Book Review: Geography and Trade

Title             : Geography and Trade

Author        : Paul Krugman

Publishers : Leuven University Press and the MIT Press/1991

ISBN            : 0-262-11159-4

Reviewer     : Yudo Anggoro, University of North Carolina at Charlotte

Paul Krugman got the idea to write this book from the lectures he gave at the Catholic University of Leuven, Belgium in 1990. The general initial idea of those lectures was on international factor mobility. But as Krugman worked for the presentation, he found that his analysis was moving further away from international economics. He found his analysis was largely influenced by classical location theory rather than international trade theory. The two main questions of this book are: (1) why is production spatially concentrated? And (2) why are particular industries often highly localized? All explanations in this book attempt to answer these questions, along with the main idea that location largely influence the economic activity and agglomeration in certain regions.

Economic Geography

What is economic geography? It is defined simply as the location of production in space. Economic geography influences various kinds of economic sectors. For example, international trade would also be largely treated as a special case of economic geography, one in which borders and the action of sovereign government play a special role in shaping the location of production.

Krugman argued that previous studies on international trade models countries as dimensionless points in which factors of production can be moved from one place to another. They tend to ignore the space involved; as a result, transportation cost is zero. The fact is, countries are not point. For example, California is farther from New York than any place in Europe is from any place else. Therefore, place and dimension play important role in economic geography. In this sense, Krugman believed that one of the best ways to understand how international economy works is by looking at what happens inside the nations.

The trend in economic geography started to receive attention in 1970s where there was a new wave theory in industrial organization. There are two reasons why economic geography is important. First, the location of economic activity within countries is an important subject in its own right. Second, the lines between international economics and regional economics are becoming blurred in some cases.

In order to understand economic geography, we should put our concern on how location may increase returns of certain economic activity. Krugman suggested that increasing returns affect economic geography at many scales. At the bottom scale, the location of particular industries reflects the “locking in” of transitory advantages. At an intermediate scale, the existence of cities themselves is evidently an increasing return phenomenon. At the grand level, the uneven development of whole regions can be driven by cumulative processes that have increasing returns at their root.

The Case of the US Manufacturing Belt

The most important thing about geography and economic activity is concentration of activity. The case of the US manufacturing belt clearly depicts this argument. This case is an example of the forces of economic geography in the United States. It is a relatively narrow stretch territory within which most of US manufacturing was concentrated from the mid-nineteenth century until the 1960s.

Early in the 20th century, the large part of US manufacturing was concentrated in the Northeast and the eastern part of the Midwest (St. Louis-Baltimore-Portland). The data in 1957 showed that this manufacturing belt contained 64 percent of US employment, only slightly reduced from its 74 percent share at the beginning of the century. The manufacturing belt persisted because of the production of agricultural and mineral. For example, in 1870 the Northeast and East North Central regions accounted for 44 percent of US resource extraction employment (agriculture, mining, forestry, fisheries), yet still these regions accounted for 70 percent of manufacturing employment. In terms of mineral resources, this manufacturing belt brought some of its critical raw materials from nearby coal mines and oil wells. As this manufacturing belt grew, by the mid-twentieth century, the large parts of the raw materials for manufactures were imported from other regions.

The existence of manufacturing belt indicates the importance of economic geography. Each individual manufacturing facility stayed within the manufacturing belt because of the advantage of being near other manufacturers. The fundamental questions in this why all those manufacturers want to cluster together. Krugman argued that given sufficiently economic of scale, each manufacturer wants to serve the national market from a single location. To minimize cost, manufacturer chooses a location with large local demand. But local demand will be large precisely where the majority of manufacturers choose to locate. Therefore, this is the tendency that keeps a manufacturing belt in existence once it is established.

