In fact, Higgins (1973)
was more forceful in suggesting that:

Measures to reduce regional gaps, far from being a luxury to be aorded when things
are otherwise going well in the country, are the essence of a policy to accelerate growth,
reduce unemployment and maintain stability. For developing countries, where eorts
to accelerate growth are inhibited by fear of aggravating ination, reduction of regional
disparities may well be the sine qua non of a successful development policy.

National and subnational policies necessarily dier for a variety of reasons. Prominent among these
dierences is that there are many fewer policy handles available to regional policymakers than there
are to national policymakers. Regional policymakers have no control over macroeconomic variables
like money supply or interest rates, they cannot regulate trade or migration, and they typically have
smaller amounts of and less discretion over funds that might be transferred from one to another
sub-region. Because regional ocials have much less control over cross-border transactions, they
nd themselves in the role of price taker rather than price maker. Regional economic systems are
typically much more open than national economies and depend on other national sub-regions for
inputs to their production processes, the provision of consumption and investment goods, and for
markets for the goods and services they produce.

As a result, policies at the regional level often focus more heavily on structural economic charac-
teristics on the one hand, and on social and economic infrastructure on the other. The healthiest
and most vital interregional economic systems are composed of healthy and vital regional economic
systems. For this reason, the starting point for most analyses of regional systems is focused on
regional structure. Most structural analyses address industrial structure, labor force characteristics,
and household income and demographic characteristics.

3 Exploring Regional Structure

Understanding the economic structure of a region can help understand where its development poten-
tial lies, and where the key bottlenecks to growth might be. Better understanding of the economic
structure of a region can also help diagnose which links with other regions are more important,
where coordination is essential, and where important links might be broken and need attention. To
demonstrate some of the key characteristics of interregional systems that support taking a regional
and multiregional structural approach to national policymaking, consider the following idealized 3-

11
region example. The three regions, I, II, and III are of decreasing size and socioeconomic conditions,
as reected by per capita value added (see table 1).

Table 1: Three Regions: Summary Characteristics

Population VA
Region (millions) (millions) PCVA
I 10 450 45.0
II 9 308 34.2
III 8 258 32.3
Nation 27 1016 37.6

By fully aggregating industry transactions, we can present the interregional accounting system in
Table 2 where the interregional transactions can be seen in the upper left 3x3 quadrant, denoted
Z, and in coecient form in matrix A.
Table 2: The Structure of Interdependence
I II III Y
I 320 63 48 569 A = 0.32 0.09 0.08
II 40 210 54 396 0.04 0.30 0.09
III 50 28 168 354 0.05 0.04 0.28
VA = 450 308 258
Imports 140 91 72
X = 1000 700 600

The diagonal values in Z are aggregations of all interindustry transactions that take place within
the regions, and the o-diagonal cells show between-regions aggregations. Value-added is presented
here is a single VA row, but is an aggregation of employee compensation, payments to government,
and gross operating surplus. Gross output, X, equals the sum of payments by industries in the
region to intermediate suppliers, to value-added, and to the rest of the world for imports. The
nancial units here can be thought of as thousands of dollars for purposes of discussion, but the
relationship between nancial units and population could be scaled dierently to reect actual
national development levels without loss of generality. This example was constructed in a way that
would be consistent with nations that are composed of larger, more developed and typically more
urbanized regions, and successively smaller and less developed regions. Such nations typically have
a large urbanized area for which productivity is higher and per capita incomes are likewise higher
than in the two smaller, less urbanized or more rural areas.

The interregional multiplier matrix (Table 3) for this national system is similarly representative.
Intraregional multipliers decrease from 1.5 in Region I, the largest and most developed region, to
1.45 and 1.39 in the smaller regions. Although the example was deliberately constructed to demon-
strate the potential for enhancing socioeconomic conditions in the lagging regions without sacricing
national equity, the trade relationships shown are not unreasonable nor out of the ordinary. Region
I is an important supplier for all regions, and it purchases much more from itself than it does from
the other two regions. Likewise, Region II purchases more from dominant Region I than it does
from Region III, and Region III purchases almost equal amounts from both regions.

Table 3: The Interregional Multiplier Matrix

12
 I II III
I 1.50 0.20 0.19
II 0.10 1.45 0.19
III 0.11 0.09 1.39
Multiplier 1.70 1.75 1.77

We take the position here that the interindustry and inter-regional industrial structure and trade
relationships play a critical role in determining the eects of various policies and programs. To
underscore this proposition, we turn our focus to the commonly proered argument that there is
an inevitable trade-o between national eciency and interregional equity, and that to enhance the
latter requires sacricing the former. Using this simple numerical example, we demonstrate that it is
indeed possible, as suggested in Section 2.2, to enact policies that can target economic enhancement
in lagging regions in ways that not only do not sacrice national eciency, but actually enhance it.

Our policy scenario is as follows. Assume that we have a national budget to support expenditures
in the amount of $90k. Such an expenditure of public capital might be channeled to physical
infrastructure, to educational infrastructure, or even direct assistance. Now, because productivity
as measured by value added per capita (PCVA) is highest in Region I, conventional wisdom might
suggest that focusing the public capital expenditure in the most ecient region would have the
greatest impact on aggregate eciency, as measured by increase in value added. To demonstrate
that this is not a foregone conclusion, we use three scenarios, one that represents each extreme
position, with all $90k invested in Region I or Region III, and an intermediate scenario in which
each region receives equal shares of the public capital investment, as shown in the table 4.

13
 Table 4: Scenario Development
Regional Expenditure
Distribution:
Scenarios A, B, and C
A B C
I 90 30 0
II 0 30 0
III 0 30 90

The impacts assessment outcomes are shown in table 5 below. As expected, value added impacts
are greatest in the investment regions for the two extremes, and when the investment is spread
evenly over all three regions, the impacts are directly correlated with pre-shock development levels.

Table 5: Impact Results

VA Impacts by Scenario PCVA Impacts by Scenario

Region Popn VA PCVA A B C A B C

I 10 450 45.0 60.6 25.5 7.8 6.1 2.8 1.0
II 9 308 34.2 3.9 23.0 7.6 0.4 2.6 1.0
III 8 258 32.3 4.2 20.9 54.7 0.4 2.3 6.8
Nation 27 1016 37.6 68.79 69.43 70.07 2.29 2.57 2.92

However, contrary to conventional wisdom, the distribution of public capital investment that gen-
erates the largest value-added impact is Scenario C, in which the entire investment is targeted to
Region III, the one with the lowest PCVA. This also is the scenario that results in the strongest
convergence in PCVA across regions, and the greatest national PCVA value (see table 6).

