The
Economic Geography of Europe: Measurement, Testing and Policy Simulations
Research
Training Network
Research
The
network The Economic Geography of
Europe: Measurement, Testing and Policy Simulations (EGEMTPS) aims to
explore the impact of integration and technological change on the location
of activity in Europe. The research of the network is organised around
three themes: Extension and
deepening of the theoretical frameworks; Testing
and measurement; and Computable
economy-wide models focusing on location issues. The report on
research progress is organised according to these three themes.
It should however be noted that we do not provide an exhaustive
list of all the work that has taken place within the framework of the
network, but instead try to focus on a set of studies that are
representative of the work taking place in the network.
Among
the main analytical tasks undertaken by the teams participating in the
Network, the following stand out:
Scientific
highlights
Extension
and deepening of the theoretical frameworks
Progress
has been made in a wide range of areas. Members of the NHH team have - partly together with members of the team at GIIS
- worked on policy design in the presence of clusters.
Victor
D. Norman (NHH) and Anthony J.
Venables (LSE) have worked on
policy towards industrial clusters, aiming at answering key questions
like: How does the equilibrium number of clusters, and size of each,
compare to world social optimum? And, second, what is the effect of
national government policy on the equilibrium? From the international
point of view should national policy be encouraged or constrained? In
their paper “Industrial clusters: equilibrium, welfare and policy”
they study the size and number of industrial clusters that will arise in a
multi-country world in which, because of increasing returns to scale, one
sector has a propensity to cluster. The emerging equilibrium is compared
with the world welfare maximum, and it is shown that the equilibrium will
generally have clusters that are too small, while there are possibly too
many countries with a cluster. Allowing national governments to subsidize
will move the equilibrium to the world welfare maximum, so there is no
‘race to the bottom’. If subsidy rates were capped then there would be
a proliferation of too many and too small clusters.
Forslid
(GIIS) and Midelfart (NHH)
have analysed industrial policy in a high wage open economy hosting an
agglomeration consisting of vertically linked upstream and downstream
firms. They find that optimal policy towards upstream industries typically
differs from the optimal policy towards downstream industries.
Internationalisation impacts on the costs as well as on the benefits
related to sustaining an industrial agglomeration. Whether maintaining the
agglomeration is compatible with a welfare maximising policy is shown to
depend on level of economic integration.
Orvedal
(NHH) has worked on the design
of industrial policy in the presence of industrial clusters and asymmetric
information. Point of departure is the policy debate concerned with the
issue of industrial clusters and industrial policy and the arguments in
favour of subsidising special industries in order to stimulate industrial
agglomeration. An important objection against such a selective industrial
policy is that the government needs full information about the industries
to be able to pick the winners. But often the government does not know
whether the industry is a cluster or not. If the policy towards a cluster
is more favourable than the policy towards other industries, all
industries will have incentives to allege to be clusters. The problem for
the government is to identify the true clusters from the ordinary
industries. Orvedal attempts to shed some light on the problem of
industrial policy and industrial clusters when there is asymmetric
information between the government and the industry. She
shows that a subsidy contingent of a certain activity level will create a
separating equilibrium.
One
of the young researchers at NHH, Coniglio (Young
researcher, NHH) has analysed the effect of a deepening of a regional
integration process on the incentive for factors of production, and in
particular labour, to spatially relocate. He adopts a general equilibrium,
economic-geography model and allows for skill heterogeneity in the
manufacturing sector. At a given level of trade costs, due to the
productivity premia associated with the high-skilled workers matching in
one region, this type of workers will be more willing to migrate than
low-skilled ones. The results of the paper show the existence of a range
of trade costs for which only high-skilled workers have an incentive to
migrate. Therefore, introducing labour heterogeneity in the basic
core-periphery model enables us to explain one of the most striking
features of interregional migration patterns, that is a positive
self-selection of the migrants.
The
GIIS team has been the hub of
research on two aspects of the extension and deepening of the theoretical
frameworks. The first aspect concerns economic geography models that are
more amenable to analytic reason than are the original models proposed by
Paul Krugman (Princeton/CEPR)
and Tony Venables (LSE). The
goal here is to first establish a definitive list of the key features of
the old model – the so-called core-periphery model, or CP model for
short – as a means of benchmarking the newer, more analytically amenable
models. Having accomplished this, one then went on to presenting,
motivating and studying the basic properties of the newer, more amenable
models. The first of the newer models is what we call the footloose
capital model (FC model for short). This is the most tractable, but it
pays for its tractability by abandoning many of the CP model’s most
remarkable features including, for example, catastrophic agglomeration.
The second model presents the framework that most closely mirrors the CP
model in the sense that it matches all of the main features. This model,
which we call the footloose entrepreneur model (FE model for short), turns
out to be identical to the CP model at a very deep level, but despite
this, it involves little of the CP model’s obduracy. The third model –
what we call the constructed capital or CC model – is almost as easy to
work with as the FC model, but it displays more of the CP model’s
remarkable features including catastrophic agglomeration. Finally, one has
also worked out the properties of models that put endogenous growth into
the modelling framework.
