Geography and Development.

The most striking fact about the economic geography of the world is the uneven distribution of activity. High-income regions are almost entirely concentrated in a few temperate zones, 50% of world GDP is produced by 15% of the world’s population, and 54% by countries occupying just 10% of the world’s land area. The poorest half of the world population produces 14% of world GDP, and 17 of the poorest 20 nations are in tropical Africa. The unevenness is also manifest within countries, with metropolitan concentrations of activity. The share of the population of developing countries in urban areas has increased dramatically in recent years; Latin American countries (as European and North American ones) are 75% urbanized, and while Asian countries are under 30% urbanized their urban populations are growing at around 4% pa.

Why do these spatial inequalities exist, and why are spatial differences in land rents and wages not bid away by firms and individuals in search of low cost or high income locations? The answers to this question have to do partly with spatial variations in institutions and endowments (natural endowments and accumulated human and physical capital), and partly also to do with geography – the spatial relationship between economic units.i There are two key (and related) geographical questions. Why do so many economic decision takers choose to locate close to each other? And, for those that cannot locate in an economic center, what are the consequences of being outside, and possibly remote from, existing centers?

This paper argues that understanding these two issues is central for understanding many aspects of economic development and underdevelopment. At the international level it is important for understanding the forces shaping the location decisions of firms, and the consequent demand for labor and pattern of cross-country wage differentials. At the national and sub-national it is important for understanding the processes driving urbanization and the evolving internal economic geography of countries and cities during their development. And at the policy level, it is important for understanding the contributions of international trading arrangements, of regional policies, and of public infrastructure investments in shaping the location of economic activities and thereby promoting development.

This paper reviews some of the recent theoretical and empirical work that illuminates these issues. In the next section we overview analytical issues, and then turn to a review of empirical work. This looks first (section 3) at the consequences of being remote from established centers, concentrating on the international setting. Section 4 turns to empirical work on the forces that drive agglomeration, where evidence is from intra-country, particularly urban, studies. Section 5 delves further into urban issues, looking both at the evolution of cities in developing countries, and at the issue of overurbanization. Section 6 turns to policy. Here we are much more speculative, but argue that a number of key policy issues need to be analyzed from a rigorous geographical perspective, and that further research needs to be done on these issues.

 

Why is economic activity so concentrated? The presence of transport costs suggests that industry might spread out to minimize the costs of reaching consumers indifferent locations, and if production takes place under conditions of constant or diminishing returns to scale, then this is exactly what economics predicts. The ‘folk theorem’ of spatial economics says that under these conditions there will be very many small plants supplying local markets. It is only the presence of increasing returns to scale which forces firms to concentrate production in relatively few locations, and thus confronts them with the choice of where to operate.

 

The increasing returns that are necessary for agglomeration may be either external to the firm or internal. External mechanisms include knowledge spillovers and externalities arising in the labor market. For example, information spillovers can arise with neighboring firms; by observing them and learning about what they are doing, firms learn about technological developments, whom to buy from and sell to, whom to hire, what product lines are selling, and the like (see Eberts and McMillen 1999 for a review). In the labor market, there may be gains from locating in a thick labor market, and in a location where other firms have already trained a supply of skilled workers (Marshall, 1890, Krugman 1991b)

External economies create incentives for firms to locate close to each other, and so too can internal economies of scale. Firms’ location decisions are based both on input price considerations and on ease of access to markets.iv Consider first market access. Firms want to locate close to demand (or, more generally, in locations from which transport networks make it relatively cheap to reach markets) and models generally yield the result that increasing returns activities are pulled disproportionately towards locations with good market access. For example, if there are 9 locations, 8 of which have 10% of final expenditure and 1 of which has 20% then, other things being equal, more than 20% of manufacturing supply will be met from this larger location as firms locate to exploit the benefit of proximity to the large market. This immediately creates a force for agglomeration of activity. As a disproportionate share of manufacturing is attracted to a location so either the wage rate in the location is bid up or labor is attracted to immigrate – either of which will tend to increase this location’s share of total expenditure still further. The market access effect is sometimes called the ‘home market effect’, and this combined with labor mobility is the basis of Krugman’s seminal 1991a paper.

A second force comes from combining market access with intermediate goods production. Demand for manufacturing comes not just from final consumers but also from intermediate demand, so a location with a lot of firms will have a high demand for intermediates, making it an attractive location for intermediate producers. This in turn makes it an attractive location for firms that use these intermediate goods, as they can economize on transport costs on inputs. There is thus a positive feedback between location decisions of upstream and downstream firms, tending to draw both types of firms together in the same location, so leading to agglomeration.vi These forces are just the backwards (demand) and forward (cost) linkages that figured so prominently in an earlier generation of development economics (in particular the writings of Hirschman 1958 and Myrdal 1957). However, as we have already remarked, these effects can only really matter in an environment of increasing returns to scale, without which upstream and downstream firms could be broken into many small plants.

