Economic Geography
New Analytical Developments

A joint CEPR workshop with LSE's Centre for Economic Performance on `New Developments in the Analysis of the Location of Economic Activity' was held in London on 3/4 November. The workshop was organized by Massimo Motta (Universitat Pompeu Fabra, Barcelona, and CEPR) and Anthony Venables (LSE and CEPR) and formed part of CEPR's research programme on `The New Economic Geography of Europe: Market Integration, Regional Convergence and the Location of Economic Activity', supported by the European Commission's Human Capital and Mobility programme.
Antonio Ciccone (Universitat Pompeu Fabra) presented `Human Capital Accumulation, Endogenous Comparative Advantage and Technological Change', noting that the poorest countries have not caught up over the last 30 years. Recent work in endogenous growth theory has interpreted this as evidence for strong complementarities among capital, skills and education of the labour force, and available technologies, which depress the return from investing in any of these factors. If these complementarities are strong enough, they will keep the poorest countries from catching up even if they adopt rich country policies. This failure could also be due to large disincentives for capital accumulation, including capital income taxation, political instability, or insecure property rights. Recent empirical work uses the neoclassical growth model and cross-country data to quantify the role of these two forces for non-convergence. This paper extends the model to illustrate why existing cross-country growth regressions are unlikely to yield many useful insights into non-convergence: they tend to attribute endogenous differences in the aggregate level of technology to differences in physical and human capital investment, and therefore overestimate the strength of complementarities between human and physical capital. Using a simple estimator which does not confuse these differences, the paper finds much weaker complementarities: weakest in poor countries and strongest in rich countries. It uses the model to account for these features of the data and show how they can explain large differences in income across countries, and the poorest countries' failure to catch up. Thierry Verdier (DELTA, Paris, and CEPR) noted that the paper does not take into account the interaction between economies, and thought this important for considering specialization due to comparative advantage.
In `Does The Enlargement of a Common Market Stimulate Growth and Convergence?', Uwe Walz (Universität Mannheim) used a three country endogenous growth model to address the effects of an enlargement to incorporate a country lagging in technology into a two country common market. Growth stems from permanent product innovations in the intermediate goods sector leading to productivity increases in an industrial final good. Liberalizing trade with the third country induces a reallocation of resources towards the dynamic sector in the two established countries, leading to faster growth. There is income convergence among the established countries in the common market. In a second integration step, barriers to the migration of skilled labour are relaxed, with an ambiguous effect on the growth rate. Relaxing barriers to the migration of unskilled labour in a third step leads to a reduction in the pace of innovation and growth as well as to more dispersed production patterns among the old countries in the integration bloc. The paper argues that from a growth point of view regional integration via trade liberalization is better than integration via liberalization of migration barriers. Christopher Bliss (Nuffield College, Oxford, and CEPR) noted that changing the characteristics of the three countries (for instance, making one of the initial members and the new entrant identical) would change the results. Giorgio Basevi (Università di Bologna) pointed out that the paper only studies one possible sequence of integration, and it cannot be concluded that eliminating migration barriers is second best to trade liberalization unless this is true for any sequence of steps.
Riccardo Faini (Università di Brescia and CEPR) presented `Increasing Returns, Migrations and Convergence'. This paper develops a model of regional growth with mobile factors, increasing returns to scale, and diminishing returns to the reproducible factor, and uses this framework to study the link between regional convergence and factor mobility. Growth in this model can be either characterized by full income convergence across regions or by steadily widening interregional differentials of income. The latter is more likely the larger the economies of scale, which favour regional concentration. A higher mobility of labour also favours regional divergence. With a fixed labour supply, faster growth in a region tends to raise wages and depress the returns to capital. Migration relaxes the labour supply constraint, avoiding a precipitous fall in wages, and can turn the returns to capital into an increasing function of the capital stock. Harry Flam (IIES, Stockholm, and CEPR) discussed how to endogenize the propensity to migrate. Peter Neary (University College Dublin and CEPR) suggested that if migration favours divergence, the country that loses workers can react by banning migration or by subsidizing local firms.
