The New Economic Geography: an overview COST Action IS1104 Urbino Settembre 2012

Outline Introduction Krugman’s cookbook: main ingredients of NEG models Krugman’s story: self-reinforcing agglomeration NEG Families, modifications and extensions Research questions 2

INTRODUCTION Section I 3

Fujita and Krugman: “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, having a variety of compositions. 4

For example, one type of agglomeration arises when small shops and restaurants are clustered in a neighborhood. 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. 5

It is also important to notice that all this types of agglomeration at different levels are embedded in a larger economy, altogether forming a complex system.” (Fujita and Krugman, 2004, Papers in Regional Science) 6

The aim of the Action is to provide a better understanding of the EU as a complex, multi- level, evolving geographical system, taking duly into account the dynamic processes occuring within such a system and to develop improved strategies for EU regional policies 7

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NEG Central question How does the spatial distribution of industrial activity look like in the long-run? 1.Equally distributed among regions 2.Agglomerated in one region 3.Unevenly distributed over the regions 9

KRUGMAN’S COOOKBOOK: MAIN INGREDIENTS OF NEG MODELS Section II 10

1.General Equilibrium Model (2 x 2 x 2) 2 symmetric and spatially homogeneous regions 2 sectors (M)anufacturing and (A)griculture A perfect competion ; M imperfect competition Two factors of production (mobile and immobile) Full interdependence across (goods and labour) markets 11

2.Increasing returns and imperfect competition Dixit-Stiglitz monopolistic competition No interaction / identical firms Product differentiation/market segmentation Production technology: a fixed component determines decreasing average cost Price: constant mark-up over marginal costs Larger production implies higher profit 12

3.Consumer’s preferences Cobb-Douglas preferences across M and A goods (fixed shares of income allocated to each sector) CES preferences across M varieties (love for variety) Cheaper and/or more numerous goods increase welfare 13

4.Distance and trade Iceberg transport costs (Samuelson, 1952, Economic Journal) Transport cost: exogenous parameter that increases price at destination For notational convenience «trade freeness parameter (between 0 and 1)» Trade is beneficial because it allows access to other regional markets However, location is also important since profits are higher where the local market is bigger (lower transport costs) 14

5.Factor mobility Induced by differentials in factor rewards (wages, profits) The dynamic process of migration/relocation is gradual over time and adaptive Typically in continuous time Link between short and long-run analysis Migration determines the long term spatial allocation of economic activities (the regional shares; whereas the overall amount of productive factors is given) 15

KRUGMAN’S STORY: SELF REINFORCING AGGLOMERATION Section III 16

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 Pivotal: Size of local market for a single firm depends: Overall market size in the region (increases it) Number of firms in the region (reduces it) 18

Thought experiment  one factor unit (i.e. manufacturing workers) and the corresponding firm move from region 1 to region 2 1.Overall size of the market in 1 increases - Market-access or market-size effect (agglomeration force): monopolistic firms locate in the largest market where average production cost is lower and factor rewards are higher 2.Number of firms increases in 1 as well - Cost of living effect (agglomeration force): the local production increases and goods are cheaper Market crowding or market competition effect (spreading force): firms locate in regions with less competitors 19

Self-reinforcing process 1 Demand linked circular causality 20 Production shifting Expenditure shifting Production shifting Expenditure shifting The productive factor and its owner move together:

Self-reinforcing process 2 Cost-linked circular causality 21 Cost of living shifting Production shifting Cost of living shifting Production shifting The productive factor and its owner move together

Stabilizing force 22 productive factor migrates to region 1 Increase in the number of firms lower factor rewards The productive factor shifts back in Region 2 Competion between firms

If agglomeration forces exceed dispersion forces. This leads to full agglomeration If dispersion forces exceed agglomeration forces this leads to symmetric distribution 23

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NEG FAMILIES, MODIFICATIONS AND EXTENSIONS Section IV 30

NEG families: differentiated according to which factor is interregionally mobile Main NEG Variants: most used in the literature Non exhaustive taxonomy of existing modifications and extensions 31