Agglomeration forces can operate across more or less broad ranges of activity. For example, the key externalities and linkages might occur between firms in a particular industry or between firms that engage in a narrow field of R&D. Alternatively they might operate at a much broader level – through aggregate demand as a whole, the development of general labor skills, or the provision of basic business infrastructure and inputs used by wide sectors of the economy. It is also argued that they may stem notfrom specialization but from diversity in the activities of a location (Jacobs 1969).

Pulling in the opposite direction are forces for dispersion. These are of essentially three types. One is negative externalities from congestion. Another is the supply of immobile factors, the prices of which will be bid up in centers of activity, encouraging firms to move to lower factor cost locations. And the third is the extent of the market, limited by the presence of geographically dispersed demand for output. Thus, if labor is dispersed it encourages a dispersed location of firms for both supply and demand reasons.

The importance of these dispersion forces depends critically on what factors are immobile, and what mobile. In a regional context labor might be mobile, and land the only immobile factor. Agglomeration then causes labor movement (eg to cities), until choked off by congestion costs or land prices. In an international context most sorts of labor are immobile, so agglomeration will bid up the price of labor as well as land. This discourages agglomeration, but means that when it occurs it will be associated with international income inequalities.

 

Outcomes are determined by the balance between agglomeration and dispersion forces. Theoretical modeling establishes the dependence of this balance on model parameters, and shows how small parameter changes can lead to discontinuous changes in the configuration of equilibria. Thus, for some values of parameters a model may predict that economic activity will be dispersed between locations. This configuration is robust until a bifurcation point is reached, at which point the dispersed equilibrium becomes unstable. If one location gains further activity then positive feedback (which in the earlier spatial literature was referred to as the process of cumulative causation) causes further activity to be drawn in, forming an agglomeration.

For example, if transport and communication costs are very high then activity must be dispersed; (under autarky every location must have its own industry to meet final demand). And if transport costs are extremely low, then firms will not care whether they are close to markets and suppliers; (if transport and communications are costless we encounter the end of geography). So it is at intermediate levels of transport costs that the likelihood of agglomeration is greatest. This is often presented in the models as an application of ‘symmetry breaking’. At high enough transport costs all locations are identical, but as costs fall below a critical value the model goes through a bifurcation, at which point the economic geography of the world self-organizes into a structure of centers of activity, with intermediate hinterland areas. Further declines in transport costs may lead to erosion of this structure.

Table1:Agglomeration:forces and outcomes

 

Typically many locations are candidates for hosting the agglomeration, and small initial differences (or historical chance, or self-fulfilling expectations) determine which gains it. However, once a site has become a center of activity, then a ‘lock-in’ effect operates. Even if exogenous circumstances change (perhaps reducing the attractiveness of the site) economic agents will not want to move away and forego the benefits of the agglomeration. This tendency will be accentuated by the durability of sunk cost investments, such as plant and infrastructure. There is therefore a path dependency in the structure of the equilibrium, with history being as important as current circumstances.

In our discussion of agglomeration and dispersion forces we distinguished according to the breadth of activities drawn together by agglomeration forces, and according to the mobility of factors of production (often corresponding to an intra- vs inter-national distinction). Different combinations of these cases apply in different situations, generate different outcomes, and correspond to different strands in the literature. Table 1 illustrates some of the possibilities.

If agglomeration forces operate primarily within particular industries and most factors are mobile, then the likely outcome is agglomeration of industries in specialized locations (top left cell of table 1). Inter-locational factor price differences are small, both because each of these centers only contains a small fraction of possible activities, and because many factors are mobile. The classic model of this type is that of Henderson (1974), who constructs a general equilibrium model of a system of specialized cities.Two extremes are analyzed -- a world of developers who set up competitive cities potentially achieving efficient outcomes, and a world without "large agents " (developers) where cities (of generally excessive size) form through "self-organization."

At the other extreme, if linkages operate at a much broader level and factors (especially labor) are immobile then agglomeration, if it occurs, will be associated with inequalities in factor prices and real incomes (bottom right cell of table 1). Thus, in the international model of Krugman and Venables (1995) industrial activity concentrates in ‘north’, even though wages may be many times higher there than in ‘south’; firms are deterred from moving south because agglomeration benefits foregone might outweigh labor cost savings. This view of the world is radically different from that of conventional international economics, predicting that the world divides into rich and poor regions, even if there are no international differences in factor endowments, skill levels, institutional quality or other underlying economic characteristics. Development and under-development are simply manifestations of agglomeration of economic activity.

