Essay on: ECONOMIC GEOGRAPHY
ECONOMIC GEOGRAPHY INDEX: 1) Introduction 2) Historical Path 2.1 Germanic Geometry 2.2 Social Physics 2.3 Cumulative Causation 2.4 Local Extenal Economies 2.5 Land Rent and Land Use 3) Krugma
ECONOMIC GEOGRAPHY
INDEX:
1) Introduction
2) Historical Path
2.1 Germanic Geometry
2.2 Social Physics
2.3 Cumulative Causation
2.4 Local Extenal Economies
2.5 Land Rent and Land Use
3) Krugman’s model
3.1 What is about
3.2 The formal model
3.3 Summary
4)Conclusion
4.1 What do we learn?
4.2 Central and periphery in Europe today
4.3 Concluding thoughts
ECONOMIC GEOGRAPHY 1. INTRODUCTION
During the 1960’s and 1970’s International trade theory was almost entirely dominated by models based on constant returns of scale and perfect competition. Even the assumption of immobility of factors had always represented a very distinctive characteristic of those models. For example lets think of the Hechsher-Ohlin Theory which we studied during our course of International Trade. It makes of all those assumptions its fundamental base. This and other models were a sort of “counter culture” in international trade that didn’t claim that other forces explained trade patterns.
Later new models were developed. They made possible to write down coherent, rigorous and often elegant models of what the economic and industrial reality was about: increasing returns and imperfect competition. Both factors gave a new understanding of all trade patterns, also explaining the role played by fixed costs, demand (domestic and foreign), taste for variety and transportation costs within the inter-industry and the intra-industry trade flows. That’s why increasing returns were no longer something to be avoided or assumed away at all costs. Furthermore IRS and imperfect competition seemed like a natural next step in development of trade theory rather than a set of disparate alternatives approaches. As a consequence all the new intellectual opportunities offered by this revolution in theory had in turn transformed a series of other fields. Specialisation moved to be based on increasing returns, rather than an effort to take advantage of exogenous differences in resources or productivity (H-O and Ricardo theories).
In the last few years the “new economic geography” has been a movement toward applying the above concepts from the theory of international trade, in order to analyse the location of production and industry within countries; or more precisely within economic units characterised by high degree of labor mobility. The latter concept is really important, because political and geographic boundaries don’t count anymore in economic geography. Countries are not points. Now factors mobility and distances matter a lot. That is why in Europe it’s wrong to consider Germany or France as an economic unit. However, is correct looking at the area including Belgium, western Germany and northern France: that in fact shows a region with an high degree of factors mobility, inside trades and, especially, huge manufacturing concentration and specialisation levels.
In order to better understand the importance of location theory, and even more of its responses and results, let just give a quick overview of the following figures about the European economic geography:
the richest regions per capita are also the most populated
the wealthy regions are clustered close together
higher wages where the access to the markets is better
This paper will try to give the basic answers to those issues.
In conclusion , it’s necessary to underline that market structure assumptions, here in terms of IRS and imperfect competition, play a key role for location theory, while they are not so relevant for international trade. Another divergence between the two fields is that, for years, international trade theorists have almost worked completely without reference to the idea of location theorists and regional scientists. This lack in communication is also due to their different approaches, the first ones dominated by the traditional presence of CRS, while the second have always taken very seriously the role of economies of scale both internal and external . That is probably the reason why many economists have supported that studies in economic geography offer a basic rethinking of the economics.
2 HISTORICAL PATH
Even though the entire paper will be based on Krugman’s theory and model, the most recent and well developed model in economic geography, it will be also important to give an historical prospective at the issue.
Five are the principal traditions in the field of spatial economics. Four out of five represent different ways of looking at the same thing, so they are almost rival alternatives; while the fifth (von Thunen) largely divorces conceptually from the other approaches.
They are: Germanic Geometry, Social Physics, Cumulative Causation, Local External Economies and Land rent and Land Use.
2.1 Germanic Geometry
It was born in Germany in the first half of the century, concerning with a distinctive problem: the geometry of location on a two-dimensional landscape. It had two traditional subsets: Weber’s analysis on the location decisions of a firm serving one or more markets and relying on one or more sources; and the central-place theory. The latter for the first time discussed the existence, location, and role of a manufacturing central serving a hypothetical evenly spread agricultural population.
