THE NEW GEOGRAPHICAL

ECONOMICS
CHAPTER 11:
THE POLICY IMPLICATIONS OF
GEOGRAPHICAL ECONOMICS

Sara Lemes Brito

Eva Béjar González

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 Agenda
 Introduction.


 Six basics policy implications of the core

model.


 Agglomeration rents, public policy, and

policy competition.


 Building a bridge.


 Welfare implications.


 Conclusions. 2
1. INTRODUCTION

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Policy implications of the core model
of the geographical economics

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 2. Six basics policy
implications of the core
model
 Ottaviano argues that the core model
gives rise to the following sixgeneral
policy implications :

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Tomahawk diagram

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3. Agglomeration rents, public
policy, and policy competitions
- Corporate income taxation and the race


to the bottom:


 The standard view




Agglomeration rents


- Government spending.


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3.1 The standard view

“Race to the bottom”

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Under- provision of public goods
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 Race to the bottom is not an
inevitable outcome when…

creasing foreign ownership offers the possibility of increasing tax rate

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 The main contribution from
geographical economics in
this topic is:

of exogenous differences in country size, but may very well be the endogeno

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3.2 Agglomerations rents
In the core region
the mobile factors
of production
receives

- Tomahawk diagram

Freeness of Equilibrium Agglomeration

trade rents
ϕ s< ϕ < 1 stable strictly positive
ϕ s ≤ϕ not stable zero or negative
ϕ =1 not stable zero

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As long as the agglomeration rents exceeds the tax
differential

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 Model North- South
(Baldwin and Krugman)
- Costs function (i):

r + Wax xi
r – wage forK W – wage for L

- Capital moves to the region with the highest real wage after tax.
- Let s k be the share of capital in North, the resulting equilibria ( stable
or unstable) can be:
sk = 1 s k= 0 0 < sk
< 1
- The freeness of trade is such that s k = 1 is a stable long equilibrium and the
economy finds itself in the equilibrium.
- This creates the AGGLOMERATION RENT for human capital.

h to South as long as this agglomeration rent is positive, so the tax rate in the North can be

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The wiggle diagram

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3.3 Government spending
“The government spending is an instrument of
locational competition between governments in their
attempt to attract mobile production factors”

- When the effects of agglomeration are important:

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 “Locations decisions can be affected
by regional government spending and
not just be the level of taxation”
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 The role of national
government spending
( the Forslid- Ottaviano model)

- The costs of producing X units of a manufacturing variety in region j are

equal to:

f j (Z j )[ r j + [ (σ
− 1) / σ ] x ]
(measures the reduction in costs and where (Z j )
- f j (Z j ) efficiency represents the level of goverment spending)
function
- r j return to human capital in
region j

Goverment production competes with privates production Optimal size of the governmen

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 - Market clearing for human capital in region j
allows the determination of the number of varieties
produced in region j :

- nj = (Kj – Zj) / fj (Zj)

Private and public sector compete with each other on the labor market

- Equilibrium
in the public sector requires that
public spending be fully paid by taxes :
- rj Zj = tj Yj ( tj uniform income tax rate
that applies to labor and
human capital )

Public sector has to pay competing wages in order to attract human capital

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 THE RELATIONSHIP BETWEEN THE
FREENESS OF TRADE AND THE DEGREE OF
AGGLOMERATION
( to know if agglomeration becomes more likely or not )

A wide range of parameter values tending to reduce the stability of the spreading equilibrium
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4. Building a bridge (policy-
inspired experiment)

 “How policy interventions that
somehow alter transport costs might
change the spatial allocation of
economic activity”

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 4.1 The pancake economy
Characteristics


ü Core model with congestion

ü
ü Circle of racetrack economy with 12 cities
ü
ü Workforce uniformly distributed
ü
ü Each city produces 1/12 of the economy´s total
ü
ü symmetric structure => long-run equilibrium or “flat
earth” equilibrium(Fujita , Krugmanand Venables
1999)

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The pancake economy
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 Average distance, pancake economy

City No links Link 2- Link 3- Link 4-

1 3 3.00
12 3.00
11 3.00
10
Cities 1 and 7 2 3 2.58 2.67 2.75
3 3 2.67 2.08 2.33
4 3 2.75 2.33 1.92
5 3 2.83 2.58 2.33
6 3 2.92 2.83 2.75
Average 3 2.79 2.58 2.51

Linked cities Link 4-10

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 Distances: pancake economy, link between
cities 2 and 12
1 2 3 4 5 6 7 8 9 10 11 12

1 0 1 2 3 4 5 6 5 4 3 2 1

2 1 0 1 2 3 4 5 5 4 3 2 1

3 2 1 0 1 2 3 4 5 5 4 3 2

4 3 2 1 0 1 2 3 4 5 5 4 3

5 4 3 2 1 0 1 2 3 4 5 5 4

6 5 4 3 2 1 0 1 2 3 4 5 5

7 6 5 4 3 2 1 0 1 2 3 4 5

8 5 5 5 4 3 2 1 0 1 2 3 4

9 4 4 5 5 4 3 2 1 0 1 2 3

10 3 3 4 5 5 4 3 2 1 0 1 2

11 2 2 3 4 5 5 4 3 2 1 0 1

12 1 1 2 3 4 5 5 4 3 2 1 0

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Distances: pancake economy, link between
cities 3 and 11
1 2 3 4 5 6 7 8 9 10 11 12

