Geographical Economics

Geographical economics takes a long-overdue look at the possible casual role location plays in the growth of productive capacity and wealth. More traditional economic theory has largely considered location irrelevant. Essentially, different regions enjoyed different natural endowments purely by accident, and regional economic growth was caused entirely by external market forces. But such dismissive explanations glossed over the ever-growing realities of spatial concentration and economic specialization, prompting some economists to ask if the two were casually related. Economic growth in effect may well be an endogenous process after all. The challenge lies in not contradicting or undermining the basic tenets of modern economic theory while making the argument. Success here was deemed worthy of the considerable effort required since it would reapply existing concepts to the role of place in economic activity left languishing for want of a broader theory.

Keywords Agglomeration; APEC; ASEAN; Central Place Theory; Disequilibrium; Exogenous Growth Theory (GATT); Heckscher-Ohlin Theory; Increasing Returns to Scale; Location Theory; MERCOSUR; NAFTA; New Growth Theory; Return to Scale; Shift-Share Analysis; Theory of Competitive Advantage

Economics > Geographical Economics

Overview

Globalization has caused neighboring countries to band together in super-regional trading blocs (most notably APEC, ASEAN, the EU, NAFTA and MERCOSUR) much more than it has turned the world into one gigantic trading bloc. The EU’s economic integration is common knowledge. However, not many know that ASEAN member countries have agreed to form their own economic bloc—the ASEAN AEC—set to become effective in 2015. This integration is especially notable given the financial crisis in Europe that began in late 2009 (Volz, 2013). Location matters in economic activity far more than once thought. Such is the premise underlying geographical economics, which has shown that economic theory previously treated location as an externality, a coincidental by-product of more fundamental economic forces. Growth occurred from exogenous causes. This conceptual bias dominated economic thought with few exceptions the last four centuries. In the final quarter of the twentieth century, a few economists began posing a radical question: Why were some goods and services being produced in some places more than in others? “Where,” they contended, belongs besides “when, what and why” as a central line of inquiry. If everything existed everywhere, the material world would lack any and all distinctiveness. Yet differences abound in kind, time, and distance. Why then was location ignored by economic theorists for centuries? Well, it seems place did not matter because, in the long run, all economic growth was either a function of the rate of savings or the rate of technological progress. The former provides capital, the latter more efficient modes of production. Both, significantly, are still considered by neoclassical economists to be near universal constants rather than the outgrowth of regional economic activity. Markets essentially were assumed to act the same wherever they were located.

Further Insights

History of Economic Markets & Their Study

17th Century

One has to go as far back as 17th century mercantilism to find an economic theory where the idea of place held any importance. The object during this time was to amass gold bullion by maintaining a surplus of exports over imports. Place mattered, then, but only as the demarcation line separating domestic and foreign markets. A particular locale was only important insofar as it proved a profitable foreign market to sell domestically produced items. Aside from cheap natural resources, imports from these very same markets, meanwhile, were kept to a minimum through the imposition of stringent tariffs. This “trade protectionism” also did much to promote a more self-sufficient domestic economy, a key political objective then as now.

18th & 19th Centuries

18th century laissez-faire economics, on the other hand, viewed markets as forums of “perfect” competition made up of numerous suppliers where individual buyers and sellers are free to enter or leave at will. Its first great theorist, Adam Smith, did state that locales differ in climate, availability of natural resources, and access to waterways. Crucially, though, such differences had to be accidental in nature and irrelevant to the actual workings of the marketplace. For, if it can shape the behavior of individual markets differently, they would no longer be structurally alike. And that would mean in turn that competition was not perfect after all. But the entire theory of free-market capitalism rests on the assumption that it is perfect. Nineteenth century Marxist theory likewise pitted capitalist against worker irrespective of place. Class struggle was inevitable everywhere given how the exploitive nature of the ownership of production inexorably forces virtually everyone to live at or below a subsistence wage.

