Location of R&D and High-Tech Production by Vertically Integrated Multinationals

This paper presents evidence that, in Europe, production of high-tech goods is attracted to large markets, while R&D activities tend to be located away from them. In order to explain this phenomenon, we develop a two-country general equilibrium model where firms make separate choices about the location of R&D and high-tech production. There are two agglomeration forces: R&D spillovers and a home-market effect creating incentives for firms to locate production in the relatively large market. We show that, for relatively weak R&D spillovers and intermediate trade costs, the smaller economy tends to specialize in R&D. We also discuss the welfare consequences of different outcomes with respect to the location of R&D, showing that while skilled labor may gain from hosting an agglomeration of R&D activities, unskilled labor will lose.