1 Lecture 1: July 4, 2007 Dimetic workshop Pécs, Hungary NETHERLANDS INSTITUTE FOR SPATIAL RESEARCH Modeling the spatial pattern of economic activities in the New Economic Geography I Mark Thissen

2 Contents Introduction to the New Economic Geography Agglomeration economies: Policy relevance A NEG application: RAEM a Spatial Applied General Equilibrium model The size of agglomeration effects Policy implications

3 NEG and Economies of Agglomeration: Literature Overview Baldwin, R., Forslid, R., Martin, P., Ottaviano, G., and Robert-Nicoud, F. (2003), Economic Geography and Public Policy, Princeton University Press, Princeton, New Jersey. Fujita, M., and Thisse J.F. (2002), Economics of Agglomeration: Cities, Industrial Location and Regional Growth, Cambridge University Press, Cambridge. Krugman, P. (1980,1991), Several Articles. Labour market Pissarides, C.A. (2000), Equilibrium Unemployment Theory, MIT Press, Cambridge Massachussetts. Applied Spatial CGE and Monopolistic competition Venables, A.J. and M.Gasiorek, 1996, Evaluating Regional Infrastructure: A Computable Equilibrium Approach, Mimeo, London School of Economics, UK Venables, A. (1996), Equilibrium Locations of Vertically Linked Industries, International Economic Review 37, pp

4 NEG: Stylized facts Agglomerations; city’s and size differences Income and productivity differences among region’s Trade; comparable products (intra-sector trade) - Yellow and green pencils

5 Space and perfect competition: The spatial impossibility theorem Homogeneous space No trade because of transport costs No cities because of land prices “Back-yard capitalism” Solutions Homogeneous space and indivisibilities No equilibrium possible (people move or firms move) Heterogeneous space The rise and decline of cities (explanation and why not more often?; no path dependency) Are spatial differences large enough Intra-sector trade

6 NEG: Imperfect competition and economies of scale Love of Variety Demand for slightly different (unique) products Consequence: Economies of scale and market power Monopolistic competition Many different firms and products Endogenous number of firms

7 NEG: Why Cities and Agglomerations Agglomeration effects: Locate close to large market Market-access: firms minimize transport costs Variety effect: benefit of many varieties Cost of living effect: consumers minimize transport costs Dispersion effects: Locate far away from large market Market-crowding: firms try to escape competition Housing costs: consumers search for low housing prices Congestion: communication and transaction costs

8 Welfare Accessibility Capital NEG, Economics in Space and Time Infrastructure investment Transport innovations Industrial investment

9 Infrastructure and NEG: An Example Congestion Versus Space

10 The Firm and Agglomeration effects

11 The Firm: Increasing city size

12 The Firm: A new road

13 Agglomeration economies: Spatial Dynamics over time. Urbanisation and agglomeration In the presence of agglomeration effects there are large gains to be made by increasing agglomeration size. There is place for different size of agglomerations at different locations (not only one big agglomeration). Multiple solutions and path dependency. However: First Welfare Theorem is no longer valid External effects of our behaviour are not taken into account in our decisions. These effects may be negative or positive. Negative outcomes if there are agglomeration forces driving migration with strong congestion effects. The dynamics of the path determine the outcomes via path dependency. Other markets?

14 Agglomeration economies: Policy relevance First Welfare Theorem We Need a Government! Spatial Planning Housing and city size; construction for the unemployed Value of open space and the environment Social Policy Supporting the perifery: Poor scientists and Rich cleaning ladies? Infrastructure Making Agglomerations

15 Infrastructure: Roads to development? 1.How large are agglomeration economies in the Netherlands? - Benefits of infrastructure projects only based on demand curve? 2.How does accessibility affect economies of agglomeration? - Should we open up the periphery? 3.Where are the largest benefits from agglomeration economies? - Which road improvements give us the largest additional benefits

16 NEG: RAEM A Regional Applied Equilibrium Model for the Netherlands Production:Cobb Douglas IntermediateVarieties Consumption:Varieties Market:Monopolistic competition Transport:Separate sector (no iceberg costs) Labour:Search behavior Imperfect competition

17 production/utility commuting Indirect effects: Internalized External Effects # varieties Amount of variety Substitution elasticity Varieties on Consumption and product markets Labour market (Spatial Beveridge curve) unemployed Vacancies travel time

18 The Empirical Research: RAEM Estimate ‘Direct Effect’ by use of transport demand function Direct effect: Benefit to all users of roads Equals perfect competition outcome Regions Region connectivity (40 simulations) Between regions (1600 simulations) Estimate ‘Total Effect’ with RAEM model NEG and Labour market imperfections results: Multiplier = total effect divided by direct effect

19 Multiplier = total effect divided by direct effect indicator for: the size of the agglomeration effect All multipliers would be equal to 1 in the absence of agglomeration effects and imperfect markets The return on infrastructure investment Investments in infrastructure in the Netherlands are based on so-called direct effects. Marginal direct effects are expected to be equal in equilibrium and proportional to the costs of Infrastructure

20 Results Regional Analysis (Commuting) Negative effects –Pushing labour out of agglomeration A R U Strong agglomeration economies in “Randstad” –Amsterdam –Rotterdam –Utrecht

21 Amsterdam versus Zaanstreek The Zaanstreek Labor market –Difference in Out- and In-commuting –Total effect lower (double counting internal commuting) Out-CommutingIn-CommutingCommuting

22 Results Inter-Regional Analysis (Commuting) Agglomeration economies in Regions –Shift of Jobs Identify agglomerations –Definition (National) –Inflows are important –No Rotterdam Arnhem- Nijmegen

23 Inter-Regional Analysis (Commuting & Trade) Longer distances important –Regional specialization and economies of agglomeration Intra-regional connection less important Relations to the east more important Agglomeration larger –Randstad

24 Commuting & Freight Main Roads Commuting

25 Conclusions 1.Agglomeration economies are important in the Netherlands, with Amsterdam the Core agglomeration. 2.Short distances within cities are more important for commuting than longer distances Spatial Shift of jobs 3.Long distances are more important for trade in goods Specialization and Agglomeration 4.Underestimation of benefits: Multipliers on important roads between 1.25 and Overestimation of benefits: Mutlipliers on non-important roads between 0.25 and 0.75

26 Questions on NEG and emperics 1.Migration and agglomeration effects. Are congestion effects taking over? What about the first welfare theorem? In other words: are the benefits of the migrant still larger then the disbenefits of the people in the agglomeration. 2.Regional distribution and Governance. Do we get rich people and poor regions or vice versa? 3.Agglomeration effects are due to what? We need more theory and more empirics! Knowledge spillovers? Linkages? Labour market?