20th Century

When 20th century Keynesian economics came along, the focus of economic theory shifted to the relationship between aggregate demand and unemployment at the national level but, like earlier theories, posited that free market economies at this scale all functioned alike. Its counterpart, neoclassic theory, was built on more traditional notions about the ways price, output, and income were determined in the interplay of supply and demand in markets. Such notions gave rise to general equilibrium theory, which contends that a change in one item's price affects the prices of all other items, potentially upsetting the market equilibrium between the supply and demand of all goods and services everywhere. So, theoretically, at least, it is necessary to trace what the “knock-on effect” of every single price change will be on millions and millions of products worldwide—so daunting a prospect that theorists eventually began to assume that all other prices remained unchanged to isolate the effect on one item's price change on just one other item's price.

Endogenous Growth Theory

It is thus perhaps no coincidence that the one exception to this rule—the endogenous growth theory of the 1980s—tipped the scales in favor of including place as a factor of production. And this change happened only because such a theory considers economic growth to be driven primarily by internal factors like human capital that vary from one locale to another. Rather belatedly, then, the idea of place gained enough of a theoretical legitimacy to revisit the early work in location theory, which states that economic activities tend to spatially congregate of their own accord for explicit reasons. The clustering of productive capacity so readily apparent around the globe, across a continent, within the borders of a nation-state, inside a provincial region, and among different urban districts and rural areas counties alike, might be modeled and explained.

And though scale itself does not play a determining role, distance does. This was the conclusion drawn in 1826 by Johann Von Thunen, who observed how crop production levels and distance to a central market were inversely related. The farther that farms were from population centers, the less intensive their cultivation. Conversely, the closer they were, the more intensive their cultivation. Von Thunen postulated that as this distance lengthened, transportation costs increased, which in effect depressed the farmers’ locational rents and their profit from growing and selling surplus crops. Industrialization had yet to transform the economic landscape Von Thunen depicted; his identification of the pivotal role played by transportation costs nevertheless applies to plants and farms alike.

The Agglomeration Principle

People congregate in large numbers in a relatively small mass of land to take advantage of lower overall costs of transportation. Travel to and from work, local marketplaces, religious institutions, and recreational outlets are cheaper, giving individuals spare income to spend on other goods and services. What is good for households is also good in a wider sense for firms and markets. Denser concentrations of customers generate greater demand for a wider variety of goods and services. High volume creates internal economies of scale that bring production costs down at the firm level. Critically, too, the broader the scope of products in demand, the more the incentive for firms to specialize their production processes. Over time, functional linkages between firms and shared infrastructure across industries in proximity also occasion external economies of scale. Agglomeration (as it is called) also facilitates collaboration and knowledge-sharing between firms and industries instrumental to technological progress (Simonen, 2006).

Agglomeration, though, is a selective process that occurs in some places but not others, creating a de facto spatial hierarchy of densely and sparsely populated areas. Climate, access to waterways, and other factors play their part here. But none of these factors satisfactorily explain why some regions produce a greater number and diversity of goods and services than others. Geographer Walter Chandler hypothesized that the outcome here depends on two variables: the smallest possible market size by population and income where there's enough demand to warrant supply of a particular good or service, and the longest distance a consumer is prepared to travel to acquire it. Decisions by individual buyers and sellers with respect to a particular location thus determine the size and scope of its market. So, the economic utility of a site attracts a proportional number of residents. As a consequence, some sites will grow larger and faster than others. This is the gist of Chandler's seminal central place theory.

Location & Revisionist Exogenous Growth Theories

On the other hand, economic base theory is more exogenous in nature. It tightly links regional economic growth to extraregional influences or “externalities,” most notably worldwide exports. An offshoot, the regional business cycle theory, contends that intraregional economic instability is specifically triggered by export variability. Inter-regional differences in economic growth arise from inequalities in the relative performance of export-oriented industries from one region to the next. Leveraging export industries in a region that is stronger than in other regions reduces these inequalities.

A strategic determination first must be made about the relative efficiency of one region's export industries compared with other regions'. This is done through applying the principle of shift-share analysis. It is most often employed to examine the degree to which the change in employment rates for industrial workers in a given locale can be attributed to (Nazarra & Hewings, 2004)

• a rise or fall in the national manufacturing rate.
• a rise or fall in an industry-wide employment rate.
• a strictly local factor of production like proximity to natural resources or a surplus in the supply of labor, in which case it has a competitive advantage.