The
second aspect concerns the application of these models to public policy
analysis. In particular were studied the implications of economic
geography models for trade policy, tax policy and regional policy. One
focus of the trade policy analysis has been the question of why small
countries have trouble attracting industries where agglomeration forces
are important – a question to which economic geography models are
perfectly suited. The GIIS team has studied the interplay between domestic and foreign
protection, domestic and foreign market size, and nations’ comparative
advantage.
The
GIIS team is together with
Philippe Martin (CERAS) working
on a book on economic geography and public policies. Draft for all
chapters were completed in 2002, and the book will focus on a broad range
of policy issues such as
analysis of efficiency, equity and optimal agglomeration, trade Policy,
regional policy, tax Policy and infrastructure policy.
When
it comes to tax policy, the research undertaken by the GIIS and the NHH team has
given many important new insights. Almost without exception, the public
finance literature on tax competition and the effects of international
taxation has relied on ‘smooth’ models. That is to say, models in
which small changes lead to small effects. Economic geography models are
‘lumpy’ by their very nature and this, as it turns out, casts new
light on a number of old issues. For instance, in these models trade costs
– as well as capital mobility – can have important effects on tax
competition when agglomeration forces are present. The main insight here
is that agglomeration forces tend to relax the constraints of tax
competition when industry is already agglomerated, but they tend to
exacerbate harmful tax competition when industry is dispersed. One has
moreover gone on to enrich the standard geography model by introducing
public goods. As it turns out, the provision of tax-financed public goods
creates a new agglomeration force, what we call the ‘amenities
linkage’ (production shifting leads to tax-base shifting which in turn
allows the ‘winning’ government to provide a more attractive package
of public amenities, which, in turn, tends to attract more production).
Following this line of thinking, it is found that in some situations the
first-best level of taxation may occur despite tax competition.
Gerlach,
Roende and Stahl from the Mannheim
team have analyzed the interaction between firms' R&D decisions and
locational choices. Stochastic R&D efforts translate into
firm-specific shocks to the labour demand. Innovative firms locating
together thus enjoy the benefits of ‘labour pooling’. Agglomeration
leads to tougher competition in the labour market, but firms can reduce
this effect by choosing different R&D strategies. In their recently
completed paper “Firms come and go, labour stays: Regional Clusters in
High-Tech Industries” (2002) they have explored in depth the
consequences of the idea of labour pooling for firms’ location choices.
In his “Principles”, Marshall (1920) argued that firms have incentives
to locate in the same region when they face imperfectly correlated
stochastic labour demands. Marshall's argument was renewed and popularised
by Krugman (1991). The authors extend and complete this argument by
demonstrating how the stochastics of R&D results affect firms' output,
and therefore input demands. In a baseline model, two firms supplying to
competitive world markets at quality-adjusted prices are faced with
stochastically independent innovation shocks that improve on their product
quality. The shocks translate into stochastic product, and therefore
labour demands. Confronted with location decisions before the outcome of
these shocks is known, the firms can decide to either locate separately in
a low density labour market each in which they are monopsonists, or to
locate (jointly) in a competitive high-density labour market. It is shown
that firms choose to agglomerate only if the innovation steps are high and
chances are high of ending up in an asymmetric situation in which one of
the firms is successful whilst the other is not. The reason is that in
expectation terms, the firms gain only under asymmetry, because if
confronted with a symmetric outcome of the innovation shock, their profits
are diluted by competition in the labour market.
Stahl
and Walz concentrate on an extension and generalization of the Marshallian
Labor Pooling argument. Taking off from Krugman’s (1991) formalization,
they consider an economy involving four firms, two of each in one
industry, that locate pairwise in two regions. The firms are confronted
with additive firm specific and industry specific demand shocks
translating into stochastic labor demand. They determine conditions under
which firms from the same vs. different industries will pair in one region
in equilibrium and under welfare maximization, given that interindustry
(and interregional) labor mobility is constrained by adjustment costs.
Roende
(Mannheim) and Motta (EUI) have
worked on the relation between intellectual property rights, technological
spillovers, and firms’ incentive to agglomerate. The focus has been on
non-compete clauses in labour contracts with knowledge workers.
Non-compete clauses facilitate the protection of intellectual property
(IP). Firms may nevertheless choose to locate next door to their
competitors and refrain from using such clauses, as this provides high
powered incentives to the employees. The analysis also points out subtle,
but important, differences between protecting IP through geographic means,
i.e. by locating away from competitors, and through legal means.
Spagnolo
and Lippert, also from the Mannheim
team, developed a general model of inter-firm and firms-employees
networks, and are using it to analyze how the governance of relational
contracts between firms (supply relations) and between firms and employees
(pooled labor markets) in dedicated industrial districts is affected by
different institutional environments. The focus is on districts with a
prevalence of non-pecuniary knowledge-related spillovers (e.g. Silicon
Valley), and the aim is to identify the institutional advantages that may
lead to the emergence of districts in some locations rather than others.