Table 6: Modied Results

New PCVA by Scenario Percent Change in PCVA
Region Popn VA PCVA A B C A B C
I 10 450 45.0 51.1 47.6 45.8 13.5% 5.7% 1.7%
II 9 308 34.2 34.7 36.8 35.1 1.3% 7.5% 2.5%
III 8 258 32.3 32.8 34.9 39.1 1.6% 8.1% 21.2%
Nation 27 1016 37.6 39.50 39.73 39.98 5.0% 5.6% 6.2%
6.9 10.1 6.8 5.4

The lessons that we draw from this exercise can be summarized as follows:

1. The structure of interindustry interregional trade within a nation plays a vital role in deter-
mining impacts of policies and programs on each region and on the nation.

2. Investments in one region will have impacts on all regions.

3. Whether a nation must sacrice eciency in exchange for increased interregional equity will
depend upon the intra-and inter-regional interindustry structure of that national system.

4. Altering the structure of intraregional trade can have dramatic impacts on own-region multi-
pliers and system-wide eects.

To further illustrate this nal point, consider the following scenario in which, as a result of import
substitution, Region III increases its intraregional dependency, as reected by an increase in its
diagonal value from 0.28 to 0.31. Making this single change while holding all else constant in Scenario

14
C results in a 4.4% increase in both the regional and national value-added impacts values. Likewise,
strengthening interregional trade can have substantial impact. Doubling Region I's relatively small
purchases from the other two regions increases the value-added impact by 1.75%.

Together, these examples indicate that a) a comprehensive understanding of the geographical distri-
bution of national policy impacts requires an understanding of interregional inter-industrial struc-
ture. The positive impacts of policies and programs can be targeted to specic regions, and relative
distribution of benets across regions can be aected by careful structuring of national programs.
Therefore, there is great value in developing a systematic approach to the altering the characteristics
of regional structure that can have the greatest eect on regional and national development. The
analysis of regional industrial structure is the topic of section 4.

The purpose of the example in this section has been to demonstrate that there is a variety of out-
comes that are possible given alternative public capital investment scenarios and public policies.
It is also undoubtedly clear that the specic outcomes that will be observed depend heavily on
the detailed structure of regional and interregional economies. Every summary value in the ex-
ample scenario embodies a number of characteristics and details that would require much greater
specication and accuracy for any real-world application. Dierent industries have dierent input
requirements and output distributions, they have dierent ties of dierent strengths to other regions,
and their value-added payments are distributed dierently, not only among the major categories of
compensation, payments to governments, and gross operating surplus, but also to dierent house-
hold categories. Labor force requirements create dierential demands on households of dierent
types and income levels, and dierent demographics. And these are just some of the many de-
tailed characteristics that require explication when analytical models are constructed for assessing
alternative policy outcomes.

Additionally, moving beyond those regional and interregional characteristics that can be captured
in interregional accounting frameworks, other regional traits and behavioral dierences can and do
moderate the ways in which policy outcomes play out from region to region. Dierences in natural
resource endowments and amenities often dene and constrain the development path. Dierences
in regional consumption savings rates, for example, can have a dramatic inuence on the ow on
eects that play a critical role in determining the total impacts of policies. Likewise, whether savings
translates to investment within or outside a regions' borders will strongly shape the developmental
impacts of increased income, savings, and investment.

Other factors that will shape policy outcomes include the extent to which development may be aided
by external economies of scale and agglomeration, by cultural norms that will inuence educational
and hence occupational skill levels, labor force participation rates, family structures, the prevalence
of crime and other social maladies that often arise from increasing density and congestion.

In the next section, a more comprehensive review of some regional analytical methods will be
provided, after which attention will be directed to methods of exploratory spatial data analysis.

4 Regional Economic Analysis Methods: Introduction and Selec-

tive Overview

At the most fundamental level, a complete description of regional economic structure begins with
an inventory of employment, compensation (wages and salaries), and output by industry. This
information contributes to economic understanding in at least four ways. First, it is useful to know

15
how specialized or diversied the regional economy is. A long-standing concern at the regional level is
overspecialization that makes a region susceptible to industry-specic national and global economic
downturns. Consumer tastes and preferences and industrial production needs shift over time, so
regions that are too highly specialized can suer traumatic consequences if industries on which
they depend experience rapid declines in demand. Second, by identifying relative concentrations
by industry, we can begin to assess regional comparative advantages. Industries that fall into this
category become candidates for further analysis, assessing their futures and potential for further
development, not only within these specic industries, but also in related industries that are strongly
connected by direct and indirect forward (sales) and backward (purchases) linkages. Third, a
comprehensive inventory of activities becomes the foundation for behavioral models that can be used
for assessing economic impacts of policy changes, positive or negative economic disruptions, and
consequences of public capital investments. These models can be used to anticipate and understand
regional economic system responses in terms of changes in employment and wages, occupational
demand, and changes to household income distributions. Fourth, models of individual regions can
be linked with other regional models to develop a better understanding of how regional fortunes are
intertwined.

4.1 Regional Economic Systems Inventorying

In this section, we provide a brief overview of a set of fundamental methods that most often form the
initial assessment of regional economic structure. The rst set  largely composed of quotient-based
metrics  focuses solely on description, while the second set lays the foundation for prospective
interventions by incorporating either a temporal or behavioral element.

The Location Quotient

The location quotient, or LQ, is a very simple metric that is designed to compare a distribution of
shares, or concentrations, with a reference distribution. In regional analysis, it has most often been
used to assess concentrations of industries by focusing either on regional employment or regional
income by industry relative to the national distribution. In this case, the industry share of national
total is used as a meaningful comparator for subnational regions, so industry LQs can be directly
compared across regions. An example would be to compute LQs for variable x (e.g., employment
or income in industry i) as

region's share of national xi regional xi /x

or
region's share of national x national xi /x

Using employment as the interest variable, the rst expression carries the interpretation of the
region's share of national employment in a specic industry relative to the region's share of total
employment, and the second expression is expressed as the industries share of regional employment
relative to the region's share of national employment. Although the objective for a given analy-
sis might lead to a preference for one or the other expression, their mathematical equivalence is
assured, as is their interpretation. LQ values greater than 1.0 indicate relative regional industry
concentrations, and values less than 1.0 indicate concentrations smaller than the national average.

More formally, in terms of employment, the location quotient for industry i is dened as

16
 ei /Ei ei /e
LQi = = (1)
e/E Ei /E

where

ei denotes regional employment in industry i,

Ei is national employment level in industry i,
e is total regional employment,

E is total national employment.

