Policy and Economic Geography:
What is new?
World Bank, Wash. DC, February 16 2006
Philippe Martin
University Paris 1 Panthéon Sorbonne and CEPR
Two main questions on economic geography:
1) What are the causes of spatial inequality?
2) What should and what can public policies do?
1) What are the causes of spatial inequality?
Main elements of answer from New Economic
Geography models:
 little emphasis on “first nature” geography but
 circular causality mechanisms
 economies of scale and transport costs
 Non linear effects of lower transport costs (easier
trade between regions): a first phase of
concentration, possibly followed by a phase of deconcentration
Simple example of location choice for a firm
(Krugman) with lessons for emerging markets
 central region: large market (or easy access to foreign
markets) but high wages and production costs
 periphery region: small market but low wages and
production costs
 economies of scale: less costly to have only one plant than
two (fixed costs)
 cost to trade (barriers to trade and transport costs)
 choice of location: minimize production + trade costs
production trade costs
medium low
costs
high
produce in
-2 regions
- central region
- periphery region
0
0
0
10
3
1.5
0.75
8
8
4
2
12
Example
suggests:
transport
infrastructures
that
At
lowtrade
trade
costs:
firms exploit
low production
AtAt
Example
high
suggests:
costs,
economic
spatial
concentration
geography
is
may
be
medium
trade
costs,
economic
geography
lower
transport
costs
between
poor
and
rich
costs
in periphery
dispersed
natural
phase
(firms
for
want
emerging
to
be
close
markets
to
all
markets)
becomes
concentrated
because firms exploit
region
may
favor
rich
region
(liberalization)
economies
of scale and trade costs still important
Some implications:
1) Necessary (but not sufficient) condition for periphery
region to develop: compensate geographical
disadvantage by lower costs (wages): important to
allow regional differences in wages (no centralized
bargaining)
2) New Economic Geography models tell us that
periphery status is endogenous
Emphasize self-reinforcing or cumulative
agglomeration mechanisms: firms follow other
firms which follow workers who are also
consumers
Are these mechanisms empirically relevant ?
Empirical results for emerging markets (Brazil):
1) Industries with increasing returns to scale are
mainly located in regions with large markets +
good market access
2) Cost and demand linkages matter (industries
locate close to customers and input providers)
3) Labor intensive industries locate in low wage
regions
Why should policy makers care about economic
geography?
The usual suspects:
 Equity
 Efficiency
Four issues on equity and geography:
First issue: Regional inequality and migration
double effect of labor mobility:
 more agglomeration
 but regional inequalities may have less effects on
welfare
 agglomeration with empty places but less regional
inequalities in GDP/cap
 workers follow firms: both labor supply and labor
demand decrease: effect of spatial concentration on
wages and unemployment rates inequalities are
lower
With low mobility of workers:
 Agglomeration has negative welfare effects on immobile
agents: hurt by departure of mobile factors as both workers
and consumers
 One implication: fostering inter-regional mobility is part of
regional policy
Some public policies make it more difficult:
- public housing (workers who move have to get at end
of line in the other region)
- some labor laws reduce inter-sectoral + inter-regional
mobility
- some unemployment benefits
- legal hurdles (China)
 But not a miracle solution:
- Cultural, ethnical differences: mobility will never be perfect
- firms move faster than workers: transition problem
- The most mobile workers are (usually) the most skilled , those
with high level of “positive externalities”, lost for those staying
behind: Increase in mobility for certain agents may worsen
effects of spatial inequalities on most fragile
 Suggests (valid for emerging markets with basic
functioning markets, not necessarily for poorest
countries)
- concentrate mobility policy on low skilled workers
- to be consistent: concentrate public resources on poor
urban areas
Second issue: Regional and individual inequalities
 Usual view of policy makers: fight regional inequalities
(regional subsidies) is a way to fight individual inequalities
 Is this true? Do wage differences across individuals depend on
geographic factors and not only individual factors (education,
age, sex…)?
Are wages in poor regions lower because?
- 1) poor regions have many low skilled
- 2) firms pay lower wages for given skill due to lower
revenues (far from markets) and higher costs (far from suppliers)
Evidence (need more for developing countries)
Studies using individual data suggest (also in emerging markets ,
Brazil)
- most of explained differences in individual wages is due to
individual characteristics (education, age, sex) : 2/3
- suggests priority is education in poor regions as a regional
policy
- but still 1/3 explained by economic geography in particular
market potential: i.e. size of market for firms
- market potential difference across regions explains twice
as much of wage variance as discrimination against women
- economic geography still matters for inter-personal
inequality
Third issue: Do spatial inequalities lead to individual
inequalities or is it the reverse?