In `Reciprocal Dumping and the Location of Firms', Jan Haaland (Norwegian School of Economics and Business Administration and CEPR) and Ian Wooton (University of Glasgow and CEPR) studied the effects of anti-dumping measures when firms are able to shift their production to other locations. If a country takes unilateral action to prevent dumping in its market, then a foreign firm that is selling there at a lower price than in its home market has two options. First, it may choose to adopt a single producer price for all of its output. This would lower the foreign firm's profits and reduce the welfare of consumers in the affected market, but it would also enhance the domestic monopoly power, increase the domestic firm's profits, and also its dumping. However, the foreign firm can also respond by establishing a production facility in the country that takes unilateral anti-dumping measures. In this case, while the foreign firm's profits are also reduced, the consequences for the other agents in the economy are reversed. The increased domestic competition lowers the home firm's profits, while consumers benefit. Second, the paper looks at the strategic interaction between governments, arguing that if they are interested in profits, they should not introduce anti-dumping measures. If they care about consumers, anti-dumping policies could be advantageous providing firms react by relocating, thereby increasing competition. Dermot Leahy (University College Dublin) pointed out that the authors assume that anti-dumping measures are always effective in eliminating dumping so that anti-dumping levies are never actually imposed. Pedro Pita Barros (Universidade Nova de Lisboa) noted that firms subject to anti-dumping measures may react by completely relocating production to the affected market, instead of by opening another plant there. Neary argued that there must be a better pro-competitive policy than using anti-dumping measures to trigger firm entry.
Philippe Martin (Graduate Institute of International Studies, Geneva) and Gianmarco Ottaviano (Università di Bologna) presented `The Geography of Multi-speed Europe'. This paper asks whether the existence of different speeds of integration in Europe can have an impact on the long-term location of economic activities on the continent. It presents two rich countries which decide to integrate their economies and leave a third, poorer, country temporarily outside. The income gap between the countries is modelled as a difference in the endowment of entrepreneurs. If they cannot migrate, when the two rich countries eliminate transaction costs, firms in the poorer country relocate towards them. If the income gap is closing over time the transition period may be beneficial: it enables the poorer country to join the integrated area at a time when the income differential is not too large and does not generate massive relocation to the core countries. The mobility of entrepreneurs creates a tendency for the agglomeration of activity, and reverses these results. In that case, a transition period during which the poorer country is excluded from the integrated market can induce the agglomeration of the increasing returns sector in the rich integrated countries. If the length of the transition period is conditional on income convergence, the country temporarily excluded may never be integrated. François Ortalo-Magne (LSE) questioned the modelling of income convergence as an exogenous process, instead of being endogenous and affected by the process of integration itself.
In `On the Stability of Geographical Patterns of Production: The Role of Heterogeneity and Externalities', Armin Schmutzler (Universität Heidelberg) attempted to clarify some aspects of the dynamic adjustment process that takes place when some shock increases the attractiveness of a region relative to an existing agglomeration. For instance, what determines how many firms relocate to the region that has gained attractiveness? Or, how fast does the adjustment take place? The paper assumes positive locational externalities, so that firms' profits depend positively on the number of other firms in the same location. Firms differ in their judgement of the relative attractiveness of regions, and the advantages of agglomeration do not build up immediately. In this framework, stronger externalities and lower heterogeneity have ambiguous effects on the total adjustment following the exogenous shock. Stronger externalities will make firms reluctant to leave the original agglomeration, and with low heterogeneity there may be a lack of `pioneer firms' with sufficiently strong preferences for the new location. On the other hand, firms that do decide to move location induce more firms to follow when externalities are stronger and the population is less heterogeneous. As a result of these two competing effects, the speed of adjustment to the new equilibrium is lower for strong externalities and low heterogeneity. Mary Amity (Universitat Pompeu Fabra and LSE) noted that it was important to consider moving costs. Basevi pointed out the lack of some structure of economic production and consumption in the analysis. Ottaviano said he would be prepared to accept reduced forms as long as there was some empirical evidence to support them.
In `Country Asymmetries, Endogenous Product Choice and the Speed of Trade Liberalization', Antonio Cabrales (Universitat Pompeu Fabra) and Massimo Motta argued that when analysing trade liberalization, more attention should be paid to differences between countries. Their paper studies the impact of trade on the type of goods produced by firms in two countries, on their profitability, and on an overall measure of welfare for each country. Firms anticipate that trade liberalization will take place when deciding their product specifications. The more distant the date of liberalization, the more important the home market conditions. The paper shows that welfare in the two countries always increases with trade liberalization, despite country asymmetries. The sooner a country opens to trade, the better for the community as a whole. However, trade liberalization has quite different effects on &nbspfirms located in the different countries. Small country firms benefit from selling in a larger market than the domestic one, but are at a disadvantage since investment in their product is negatively affected by the scale of the domestic market. The opposite is true for firms located in the large country. Thus, small country firms will gain from trade when the relative size of their country is low and when the incentive to invest in product quality is not related to the size of the market. If liberalization is delayed, small country firms will have adopted an investment strategy for the small domestic market, and will probably be less competitive than large country firms. Alasdair Smith (University of Sussex and CEPR) said that while trade negotiations are difficult, once completed, countries tend to speed up integration without difficulty. This was not coming out of the model because of the irreversible choice of product specification: if firms could change their specification, they would be hesitant to adapt from autarky to trade conditions; but once liberalization was decided, they would prefer to go ahead with it quickly. Arne Melchior (Norwegian Institute of International Affairs) argued that the relative number of firms in a country may matter more than relative country sizes. Bliss noted that with an endogenous number of firms it is not clear that freeing trade is welfare improving.