While there can be many explanations for high and low concentrations of industries in a given
region, high LQs suggest regional comparative advantage for the industry, and therefore they point
to industries that might be important exporters and sources of regional product, and low LQs
suggest that these industries might be underrepresented in a region and hence their products might
need to be imported, hence accounting for some negative entries in regional balance of payments.
These speculations depend on a range of assumptions about industry mix, consumer tastes and
preferences, and the like, so LQs are clearly only broad-brush indicators, but can be useful in
pointing the analyst to industries that warrant further attention. Other methods discussed below
will relax some of the assumptions that underpin LQ interpretations.

Related Measures of Concentration

A related measure that focuses on a single industry's concentration across all regions is the Coef-
cient of Localization (CL). The CL relies not on the ratios of ratios, but instead is computed as
one-half the sum of the absolute dierences of between numerators and denominators in the LQ
calculations for the industry in all regions. The closer this value is to unity, the more concentrated
the industry is in the nation. An example for a ctitious industry and nation can be seen in the
table below, where the LQ indicates that the industry is relatively concentrated in regions 4 and
5, and the value of the CL is 0.21. Industries with low CL might be less tied to specic regional
attributes, and therefore might be good candidates for regional diversication in regions where the
LQ is less than one. Diversication strategies will be discussed further, below.

All Regions
Region 1 Region 2 Region 3 Region 4 Region 5 Region 6 Total
A)Region's share

of national industry 0.050 0.070 0.150 0.250 0.290 0.190 1

employment

B) Regions share

of national total 0.100 0.150 0.200 0.150 0.180 0.220 1

employment

|A - B| * 0.5 0.025 0.040 0.025 0.050 0.055 0.015 0.21

LQ 0.500 0.467 0.750 1.667 1.611 0.864

More formally, the CL equation can be written as

X ei Ei
CLR = .5 − (2)
e E

17
LQs and CLs also are related to Lorenz Curves, which graphically display the unevenness of distri-
butions, and can be used to compare industry distributions by plotting more than one Lorenz curve
on a single graph. To generate the Lorenz curve for an industry, regions are ranked by location
quotient, and regional shares of national industry and national total employment are plotted on a
cumulative basis, as shown below.
3 The slopes of straight-line segments are location quotients of

regions. The ratio of the area between the curve and the diagonal line to the total area of the right
triangle is another coecient of localization. The closer this ratio is to 1.0, the more uneven is the
distribution.

Industrial Diversity
Until relatively recently, industrial diversication was a dominant regional economic development
strategy. The diversication strategy rests on the recognition that while a heavy concentration of
employment in a single industry or set of closely related industries might carry some advantages,
which will be discussed in the context of industrial clustering as a development strategy, it also
carries with it a concentration of risk should the industry experience a downturn. By diversifying
a regional economy, the region would be diversifying the risk of employment downturn in the same
way as an investor guards against heavy losses by diversifying her stock portfolio. Diversication,
then, would be expected to contribute to employment stability.

Despite the more recent emphasis on potential economies of industrial clusters and implications
for more rapid growth, industrial diversity remains an important indicator of economic structure.
Whereas the LQ and related concentration measures focus on individual industries, there is another
set of measures that are used to quantify the degree of specialization or diversity of industry structure
for all industries in a region. Among the most common regional industrial diversity indices are the
National Average Index, the Herndahl Index, and the Entropy Index. Each of these metrics

3
When the order of industries is reversed, the Lernez Curve will lie below the diagnonal.

18
provides a summary measure of the dierence between a given region and its national economy in
terms of industrial distributions. The implication is that the national economy itself is in some
sense optimally diversied, hence these indices become normative. Of course, it would be possible
to substitute any alternative industrial distribution for the national economy if there were rational
economic reasons for doing so. These measures are also usually based on income or employment
statistics, largely because these data are typically more readily available and reliable than estimates
of output. However, any of these measures could be used.

Common Diversity Indices

Each of the industrial diversity indices rests on a normative assumption concerning the ideal regional
industrial economic structure. Because the normative ideal can be expressed in a variety of ways, the
measures dier accordingly. The national average index is among the earliest and simplest measures
of regional industrial diversity. It emerged in the context of highly developed economies, where the
national economy could be assumed to be diverse, and its structure taken as the norm. A perfectly
diverse regional industrial structure would therefore mirror the national industrial structure, and
departures from the national industrial concentrations reect regional specializations, or departures
from perfect diversity. When deviations are expressed in absolute value, the virtually identical to
the coecient of localization. When deviations are expressed as squared dierences, the equation
for the National Average index for region R is

X  ei 2
R Ei
NA = − (3)
e E

A value of zero reects perfect industrial diversication and larger departures from zero reect
greater regional industrial specialization.

A second regional industrial diversity index that has become increasingly popular in the related
literature is the Herndahl-Hirschman Index (HHI). This measure, which also is often used in
studies of industrial organization and market power, is a function only of the region's own industrial
structure, rather than a relationship to a reference region. The normative ideal in this conceptual
framework is equal shares of employment (or income or other industry size metric) in all industry
sectors. A perfectly diverse region would thus have 1/N of its employment in each of its N industries.
Departures from the normative 1/N share inuence the HHI strongly, as the industrial shares are
squared are summed, as shown in the formal equation below.

N  2
R
X ei
HHI = (4)
e
i=l

The HHI value can vary from a minimum of 1/N to a maximum of 1.0. The maximum value would
indicate that the region has only one industry.

A nal index of diversity is derived from information theory and is known as the entropy index.
The norm with the entropy measure is similar to that of the HHI, but this measure is sensitive to
the number of dierent industries in a region, in that its maximum value increases as that number
increases. The form of the expression most often use is referred to as Shannon's H, the formula for
which is

19
 N    
X ei ei
H=− ln (5)
e e
i=1

Shannon's H values range from 0 to ln N . Because this measure is sensitive to numbers of industries,
its value reects not only the distribution of industry employment (or other relevant) shares, but
also the numbers of industries that compose the dierent regional economic structures. This can be
useful for monitoring intertemporal change, but for comparisons across regions, the value is often
normalized by its maximum, to once again yield values that range from a minimum of 1/N to a
maximum of 1.0. The normalized equation is

N
   
P ei ei
− e ln
e
i=1
H∗ = (6)
lnN

Although industrial diversity continues to be a mainstay of regional economic structural assessments,

another side of the economic development coin focuses on the benets of key industries, and clusters
of similar and synergistic industries.

