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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 Discussion Paper Series, 2008, 14(8) 146 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. Discussion Paper Series, 2008, 14(8) 148 Lefteris Topaloglou, George Petrakos 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 Discussion Paper Series, 2008, 14(8) 150 Lefteris Topaloglou, George Petrakos 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 UNIVERSITY OF THESSALY, Department of Planning and Regional Development Tracing a Model on Economic Geography of Borders 151 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. Discussion Paper Series, 2008, 14(8) 152 Lefteris Topaloglou, George Petrakos 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 UNIVERSITY OF THESSALY, Department of Planning and Regional Development 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. Discussion Paper Series, 2008, 14(8) 154 Lefteris Topaloglou, George Petrakos 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 UNIVERSITY OF THESSALY, Department of Planning and Regional Development 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 Discussion Paper Series, 2008, 14(8) 156 Lefteris Topaloglou, George Petrakos 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. 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