PERSONAL NOTES
CIRCULATED)
ON
NEW
ECONOMIC
GEOGRAPHY
(NOT
TO BE
CONCENTRATION OF ECONOMIC ACTIVITY (MAP OF CONCENTRATION OF
ECONOMIC ACTIVITY)
Economic activity is spatially concentrated. When we draw a map of
economic activity in Europe, for instance, what will emerge is a very uneven
distribution.
There is a vast area comprising most of Germany and France, Netherland,
Belgium, northern Italy and south England with a strong presence of industry
and services and there is another vast area comprising most of Spain, Southern
Italy, Portugal, Greece, the eastern European countries and part of the
Scandinavian countries with a much lesser dense presence of industries and
services. Economists name “core” the first area and “periphery” the second area.
This dualistic division of Europe between core and periphery suggests that
economic development is not distributed evenly in space, but that it entails the
creation of agglomerations and peripheries.
GDP PER CAPITA AT NATIONAL LEVEL (MAP OF GDP PER CAPITA AT
NATIONAL LEVEL)
Should we worry about concentration of economic activity? Should we worry in
particular for the presence of peripheral regions in Europe? The problem is that
concentration of economic activity is often associated with strong disparities in
income per capita that we take as a proxy for people living standard. Have a look
at the map reporting the GDP per capita at national level. You can appreciate
that the huge gaps in GDP per capita among national states roughly corresponds
to the concentration of economic activity. Where there is a concentration of
economic activity, there people enjoy an higher standard of living in terms of
consumption possibilities
GDP PER CAPITA AT REGIONAL LEVEL (MAP OF GDP PER CAPITA AT
REGIONAL LEVEL)
A more careful analysis will show of course that the dualistic division between
core and periphery is somewhat simplistic. Processes of agglomeration of
economic activity do not coincide with national boundaries. There are important
differences in the concentration of economic activity both, within the “core” and
within the “periphery”. This Map reports the levels of GDP per capita at regional
level rather than national level. You can immediately see that inequalities within
national states can be very huge indeed. Let consider the Italian case, for
instance, where regions fall under five different income brackets. The same is
true in Spain where there is a strong divide between northern regions and
southern regions. Further in most cases, we find a considerable gap between
capital regions (regions where the capital of the state is placed) and other
regions of the same nations. This is true for both the more and the less advanced
countries of Europe (see Greater London, Ile de France or Warsaw and Prague).
Finally, note that, if there were availability of data at sub regional level, we could
appreciate significant differences even within each region. Processes of
agglomeration do not coincide with regional administrative boundaries either.
LABOUR MARKET AT NATIONAL LEVEL ( MAPS ON EMPLOYMENT AND
UNEMPLOYMENT RATES AT NATIONAL LEVELS)
Differences in income per capita are often associated with differences in the rate
of employment, of unemployment, of long term unemployment or of youth
unemployment. Peripheral regions in other terms are often at disadvantage not
only in terms of consumption possibilities but also in terms of availability of
jobs. These two Maps report the data on employment and unemployment rates
at national level. You can appreciate a correlation between levels of Gdp per
capita, rates of employment and rates of unemployment. Higher Gdp per capita
is associated with higher rates of employment and lower rates of
unemployment. But note also that this correlation is far from being perfect.
Labour markets have strong national specificities so that employment and
unemployment rates do not depend only on the level of economic development.
LABOUR MARKETS AT REGIONAL LEVEL (MAPS ON EMPLOYMENT AND
UNEMPLOYMENT RATES AT REGIONAL LEVELS)
Again the same maps at regional level offer you a much more diversified picture
of the national labour markets. In many cases regions with high and low rates of
employment and high and low rates of unemployment coexist within the
national state.
An even more accurate analysis would show that peripheral regions are often at
disadvantage in other crucial aspects of social and economic life, such as health
provision or standards of education. There are of course important exceptions,
but generally speaking, we can say that people in the peripheral regions or areas
are at disadvantage relatively to people in the core regions or areas.
The answer to our question “should we worry about agglomerations” is positive
since concentration of economic activity is often associated with inequality of
income, of employment and in several dimensions of well-being.