Key Industries
A prominent line of reasoning that can be traced growth pole/growth center theory revolves around
the concept of key industries. Following work by Hirschman (1958) and Rasmussen (1956), whose
measures were founded on input-output (IO) relationships among industries, key industries became
the focus of a large literature. IO facilitates the identication of industries that exert greater than
average inuence on their economies by virtue of their forward (sales) and backward (purchases)
linkages with other industries. Intermediate sales and purchases bind industries one to another
and create interdependencies. Those that occupy the most prominent positions in multiple supply
chains are identied as key industries. The absence of such industries in a region, where these
industries are deemed to be capable of operating economically, have become the basis for regional
public agencies' eorts to attract these key industries.
4

4.2 From Individual Key Sectors to Industrial Clusters

Many regions' policymakers have abandoned development policies focused on individual sectors
(such as key sector strategy) in favor of a cluster-based approach. Rather than focusing on indi-
vidual key sectors, this approach centers on the identication of clusters of industrial sectors with
substantial mutual synergies based on mutual sales and purchases interdependencies (Feser and
Bergman, 2000). These strategies, which rest on the theory of agglomeration economies, emphasize
ways of promoting and supporting these clusters to facilitate and deepen their development. Bekele
and Jackson (2006) have identied and discussed the most common approaches to industrial cluster
identication.

Melding Clustering and Diversication Strategies

Despite the apparent contradictions between clusters and diversity, however, there has been increas-
ing discussion of the coexistence  or at least creative perspectives on clustering and diversication.

4
For a recent review and discussion of key sector measures, see (Temurshoev and Oosterhaven, 2014).

20
Jackson (2015) has provided an input-output based method for devising strategies that recognize
comparative advantages in existing regional structures, quantify the strength of clusters already
present, identify gaps and bottlenecks in cluster supply chains, explore the regional consequences
of potential cluster diversication strategies that might serve to further diversify regional industrial
structures. Outcomes from such strategies have been called diversied clusters. Jackson's cluster
assessment diversication strategy (CADS) follows these general steps:

1. Use a single-sector method to select an industry or set of industries from a study region for
consideration as the anchor industry or industries of one or more clusters,

2. Identify the current employment or output levels for these anchors,

3. Determine the industrial distribution of supporting, supply chain-linked industries that would
be needed to fully support these anchors at existing production levels,

4. Assess the suciency of the anchor industry or industries for supporting the selected clusters
by comparing existing production to supply-chain requirements, and

5. Evaluate the implications of diversifying into new specializations.

CADS provides a set of detailed instructions for implementing these steps, which can identify
existing strengths and gaps or bottlenecks in the regional economy  in terms of supply decits;
it can be used as a standard against which the existing distribution of industrial activity can be
measured; and it can be used to identify the distributional implications of diversifying into new
industry clusters, all of which will can lead to more rational economic development decisions
(Jackson, 2015, p. 123).

4.3 Identifying Supra-Regional Trends

Nearly all of the metrics discussed thus far are founded on static concepts. As such, there is an
unintended and potentially misleading implication that all industries are equally viable candidates
for development, from both regional and supra-regional perspectives. This conclusion could lead
a regional policymaker to work toward the recruitment or promotion of a targeted industry that
simply might not be competitive in a given region. One broad brush approach that has allows
the decomposition of changes in industrial structure into components that reect national (supra-
regional) trends, industry mix, and region-specic characteristics is called Shift-Share Analysis.
This method has been in use for decades and owes its longevity to simplicity of implementation,
interpretation, and extension.
5 Shift-Share Analysis has been used in a variety of policy contexts,

including the identication of regional comparative advantages and other region-specic, relative
strengths and weaknesses.

Shift-Share Analysis6
Once again, we use regional employment by industry as our indicator of industrial structure, al-
though personal income or output data by industry would be equal informative when these data if
and when these data are available. This method, however, requires industrial structure data for two
dierent time periods. While there are numerous extensions, including dynamic shift-share (Bar

5
More sophisticated methods called structural decomposition analyses have been developed using input-output
accounts as empirical foundations. See Lahr and Dietzenbacher (2017) for details.
6
This section draws heavily on Jackson and Haynes (2009), where various issues involved in selecting an appropriate
time period for analysis, data development, and methodological extensions are addressed.

21
and Knight, III, 1988) and the incorporation of spatial structure (Nazara and Hewings, 2004), the
presentation below reects the method in its most fundamental form.

With data for two dierent time periods, we use time t−l as a reference to the beginning period and
time t to the ending period. Our industrial structure changes will thus refer to the period spanning
time t−l to time t. Our variables are dened as follows:
ert - total employment in region r at time t
eri,t - employment in region r industry i at time t
ent - total national employment at time t
eni,t - national employment in industry i at time t
We rst calculate the following three growth rates:

eri,t
ri = eri,t−1 = growth rate for regional industry i (7)

eni,t
ni = en = growth rate for national industry i (8)
i,t−1

en
n= en
t
= average national total growth rate (9)
t−1

By denition:
eri,t
 
eri,t = eri,t−1 ri = eri,t−1 (10)
eri,t−1

If regional industry i grew at the average national rate, its change over the time period would be

eri,t = neri,t−1 (11)

and the change in industry i in region r would be attributed solely to average national trends.
However, if industry i is particularly fast or slow growing, there will be a dierence between n
and ni . We can account for the deviation of a given industry from the national average using the
following expression:

eri,t = eri,t−1 [n + (ni − n)] (12)

If the industry is fast-growing nationally, eri,t will be greater than the value obtained from equation
(11), and it will be less than that value if it is growing more slowly than the nation.

If industry i grows at dierent rates in dierent regions, then there will be a non-zero dierence
between ri and ni . We can capture this eect with the following expression,

eri,t = eri,t−1 [n + (ni − n) + (ri − ni )](13)

 
eri,t
In which the bracketed term reduces to ri = eri,t−1 , which duplicates the identity in equation (7).

The integrity of the accounting system that denes changes in regional employment by industry can
be veried by subtracting eri,t−1 from both sides, yielding

22
 eri,t − eri,t−1 = eri,t−1 [n + (ni − n) + (ri − ni )] − eri,t−1 (14)
or
∆eri = eri,t−1 [n + (ni − n) + (ri − ni ) − 1] (15)
and
∆eri = eri,t−1 [(n − 1) + (ni − n) = (ri − ni )], (16)

where ∆eri is the study period change in regional industry i employment.

By separating the components of the right-hand-side of equation (16) we can identify the following
values and interpretations:

The national share component Ni = eri,t−1 (n − 1), which is the growth in the regional industry that
can be attributed to the national average rate of growth;

The industry mix component Mi = eri,t−1 (ni −n), which identies the growth in the regional industry
due to the dierence between the specic industry's national growth rate and the national average
rate of growth; and

The regional shift Ri = eri,t−1 (ri − ni ) regional industry i growth that cannot be attributed to
industry or national eects. This regional shift component is often used as a measure regional
comparative advantage for industry i .

