ABSTRACT.A large proportion of regional production takes place in nontraded goods and services. In addition, significant productivity increases can be observed in some segments of this sector. Starting from these two empirical observations we construct a model of growth in a two‐region setting with factor mobility. The growth process is based on endogenous technological change in the nontraded input sector, whose output serves as an input in the production of one of the two final goods, the so‐called industrial good. We consider two extreme cases, one with locally limited, the other with interregional knowledge spillovers. Conditions are established under which interior solutions with production of local inputs and steady‐state growth in both regions result, and others under which we find a core‐periphery pattern with growth concentrated in one region only. The stability of the equilibria is discussed by considering the transition processes. Finally, it is shown that catching‐up as well as leapfrogging may occur, if new technologies become