Labor-market Matching, Demand-linkages and the Location of Firms

We incorporate an endogenous choice of qualification into a standard New Economic Geography model: workers can choose to invest time to acquire skills in order to work in the industrial sector and earn a higher wage. Hence, expenditures in a given country depend on the number of firms in that country, giving rise to a standard circular causation mechanism as in Krugman [9]. However, our model remains analytically tractable. Moreover, agglomeration is shown to be non-catastrophic contrary to Toulemonde [17]. Then, we show that trade liberalization leads a to mean wage differential between the two countries as the mean wage in the core regions increases as firms agglomerate there. Also, we show that contrary to all existing NEG models, a higher share of industrial spending renders the symmetric equilibrium more stable whereas a higher elasticity of substitution between varieties has the opposite effect. Finally, we study the effect of a public policy that aims at reducing the uncertainty of the labor-market. We show that, starting from an even distribution of firms between countries, this policy succeeds at attracting firms in the country where the labor-market is the most efficient.