Given these denitions,

∆eri = Ni + Mi + Ri (17)

Finally, we can sum both sides over all industries and show that

X X
∆eri = (Ni + Mi + Ri ) (18)
∆er = N + M + R (19)

Shift-Share Analysis provides results for each industry that yield specic interpretations. Combi-
nations of negative and positive values for the Mix and Regional Shift components characterize the
industry's performance relative to the national average industry, and its performance in the region
relative to its performance in other regions. These are summarized in the table, below.

M RS Interpretations

- - The industry was a poor performer nationally, and even poorer in the region
than in the nation.
- + The industry was a poor performer nationally, but better in the region than
in the nation.
+ - The industry was a good performer nationally, but poorer in the region than
in the nation.
+ + The industry was a good performer nationally, and even better in the region
than in the nation.

This summary information can be used to supplement and reinforce (+ +) or dampen (- -) regional
enthusiasm for industries that other methods might identify as key industries or industry clustering
targets.

23
4.4 Industrial Restructuring Challenges

Virtually all of the industry targeting and industrial restructuring methods must be considered in
the context of local understanding and more comprehensive knowledge of the study region. These
strategies can be complicated by a number of considerations, some of which are listed below.

1. Changes in rm ownership patterns can result in organizations of production that align more
strongly with aspatial competitive advantages rather than with locational advantages. Some
analysts have questioned whether geographical proximity is the major source of agglomeration
economies.

2. Missing supply chain linkages might reect the lack of a sucient volume of demand to allow
the activity to reach its minimum ecient scale, and hence, make that sector viable in the
region.

3. Decreasing real transportation costs allow rms to search over wider geographies for inputs
and markets.

4. Labor force skills and quality, physical infrastructure, and other industry-specic requirements
must be sucient to support targeted industries.

The ability of regional policy makers to eect signicant change is in many cases constrained by
national policy and global forces. Accordingly, attention is often directed to changes at the margin
 enhancing a region's connectivity, investment in human capital and the provision of incentives
or indirect support to enable local rms to upgrade technologically. Much less attention has been
given to addressing the market failures that are in the scope of most regional and local governments,
such as ensuring the uidity of land markets or promoting a favorable business environment. The
recent attention directed to the idea of smart specialization provides an example of an innovation
in policy thinking that has been clearly motivated by the diculties of measuring the contributions
of past policy initiatives.

5 Regional Accounts and IO Software

Regional Accounts

Regional accounts are to regions what national accounts are to nations. These accounts provide
the foundations for a wide array of analytical tools and techniques. The accounts detail the in-
teractions among economic agents within the system and with other regions and the rest of the
world. These economic agents are the establishments and rms that compose the production sector
of the economy, and the consumers of the goods and services that they produce, which includes
households, governments, investment, and trade. The establishments are grouped in industries, and
their products are grouped into corresponding commodities.

Because region economic systems are typically more open than national counterparts, an accurate
identication of which interactions take place within the region and which cross the regions borders
 in the form of imports and exports  is critical for the generation of meaningful analyses using the
suite of tools and techniques that are available. Analysts' initial challenge is often the acquisition or
construction of regional accounts. This challenge is amplied by two factors. First, regional accounts
constructed from primary data are rare. Most regional analysts must rely on one of several methods
that can be applied to generate regional accounts from corresponding national accounts using a
smaller set of region-specic data to estimate counterparts to national parameters. Second, whereas

24
most of the tools that have been developed for national or regional input-output accounts operate on
industry-by-industry (or interindustry) accounting frameworks, it is a reality of the data collection
and reporting conventions that most nations publish accounts not in interindustry format, but in
what is known as a supply-use framework. Interindustry accounts can be derived from supply-use
data, but the necessary data manipulations are not always straightforward and intuitive.

As an aid to regional analysts, computer software applications have been developed primarily for
the purpose of facilitating the construction of regional accounts. For example, IO-Snap, described
further below, supports accounts generation and standard nal demand impacts assessment, but
more extensive analytical capabilities beyond multiplier analysis, descriptive economic statistics,
and impacts assessment are still being added. While additional analytical features are under devel-
opment, however, IO-Snap can be used to generate regional interindustry accounts that can then be
exported for use with software applications like REAL I-O that provide a much more comprehensive
suite of analytical tools. IO-Snap and REAL I-O are described briey, below.

IO-Snap

IO-Snap, which stands for Input-Output  State and National Analysis Program, is a Windows-
based computer software program that was developed to facilitate the use of input-output data
from U.S. national make and use tables. In the process of assembling the various utilities that
support national and state-level input-output analysis, the developers also created an environment
that facilitates inter-state comparisons of input-output related variables such as employment and
worker compensation. Annual U.S. IO tables from the Bureau of Economic Analysis (BEA) for 1998
through the most recently published year are included with the software. In addition to default data
covering the U.S. 50 states and the District of Columbia, user-supplied data in make-use format can
be imported for other geographic areas.

Make and use tables contain a wealth of data in their original formats. Production functions and
output distributions, and nal demand activity supplemented by employment and compensation
by industry data can be easily accessed and extracted for use in other applications. Using the
default state-specic data or user-supplied data for other U.S. regions, users can generate regional
input-output accounts. With the national, imported, or user-generated tables, users can create
Industry by Industry, Industry by Commodity, and Commodity by Commodity direct and total
requirements tables for a variety of supported applications. Final demands by commodity or by
industry can be specied, and impacts assessments results can be produced. Standard results can
be generated, including income and employment impacts, disaggregated and total multipliers. Cut
and paste options are enabled throughout so that users can easily transfer data to spreadsheets or
other analytical software for further analysis, graphing, etc.

Within IO-Snap, data can be edited and displayed in a variety of formats, compared and contrasted
across geographical denitions at dierent times, and fundamental input-output based analyses can
be implemented. Prior to generating the requirements tables, the user can modify use table columns
(including nal demand distributions) and make table rows. Available codes of table operations and
analysis are outlined in the Annex. IO-Snap software is available from [Link]

REAL I-O Software

REAL I-O, an input-output operation software is a generic toolbox of Input-Output (IO) analysis
based on open-source architecture running on Windows XP/7. Following the previous versions,
termed PyIO (Nazara and Hewings, 2004), Python is retained as the interface building software.

25
However, the main modules of matrix calculations have been currently migrated to the R language
environment (SPlus equivalent freeware). This change allows the users to introduce their own
database and additional functions in a much more convenient way than in previous versions. The
migration will continue over the next several months and should be complete by the end of August
2018.