CONVERGENCE OR DIVERGENCE?
Is there any tendency for these inequalities to reduce over time? If this were the
case, we could just rely on the passing of time to see inequalities gradually
disappear. The data here do not lead to definite results. Focusing on Europe,
there has been in the last decade a narrowing of the gaps in national per capita
income relatively to the European average but not in regional per capita income.
This implies that economic development in many countries has been very
spatially unbalanced. There are nations, specially Eastern European countries,
that experimented a process of rapid growth but spatially concentrated, the
result being a narrowing of the gap with the rest of Europe at national level but
a widening at regional level.
THE IMPACT OF THE PRESENT CRISIS
The last Table shows the overall rate of growth between 2000 and 2007 and the
yearly rates of growth from 2007 to 2013 at national level. They show the
process of catching up of several countries in the first part of the decade. They
also show that all countries were heavily affected by the global crisis. But also
that the strength of this impact has varied a lot for different countries and that
also the speed and the strength of the recovery has been different
START
We have reached four conclusions so far:
1) Economic activity is spatially concentrated
2) The map of economic distribution of activity does not respect national or
regional boundaries. Strong gaps can be found both between national
states and among regions within each national states
3) These inequalities imply in most cases that people living in the core
regions enjoy a standard of living higher than people living in peripheral
regions
4) A process of convergence in the last decades can be detected at national
level while this is not the case at regional level, where, if any, divergence
has increased in most countries.
SLIDE 27
FROM FACTS TO THEORIES
We now live the facts and turn to the theory. Is there any theory which explains
why economic development leads to concentration of economic activity?
It is not our aim, not the aim of this course, to undertake a survey of theories of
growth and of their implications in terms of balanced development. We know
already that there are theories that predict a long run process of convergence
and theories on the contrary that provide for inequalities to maintain or even to
worsen. We shall focus exclusively on a strand of theoretical thought, known
under the name of New Economic Geography, because it has been and still is at
the centre of the current debate on agglomeration, on its consequences and on
the policies to deal with. I shall focus on the original version of the model
disregarding the complex and rich debate that followed the first seminal
contribution by Krugman.
SLIDE 28
THE NEG GOALS
The defining issue of the new economic geography is how to explain the
formation of a large variety of economic agglomeration (or concentration) in
geographical space. Agglomeration or the clustering of economic activity occurs
at many geographical levels and can take different forms. For example, one type
of agglomeration arises when small shops and restaurants are clustered in a
neighbourhood. Other types of agglomeration can be found in the formation of
cities, all having different sizes, ranging from New York to Little Rock; in the
emergence of a variety of industrial districts; or in the existence of strong
regional disparities within the same country. At the other extreme of the
spectrum lies the core-periphery structure of the global economy corresponding
to the North-South dualism.
A GENERAL EQUILIBRIUM APPROACH
The existence and the functioning of agglomerations was of course well known
before the advent of the NEG. It was the main object of study by geographers and
economic geographers. It was also a central issue for scholars in the fields of
economic growth and development, such as Myrdal or Kaldor. They already
identified and described the macroeconomic mechanisms which could lead to
processes of cumulative causation.
The novelty of the Neg is to explain agglomeration within a framework of
general equilibrium, that is to explain agglomeration and dispersion within the
same model. This entails clear up where the resources of agglomeration come
from, what are the main motivations for resources to move and the effects not
only on agglomerations but also on periphery. The Neg approach should also
allow to analyse simultaneously the centripetal forces that pull economic
activity together and the centrifugal forces that push it apart. Indeed, it should
allow us to tell stories about how the geographical structure of an economy is
shaped by the tension between these forces. And it should explain these forces
in terms of more fundamental micro decisions, at firm and worker’s level.
