On the new economic geography of a multicone world

• Author: P. Commendatore,I. Kubin,P. Mossay
• Date: 01 August 2018
• Published date: 01 August 2018
• DOI: http://doi.org/10.1111/roie.12312

SPECIAL ISSUE PAPER

On the new economic geography of a multicone

world

P. Commendatore

1

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I. Kubin

2

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P. Mossay

3

1

University of Naples ‘Federico II’, Italy

2

Vienna University of Economics and

Business Administration,Austria

3

Newcastle University, UK, and CORE,

Belgium

Correspondence

P. Mossay, Newcastle University, 5

Barrack Road, NE1 4SE Newcastle, UK.

Email: pascal.mossay@ncl.ac.uk

Funding information

COST Action IS 1104, European

Cooperation in Science and Technology

Abstract

We build a new economic geography model incorporating

differences in productivity among sectors and countries, thus

allowing for comparative advantage. We study the role that

market size, absolute advantage, and comparative advantage

have on the trade patterns and the long-run spatial distribu-

tion of economic activity in a world with multicones of

specialization. We briefly mention the possibility of long-

term fluctuations in the spatial distribution of industry by

relying on a discrete-time framework.

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INTRODUCTION

In an influential work, Krugman (2008) highlights that as developing countries engage further in trade

in industrial commodities, they tend to specialize in manufactured commodities differing from those

that industrialized countries specialize in. This notion of mutiple cones of specialization, dating back to

Leamer (1987), has gained increasing attention in the analysis of international trade patterns (for more

recent evidence see, e.g., Kiyota, 2014). At the same time, firms’market power and increasing returns

to scale are known to affect industrial production and its location, especially in a globalized world

where productive factors become increasingly mobile. The main motivation of our paper is to reconcile

the imperfect competition modeling of core–periphery structures with the evidence on multicones of

specialization.

New economic geography (NEG) models rely on the presence of increasing returns to scale in pro-

duction and factor mobility to explain the spatial agglomeration of economic activity and the emer-

gence of core regions and peripheries, see for example, Krugman (1991), Fujita, Krugman, and

Venables (1999). When agglomeration takes place, larger markets tend to attract further economic

activity. In contrast, classical models of trade based on comparative advantage (CA) rely on differences

in productivity among regions or countries to explain specialization patterns.

The aim of the paper is to analyze the role that absolute advantage (AA) and CA have on the spa-

tial distribution of economic activity in the presence of market size effects in a multicone world. For

that purpose, we develop a NEG model where differences of productivity across countries, providing

them with AA and CA, interact with the agglomeration force driven by increasing returns to scale.

Rev Int Econ. 2018;26:539–554. wileyonlinelibrary.com/journal/roie V

C2017 JohnWiley & Sons Ltd

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DOI: 10.1111/roie.12312

Some contributions in the literature deal with CA and industrial concentration within a NEG frame-

work. In his seminal work Ricci (1999) introduces two manufacturing sectors in Krugman’s (1991)

core–periphery (CP) model. A country can have a CA or an AA in the production of one of the manu-

factured goods, as reflected by a lower marginal cost of production (either in relative or absolute

terms). In Ricci’s (1999) analysis, CA has a positive direct effect on specialization—firms of a given

sector are attracted by the country that has a CA in that sector—as well as a negative indirect effect: an

increase in market size induced by the influx of firms of the sector where the country has a CA implies

lower specialization as firms of the other sector move to that country as well. So a “perverse”relation-

ship between CA and specialization may occur (but not a complete reversal). Moreover, CA could act

as a dispersion force, so that a reduction in trade costs does notnecessarily lead to more agglomeration,

depending on the counterbalancing of CA (and AA) and market size. Moreover, the possibility of sta-

ble multiple equilibria could lead to partial agglomeration in the less productive country (in AA terms).

In Ricci (1999), full specialization is not considered as both countries are assumed to be producing

both goods. Moreover, congestion externalities are introduced so as to avoid full agglomeration of the

industrial activity in either country.

1

Ricci’s (1999) analysis is further developed by Forslid and

Wooton (2003), in a slightly different CP model where firms in the same sector are characterized by

different fixed production costs.

2

Differences in productivity also depend on where firms locate, thus

allowing for CA in each county over a range of product varieties. Forslid and Wooton (2003) show

that the counterbalancing of CA and agglomeration forces, especially driven by market size, is affected

by trade integration in the following way: at high trade costs, the economic activity is fully dispersed

owing to the prevalence of local demand. At low trade costs, where agglomeration forces are weak,

CA representing a dispersion force (firms are attracted symmetrically where they can be more produc-

tive) overcomes the market size effect, so that again, industrial activity is fully dispersed. For interme-

diate trade costs, agglomeration forces are sufficiently strong to prevail over the dispersion effect

induced by CA, so that partial agglomeration occurs. Note that the existence of multiple stable equili-

bria is obtained, with smooth transition in two directions: towards higher agglomeration or towards full

dispersion. Finally, both full specialization and full agglomeration are excluded, since the incentive for

a firm to locate in the country where it is more productive increases rapidly as the number of firms in

that country decreases. Finally, in a quite different set-up, Pfl€

uger and Tabuchi (2016) are able to dis-

entangle the effects of CA and market size. They consider a vertically integrated economy, where CA

and constant returns to scale characterize the final good sector and increasing returns to scale of the

sector producing intermediates. For our purposes, their most interesting result is the combined effect

from reducing simultaneously the costs of trading final and intermediate varieties, which are assumed

to be different. In Pfl€

uger and Tabuchi (2016), agglomeration forces are enhanced by reducing the

costs of trading the intermediates, whereas lowering trade costs in the final good sector enhances the

effect of CA, which is a dispersion force favoring the spread of economic activity. The simultaneous

increase of trade freeness in these two sectors leads to their spatial concentration. Full agglomeration

can only occur in the intermediate good sector, with both the core and the periphery producing the final

good, although in different proportions.

Our framework extends the two-country footloose capital model by Martin and Rogers (1995) to

the case of two monopolistically competitive sectors. This provides a more tractable model than that

by Ricci (1999) who used a similar extension in the context of Krugman’sCPmodel.Unliketradi-

tional NEG models, the footloose capital model does not exhibit circular causality as location of

demand is not endogenous, see Baldwin, Forslid, Martin, Ottaviano, and Robert-Nicoud (2005), and

Head and Mayer (2004). As in Ricci, the labor requirements vary across sectors and countries so that

each country has a CA in a particular sector. In the short-run equilibrium, the international distribution

of capital determines the specialization patterns across countries. So as to focus on multicones of

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