The results said that the market areas should be hexagonal (Loch) with a hierarchical role played by the central (Christaller). These kinds of results were often consequences of the strong and, even sometimes unrealistic, assumptions of distribution of demand, and the relationships between costs of transportation and distances.
If, on one hand the Germanic traditions introduced for the first time new issues, economic parameters and trade-off (economies of scale vs. transportation costs), on the other hand they revealed some problems. First of all, Losh was blurry about who was making the decisions and how decisions of individuals might effect one other. That will be the key point for the further theorems (i.e. cumulative process).Second, market structure description wasn’t fully provided. Not even forgetting the difficulties of accessibility for non-German speaking.
Nevertheless, both served a sort of schematic, a way of organise thoughts and data about urban systems.
2.2 Social Physics
This new approach faced the location matters indirectly, as the solution to some maximum or minimum problem. It introduced dynamics in the location process and decision as well, doing geography in analogy with physics, in applying the old neo-classical economic analysis (i.e. the Zipf’s law that gives the distribution of city sizes via incorpora CorelEquation \s , where N is the population of city j, R its rank and b an exponent close to one; or a very useful index like the market potential one incorpora CorelEquation \s , that depends on k the market, Y the income or purchasing power of the market, D the distance between two markets, and g(.) some declining function).
All of this offered a new scientific point of view for special economics, guaranteeing some striking empirical regularities and useful basis for empirical work.
2.3 Cumulative Causation
In this fields the two pioneers were Harris and Lowry with their two papers, one on the US manufacturing belt , and the other on the numerical land use .
At the basis of their works there was a circularity relationship between two economic parameters not really new for spatial economics (market potential analysis): market size and firm location. Basically they affirmed that firms want to locate where market potential is high, and markets tend to be larger where lots of firms locate. The results explain the existence of multiple equilbria.
This approach is very similar to the Big Push type-stories, one of the bottom lines of the more recent and “advanced” Krugman’s economic geography theory and model.
In 1980 Murphy, Shleifer, and Vishny formalised the Big Push, analysing how, in an imperfectly competitive economy, the industrialisation could move from a bad to a good equilibrium, with a particular emphasis in case of developing countries.
The main assumption is that the industrialisation process involves primarily all the sectors with large economies of scale potential advantages. In order to fully exploit the above advantages it’s necessary to have a large sized domestic market and also free-cost trade (that means high exports). Nonetheless, in a imperfect competitive economy with large fixed costs, there even are other sources of multiplicity of equilibria, due to pecuniary externalities (IRS external to the firm) and demand spillovers created by simultaneously increasing returns technologies in profitable sectors.
Another important assumption is that the industrialised sector doesn’t keep for itself all 100% of the profits, because profits are the only channel of spillover.
In this type of economy the investments profitability in a specific sector is not the only regard. A correct evaluation of an investment depends as well on being enough for the other related sectors via demand spillover. That’s why the coordination degree of investments is an important measure. In these terms infrastructure (intermediate common goods) shows a quite high degree.
In conclusion, regarding government’s exploitation of Big Push effects, two are the conditions in order to reach higher levels of industrialisation and multiple equilibria: free market policies, that means lower transportation costs and more exports, and coordinated investments in infrastructures.
The concept of circular and cumulative causation, could also be associated with Pred’s story, a variant on Big Push. Briefly, he supposed an import substitution with local production due to economies of scale. That would have expanded regional employment, local market and thus induced a cascade of growth with circular relationships between market size and range of industries within the region.
Definitely all the concepts above offer a very useful set of boxes and arrows for a better understanding of the location patterns, decisions and growths.
2.4 Local External Economies
The third tradition is probably the most close to mainstream economics. The basic idea is that clustering of producers in a particular location yields advantages, and in turn these advantages explain such clustering.
These advantages are mainly due to external economies. They differentiate into technological external economies, which are pure spillover, and peculiar externalities mediated through the market. The latter, however, have only the reason to exist and to create advantages in a specific market structure: a world with increasing returns to scale at the level of the firm, and with imperfect competition (while the first ones don’t).