SLIDE 29-30-31
THE KEY ASSUMPTIONS OF THE ORIGINARY MODEL
A first very simplified model- a core-periphery model- was put forward by Paul
Krugman in 1991. The key assumptions of the model are:
Positive transport costs. This means that space is important. The world is not
flat. For a firm it is not the same thing to sell his products in the home market
(the market where the firm is located) and outer markets. To sell in the outer
market is more costly. The firm must incur in various additional costs: the cost
of shipping, first of all; then various other trade costs linked to legislative or
cultural differences between the exporting and the importing regions. This
means that the cost of production of selling in the outer market is higher than
the cost of production of selling in the home market. This has obvious
implications for the location of a firm. When one firm must decide where to open
a plant, it must consider the level of transport costs. When the transport costs
are very high, it will be very costly for a firm serve outer markets by means of
exports. It will be cheaper to open a new plant in the outer market. This means
that each market will be served exclusively by firms located in that market.
There will be no exports. But if the transport costs are low, it may become
realistic for a firm located in Market A, to export also in market B as an
alternative to the opening a new plant in market B. Then transport costs
matter a lot for the localization choice of a firm
Increasing returns to scale and monopolistic competition in the
manufacturing sector. This means that the average cost of production
diminishes as the level of production increases and that firms located in bigger
markets can benefit from economies of scale and incur in an average production
cost lower than firms located in smaller markets. For instance, assuming a fixed
cost for setting a plant, the average fixed cost will decrease as the size of the
market, that is the level of production, increases. This means also that firms have
some market power (there is product differentiation ), can fix the price above
the marginal cost and have a competitive advantage relatively to firms operating
in smaller markets. This matters a lot for the localization choice of a firm. Other
things being equal, firms will find convenient to locate in the bigger
market, to exploit economies of scale, to produce at a lower average cost
and export in smaller markets (home market effect)
Factor mobility. A third key hypothesis of the NEG models is factor mobility. To
explain localisation choices of firms, we must assume some form of factor
mobility. In case of perfect factor immobility, firms and workers could not move,
only products would move. Agglomeration could not literally take place.
Krugman, in his first version of Neg models assumed that workers in the
manufacturing sector were fully mobile while farmers operating in the
agricultural sector were perfectly immobile. This implies that if a manufacturing
firm moves his location from one place to another, workers will move too.
Under these hypotheses, the new economic geography will show how the
interaction among increasing returns at the level of the firm, transport costs and
factor mobility can cause agglomeration to emerge.
SLIDES 31-32-33- 34
A SKETCH OF THE MODEL
This is the simplified version of the model
Two regions: region A and region B
Two sectors: agriculture and manufacturing.
Firms and farmers in the agriculture sector cannot move, while firms and
workers in the manufacturing sector can.
Manufactured goods can be produced in either or both locations.
If a given manufactured good is produced in only one location, transportation
costs must be incurred to serve the other market.
On the other hand if the good is produced in both locations, an additional fixed
set up cost is incurred.
THREE OPTIONS
A manufacturing firm must decide where to locate. It has three options.
The first is to open in market A and export in market B;
the second is to open in market B and export in market A;
the third is to open two plants, one in A and the other in B.
The decision will depend on two elements: the size of the market and the
transport cost.
THE SIZE OF THE MARKET
The firm, other things being equal, has the convenience to open the plant in the
bigger market for at least two reasons: one, because it exports a smaller fraction
of its production, saving on transport costs; the second because it can operate at
lower average total costs (increasing returns) and be more competitive on the
external market relatively to the other firms.
TRANSPORT COSTS
The firm however must also consider transport costs. If transport costs are very
high, then the option of having one location and export to the other location is
unfeasible. Exports would be too expensive relatively to home produced goods.
In this case the firm in order to sell its products in the two markets, must open
two plants, one in market A and one in market B. If however transport costs are
sufficiently low, then the firm may find more convenient to open only one plant
in the bigger market and export in the smaller market. We have therefore two
forces going in the opposite direction. The size of the market is a centripetal
force pushing firms to open plants in the bigger market. The transport cost is a
centrifugal force pushing firms to open a plant in each market.
CUMULATIVE CAUSATION
There is here one thing which is at the hearth of the model. The model is
circular. The choice of location of a firm depends on the size of the market but
the size of the market depends in turn on the choice of localization of the firms.
