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Skip to 0 minutes and 8 seconds In this step, we look at one of the most interesting aspects of economic integration that there is. We call it economic geography. The basic question is, why does economic activity tend to cluster when distance should matter less? As we saw before, urbanisation is often associated with globalisation. But that seems a bit crazy. As the cost of moving goods comes down, why should everybody cluster together? That puzzle is what the whole new economic geography is about and what we’re going to be talking about this step. But let me start by showing you a picture, which should change the way you think about economic integration and globalisation more generally, the organisation of the world economy.

Skip to 0 minutes and 59 seconds A good way to understand this is to look at this map.

Skip to 1 minute and 4 seconds This is a map of what the world looks like at night. It’s a composite of satellite photos of Europe and Northern Africa here. And when you start looking at this, you can think differently about international economics, globalisation– in fact, the whole organisation of the world economy. As you can see, economic activity is very concentrated. The lights are where people live and where economic activity happens. And there’s lots of dark areas where there’s very little economic activity. Moreover, this pattern of international activity does not respect national borders. There’s a few that you can identify. Let’s look here. This is the Nile River Valley, which is basically Egypt. That’s where all the economic activity happens in Egypt.

Skip to 1 minute and 51 seconds But if you look over here, this is northern Italy and part of France and part of Switzerland. All seems to be together. If you look at this, that’s the Benelux. That’s Belgium, Luxembourg, Netherlands, and northern France, all looking like a single piece or single country. You can see individual cities. That’s Moscow over there. But the interesting thing is that the actual economic geography follows the physical geography in many, many ways. Now, what we want to talk about is, in some sense, how can we explain this clustering on a massive scale?

Skip to 2 minutes and 32 seconds And in particular, as we’re going to go along, we’re going to focus on why would falling trade cost make economic activity cluster like this, especially in ways that don’t respect borders? That’s the next task. Let me move to the next slide. What we’re going to talk about circular causality and demand linkages. But let me give you a little background first. The whole point of economic geography is going to look at two types of forces– agglomeration forces, and dispersion forces. Now, that’s just a very complicated word for forces that tend to make stuff happen near each other and forces that tend to push in the opposite direction.

Skip to 3 minutes and 16 seconds And what we will see is that trade liberalisation, lowering trade costs, increases or decreases those forces together. And the result is a change in the location of economic activity. Now, to drill down on that a little bit better, I’m going to first look at the agglomeration forces, the clustering forces, focusing on demand linkages and the circular causality it causes. So here we have the circular causality. What you can see with the– let me get just a different colour pen here. What you can see here is we’re going to see how a cycle gets started. And what we’re going to do is a thought experiment. Let’s suppose we have two regions that are pretty close in size.

Skip to 4 minutes and 5 seconds But one region is bigger than the other. Now, we’re going to start with trade costs falling. Now, when trade costs fall, there’s going to be some firms who move from the small region into the big region, because to pay less for trade costs, firms prefer to locate in the big market, where there are more customers. We call that production shifting. Now, the production shifting means that some jobs go from the small region to the big region. Now, since those jobs bring workers with them, and the workers spend their income locally, the movement of production leads to change in the market size. In particular, the big market gets bigger, and the small market gets smaller. That’s what we call expenditure shifting.

Skip to 4 minutes and 49 seconds So the production shifting changes the number of firms in one region– let’s call it the north– which then changes this relative sizes, making the northern market larger, which will lead to more production shifting. And the cycle continues. As firms hire more workers in the north, workers move to the north too. And since they spend their income locally, the large north market gets larger, and the south market gets smaller. That was essentially what was going on in the great divergence, but it happens even on a continental level. So that explanation kind of shows how the movements of firms can lead to feedback, which encourages more movement of firms. That’s the circular causality going on.

Skip to 5 minutes and 31 seconds Now, what I was talking about is demand linkages, where firms move to be closer to their customers. But there’s a very similar logic that works on the supply side, not the demand side. That is, firms not only sell things. They need to buy things to make what they do. So if we go back to that same thought experiment, where there’s these two regions, approximately the same in size, trade costs come down, so it’s easier to supply one market from the other. Firms will move to the market with the most suppliers to be close to their suppliers.

Skip to 6 minutes and 8 seconds But as they move to be closer to suppliers, since firms themselves are suppliers to other firms, the supplier network gets denser in the bigger market. And since that gets denser, it attracts more firms, and the cycle is completed. So very much with this logic of circular causality, where the movement of firms changes conditions, which makes more firms want to go, that works on the supply side, as well as the demand side. Now, if there weren’t anything pushing back against this, everything would end up in one place. And in fact, in many countries, this is often the capital city, where you see a vast amount of economic activity piling up really just in one city. But there are dispersion forces.