In a paper written with Xavier Martínez-Giralt, `The Impact of the "Chunnel" on the Location of Production Activities', Pedro Pita Barros presented a simple two-country model of firm location. Its distinctive feature is the existence of two markets which are not connected, that is, there is a segment like the English Channel which has no consumers and is not suitable for firms' location. The paper examines the effect of linking the two markets, as the `Chunnel' has done. It finds that relocation towards the Chunnel would only take place under highly restrictive assumptions unlikely to hold in practice, and argues that this result casts doubt on investment efforts by local authorities like the ones deployed in Kent's business parks. Konrad Stahl (Universität Mannheim and CEPR) doubted that relocation towards the Chunnel was an equilibrium of the model even under its restrictive assumptions. Motta pointed out that firms' commitment to other locations may provide a simple explanation of why they do not relocate to parks in Kent as much as their developers had expected.
In `Industrial Agglomeration under Cournot Competition', Pierre-Philippe Combes (CREST, Paris) stressed the importance of analysing the strategic interaction between firms in order to understand their location decisions. The paper develops a two-region model where firms compete on quantities in a Cournot fashion (so that competition is not as intense as if they competed on prices), and determines under what conditions an agglomeration of firms in only one region emerges. More intense competition in markets with a larger number of firms tends to give firms located there lower profits. Counteracting this effect, and favouring agglomeration, are the higher income and demand in markets with more firms. Overall, when the regional conditions of production are identical, firms tend to agglomerate in one location, providing transport costs are low or scale economies high. Konstantine Gatsios (Athens University of Economics and Business and CEPR) questioned the assumptions of fixed wages and non-clearance of the labour market. Venables suggested using techniques from catastrophe theory to analyse the switch to agglomeration.
Johan Torstensson (Lund University) presented `Country Size and Comparative Advantage: An Empirical Study', a paper which attempts to test empirically whether countries with an abundant absolute endowment of skilled labour are net exporters of high-technology products, and whether countries with a large domestic market are net exporters in industries characterized by increasing returns to scale. Using data on net trade by individual OECD countries, the paper finds that the absolute as well as the relative endowment of skilled labour affects the trade pattern. However, it is more difficult to detect a relationship between measures of scale economies and country size. Introducing country and industry characteristics and combining the data from every OECD country, the paper again finds support for the hypothesis that both relative and absolute endowment of skilled labour affect the trade pattern as suggested. The evidence relating scale economies to market size is still mixed, as is the effect of physical capital on trade. Membership of the EU or the EFTA may have a positive effect on net exports in increased returns to scale and high-technology industries. Thomas Gehrig (Universität Basel) argued that theoretically scale economies would only matter in the presence of trade costs, which are absent from the paper. He also noted the importance of considering migration flows of skilled workers across OECD countries. Ciccone suggested that simultaneity may explain why scale effects do not come out as significant.
Anthony Venables presented `The Theory of Endowment, Intra-industry, and Multinational Trade', written with James Markusen. For many years, international differences in factor endowments were the basis of the dominant positive theory of international trade. In the 1980s, elements of increasing returns, imperfect competition, and product differentiation were added in order to explain the large volume of intra-industry trade. This paper addresses two problems that remain: the theory generally neglects multinationals, and the Helpman-Krugman framework relies on assumptions that generate factor price equalization and is not useful for trade policy analysis. Using a model with a monopolistic competition sector in an otherwise standard Heckscher-Ohlin framework, the Helpman-Krugman results are extended to allocations that do not generate factor price equalization or positive trade costs. The paper allows firms in the differentiated products sector the option to become multinationals by opening a second plant, thereby incurring an additional fixed cost but saving on transport costs. Multinationals exist when trade costs are high and the ratio of total multinational to single plant production low, and for given levels of these, when countries are similar in relative size and factor endowments. Multinationals reduce trade volumes and raise world welfare, while having an ambiguous effect on each country's welfare. Lastly, the paper studies the possibility of agglomeration of the increasing returns sector. Here, agglomeration requires mobility of the factor used intensively. The presence of multinationals reduces the area of endowment space from which agglomeration may occur. Katia Montagna (University of Dundee) pointed out that the model does not consider the ownership of multinationals, an important issue if FDI flows are to be studied. Stahl thought that the main reasons for firms becoming multinationals are to overcome `home bias', and to produce with cheaper labour and then ship the goods to richer markets, rather than to save transport costs.