When a firm decides to locate a plant in one region because the market there is
bigger, it will hire new workers, who will move from the other region attracted
by the availability of better jobs, by higher wages or by a more diversified
market of consumption goods. But the migration of new workers will make the
market of that region even bigger because they will represent an increase in
demand for firms located in the bigger market (workers spend most of their
money in the market where they live) So, a cumulative process starts with new
firms entering the big market, new workers moving to the region, the big market
becoming even bigger and attracting new firms and new workers …at the end,
other things being equal, all manufacturing firms will locate in the big market
and will export in the small markets.
SLIDE 35-36-37-38-39-40-41
A NUMERICAL EXAMPLE FROM KRUGMAN
Let assume that manufacturing labour force in each location is proportional to
the share of manufacturing of that location; that demand is strictly proportional
to the labour force. Let assume also that total demand of manufacturing is 10
and that labour force in agriculture is 60% of total labour force. Therefore 60%
of demand for manufacturing comes from farmers. This is equal to 6 (60% of
10), 3 for each location. The trade cost for unit of production is 1. The cost of
setting a new plant is 4.
TOTAL DEMAND OF MANUFACTURING: 10= 6 FROM FARMERS + 4 FROM
WORKERS
DISTRIBUTION OF DEMAND FOR MANUFACTURING WHEN
MANUFACTURING PRODUCTION IS PRODUCED IN A
IN A: 3 FROM FARMERS LIVING IN A + 4 FROM WORKERS LIVING IN A
IN B: 3 FROM FARMERS LIVING IN B
ALL
DISTRIBUTION OF DEMAND FOR MANUFACTURING
WHEN ALL MANUFACTURING PRODUCTION IS PRODUCED IN B
IN B: 3 FROM FARMERS LIVING IN B + 4 FROM WORKERS LIVING IN B
IN A: 3 FROM FARMERS LIVING IN A
DISTRIBUTION OF DEMAND FOR MANUFACTURING WHEN MANUFACTURING
PRODUCTION IS EQUALLY SHARED BETWEEN A AND B
A=3 FROM FARMERS LIVING IN A +2 FROM WORKERS LIVING IN A
B=3 FROM FARMERS LIVING IN B + 2 FROM WORKERS LIVING IN B
ALL MANUFACTURING PRODUCTION IN A AND FIRM IN A
4 FIXED COSTS + 3 TRANSPORT COSTS
ALL MANUFACTURING PRODUCTION IN A AND FIRM IN B
4 FIXED COSTS + 7 TRANSPORT COSTS
ALL MANUFACTURING PRODUCTION IN B AND FIRM IN B
4 FIXED COSTS + 3 TRANSPORT COSTS
ALL MANUFACTURING PRODUCTION IN B AND FIRM IN A
4 FIXED COSTS + 7 TRANSPORT COSTS
ALL MANUFACTURING IN A AND FIRM BOTH IN A AND B
8 FIXED COSTS
ALL MANUFACTURING IN B AND FIRM BOTH IN A AND B
8 FIXED COSTS
The final location of firms depends on the initial distribution of production and
on the interplay of three parameters.
1) The cost of transport per unit of production (t). For sufficiently high values
of this parameter, other things being equal, firms will choose to open two
plants. (For instance, starting from Krugman example, if you increase the
value from 1 to 1,5, the firm will always choose to open two plants
whatever the initial distribution of production)
2) The fixed set up costs (F), that is the relevance of increasing returns to
scale. The higher the fixed set up costs, the greater the convenience to
concentrate production of manufacturing in only one location, the bigger
market. (For instance, starting from the numerical example in Krugman, if
you increase fixed costs from 4 to 6, the firm will always choose to
concentrate production in only one location, even when the initial
production is evenly distributed between the two regions).
3) The share of manufacturing in the total labour force(π). The convenience
to concentrate location is higher, the higher is the share of manufacturing
(mobile labour force) relatively to the share in agriculture (immobile
labour force). The reason of that is straightforward. If the share of
immobile population is very high, a firm with only one plant must sustain
very high total costs of transports because external demand from farmers
is high. In Krugman example this share (π) was 60%. The total cost of
transport (t), locating the plant where the entire manufacturing
production is concentrated, was t*(1/2) (1- π )*10)= 1(1/2)(1-0,40)*10=
3. If you decrease the share of manufacturing from 40% to 10%, the total
transport cost will become 1(1/2)(1-0,90)*10= 4,5. It becomes then
convenient to open two plants whatever the initial distribution of
production
SLIDE 42-43-44-45-46
Conclusions:
1) The choice of location of a firm will depend on the location of other
firms
2) Other things being equal, the firm has the convenience to locate in the
bigger market to exploit increasing returns and save transport costs.