Skip to 6 minutes and 53 seconds And these dispersion forces give firms an incentive to locate far away. Now, there are many of these things. In a city, it’s high rent. It’s high wages, congestion, long commuting delays. But at the global level, it’s more about competition. So if you move to an area where there’s already lots of firms, you’re moving to an area where there’s lots of competition. So there’s a tendency to want to stay away to reduce the competition. So that’s the dispersion force in this global level economic geography. Now, what we’ll do is look at how these whole things play out together. I think a nice way to think about it is to think about it as a kind of balance or a children’s seesaw.

Skip to 7 minutes and 40 seconds Let’s have a look at this graphic here. Now, in this graphic here, the share of industry in the big region adjusts to balance agglomeration and dispersion forces. So what we have down here is 0% of activity in the big region, all the way up to 100% in the big region. And what we’re going to try and see is how the location of activity, which is where this little fulcrum or triangle is, will adjust to balance the agglomeration forces and the dispersion forces. What we have here is the dispersion forces aren’t too big. The agglomeration forces are really big. So this fulcrum has to be pretty far over this way.

Skip to 8 minutes and 22 seconds Now, if the agglomeration forces get stronger, and the dispersion forces get less strong, the activity will cluster more towards the big region. And that’s basically what comes out of it. Now, the economic logic of why it has to happen that way when trade costs come down is very, very complex. So let’s look at a case study. What I want to look at is a map that shows what happened to the location of economic activity during the break up of the USSR and the removal of the barriers between Eastern and Western Europe.

Skip to 8 minutes and 59 seconds So as you can see in this slide here, it’s going to be a case study of the break up of the USSR, clustering in 1992 versus clustering in 2009. Now, this is a very clever map of Europe, taken with the lights, but imposing the two years on each other. And what they’ve done– this is all coming from NASA– is where there’s purple, that’s going to be where economic activity has declined in concentration. If we look at the yellow areas, that’s where the economic concentration has increased. And the white, there’s no change. So let’s take a classic white example. That right there in the middle is Moscow. And Moscow was the centre of the Soviet Union. It’s the centre of Russia.

Skip to 9 minutes and 48 seconds It’s an enormous, vibrant city. It didn’t change much. But when the barriers between East and West and the controls inside the Soviet Union went down, lots of these areas saw declining economic activity. Now, the yellow shows where it went. And you’ll notice that the yellow is mostly where the white zones are. So in other words, the new economic activity took place near where the economic activity was going on already, which was, to a large extent, Central Europe and Western Europe. This shows how economic activity tends to cluster more as trade barriers come down.

Skip to 10 minutes and 30 seconds You also see a little bit elements of it as, say, in Sweden and in northern Norway, there’s a tendency, as globalisation proceeds, for things to move from rural regions to larger coastal regions, like Stockholm and Oslo, which are here. Now, that’s not proof. But if you look around your world, almost everywhere you go, cities are getting bigger, and people are moving from the rural areas into the urban areas, as the costs of moving goods and ideas has come down. What we’ve tried to do in this step is explain how this is outcome of a balance of agglomeration forces and dispersion forces. And as trade costs come down, both of those weaken.

Skip to 11 minutes and 18 seconds But as it turns out, the dispersion forces weaken faster, so economic activity clusters as trade gets freer.

The new economic geography

This video explains the basics of agglomeration and dispersion forces that interact with globalisation in ways that affect the location of economic activity with nations and between nations.

Powerful forces tend to lead firms to cluster together in certain countries, certain regions, certain cities or even individual industrial districts – for example the desire of firms to be close to their customers and suppliers (who are, often, each other). Yet there are also powerful forces against such clustering, including high wages, high rents, and land prices, long commuting times and congestion.

Reducing trade costs affects both the pro-clustering forces (known as agglomeration forces) and anti-clustering forces (known as dispersion forces). As it turns out, globalisation tends to weaken both forces (distance matters less in both cases) but it weakens the dispersion forces faster, so globalisation is almost universally associated with more agglomerated economic activity. The worldwide urbanisation trend is one very clear example of this.

This video explains the basic economics, and then considers why globalisation’s impact on the location of industry is important.

After you have watched the video, you can dig deeper into the subject in the next step with an article that is based loosely on Chapter 6 of my 2016 book, the Great Convergence.

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This video is from the free online course:

International Affairs: Globalisation

The Graduate Institute of International and Development Studies