At the moment, several analytical functions of intra and inter-regional input-output analysis are
preloaded in the REAL I-O package. The available codes of table operations and analysis are
listed in the Annex. The latest version of the REAL-IO software is available at [Link]
[Link]/realio/. The example data sources (e.g., OECD STAN Input-Output Database for
44 countries and Inter-country inter-industry) are also included.

6 Spatial Analysis of Regional Economies

Regional economics oers a rich empirical setting for the application of geospatial methods, as our
review of regional economic development research has highlighted a number of theoretical constructs
that call out for empirical measurement. In this section, we outline a number of such methods,
linking each to particular theoretical concepts and discuss their implementation and use in the
analysis and monitoring of regional economic systems.

We begin with measures of inequality, polarization and concentration for a national system composed
of interacting regional economies. Closely related to, but distinct from, polarization measures are
measurements of spatial clustering, which include global measures of spatial autocorrelation. We
provide an overview of so-called global measures of spatial autocorrelation as well as their combined
use with measures of polarization. We then shift the spatial focus to discuss local measures of spatial
association. These provide the ability to detect hot(cold)-spots of economic activity that might be
responsible for the overall patterns detected by the global measures or spatial-outliers that depart
from the global pattern.

The measures of polarization, clustering, and local spatial association are all focused on static
patterns measured at one point in time. Recent work in spatial statistics and GIScience has focused
on developing new methods that extend these to consider the dynamics of these patterns. Methods
of exploratory space-time data analysis can be used to study questions of spatial income mobility
that has to date been largely absent from the debates surrounding the regional equity-eciency
tradeo. We close this section with an overview of recent developments of machine learning in
GIScience which may oer new approaches to the study of regional economies.

6.1 Inequality, Lorenz Curves and Convergence

Inequality for a collection of R regions in a national system has been measured in a number of ways.
The concept of σ -convergence Young et al. (2008) is perhaps one of the most widely employed,
relying on the sample standard deviation:

v
u R
uX (yr,t − y )2
t
st = t (20)
R−1
r=1

R
P
where yr,t is income in region r at time period t and yt = yr,t /R. For comparative analyses, the
r=1

26
coecient of variation is sometimes employed:

st
cvt = (21)
yt
These measures of σ -convergence are scalar indicators that capture one aspect of the entire dis-
tribution of incomes across the R regions in the national system. Measures that are designed to
consider more fully the distribution can be obtained by repurposing the Lorenz Curves and Gini
coecients, we previously encountered in the study of regional industrial structure, by replacing
measures for dierent industries within a region with say per-capita incomes across the R regions
(Frick and Goebel, 2008).

Polarization within the interregional system has been measured using regional adaptations of the
Esteban and Ray (1994) index

R X
X R
p(α)t = s1+a
r,t sq,t |yr,t − yq,t | (22)
r q

where α is a parameter that expresses the sensitivity to polarization, and sr,t is the population share
of region r (Ezcurra, 2009).

6.2 Spatial σ -convergence and Spatial Gini

The previous measures of inequality and dispersion are silent on the geographical arrangement of
the regional economies. Put another way, in addition to the observed map consisting of R regions,
there are a total of R! map patterns that could be generated such that each map obtains the
same values for the measure of inequality at hand. Because of the locational invariant property of
traditional measures of inequality, several authors have suggested spatially explicit measures for σ
convergence (Rey and Dev, 2006; Egger and Pfaermayr, 2006). These allow for the partitioning of
overall dispersion/inequality into a pure inequality component and spurious dispersion that arises
from the complications due to spatial dependence. In the same spirit as spatial σ -convergence, Rey
and Smith (2013) have suggested a spatial decomposition of the Gini coecient which distinguishes
between pairwise inequality for neighboring economies versus inequality between pairs of regions
that are geographically distant from one another.

6.3 Theil Interregional Inequality Decomposition

R
X
Tt = str log(Rstr ) (23)
r=1
and:
R
X
str = yrt / yrt (24)
i=r

where R is the number of regions and yrt is per capita income in region r in period t.
Decomposition of total inequality is obtained as:

ω
X ω
X X
Tt = stg log(n/ng stg ) + stg sti,g log(ng sti,g ) (25)
g=1 g=1 iϵg

27
 P t
P t
Pn t
where ng is the number of observations in group g (and g ngP= n), sg = iϵg yi,g / i yi is the
ng
share of total income accounted for by group g , and sti,g = t t
yi,g / i=1 yi,g is region i's share of group
g 's income.

Regional applications of this decomposition are based on an exhaustive and mutually exclusive
assignment of regional economies to groups. As a result, inequality is split into that due to average
dierences between regional groups (so called interregional inequality, the rst term) and inequality
between regions belonging to the same group (intraregional inequality, the second term). Shorrocks
and Wan (2005) summarize the literature nding that the interregional component is often smaller
than the intraregional counterpart.

6.4 Exploratory Spatial Data Analysis

Recent developments in the eld of exploratory spatial data analysis (ESDA) aord numerous
opportunities that can be used to analyze interregional linkages. The exploratory nature of these
measures implies that their role is to characterize spatial patterns in terms of departures from
spatial randomness due to spatial clustering and or dispersion. By themselves, these methods are
not intended to explain these patterns but are powerful diagnostics to detect spatial structure
and suggest that spatial processes are at work. This exploratory stance is sometimes dismissed as
measurement without theory, however we feel that this critique is misplaced. Indeed as Rey and
Le Gallo (2009) argue, ESDA methods can oer important complementarities to formal econometric
modeling of regional economic systems. We see much potential for a more comprehensive analytical
framework for regional economic analysis that integrates ESDA methods with economic process
modeling including spatial econometric, computable general equilibrium models and interindustry
modeling frameworks of input-output and social accounting

6.5 Global Autocorrelation Measures

Spatial autocorrelation is an articulation of Tobler's rst law of geography: Everything is related

to everything else, but near things are more related than distant things (Tobler, 1970). From
an economic perspective, the presence of spatial autocorrelation can reect the operation of many
processes that link regions together. Labor migration, capital ows, trade networks, value chains,
intergovernmental transfers and policy copy-catting are but a few of such processes that can give
rise to spatial association.

It is important to note that autocorrelation and concentration, while similar, actually capture
dierent characteristics of economic space. Concentration or polarization derives from the a-spatial
attribute distribution - and speaks to the degree of modality. A high degree of modality would
indicate that the attribute in question (say regional GDP) is concentrated in sets of regions but
does not necessarily provide any further information about the spatially explicit nature of those sets
of regions.

