78
Richard Baldwin
Figure 3.9. Welfare Effects of Complete Liberalization Home market only price
euros
markup
demand curve
BE BEFT
p’ p”
E’
E’
µ’
p’ E”
p”
C
E”
E’ E”
µ”
AC
COMP
MC
x’ x”
sales per firm
n’ C’ C”
n”
number of firms
total sales
Source: Author’s elaboration.
and undertake mergers and acquisitions quickly enough to avoid big losses. In figure 3.8, this would look like a move from E' directly to E". Agglomeration and the New Economic Geography Industrialization and deindustrialization are core concerns of developing-country policy makers around the world. Or, to put it differently, policy makers care about the location of industry. Although a whole host of policies affects a nation’s industrialization, trade policy has proved to be a critical element in industrialization in almost all countries. This section considers an analytical framework that permits us to think logically about several of the key forces affecting industrialization and how they interact with trade barriers. The framework is often called the new economic geography, following the terminology of 2008 Nobel laureate Paul Krugman. The basic focus of the new economic geography is on whether firms would enter or exit a particular market. The key determinant, in this simplified view of the world, is the firms’ profitability. If setting up a new firm in a particular country would be profitable, then the firm is created. If production in a particular country becomes unprofitable, the firm ceases production. The entry or exit decision rests on the balancing of two sets of forces: agglomeration forces and dispersion forces. Agglomeration forces promote the spatial concentration of economic
activity, whereas dispersion forces discourage such concentration. The spatial distribution of economic activity at any moment in time depends on the balance of the proconcentration (agglomeration) forces and the anticoncentration (dispersion) forces. The main question in this section is, how does trade integration affect the equilibrium location of industry? To set the stage for the equilibrium analysis, we first consider dispersion and agglomeration forces in isolation. For better understanding of how trade arrangements affect profitability, and thus industrialization, it is convenient to employ a simple analytical framework, one constructed by Puga and Venables (1998). It focuses on four forces: two dispersion forces (factor-market competition and local-market competition), and two agglomeration forces (input-cost linkages and demand linkages). Dispersion and Agglomeration Forces Dispersion forces favor the geographic spreading out of economic activity. Land prices are the classic example. The price of land, and therefore the price of housing, office space, and so on, is usually higher in built-up areas such as central London than in rural areas such as northern Wales. If everything else were equal, firms and workers would prefer to locate in less built-up areas. (Of course, we know that other things are not equal.) The forces that make built-up areas more attractive are called agglomeration forces; we set them aside for the moment to concentrate on dispersion