- In Poland for example: evidence going in both directions
 the increase in individual inequalities (higher return to
education and skills) may have led to an increase in spatial
inequalities: those in the big cities are those with human capital
(composition effect)
 FDI has been concentrated in richer regions and has led to
increase in relative labor demand (geography effect)
Fourth issue: Do subsidies to firms investing in poor
regions take from the poor of rich regions to give to the
rich of poor regions?
 subsidies to firms relocating in poor regions are often subsidies
to capital: capital is mobile so if return to capital increases in
poor region should increase also in rich region
 reducing regional inequalities (through subsidies to capital and
not labor) may increase inequalities between workers and capital
Efficiency argument for regional policies
 Is spatial agglomeration of economic activities efficient or “an
underutilization of economic and social potentials”?
 if economies of scale exist: some agglomeration must be
efficient
- internal economies of scale: save on transport costs and
fixed costs for firms
- external economies of scale: localized spillovers are
maximized with spatial concentration (many empirical studies on
this, also in developing countries: not only high tech)
 at what level does congestion makes agglomeration inefficient?
- congestion depends on public policies (urban infrastructure)
Is there a efficiency-equity trade-off at the spatial level?
 If growth poles or clusters are necessary to trigger the
growth of a country: difficult economic choice
 what should be the priority?
- External convergence of the country
-Internal convergence between regions inside the
country
- if trade-off exists, public policies that have a spatial
dimension (public infrastructure, regional
subsidies…) have to explicitly take it into account
 What is the evidence for this tradeoff?
Evidence for trade-off: European regions (NUTS1) GDP/cap and
regional inequality (Crozet and Koenig, 2005)
Does this trade-off hold for developing countries?
Short answer: we don’t know ! Need for research on this
Reasons for which the trade-off may be less important
(or even reversed) :
-1) in poor countries with little manufacturing, mechanisms
based on economies of scale will matter less
- 2) under-utilization of capital and labor in poor regions
(capital and labor market failures)
- 3) congestion problems (cities) due to insufficient public
resources may be more important
- 4) inter-regional, ethnic conflicts may be more important
in countries with more regional inequalities
Reasons for which the trade-off may more important
in developing countries:
- 1) in emerging markets, growth is based on
manufacturing: mechanisms based on economies of
scale will matter a lot (more than in service based
economies)
- 2) in emerging markets, industrial clusters are
in formation: important not to counter them
- 3) export-led growth favours coastal cities
(China) : most international trade is made between
cities; and regions close to export market (Mexico)
Regional policies are difficult to evaluate
- economic geography is a cumulative process: firms
follow other firms which are their consumers and their
input producers
implication: very non linear effects of regional policies
-a policy that gives subsidies to a poor region may have
no effect at all if does not put into motion a cumulative
process (agglomeration rent)
-rarely, a small public policy may have very large
effects when economic geography is not settled
(anecdotal evidence is biased!)
Infrastructure policies:
 demand and supply effects may be of opposite
sign
Example: transport infrastructure between poor and
rich region
- short term (keynesian) positive effect : local
politicians are likely to only care about these
- more complex supply long term effect
Lower transport costs between rich and poor region:
 can make it easier for firms in sectors with
economies of scale to concentrate production in the
large market and re-export in the poor region:
increases agglomeration (but may be efficient)
Lower transport costs inside poor region (local roads)
 increases effective market size: relocation towards
poor region: efficient?
 empirical studies show mixed results of regional
policies
- non surprisingly: positive short-term effect
- controversial on the long term
 basic infrastructure (education, health, transport,
etc.) in the poorest regions of these countries may
contribute to reduce labor mobility: problem if do not
attract firms too
Again: equity-efficiency trade-off
growth
GG
-lower inter-regional
transport costs
- liberalization of trade
(inter-regional and
international)
AA
agglomeration
growth
- education policy
GG
AA
agglomeration
Conclusion: some debatable implications (for emerging
markets):
1) market forces may lead to economic geography that is not
concentrated enough (from a pure efficiency point of view)
- 2) agents in poor regions can gain from agglomeration in richer
regions if increases growth of country (if enough mobility)
- 3) transport infrastructure between rich and poor regions may
lead to more concentration rather than less but this may be good
- 4) Education policy in poor regions may help both reduce interregional inequalities and increase mobility
- 5) public policies should facilitate migration to growth poles
which implies more resources for public services in those regions
(congestion)