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Discussion Paper Series, 14(8): 143-158
Tracing a Model on Economic Geography of
Borders
Dr Lefteris Topaloglou
Research Fellow,
Department of Planning and Regional Development
University of Thessaly,
e-mail: [email protected]
George Petrakos
Professor, Department of Planning and Regional Development
University of Thessaly,
e-mail: [email protected]
Abstract
The present essay attempts to shed some light on the economic
geography of borders through the development of a theoretical model.
The impact of integration on border space is explored and within the
same context the paper also examines the manner and extent to which
the location pattern of firms is affected by transport costs, market size,
urban systems and non tariff barriers. In addition, the crucial question of
the consequences of migration flows on a border economy is examined
from a labor market perspective. The answers to these questions
provide useful insights into the dynamic effects on space and the
economy when the obstacles created by borders are abolished.
Key words: Borders, economic geography, theoretical model, integration
January 2008
Department of Planning and Regional Development, School of Engineering, University of Thessaly
Pedion Areos, 38334 Volos, Greece, Tel: +302421074462, e-mail: [email protected], http://www.prd.uth.gr
Available online at: http://www.prd.uth.gr/research/DP/2008/uth-prd-dp-2008-8_en.pdf
Tracing a Model on Economic Geography of Borders
145
1. Introduction
The impact of integration on border space has been an issue of concern in the
bibliography in recent years. Although arguments may vary concerning the border effect,
almost all studies come to the conclusion that the level of interaction would be much
more intense within a borderless world (McCallum, 1995, Helliwell, 1998, Brocker, 1998,
Wei, 1996). Hence, borders operate to a certain extent as a barrier to personal mobility
and the transfer of goods, services, capital, ideas and information (Kamann, 1993; Ratti,
1993; Suarez-Villa, 1992; Clark, 1994). Given that increased distance is associated with
decreased trade volume, it can be argued that border obstacles operate as parameters
increasing distance (Rauch, 1991; Kinoshita and Campos, 2003; Johnston, 1994).
Despite the general agreement in the literature regarding the spatial distribution of
activities when borders are closed, this consensus becomes more and more ambiguous
when border obstacles are removed.
In addition, the crucial question of the consequences of migration flows on a border
economy is examined from a labor market perspective. The answers to these questions
provide useful insights into the dynamic effects on space and the economy when the
obstacles created by borders are abolished.
The paper proceeds as follows. The following section provides a review of the current
state of theoretical discussion. Section 2 lays out the development of a theoretical model
on the economic geography of borders. The last section presents the conclusions.
2. Α Theoretical Review
From the traditional location theory point of view, frontiers distort market size, increase
the cost of trade/production and discourage firms from locating close to borders. Gierch
(1940), had, from the start, analyzed the border effect on the location pattern. In
particular, he pointed out that internal economies of scale in production and reductions
in transport costs push firms to locate centrally rather than close to borders since this
gives them a hold over a larger share of the market. Consequently, the greater the
market, the weaker the tendency for firms to be located close to borders. Following the
same line, Lösch (1944/1954), views borders as a desert in which goods can only be
acquired from a distance.
The abolition of border obstacles reduces cross border transport costs and increases
accessibility for both sides. According to Brülhart(2004), domestic firms have a greater
incentive to move closer to borders in order to be nearer to consumers in the
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Lefteris Topaloglou, George Petrakos
neighboring market. Consequently, agglomeration dynamics associated with domestic
purchasing power are reduced due to increasing consumer demand from the
neighboring country.
Several research studies exist in the literature confirming this assertion especially in
regard to the case of the USA-Mexico border (Hanson, 1996, 1998). In particular, this
highlights the fact that as long as there were significant trade obstacles, Mexican firms
were located mainly around the capital; but as trade obstacles were dismantled under
NAFTA, there was a relocation of firms to the border aimed at the large USA market.
This capital mobility leads to the convergence of regional wages, confirming, to a certain
degree, the Hecsher-Ohlin theorem.
It seems that these processes increase the attractiveness of border regions. At the
same time, however, firms located close to the borders are subject to competition from
the other side of the border where production costs are lower. Consequently, firms are
forced to move to the hinterland, away from competition or to relocate to the
neighbouring country.
