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CEP discussion paper
Why Capital does not Migrate to the South: A New Economic Geography Perspective
Jang Ping Thia
November 2008
Paper No' CEPDP0895:
Full Paper (pdf)

JEL Classification: F12; F15

Tags: firm heterogeneity; capital mobility; economic geography

This paper explains why capital does not flow from the North to the South - the Lucas Paradox - with a New Economic Geography model that incorporates mobile capital, immobile labour, and productively heterogeneous firms. In contrast to neoclassical theories, the results show that even a small difference in the ex-ante productivity distribution between North and South can a have significant impact on the location of firms. Despite differences in aggregate capital to labour ratios, wage and rental rates continue to be the same in both locations. The paper also analyses the effects of risk on industrial locations, and shows why ‘low-tech’ industries tend to migrate to the South, while ‘high-tech’ industries continue to locate in the North.