Space and Economics
(or did Krugman deserve his Nobel Prize?)
Danilo C Igliori
2015
Departamento de Economia
Universidade de São Paulo
Road map
1. Motivation
2. Facts
3. Questions
4. Concentration and Dispersion
5. Beyond my scope
6. Constant returns
7. Increasing returns
8. The Dixit-Stiglitz Approach
9. Krugman and the NEG
10. Growth and Agglomeration
11. Moving goods x moving ideas
12. Beyond geographical space
Motivation:
Understanding Economic Landscapes
• Spatial analytical structures can help to shed
light on a number of relevant economic issues;
• The implications of the spatial configuration of
economic activities are numerous, affecting,
among other things: economic growth, industrial
organisation, technological progress, welfare
levels, inequality, and environmental problems;
• Space has not to be necessarily geographical
space.
Facts:
Agglomerations
• The spatial distribution of population and economic
activities is extremely unequal.
• At any geographical scale it is the case that
agglomerations are pervasive.
• At a global scale it is easy to see that income and
GDP are concentrated in a small number of countries.
• However, the spatial concentration within countries is
equally important, with economic landscapes
reflecting the variety of cities and urban systems.
Facts:
Cities, Clusters and Industrial Districts
• On the one hand we see large metropolises such as
New York, London, Paris and Tokyo (or Sao Paulo,
Mexico City and New Delhi).
• On the other, there are specialised cities or regions
forming industrial districts and economic clusters
such as the Silicon Valley or the Third Italy.
2
Facts:
Internal Structure of Cities
• Agglomerations are also found at smaller scales,
forming the internal structure of cities.
• We see commercial districts where shops and
restaurants cluster in neighbourhoods or even in a
single street (one could also think of offices and job
centres)
• In the extreme case we can think of a shopping mall
as a small agglomeration.
Questions
• What are the economics behind the tendency for
people and firms to agglomerate in space?
• What are the agglomeration advantages?
Disadvantages?
•
What are the incentives for formation of urban
systems (and rural areas)?
• What are the implied dynamics generated by different
spatial configurations?
Concentration and Dispersion
• In general, the spatial configuration of
economic activity is the outcome of processes
combining two groups of opposite forces:
agglomeration forces and dispersion forces.
• The recent literature of spatial economics
emphasizes the fundamental link between
these forces and the existence of transport
costs, increasing returns to scale,
externalities and imperfect market structures.
Concentration and Dispersion
Beyond my Scope
•
•
•
•
•
•
German tradition (Christaller, Losch, Weber)
Regional Science (Isard)
Economic Geographers
Kaldor
Evolutionary economics
Trade issues
...I have no ambitions to do justice to the field!
Models with Constant Returns
• Starret and the Spatial Impossiblity Theorem
• Thunen’s monocentric cities
• Hotelling and market areas
The Role of Increasing Returns
• Indivisibilities;
• Adam Smith and market size;
• Alfred Marshall and industrial districts;
• Jane Jacobs and city life;
• Limits to increasing returns (congestion
effects).
Innovation and Tacit Knowledge
• Increasing returns to innovation is crucial for
understanding the performance of urban areas;
• Different places host different combinations of
Marshall and Jacobs Externalities;
• The concept of tacit knowledge is key in the
theoretical literature.
• Empirical testing is a major issue.
Modern Modelling Approaches:
The Increasing Returns Revolution
• Dixit, Avinash K. and Stiglitz, Joseph E. "Monopolistic
Competition and Optimal Product Diversity." American
Economic Review, June 1977, 67(3), pp. 297-308
• Krugman, Paul R. (1979), "Increasing Returns,
Monopolistic Competition, and International Trade",
Journal of International Economics, 9(4) 469-479.
• Romer, P. (1986). Increasing returns and long-term
growth. Journal of Political Economy, 94(5): 1002-37.
• Krugman, Paul, 1991. ‘Increasing Returns and Economic
Geography’, Journal of Political Economy, vol. 99(3),
pages 483-99.
The Dixit-Stiglitz Approach
• Application: Industrial Organisation;
• Structure: 2 sectors economy (one Walrasian;
one facing monopolistic competition and subject
to increasing returns);
• Market size, love for variety and external
economies.
Utility Function