Though quantitatively rigorous, shift-share analysis fails to adequately explain why, in the long run, some sectors grow and others do not, and why some industries migrate into an area and others out of an area. Even so, its rich data-mining capabilities and straightforward calculations can and do yield information and insights about short-term conditions. Proponents of the theory of comparative advantage find shift-share analysis particularly useful.

Specialization & Regional Competitive Advantage

Specialization, a key component of modern-day trade theory, maintains that a given region has unique productive capacities that can be leveraged into a competitive advantage in one or more world markets. As contemporary-sounding an idea as this may seem, it can be traced directly to Alfred Marshall's early twentieth century observations of the pivotal importance location plays in the specialization of production processes. For more than thirty years, he studied the efficiencies brought about by the conglomeration of a skilled workforce, a diverse network of ancillary specialists to call upon, and the backward and forward integration of production between nearby firms. The theory of comparative advantage applies these principles on a truly grand scale. This theory was applied formally to international trade for the first time in Heckscher-Ohlin theory, which maintains that historical accident endowed various regions of the world with different natural resources and kinds of technological expertise that naturally lend themselves to a comparative cost advantage in the production of certain goods and services. The resulting advantageous price differential in world markets fosters greater and greater local economies of scale.

Countries and transnational regions incur an opportunity cost every time they allocate resources to productive ends. Every investment made, moreover, could be put into some other activity. The amount that could be earned pursuing this alternative is its opportunity cost. Investing in an activity with lower expected returns than the opportunity cost of another option is not the most efficient use of funds (Clever, 2002). Every country therefore should concentrate on developing only those industries that promise it the highest returns in the global marketplace. Also, a country can readily and more cheaply import the goods and services it produces inefficiently from countries with complementary competitive strengths. Such, at least, is the theory. The realities of countervailing tariffs and import quota persist. Globally speaking, then, “free market” remains a relative concept. It is an entirely different matter, however, in large sections of the world belonging to regional custom unions and common markets where a greater parity in trade and transaction costs has been actively sought.

The New Growth Theory

The conceptual breakthrough that led to the reevaluation of spatial concentration as a cause rather than an effect of economic activity came in 1991. That year, Paul Krugman introduced a theoretical model that has since become synonymous with new growth theory. It is based on the premise that market competition is inherently imperfect, for at any given moment some markets will be in disequilibrium, others not. This puts the proposed model within the pale of the partial equilibrium theory. More important, it also means spatial concentration and increasing returns to scale can be linked. The latter occurs whenever a change in input in production leads to a proportionately greater change in output. This is essentially the driving force behind improving economies-of-scale.

One remaining connection had to be made for the model to pass theoretical muster. And that was to show how spatial concentration in and of itself creates advantages and opportunities that attract migrants. This necessitated a rethinking of what kinds of individual economic agents make location decisions. Firms alone were once thought to make this decision. But a given spatial concentration must generate enough local consumer demand to achieve increasing returns to scale in the first place. Such an outcome is much more likely economically when consumers, and firms, are free to migrate. Also, a person typically has to be a worker to be a consumer, so the spatial distribution of production and demand are two sides to the same coin. Krugman's model posits that both capital and labor are mobile, and both combined will accelerate the agglomeration principle more than capital mobility alone would.

To put this layperson’s terms, firms originate or migrate to a particular locale for the competitive advantages it affords. These firms attract additional workers seeking a better quality of life who quite naturally consume goods and services produced locally because of lower transportation costs and lower price structures. Once unleashed, the resulting centripetal forces fuel a cycle of local economic growth that, barring external shocks, continues until population outstrips available resources. The more these forces exert themselves, the more centralized and integrated the economic infrastructure and consequently, the greater local economies-of-scale and scope achieved. And this, in turn, attracts more people, some of whom will bring technical expertise and innovative ways of thinking with them. All of which, significantly, can be accelerated by local investments in infrastructure and human capital. In the end, though, new growth theory's greatest single contribution may lie in the new lines of inquiry it has opened up. For at heart it asks two important questions.