3) The choice of the firm to locate in the bigger market, will make that
market bigger, and a bigger market will attract new firms starting a
circular process towards the concentration.
4) Agglomeration is only a possibility. Whether agglomeration will take
place or not depends on the relative values of transport costs, fixed
costs, share of immobile population. High transport costs and an high
share of immobile population are an obstacle for agglomeration while
high fixed costs are an incentive for agglomeration
5) There are then multiple equilibria. You can find equilibrium producing
manufacturing entirely in West, entirely at East or with two plants both
at west and at east
6) You can also appreciate that when t=0 (no transport cost) the solution
of one plant is always convenient. The world is flat. Spatial distance is
irrelevant and the firm can locate the plant indifferently everywhere.
SLIDES 47-48-49
A MORE COMPREHENSIVE VIEW OF CENTRIFUGAL AND CENTRIPETAL FORCES
AT WORK
The first version of the model put forward by Krugman was organized on the
interaction of only two variables: increasing returns and transport costs. It was
however clear to the same author that this model was offering an exceedingly
simplified description of real processes of economic agglomeration. Several
studies by other authors and by Krugman himself, after 1991, contributed to a
more realistic and complete account of these processes. It was recognized that
various centripetal and centrifugal forces were at play, other than market size
and transport cost. Let us introduce and briefly comment these forces.
BACKWARD AND FORWARD LINKAGES
The original model was assuming that manufacturing firms were using only
labour as a factor of production and all were producing consumption goods. In
reality however firms use also intermediate inputs as factors of production
which are produced by other manufacturing firms. We must think of
manufacturing industry as a vertical structure of production in which one or
more upstream sectors produce inputs for one or more downstream sectors,
while both upstream and downstream producers are subject to increasing
returns and transport costs. This means that there are backward (Venables
1996) and forward linkages among producers that tend to concentrate both the
upstream and downstream producers in a single location. Why is that?
Producers of intermediate goods have an incentive to locate where they have the
largest market to exploit increasing returns and save on transport costs, which
is where the downstream industry is; and producers of final goods have an
incentive to locate where their suppliers are, which is where the upstream
industry is located, because they can find their intermediate inputs more easily
and more cheaply. The existence of backward and forward linkages act as a
centripetal force inducing firms to open plants in the same location. This is the
reason why in the real world we observe economic agglomerations specialized
in a specific sector, as for instance in the case of Italian industrial districts.
MARSHALLIAN EXTERNAL ECONOMIES
The first contribution by Krugman focused on economies of scale internal to the
single firm. There is however a long tradition of scholars, starting from Marshall,
which focused on external economies. External economies are factors external
to the single firms and outside of their control, which increase the productivity
of the firms and reduce their cost of production. They act on the supply side and
not on the demand side. These external factors refer to an industry operating in
a specific and limited geographical area. They are then highly specific to that
industry and to that territory. Since all firms can benefit from these positive
factors and none of them can be excluded from their use, these factors assume
the form of a public good (or rather of a club good). Following Marshall
description, it is possible to identify three of these factors: specialized providers
of industry inputs, thick markets for specialized labour skills, information and
knowledge spillovers.
Firms operating in an agglomeration can benefit from the availability of a vast
range of specialized inputs and a large pool of skilled workers. For instance, a
firm operating in the tile industry get important benefits from locating a plant in
an industrial district specialized in the tile industry. There, this firm can easily
access better and more specialized inputs and better and more skilled workers.
On the contrary, a firm, located in an area where there are not other firms
operating in the same sector, will encounter difficulties in finding the right
inputs and the right workers. This implies that this firm will incur in higher costs
or will suffer of a lower productivity. Skilled workers will benefit too from
moving to specialized industrial areas. The demand of labour for workers with
specific skills in these areas will be greater and more diversified.
