This paper studies the relationship between the degree of regional integration and regional differences in production structures and income levels. For high trade costs, industry is spread across regions to meet final consumer demand. For intermediate trade costs, increasing returns interacting with migration and/or input-output linkages between firms create a propensity for the agglomeration of increasing returns activities. When workers migrate towards locations with more firms and higher real wages, this intensifies agglomeration. When instead workers do not move across regions, at low trade costs firms become increasingly sensitive to cost differentials, leading industry to spread out again.
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