Monday, September 19, 2011

Economic Geographies

Via Tyler Cowen, I came across an interesting essay by Noah Smith discussing possible causes for the recent economic stagnation. He adapts a theory of economic geography from Paul Krugman:
The basic idea of the theory is this: It is expensive to move products around. This means that if you have a factory, you want to locate it close to where your customers are, to avoid paying a bunch of shipping costs. Now consider two factories. The workers in the first factory will be the consumers for the second factory, and vice versa. So the two factories want to locate near each other ("agglomeration"). As for the workers/consumers, they want to go where the jobs are, so they move near the factories. Result: a city. The world becomes divided into an industrial "Core" and a much poorer agricultural "Periphery" that produces food, energy, and minerals for the Core....
So this could explain why people in the rich world are getting poorer. In the 50s, America was the only industrial "Core" on the planet. But since the 60s, we have seen successive "growth miracles": Japan and Europe in the 60s/70s, then Taiwan/Korea/Singapore in the 80s, then China since then, and now even India. In a New Economic Geography world, we would expect these successive relocations of manufacturing to hold down income growth in the U.S., even if technology was advancing as usual. And now Japan and Europe are feeling the pinch as well.
Smith further expands upon the situation of the USA:
It may be that American manufacturing strength was due to a historical accident. Here is the story I'm thinking of. First, in the late 19th and early 20th centuries, our proximity to Europe - at that time the only agglomerated Core in the world - allowed us to serve as a low-cost manufacturing base. Then, after World War 2, the U.S. was the only rich capitalist economy not in ruins, so we became the new Core. But as Europe and Japan recovered, our lack of population density made our manufacturing dominance short-lived.

Now, with China finally free of its communist constraints, economic activity is reverting to where it ought to be. More and more, you hear about companies relocating to China not for the cheap labor, but because of the huge domestic market.
There are many good points here, especially the role of sudden shocks to the economy in changing events; the essay is well worth reading in full.
However, I'm somewhat skeptical of this theory of economic geography.

First of all, I think it may overvalue the cost of transporting goods. Shipping costs were a much bigger weight in 1830 than they are today, and producers are less tied to the physical territory of potential consumers now than they were. After all, the past few decades have seen many factories close down in the American market only to relocate thousands of miles away to sell to this very same market. The story of globalization over the past twenty years is in part the story of the diminution of shipping costs (broadly considered), which I think may complicate the narrative of this model.

Moreover, this theory of economic geography seems to suggest in some way that the most densely concentrated areas are likely to be destined to be the richest (I admit that this is a simplification of the model). However, often very densely concentrated countries are very poor, while there are plenty of wealthy less dense countries. I wonder whether density of population is really the most crucial variable for discussing national wealth or national capacity for wealth.

Smith's reading of the US economic path is interesting, but I think it also has some limitations. While our closeness to Europe might have allowed us to serve as a "low-cost manufacturing base" (though the US was much farther from Europe than many poorer nations), the growth of American industry in the nineteenth century was also accompanied by the increase of American living standards over those of many wealthy European nations (such as Great Britain); this combination of high wages with industrial growth differs from current low-wage trends. And the US had a huge manufacturing capacity even before the other great powers destroyed themselves during the two World Wars.

Also, I think Smith may underestimate the role of human agency in his claim that "you hear about companies relocating to China not for the cheap labor, but because of the huge domestic market." The appeal to the giant Chinese domestic market has merit, but we should not forget that the Chinese government often requires companies to invest in factories and other places of employment in the PRC in order for them to have access to the broader Chinese market. Beyond the "natural" appeals of economic geography, state coercion plays a considerable role in this narrative of Chinese expansion.

Though I'm doubtful about many of his policy suggestions, Smith is right in his recommendation that American update its transportation infrastructure. I think there's more to economic destiny than population density, and the "historical accident" of American wealth is in part the result of the deliberate choices of American policymakers in the past (even if some of these policies, such as tariffs, may run afoul of contemporary orthodoxies).

Update: Matt Yglesias has some more observations on the China market here.

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