Following
up on Spagnolo (2000), Spagnolo and Blonski (Mannheim) have worked on the relation between Globalization (seen as
increased market integration and variety of supply), the IT revolution,
and the governance of industrial districts. Interfirm relations within
districts and knowledge exchanges between different firms’ employees are
governed by long term, and often multilateral relational (implicit,
unwritten) agreements. Markets
integration affects agents’ outside options, hence the sustainability of
such arrangements. Information tecnology affects agents’ search costs,
and may also affect, in different ways, intra-districts arrangements.
Whether these forces will strengthen or loosen agglomeration forces, i.e.
districts’ ability to internalize local spillovers, is the subject of
the study.
Paolo
Manasse and Alessandro Turrini (both IGIER)
have studied the effects of ‘globalization’ on income inequality in an
economy where sellers with higher skills enjoy larger market shares and
higher earnings (“Trade, wages, and ‘superstars”). In their global economy: (a)
innovations in production and communication technologies enable suppliers
to reach a larger mass of consumers and to improve the (perceived) quality
of their products, and (b) trade barriers fall. When transport costs fall,
income is redistributed away from the non-exporting to the exporting
sector of the economy. As the latter turns out to employ workers of higher
skill and pay, the effect is to raise wage inequality. Whether the least
skilled stand to lose or gain from improved production or communication
technologies, in contrast, depends on how technological change relates
with skills. Their model provides an intuitive explanation for why changes
in wage premia are significantly associated with the export status of
firms in recent firm-level empirical investigations.
Philippe Martin (CERAS) has during his one-year visit at the New York Federal Reserve
Bank research department, also worked with James Harrigan on the impact of
terrorism on cities with the events of September 11 as a motivation. Their
objective has been to use new economic geography models to understand how
city specific shocks on firms’ costs or inhabitants’ utility, due to
terrorist attacks, can affect the mechanics of economic agglomeration. It
is argued that under plausible scenarios, the gains of agglomeration are
so large that urban concentration would remain a feature of our societies.
However, a scenario is possible in which firms leave the targeted cities
followed by workers, which leads more firms to leave. In this scenario,
the "disappearance" of the city is not a slow gradual process
but rather a very sudden one. Philippe Martin has also started work with
Giancarlo Corsetti (University of Roma) and Paolo Pesenti (New York
Federal Reserve Bank) on the effect of monetary policy in models where
economic activity is “footloose”. Some mechanisms of the economic
geography literature such as the Home Market Effect are analyzed.
Duranton
and Puga at LSE team have
developed a model explaining and relating stylised facts about firms'
organisation and urban structures. Sharing of business services by
headquarters and of sector-specific intermediates by production plants
within a city reduces costs, while congestion increases with city size. A
fall in the costs of remote management leads to a shift in urban
structure, from a configuration where cities specialise by sector and host
integrated headquarters and production plants, to a configuration where
cities specialise by function, with headquarters from all sectors and
business services clustered in a few large cities and production plants
from each sector clustered in smaller separate cities. (see Duranton and
Puga, “From sectoral to functional urban specialisation”.)
Pierre-Philippe
Combes (CERAS) and Gilles
Duranton (LSE) are working on
several projects investigating the links between local labour markets and
agglomeration. When firms cluster in the same local labor market, they
face a trade-off between the benefits of labor pooling (i.e., access to
workers whose knowledge help to reduce costs) and the costs of labor
poaching (i.e., loss of key workers to competition and the indirect effect
of a higher wage bill to retain workers). Depending on market size and on
the degree of horizontal differentiation between products, Combes and
Duranton characterize the strategic choices of firms regarding locations,
wages, poaching and prices. Their results show that co-location, although
it is always efficient, is not in general the equilibrium outcome.
Thierry
Mayer (CERAS) together with
Keith Head and John Ries from the University of British Columbia
investigated the pervasiveness of the home market effect, a core
relationship of economic geography models. This relationship predicts that
a large country hosts a disproportionate share of firms in the increasing
returns sector. This paper analyzes three additional models featuring
increasing returns, firm mobility, and trade costs to assess the
robustness of home market effects to alternative modelling assumptions.
Results are strikingly robust to changes in assumptions about the nature
of demand, competition, and trade costs. However, a model that links
varieties to nations rather than firms can generate opposite results.
Philippe
Martin (CERAS) is co-authoring
a chapter of Volume 4 of the Handbook
of Regional and Urban Economics edited by V. Henderson and J.F. Thisse
and to be published by Elsevier in 2003. The chapter written with Richard
Baldwin (GIIS) focuses on
Agglomeration and regional growth.
