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The New Economic Geography:
an overview
COST Action IS1104
Urbino 18-19 Settembre 2012
Outline
• Introduction
• Krugman’s cookbook: main ingredients of NEG
models
• Krugman’s story: self-reinforcing
agglomeration
• NEG Families, modifications and extensions
• Research questions
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Section I
INTRODUCTION
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Fujita and Krugman:
• “The defining issue of the new economic
geography is how to explain the formation of a
large variety of economic agglomeration (or
concentration) in geographical space.
Agglomeration or the clustering of economic
activity occurs at many geographical levels,
having a variety of compositions.
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• For example, one type of agglomeration arises when
small shops and restaurants are clustered in a
neighborhood.
• Other types of agglomeration can be found in the
formation of cities, all having different sizes, ranging
from New York to Little Rock; in the emergence of a
variety of industrial districts; or in the existence of
strong regional disparities within the same country.
• At the other extreme of the spectrum lies the coreperiphery structure of the global economy
corresponding to the North-South dualism.
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• It is also important to notice that all this types
of agglomeration at different levels are
embedded in a larger economy, altogether
forming a complex system.” (Fujita and
Krugman, 2004, Papers in Regional Science)
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• The aim of the Action is to provide a better
understanding of the EU as a complex, multilevel, evolving geographical system, taking
duly into account the dynamic processes
occuring within such a system and to develop
improved strategies for EU regional policies
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NEG Central question
• How does the spatial distribution of industrial
activity look like in the long-run?
1. Equally distributed among regions
2. Agglomerated in one region
3. Unevenly distributed over the regions
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Section II
KRUGMAN’S COOOKBOOK:
MAIN INGREDIENTS OF NEG MODELS
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1. General Equilibrium Model (2 x 2 x 2)
• 2 symmetric and spatially homogeneous regions
• 2 sectors (M)anufacturing and (A)griculture
A perfect competion ; M imperfect competition
• Two factors of production (mobile and immobile)
• Full interdependence across (goods and labour)
markets
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2. Increasing returns and imperfect competition
• Dixit-Stiglitz monopolistic competition
• No interaction / identical firms
• Product differentiation/market segmentation
• Production technology: a fixed component
determines decreasing average cost
• Price: constant mark-up over marginal costs
• Larger production implies higher profit
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3. Consumer’s preferences
• Cobb-Douglas preferences across M and A
goods (fixed shares of income allocated to
each sector)
• CES preferences across M varieties (love for
variety)
• Cheaper and/or more numerous goods
increase welfare
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4. Distance and trade
• Iceberg transport costs (Samuelson, 1952, Economic
Journal)
• Transport cost: exogenous parameter that increases
price at destination
• For notational convenience «trade freeness parameter
(between 0 and 1)»
• Trade is beneficial because it allows access to other
regional markets
• However, location is also important since profits are
higher where the local market is bigger (lower
transport costs)
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5. Factor mobility
• Induced by differentials in factor rewards (wages,
profits)
• The dynamic process of migration/relocation is gradual
over time and adaptive
• Typically in continuous time
• Link between short and long-run analysis
• Migration determines the long term spatial allocation
of economic activities (the regional shares; whereas
the overall amount of productive factors is given)
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Section III
KRUGMAN’S STORY: SELF
REINFORCING AGGLOMERATION
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Pivotal: Size of local market for a single firm
depends:
• Overall market size in the region (increases it)
• Number of firms in the region (reduces it)
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Thought experiment
 one factor unit (i.e. manufacturing workers) and the
corresponding firm move from region 1 to region 2
1. Overall size of the market in 1 increases • Market-access or market-size effect (agglomeration force):
monopolistic firms locate in the largest market where
average production cost is lower and factor rewards are
higher
2. Number of firms increases in 1 as well • Cost of living effect (agglomeration force): the local
production increases and goods are cheaper
• Market crowding or market competition effect (spreading
force): firms locate in regions with less competitors
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Self-reinforcing process 1
• Demand linked circular causality
Expenditure
shifting
Production
shifting
Production
shifting
Expenditure
shifting
The productive factor
and its owner move
together:
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Self-reinforcing process 2
• Cost-linked circular causality
Production
shifting
Cost of
living
shifting
Cost of
living
shifting
Production
shifting
The productive factor
and its owner move
together
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Stabilizing force
• Competion between firms
productive
factor
migrates to
region 1
The
productive
factor shifts
back in
Region 2
Increase in
the
number of
firms
lower
factor
rewards
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If agglomeration forces exceed dispersion
forces. This leads to full agglomeration
If dispersion forces exceed agglomeration
forces this leads to symmetric distribution
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Competition effect dominates
Market size effect dominates
1
Share of
capital in
region 1
0
0
Trade Freeness
1
24
Competition effect dominates
Market size effect dominates
z
1
Share of
Multiple
equilibria
capital in
region 1
0
0
Trade Freeness
1
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Competition effect dominates
Market size effect dominates
1
Mutiple
equilibria
Share of
Catastrophic
capital in
Agglom
region 1
0
0
Trade Freeness
1
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Competition effect dominates
Market size effect dominates
1
Multiple
equilibria
Share of
Catastrophic
capital in
Agglom.
region 1
Endogen.
Asymmetr.
0
0
Trade Freeness
1
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Competition effect dominates
Market size effect dominates
Multiple
1
equilibria
Catastrophic
Share of
Agglom.
capital in
Endogen.
region 1
Asymmetr.