Firms operating in an agglomeration can also benefit from a more rapid and
complete flow of information and of knowledge. Employers and skilled workers
have the possibility of a continuous interaction; they can compare their work
experiences, discuss problems and solutions, communicate technological
novelties on a daily basis. This continuous interaction creates a fertile ground
for innovation, in the form of incremental technical progress. A technical
progress that does not depend on big technological discoveries but on processes
of learning by doing socialized at local level. As Marshall put it: “The mysteries of
the trade become no mystery, but are, as it were, in the air.”
Note that proximity is important in all three cases. The ability of employers and
workers to meet face to face allows a continuous exchange of information and
knowledge and facilitates the creation of trust relationships. This reduces
transaction costs, costs of collecting information and costs of innovation.
OTHER EXTERNAL ECONOMIES
Other authors have enlarged the scope of external economies. These are not
referred only to properties of industrial clusters but also to features of the
context at large. Quality of public services in sectors such as health, education,
transport infrastructure, communication network may represent a powerful
factor of attraction for firms and workers. The same can be argued for social
characteristics such as low level of inequality, good industrial relations,
satisfactory level of social integration, endowment of social capital. The same for
the quality of institutions, that has always been identified as one of the crucial
conditions for development to take place. That of institutions is a very big issue
we can only mention here.
CENTRIFUGAL FORCES
The NEG focused the attention on centripetal forces to explain why
agglomeration could result from economic growth. Scholars of this line of
thought however are well aware that powerful centrifugal forces are at work
alongside the centripetal forces. Agglomeration then takes place when
centripetal forces prevail on centrifugal forces. Let examine then the forces
pushing for the dispersion of economic activity, let aside of course transport
costs, the role of which has been already examined.
THE PRICE EFFECT
The NEG has emphasized the advantages for the firm of agglomeration. It has
however underscored some important drawbacks. The firm that locates in an
agglomeration suffers a stiffer competition compared to a firm that locates in a
peripheral area with a much less density of economic activity. More competition
may imply lower prices and then minor profits for the firm located in an
agglomeration. Each time then that a firm move from the small to the big
market, we have two effects on its profitability: a market size effect that, as we
have seen before, makes the agglomeration more attractive, and a price effect
that makes it less attractive. A sufficiently strong price effect may obstacle or
even stop the process of territorial concentration.
CONGESTION COSTS AND EXTERNAL DISECONOMIES
Under the heading “congestion costs” are grouped different factors. Some of
these costs refer to inputs. It is well known that concentration of economic
activity above a certain threshold may result in an increase of prices of
productive factors. The typical example is the price of land that in an
agglomeration may be several times higher than in a peripheral area. Other costs
may refer to the quality of life. People well-being may be affected in
agglomerations by air and noise pollution, traffic congestion, high crime rates,
low social cohesion. These phenomena may encourage workers and firms alike
to move to less chaotic and safer areas, where the standard of living for some
respects is higher. This is what happened in several cities where a part of
population moved to outlying areas where prices were lower and the perceived
quality of life higher.
IMMOBILE FACTORS
A powerful factor of dispersion of economic activity is the immobility of factors.
The Neg approach is based on the hypothesis of mobility of an important part, at
least, of the labour force. This is of course a necessary assumption for
agglomeration to take place. The alternative extreme hypothesis of perfect
immobility would lead to a distribution of the economic activity roughly in line
with that of population. Firms would distribute on the territory in function of
consumers’ demand, which in turn would depend on resident population.
Generally speaking, the lower is the share of mobile labour force and population,
the less is the room for agglomeration processes to occur.
Population and labour force are not the only immobile factors of a territory.
Natural resources, cultural and architectural heritage, some types of human
capital are immobile factors that may represent an important force of dispersion
of economic activity. All territories, peripheral areas included, have, to a greater
or lesser degree, an endowment of endogenous and not transferable resources,
whose exploitation represents a development opportunity.