From this point of view, integration emphasizes the effect of both centripetal and
centrifugal forces on border space. However, the location of the balance point between
these two countervailing dynamics remains an open question. Using a relevant model,
Brülhart (2004), argues that the positive attractions of border regions will eventually
overcome the negative effects caused of intensified competition, due to improved
accessibility.
Krugman (1991), asserts that the reduction in transport costs accruing from the abolition
of trade obstacles, encourages firms to locate in metropolitan areas where strong
agglomeration economies already exist. Thus, the larger market, found at the core,
attracts firms and labor from smaller peripheral regions, further enlarging its market size
and attractiveness. This accumulative process takes place mainly through two
mechanisms. The first is based on labor mobility and the associated demand for goods
(Krugman, 1991, Krugman and Venables, 1995). The second mechanism hinges on the
backward/forward linkages among the actual firms themselves within the same area.
This cross linking creates favorable cost conditions in transport, infrastructure,
intermediate products, research and innovation (Krugman and Venables, 1995,
Venables, 1996).
The abolition of border obstacles alters the relevant geographic location of a border
region within an integrated market, affecting not only the location pattern of firms but
also the labor market. Integration, more specifically, has an impact on the regional labor
market through three mechanisms, that of trade, migration, and direct foreign
investments (Boeri and Brücker, 2000). In accordance with the neoclassical models of
analysis, the differences in wages and the levels of unemployment between two regions
constitute the driving force behind labor mobility. This process of counterbalancing
substantially shifts the factor of labor toward the region where wages are higher. What
UNIVERSITY OF THESSALY, Department of Planning and Regional Development
Tracing a Model on Economic Geography of Borders
147
results from this process is a convergence of wage levels between both regions. Given
this, should the border obstacle dividing two regions be abolished, the wages in both
regions will equalise after a certain period of time. This hypothesis is represented by the
following equation:
Inter regional migration stability :WA-WB
(1)
WA represents the inequality in wages in region A while WB is the inequality of wages in
region B.
However, those economic exchanges between two border regions are not only an issue
of liberalization in the institutional framework. Differences in language, culture, business
practices, and differences in the legislative system and perceptions can prove to be
decisive factors in economic interaction even within a borderless world (Galasinska,
2003, Meinhoff, 2003). It is worth noting, that even among the six founding-countries of
the European Union which have achieved a high degree of integration, trade obstacles
at the borders still remain substantial (Helliwell, 1998; Bröcker,1998). Hence, the
abolition of trade obstacles does not mean symmetry in levels of cross border trade.
Consequently, integration models of analysis cannot ignore non-economic obstacles
operating at the borders such as cultural, historic and societal differences. In other
words, even if obstacles were to be abolished completely, cross border interaction
would still be less than the economic interaction within the interior of a country due to
the “interference” of several “national factors” (Brenton and Vanauteren 2001).
3. Introducing a Theoretical Model
In the section that follows, an attempt is made to introduce a theoretical model referring
to the spatial dynamics and economic geography of border regions before and after the
opening up of borders. The variables taken into account for the development of the
theoretical model involve: production cost, urban system (representing market size),
distance (representing transport cost), sectoral specialization (e.g. labor intensity), tariff
and non tariff barriers, and migration.
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3.1 Borders, economic integration and cost of production
In the first stage of the theoretical model, shown in diagram 2.1, we assume there are
two neighboring countries, one located in the West and the other located in the East.
Each country has two producers of the same goods, while one of the producers is
located close to the border and the other in the hinterland. Our model relies on the
hypothesis of constant economies of scale and therefore the production cost for each
unit is stable. This means in practice that it makes no difference whether the given
product is produced by one or more than one firm. Given that the productive sector is
labor intensive, the production cost in the East is lower, due to the lower wages of the
productive coefficients and differences in standard of living. Furthermore, we assume
that producers MW and ME are located in larger cities with metropolitan characteristics in
relation to producers BW and BE respectively. This means that the actual producers
benefit from agglomeration economies and, by selling their goods at a lower price, gain
a greater market share. As long as different agglomeration economies exist, the price of
goods is lower in the larger cities. It is also presumed that the transfer of firms from one
point to another can be made without any impediment.