1 
U M A
Subutility Function
1




M    m(i ) di 
0

n
0   1
Love for Variety
1

1 
(CES)
• The parameter rho represents the intensity of
the preference of variety.
• When rho is close to 1 manufactured goods are
nearly perfect substitutes.
• As rho decreases toward zero, the desire to
consume a greater variety of goods increases.
Internal Increasing Returns
l (i )     m (i )
Labour requirement in the manufacturing sector
The Core-Periphery Model
• The workhorse of the so-called New Economic
Geography was first proposed by Krugman
(1991) and has been labelled as the CorePeriphery Model.
• Although recognising the value of the three
sources of externalities originally proposed by
Marshall, in the Core-Periphery Model Krugman
adopts a highly parsimonious setup (DixitStiglitz) focused on increasing returns, pecuniary
externalities and transport costs
The C-P Model
• The Core-periphery model has been celebrated
for providing several insights about the
geography of economic activities through
behavioural and formalised models.
• However, it has important limitations as well.
Transport Costs
(Samuelson’s Iceberg)
1
T rs
Migration Equation

 r   ( r   ) r
Source: Baldwin et al (2003)
The 3 Effects
•
The mechanics of the model is driven by
three effects:
1. market access,
2. cost of living,
3. market crowding.
Tomahawk Diagram
Source: Baldwin et al (2003)
Policy Implications
• threshold effects;
• Discontinuities;
• hysteresis.
What’s New About NEG?
‘Since 1990 a new genre of research, often described as the
‘new economic geography’, has emerged. It differs from
traditional work in economic geography mainly in adopting a
modelling strategy that exploits the same technical tricks
that have played such a large role in the ‘new trade’ and
‘new growth’ theories; these modelling tricks, while they
preclude any claims of generality, do allow the construction
of models that—unlike most traditional spatial analysis—are
fully general-equilibrium and clearly derive aggregate
behaviour from individual maximization.
The new work is highly suggestive, particularly in indicating
how historical accident can shape economic geography, and
how gradual changes in underlying parameters can produce
discontinuous change in spatial structure. It also serves the
important purpose of placing geographical analysis squarely
in the economic mainstream.’ Krugman (1998)
Neary on NEG
• The problem with this kind of model is that it
is too simple. The focus is on monopolistic
competition as the cause of agglomeration.
• It is true there is some benefit to be derived
from focussing on a single feature, this type of
model is essential for understanding the
world.
• But no monocausal model can hope to capture
the complexity of any applied problem,
certainly not one where firms are all identical,
infinitesimal in size, the CES function is so
important to the outcome and externalities are
dealt with in such a limited way.
Glaeser on Krugman
‘Krugman (1991) shows that a brilliant theorist
can explain cities without non-market
interactions. But it is less obvious to me why
one would want to do so. The flow of ideas
and values that occurs through face-to-face
interaction may be the most interesting feature
of a city’
E. Glaeser (1999)
Agglomeration and Growth
•
By introducing externalities associated with
knowledge accumulation it is possible to merge
spatial with growth models (see Baldwin et al
2003)
•
Key Issues:
1. The spatial equity-efficiency trade-off
2. Static losses x dynamic gains
3. Moving goods x moving ideas
Global x Local Spillovers
• Baldwin et al (2003) propose 2 different models:
one with global spillovers and another with local
spillovers.
• They aim to capture the impact of knowledge
transfers of different kinds.
Local Spillovers - Forces
• Endogenous growth and knowledge
accumulation as agglomeration forces
• Knowledge spillovers as a dispersion
force
Local Spillovers - Outcomes
• Policies reducing transport costs for goods
encourage agglomeration
• Policies that lower the cost of transporting both
goods and public knowledge may avoid extreme
agglomeration.
• Key: Congestion levels in central areas
Glaeser and Kolhase
• Transport costs are still important, but the
relevant transport costs are likely to be for
moving people, not goods.
• The advantages from proximity to other
people appear to come from saving the
costs of providing and acquiring services
and from improving the flow of knowledge.
Transport Revenues
Income x Density
Business Services x Density
FIRE – Finance, Insurance and Real Estate
Manufacturing x Density
Explaining the Past?
• urban economics and the new economic
geography need updating.
• Both frameworks are analytically beautiful
and remarkably apt characterisations of
the city of the past.
• But a new regional model, without centres
and without transport costs for goods, will
better capture the future of the city.
Understanding the Future
•
Glaeser and Kohlhase view is that such a
model would have the following basic
elements:
1. Productivity would be a function of
agglomeration because there are gains from
people being able to interact.
2. The key transport mode – the automobile –
travels much faster on highways than on city
streets and is subject to congestion effects.
Understanding the Future
3. Physical output is generally relatively costless
to ship.
4. Even though output is almost costless to ship,
most people produce services that require
face–to–face interaction. Moving people is still
expensive.
5. Land is heterogeneous and some places are
nicer than others.
Beyond Geographycal Space
• Economic distances
• Product characteristics
• Political spectrum
• Knowledge space
Spatial Economic Analysis
• http://www.tandf.co.uk/journals/titles/17421772.asp