It was Alfred Marshall who presented the classic economic analysis of the phenomenon. He identified three distinct reasons for the localisation. First, by concentrating a number of firms in an industry in the same place, an industrial center allows a pooled market for workers with specialised skills. It benefits workers and firms, ensuring a lower probability of unemployment and a lower probability of labor shortage. Second, localised industries can support the production in greater variety and at lower costs of nontraded inputs specific to the industries. Third, because information flows locally more easily than over greater distances, an industrial central generates technological/informational spillovers.
If, on one hand the Local External Economies reinforced the circular causation creating concepts like backward and forward linkages; on the other hand it focused only on answering why a particular industry is concentrated, instead than explaining the reasons of the dualism between a manufacturing core and an agricultural periphery, as the more recent economic geography will do.
Another critic regards of the monopolistic competition models they used, models in which economies of scale were purely external. Those appear to be limited for three reasons. First, the disembodied, abstract nature of pure external economies may have seemed unsatisfactory. Second, external economy models of trade typically seemed to yield a bewildering variety of equilibria, leaving the model with a taxonomy, rather than a clear set of insights. Finally, much of the traditional literature on external economies models regarded of external economies as being one source of modifying or distorting the pattern of specialisation away from that implied by resource abundance. That’s why external economies are by no means always, or even usually, consistent with the integrated-economy approach, and the economic tradition.
2.5 Land Rent and Land Use
It derives directly from von Thunen and his pioneering Isolated State. His idea is based on the existence of an agricultural plain supplying a variety of products to an isolated central city. The configuration of this model is made by a series of concentric rings in which different crops would be cultivated and/or different farming methods adopted. That would be a consequence of high transportation costs. Stays in fact that there would be high rent land near the central which would be reserved for crops with high costs of transportation and/or crops yielding high value per acre (certainly not land intensive cultivation). That means rents would decrease with the increase in distance from the central.
Its contribution to spatial economy is important, especially in terms of analysing the internal structure of urban areas and its equilibrium. However the von Thunen model doesn’t say much about the central issue, in terms of avoiding the backyard capitalism and explaining the forces that spread economies activities away from the central (centrifugal forces), keeping others together (centripetal forces).
As a consequence, economic geography needed to revitalise, bringing back the other missing half of the story, trying to legitimise and make sense of the insights of the outcast approach.
All five traditional references above certainly offered an interesting set of core ideas, and make considerable sense in light of more recent economic geography analysis. They introduced new important economic parameters and concepts, also giving a dynamic process for the interpretation of location and spatial patterns.
However these ideas resulted to be unacceptable to mainstream economics. The main reason was that they could not at that time be modelled. The problem was amplified by the fact that even the peculiar market structure (increasing returns to scale and imperfect competition ), acute problem in this type of matter, wasn’t fully formalised by that time. Thus, due to the impossibility of modelling macrobehavior explanations, these economists settled for what they could do, interacting micromotives via schematic descriptions of data and organising principle that made intuitive sense.
The methodological problems that afflicted this field, brought the narrow minded mainstream economists to think that, what the first ones could not formalise, had to be almost ignored. This was the reason why the economic literature talked about of exile of economic geography.
Although economists can often be remarkably obtuse, failing to see things that are in front of them, sometimes a bit of obtuseness in not entirely a bad thing. That was the case, because modelling presents costs but also lots of benefits, in primis the ability of reduce complexity of methodological problems, simplifying especially through negligible assumptions and available techniques (nevertheless costs in formalization too).
In conclusion, however, the sad intellectual exile of economic geography had not villains, although the unwillingness to grant even one page in a thousand of fairly sensible efforts and to make sense of an important subject seemed extreme. Sometimes the temporary evolution of ignorance may be the price of progress, an inevitable part of what happens when someone tries to make sense of the world’s complexity.
3 KRUGMAN’S MODEL
3.1 What is about
In response to the inability of economists to produce models of economic geography that satisfied the profession’s ever growing demand for rigor ( inability that was in turn, as it was said before, essentially tied to the problem of modelling specific market structures), Krugman, thanks to the efforts of industrial and trade theorists over the past twenty years, was in 1991 able to face geographical matters as rigorously as it was requested even by the economic journals’ requirements. In such a way, he claimed that the model demonstrated the feasibility of telling the kind of stories that are needed to do meaningful economic geography in a way that mainstream economists can live with.