1
Diagram 2.1: Borders, Economic Integration and production cost (1)
EAST
Mw
x
Bw
z
55
65
62,5
70
Border
WEST
ψ
BE
MΕ
We observe that while borders remain closed the firms in the West divide the market
share between them at point X while firms in the East designate their market share at
1
In diagram 2.1 the basic assertions are the following: (1) Selling price of product from producers
Aw=70,Be=62,5,Cw=65,De=55 units. (2) Transport cost 0,20units/kilometer. (3) Distance from the borders:
Producers Dw, De=100 Kilometers, Producers Aw, Be=25 kilometers. (4) Zero migration
UNIVERSITY OF THESSALY, Department of Planning and Regional Development
Tracing a Model on Economic Geography of Borders
149
point Y. It is also obvious that the border line distorts firm BE‘s market size. However,
when borders are abolished the producers in firm BE can now penetrate the market
share of producer Aw up to point Z, as producer BE is now able to sell his product at a
lower price. Hence, the opening up of borders has created spatial impacts on the border
urban system as production is increased in the border city located in the East while the
respective production in the West decreases. Nevertheless, it should be pointed out
that, due to distance (and the transport cost entailed) on the one hand, and the small
differences in production costs on the other, the producer in the border city in the West,
even though its output has shrunk, is still in operation.
Diagram 2.2: Borders, Economic integration and production (2)
EAST
Border
WEST
Mw
z xκ
50
60
57,5
70
(ε)
ψ
Bw
MΕ
BE
What changes in diagram 2.2, in relation to the previous diagram, is the presumption of
a greater difference in the selling price of the product between producers Aw and BE due
to the cost differences between the West and the East. Furthermore, it is asserted that
there is a reduction in the selling price of the goods from producers MW and ME on
account of the strong agglomeration economies that develop in the capital cities. More
specifically, what we have is the following hypothesis:
Selling price of good of producers BW=70, BE=57,5, MW=60, ME=50 units.
By illustrating the above hypotheses in diagram 2.2 we observe that the abolition of
obstacles at the borders gives producer BE the opportunity to sell his goods at lower
prices up to point Z, by penetrating the whole market area of producer MW and parts
(from distance X to Z) of the market area of producer ME. As a result, it seems that
producer BE gains in the short term, as he expands his activities into the neighboring
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country. What happens however with the firms operating in the West? Producer BW, has
basically two options in order to survive. The first option is to locate more to the right
from point K, in order to avoid the competition coming from the East. Point K is
determined from the section of the horizontal line e (which is the level of the selling price
from producer BW free of transport cost), with the slope of the selling price from producer
BE (burdened by transport costs). Given this option, producer BW is still in operation but
his market has been greatly reduced. It is obvious that given these conditions, the
opening up of borders was a negative development for producer BW. Producer BW‘s
second option is to relocate to the East taking advantage of the lower cost of production.
In addition, in order for producer BW to maintain its former market size it would be logical
to relocate close to the border. Producer MW will choose to locate further to the left in
order to maintain its market share in full and avoid the competition pressure deriving
from producer BE. Overall, it seems that the border firms in the West tend to develop
either to the East close to the border, or accept a reduction in size in the West and
relocate away from the border. Reverse flows are expected to result in the case of
capital intensive sectors. In conclusion, the spatial impacts on the urban system
resulting from the opening up of borders is visible (at the given level of differences in
production cost), on both sides of the border. In the West the cities close to the border
lose income and employment, since the firms operating in the border cities in the West
tend to move either away from the border (more to the left) or cross onto the opposite
side of the border (in the East). In the East, on the other hand, the levels of wages,
employment and income are expected to increase.
Diagram 2.3: Borders, Economic Integration and production cost (3)
EAST
Border
WEST
Mw
z
x
40
50
60
70
(ε)
ψ
Bw
BE
MΕ
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In diagram 2.3 we assume that the gap in production cost between the East and the
West is even greater, given that all the variables mentioned earlier remain the same.
More specifically, we put forward the following hypothesis:
Selling price of good of producers: BW=70, BE=50, MW=60, ME=40 units.
It is evident now that economic integration allows producer BE to penetrate the whole
market area of producer BW as well as into the greater part of producer MW‘s market
share (distance point X to Z). This means that producer MW will have to relocate more to
the left in order to maintain his market area previous to the opening up of the border.