Roende
(Mannheim) and Motta (EUI/CEPR)
completed their work on the relation between the protection of
intellectual property rights and incentives to innovate. In their paper
“Trade secret laws, labor mobility, and innovations” (2002) they
showed that when the researcher's (observable but not contractible)
contribution to innovation is crucial, a covenant not to compete (CNC)
unambiguously reduces both his effort and his firm's profits, under both
spot and relational contracts. Having no CNC endows the researcher with
the threat of leaving for a rival. This alleviates a commitment problem
for the firm by forcing it to reward a successful researcher. However, if
it is mainly the firm's R&D investment that matters, including a CNC
in the contract is optimal: by preventing the researcher from leaving, a
covenant allows the firm to appropriate the returns on its investment and
favours innovation.
Jacques
Thisse (CEPR) together with
Pierre Picard (University of Manchester) and Eric Toulemonde (University
of Namur) investigated the importance of the way profits are distributed
among agents for the space-economy. They show that the existence of mobile
rentiers is sufficient to make the symmetric configuration unstable for
all transport cost values and to make partial agglomeration of firms
stable. This work suggests that it is imperfect competition more than
increasing returns that matters for the formation of agglomeration in
economic geography.
Thisse (CEPR)
and Takatoshi Tabuchi (University of
Tokyo) studied the impact of the heterogeneity of the labour force on the
spatial distribution of activities. They show that taste heterogeneity
acts as a strong dispersion force and that the relationship between the
spatial distribution of the industry (the wage differential) and trade
costs is smooth and bell-shaped. Finally, while Rawlsian equity leads to
the dispersion of industry, their analysis reveals that efficiency leads
to a solution close to the market outcome, although the latter is likely
to involve too much agglomeration compared to the former.
Work
at UCD under this heading has
concentrated on developing more satisfactory models of strategic
competition between firms and on exploring their implications for
industrial location and for the responses of economies to external shocks.
Dermot Leahy and Peter Neary, with their co-authors, have considered how
heterogeneous costs and investment under uncertainty affect the
desirability of subsidising large export-oriented firms.
They have also explored the best form that such subsidies should
take, confirming that subsidies to investment are more robust than
subsidies to exports. This part of the research programme has implications
for whether and to what extent R&D should be subsidised.
On-going research is exploring the implications for assistance to
firms of constraints on governments' actions due to restrictions on the
kinds of subsidies which can be offered or to budgetary constraints.
Peter
Neary has considered the implications of different approaches to modelling
inter-firm competition. In a review of the literature on economic
geography to date (Journal of
Economic Literature, 2001), he noted some unsatisfactory aspects of
the assumption of monopolistic competition, widely used in the literature.
Similar points were made in a review of the contribution of work on
monopolistic competition to international trade theory as a whole.
This approach has made possible for the first time the systematic
study of increasing returns and product differentiation in general
equilibrium models. It has thus opened up exciting new research fields
with applications to intra-industry trade, multinational corporations, and
patterns of geographical location. However, the underlying assumptions of
monopolistic competition - a perfectly elastic supply of atomistic firms,
facing no barriers to entry or exit, and unable to engage in strategic
behaviour - represent little advance in descriptive realism over perfectly
competitive models. They therefore cannot explain how firms may engage in
non-price competition; nor can they throw much light on the ways in which
changes in trade or other policies (such as the completion of the EU
Single Market) can influence market structure.
Recent
work has attempted to overcome these problems by developing a new model of
general equilibrium which explicitly allows for large firms that compete
against each other in oligopolistic markets. This work shows that
abandoning the assumption of free entry has important implications for the
behaviour of open economies. Trade liberalisation may not lead to
specialisation in production, since barriers to entry allow firms to make
profits in sectors in which their country of origin does not have a
comparative advantage. The resulting patterns of trade and location may
reflect "competitive" as well as "comparative"
advantage, ideas which have been much discussed in business schools but
have not yet been systematically incorporated into mainstream economic
theory. Foreign competition may affect home firms even if no imports
actually take place. The threat of foreign competition may be sufficient
to encourage home firms to engage in "defensive innovation",
increasing their demand for skilled labour and worsening the relative
position of unskilled workers. This suggests that the focus of much
popular and professional debates on imports from less developed countries
as a threat to unskilled workers in OECD countries may be misplaced:
"North-North" trade may be more important than
"North-South" trade in affecting income distribution. Finally,
trade liberalisation may generate incentives for industrial restructuring,
which manifests itself in the form of cross-border merger waves.
Joe
Tharakan (Young Researcher, UCD)
has worked on the determinants of regional disparities in real income,
showing how they are affected by the location of national boundaries and
the mis-match between jobs and workers' skills.
Testing
and measurement
The
LSE team has together with the NHH
team worked on two major empirical studies of industry location in Europe.
The objective of the study “The location of European industry” are to
describe the changes in industrial location that have occurred in Europe
in recent decades; to establish whether these are associated with
countries’ economic structures becoming more or less similar, and
industries becoming more or less spatially concentrated; to compare
industrial location patterns in Europe and the US; and to identify the
underlying forces that determine industrial location and assess the extent
to which these have changed in recent years. The report finally offers
some preliminary predictions and a discussion of policy implications. In
the second paper, entitled “Comparative advantage and economic
geography: estimating the determinants of industrial location in the EU,
the authors develop and econometrically estimate a model of the location
of industries across countries. The model combines factor endowments and
geographical considerations, and shows how industry and country
characteristics interact to determine the location of production. They
estimate the model on sectoral data for EU countries over the period
1980-97, and find that endowments of skilled and scientific labour are
important determinants of industrial structure, as also are forward and
backward linkages to industry.