6.6 Local Autocorrelation Measures (Spatial Clusters/Hot-Cold-Spots)

The global measures of spatial autocorrelation provide what are referred to as whole map statistics.
That is, they provide scalar measures of the extent to which the map pattern as a whole departs from
the null hypothesis of spatial randomness. Important complements to the global measures are local
indicators of spatial association (Anselin, 1995). These serve two main roles. As focal measures,
the LISAs can be used to identify so called hot (cold) spots that may be driving the overall pattern

28
of spatial association. For example, a map with strong positive global autocorrelation might reect
patterns of value-similarity in space (neighboring units having similar attribute values), while the
LISA values for each region can be inspected to identify the relative importance of local units for
contributing to the global pattern.

The second role for LISAs is to detect spatial outliers. These are local units that display association
distinct from the overall pattern. For example, in the case of positive global spatial association, a
local spatial outlier would reect negative association with its own attribute value being inversely
related to those of its neighbors. These locations could become the focus for subsequent investigation
or targeting.

6.7 Markov and Spatial Markov/Distribution Dynamics

The measures of inequality and polarization reviewed above focus on a single cross-section of re-
gional economies. The evolution of these measures can provide policy makers insights as to the
eectiveness of policies designed to reduce regional disparities. Yet these measures are fairly ag-
gregate in scope, informing on the external characteristics of regional income distributions such as
whether polarization (modality) or dispersion (sigma convergence) are declining or worsening.

The rise of the distributional dynamics school of analysis can be seen in part as a response to
this external focus, as well dissatisfaction with the overly restrictive nature of formal models of
economic convergence (Fingleton, 1999). Distributional dynamics has introduced the concepts of
discrete Markov chains (Quah et al., 1993) and stochastic kernels (Quah, 1996) to study the internal
dynamics of regional income distributions. More specically, these approaches can quantify the
amount of internal mixing and churn in regional income distributions over time, as well as support
measures of regional income mobility, a topic we return to below in more detail. Closely related
to stochastic kernels is the application of stochastic dominance to study the evolution of regional
income distributions over time (Carrington, 2006).

Stochastic kernels and discrete Markov chains have seen widespread application in the regional
economics literature, following their use in international comparative studies. However, their appli-
cation at the regional scale had largely ignored the empirical regularities of regional income series,
namely strong levels of spatial dependence and/or spatial heterogeneity. Several extensions of the
traditional Markov framework have been suggested to incorporate spatial dependence. The spatial
Markov framework (Rey, 2001; Rey et al., 2016) allows for the transitional dynamics (i.e., the prob-
ability of a region moving up or down the regional income distribution) to be related to the levels
of income found in its neighboring regions. Application of spatial Markov methods has uncovered
widespread evidence of spatial poverty traps and growth magnets (Le Gallo and Ertur, 2003; Mossi
et al., 2003; Bosker, 2007; Bosker and Krugell, 2008; Villaverde and Maza, 2012).

The Markov paradigm has also provided a mechanism to move the cross-sectional measures of
spatial autocorrelation into a dynamic frame. By embedding the quadrants of a Moran scatterplot
(HH, LH, LL, HL) as states in a Markov chain, a LISA Markov can be developed which aords
a rich taxonomy of space-time transitions (Rey and Janikas, 2006). The following table reports
results from application of the LISA Markov to 32 Mexican states over the period 1940-2000. The
transition matrix is diagonally dominant, with the HH and LL states displaying the strongest staying
probabilities. In the long run, this is estimated to result in a strengthening of spatial clustering as
the ergodic distribution accumulates more mass in these two states.

29
 k HH LH LL HL
HH 0.897 0.051 0.026 0.026
LH 0.115 0.577 0.231 0.077
LL 0.000 0.078 0.833 0.089
HL 0.108 0.081 0.135 0.676
Ergodic Distribution 0.326 0.139 0.373 0.161

6.8 Mobility

Although regional inequality and growth have commanded the vast majority of attention in the
regional science literature, the concept of economic mobility has recently begun to draw focus. Re-
gional scientists are borrowing from the literature on intergenerational income mobility (Maasoumi,
1998) where the focus is on the upward or downward movement of individuals in an income dis-
tribution relative to the position of their parents. A spatial turn to the notion of income mobility
replaces the life-time earnings of parents and their ospring with regions at dierent moments of
time and considers how regions may, or may not, change position in the regional income distribu-
tion. As mentioned above, the Markov framework can be used to provide aggregate measures of
spatial income mobility. More recently, there have been a number of new measures of spatial income
mobility employing concepts of rank concordance and circular statistics (Hammond and Thompson,
2002; Rey et al., 2011; Rey, 2014, 2016).

6.9 Integrating equity, eciency and mobility

There is a need to revisit the debate surrounding regional inequality and national growth (eciency)
to introduce mobility (Moser and Schnetzer, 2017; Rey, 2018). It is generally acknowledged that
studying inequality or national growth separately provides only a limited understanding of either
phenomena. The same argument holds for the concept of regional income mobility. For example,
estimating the rate of spatial income mobility, while important may fail to address broader ques-
tions about the role of that mobility in interregional welfare. In the intergenerational literature,
much attention has been placed on the question as to whether mobility is equalizing in long run
incomes (Fields, 2010). We currently do not know whether regional income mobility works to reduce
regional disparities, nor do we know the relationship between national economic growth and spatial
income mobility. This tri-variate relationship will require new models and frameworks but oers
the potential for a more holistic understanding of regional development., ,

6.10 Spatial Counterfactuals

Counterfactuals provide a way to disentangle the role of changes in attributes and the changes in
model parameters as drivers of distributional change. (Fingleton and Palombi, 2013; Carrillo and
Rothbaum, 2016). Originally used in the analysis of gender discrimination in the labor market,
the approach relies on the construction of two dierent conditional wage distributions. The rst is
estimated for female participants in the labor market where the wage distribution is conditioned
on observed years of schooling and experience. In a similar fashion, a conditional distribution is
also estimated for male participants. A counterfactual distribution is then estimated for females
reecting the conditional wage distribution that would obtain given their distribution of experience
and schooling and the returns to these characteristics for male labor market participants.

Carrillo and Rothbaum (2016) have turned a spatial lens on this approach in the context of modeling
urban residential location choices. The approach rst estimates conditional distributions for the

30
residential location of Hispanics in Washington D.C. subject to observed individual characteristics
including age, education, and gender. With this conditional distribution in hand, the change in
the actual distribution of residential locations of Hispanics over an interval is decomposed into
components due to changes in the returns to these characteristics in inuencing locational choice,
and changes in the characteristics themselves over the two periods. This is accomplished through
the creation of the counterfactual distribution for residential locations in the second period assuming
that the returns to individual characteristics remained the same as in the rst period, while allowing
for the individual characteristics to change.