What happens, however, with producer MW? Taking into account the new conditions,
producer AW no longer has an incentive to relocate further to the left, since producer MW
could sell his goods cheaper at all points in the distance between them. Consequently,
the only option for producer BW now is to relocate to the East. In this case, the incentive
for relocating to the other side of the border is stronger due to the greater differences in
cost of production. What can be concluded is that the spatial impacts from the opening
up of a border are not limited to the border space itself but extend even further to the
urban system in the hinterland. In other words, under the assumption of significant cost
differences between the West and East, the West is likely to lose production share,
income and employment, not only within the border space but also in larger cities
located further away.
At this point, it is worth noting that in all three theoretical hypotheses mentioned in the
diagrams above, producer MW managed to survive even within a shrunken market area.
This finding allows us to assert that the comparative advantage of a country in a
particular sector does not result in the elimination of that sector in the other country as
suggested by Ricardian Theory. This happens because of the transport cost which
protects (to a certain extent) the Western producers from low cost competition coming
from the East. Consequently, transport costs affect the market size of firms located
close to the borders. Within this context, the higher the transport cost of goods are the
less the impact from the abolition of borders will be in that particular market.
3.2 Borders, economic integration and transport costs
In relation to the assumption regarding differences in production costs we add the
hypothesis that the transport cost of a good from one side of the border to the other is
either very high (1,0 units/ kilometer), or very low (0,25 units/kilometer). Also, in an
attempt to simplify the model, we assert that there are actually two producers (one in the
East and one in the West) at a 50 kilometer distance from the borders.
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2
Border
Diagram 2.4 Borders, economic integration and high transport cost
EAST
50
70
WEST
Bw
x
BE
3
Diagram 2.5 Borders, economic integration and low transport cost
EAST
50
70
Border
WEST
Bw
x
BE
2
In diagram 2.4, the basic assumptions made are: (1) One good and two producers, one in the West (BW) and
one in the East (BE). (2) The good’s sector is labor intensive, (3) Selling price of producers’ good MW =50 units.
(4) Transport cost 1,0 units/kilometer. (5) Distance from borders of producers BW and BE 50 kilometers. (6)
Zero migration
3
In diagram 2.5 the same assumptions apply as in diagram 5.4, except that the transport cost is now 0,25
units/kilometer
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Tracing a Model on Economic Geography of Borders
153
In diagrams 2.4 and 2.5 what can be observed are the spatial impacts from the opening
up of borders when transport cost is high or low respectively. It is obvious that in the
case of high transport cost the degree of penetration from firm BE in the market area of
producer BW is low. In this case the final selling price of the goods is affected mainly by
transport costs. Conversely, when the transport cost is low the penetration of firm BE in
the West is quite significant. In this case, the selling price is mainly affected by the
production cost. What can be concluded is that when the level of transport cost is low,
the impact on the economic geography of the border region is important. In other words,
the level of expenses regarding the transportation of goods significantly affects spatial
dynamics, economic activities, in addition to the existing urban system located close to
the borders. Hence, the greater the reduction in transport cost, the less the protection
afforded to the firms of the cities in the West close to the borders. Overall, we can claim
that the degree of economic penetration of firms from one side of the borders into
adjacent markets is dependent on the relationship between transport cost and cost of
production.
3.3 Borders, economic integration and non economic obstacles
Moving onto with the development of our theoretical model, we make the assumption
that whilst borders between East and West are closed there are economic and
institutional obstacles in force. These involve issues such as tariffs, quotas, custom
control, bureaucratic proceedings, tax barriers, and other similar obstacles restricting the
movement of production factors. In simplifying the theoretical model, we assume that
the cost of crossing borders when faced with the above economic and institutional
obstacles is 5 units per unit of goods. When borders are opened, this cost is eliminated
and cross border mobility is enhanced.
We do consider, however, that even if all economic and institutional obstacles at the
borders are abolished by economic integration there will always be some non economic
obstacles in cross border interaction. Obstacles of this kind may involve differences in
language or culture, negative historical past, issues involving security, political stability,
as well as formulated perceptions of “us” and the “others”. To simplify our hypothesis,
we assume that in diagram 2.6 the non-economic parameters create a burden of an
extra 5 units the price for every unit of goods when it crosses the border.
