The Economic Rationale of Local Economic Development

The economic rationale for local economic development (LED) is linked to the problem of market failure. It is an accepted fact that in the real world markets never fit into the idealized assumptions of simple neoclassical models. There are not perfect markets, and market failures have to be accepted. Any intervention which pretends to remedy market failure has to be assessed in terms of the additional distortion and transaction costs it creates.

However, at the local level there are specific types of market failure which can be remedied at little cost and creating little distortion. An important market failure is asymmetrical information. There may be all sorts of companies offering all sorts of goods and services, but the only practical way of scanning them is often the yellow pages. The suppliers have good information about their offer, but potential customers have little relevant information: systematically assessing the quality and price of all the available suppliers and providers is a costly exercise. Therefore, established companies will often rely on long-time suppliers and providers, creating inefficiencies and barriers to entry for new suppliers. A simple way to remedy this problem is the organization of local fairs. If this is a viable business it will be done by specialized companies. But often this will not be the case, and then a public or para-statal development agency may organize a fair to match suppliers and customers.

A similar logic applies to entrepreneurship development and support for new businesses. With inadequate information, the barriers to entry for a potential entrepreneur will often appear unsurmountably high. Improving information on existing local demand, not only through fairs but also through other types of information events, is an activity which can clearly be justified in terms of market failure.

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