Krugman’s model is, indeed, simply an attempt to capture most of the classical writing traditions seen above, within a formal framework which he draws on the insights and the technical tricks of the new trade theory.
The entire model is based on the central-periphery dilemma and relationship,and characterised by the interaction of increasing returns and transportation costs, so explaining the uneven regional development at a grand level. It provides at least a rough synthesis of two theories: the central-place theory and the cumulative causation theory. For both the formation of cities is driven by economies of scale at the level of individual firm. The process of city formation is one of cumulative causation, but the eventual locations of cities tend to have a roughly central-place pattern. Even for Krugman’s model, those circular relationships among economic parameters are central, and in many cases they represent the source of multiple equilibria.
Beside IRS and transportation costs, a very important economic variable of the model is the demand, especially in terms of domestic demand. Is the interaction between these three that drives the cumulative process of regional divergence through circular causation. In these terms manufacturing will move toward more desirable sites and away from less desirable ones, but in doing that will change the market potential map, typically reinforcing the advantage of al ready favoured location. Thus, the market potential becomes part of the story of circular and cumulative causation. An example, given sufficiently strong economies of scale, each manufacturer wants to serve the national market from a single location. To minimise transportation costs, it chooses a location with large local demand. But local demand will be large precisely where the majority of manufacturers choose to locate (loop between manufacturers location and demand).
If on one side, the model presents a relevant dynamic process, that is mostly a consequence of a kind of pecuniary external economy, description certainly not really inconsistent with Marshall’s one. So that demand externalities and clustering together are indeed two of the main sources of the entire cumulative path. On the other side, however, history and accidents (initial advantages and points in time) have a decisive role and matter a lot. Moreover they perhaps sheer self-fulfilling prophecy, transforming location from a result of transitory advantages to a result of sustained advantages (in primis IRS exploitation). The key role of history depends more precisely on three parameters: in addition to the two mentioned before, IRS and transportation costs, the third is the share of “footloose” production not tied down by natural resources. With a sufficiently large share, production and trade concentration/specialisation patterns would not depend on comparative advantages, in terms of exogenous differences in productivity and/or in resources endowments (Ricardo and H-O theorems).
To conclude this brief presentation of Krugman’s model , it’s interesting to notice two similarities. One, how closest in spirit to this model is the literature on “market potential” index, begun by Harris. Second, how through the model is possible to carry out a number of simulation experiments with a highly stylised economy, in which locations are lined up symmetrically around a circle. That appears to be really close to the concepts of spacing the central imagined by Chrisataller and Losch, and earlier mentioned. In fact it shows a quite defined agglomeration shadow, where the central could be single or multiple-rivals depending on the parameter values, that also influence the distances between the centers (nevertheless always more and more regular).
3.2 The formal model
The purpose of a fully specified and general equilibrium core-periphery model is to lay out a version of the same story presented in the previous paragraph, but that doesn’t have any loose ends.
The difference from the traditional urban approach is that any special direct assumptions are made about localised external economies or nontradeability, indeed cities are not primitive concepts in the model. However, as we have learned in class, assumptions play a key role within empirical testing and modelling, and even here they do so.
Externalities emerge as a consequence of market interactions involving economies of scale at the level of individual firm. Thus it’s necessary to model an imperfectly competitive market structure. The workhouse model of this kind, also used by Krugman, is the Dixit-Stiglitz model of monopolistic competition. If, on one hand, it is grossly unrealistic and involves a kind of layering of implausible assumptions, on the other hand, it is tractable, convenient, and it has turned out to be a remarkably flexible tool of analysis.
