1. Lecture 3c ECONOMIC GEOGRAPHY: THE CORE-PERIPHERY MODEL By Carlos Llano, References for the slides: Fujita, Krugman y Venables: Economía Espacial. Ariel Economía, 2000. Materiales didácticos de diferentes autores: Baldwin; Allen C. Goodman; Bröcker; J. Sánchez

2. 1.Introduction. 2.Core-Periphery Model (FKV, 1999). 1.An intuitive view. 2.The model. 3.Implications. 3.Conclusion. 4.Applications. Index

3. Tema 5 -EE Gobalización, comercio internacional y economía geográfica 3 1. Introduction

4. Tema 5 -EE Gobalización, comercio internacional y economía geográfica 4 1.The Dixit-Stiglitz model is the starting point of the monopolistic competition models (DS, 1977). 2.FKV-99 present a spatial version of the DSM: 2 regions; 1 mobile productive factor (L= labor). 2 products: Agriculture: residual sector, perfect competition, constant returns to scale. Manufacturing: product differentiation (n varieties); economies of scale; monopolistic competition; Goods mobility (transport costs) but not factors Iceberg transport cost for both goods. 1. Introduction

5. Tema 5 -EE Gobalización, comercio internacional y economía geográfica 5 Conclusions of the Dixit-Stiglitz-spatial model: 1.Price Index Effect (Forward Linkage): the region with a larger manufacturing sector will have a lower price index for manufactured goods, since a small part of manufacturing consumption in this region is carrying the transport costs. (the region is self-sustainable). 2.Home market Effect (Backward Linkage): an increase in the manufacturing demand (dY/Y) causes: If labor supply is perfect elastic: a more than proportional increase in production and employment (dL/L). A country/region with an idiosyncratic demand of a product become a net exporter rather than a net importer. If the labor supply is positive : part of the home market advantages results in higher wages rather than in exports causing the agglomeration of high-qualified labor. 1. Introduction

6. Tema 5 -EE Gobalización, comercio internacional y economía geográfica 6 Basic Model: Assumptions of the Core-Periphery Model (FKV, 1999): –2 countries (north-south) –2 sectors (A agriculture. & M manufacturing) –1 factor labor. 2 specializations: agricultural L A and manufacturing L M. Only L M is mobile Migration is based exclusively in the wage differences in L M. –There are only transport costs in M: in the form of iceberg costs ( T rs ) The short run model: L M is only used in producing M (DS sector) L A is only used in A (Walrasian model or perfect competition) 2. The Core-Periphery Model: an intuitive view

7. Tema 5 -EE Gobalización, comercio internacional y economía geográfica 7 Sector-M (Manufactures) - Dixit-Stiglitz Model monopolistic comp. - Increasing Returns to Scale: Fixed + Variable costs North & South Mkts L A (immobile factor ) L M is moving according to the differences in real wages, w-w*  w/P - w*/P* Z is the freeness of trade: (if T=1, Z=0, trade is costless; if T=∞; Z=1 trade is impossible) Iceberg transport costs and “the index of freeness of trade varies between 0> Z >1 Sector-A (agriculture) -Walrasian (CRS & Perf. Comp.) -Variable Costs = a A units of L per unit of A -A is the numeraire (p A =1) L M (mobile factor ) North-South and South-North Migration No costs of trade

8. Tema 5 -EE Gobalización, comercio internacional y economía geográfica 8 Build Intuition: Study model with symmetric nations This model describes 3 localization forces:  2 agglomeration forces (symmetry de-stabilizers) Relationships between costs & demand (agglomeration forces)  1 dispersion force (symmetry stabilizer) Local competition (dispersion force), Two key variables : T and λ  T= transport cost;  λ = % of the industry in the North.  In the beginning it will be λ= 1/2. Then it can tend to concentration.  The proportion of the industry and its employment in a region is the same. 2. The Core-Periphery Model: an intuitive view

