A joint CEPR conference with the Graduate Institute of International Studies of Geneva and with the Conference Universitaire de Suisse Occidentale on `Trade, Location and Technology' was held on 16-21 February in Champéry (CH). The workshop formed part of CEPR's research programme on `The New Economic Geography of Europe - Market Integration, Regional Convergence and the Location of Economic Activity', funded by a grant from the European Commission under its Human Capital and Mobility Programme. It was organized by Richard E. Baldwin (Graduate Institute of International Studies, Geneva and CEPR), Philippe Martin (Graduate Institute of International Studies, Geneva and CEPR) and Jacques Thisse (Université de Paris I - Sorbonne, CERAS and CEPR).
In the paper `Economics of Agglomeration' Masahisa Fujita (Kyoto University and University of Pennsylvania) and Jacques Thisse (Université de Paris I - Sorbonne, CERAS and CEPR) address the fundamental question arising in economic geography: why do economic activities agglomerate in a small number of places? The main reasons for the formation of economic clusters involving firms and or households are analyzed: externalities under perfect competition; increasing returns under monopolistic competition; and spatial competition under strategic interaction. They review what has been accomplished in these three domains and identify a few general principles governing the organization of economic space. Other standard lines of research in location theory are also discussed while a few alternative, new approaches are proposed.
Elhanan Helpman (Tel Aviv University and CEPR) presented his paper on `The size of regions'. Krugman's work on economic geography emphasizes the centripetal force of a manufacturing sector that supplies costly transported differentiated products. It builds on a centrifugal force that consists of regional demand levels that are driven by immobile individuals. Helpman provides an alternative framework, in which agriculture is replaced by housing. A prominent feature of housing services is that they are traded within a region but not across regions. As a result locally supplied housing services produce the major centripetal force. While in Krugman's framework low (high) transport costs lead to extreme (small) agglomerations, in Helpman's framework the low (high) transport costs lead to little (larger) agglomeration. In Helpman's economy free markets provide too little agglomeration.
In `The Seamless World: A Spatial Model of International Specialization' by Paul Krugman (Stanford University and CEPR) and Anthony Venables (London School of Economics and CEPR), the authors try to do international trade theory without mentioning countries. Nearly all models of the international economy assume that trade takes place between nations which are themselves dimensionless points. They develop a model in which economic space is instead assumed to be continuous, and in which this seamless world spontaneously organizes itself into industrial and agricultural zones because of the tension between forces of agglomeration and disagglomeration. One might expect such a model to be analytically intractable but they gain considerable insight through a combination of simulations and an analytical approach originally suggested in a biological context by Alang Turing.
In `Agglomeration Externalities, Geography, and the Labour Market: Theory and Evidence', Francisco L. Rivera Batiz (Columbia University) and Luis A. Rivera Batiz (IMF, Washington, Universitat Pompeu Fabra) develop a theoretical model to explain how the earnings of workers in a particular location are affected by the characteristics of the neighbourhoods and areas surrounding their place of work. Based on the theoretical framework, they estimate human capital wage equations using data for New York State, based on the 1990 United States Census of Population and Housing. The evidence presented concludes that, on average, the characteristics of neighbouring locations account for a significant fraction of the earnings of workers in any given place of work. Agglomeration externalities thus help explain a substantial share of the geographical wage differentials among the various counties in New York State. At the same time, the data confirms a lack of impact of neighbourhood effects on manufacturing productivity.
Philippe Martin (Graduate Institute of International Studies, Geneva and CEPR) and Gianmarco Ottaviano (Universita' di Bologna and CEPR) presented `Growing Locations: Industry and R&D Location in a Model of Endogenous Growth'. They show that with global spillovers in R&D, a high world growth rate and a high level of transaction costs are associated with relocation to the newly created firms in the South (with low initial human capital) . With local spillovers in R&D, this activity will be agglomerated in the North and the rate of innovation will increase with the concentration of firms in the North. This implies that a decrease of transaction costs will increase the growth rate because it leads to relocation of firms where the R&D is located. The authors show that the interaction of growth and location can be at the origin of an agglomeration process because concentration of firms in the North fosters growth through local spillovers. Growth tends to increase the differential in market size between North and South which itself induces firms to relocate to the North. Finally, because the location decision of firms is taken independently from the decision of researchers to engage in R&D, the growth rate will in general be too low in the market equilibrium.
Diego Puga (London School of Economics) and Anthony Venables (London School of Economics and CEPR) describe the spread of industries from country to country as a region grows in the paper `The Spread of Industrialization'. All industrial sectors are initially agglomerated in one country, tied together by input output links between firms. Growth expands industry more than other sectors, bidding up wages in the country in which industry is clustered. At some point some firms start to move away, and when a critical mass is reached industry expands in another country, raising wages there. They establish the circumstances in which industry spills over, which sectors move out first, and which are more important in triggering a critical mass.
Antonio Cabrales (Universitat Pompeu Fabra) and Massimo Motta (Universitat Pompeu Fabra and CEPR) presented `Country Asymmetries, Endogenous Product Choice and the Speed of Trade Liberalization'. The paper analyzes the effects of trade liberalization on firms' decisions and profits, and on consumer's welfare, in a product differentiation model with countries which have different sizes. Firms decide product specifications at the beginning of the game, in which autarchy is followed by trade liberalization (date anticipated). Despite the heterogeneity, the highest level of welfare is attained for both countries when trade opens immediately. However, the impact of firms' profits can differ. Small country's firms benefit from larger market size but are disadvantaged when the scale of the home market affects the product choice. The opposite is true for the firm located in the large country.