Let consider a country that contains two locations, East and West, and produces two kind of goods (two sectors), agricultural and manufactured. Agricultural production is homogeneous, produces under constant returns of scale and in perfect competition. Manufactures consists of a number of differentiated products, each produced subject to economies of scale, with a monopolistically competitive market structure, and everyone in the economy is assumed to share tastes, sharing the same Cobb-Douglas function of consumption of aggregate goods:
incorpora CorelEquation \s
where incorpora CorelEquation \s is the share of manufactured goods in expenditures. Manufactures, however, is a composite of a large number of symmetric products varieties, with a constant elasticity of substitution between any two varieties ( incorpora CorelEquation \s ), so:
incorpora Equation.2
There are as well two factors of production, each of which is specific to a particular sector. Labor and possibly capital are the mobile factors, while land is the immobile factor, mobile and immobile both used in both sectors. The peasant population, who produces agricultural goods, is assumed completely immobile between regions, with a given peasant supply of (1-u)/2 in each region; workers are however mobile, moving to whichever location offers them a higher real income; and the total supply is constant:
incorpora CorelEquation \s
Farming takes place under CRS, thus farm labor used in producing any given quantity of agricultural goods can be set equal to production:
incorpora CorelEquation \s
Manufacturing, however, is characterised by IRS and, thus, involves fixed costs and constant marginal costs:
incorpora CorelEquation \s
Because the economy-wide supply is fixed, if incorpora CorelEquation \s is the force of farm labor in the location j ( share taken exogeneously ), and at any point in time a share incorpora CorelEquation \s of manufacturing labor is also in location j, then these shares will evolve to:
incorpora CorelEquation \s incorpora CorelEquation \s
Finally, let introduce transportation costs. For simplicity, some unrealistic assumptions about these costs. First, assume that they apply only to manufactured goods, and second assume that they take the iceberg form introduced by Paul Samuelson. That means only a fraction, y<1, of any manufactured goods shipped melts away on en route (arrives). It has two advantages as a model trick. First, it eliminates the need to introduce transportation as an additional sector. Second, it implies that the elasticity of demand with respect to a firm’s f.o.b price is the same as that with respect to its c.i.f price, eliminating many potential complications. Moreover, assuming that agricultural goods’ transportation is costless, is very conventional because it ensures that the wage rate of farmers and the price of those goods is the same in the two locations. Specifically, let x be the amount of some goods shipped from j to k , and let z be the amount that arrives, so:
incorpora CorelEquation \s
where y is the inverse index of transportation cost and incorpora CorelEquation \s is the distance between the two locations. y will be also the final parameter determining whether regions converge or diverge.
Now, turning to the behaviour of firms, let describe some of the features of short-run equilibrium. There are a large number of manufacturing firms, each producing a single product. The profit-maximising strategy is to set a price as a fixed mark-up over marginal costs:
incorpora CorelEquation \s where w is the wage rate within the location.
If there is free entry of firms into manufacturing, profits will be driven to zero. The zero-profit condition may be written as:
incorpora CorelEquation \s
price condition, where the price is equal to the average cost. This means that the ratio of average costs to marginal costs (one measure of economies of scale) is incorpora CorelEquation \s , thus equilibrium economies of scale are function only of incorpora CorelEquation \s , a parameter of taste rather than of technology, nonetheless acts as a sort of inverse index of importance of IRS.
The zero-profit and pricing condition imply:
incorpora Equation.2
Furthermore output per firm is the same in each region, irrespective of wage rates, relative demand, and so forth.
Since all varieties are produced at the same scale, the number of varieties produced at any given location is simply proportional to that location’s manufacturing labor forces:
incorpora CorelEquation \s
The latter equation plays a crucial role in the whole analysis of this approach. Within it stays visible the increasing returns parameter that is crucially on the logic of the model. That makes profitable to produce each variety in only one location, that means different locations produce differentiated bundles of products. When a location gains labor it doesn’t produce more of the same mix of products, but adds new products. This quantization of production is the only way in which increasing returns enter the solution, but is perhaps enough.
The short-run equilibrium is also possible to be represented as the solution of four sets of equations: the income, the price index, the equilibrium wage rate, and the real wage.
The income of each location is equal to the sum of farmers’ (share of 1-u/2, same in each location) income and workers’ (share of u just in one location, the manufacturing concentrated for hypothesis) income:
incorpora CorelEquation \s
In the two region model (all equations easily solved by the computer), the income of the manufacturing concentrated location will be Y=(1+u)/2, while in the other location, that only has its immobile farmers, the income will be Y=(1-u)/2.
