Spatial Economics

Throughout history, transport costs have hampered specialization, and improvements in transport and communications have been among the main driving forces of economic progress. In medieval Europe and China, most ordinary people never moved farther than twenty miles from their birthplaces, and before the advent of book printing, most people knew very little about what happened beyond those narrow horizons. Firms that depended on heavy inputs, such as steel makers, used to locate near the source of major inputs—coal mines, in particular. By contrast, firms that interacted intensively and frequently with customers tended to locate near the demand. Thus, gasoline stations are still found near busy intersections.

In recent decades, technical and organizational progress has caused the costs of transport to fall steadily and communication costs to plummet. Between 1950 and 2000, the price of bulk sea freight and port handling dropped, on average, by 0.9 percent annually, of long-distance passenger air transport by 2.6 percent annually, and of trans-Atlantic phone calls by an astounding 8 percent annually. The inflation-adjusted price of a long-distance phone call from New York to London is now less than 1 percent of what it was in 1950. Fax machines, portable video cameras, satellite TV, computers, and cell phones have all cut communication costs greatly. More recently, the Internet has made global communication so cheap and user friendly that words and images can be distributed by almost anyone globally, without delay and at near-zero cost. These technologies have opened new, easily accessible channels of communicating, so that entirely new forms of the division of labor between different locations have become feasible.

This reduction in transport costs has revolutionized decisions about where goods and services are produced. The relative costs of employing immobile production factors, such as land and labor, have become relatively more important in influencing the spatial arrangement of industries, irrespective of national borders. Yet, most businesses still take account of transport and communication costs (and the risks of disruptions) between the locations from which their inputs are supplied and the locations where they find their market demand.

In the wake of these changes, globalization has become a tough political issue. Lower transport and communication costs have thrown many firms and their workers into global competition. Now, with concerns about competitors in faraway places entering the local market, locals must control costs more tightly, remain innovative, and sell at lower prices than before. Manufacturers have long known that foreign producers can make inroads into local markets and that their own market is increasingly the world, rather than simply the national market. Thus, there are now steel plants in China, Japan, and South Korea, far from iron and coal mines but near ports; the falling cost of shipping has made it possible to transport coal and iron ore to seaside locations, from where steel is sold around the world. What matters more for capital-intensive industries is whether the capital owners enjoy secure property rights where they invest. Consequently, locations now have to compete by providing good property-rights protection and other such trust-inspiring institutions.

Because the Internet now makes it possible to provide many services over long distances and even globally, service providers—in accounting, finance, and managerial supervision, for example—have also become more mobile. Thus numerous low-skill service jobs have begun to migrate from high-wage locations to low-cost locations overseas. Established service providers are now often coming under competitive pressure from new, low-cost competitors in distant places, such as call centers and software developers in Ireland or India. By the same token, engineers in New York offices are now supervising construction work in Brazil in real time, and academics in California are delivering lectures and tutorials via computer terminals throughout East Asia, adding high-skill job opportunities in America.

The work of nineteenth-century German economist Johann Heinrich von Thünen explains the economic effects of falling space-bridging costs. Thünen became the father of spatial economics when he laid out the basic logic of how producers distribute themselves in space. He explained that the owners of mobile production factors, such as capital and technical knowledge, have to be paid the same return whether their assets are employed in the center of activity or on the periphery, at a distance from the central marketplaces. Otherwise they engage in “locational arbitrage”—that is, move from places where they are paid less to places where they are paid more.

The story for owners of immobile production factors such as land and labor is different. If they are in remote locations, then, to stay in business, they must absorb the entire transport-cost disadvantage. Landowners and workers in the center of markets, on the other hand, can earn a premium. In short, the prices of immobile land and labor vary inversely with the distance from the central marketplaces. This “Thünen principle” can be demonstrated at various levels of locational analysis:

A. In a city or region, real estate rents drop as one moves away from the center of activity. In the center, enterprises use a lot of capital to build high-rises, thus saving on land costs, and only space-saving offices are located there. Cheap land on the periphery is devoted to space-intensive uses, such as manufacturing plants, logistics centers, and dumps. If landowners on the periphery were to raise their rents, they would soon be out of business.

B. Within a nation, landowners and workers can earn high “location rents” if they operate in the central areas of economic activity, such as Chicago or Los Angeles. There, mobile factors crowd in and make intensive use of land and labor, and people earn high incomes. High rental prices for the immobile inputs determine what is produced in the central cities. If the differentials in land and labor costs between central regions and more remote areas exceed the transport cost of products from the remote locations to the central markets, enterprises migrate. That is how industry has spread from historic centers such as New York and Boston to new industrial regions.