• What identifiable advantages do spatial concentration create that cause it to subsequently grow and intensify?
• What exactly turns slight differences between locations into major ones?

Satisfactory explanations to one or both questions will further the possibility that if-then relationships do indeed exist between spatial concentration and productive capacity.

Viewpoints

So how do all these theories relate to actual international trade? It is a fair question; unfortunately there is no clear answer. Theory is just that—theory. It simplifies incredibly complex phenomena so we can better understand their governing principles. To do this satisfactorily one has to generalize, and to generalize one has to ignore exceptions to the rule. So, whereas international trade involves physical goods and services bought with real money on truly massive scales, trade theory debates the role externalities or returns to scale play in regional and global markets. These can seem maddeningly obtuse until you try to make some kind of sense of the minutiae of international trade. Be it exogenous or endogenous in origin, the economic consequences of the spatial concentration of economics are verifiable trends. Location theory and the like are useful because they suggest the most likely outcomes possible in policy decisions about economic development. It is fair to say that the custom unions and free trade zones cropping up all over the world owe their existence in part to the widespread acceptance of concepts such as agglomeration and central place theory. The question is not so much whether one or the other is economically tenable as it is the degree of influence over future globalization each may assert. Will it follow a more endogenous path and stabilize around regional trading blocs, or will it follow a more exogenous path and expand until the world is truly one enormous market?

Terms & Concepts

Agglomeration: The geographic concentration of interrelated industries and economic sectors.

APEC: The Asian-Pacific Economic Cooperation is an association of the Pacific Rim economies of Australia; Brunei; Canada; Chile; China; Hong Kong, China; Indonesia; Japan; Malaysia; Mexico; New Zealand; Papua New Guinea; Peru; the Philippines; Republic of Korea; Russia; Singapore; Taiwan (Chinese Taipei); Thailand; the United States; and Vietnam.

ASEAN: The Association of Southeast Asian Nations is a regional free- trade zone encompassing Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar (Burma), the Philippines, Singapore, Thailand, and Vietnam.

Central place theory: Central place theory states that there exists an economic rationale behind the concentration of human settlement that involves a trade-off between two fundamentals: the minimum market size it takes to sell a good or service and the maximum distance consumers are prepared to travel to acquire that good or service. The wider the scope of goods sold in a given area, the higher its population density.

Disequilibrium: Disequilibrium is the process of arriving at a new price that brings fluctuating supply and demand back into alignment.

Endogenous growth theory: Endogenous growth theory contends that features particular to an area or region above and beyond its natural resources contribute directly to its economic development.

Exogenous growth theory: Exogenous growth theory contends that economic growth in a particular area or region is entirely a function of outside market forces.

GATT: The General Agreement on Tariffs and Trade is the legally binding instrument governing worldwide free trade. GATT is amended and expanded periodically through negotiations among about seventy countries.

Heckscher-Ohlin theory: Contends that competitive advantage in international trade can be attributed to differences in the resources countries are endowed with.

Location theory: Location theory states that the longer the distance between buyer and seller, the high the transaction cost of bringing a good or service to market; as such, economic activity tends to cluster in high density areas.

Mercosur: Mercosur (Mercado Común del Sur) is the common market of Southern Latin America. It is an intergovernmental agreement aimed at reducing and eliminating trade barriers between Argentina, Brazil, Paraguay, Uruguay, and Venezuela. Those countries that participate to a lesser extent as associates are Bolivia, Chile, Colombia, Ecuador, and Peru.

NAFTA: The North American Free Trade Agreement is formed by Canada, Mexico, and the United States.

Return to scale: A return to scale is the degree to which a change in input results in a proportionately higher, lower, or the same change in output.

Shift-share analysis: Shift-share analysis examines the effects on local employment rates attributable to changes in national, industry-mix, and regional factors.