Let us now put it all together. The spatial effect of economic development
depends on the balance of centripetal and centrifugal forces.
CENTRIPETAL FORCES
MARKET SIZE
CENTRIFUGAL FORCES
TRANSPORT COST
BACKWARD
AND
FORWARD PRICE EFFECT
LINKAGES
MARSHALLIAN ECONOMIES OF SCALE CONGESTION COSTS AND OTHER
DISECONOMIES OF SCALE
OTHER
EXTERNAL
ECONOMIES: IMMOBILE FACTORS
institutions, social capital, public
goods
The final effect of the interplay of these forces cannot be known in advance.
Agglomeration is not an inevitable result of growth but it is a concrete
possibility, confirmed by empirical data.
GEOGRAPHY, ACCIDENTS AND HISTORY IN THE BIRTH, GROWTH AND
MANTAINANCE OF AGGLOMERATIONS
What factors originally determine the distribution of industry? Why
agglomeration in the first place takes place in one region rather than another?
The original reasons behind the concentration of economic activity in one region
rather than another may depend on several factors. Some of these factors may
be linked to the geographical characteristics of the area- such as the presence of
a river or of a canal-(New York) or it may be due to a pure accident (Silicon
Valley). This is not a topic much investigated by Neg economists. What is really
important for NEG economists is that once an agglomeration has taken place, the
original factors that historically had produced that agglomeration, may become
irrelevant. The advantages of locating in a region today may not depend
anymore from the initial advantages but may depend entirely on the advantages
of the agglomeration per se. And these advantages tend to persist, that is there is
a strong element of path dependency in the choice of economic localization
SLIDES 51-52-53
AGGLOMERATION AND EUROPEAN ECONOMIC INTEGRATION
Next step is to understand whether the process of European economic
integration and the creation of the single market affect the concentration of
economic activity or not.
European economic integration has different potential effects. Some of these
effects are expected to be positive for the whole European Union.
POSITIVE EFFECTS OF EUROPEAN INTEGRATION
A first expected positive effect is that of specialization. The openness of trade
within Europe should push national countries to specialize according to their
comparative advantage. The principle of comparative advantage (see below)
establishes that the opening of trade will push countries to specialize in the
sectors where they have a comparative advantage and increase trade in the
sectors where they have not a comparative advantage. For instance, to make a
very simplistic example, if one country has a comparative advantage in textiles
and another country has a comparative advantage in machinery, the opening of
trade between these two countries will push the former country to specialize in
textiles, increasing production in textiles and exporting textiles to the latter
country and will push the latter country to specialize in machinery increasing
production in machinery and exporting machinery to the other country.
Standard international trade theory shows that both countries will benefit from
trade, that is, they will get after trade more of both goods. (under certain
conditions)
A second expected result derives from the exploitation of increasing returns. In
an enlarged market firms could increase their level of production, get economies
of scale and reduce the average cost of production. These efficiency gains would
translate in lower prices and a higher real income of consumers.
A third expected benefit from integration derives from more competitive
markets. The process of integration has been accompanied by measures to make
the markets more competitive and more flexible, eliminating monopoly and rent
positions and distortions of various kind. More competitive markets lead again
to efficiency gains with a reduction of the average costs of production and of
prices.
Other potential positive effects of integration derive finally from increased flows
of knowledge and from an higher mobility of researchers and high skilled
workers with positive effects on the speed of technical innovation.
SPATIAL EFFECTS OF EUROPEAN INTEGRATION
These expected positive effects of integration however refer to Europe as a
whole or to national countries. Nothing is said about their spatial distribution. It
may well be that an overall gain results from a gain of some regions and a loss of
other regions. This will occur if the process of European economic integration
leads to a spatial concentration of economic activity, according to a model of
agglomeration.
Is there any reason why we should expect or at least contemplate the possibility
that the integration process leads to concentration of economic activity and
therefore to an increase in regional inequalities?
The answer is positive. This is so because the process of European integration
leads to a lowering of transport costs, to a larger scope for increasing returns
and to a greater factor mobility.
