Risk, Activity Modularization, Sourcing, and Economic Geography

Abstract

Economic geography is fundamentally concerned with describing spatial variation in the economic landscape and explaining the processes through which this geography takes form. Firms are the primary units through which these processes operate. I reinterpret portfolio theory to provide a novel way of explaining and modeling the spatial implications of control structures and organizational decisions within and between firms. In this paper, I argue that each activity of the firm is like an asset with an expected rate of return and a level of risk. Firms implement spatial strategies to manage risk that trade profits for reductions in risk. These strategies encourage geographic switching and perpetuate regional disequilibria in production technology and employment. Risk management and the structure of control in a production chain explain the geographic distribution of economic activity better than do transaction costs, flexible specialization, or agglomeration economies.