New Economic Geography: An appraisal on the occasion of Paul Krugman's 2008 Nobel Prize in Economic Sciences☆

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Abstract

Paul Krugman has clarified the microeconomic underpinnings of both spatial economic agglomerations and regional imbalances at national and international levels. He has achieved this with a series of remarkably original papers and books that succeed in combining imperfect competition, increasing returns, and transportation costs in new and powerful ways. Yet, not everything was brand new in New Economic Geography. To be precise, several disparate pieces of high-quality work were available in urban economics and location theory. Our purpose in this paper is to shed new light on economic geography through the lenses of these two fields of economics and regional science.

Introduction

Economic geography seeks to explain the riddle of unequal spatial development. The most salient feature of the spatial economy is in effect the presence of a large variety of economic agglomerations. Hundreds of books and papers have been devoted to this topic but it was not until Paul Krugman's (1991a) seminal paper that a full-fledged general equilibrium model became available to explain why, how and when the economic activity may be agglomerated in a few places.

Although using “economic agglomeration” as a generic term is convenient at a certain level of abstraction, it must be kept in mind that this concept refers to very distinct real world situations. At one extreme of the spectrum lies the North–South divide. At the other extreme, agglomeration arises when restaurants, movie theaters, or shops selling similar products are clustered within the same neighborhood, not to say on the same street.

What distinguishes those various types of agglomeration is the spatial scale, or the spatial unit of reference, chosen in conducting one's research, very much as there are different levels of aggregation of economic agents. Whatever the scale of analysis retained, the emergence of economic agglomeration is naturally associated with the emergence of inequalities across locations, regions or nations. Such inequalities are often at the origin of strong tensions between different political bodies or jurisdictions, or even social, religious or ethnic groups when they are geographically concentrated. Understanding how spatial inequalities in living standards arise is thus a fundamental challenge for economists and regional scientists.

Paul Krugman has clarified the microeconomic underpinnings of both spatial economic agglomerations and regional imbalances at national and international levels. He has achieved this with a series of remarkably original papers and books that succeed in combining imperfect competition, increasing returns, and transportation costs in new and powerful ways.

Yet, not everything was brand new in Krugman's New Economic Geography. To be precise, several disparate pieces of high-quality work were available in urban economics and location theory. Our purpose in this paper is to shed new light on economic geography through the lenses of these two fields of economics and regional science.

Section snippets

On the relationships between economic geography, urban economics, and location theory

How is economic geography related to other fields such as urban economics and location theory? The former aims to explain the internal structure of cities, that is, (i) how land is distributed among plants, offices, dwellings, and infrastructure, and (ii) why cities have one or several central business districts. The basic concept of urban economics is the land market, which serves to allocate both economic agents and activities across space. Alonso (1964) and Mills (1967) may be considered as

The Spatial Impossibility Theorem

To start with, it is useful to summarize briefly what the neoclassical model has to offer regarding the spatial distribution of activities. In a frictionless world, production factors will act to remove any inequalities in earnings by moving from regions where their remunerations are lower to those where they are higher. If, as assumed in the neoclassical model, there is perfect competition and constant returns to scale, then the marginal productivity of each factor must rise in the regions of

What are the alternative modeling strategies?

Thus, if we want to understand something about the spatial distribution of economic activity and, in particular, the formation of major economic agglomerations as well as regional specialization and spatial inequalities, then the Spatial Impossibility Theorem tells us that we must make at least one of the following three assumptions: (i) space is heterogeneous, (ii) externalities in production and consumption exist, or (iii) markets are imperfectly competitive. Of course, in reality, the

The beginnings of NEG

There seems to be a large consensus among economists and geographers that the space-economy can be viewed as the outcome of a process involving two types of opposing forces: agglomeration (or centripetal) forces and dispersion (or centrifugal) forces. The resulting spatial distribution of economic activities is thus a complex balance between these forces that act on both consumers and firms. By identifying the main forces at work in NEG, two groups of papers have played a major role in the late

The core-periphery structure with labor mobility

While the movement of capital to a region brings with it the benefits of added production capability, it is not true that the returns from this capital need be spent in the same region. In contrast, when workers move to a new region, they bring with them both their production and consumption capabilities. As a result, their movements affect the size of labor and product markets in both the origin and destination regions. This is one of the main differences between capital and labor mobility.

Input–output linkages and the bell-shaped curve of spatial development

So far, agglomeration has been considered as the outcome of a circular causation process fed by the mobility of workers. However, agglomeration of economic activities also arises in contexts in which labor mobility is very low, as in most European countries. This underscores the need for alternative explanations of industrial agglomeration.

One strong contender is the presence of input–output linkages between firms: an output of one firm can be an input for another, and vice versa. In such a

City formation and urban system

It should also be emphasized that much interest generated by Krugman's landmark paper in 1991 is due to the fact that it offers an analytical approach to a wide range of related issues, including city formation, urban system and regional growth.

Cities, and more generally metropolitan areas, constitute the most extreme form of economic agglomerations within nations — blending a very high share of their economic activities within a very small share of their land. Both the metropolitan areas of

Regional growth

As mentioned above, the core-periphery model of Krugman (1991a) can also be used to address questions of regional growth. Of particular interest is the question of whether regional discrepancies increase or decrease over time. Moreover, if these discrepancies do change, then what are the main reasons for such divergence or convergence? To answer this question, we must consider the complex issue of possible interactions between spatial and temporal decisions. Since both agglomeration and growth

Where do we stand?

The foregoing results are very important for the way the space-economy is organized. This is why it is critical to know how they depend on the specificities of the framework used. In his contribution to the Symposium “Urban Agglomeration” published in the Journal of Economic Perspectives, Krugman (1998) set up indirectly the agenda for future research by summarizing NEG with the slogan “Dixit–Stiglitz, iceberg, evolution, and the computer.” Let us discuss each part of the slogan.8

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    We thank T. Smith for the comments and suggestions. This paper was written when the second author was P.K. Professor of Economics at Zhejiang University.

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