Sequential Location Contests in the Presence of Agglomeration Economies

This paper models the competition among jurisdictions for two firms in the same industry as a sequential auction. Before choosing a site, the firms solicit fiscal incentives from jurisdictions. In the presence of agglomeration economies, winning the first location contest makes a region more attractive for subsequent firms. The first firm receives a higher recruitment subsidy and the second firm a lower one than in the absence of positive interfirm externalities. Moreover, the complementarity effect often increases total subsidies across periods. Consistent with empirical findings, the size of the agglomeration benefit affects positively the formation of industry clusters. The sequential auction does not support the first-best location outcome. In particular, the industry may be, in equilibrium, locked in the “wrong” site. When the path-dependence of location decisions is taken as given, however, a sequential auction with contingent contracts can be constrained efficient.