1 0 1 2 3 4 5 6 5 4 3 2 1

2 1 0 1 2 3 4 5 5 4 3 2 2

3 2 1 0 1 2 3 4 4 3 2 1 2

4 3 2 1 0 1 2 3 4 4 3 2 3

5 4 3 2 1 0 1 2 3 4 4 3 4

6 5 4 3 2 1 0 1 2 3 4 4 5

7 6 5 4 3 2 1 0 1 2 3 4 5

8 5 5 4 4 3 2 1 0 1 2 3 4

9 4 4 3 4 4 3 2 1 0 1 2 3

10 3 3 2 3 4 4 3 2 1 0 1 2

11 2 2 1 2 3 4 4 3 2 1 0 1

12 1 2 2 3 4 5 5 4 3 2 1 0

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 Distances: pancake economy, link
between cities 4 and 10
1 2 3 4 5 6 7 8 9 10 11 12

1 0 1 2 3 4 5 6 5 4 3 2 1

2 1 0 1 2 3 4 5 5 4 3 3 2

3 2 1 0 1 2 3 4 4 3 2 3 3

4 3 2 1 0 1 2 3 3 2 1 2 3

5 4 3 2 1 0 1 2 3 3 2 3 4

6 5 4 3 2 1 0 1 2 3 3 4 5

7 6 5 4 3 2 1 0 1 2 3 4 5

8 5 5 4 3 3 2 1 0 1 2 3 4

9 4 4 3 2 3 3 2 1 0 1 2 3

10 3 3 2 1 2 3 3 2 1 0 1 2

11 2 3 3 2 3 4 4 3 2 1 0 1

12 1 2 3 3 4 5 5 4 3 2 1 0

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 4.2 Bridges and the
equilibrium spatial
distribution.
Uniform initial distribution=> stable flat earth equilibrium
for the base scenario parameter setting:

Share of income spent on manufacturing  = 0.6

ρ
Elasticity of substitution =5

Transport costs T = 1.2

Congestion parameter  = 0.1

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 Buildinga bridge has a large impact on
the distribution of manufacturing
production, and leads to
considerable agglomeration of
economic activity.
City Link 2-12 Link 3-11 Link 4-10
1 8.20 4.1 2.7
2 16.4 7.0 3.8
3 10.3 20.7 8.5
4 7.1 9.8 22.8
5 5.4 5.3 8.5
6 4.6 3.5 3.8
7 4.3 3.0 2.7

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Impact of buiding a bridge on spatial
distribution

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Effects of parameter changes with
a bridge between cities 4 and 10

T
 Determine the long- 
run equilibrium ρ
δ


 Determines the
responsiveness to

real wage
differences
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 Changing transport costs
(the most important parameter)

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Changing spending on manufactures

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Changing elasticity of substitution

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Changing congestion costs

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Changing adjustment speed

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Adjustment speed and long-run
equilibrium

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 5. Welfare implications
 … of the core model of geographical economics



For example : Mobile workforce increases welfare level

Agglomeration in
 region 1
Immobile workforce in region 2 is worse
 off compared to the spreading
equilibrium

So we have to weight the importance of various groups,

using their size as weight

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To determine the welfare level for both types of workers:

Total income in region i

Correct for the price level

Welfare

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Welfare implications of a bridge
in the pancake economy
 Building a bridge=> uneven
distribution of the reduction in
average distance =>inhabitants in
different cities enjoy different
welfare effects =>migration
=>economic agglomeration
 13 economic agents:
Farm Farm Farm
Manufacturing workers in
workers in workers in
workers region 12
region 1 region 2

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Overview of welfare effects:
long-run equilibrium

Link Link 3- Link 4-

2-12 11 10
Average change in real 0.9 1.9 2.2
income
Average change in real - 0.3 0.2 0.2
farm income
Average change in real 1.6 2.8 3.5
manufactuing income

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… on the welfare of the average farm worker is
a poor indicator of what happens to a
particular farm worker…

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 6. CONCLUSIONS
THE WORLD DEVELOPMENT REPORT, 2009
(WORLD BANK)

- Solutions to problems of economic integration and its

relation to policy decisions.

- The main idea: while economic growth tends to be

unbalanced from the standpoint of geographic,
development can be achieved throughout the country.

- How to achieve both the immediate benefits of the

concentration of production along with long- term
benefits of the convergence of living standars between
different geographical areas is “the economic
integration”.
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WDR puts forward solutions to the


problem of economic integration:

 When politicians make their decisions
they must take into account the
economic geography of their country.
 They should avoid focusing only on
incentives or targeted interventions
in lagging regions and should use all
instruments, like
 “ linking institutions, infrastructure
linking, targeted interventions”

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THANK YOU FOR
YOUR ATTENTION

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