9. Tema 5 -EE 9 Backward and Forward Linkages λ =1/2 (initially) We consider a “migration shock” dλ >0 Backward (i.e. demand-wages) Linkage Adjusts in Expenditure Market Size Effects: The market in the North grows, in the south it decreases. Adjusts in Production Due to the costs of trade firms prefer to settle in large markets. This attracts+ L M. The L M migrated spends its income in the North rather than in the South. 2. The Core-Periphery Model: an intuitive view

10. Tema 5 -EE 10 λ =1/2 (initially) We consider a “migration shock” dλ >0 Forward (i.e. costs-prices) Linkage Adjusts in Production Price Index Effect: P-North falls, P* South rises Adjusts in Production (+ migration) Ceteris paribus, Smaller costs-of-living Attract + L M Now + varieties are produced in the North than in the South The Northern import Varieties and due to < less costs of trade lower P & higher P*. 2. The Core-Periphery Model: an intuitive view

11. Tema 5 -EE These two centrifugal forces (BL and FL, which push towards “agglomeration”) opposes to a stabilizer force: “Local competition” Ceteris Paribus, firms will tend lo settle where there is a smaller number of competitors. Results => this stabilizer force push towards “dispersion” of the economic activity, that is, an “equal distribution” of manufactures in North and South. Thus, it oppose “agglomeration”. 2. The Core-Periphery Model: an intuitive view

12. Tema 5 -EE Gobalización, comercio internacional y economía geográfica 12 Labor forces: L A agricultural workers and L M manufacturing workers, The L A is given. L M is initially given, but then will move looking for higher wages. Therefore, the geographical distribution is exogenous (first) but endogenous (afterwards): Φ r (phi): exogenous share of the agricultural labor force in region r. λ r (lambda): share of manufacturing labor force ( L M ) in region r. To simplify, it is assumed that the initial share of manufacturing employment is: ( L M =µ ; L A = 1- µ). 2. The Core-Periphery Model: the model

13. Tema 5 -EE 13 2. The Core-Periphery Model: the model The agricultural wages equal 1 in both regions: The manufacturing wages may differ. The migration of the workers between N-S is determined by the differences in wages: –If the real wage is below the average real wage, people migrate: Average real wage The variation in the share of manufacturing workers in region r depends on the difference between the wage and the average

14. Tema 5 -EE 14 2. The Core-Periphery Model: the model 2. Instantaneous equilibrium: on instant t. –Simultaneous solution of 4 equations: 1. Income: Since W A =1 for every r; the income for every region r depends on its corresponding share of manufacturing workers and its corresponding wage. 2. Price index: expression from the DS. Model : –The price index in r tends to be lower when the share of manufacturing (λs) in the nearest regions to r (those with low transport costs to r) increases. –Thus, due to the concentration of industry in one region, prices decreases in the later and rises in the others ( Forward linkage effect ).

15. Tema 5 -EE 15 2. The Core-Periphery Model: the model 3. Nominal wages: it shows the level of wages at which manufacturing in region r breaks even: –If the price indexes in all regions were similar, the nominal wage in region r tends to be higher if the income in the other nearest regions (low T rs ) is high. –Firms pay >w if they have access to a larger market. Backward linkages.

16. Tema 5 -EE 16 2. The Core-Periphery Model: the model 4. Real wages: nominal wage deflated by the cost-of- living index in region r. The differences between regions only depend on the manufacturing worker’s real wage and the price indexes in those regions. Agricultural workers always earn = and the price of its products is =1 (perfect competition). Solution of the basic C-P model. We analyze the solution when R=2. We wonder if manufacturing tends to concentrate, inducing: –Differences in prices, income and wages. –A pop-up of a manufacturing “core” vs an agricultural “periphery”.