Members
of the LSE team (Overman,
Redding and Venables) have also undertaken a survey of the empirical
literature on economic geography of trade flows, factor prices, and the
location of production. In “The economic geography of trade, production,
and income: a survey of empirics”,
the discussion is structured around the empirical predictions of a
canonical theoretical model. The authors review empirical evidence on the
determinants of trade costs and the effects of these costs on trade flows.
Geography is a major determinant of factor prices, and access to foreign
markets alone is shown to explain some 35% of the cross-country variation
in per capita income. The paper documents empirical findings of home
market (or magnification) effects, suggesting that imperfectly competitive
industries are drawn more than proportionately to locations with good
market access. Sub-national evidence establishes the presence of
industrial clustering, and we examine the roles played by product market
linkages to customer and supplier firms, knowledge spillovers, and labour
market externalities.
The
LSE team has also worked on the
geographical aspect of intra-industry trade is analysed in Rice, Stewart
and Venables. Spatial variation in factor prices within Europe and more
widely are studied by Redding and co-authors in a series of papers.
The geography of production structures across Europe is analysed by
Redding and Vera-Martin.
Important
innovations of empirical method have been made by Duranton (LSE) and Overman (Young
Researcher, NHH), (Testing for localisation using micro-geographic
data), who used plant-level data for the UK to carefully analyse whether
location of finely disaggregated industrial sectors is more spatially
concentrated than would be expected by chance alone.
They find that around one half of industries exhibit statistically
significant concentration, typically at a very small geographical scale.
Employing
the approach to analyze industrial location in the EU developed in
previous work with Tony Venables (LSE),
Midelfart (NHH) and Overman (Young Researcher, NHH) have analysed the impact of national and EU
aid programmes on industrial location in the EU. They hereby aim at
assessing whether structural funding is promoting or hampering the
integration process. Their study “Delocation and European integration:
is structural funding justified?” was published in Economic
Policy autumn 2002.
The NHH team
(more specifically, Hagen, Heum, Haaland, Midelfart and Norman) published
a book on Globalisation, Location of Industry and Economic Policy
in February 2002. The prime
objective of the book is to provide a comprehensive and accessible account
of research based knowledge about some of the major issues in the current
economic-political debate, such as: How are the localisation choices of
firms affected by the integration processes in Europe? What does the
strong growth in multinational companies and foreign direct investments
across countries mean for a small, open economy like the Norwegian one?
How is the possibility of conducting economic policy at a national level
affected by the fact that companies, capital and labour are becoming more
mobile across countries? These are central issues in the current
economic-political debate. These are also issues that have been subject to
much attention in recent research on industrial development and
international economics. What do we know about the implications of
globalisation and integration for the economic development? How has
economic integration affected Norwegian and European trade and industrial
structure so far? What can we
expect in the future? And –
not least – how can and should economic policy be outlined to best meet
these new challenges? Throughout
the book, the authors draw on theoretical and empirical research to show
implications for European and Norwegian industrial development and
economic policy. What are the new possibilities and challenges facing trade,
industry and authorities in an increasingly integrated world economy?
The
IGIER team has worked on
innovation and agglomeration. Among the studies that have been undertaken
are “Globalization and Local Proximity in Innovation: a Dynamic
Process” , where an industry life cycle model is developed that
reconciles the observed and documented different pattern of (geo)concentration-dispersion
of industries through time. Our theoretical framework supports the finding
of a different dynamic of localization between different sectors through
time and the evidence of higher spatial concentration of more mature and
low-tech industries as well as of highly innovative ones. Work has also
been done aiming at tackling the extremely important task of identifying
and estimating a “production function”
of innovation for European regions using Patent and R&D data,
1977-1995; and has resulted in the paper “Innovation and Spillovers:
Evidence from European Regions”.
Cherdron
and Stahl, in Mannheim, in
cooperation with Andre Sapir (Team
Leader, CEPR), have started taking up the original challenge, namely
to describe, within a detailed case study framework, the locational
strategies of multinational firms within specific industries. The case
industries selected are the automotive industry; the banking and insurance
sector; and the computer hard and software industry.
They
started by looking in detail at the upstream supply relationships in the
automotive industry. A principle tension arising here is between
globalization in procurement on one hand, and production to order on the
other hand. The former leads to the spatial dispersion in supply patterns,
the latter to their spatial concentration. The general tendency emerging
is that while the former has led to a sharp increase in the
competitiveness in all upstream supply tiers, supplier patterns continue
largely as before the globalization fad, and remain spatially close to the
OEM (original equipment manufacturer) outlet. This also implies that
whenever OEM’s establish new plants (such as the Smart polant in Hambach/Lorraine),
the established suppliers will “move with the OEM” either by
establishing a JIT (just in time) manufacturing, or an inventory plant.
