Economic Geography as seen from Economics: Neglect, (Re)Discovery & (Missed) Opportunities

1. Economic Geography as seen from Economics: Neglect, (Re)Discovery & (Missed) Opportunities Harry Garretsen (Spatial Economic Analysis (SEA) Lecture, RSA 2012 Delft) .

2. SEA journal: “… methods of spatial economics” Central theme RSA 2012 conference: spatial interactions Why me? →→→→→→→→

4. Spatial interactions or dependencies…….. • ……..central to the field of economic geography (EG).. • …....aims to explain (uneven) spatial development….. • ………various analytical approaches……… • This lecture: what does economics have to offer to the analysis of spatial interactions and hence to EG?

5. OUTLINE • Central theme: EG & spatial interactions…. • …….. in economics prior to 1991 • …….. 1991: New Economic Geography (NEG) • Krugman’s NEG: his 3 key ”Nobel” insights • 20 years on: missed opportunities?? • Example: Urbanization in China • How to proceed with (N)EG?

6. The Litmus Test of EG Does it matter where Delft is located in The Netherlands? YES: space & location matter

7. Spatial interactions in economics pre-1991 • International economics? • Regional economics? • Urban Economics? • CONCLUSION: Neglect or, at best, partial analysis

8. Krugman: Nobelprize 2008 Something changed between 1991 and 2008!!!

9. New Economic Geography/Geographical Economics • Three main insights make for core NEG model • NEG what’s in a name? NEG vs geographical economics • This model sets the scene for remainder lecture

10. NEG 3 key insights (I) • NEG’s core model: Krugman (1991, JPE) • NEG originates in international trade theory, not in urban/regional economics • We proceed in 3 steps: Krugman (1979, 1980, 1991) • International trade theory in 1979: old (=18th century) theory (Ricardo) at odds with facts • Theory: inter-industry trade; facts: intra-industry trade (it’s not “cloth for wine” anymore)

11. Manufacturing intra-industry trade; 1988-2000, selected countries

12. NEG 3 Key Insights (II) • Krugman (1979): introduce internal increasing returns to scale • Model of imperfect competition (Dixit and Stiglitz, 1977) • Rationale for (intra-industry) trade, but no role for geography yet……..

13. Average costs under increasing returns to scale

14. NEG 3 Key Insights (III) • Krugman 1980: add transport costs to IRS • Assume two countries, a and b: Sa >Sb (market size S for A larger than B); • And assume transport costs T>0; if α>(T x Sb), then locate firm in larger market • “Home market effect”: geography matters • But: why should Sa>Sb to begin with????

15. NEG 3Key Insights (IV) • Krugman (1991): 1st NEG model: add factor (=labour) mobility to T and IRS • Also external IRS (pecuniary or market size externality) • Big Q: where will footloose firms&workers locate? • Answer: it depends……………

16. NEG 3 Key Insights (V) • ……..it depends on relative strength of agglomeration and spreading forces • Agglomeration forces: home market effect, price index effect • Spreading forces: competition effect • “Tug of War”: key model parameters, notably level of transp. costs, T [Where’s the novelty of Krugman 1991?]

18. So basically, α+T+λ give us………. ………….a very happy economist on October 13th 2008

19. NEG after Krugman (1991) • Reception of NEG in- andoutsideeconomics • NEG after 1991: Theory?Extensions of core 1991 model? Empirics? Real test of underlying model? Policy Relevance? General vsspecificpolicies?

20. Reception……. • Economics: initial wave of research; NEG has done its job, no longer separate sub-field of research? • Outside economics: Not new, bad economics and real lack of geography • Krugman (2011): Middle-aged NEG does not look too well??

21. What happened? (I) • THEORY: focus on mix of agglomeration and spreading forces, but too little progress? (n-region problem?, simulations?) • EMPIRICS: outburst of NEG inspired empirical research, but where’s the real test of NEG?

23. What happened? (II) • Empirical research: focus on short run instead of long run version of NEG!!! • “Krugman (1980) beats Krugman (1991)” • Market potential/access: not relevant on regional level??

24. What happened (III)? • POLICY RELEVANCE? (see THEORY+EMPIRICS): • General conclusion: policy in a lumpy world, role of threshold effects (Baldwin et al, 2003) • Specific policy conclusions rather difficult or based on “wrong” version of NEG model (main example: World Bank, World Development Report 2009)

26. The Wiggle Diagram

27. Lessons (Not) Learned • Lack of theoretical progress & wrong focus in empirical research: main message of NEG got lost!! • So what? [assuming(!) mainstream economics can add to understanding of spatial interactions] • Example: Urbanization in China (to show comparative advantage of NEG)

28. Two background papers for our example • Bosker M, S Brakman, H. Garretsen & M Schramm: • “Adding Geography to the New Economic Geography”, Journal of Economic Geography, 10(6), pp. 793-823, 2010. • “The New Economic Geography of Prefecture Cities in China: The Relevance of Market Access and Labor Mobility for Agglomeration”, mimeo, February 2012

29. Behavior of NEG models in n-region case • Does “real world”with many regions which are not equi-distant and differ in size resemble anything like the “Tomahawk” or “Bell-Shaped Curve” from the 2 region NEG models? • Answer: (qualified) YES

30. Transport costs and the long run equilibrium when distance matters, n=194

31. Transport costs, distance, initial conditions, n=194

32. Motivation for Chinese cities study • Are Chinese cities too small? (despite rapid urbanization)…. • … if so: does China, does not benefit fully from agglomeration economies? • Main culprit: Hukou system (restricted interregional labour mobility) • What will happen with increassed labour mobility? • Krugman (2011): China=NEG; “what if” questions

34. Set up of analysis • NEG model (extensive mix of agglomeration and (!) spreading forces (housing rents)) • Use wage equation to estimate structural model parameters (notably “freeness of trade”) • Model simulations (with real migration dynamics)

35. Initial (2000) distribution

37. Conclusions based on China example • Use strong (and novel) points of NEG approach: agglomeration is endogenous; NEG provides answers to “what if” questions • Comparative advantage of NEG, but this advantage is not used very well

38. Final words…….. How toproceed? • Economicscanbe of greateruseto analysis of EG/spatialinteractions, • Make betteruse of NEG whilerecognizingitslimitations • More collaboration or debate? (today’slecture……) Crediblemodels in EconomicGeography at large? (Garretsen& Martin, SEA, 2010)