Space and Economics (or did Krugman deserve his Nobel Prize?)

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Space and Economics(or did Krugman deserve his
Nobel Prize?)

• Danilo C Igliori
• 2015

Departamento de Economia Universidade de São Paulo
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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

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MotivationUnderstanding 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.

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FactsAgglomerations

• 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.

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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.

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FactsInternal 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.

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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?

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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.

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Concentration and Dispersion
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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!

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Models with Constant Returns

• Starret and the Spatial Impossiblity Theorem
• Thunens monocentric cities
• Hotelling and market areas

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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).

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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.

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Modern Modelling ApproachesThe 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.

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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.

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Utility Function
Subutility Function
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Love for Variety
(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.

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Internal Increasing Returns
Labour requirement in the manufacturing sector
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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 Core-Periphery
  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
  (Dixit-Stiglitz) focused on increasing returns,
  pecuniary externalities and transport costs

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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.

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Transport Costs(Samuelsons Iceberg)
Migration Equation
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Source Baldwin et al (2003)
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The 3 Effects

• The mechanics of the model is driven by three
  effects
• market access,
• cost of living,
• market crowding.

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Tomahawk Diagram
Source Baldwin et al (2003)
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Policy Implications

• threshold effects
• Discontinuities
• hysteresis.

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Whats 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
  thatunlike most traditional spatial analysisare
  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)

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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.

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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)

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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
• The spatial equity-efficiency trade-off
• Static losses x dynamic gains
• Moving goods x moving ideas

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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.

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Local Spillovers - Forces

• Endogenous growth and knowledge accumulation as
  agglomeration forces
• Knowledge spillovers as a dispersion force

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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

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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.

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Transport Revenues
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Income x Density
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Business Services x Density
FIRE Finance, Insurance and Real Estate
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Manufacturing x Density
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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.

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Understanding the Future

• Glaeser and Kohlhase view is that such a model
  would have the following basic elements
• Productivity would be a function of agglomeration
  because there are gains from people being able to
  interact.
• The key transport mode the automobile travels
  much faster on highways than on city streets and
  is subject to congestion effects.

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Understanding the Future

• 3. Physical output is generally relatively
  costless to ship.
• Even though output is almost costless to ship,
  most people produce services that require
  facetoface interaction. Moving people is still
  expensive.
• Land is heterogeneous and some places are nicer
  than others.

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Beyond Geographycal Space

• Economic distances
• Product characteristics
• Political spectrum
• Knowledge space

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Spatial Economic Analysis

• http//www.tandf.co.uk/journals/titles/17421772.as
  p