 

Agglomeration mechanisms are one way to explain the observed unevenness in the spatial distribution of activity and income. Development must then take the form either of mitigating the disadvantages of being outside existing centers, or of the creation of new centers of activity. What does this approach have to say about the birth of new centers? This question has typically been addressed by supposing that there is some exogenous growth process – population or technical change – and showing how this will create new centers of activity.

In the urban context, Fujita, Krugman and Venables (1999) show how rising population will lead to the birth of new cities. Population growth expands the agricultural hinterland surrounding existing cities, and at some point it becomes profitable for a new frontier city to develop. Continuing growth will lead to the development of multiple cities, spaced out from each other and locked into their locations.

In the international context, Puga and Venables (1999) model the spread of an agglomeration from country to country.vii They suppose that world demand for manufactures is increasing (due perhaps to exogenous technical progress), and tending to widen the wage gap between countries with industry and those without. There comes a point at which the wage gap is too large to be sustainable, and manufacturing begins to move out of established centers to low wage regions. However, just one (or a few) new industrial centers will become established at a time. The logic is as we have already seen. An equilibrium with dispersed industry is unstable; any location that gets just slightly ahead of the others gains from forward and backward linkages, these positive feedbacks causing the location to develop faster and the others to fall back. Development therefore takes the form of enlargement of the set of countries that are in the ‘center’, while most countries remain outside, largely unaffected. As the growth process continues, so enlargement of the set of ‘central’ countries proceeds sequentially, adding countries in turn. The approach predicts that development is not a process of steady convergence of poor countries to rich ones, but instead the rapid transition of selected countries from the poor club to the rich club.

Which countries are most likely to make this transition? It may be determined by very small initial cross-country differences (indeed, if all countries were identical, it would simply be a matter of chance). The pertinent dimensions of difference are those which determine the profitability of the first firms to relocate, so include labor market factors, internal infrastructure (Martin and Rogers 1995), as well as institutional characteristics of the country. Since the first entrants will be highly dependent on imported intermediate and capital goods and on export markets for final sales, they will tend to go to locations close (or with good transport links) to established centers.

A further issue concerns the industrial structure of these newly industrializing economies. What sectors do they attract first, and how does their industrial structure change during development? The first sectors to become detached from an existing agglomeration will typically be those that are intensive in immobile primary factors (the prices of which are high in the center), and that are not too heavily dependent on linkages with other firms. These may be firms with low usage of intermediate goods, low levels of sales to other industrial sectors, or that do not need to cluster with related activities to gain new technology. As these sectors relocate, so they may begin to create linkages and attract other sectors. The sequence in which industries enter then depends on their factor intensities, their tradability, and the way in which they benefit from linkages to other activities, and create their own linkage effects.

The message then, is that new centers of activity can develop, but the process is not one of steady convergence of all locations. Instead, it is rapid development of a few locations, leaving others essentially unaffected. This fits well with the historical record. Recent decades have seen a small group of countries make a rapid transition from being amongst the low income group to join the middle- or high-income countries, while divergence has continued between high-income and the great majority of low income countries (Quah 1997). Furthermore, growth performance is much more variable across countries than is accumulation of either physical or human capital (Easterly and Levine 1999).

Although new centers can form, most locations remain outside. What determines the structure of activity outside established centers, and the magnitude of the income penalty to being outside?

The costs of distance from an established center arise essentially because of the costs of trading goods with, and receiving information and technology from, the center. These costs will impact entirely on immobile factors, and if these account for a small share of production costs, then even quite low transport costs can have a large effect on their prices. The classic analysis of this is von Thunen (1826). A city is located in the center of a ‘featureless plain’ and labor is mobile between the city and agricultural employment in the surrounding area. Regions specialize – forming concentric circles of activity – according to the transport intensity of the products, and transport costs determine the rent gradient. Rents diminish steadily with distance since land – the only immobile factor – bears all the costs.

If labor is immobile – or has frictional costs in moving – then it too will bear some of the costs of distance. An international application of the von Thunen model is developed in Venables and Limao (1999) in which there are several immobile factors in countries at increasing distances from an economic center. The countries specialize according to the interaction between two pairs of forces. One is products’ transport intensity interacting with distance, as in von Thunen; the other is products’ factor intensity interacting with countries’ factor endowments, as in Heckscher-Ohlin trade theory. Real incomes decline with distance, although the prices of individual (immobile) factors need not, as changing patterns of specialization influence factor demands.