History
0
matters
0
Trade Freeness
1
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Competition effect dominates
Market size effect dominates
Multiple
equilibria
1
Catastrophic
Agglom.
Share of
Endogen.
capital in
Asymmetr.
region 1
History
matters
0
Irreversibil.
Hysteresis
0
Trade Freeness
1
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Section IV
NEG FAMILIES, MODIFICATIONS
AND EXTENSIONS
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• NEG families: differentiated according to
which factor is interregionally mobile
• Main NEG Variants: most used in the literature
• Non exhaustive taxonomy of existing
modifications and extensions
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NEG Families
• Core-Periphery (CP) model (Krugman, 1991, JPE)
mobile factor: manufacturing workers
immobile factor: agricultural workers
technology: M workers both variable and fixed component
• Footloose entrepreneur (FE) model (Forslid & Ottaviano, 2003, JEG)
mobile factor: entrepreneurs/human capital
immobile factor: unskilled workers
production technology: entrepreneur only fixed component (simpler)
• Footloose capital (FC) model (Martin & Rogers, 1995, JIE)
mobile factor: physical capital
immobile factor: workers
technology : physical capital enters only fixed component (simpler)
no circular causality (much simpler)
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NEG main variants
• Constructed capital (CC) model (Baldwin, 1999, EER)
- mobile or immobile endogenous physical capital
- circular causality via capital construction and destruction
may lead to growth (growth poles / growth sinks)
• Vertical linkages (VL) model (Venables, 1996, IER)
- intermediate manufacturing goods enter in production
- circular causality via demand and supply linkages (supplier of
intermediate inputs locate in larger output markets / firms locate
where the number of supplier of intermediate inputs is larger and
production costs lower)
• Global and local spillovers (GS and LS) models (Martin & Ottaviano,
1999, EER; Baldwin, Martin and Ottaviano, 2001, JE Growth)
- variants of the CC model that allow for endogeous growth
- local spillovers are a dispersion force
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Taxonomy of extensions 1
Regions
asymmetric
dis-homogeneous
(first nature
features)
n > 2 Regions
Spatial
structure
Unidimensional
(equidistant,
racetrack)
Manufacture
Cournot
Competition
Structure of
the Economy
Sophisticated
modelling of
labour market
continuous space
Differentiated
trade costs
Network
structure
Transport
sector
Heterogeneous
firms
R&D activities
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Taxonomy of extensions 1
Regions
asymmetric
dis-homogeneous
(first nature
features)
n > 2 Regions
Spatial
structure
Unidimensional
(equidistant,
racetrack)
Manufacture
Cournot
Competition
Structure of
the Economy
Sophisticated
modelling of
labour market
continuous space
Differentiated
trade costs
Network
structure
Transport
sector
Heterogeneous
firms
R&D activities
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Taxonomy of extensions 2
Public policy
Dynamics
Expectations
Preferences
government
expenditures,
taxation and
subsidies
Factors relocation,
growth,
demographic
changes
myopic
Upper-tier: quasilinear
Local goverments
competition
Analytical core:
processes modelled
in continuous time
adaptive
behavioural rule
welfare analysis
Discrete time:
nonlinear maps
generating complex
behaviour
Forward looking
Lower-tier: CES
Upper-tier: CES
Lower-tier CES
Intertemporal
choice
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Taxonomy of extensions 2
Public policy
Dynamics
Expectations
Preferences
government
expenditures,
taxation and
subsidies
Factors relocation,
growth,
demographic
change
myopic
Upper-tier: quasilinear
Local goverments
competition
Analytical core:
processes modelled
in continuous time
Adaptive
behavioural rule
welfare analysis
Discrete time:
nonlinear maps
generating complex
behaviour
Forward looking
Lower-tier: CES
Upper-tier: CES
Lower-tier CES
Intertemporal
choice
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Section V
RESEARCH QUESTIONS
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Research topic 1
 To represent the economy as a multi-regional Network
with more ‘realistic’ features.
Suggested preliminary steps:
1. Search for the most suitable analytical framework
2. Identification of EU regional specificities (also through
data collection, screening and analysis)
3. Identification of the network structure (type of links,
strength and number of connections)
4. Implementation of a specific software for the discovery of
the network nature and statistical properties
5. Simulation exercises and comparison with real data
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Research topic 2
 To model more elaborated firm relocation decisions (in NEG models very
simplistic).
Improvements (drawing also from contributions by Dawid; Zou):
1. Can we learn something from the behavioural literature on
strategic swithching in (financial) markets (chartist vs
fundamentalists, discrete choice models, replicator dynamics,
experiment on learning, new experiments on spatial
decisions)?
2. Can we learn something from the much more elaborate
modelling of IO (strategic interaction, heterogeneous firm,
continuous space)?
3. Can we incorporate financial markets and its role in the firm
(re-)location decision?
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Research topic 3
 To identify determinants of regional attractiveness not included in
NEG models.
• for a firm several factors (such as local government quality,
crime rates, access to credit, legislation, degree of
scholarization of the workforce and so on) may affect
relocation.
• Similarly, factors different from wages or remunerations that
may affect workers and human capital migration are various
(provision of public servicies, housing prices, amenities, work
environment, and so on)
• These indicators can be very useful for a better understanding
of the distribution of economic activities.
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Research topic 4
Literature reviews:
• To provide an exhaustive taxonomy of the NEG
literature.
• To compare old and new approaches to
geographical economics
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