In `Strategic Trade and Industrial Policy Towards Dynamic Oligopolies' J Peter Neary (University College Dublin and CEPR) and Dermot Leahy (University College Dublin and CEPR) explore the choice of optimal trade and industrial policy in dynamic oligopolistic markets. If governments can commit to future policies, optimal first period intervention should diverge from the profit-shifting benchmark to an extent which exactly offsets the strategic behaviour implied by Fudemberg and Tirole's `fat cats and top dogs' taxonomy of business strategy. Without government commitment, there is an additional basis for intervention, whose sign depends on the strategic substitutability between future policies and current actions. Applications are considered to models with learning by doing, trade in natural resources and R&D spillovers.
Luca Ricci (Graduate Institute of International Studies, Geneva) investigates the effects of fixed versus flexible exchange rate regimes on location choices of firms and on the degree of specialization of countries in his paper `Exchange Rate Regimes and Location'. In a two country, two differentiated good monetary model, demand, supply and monetary shocks arise after wages are set and prices are optimally chosen. The exchange rate performs then an adjustment role for firms located in the country relatively specialized in the good they produce, but it constitutes a factor of disturbance for the others. As firms choose ex ante the location that offers the higher expected profits for their industry, he finds that countries are more specialized under flexible exchange rates than under fixed rates. One important implication is that the adoption of a fixed exchange rate regime increases the desirability of such a currency area, as it induces sectoral dispersion of production and consequently reduces the degree of asymmetry of shocks.
In `The Formation of Cities' Yossi Hadar (Tel Aviv University) investigates the effects of changing the number of the cities in the economy, and the cost of transportation on the final distribution of the population in the economy. The technology and the preferences of the agents in this model are the same as those in Helpman (1995), namely there are workers who can immigrate from one city to another and they receive income for their labour and rents for the houses in the cities. Using simulations, this model investigates two types of equilibria. One with equally populated cities and an equilibrium with one big city and many equally populated small ones. As the number of the cities increases the equally populated cities becomes locally stable, and for an even higher number it becomes the only stable equilibrium. When the two equilibria coexist the one with the big city offers higher utility to the population. Moreover as the number of cities increases the proportion of the population that resides in the big city and the utility in the economy decrease. As the cost of transportation increases the population residing in the big city and the utility increase.
Randy Becker (Brown University) and Vernon Henderson (Brown University) presented `Notes on City Formation'. Workers and entrepreneurs interact in an urban economy to generate joint economies of scale. Entrepreneurs generate an externality, because upon entry into a city, they allow other firms in the city to achieve a greater degree of specialization. Efficient outcomes in market economies require subsidization of entrepreneurs equalling total urban land rents. With large land developers, cities achieve efficient sizes and numbers through implicitly trading off the costs/benefits to workers with entrepreneurs. In order for the large agent solution to happen, developers need to be able to announce and credibly specify either the business/worker density or the residence population and business numbers. In the absence of large agents, there will be self organization outcomes.
The rapid urbanization trend of the world economy implies an increasing importance of cities as basic units of national and international trade. In `On the Evolution of Hierarchical Urban Systems' Masahisa Fujita (Kyoto University and University of Pennsylvania), Paul Krugman (Stanford University and CEPR), Tomoya Mori (University of Pennsylvania) model the endogenous formation of a hierarchical urban system. To overcome the multiciplity of equilibria, they propose an evolutionary approach which combines a general equilibrium model with an adjustment dynamic and equilibrium selection rules. This approach is applied to demonstrate that as the economy's population size increases, the urban system organizes itself into a unique evolutionary path, generating a Christaller type hierarchical system.
Federico Trionfetti (Graduate Institute of International Studies, Geneva) presented `Public Expenditure and Economic Geography'. The geographical concentration of industries is much higher within the United States than it is within Europe. It has been convincingly argued that the reason for this is the presence of higher barriers to trade within Europe than within the United States (Krugman and Venables 1993). High trade barriers in Europe have prevented agglomeration forces in the past but as the old continent moves towards a fully integrated single market, the agglomeration phenomenon experienced by the US might occur in Europe. The argument rests on the role of transport costs. Trionfetti offers an alternative explanation based on the role of government spending. He argued that the difference in the patterns of government spending between the US and Europe might have facilitate agglomeration in the US while preventing it in Europe. He suggest that to avoid agglomeration Europe should use government procurement to buy domestic goods.
`Competing Exchanges: Do Large Markets Drive Out Small?' was presented by Thomas Gehrig (University of Basel and CEPR), Konrad Stahl (University of Mannheim and CEPR) and Xavier Vives (Institut d'Analisi Economica CSIC, Barcelona and CEPR). Using a fairly general model, they established that despite strong forces working towards the concentration of trade in one market, trade in fragmented stock exchanges may constitute an equilibrium outcome. The comparative informational advantage enjoyed by the local investors over the non local ones is an important precondition for this outcome. Thus, as the dissemination of information on established firms advances, one should expect a further concentration of trading and a declining relative importance of regional exchanges. However, a growing number of firm births can easily counteract this tendency. By nature the information about new firms is localized to a large extent thus increasing the potential for local trading.