Krugman developed a simple model which shows that the interaction of increasing returns, transportation costs and demand can result into the spatial concentration of the whole manufacturing sector. In the early history United States, where manufacturing was marked by few scale economies and where transportation was costly, no strong geographical concentration could occur. As the country began its industrial transition, manufacturing grew in areas that contained most of the agricultural population outside the South. As the scale of manufacturing economies increased, transportation cost fell, and the share of the population in nonagricultural occupation rose. As a result, the initial advantage of the manufacturing belt was locked in.

Another factor that contributed to the rise of manufacturing belt is the presence of railroad network that connecting the cities. Again, the reason behind this is to minimize transportation cost. The US manufacturing belt was characterized not only by a denser population but also by a better transport network than any other part of the country, and this created better market access to manufacturers.

Localization

Krugman brought interesting fact that manufacturing industries within the United States are highly localized. He cited the work of Alfred Marshall (1920) to explain this phenomenon of localization. Marshall (1920) identified three distinct reasons for localization. First, by concentrating a number of firms in an industry in the same place, an industry center allows a pooled market for workers with specialized skills; this pooled market benefits both workers and firms. Second, an industrial center allows provision of non-traded inputs specific to an industry in greater variety and at lower cost. Third, because information flows locally more easily than over greater distances, and industrial center generates what we would now call technological spillovers.

Labor market pooling is also a strategy for firms within the same area to minimize risk and uncertainty. Krugman argued that if the firms are in the same place, then at least sometimes one firm’s bad times will be offset by the other firm’s good times, and the average rate of unemployment will be lower. This strategy is also appropriate to increase the credibility of firms in the eye of workers. Firms would like to convince workers that they will not try to exploit workers so that they can attract workers to their production location. But the only credible way to do this is to have enough firms in the location that there is an assurance of competition for workers.

The second Marshall’s argument about localization is that a localized industry can support more specialized local suppliers, which may make that industry more efficient and foster the localization. This also relates to minimizing transportation cost. When an industry needs intermediary inputs to produce final goods, it is better to get these inputs from the industries within the same area rather than obtain it from other areas.

The famous examples of technology spillovers advantage from localized industry are Silicon Valley and Boston’s Route 128. It is an empirical fact that many of the industries that are highly localized within the United States now are nothing like high technology sectors. But other industries also show strong technology spillovers. Other examples of technology spillovers may be found of carpet producers around Dalton, Georgia; of jewelry producers around Providence, Rhode Island; of financial services in New York; of shoes industry in Massachusetts, and rubber industry in Akron.

In terms of high-technology cluster such as Silicon Valley, Route 128, and North Carolina’s Research Triangle, the key success factor of these clusters is the existence of a pool of people with certain skills. Boston area, for example, has been a good place for people who have good software skills to live. Growth companies in the software field can easily find people with sufficient knowledge to work in.

Regions and Nations

In this part, Krugman attempted to explain international trade in the perspective of economic geography. Before going further, he wanted to emphasize the notion of Nation. Krugman stated that a nation is not a region or a single location. Nation matters because they have governments whose policies affect the movements of goods and other factors. In particular, national boundaries often act as barriers to trade and factor mobility. Every modern nation has restrictions on labor and capital mobility. Therefore, the actual limits on trade are pervasive, depending on the best efforts of trade negotiators.

As an example, during the era when US manufacturing belt was emerging, European nations were delinking their economies through tariffs. Trade in manufactured goods among advanced countries is at this point free, and entirely free within the European Commission. If trade were completely free, the immobility of labor and capital among nation-states would not necessarily pose a barrier to industry localization. Instead, each country would tend to develop its own set of localized industries, exporting the products of those industries it has, importing those it does not have.

Krugman also compared economic activity and localization in Europe versus United States. The “great regions” of the United States (Northeast, Midwest, South, and West) have the same size and population as the European Big Four (France, UK, Italy, and Germany). Therefore, one might expect that the degree of economic differentiation among US regions and the European nations are similar. Moreover, one might expect that localization also proceeded further in Europe because the distances in the US are greater. After comparing those two regions, Krugman found that European nations are less specialized than US regions. He also found that US industry is far more localized; localization has gone much further in the US than in Europe.

