The core-periphery model with asymmetric inter-regional and intra-regional trade costs Vasco Leite Phd student from Faculdade de Economia. Universidade.

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The core-periphery model with asymmetric inter-regional and intra-regional trade costs Vasco Leite Phd student from Faculdade de Economia. Universidade do Porto. Portugal. Sofia B.S.D. Castro CMUP and Faculdade de Economia. Universidade do Porto. Portugal. João Correia-da-Silva CEMPRE and Faculdade de Economia. Universidade do Porto. Portugal. 1

Krugman’s model versus Our model Asymmetric internal and external trade costs

Why are asymmetric trade costs important to industrial location? Trade costs are highly variable across countries. (Anderson and Wincoop, 2004). Differences in trade costs explain some of the income inequality across countries (Redding and Venables, 2004). In industrialized countries trade costs are equivalent to a 170 % ad valorem tax that can be decomposed in the following way (Anderson and Wincoop, 2004). About 55% of them are domestic trade costs, and they are associated with local distribution; About 74% of them are international trade costs. What is the impact of asymmetric internal and external trade costs on the spatial distribution of the industrial activity and on the welfare of the different interest groups in an economy? 3

Model: assumptions The economy comprises two regions and two sectors. Regions are symmetric in terms of technology, preferences, factor supply, but they can differ relatively trade costs. The agricultural sector is perfectly competitive and produces a homogeneous good under constant returns to scale, using only farmers, who are immobile between regions, and farmers get a constant wage. The manufacturing sector is monopolistic competitive (Dixit-Stiglitz) and produces a continuum of varieties of a horizontally differentiated product under a fixed cost and a constant marginal cost, using only workers, who are mobile between regions. The wages are endogenous. 4

…. A fraction of the population works in the manufacturing sector, μ while the other fraction works in the agricultural sector, 1-μ. Given both the symmetric distribution of the peasant population and their immobility between regions, the agricultural population in each region is (1- μ)/2. The industrial population in region 1 and 2 is L1 and L2 , and f = L1 /(L1 + L2 ) is the share of workers in region 1. Finally, the trade of manufactures includes an “iceberg" transportation cost. Of each unit of manufactures shipped from one region to the other, only a fraction 0< ij <1 arrives. Thus, a high ij corresponds to a low transportation cost. The transportation of agricultural products is assumed to be costless.

Equilibrium Given the preferences, technology and trade costs, consumers and firms interact to determine equilibrium prices and quantities in the markets for goods and labour. The real wage in each region is the quotient between the nominal wage, Wi and the price index, Pi. The ratio of real wages is: , where μ is the weight of the industrial sector in the economy, σ is the elasticity of substitution between the industrial products, and f=L1/(L1+L2) is the share of manufacturing labor force in region 1, with: 0 ≤ f≤1

Equilibrium Short-run equilibrium (f is predetermined) : The short-run equilibrium determines the relative real wage taking as given the amount of the industrial workers in each region. Long-run equilibrium: The long-run equilibrium is a situation where migration does not occur and there are two possible outcomes: Dispersion: The industrial activity is equally distributed between regions, f=0.5. Concentration: All industrial activity is concentrated in one region. f=1 (all industrial activity is concentrated in region 1); f=0 (all industrial activity is concentrated in region 2).

Dispersion stability A Dispersion is a stable equilibrium if and only if: A

Concentration stability Concentration in region 1 is a stable equilibrium if and only if : Concentration in region 2 is a stable equilibrium if and only if: A

Results Asymmetric internal transportation costs: Asymmetric external transportation costs:

Asymmetric internal transportation costs

The spatial distribution of industrial activity A decrease in the internal transportation costs in region 2 Short-run Long-run

The welfare analysis in the short-run Analytical results show the impact on the welfare of each interest group. Workers ( are mobile) Region 1: Region 2: Farmers (are immobile) Region 1: Region 2:

Asymmetric external transportation costs

The spatial distribution of industrial activity A decrease in the cost to transport products from region 1 to region 2. Short-run Long-run With a low weight of the industrial sector in the economy, μ: With a high weight of the industrial sector in the economy, μ:

The welfare analysis in the short-run Analytical results show the impact on the welfare of each interest group. Workers Region 1: Region 2 : With a low weight of the industrial sector in the economy: With a high weight of the industrial sector in the economy: Farmers Region 1: Region 2:

Conclusion -The decrease in the internal trade costs in one region only penalizes the workers in the other region; -If the weight of industrial sector is high, a decrease in the external trade costs in one region only penalizes the farmers in that region. Welfare Region 1 decreases: Industrial activity in region 1 Workers in region 1 Workers in region 2 Farmers in region 1 Farmers in region 2 The internal trade cost + (-) The external trade cost + if μ (-) if μ