The price index of the manufactures aggregate to consumers in each location will be function of the fixed mark-up on its marginal cost, which in turn is proportional to wages, of the transportation costs and thus of distances. Given the constant elasticity of substitution function the price index will therefore be:
incorpora Equation.2
Staying always into the two region model, the price of manufactured goods in the “only farms” location will be 1/y times as high as that in the other location. It means that the overall price index, which is a geometric average, will thus be incorpora CorelEquation \s times as high.
Given the price index, the equilibrium wage rate can be solved as:
incorpora Equation.2
The last equation, however, only determinates the wage rate in terms of agricultural goods, but because workers are more interested in terms of real wage (consumption basket). Thus, it would be more correct write:
incorpora CorelEquation \s
Moving again to the two region model, where for assumptions incorpora CorelEquation \s and incorpora CorelEquation \s , normalising the distance between the two locations to 1, the real wages will turn to:
incorpora CorelEquation \s incorpora Equation.2 (*)
At this point, it’s possible to bear out the intuition that agglomeration is due to the circular relationship between the location of the market and the location of manufacturing. If manufacturing were a very small part of the economy, u close to 0, the real wage in location two would be:
incorpora Equation.2 which is less than 1 because of Jensen’s inequality. That means, it would be advantageously to move away from any concentration of manufacturing. This shows the centrifugal force in the model, that pushes toward dispersal of workers. Assumed the immobility of farmers, if there were no economies of scale , workers would do of course have an incentive to move toward locations where they were a relatively scarce force. However, manufacturing sector (huge economies of scale) is a significant part of the economy. Therefore there are two other forces, centripetal, which work to hold the agglomeration. First, the region that has the a larger population of workers will also offer a larger market for manufactured goods (a kind of Hirschman forward linkage). Second, workers will, other things equal, receive a higher real wage if they are located closer to the suppliers manufactured goods (backward linkage). Mathematically, it means that the first term in equation (*) becomes less than one, and the expression inside the brackets involves an higher weight on the component that is less than one and a lower weight on the component that is greater than one.
Regarding the second parameter y, the transportation costs, concentration is more likely when it is low. When y=0 , incorpora CorelEquation \s , no transportation costs location doesn’t matter. With y close to 0
incorpora CorelEquation \s is less than 0, while it becomes greater with the increasing of y. Moreover when incorpora CorelEquation \s (the first term is the ratio of hence average cost to marginal cost and price-a measure of economies of sale) than as y grows the real wage in location two must exceed one. It means that if scale economies and the manufacturing share are too sufficiently large, workers will prefer to cluster together even with prohibitive transportation costs. Illustrating the relationship between real wage and transportation cost, the shape would be the one showed in allagate 1. Notice that there is a critical value of y (y*),under which concentration is an equilibrium.
Considering the effect of other two parameters on the critical value y*, it possible to show, holding first incorpora CorelEquation \s and then incorpora CorelEquation \s , that:
incorpora CorelEquation \s incorpora CorelEquation \s
They mean that concentration would be more likely the higher is the share in manufacturing, and that an high elasticity of substitution(equilibrium degree of economies of scale)works against agglomeration. In conclusion, all it has been presented in the previous static analysis shows nothing more that the effects of centripetal and centrifugal forces on agglomeration decisions.
3.3 Summary
The framework developed in the model is extremely special and unrealistic. Nonetheless, it has the useful feature of being relatively tractable in an area that has long seemed very resistant to formal modelling. And rather than displacing the traditional insights in that field, this effort at modelling seems to confirm their usefulness. Thus, one of the pleasant surprises of applying the methods of new trade theory to location issues is that they appear both to validate and to unify a number of seemingly disparate traditions in economic geography, especially the cumulative process, with circular causation with the market potential functions ,with central-place theory.
