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GEOGRAPHICAL ECONOMICS (SECOND PART) URBAN AND REGIONAL ECONOMICS José-Luis Roig WHAT IS URBAN AND REGIONAL ECONOMICS Urban and regional economics adds geographical space to the economic analysis of utility-maximizing households and profit-maximizing firms. It lies at the intersection of economics and geography. Urban and regional economics recognizes that goods are produced at certain locations, traded at some locations and bought by individuals who live at one location and work at another location. Distance between different economic activities implies costs for transporting goods and moving people. Distance also defines communication and social interactions among consumers and workers. Increasing Urbanization Rates More than half of the World’s population now lives in cities 100.0 90.0 80.0 70.0 60.0 50.0 40.0 30.0 20.0 10.0 WORLD AFRICA ASIA EUROPE LATIN AMERICA AND THE CARIBBEAN NORTHERN AMERICA Source: UN World Urbanization Prospects, 2014 Revision, esa.un.org/unpd/wup 2049 2046 2043 2040 2037 2034 2031 2028 2025 2022 2019 2016 2013 2010 2007 2004 2001 1998 1995 1992 1989 1986 1983 1980 1977 1974 1971 1968 1965 1962 1959 1956 1953 1950 0 Urban Concentration in Europe Population density in 2005 by OECD TL3 region Economic Concentration in Europe GDP per km2 in 2005 by OECD TL3 region Employment in the wine industry (SIC 2084) Sectoral concentration explained by natural advantages Employment in the computer software industry (SIC 7371, 7372, 7373, 7375) No natural advantages Employment in the Computer Software Industry (SIC 7371, 7372, 7373, 7375) San Francisco Employment in the Carpet Industry (SIC 2273) Productivity increases with employment density Elasticity around 5%(U.S.),4.5%(Europe) Doubling density increases productivity by 5%(4.5%) Agglomeration economies Firms can benefit from the concentration of other firms (A. Marshall): - Large labour market - Large market of intermediate input suppliers - Knowledge spillovers Strong regional disparities of GDP per capita in EU - Blue Banana - Nordic Countries - Periphery - Large difference within some countries - Spatial contagion (spatial diffusion of development) Accessibility and Transport Cost: The Market Potential GDP level provides a crude measure of economic size of a region. Some insight into the potential of attraction of new activity Besides its size, one expects the accessibility of a region from others to be another critical determinant of firms’ and workers’ locational decisions The market potential aims to capture the idea that being close to prosperous regions makes a region more attractive because it offers good access to several large markets 4 Mj j 1 j i d ij MPi M: Population, GDP,… Strong core-periphery pattern •More spatial dispersion. Prosperous states scattered all over the country •Regional disparities are much wider within the European Union than in the United States. Less strong core-periphery pattern How to model the spatial economy We must start from at least one of three assumptions: i. Space is heterogeneous as in the neoclassical theory of international trade ii. There are externalities in production and/or consumption iii. Markets are imperfectly competitive Theory of Industrial Location What leads firms to locate where they do? Can space confer monopoly power? How do compete firms in space? Theory of Industrial Location A. Location of the firm and transport costs B. Location and market areas: spatial monopoly C. Location and market areas: spatial competition A. Location of the firm and transport costs • The Weber location-production model (fixed coefficients technology) • The Moses location-production model (factor substitutability) The Weber Location-Production Model • Transfer-oriented firm: transport cost is the dominant factor in the location decision The firm chooses the location that minimizes total transport costs Two types of cost: - Procurement cost is the cost of transporting raw materials from the input source to the production facility - Distribution cost is the cost of transporting the firm’s output from the production facility to the market • Four assumptions: 1. Single transferable output. The firm produces a fixed quantity of a single product, which is transported from the production facility to a market M 2. Single transferable input. The firm may use several inputs, but only one input is transported from an input source, F, to the production facility. All other inputs are ubiquitous. 