Lower trade costs, because the integration process and in particular the creation
of the single market, have eliminated all sorts of tariff and non tariff barriers to
trade. Export and import within Europe has been made much simpler and much
cheaper. Further, the huge investment made by the European Union on
infrastructure such as roads, motorways, airports have decreased dramatically
the cost of transport, strictly speaking.
The dramatic enlargement of the size of the market as a result of the integration
process has also led to an increase in the scope of increasing returns to scale.
Firms have a bigger incentive in the new environment to increase their size and
exploit potential increasing returns to scale.
Finally, the integration process has also led to a greater mobility of factors of
production. The goal of the single market was from the beginning to create a
market where not only goods, but also firms, workers and capital could move
feely.
These three changes induced by the single market, lower transport costs, more
scope for increasing returns to scale due to an increase in the overall size of the
market and greater factor mobility, favour the process of economic
agglomeration. These three changes act as centripetal forces in regard to the
localization of economic activity. When transport costs are lower and potential
increasing returns are higher, it becomes more advantageous for the firms to
localize in the region where the market is bigger rather than to open more
plants in various regions, as we have seen in our previous analysis.
REGIONAL AND NATIONAL FACTOR MOBILITY
This conclusion however must be qualified. This conclusion is much more true
for regions and much less true for nations. The reason is that the international
mobility of factors of production is much stronger within a country than
between different countries. Firms and workers are much more mobile within
countries rather than between countries. Agglomeration to take place
presupposes mobility of factors of production.
This may explain why the integration process ha been accompanied by a
narrowing of the income disparities at national level but not at regional level. At
national level agglomeration has been hampered by a still weak mobility of
factors of production while the greater mobility of factors between regions of
the same country has made possible an increase in the spatial concentration of
economic activity.
SINGLE MARKET, EMU AND COHESION POLICIES
The theoretical and potential link between the integration process of the
European Union and the agglomeration of economic activity has been
historically a strong reason to implement cohesion policies. The launch and the
strengthening of the cohesion policies have been always associated with the
plans to create and deep the single market and to proceed towards the monetary
union. There was the conviction that the single market first and the monetary
union afterwards, may produce asymmetric benefits at spatial level. In
particular there was the perception of the risk that backwards countries and
backwards regions could be damaged by the liberalization and unification of the
markets. It was necessary then to implement policies in these regions to remove
the structural obstacles which prevented them to get the potential benefits of
integration. This was clearly so, for instance, in the approach by Jacques Delors
when he launched the single market programme. His approach was not just an
approach of simple market liberalisation. On the contrary, the single market and
cohesion policies had to go hand in hand. The strengthening of cohesion was
presented by the Commission as the sine qua non of the ambitious program of
single market in recognition of the potentially damaging effects of the 1992
Programme on the more fragile economies of the Union. The message found
intellectual support in two influential reports sponsored by the Commission, the
Padoa-Schioppa and Cecchini Reports
It is then not a coincidence that in the mid eighties we have the most important
process of reform of the cohesion policy. The process starts in 1985 changing
the legal basis of cohesion policy through the introduction in the Single Act
Treaty of a specific title of Economic and social cohesion. The policy objective of
the policy was defined in the Treaty as promoting the “overall harmonious
development of the Community and “strengthening economic and social
cohesion” The process ends with the reform of 1988 which changes drastically
the institutional architecture of the policy and which doubles the financial
resources devoted to the policy for the programming period 1988-1993. The
reform transforms the policy from a mere redistribution mechanism of
resources between member states with no role for the Commission to a genuine
regional development tool managed in conjunction by the Commission and by
the Member states.
And it is not a coincidence that economic and social cohesion becomes a core EU
objective on a par with the internal market and EMU in the Maastricht Treaty,
that is in the Treaty which contained the road to monetary unification . And
that the following year a new reform of the cohesion policy is approved which
doubles the endowment of resources for the planning period 1994-1999 and
introduces a new instrument of cohesion.
The necessity and the possibility of conciliating liberalization of the markets and
free competition on one side and social and territorial cohesion on the other
hand represents the heart of the so called European social model. The
intellectual and political conviction that there is not a trade off between
competition and cohesion. The two things on the contrary are, at the very least
compatible, and at most complementary.