Enrico
Pennings (Young Researcher, IGIER)
together with Leo Sleuwaegen (Catholic University of Leuven) has completed
the study on the reorganization decisions of
troubled firms that was started in May. In “The Reorganization
Decisions of Troubled Firms: Exit, Downscale or Relocate “ they study
how poorly performing firms need to improve their profitability through
restructuring their operations. In many cases this means downsizing by
means of collective layoff of employees. Based on a unique sample of
Belgian firms reporting collective layoffs this paper analyzes whether a
firm dismisses all employees (exit), a significant proportion of its
employees (downscaling), or closes down part of its activities and moves
production abroad (international relocation). It is argued and
demonstrated that the choice of downsizing approach differs depending on
the strategic options and characteristics of the firm. The authors find
that firms that downscale are more sensitive to profit changes. Relocating
firms are labor intensive and move production to lower wage countries to
operate more capital-intensive in Belgium in line with the comparative
advantage of the country. Exiting firms are typically small and young
underscoring the theory on evolutionary learning.
In “New Empirical Evidence on the International Relocation of
Production “ Enrico Pennings and Leo Sleuwaegen
deal with the decision to relocate productive capacity from Belgium
to other countries. Belgium is a typical example of a country with an open
economy in which foreign firms account for more than half of the total
production. Consistent with basic theoretical models, and in contrast with
global relocation, it is found that relocation to adjacent countries takes
place when firms are relatively capital-intensive and relatively small.
For the latter type of relocations there are also more cases where public
aid plays a decisive role in the investment decision, suggesting its
strategic nature and potential harmful role in distorting competition.
Joint
with Carlo Altomonte (|GIER), Pennings started to work on ‘The Hazard
Rate of Foreign Direct Investment in Transition Countries: A Direct Test
of a Real Option Model’. First results will be presented at the next
network meeting in Villars (January 2003).
Real
option models predict that uncertainty raises the critical value at which
it is optimal to invest. Many empirical tests have confirmed this negative
relationship, but up to now only through indirect tests. In addition,
recent studies argue that the relation between uncertainty and the
probability of investment may be non linear. By deriving the hazard rate
of investment in a real option model we directly study this non-linear
relation between uncertainty and investment. Maximum likelihood estimates
for various specifications of the hazard are derived using a dataset of
MNEs that have invested in Central and Eastern Europe over the period
1990-1998. Whereas uncertainty has a negative effect on investment in an
approximate hazard, the indirect estimations fails the specification test.
In the real option-based hazard uncertainty is not significant showing
that the effect of uncertainty works on the mean through risk aversion and
not because of a value in waiting.
Laura
Bottazzi together with
Giovanni Peri (both IGIER) have
continued their study on the determinants
of new ideas and on the importance of existing knowledge, brains and
laboratories in the innovation production function of fifteen OECD
countries as well as on countries’ productivity. In the first paper, “
The Creation of New Ideas: a Cointegration approach” the authors adopt a
cointregration approach to estimate the long run relation between the
creation of innovation, workers in R&D and worldwide knowledge
spillovers. They adopt a vector cointegration approach to look at the
effects of the increase in R&D spending on the creation of new ideas.
Giovanni
Peri
has completed a paper
entitled "Young Workers, Learning and Agglomerations" in which
he studies how, since
90’s, densely populated locations, such as urban areas, have attracted a
disproportionate share of young college-educated workers. He explain this
stylized fact as a result of co-location due to learning externalities
among educated workers. Workers learn from each other when young,
increasing their skills and their productivity. Once they grow mature and
their learning decreases, some of them choose to move out of densely
populated areas. As skills grew more transferable thanks to
computerization and flexibility in the 80’s and 90’s, urban areas
became learning grounds for educated young workers.
In
“ Knowledge Flows and Innovation” Giovanni Peri estimates
knowledge flows across regions in Europe and North America as revealed by patent
citations. Only if these knowledge flows affect the productivity of
researchers in generating new ideas do they generate externalities in
innovation. We find that knowledge diffusion is strongly affected by
immediate proximity, distance, national borders, linguistic and
technological barriers. While some sectors such as Computer Technology are
more “globalized” than others, all knowledge flows are much more
far-reaching than trade or migration flows. However, once we control for
R&D inputs, we do not find evidence that these flows of knowledge have
an impact on innovation.
Thierry
Mayer (CERAS) and Keith Head (UBC)
have finalised their investigation on the role of market potential in the
location decisions of Japanese firms in Europe. In their theoretical
framework, the location decision is a function of demand in all locations
weighted by accessibility to consumers. The spatial distribution of
competitors should also be factored into the location choice. The
empirical implementation of the model makes use of a sample consisting of
firm-level location choices by Japanese firms between 1984 and 1995 and
uses both the information on the choice of country and the choice of
region inside each country. Results show that market potential does matter
for location choice but that traditional agglomeration variables retain an
important role in the location decision.