6.11 Machine Learning and Big Data

Use of machine learning methods has begun to appear in the regional economics literature. One of
the earliest applications involved the use of regression trees to identify convergence clubs (Durlauf
et al., 2005). That paper is important for signaling a change in the receptiveness of economists to
the use of data instigated approaches to economic analysis. Previously dismissed as measurement
without theory, these new machine learning methods are increasingly seen as being novel approaches
to uncover empirical patterns that have been previously unrecognized. These new patterns, in
turn, provide the basis for more exible process-based modeling of regional economic growth, and
the fusion of machine learning approaches with econometric models oers new avenues to address
questions surrounding model stability and process heterogeneity.

Alongside the adoption of machine learning methods, has been a recognition of the potential for
new types of data sources to advance the study of regional economic development. Drawing on the
big data revolution, economists have begun to tap into new forms of data that are now becoming
available at spatial extents, scales, and temporal frequencies that were previously beyond reach.
A prominent example is the use of remote sensing imagery and pattern recognition algorithms to
provide scalable analyses of regional growth (Lessmann and Seidel, 2017). The question of the
inverted-U relationship between the level of spatial inequality in a country and the country's level
of economic development is revisited through an expanded cross-section of regions made possible
using remote sensing data on night-time lights. The approach is to rst estimate a model relating
regional incomes to luminosity for countries with established regional accounts. This relationship
is then employed to generate estimates for income in regions in developing countries where regional
accounts are unavailable or of low quality, yet remote sensing data are available. This substantially
expands the empirical basis for the inequality-development analysis since the traditional sample
bias that had limited the analysis to more developed economies with ocial regional accounts is
now removed.

7 Conclusion

As policy makers move forward in their eorts to improve living conditions and economic growth
across regions of a country, acknowledging and understating that the mechanisms through which re-
gional economic growth can be achieved dier from those that lead to national growth. Researchers
and policy analyses that seek to such policies must consider that assumptions of traditional neo-
classical growth models pose serious constraints for the analysis of regional economies. For regions,
interregional factor endowments, and dierences in levels of factor productivity, may account for
the advantage or constraints faced by an area compared to the rest of the country, or the world.

We have provided here a motivation as to why dierent methods are needed to understand the
challenges of regions. It then follows to review some of the methods available to understand and

31
assess the challenges regions face. While this review is not comprehensive, it provides the reader
a set of tools that can be used to better understand the works of regional economies. These
tools can be used to better asses needs of regions and carefully determine the possible impact of
policies. We have identied several avenues to improve our understanding of regional economies.
First, a better understanding of the economic structure of local economies is key for policy design.
The layout of the interindustry and inter-regional industrial structure and trade relationships play
a critical role in determining the eects of various policies and programs. Second, a complete
description of regional economic structure begins with an inventory of employment, compensation
(wages and salaries), and output by industry. This will deepen the understanding of how specialized
or diversied is the regional economy, what are its comparative and absolute advantages, it will
facilitate the development of behavioral models for assessing impacts of policies, and it will increase
the understanding of inter-regional linkages. Regional accounting systems appear as a fourth tool
that can contribute to the accurate identication of interactions that take place both within the
region and those that cross the regions borders  in the form of imports and exports. Finally,
the spatial dimension of regional analysis can leverage the use of geospatial information and bring
additional information to discussions such as inequality or conict that often are engrained in
spatially conned areas but for which the spatial dimension is often ignored in economic analysis.

While most of these methods have been widely applied in the developed world, more work is needed
in developing countries to understand how regional economies work and how methodologies appli-
cable in developed countries fare when used to analyze developing countries' challenges. A lack of
data has long been an important constraint in the developing world, but new data sources promise
to address this gap.

32
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38
Annex

IO-Snap Software

The organization of the IO-Snap menu structure is presented below as a description of IO-Snap
∗
functionality. Starred ( ) items open additional user input forms.

ˆ File
 Load Data∗
 Save Data∗
 Excel∗ under development

 Print∗
 Preferences∗
 Program Reset
 Exit
ˆ Data
 IO Accounts∗
 State Industry Data
* By Region∗
* Compensation Rates (All Regions)
* Employment (All Regions)
* Gross Industrial Product (All Regions)
* FTE-Job Ratios
 Gross Domestic Product
 Requirements Tables∗
 Multipliers∗
 Sector Distributions
* Industry Accounts
* Commodity Accounts
* Industry Labor
* Commodity Trade Balance
 Edit
* Aggregation∗
* Modify Data

39
 · Use∗
· Make∗
· Final Demand∗
ˆ Analyze
 Regionalize∗
 Impacts∗
* Type 1 Industry-Driven∗
* Type 2 Industry-Driven∗
* Type 1 Commodity-Driven∗
* Type 2 Commodity-Driven∗
ˆ Help
 About
 Documentation
 Activate∗
 Deactivate∗

REAL-IO Software

The available REAL-IO operations and analyses are organized as follows:

Table operations
Displaying I-O tables

ˆ Displaying industrial structure of target regions by value-added and Output

Single region (country) analysis

ˆ Import penetration ratio

ˆ Key sector analysis

 Leontief inverse (using purchase coecients)/ Backward linkages

 Goshian inverse (using sales coecient)/ Forward linkages

ˆ Import content shares of exports

 Estimates the leakage through import when export activity increase

ˆ Induced value-added by exports

 Estimates the additional value added generated by increased export activities

ˆ Labor multipliers

 Estimate the indirect and induced eects of direct changes in labor by sector

40
 ˆ Field of inuence

 Estimates the economy-wide impact of change in individual, multiple, row or column

coecients

ˆ Average propagation link

 Estimates the rounds of spending generated by an expansion in each sector

ˆ RAS procedure to update tables

 Provides a method to update input-output tables given information on the margins for
a future year

Multi region (country) analysis

ˆ Interregional spillover eects

 Estimates the spillover eects from changes in one region or sector

ˆ Average propagation link of multiregional framework

 Estimates the rounds of spending generated by expansion in one sector in one region

Under Development
ˆ Feedback loop analysis

 Decomposes the structure of interdependence between sectors into a hierarchical system

of loops

ˆ Structural decomposition analysis

 Decomposes change in an economy into contributions by technology demand and their

interactions

ˆ Hypothetical extraction

 Explores the impacts of the removal of a sector (single economy) or a region (multiregional
system) on macro measures (output, income, employment)

41