Based on the NEG literature, there are two factors that will influence industrial location of firms across EU countries: Access to customers and access to suppliers (Fujita, Krugman and Venables, 1999). Another factor outlined includes the dispersion forces: As production concentrates, the price of immobile factors will rise relative to locations where production does not take place. Agglomeration and dispersion forces decide where firms locate (Fujita, Krugman and Venables, 1999).
Trade barriers will affect both trade costs and to a degree the mobility of labour. Free trade allows for the separation of consumption and production, and comparative advantage shows how the location of production is determined by differences in the technology or factor endowments of regions or countries. One expects that as trade barriers are reduced production will relocate solely according to comparative advantage.
The changes in demands for factors of production that follow from this will tend to equalize factor prices across countries. Differences in institutions and infrastructures should change the efficiencies of factors of production across countries, and even small remaining trade barriers or transport costs can disrupt the predicted pattern of trade. On one hand, a reduction in trade barriers facilitates the separation of production from consumption, allowing geographical advantage to play a more important role.
On the other hand however, if trade barriers and transport costs become extremely small, then differences in these costs across locations become minor. The balance between these forces usually resolves itself in an inverse U-shaped relationship, saying that geographical advantage will be greatest at some intermediate level of trade costs. Hence, in moving from very high trade barriers to 'intermediate' ones, the theory predicts that activity will be drawn into regions with good market access (core).
However, as regions integrate more and more as can be seen in the EU, the process becomes reversed: Trade costs become relatively small so firms are less willing to pay the higher core wages, and a reverse flow of industry to peripheral regions occurs. If one examines recent developments in the European Union single market, it is striking that the regions on the perceived periphery of the EU, such as Portugal and Ireland have been doing better in economic growth terms than regions associated with the core such as France and Germany.
Especially high-tech industries in Ireland have been doing very well. This may be explained by the fact that these industries are considered somewhat "footloose". It may partly also be explained by the EU's regional policies, which transfers financial aid from the more prosperous member states to regions which are seen to be economically underdeveloped. However, Midelfart-Knarvik and Overman (2002) note that these countries, in particular Ireland, have been doing so well because she was able to increase specialisation.
They conclude that the lack of labour mobility (relative to capital mobility) has prevented other regions within the perceived core member states from adjusting effectively in order to capitalise on comparative advantage. Conclusion Initially, this essay has described what determines industrial location using the three strands of location theory. In the second part we have seen that in theory firms should only be competing on comparative advantage, once trade barriers have been removed.
However, continuing integration means that at intermediate levels of transportation cost, geographical advantage becomes of strong importance leading to concentration of businesses. At high levels of transport cost, firms in custom-unions are likely to move to the periphery as the trade-off becomes more favourable. Towards the end of the essay we have seen that a number of industries that were initially spatially dispersed have become more concentrated on the periphery of the European union, especially in high technology 'footloose' industries in countries like Ireland.