Theory of comparative advantage: The theory of comparative advantage argues that a country's economic self-interest is best served by developing only export industries in which its physical, human, and productive resources enable it—more so than other countries—to sell goods more cheaply and efficiently in global markets.

Bibliography

Bode, E., & Rey, S. (2006). The spatial dimension of economic growth and convergence. Papers in Regional Science, 85, 171-176. Retrieved August 2, 2007, from EBSCO Online Database Academic Search Premier. http://search.ebscohost.com/login.aspx?direct=true&db=aph&AN=22554345&site=ehost-live

Clever, T. (2002). Chapter 5: Free trade, regional agreements and strategic policies. In Understanding the world economy (pp. 91-107). Oxfordshire, UK: Taylor & Francis. Retrieved August 18, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=16867349&site=ehost-live

Nazara, S., & Hewings, G. (2004). Spatial structure and taxonomy of decomposition in shift-share analysis. Growth & Change, 35, 476-490. Retrieved August 22, 2007, from EBSCO Online Database Academic Search Premier. http://search.ebscohost.com/login.aspx?direct=true&db=aph&AN=14798120&site=ehost-live

Pike, A. (2013). Economic geographies of brands and branding. Economic Geography, 89, 317-339. Retrieved November 25, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=90633671&site=ehost-live

Siegel, P., & Johnson, T. (1995). Regional economic diversity and diversification. Growth & Change, 26, 261. Retrieved August 21, 2007, from EBSCO Online Database Academic Search Premier. http://search.ebscohost.com/login.aspx?direct=true&db=aph&AN=9508170731&site=ehost-live

Simonen, J. (2006). Regional externalities in the dynamic system of three regions. Papers in Regional Science, 85, 421-442. Retrieved August 2, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=aph&AN=9508170731&site=ehost-live

Volz, U. (2013). ASEAN financial integration in the light of recent European experiences. Journal Of Southeast Asian Economies, 30, 124-142. Retrieved November 25, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=89370320&site=ehost-live

Werker, C., & Athreye, S. (2004). Marshall's disciples: Knowledge and innovation driving regional economic development and growth. Journal of Evolutionary Economics, 14, 505-523. Retrieved August 21, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=15204865&site=ehost-live

Suggested Reading

Association of Southeast Asian Nations. (2013). ASEAN Economic Community Chartbook 2012. Retrieved November 25, 2013, from http://www.asean.org/images/2013/resources/publication/2013%20-%20AEC%20Chartbook%202012.pdf

Clever, T. (2002). Chapter 6: Customs unions and common markets. In Understanding the world economy (pp. 108-124). Oxfordshire, UK: Taylor & Francis. Retrieved August 18, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=16867385&site=ehost-live

Gleeson, B. (2003). Learning about regionalism from Europe: “Economic normalisation” and beyond. Australian Geographical Studies, 41, 221-236. Retrieved August 2, 2007, from EBSCO Online Database Academic Search Premier. http://search.ebscohost.com/login.aspx?direct=true&db=aph&AN=11463086&site=ehost-live

Jayasuriya, K. (2003). Embedded mercantilism and open regionalism: The crisis of a regional political project. Third World Quarterly, 24, 339-355. Retrieved August 2, 2007, from EBSCO Online Database Academic Search Premier. http://search.ebscohost.com/login.aspx?direct=true&db=aph&AN=9756541&site=ehost-live

Lopez-Bazo, E., Vaya, E., & Artis, M. (2004). Regional externalities and growth: Evidence from European regions. Journal of Regional Science, 44, 43-73. Retrieved August 2, 2007, from EBSCO Online Database Academic Search Premier. http://search.ebscohost.com/login.aspx?direct=true&db=aph&AN=12264441&site=ehost-live

Phillips, N. (2003). The rise and fall of open regionalism? Comparative reflections on regional governance in the Southern cone of Latin America. Third World Quarterly, 24, 217-234. Retrieved August 2, 2007, from EBSCO Online Database Academic Search Premier. http://search.ebscohost.com/login.aspx?direct=true&db=aph&AN=9756539&site=ehost-live