Increasing Returns and Economic Geography

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The central subject of this paper is to create a model simply enough to show how a country can become differentiated into industry and agriculture. Generally, manufacturing firms tend to establish their headquarters in the places where they have the highest demand in order to realize economies of scale, minimizing the transport costs in the same time, but the distribution of manufacturing gives the location of demand.

Standard economic analysis allocated just a small part to the study of economic geography, considering countries as dimensionless points and the transportation costs between nations as equal to zero. But the study of economic geography plays a marginal role in the international trade economy. “Yet the study of economic geography, at least within the economics profession, has lain largely dormant for the past generation, as the author affirms”.

The purpose of the work is to lead to the reconsideration of economic geography through the application of techniques and formal models coming from theoretical industrial organization. The author proposes a simple model with the desired goal of answering the key question of location:”Why and when does manufacturing become concentrated in a few regions, leaving others relatively undeveloped?” The model will develop a simple example of interacting transportation costs with economies of scale among the geographical concentration of manufacturing.

In the first part of the paper, some previous scientific contributions to the model are set:” Alfred Marshall’s original exposition of the concept of external economies was illustrated with the example of industry localization, identifying three reasons for localization.” The concentration of many firms in a single place offers a wider market for the specialized labor force, ensuring a higher stability of the place of work and a lower probability of labor shortage. Secondly, when the industries are located in the same place, the production of nontradable specialized inputs can be supported. In the third place, informational spillovers can give clustered companies a higher production than the individual producers.

”Why manufacturing in general might end up concentrated in one or a few regions of a country, with the remaining regions playing the “peripheral” role of agricultural suppliers to the manufacturing “core”?” is the next question that has to be answered. Externalities that lead to emergence of a core-periphery pattern are pecuniary externalities that generally have no welfare significance, but they become important in the presence of the imperfect competition and increasing returns. Focusing on pecuniary externalities, the firms are able to make a much more concrete analysis than if they would allow external economies to arise in some invisible form.

The author imagines a country specialized in two types of products: agriculture, characterized by constant return to scale and by an intensive use of immobile land, and manufacturing, characterized by increasing return to scale, but a modest use of land. The production of manufacturers will be placed in the sites nearby demand because in this way the transportation costs will be minimized and the other locations could be supplied from these localized centers. “Manufacturers production will tend to concentrate where there is a large market, but the market will be large where manufacturers’ production is concentrated.” This was called “positive feedback” by Arthur (1990).

Hirschman (1958) types: “other things equal, it will be more desirable to live and produce near a concentration of manufacturing production because it will then be less expensive to buy the goods this central place provides.” He called this “backward linkage”.

In a preponderant agricultural country, manufacturing concentration doesn’t depend by the fact that this industry employs only a small part of the population generating only a little fraction of demand or if a weak economy of scale combined with a high transportation costs induces suppliers to the agricultural sector to locate nearby their markets. In a society like this, the biggest part of the population is engaged in agriculture and the transportation costs that couldn’t be ensured by the rural producers of the goods would be satisfied by the local market’s distributors from the small towns.

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