How does this condition happen? Krugman believed that this is because the existence of barriers to trade. Localization tends to take place when transportation costs fall and economies of scale increase. During the nineteenth century, transportation costs in both Europe and US fell and economies of scale grew significantly. But in Europe the fall of transport was opposed by tariffs. Europe was also fragmented, and borders have remained significant barriers to trade, supplemented by differences in regulation and government policies that discriminate in favor of national products.

Discussion and Summary

The whole parts of this book show how Krugman attempted to propose his argument for the acceptance of economic geography as a major field within economics, and in some sense related to international trade. Moreover, Krugman argued that location is the key success factor in determining economic activity and agglomeration. However, he did not mention any other factors that might determine this phenomenon. This might be one critique of this book.

Related to the US manufacturing belt, Krugman explained that the manufacturing belt began in the Northeastern part of the US because these regions have rich mineral and agricultures. This illustration is in line with urban theory perspective. In urban theory, we learn that industrial revolution occurred between 1840 until 1860 as the industrial cities emerged. Most of those industrial cities were located in the Northeast, such as New York City, Boston, Philadelphia, and Baltimore. This emergence of US manufacturing belt gained the advantage from massive immigration as the source of cheap labor. Krugman also said that the US manufacturing belt occurred from the Southeast to the South and Midwest part of the US. This argument is also similar from the history of urbanization that we learn in urban theory that urbanization in that period shifted from the Frostbelt cities to the Sunbelt cities.

From the perspective of urban theory, this pattern of US manufacturing belt seems plausible. As we know that business is going to take place in a location that has more appropriateness to do business. This can be where the demand is high or the location is strategic and accessible. US manufacturing belt were formed as a strategy to minimize the cost of production and cost of transportation. As these industries formed cluster in a location where the demand is high, they may got advantage from the high of economies of scale.

The formation of US manufacturing belt was also closely related to the development of infrastructure and railroad system in the US. As urban theory said, infrastructure has large impact on economic development in a region. In the case of US manufacturing belt, this would be the need of transportation system. Transportation has gained serious attention from government and business practitioners during the industrial revolution period. The main concern was how to transport raw materials and finished goods as fast as possible by using as minimum cost as possible. The solution was by using train. Therefore, during that period, the industrial clusters were located close to the railroad system. As a result, US have shown advanced railroad system at that period of time.

Another effect of industrial revolution and localization is the knowledge spillover effect. Some regions were well known for some specific industry specialty in their regions. For example, Silicon Valley is well known as the cluster of information technology, New York City is the center of financial industry, and Providence, Rhode Island is famous as the center of jewelry industry. Related this knowledge spillover phenomenon to the urban theory, we might conclude that one of the causes of this phenomenon was the entrepreneurial movement in the US. The US people have been famously known from their entrepreneurial spirit. This spirit has enabled those entrepreneurs to invent and create innovative products. At the early movement of this spirit, entrepreneurs were looking for inexpensive land and then developed their “suburban dream”. Private enterprise was the basis of this knowledge spillover. As these people invented, other entrepreneurs would follow and they create industrial clusters. As a result, knowledge spillovers occurred.

In the last part of this book, Krugman compared the specialization and localization between the US and European countries. His study indicated that US was more centralized and localized than the Europe. He argued that this happened because European countries had barriers to trade, including the barrier of capital mobility among nations. From Logan and Molotch (1987), we learned that cities are the capital generators and profit makers. The United States gets the advantage from this theory. While capital formation in Europe had the national barrier from one country to another, the United States did not have this barrier. The capital formation among regions in the US might continue to form.

Overall, this book is readable and thought-provoking. It contains a lot of insights regarding geography and regional economic. The use of simple models to increase our understanding of ideas that some might refer to as “common sense” is actually the strength of the book. However, the idea that location plays an important role in economic development does not seem to be a new idea. Geographical science has long had the argument that space and location matter. The contribution of this book is on how to approach geographical science by using economic perspective.