Costs of transactions across space and economies of scale in production are the two key facts in the entire story. Because of economies of scale producers have an incentive to concentrate production of each good or service in a limited number of locations. Because of the costs of transacting across distance, the preferred locations for each individual producer are where demand is large or supply of inputs is particularly convenient. Thus concentration of industry, once established, tend to be self-sustaining. In terms of economic parameters, agglomeration is favoured by low transportation costs, low incorpora CorelEquation \s , by a large share of manufacturing in the economy- expression of a self-sustaining manufacturing concentration due to forward and backward linkages -, high incorpora CorelEquation \s , and strong economies of scale at the level of the firm, low incorpora CorelEquation \s . However, there are other very important parameters that indicate key determinants of the nature equilibrium in location, and which influence and are influenced by the whole cumulative and circular process. First, the share of non agricultural goods expenditures, that is positively correlated to agglomeration; second, the initial distribution of population, positively correlated, and third, the footloose production/demand not tied down by natural resources, even positively correlated.
Further thoughts ought to be spent on transportation costs’ issues. First of all, something about the misleading impression occurred between the Weber-type story of transport cost minimisation and the central-periphery model by Krugman. Weber suggested that localised industrial complexes will emerge only if it is more costly to transport intermediate inputs than final goods, conveying the impression that localisation due to the clustering of suppliers occurs only in this special case. In the Krugman’s model, however, the localisation will tend to occur unless the costs of transporting intermediates are particularly low compared with those of transporting final goods. Moreover, a general reduction in both transport costs will ordinarily tend to encourage localisation rather than discourage it. To see why, it is useful to consider a tricky sort of model where intermediates and final goods are the same thing then all will appear clear following the usual model.
Second thought, given a central location in which the wage rate and hence production costs are high but which has good access to markets, and a peripheral location in which labor costs are low but access to markets is less good, a reduction in transportation costs will have two effects. On one hand, it will facilitate locating production where it is cheapest, on the other it will also facilitate concentration in one location in order to realise economies of scale, and that will happen in the location with higher costs but better access. All of this in order to understand that, if the goal is minimise the sum of production and transport costs, production costs (in terms of wage) are not the central matter. What counts is the trade off between transportation costs and economies of scale. Strictly regarding transportation costs, there are three cases: high , medium, and low(zero). When they are high, production will take place in both location, the opposite when they are low (zero), it will be total concentrated in low wage location. Peculiar is the case when they are medium, decreasing from the high status. Here the production will shift away from the low wage location, because access to the market will become the key determinant of location. This fully explain the u shape of the graph in allegate 1 rather the monotonic: transportation costs matter in locating and in concentration decisions whenever are small, but exist.
4 CONCLUSION
4.1 What do we learn?
Came to the end of this paper, covering a quite new “branch” of international economy and trade (stays in fact the available literature on these issues is not abundant at all. Indeed that creates some difficulties due to the impossibility to confront different sources and points of view), the things we learned a basically four.
First, we saw how important modelling is in economics. In chapter 2 we faced different traditional approaches to economic geography, which even offered few goods and correct ideas/concepts. However, the inability of modelling by spatial economists, caused that those had been unacceptable to mainstream economics. Definitely the benefits of modelling are remarkable, cutting through the complexies of a situation. Nevertheless, we also observed more the role played by the assumptions in every model. Whichever they are: negligible, domain, or heuristic, they always are the key factor in order to make significant a theory. It doesn’t matter if they are false or unrealistic, because their purpose is to create a flexible set of tools of analysis of the phenomenon or to be just a set of steps toward more precise predictions.
Second, both ,the early tradition in spatial economics and the Krugman’s central-periphery model, are mainly based on the concept and principle of circular and cumulative causation. All the economic parameters we mentioned interact one to each other, through forward and backward linkages. The “loop” between domestic demand and manufacturing location is probably the core of the entire model. Although even levels of transportation costs effect the dynamics in manufacturing concentration and specialisation, nevertheless within the circularity history matters, and a lot. Over every circle of equilibrium there is a initial point, an initial advantage, an accident, that is the primary origin of the whole economic and trade pattern. That’s why dramatic changes can happen at any time, we must just be prepared to, be flexible.
Third, whenever we talk about economic geography and inter-regional trade (even international trade if we consider the new concept of nation as it has been presented at the beginning of the paper), we mostly refer to the pattern of intraindustry trade, a two-way trade within the x industry.
