Abstract
It is a general fact of economic life that regions differ markedly in their innovative capacity and economic prosperity. This is certainly true for nations across Europe, but is similarly true across regions within each nation. Successful regions have economic profiles different from those of less successful ones. This paper compares differences in both regional specialization giving rise to Marshallian (or MAR) externalities and urban diversity giving rise to Jacobian externalities. The analysis is based on a structural equation model with data from 211 regions in Europe. It shows that both types of externalities play important roles, but in different ways. First, our results show that MAR externalities are important for economic prosperity, but only indirectly through innovation. Specialized regions in Europe perform much better in terms of innovation input and output, which in turn leads to improved GDP/capita. Second, urbanization plays a direct positive role for economic prosperity. It also plays a role in explaining public R&D, but is not directly linked with business R&D or innovation output. Third, public R&D only leads to innovation output through business R&D, and thus the notion that more investments in public R&D should lead directly to more innovation does not agree with the empirical results for Europe.