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Border
Diagram 2.6 Borders, economic integration and non economic obstacles
EAST
55
70
WEST
4
x
Bw
z
BE
The total border crossing cost in diagram 2.6 is twenty (20) units. More specifically,
transport cost is ten (10) units (5x0,2/kilometer), economic-institutional obstacles five (5)
units and non economic obstacles five (5) units. Economic integration reduces the cost
of crossing at the border per five (5) units, whereas the non economic obstacles (of 5
units) remain in force.
This means that producer BE has the potential to expand in producer’s BW market area
up to point Z. On the assumption, however, that there are no economic obstacles in
place, producer BE could penetrate in the market area of producer BW only up to point X.
To a large extent, the section of the market between points X and Z represents the
protection zone which producer BW enjoys due to the presence of non economic
obstacles. In other words, non economic obstacles operate to a certain extent as a
protective barrier for firms in the West operating close to the border.
3.4 Borders, economic integration, non economic obstacles and
migration
In an attempt to develop our theoretical model even further, we introduce into our
analysis the assumption that there are migration flows from East to West. Within this
4
In diagram 2.4 the basic assumptions made are: (1) One product and two producers, one in the West (Aw)
and one in the East (BE). (2) The product sector is labor intensive. (3) Selling price of producers’ goods AW =70
units, BE=55 units. (4) Transport cost 0, 20€/kilometer. (5) Distance of producers Aw and BE from borders ;50
kilometers (6) Zero migration
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Tracing a Model on Economic Geography of Borders
155
context, we assume that the wages in the West are higher than those in the East. As a
result, the opening up of the border encourages, to a certain extent, the movement of a
number of people (even without complete labor mobility) from one side of the border to
the other.
Diagram 2.7 Borders, economic integration, non economic obstacles and migration
EAST
55
60
70
Border
WEST
5
x
Bw
z
BE
In diagram 2.7 we observe that the abolition of economic and institutional obstacles at
the borders initially allows producer BE to penetrate into producer’s BW market area up to
point X. The potential, however, for labor movement from East to West results in a
reduction in the cost of production for producer BW from 70 units to 60 units. This is due
to an increased supply of low cost labor in the West coming from the East, which in turn
results in a reduction in wages. The reduction of the production cost in the West creates
a new balance in the market areas of producers BW and BE at point Z. In other words,
the market share from point X to point Z is the end result of the labor mobility from the
East to the West. The migration flows, in particular, from the East increase the
competitiveness of the firms in the West which are close to the border and limit to a
certain degree the presence of firms coming from the East. Given these conditions, the
firm which gains more is the one located in the city where most of the migration flow
ends up. This is because there is a potential for a greater wage squeeze and
consequently a reduction in the cost of production.
5
Diagram 2.7 is based on the following assumptions: (1) One product and two producers, one in the West (Aw)
and one in the East (BE). (2) The product sector is labor intensive. (3) Selling price of producers’ goods AW =70
units, BE=55 units. (4) Transport cost 0, 20€/kilometer. (5) Distance of producers Aw and BE from borders ;50
kilometers (6) Zero migration
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4. Conclusions
This article has attempted to present a theoretical model of the economic geography of
borders. The model’s theoretical assumptions were based on the relevant discussion in
bibliography concerning the new economic geography.
In summarizing the above analysis we can argue that under integration conditions the
most important factors shaping the economic geography of border regions are the
following: First, the level of cost disparities among neighboring productive systems,
second, the level of non economic obstacles, third, the level of transport costs
associated with distance, fourth, the market size of the urban system at the border, and
fifth, the intensity of migration flows in relation to the spatial and sectoral dimension of
migration.
In other words, when the level of cost disparities and market size is low while at the
same time migration flows and distance as well as non economic obstacles are large,
the spatial dynamics of integration at the border space are not significant. The exact
opposite mixture of factors mentioned above produces important impacts on space and
economy on border regions. The “dosage” of each of the above factors will determine
not only the point of balance of the integration impacts in the border space but also the
degree of penetration by firms from one side of the border to the other.
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