If the varieties of x were produced under constant returns, it would be possible to reproduce the integrated economy by dividing the production of each variety among countries, and there would be not need to engage in intraindustry trade to satisfy consumers’ taste for variety. But is IRS that prevent each country from producing the full range and that explain concentration and specialisation within the x industry. So, the essential reason for the intraindusty trade is the existence of economies of scale..
Krugman’s model takes widely in consideration this economic parameter as well, in terms of degree of differentiated products ( incorpora CorelEquation \s ), reinforcing that IRS (always linked to demand/market size) are today the leading parameter in relocation for manufacturing production, in both directions, toward the core and the periphery. That’s why Volvo and Volkswagen exist and why Sweden, although periphery, is still leader in pulp and paper production. However, attention, transportation costs still distort the trade pattern because they still exist, even though the world seems to be more and more integrated.
4.2 Central and periphery in Europe today
It’s very interesting to evaluate the European Community integration in terms of economic geography in order to better understand the patterns of manufacturing localization and competitiveness between the two “poles”: central (Belgium, France, and Germany) and periphery (Southern and Northern Europe). First of all, the main reason for keeping manufacturing relocation away from the low-wage entering countries (reasonable following the comparative advantages approaches) is due to the importance of transportation costs and, even more, of the easier access to the market which the central has. Both factors, as we have seen before, play a crucial role in cumulative-circular causation, and thus in the model. That especially happens, because simultaneously with integration doesn’t occur any complete elimination of those costs, but only a shift from high to medium cost case, indeed reinforcing the central’s role. Definitely that is the case of Europe, where moderate barriers, transport costs, difficulties of communication, and cultural differences as well as governmentally imposed costs, interacting with economies of scale have encouraged concentration in high-cost locations with good market access.
The degree of spacialization of European nations is however less than US regional one. The US industry is far more localized. Obviously the reasons are due to that in Europe still exist barriers of trade (tariffs in primis), and that we are at a different point in the cumulative process. The latter is even supported by completely different role played by history and accidents in the last decades, especially in terms of factor mobility and trade.
The population distribution of Europe is as well nothing like the unevenness of the American distribution, even though Europe is characterised by a strong center-periphery pattern more considering purchasing power(income), than population. That means there is a more casual relationship running from peripheraly to income.
Another characteristic, that differentiates Europe from the US, is the multiple European equilibria, instead than a single core equilibrium typical of the US. An explanation could be that European economic integration took more the form of intraindustry, rather than interindustry, as happened in the past in the US.
In conclusion, we should say that, on one hand in Europe center-periphery pattern is primarily not the result of forces that the model stress. On the other, even applying the model, integration and improved access might actually hurt, not help, peripheral industry due to high and substantial natural barriers.
4.3 Concluding thoughts
Two last brief remarks. First, the entire Krugman’s center-periphery model is defined in such a way that location matters and a lot for manufacturing success. Nevertheless there are other way of thinking. An example is the one in which infrastructure and human capital investments would count more in determining whether a country will expand or shirk its manufacturing sector. In other words, being located, one could shift from the periphery to the center by accumulating human capital and physical capital. That could be seen as a new way of interpreting the future development of peripheral countries in Europe, certainly opposite to the negative path drawn by Krugman’s economic geographical approach.
Second, transportation costs, that are an important key determinant of “our” model, are also central to model multinational enterprise theory. Models in which firms place operations in different countries for comparative advantage reasons, are today unsatisfactory as a complete explanation for the actual pattern of foreign direct investment. The alternative view indeed is that firms go multinational in order to improve their access to markets, avoiding transportation costs or other barriers to trade in their products. For example the Brainard and Horstmann, and Markunsen have recently offered models of MNE in which the decision of go multinational reflects the trade-off between the loss of economies of scale associated with multiple plants, and the reduction of transport costs they can achieve by producing locally for each market. These models are however fairly general. But factor proportion as well as transport costs may motivate overseas production and firms can make a trade-off between fixed and variable costs. MNE theories represent a quite new field of international economics, even very interesting in these days, when globalization is very, sometimes too much, fashioned. Unfortunately now there is any time and space in order to face those issues further .
References
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