NEG Families Core-Periphery (CP) model (Krugman, 1991, JPE) mobile factor: manufacturing workers immobile factor: agricultural workers technology: M workers both variable and fixed component Footloose entrepreneur (FE) model (Forslid & Ottaviano, 2003, JEG) mobile factor: entrepreneurs/human capital immobile factor: unskilled workers production technology: entrepreneur only fixed component (simpler) Footloose capital (FC) model (Martin & Rogers, 1995, JIE) mobile factor: physical capital immobile factor: workers technology : physical capital enters only fixed component (simpler) no circular causality (much simpler) 32

NEG main variants Constructed capital (CC) model (Baldwin, 1999, EER) - mobile or immobile endogenous physical capital - circular causality via capital construction and destruction may lead to growth (growth poles / growth sinks) Vertical linkages (VL) model (Venables, 1996, IER) - intermediate manufacturing goods enter in production - circular causality via demand and supply linkages (supplier of intermediate inputs locate in larger output markets / firms locate where the number of supplier of intermediate inputs is larger and production costs lower) Global and local spillovers (GS and LS) models (Martin & Ottaviano, 1999, EER; Baldwin, Martin and Ottaviano, 2001, JE Growth) - variants of the CC model that allow for endogeous growth - local spillovers are a dispersion force 33

Taxonomy of extensions 1 Regions asymmetric dis-homogeneous (first nature features) n > 2 Regions Spatial structure Unidimensional (equidistant, racetrack) continuous space Differentiated trade costs Network structure Manufacture Cournot Competition Heterogeneous firms Structure of the Economy Sophisticated modelling of labour market Transport sector R&D activities 34

Taxonomy of extensions 1 Regions asymmetric dis-homogeneous (first nature features) n > 2 Regions Spatial structure Unidimensional (equidistant, racetrack) continuous space Differentiated trade costs Network structure Manufacture Cournot Competition Heterogeneous firms Structure of the Economy Sophisticated modelling of labour market Transport sector R&D activities 35

Taxonomy of extensions 2 Public policy government expenditures, taxation and subsidies Local goverments competition welfare analysis Dynamics Factors relocation, growth, demographic changes Analytical core: processes modelled in continuous time Discrete time: nonlinear maps generating complex behaviour Expectations myopic adaptive behavioural rule Forward looking Preferences Upper-tier: quasi- linear Lower-tier: CES Upper-tier: CES Lower-tier CES Intertemporal choice 36

Taxonomy of extensions 2 Public policy government expenditures, taxation and subsidies Local goverments competition welfare analysis Dynamics Factors relocation, growth, demographic change Analytical core: processes modelled in continuous time Discrete time: nonlinear maps generating complex behaviour Expectations myopic Adaptive behavioural rule Forward looking Preferences Upper-tier: quasi- linear Lower-tier: CES Upper-tier: CES Lower-tier CES Intertemporal choice 37

RESEARCH QUESTIONS Section V 38

Research topic 1  To represent the economy as a multi-regional Network with more ‘realistic’ features. Suggested preliminary steps: 1.Search for the most suitable analytical framework 2.Identification of EU regional specificities (also through data collection, screening and analysis) 3.Identification of the network structure (type of links, strength and number of connections) 4.Implementation of a specific software for the discovery of the network nature and statistical properties 5.Simulation exercises and comparison with real data 39

Research topic 2  To model more elaborated firm relocation decisions (in NEG models very simplistic). Improvements (drawing also from contributions by Dawid; Zou): 1.Can we learn something from the behavioural literature on strategic swithching in (financial) markets (chartist vs fundamentalists, discrete choice models, replicator dynamics, experiment on learning, new experiments on spatial decisions)? 2.Can we learn something from the much more elaborate modelling of IO (strategic interaction, heterogeneous firm, continuous space)? 3.Can we incorporate financial markets and its role in the firm (re-)location decision? 40

Research topic 3  To identify determinants of regional attractiveness not included in NEG models. for a firm several factors (such as local government quality, crime rates, access to credit, legislation, degree of scholarization of the workforce and so on) may affect relocation. Similarly, factors different from wages or remunerations that may affect workers and human capital migration are various (provision of public servicies, housing prices, amenities, work environment, and so on) These indicators can be very useful for a better understanding of the distribution of economic activities. 41

Research topic 4  Literature reviews: To provide an exhaustive taxonomy of the NEG literature. To compare old and new approaches to geographical economics 42

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