Pierre-Philippe
Combes (CERAS), Gilles Duranton
(LSE), and
Laurent Gobillon (CREST) use a very large panel of French workers
over 1976-1998 to estimate a model of wage determination across different
local labour markets. They control for individual characteristics,
individual fixed effects, characteristics of the local labour market and
local fixed effects. When not controlling for unobserved individual
heterogeneity, differences across local fixed effects seem rather small
and explain only a small part of the observed variance across local labour
markets. In contrast, local skills and the overall scale of the local
labour market act as important determinants of local wages.
Pierre-Philippe Combes and Miren Lafourcade
(both CERAS) have finalised their long-term project on the structural
estimation of a tractable economic geography model incorporating strategic
firms. The empirical implementation is a study of regional inequalities in
France. They find that intermediate inputs and geographical features play
a critical role in the concentration pattern of French economic
activities. Estimations being consistent with plausible values for the
structural parameters of the model, they also provide simulations of
French local sectoral employment and production conditions. A major
feature of their results is the very strong core-periphery structure of
short-run profits, which means that large concentration incentives exist
in France. By contrast, a short-run analysis of the impact of a transport
costs decline reveals that whereas dispersive forces become prevalent at
the country level, agglomeration incentives strengthen specialization
within a large number of the French regions. As regards profits, the
emergence of a duo-centric structure confirms such a feature.
Pierre-Philippe
Combes and Miren Lafourcade (both CERAS)
are currently working on the methodology of transport costs calculation,
and how this drives results in the analysis of regional policy and in
particular of the impact transport infrastructure investment. They aim to
provide answers to the following questions: How do transport costs differ
across regions ? How much of these differences are
related to transport infrastructure policy, market structure, or
physical geography? How are transport costs likely to change as a result
of new information technologies, improved inter-modal transport, and other
trends? This paper aims at enlightening those questions by analysing first
the transport costs measures that have been used in the economic empirical
literature and pointing out their limits. Second, it presents an original
methodology for calculating inter-regional transport costs and provides
descriptive statistics on their foundations, levels and evolution in
France, during the 1978-1998 period. Finally, it illustrates the potential
use of this new data set to derive and analyze French “Market
potentials”.
Thierry
Mayer (CERAS) and Keith Head (UBC)
currently wok on the impact of different distance measurements and how
different methodologies can participate in inflating the so-called border
effect in trade puzzle. This puzzle
was first presented by McCallum (1995) and has gone on to spawn a large
and growing literature on so-called border effects. They argue in this
paper that, because distances are always mismeasured in the existing
literature, the border effects may have been mismeasured in a way that
leads to a systematic overstatement. The goal here is to develop a correct
measure of distance that would be consistent for international as well as
intra-national trade flows. It is shown how the use of the existing
methods for calculating distance leads to “illusory” border and
adjacency effects. The methods are applied to data on interstate trade in
the United States and inter-member trade in the European Union. The new
distance measure reduces the estimated border and adjacency effects but
does not eliminate them. Thus, while they do not solve the border effect
puzzle, they do show a way to shrink it.
Pierre-Philippe
Combes, Miren Lafourcade and Thierry Mayer (all CERAS), use newly available data
on bilateral trade flows between 94 French regions, for 10 industries and
2 years (1978 and 1993) to study the magnitude and variations over time of
trade impediments, both distance-related and (administrative)
border-related. They focus on assessing the role that business and social
networks can play in shaping trade patterns and explaining the border
effect puzzle. Intra-national administrative borders are shown to
significantly affect trade patterns inside France. The impact is of the
same order of magnitude as in Wolf (2000) for trade inside the United
States. The main results of this paper lie in the explanation of those
intra-national border effects through the existence of networks similar to
the ones emphasized in Rauch (2001). More than 60% of these (puzzling)
intra-national border effects can be explained by the composition of local
labour force in terms of birth place (social networks) and by inter-plants
connections (business networks). In addition, controlling for these
network effects reduces the impact of transport cost on trade flows by a
comparable factor. Thus, business and social networks that help reduce
informational trade barriers are shown to be strong determinants of trade
patterns and to explain a large part of the border puzzle.
As
already mentioned above, the CERAS team is very much involved in the
preparation of the Volume 4 of the Handbook of Regional and Urban Economics edited by V. Henderson and
J.F. Thisse and to be published by Elsevier in 2003, and in particular
concerning the empirical implementations of Economic Geography models with
applications to the EU:
Pierre-Philippe
Combes (CERAS) is working with
Henry Overman (LSE) on a
chapter on spatial distribution of economic activities in the European
Union
Thierry
Mayer (CERAS) and Keith Head (UBC)
are preparing the chapter on the empirics of agglomeration and trade. They
investigate the existing evidence on the importance of forward and
backward trade linkages in causing the spatial concentration of economic
activity. Two possible
empirical strategies are considered: First, one can assess the assumptions
of new economic geography. Do
the data support the theory's fundamental building blocks? Second, one can
assess the predictions of the
models. Does agglomeration actually arise under the predicted
circumstances? Each of those aspects are treated and the authors conclude
with an overall assessment and suggest some directions for future
research.