C. On a global scale, North America, northwest Europe, and northeast Asia are now the central locations. Because they are the major gateways to global economic networks, these central locations are where world-market prices and product standards are determined and the highest incomes are earned. Mobile and immobile inputs are combined there most intensively and with the highest productivity. Farther away in economic space are new industrial countries, such as Mexico, Taiwan, and Malaysia, where immobile laborers and landowners earn lower incomes. And still farther afield, on the periphery of global economic networks, are the underdeveloped countries where locals earn very low incomes. As wages in the new industrial countries rise, producers have to raise productivity to retain footloose industries. Otherwise, mobile capital, know-how, and enterprise move to newer and cheaper locations.

Since Thünen’s days, government administration has become another important immobile production factor. The cost-benefit ratio of government administration can nowadays play a major role in decisions about where to locate activities, both within a nation and globally. Reliable property rights, expedient and transparent regulations, impartial law enforcement, and relatively low taxation attract new investments, which causes industrial locations to expand. Governments in remote locations must keep taxes particularly low and provide good, small government if they want to attract capital and enterprise. In this sense, they are not completely sovereign; instead, they face a strong incentive to act like other immobile production factors in the “Thünen system,” offering competitive support services to local workers and landowners. In the past, government administrators on the periphery of the global economy, who realized that they had to compete indirectly with their counterparts elsewhere, were crucial in creating new industrial centers. Thus, the governments of Singapore, Hong Kong, and Taiwan offered tax concessions, developed industrial land, and simplified regulations to attract foreign capital and enterprises, and were spectacularly successful in raising their populations’ living standards.

Another aspect of spatial economics, one that has become increasingly contentious in recent years, is the legal and illegal migration of workers across borders. This aspect of globalization is now putting social strain on some societies. A potentially less disruptive measure would be to reduce government barriers to mobility of capital and goods. As international trade economists have known for a long time, to the extent that governments restrict free trade and the free movement of capital, they create incentives for people to move. For example, the stronger are the U.S. government’s restrictions on imports from Brazil and the Brazilian government’s restrictions on investment from the United States, the stronger is the inducement for Brazilians to migrate to the United States.

The freer flow of information and new transport and communications technologies have now raised the mobility of capital—human, financial, and physical—entrepreneurs, and entire firms to unprecedented levels. The owners of these mobile production factors, who wish to supply world markets, are increasingly “shopping around” for the labor, work attitudes, and style of government administration that promise them high rates of return and low risks. Many companies are becoming “locational innovators” and multinationals. Lack of economic freedom and well-working government institutions makes some countries unattractive to mobile factors of production. However, low labor-unit costs and an expedient administration, which keep transaction costs and business risks low, are market signals that aspiring industrial countries can use to make themselves highly attractive. The influx of multinationals will then raise productivity and further enhance the attractiveness of such new locations, even if wage rates are gradually rising. In addition, originally peripheral places can address their transport-cost disadvantages by investing in efficient transport infrastructures. Understanding and correcting the “Thünen disadvantage” has rewarded Singapore, Hong Kong, and Taiwan with spectacular success.

The rising global mobility of products, people, capital, and enterprise poses new competitive challenges to producers and workers in the established economic centers, who are losing some of their relative advantage. They can react to the emergence of competitive new economies in one of two ways. They can “Japan/Korea/China bash” to extract subsidies and political patronage, or, instead, they can be competitive and innovative, raising productivity in the traditional central production places and specializing in goods and services that still incur high transport costs, so that they still enjoy a degree of locational advantage. They can also draw on cheap imported inputs to produce end-products competitively for domestic and world markets. The mature, high-income economies at the center of the global system enjoy an important asset in the dynamic game of global competition: their innovative capacity. On that score, they are more likely to succeed if they reject political and social regulations that hamper innovative enterprise and cause high costs of transacting business, such as a legal system that raises the risks of innovation (see liability). Competitive producers in the old centers are also discovering that the new industrial countries buy many goods and services that the advanced economies are still best able to produce.

Economic theory suggests—and history amply confirms—that defensive political responses are rarely sustainable over the long term, whereas the competitive, open response of enterprises generates opportunity for most. Globalization is a positive-sum game, one reason being that economic openness to trade and factor mobility has been the most powerful antidote to political “rent-seeking” (the use of political restrictions to secure artificial market niches). In open economies, political and bureaucratic energies are channeled to support mobile producers and to create an investment climate in which all production factors can thrive by cooperating. Openness was the reason modern industrial development took off in Western Europe. There, small, open states had to attract footloose merchants and industrialists by providing the rule of law, secure private property rights, and other economic freedoms, protected by expedient, impartial courts of law. By contrast, the closed worlds of Imperial China and Mughal India had no reason to abandon arbitrary, despotic rule. They had little innovative enterprise and experienced relative economic decline for centuries, despite their often much more advanced technical know-how.

In recent decades, this has, of course, changed: now that China and India are opening up, they are using progress in transport and communications to thrive. With time, they may well shed the former periphery handicaps and become new industrial centers in their own right, changing the global economic space.