Due to localized externalities, we have the presumption that agglomerating industry and/or innovation activities is beneficial to growth. From the geography literature, we see that gradual integration may produce a catastrophic agglomeration process marked by three very distinct stages. In the first stage – while trade costs are still quite high – falling trade costs have the usual static effects on prices, trade and welfare, but no location and no growth effects. Growth in this stage may be positive, but it proceeds at a fairly low rate, since the geographical dispersion of industry hinders the externalities that are essential to cease-less innovation and growth. In the middle stage – when trade costs have just entered the ‘catastrophic’ region – agglomeration occurs very rapidly and, to be specific, say it occurs in the north. This industrialization triggers a take off in northern growth because geographical agglomeration amplifies the exploitation of technical externalities related to innovation.
Agglomeration of industry in the north is accompanied by stagnation in the south, so the agglomeration of industry not only generates industrialization and a growth take-off, it also produces income divergence. Yet despite this, we shall see that the south may still benefit in welfare terms. In the third stage, high growth becomes stable and self-sustaining.
The main focus of this paper is on the four phenomena mentioned above. We also show-, however, that the model can generate rapid industrialization in the south and convergence. This emergence of southern industry slow’s global growth somewhat and forces a relative de-industrialization in the north.
While these stages of growth are highly suggestive, our model is – of course – far too simple to comprehensively track two-centuries of global economic history. We prefer, therefore, to think of it as a first step in examining the internal logic of one trade-and-growth mechanism where international integration spurs industrialization and a growth take-off.