The
UCD team led by Peter Neary and
his co-authors has considered various aspects of the experience of the
Republic of Ireland, easily the fastest-growing economy in the EU in
recent years, in the light of theories of economic geography and
industrial location. This has involved scrutinising the contribution of
foreign direct investment on the one hand and EU structural funds on the
other to Ireland's economic transformation.
It has also involved considering the likely effects of EU
enlargement on inflows of foreign direct investment to Ireland.
Computable
economy-wide models focusing on location issues
One
basic objective of the research program is to expand the set of available
econometric tools for the analysis of general equilibrium-theory based
theoretical predictions. This
will allow us to explore, in the context of large general equilibrium
models, how the existence of linkages between industries affects
agglomeration and the geographic location of industry in Europe. This
involves development of GAMS-based estimation methods for use within the
confines of large general equilibrium models.
This poses a number of problems.
One is the fact that we immediately find ourselves working within a
large system of non-linear simultaneous equations.
Another is that the same parameters generally occur in more than
one structural equation within the general equilibrium system, posing
cross-restrictions. Most
important, the endogenous variables necessary to build a full time series
are often unavailable, or worse still impossible to observe directly. This
requires sparse-data techniques that are not well developed for
simultaneous non-linear systems estimation. The Tinbergen
Institute has made good progress in the extension of this class of
techniques. In particular, they have been exploring methods for CGE
system-based parameter estimation and specification testing, given limited
data availability (and without calibration). The plan in the next phase of
this research is to apply these techniques to examine empirical issues
related to the economic geography of Europe.
The
NHH team has completed a
simulation study of industrial location and agglomeration in Europe,
entitled “A U-shaped Europe? A simulation study of industrial
location”. They use a large-scale CGE-model to simulate the effects of
gradual economic integration on the location of industrial production. The
results reveal large differences among industries. Industries with high
scale elasticities typically display a non-monotonous relationship between
trade liberalisation and concentration, with maximum concentration for
intermediate trade costs. Other industries, more driven by comparative
advantage, become monotonously more concentrated as trade costs fall. On
the aggregate level we find an (inverted) U-shaped relation between trade
costs and concentration. The results also show a close correlation between
real income gains and growth in manufacturing production, stemming from
pecuniary externalities in the manufacturing sectors.
The
NHH and GIIS teams have also completed various CGE (computable general
equilibrium) based analyses of the impact of European integration on
industrial location and welfare inside and outside the EU. All analyses
apply a newly developed CGE-model, which divides the world into ten
regions, five of which are European, and 14 industries, of which 12 are
imperfectly competitive. With a complete input-output structure, the model
captures comparative advantage mechanisms as well as intra-industry trade
and “new economic geography” agglomeration forces. One set of
simulations focuses on the consequences of successful transformation in
Eastern Europe. The results indicate that transformation and European
integration are of great importance for Eastern Europe, while the overall
effects for other European regions are small.
Individual sectors in the EU, such as Textiles and Transport
Equipment, are, however, in some cases strongly affected.
Another
set of simulations focuses on the impact of tighter European integration
on outsider regions. It is argued that because theoretical models
analysing PTAs have very few contact points with reality, further research
is needed to evaluate whether the effects highlighted by these models –
catastrophic agglomeration and non-monotonic relocation, for example –
are theoretical aberrations of highly specific models, or important
effects that help us explain real world events.
In their 14-sector, 10-region model, they find broad confirmation
for the theoretical PTA models, and in particular for the Puga-Venables
effects. They find that tighter European integration has a significant
impact on Central and Eastern European countries, but the impact on other
regions of the world is rather small.
Their findings do however suggest that the simple models of
economic geography analysing PTAs miss important elements.
The most important of these are comparative advantage and real
trade costs.
One basic objective of
the research program for the Tinbergen
team is to expand the set of available econometric tools for the analysis
of general equilibrium-theory based theoretical predictions. This has
involved development of both GAMS-based and GEMPACK-based estimation
methods for use within the confines of large general equilibrium models.
The team has made good progress in the extension of this class of
techniques. In particular,
they have been exploring methods for CGE system-based parameter estimation
and specification testing, given limited data availability (and without
calibration). Results were
presented at the annual Conference on Global Trade Analysis (Purdue
University) last summer. A related paper on method will be presented at
the European Trade Study Group conference this fall.
The team’s plan in the next phase of this research is now to
apply these techniques to examine empirical issues related to the economic
geography of Europe. They are also working on a dataset (with emphasis on Europe) covering financial market
indicators and economic performance indicators.
This dataset is now largely complete, and will be used to explore
theoretical and empirical linkages between financial market integration
and the geographic location of industry.
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