17. Tema 5 -EE 17 2. The Core-Periphery Model: the model 2.3. The CP Model: Statement and Numerical Examples 2 regions * 4 equations= 8 equations for equilibrium:

18. Tema 5 -EE 18 “wiggle diagram” High transport cost; T=2,1 σ= 5; μ=0,4 1/2 0 1 λ = percentage that represents manufacturing in region r(1) 2. The Core-Periphery Model: implications 0 W 1 -W 2 >0 if λ<0,5 When manufacturing is + concentrated in R=1 (λ>0,5), its labor force earn – (+ competition, less ec. scale, expensive production) Workers migrate to the other one. It tends to the symmetric equilibrium in manufacturing. Similar scenario to the movement of factor L without trade (Lesson 4)

19. Tema 5 -EE 19 Low transport cost, T=1,5 σ= 5;μ=0,4 1/2 0 1 2. The Core-Periphery Model: implications 0 W 1 -W 2 <>0 for any λ The + share of manufacturing + agglomeration forces due to: – BL: the > local market, > nominal wages. – FL: the > variety of locally produced goods, < price index. Tendency towards agglomeration. Unstable Equilibrium even when λ=0,5 λ = percentage that represents manufacturing L in region r (1) (remember that we assume (λ r =μ r )

20. Tema 5 -EE 20 “wiggle diagram” Intermediate transport costs; T=1,7 σ= 5;μ=0,4 1/2 0 1 λ =percentage that represents manufacturing in region r 2. The Core-Periphery Model: implications 0 5 equilibriums: 3 stable; 2 unstable The equilibrium is locally stable: –If the initial share is unequal, it tends towards concentration (C-P). –If the initial share is equal, industry allocates equally (λ=0,5)

21. Tema 5 -EE 21 T(S) “wiggle diagram” 1,5 2. The Core-Periphery Model: implications “The Tomahawk diagram” Solid lines: stable equilibriums ; Doted lines: unstable eq. With high transport costs: there is an stable equilibrium (λ=0,5). 0 1 λ 0,5 T T(B) Two critical points: T(S): sustain point in the core-periphery pattern. T(B): symmetry break point (equilibrium is stable). When are these critical points possible? 1

22. Tema 5 -EE 2. The Core-Periphery Model: implications

23. Tema 5 -EE 2. The Core-Periphery Model: implications

24. Tema 5 -EE 2. The Core-Periphery Model: implications

25. Tema 5 -EE 2. The Core-Periphery Model: implications

26. Tema 5 -EE Gobalización, comercio internacional y economía geográfica 26 “wiggle diagram” 2. Applications Davis and Wenstein (2002): “Bones, bombs, and break Points: The Geography of Economic Activity”. American Economic Review. It analyzes the concentration of the Japanese population and industry in 303 Japanese cities, since -6000 b.c. until 1998. Shock: “ The Allied strategic bombing of Japan in World War II devastated the targeted 66 cities. The bombing destroyed almost half of all structures in these cities—a total of 2.2 million buildings. Two-thirds of productive capacity vanished. 300.000 Japanese were killed. Forty percent of the population was rendered homeless. Some cities lost as much as half of their population owing to deaths, missing, and refugees."'

27. Tema 5 -EE 2. Applications

28. Tema 5 -EE Gobalización, comercio internacional y economía geográfica 28 Davis and Wenstein (2002): “Bones, bombs, and break Points: The Geography of Economic Activity”. American Economic Review. 2. Applications

29. Tema 5 -EE Gobalización, comercio internacional y economía geográfica 29 Davis and Wenstein (2002): “Bones, bombs, and break Points: The Geography of Economic Activity”. American Economic Review. 2. Applications

30. Tema 5 -EE Germany: Brackman, Garretsen and Schramm (2004): They apply the same method to the allied bombing of German cities in the IIWW: Did individual cities returned to the pre-war growth path after the war? Are those cities like point “C”. 1/2 0 1 λ 0 C Country/shock α= -1.03 (S.error 0.163); t=18 α= -0.52 (t-value 5.467); t=17 α=-0.003 (t-value 0.02); t=18 2. Applications

31. Tema 5 -EE Figure 6.1 The plague and Italian cities Italy-”black death”: 3 M decline in population between 1300- 1400 in Italy 2. Applications