3. Fixed-factor proportions. The firm produces its fixed quantity with fixed amounts of each input. No factor substitution 4. Fixed prices. The firm is so small that it does not affect the prices of its input or its output The only cost that varies across space is transport cost The firm will choose that location that minimizes transport costs Resource-oriented firm. Firm that has relatively high costs for transporting its input. Example: A firm produces baseball bats Monetary weight input mi ti 10 $1 $10 Monetary weight output mo to 3 $2 $6 PC mi ti x 10 1 x DC mo to ( xM x ) 3 2 ( xM x ) 7 tons of beets needed for 1 ton of sugar Market-oriented firm. Firm that has relatively high costs for transporting its output to the market Example: Bottling firm of beverages Monetary weight input mi ti 1 $1 $1 Monetary weight output mo to 4 $1 $4 PC mi ti x 1 1 x DC mo to ( xM x ) 4 1 ( xM x ) 10 tns. of wheat needed for 100 tns. of beer • Transshipment points and port cities • Labor markets and location choices Two inputs and one market: the Weber location triangle Example: car manufacturer uses steel and plastic Single establishment – profit maximizer – price taker – perfect competition – 2 inputs single output Critical factors m1 m2 m3; p1 p2 p3; M1 M2 M3; t1 t2 t3; K Maximise profit by minimising total costs Profit of the firm: p3m3 ( p1 t1d1 )m1 ( p2 t2d2 )m2 t3d3m3 Given the assumptions of fixed coefficients of inputs and fixed prices: 3 Min Transport cost = mi ti d i i 1 The Moses location-production model - Now the firm can substitute in favour of the cheaper inputs - The distance from the factory to the market, d3, is fixed - The firm chooses a location along the arc IJ Budget constraints at the end points I and J The envelope budget constraint Location-production optimum Effect of a road-building program that takes place in the area around M1 B. Location and market areas: Spatial monopoly Spatial market areas: linear market with equal transport rates Space can confer monopoly power on firms The lower transport and production costs are, the larger the monopoly area Spatial market areas: linear markets with different transport rates and production costs C. Location and market areas: spatial competition The Hotelling location game Assumptions 1. Costless firm movement 2. Homogenous product 3. Consumers equally spaced along main street (i.e., sales are a + function of the market area) 4. Perfectly inelastic demand 5. Identical costs and transport rates Welfare implications of the Hotelling result Loss Loss Gain Effect of price competition on the Hotelling result • • • • • A firm lowers its price assuming that its rival’s prices will not change. Rival firm lowers its price assuming that the original firm will not change its price again. Etc. Every firm is surprised when the other firm retaliates. Result: Price shading continues until the firms price at or (temporarily) below MC Figueiredo et al (2002) (Case of Portugal) • Preference for the “home base” (“home bias”) • Reasons: - Personal factors - Tangible, non-transferable assets - Social capital (networks of institutions and relationships cannot be replicated outside de home base) •Data on firms can identify entrepreneurs’ “prior locality of economic activity” Spatial distribution of new manufacturing plants Spatial distribution of new manufacturing Plants created in the investor’s “prior locality created outside the investor’s “prior locality of economic activity” of economic activity” Investor I weighs in all the regional characteristics of the available spatial choice set and selects the one that will potentially give him the highest profit: k ij r X rj r 1 Linear combination of characteristics of the area An additional variable is included that allows the investor to value differently the potential profit associated with each choice k ij r X rj Dij r 1 Dij 1 0 Region coinciding with the investor’s prior locality of economic activity If there are lower costs (and higher profits) associated with the prior Locality of economic activity of the investor Alternatively: k k r 1 r 1 ij r X rj r X rj Dij Dij The investor values differently the impact of relevant factors in accordance with the local/non-local nature of the choice Those factors that affect potential profit by reducing information costs are not as significant when the choice under consideration is the investor’s home base For other locations, the investor will have higher information costs and thus may value agglomeration economies and proximity to core regions where more and better quality information is available Effect of the localization in the prior locality of economic activity on each characteristic: Decisions made by 1246 start-ups between 1995 y 1997 Information on the owner situation between 1992 y 1996 Where the current owner (entrepreneur) when worked before the creation of the new firm Spatial unit: “concelhos” (275 with an average area of 322.5 km2 ) A STRUCTURAL MODEL: DIXIT-STIGLITZ-KRUGMAN Accessibility to markets and firm’s profit: a framework for the empirical analysis q rs ( p mr ) rs q mr 1 rs rs pr r rs mill price rs iceberg transport cost marginal cost mr elasticity of substitution/price elasticity qrs quantity sold by the firm in s prs pr rs pr mr 1 prs rs mr 1 In the short-term with a given number of firms: qrs p r rs sYs Ps ( 1) Ps r nr ( p r rs ) ( 1) 1 ( 1) r rs Fr cmr ( 1) RMPr Fr Total profits of r over all markets s c ( 1) ( 1) where RMPr s rs sYs Ps 1 rs rs1 is the Real Market Potential freeness of trade RMPr s rs sYs Ps 1 recall MPr s Ys d rs Market potential and factors attraction (Head y Mayer, 2004) Location decision of firms between two locations i and j depends on i j → Carlton (1983) logit model Hypothesis: firms locate where markets accessibility is highest Sample de 452 Japanese branch plants localized in 57 regions from 9 EU countries in the period 1984-1995 Ur ln ln( r F ) ln mr ( 1)1 ln RMPr 1 ln mr ln wr (1 ) ln r ln Ar Variable costs: wages w¨r price of other inputs (land, intermediates) r Ar Total factor productivity U r ln wr (1 )ln r ln Ar ( 1) 1 ln RMPr U~r ln wr (1 ) ln r ln Ar ( 1) 1 ln RMPr i Pr expU r s expU s Construction of the market potential: RMPr s rs sYs Ps 1 Problem: we do not have data of rs and Ps We need to proxy these two variables: we will do it with trade flows Trade flows estimated with a gravity equation: qrs prs Ps( 1) sYs X RS nR qRS pRS nR p1R RS S YS PS 1 Market potential ln X RS FX R ln RS FM S Supply capacity of export country Market capacity of the import country FX R ln(nR p1R ) FM S ln(PS 1 S YS ) ln RS ln d RS S FRRS LRS FRRS Distance, border effect , same language ln X RS FX R FM S ln d RS S FRRS LRS FRRS X RR National production minus exports ˆrs exp( ˆS ˆ LRS )d rs Regions from different countries ˆrs d rs Regions from the same country ˆ ˆ 2 Superf r ˆ ˆrr d rr 3 sYˆs Pˆs Ys / YS 1 ˆ Intra-regional trade (Ys / YS ) exp(FMˆ S ) Share of GDP of s on national GDP of country S Potential built for 18 sectors (2 digits) each year Production costs: 1. Labor costs observable (payroll sector /number of employees in the region) additionally: non labor costs (only vary across countries) Unemployment rate 2. Other costs non observable a. Capital cost affected by subsidies/taxes: - Corporate tax rate (only vary across countries) - Elegibility to benefit from Structural Funds (Objective 1) b. Control for land supply and price: - Area of the region Evidence on clusters. 3 types: - Number of establishments in the two-digit industry region - Number of Japanese affiliates in the three-digit industry region - Number of affiliates owned by the same Japanese parent or members of same vertical keiretsu Possible efects of these clusters: - Lowering intermediates prices regional production networks - Share knowledge (non observable) A - Clusters will form around the same exogenous sources of low input costs or high productivity Hypothesis: clusters form in areas with high market potential in the relevant industry The hypothesis would receive support if after controlling for market potential, the presence of same industry firms lowers the attractiveness of a region Main results: Ambiguous with respect to RMP: - 10% of RMP increases the probability of locating in the region in 3%-11% - “theory doesn’t pay” - Agglomeration variables the most important but, omitted variables?