[An updated version of this article can be found at Spatial Economics in the 2nd edition.]
Producers and buyers are spread throughout space, and bridging the distances between them is costly. Indeed, much commercial activity is concerned with "space bridging," and much entrepreneurship is aimed at cutting the costs of transport and communication. The study of how space (distance) affects economic behavior is called "spatial" economics.
Throughout history, space has often been a hindrance to economic growth. But improvements in transport and communications have been among the main driving forces of economic progress, as Australian economist Colin Clark pointed out. In medieval Europe and China three-quarters of the population never traveled farther than five miles from their birthplaces, and before the advent of book printing, most people knew very little about what happened beyond their narrow horizons. Since then technical and organizational progress has continually reduced the costs of transporting goods and "transporting" ideas (communication). Transport and communication have also become user-friendly. Now fax machines, satellite TV, and global computer networks are revolutionizing the world economy yet again.
Businesses locate their plants so as to economize on transport and communication costs (and reduce the risks of transport disruptions) between the locations of their inputs and the locations of their market demand. In the past, firms that depended on heavy inputs, such as steel makers, located near the source of major inputs, such as coal mines. Firms that require intensive and frequent interaction with their customers locate near the demand. Gasoline stations, for example, locate near busy intersections. Transport and communication costs normally give firms a degree of local monopoly. But concern about neighboring competitors entering their market niche tends to keep them from abusing this market power, keeping them in "creative unease" and thus forcing them to control costs and to remain innovative.
Falling transport and communication costs threaten such market niches. Producers are now often able to move away from their sources of supply or the neighborhood of their demand. Many firms have become more "footloose." Thus, we now find steel plants in Japan and Korea, far from the iron and coal mines but near ports, because the low cost of sea transport made it possible to ship coal and iron ore to locations with a favorable investment climate. Similarly, the telecommunications revolution has made many service operations footloose. The airline booking clerk one calls on an 800 number from New York, for example, may work in Omaha, and daily accounting services for a business in Chicago may be done by an office at the end of the fax line in Singapore.
Businesses combine inputs that are mobile in space, such as know-how and capital, with inputs that cannot be moved at all or only at great cost, such as land or unskilled labor. One immobile factor that must not be forgotten is government. Good government can raise the productivity of the other inputs and make certain locations attractive. Bad government—a hostile government or a confusing, complex set of regulations; high taxes; and poor public infrastructures—can lower productivity and induce the flight of mobile production factors.
The nineteenth-century German economist Johann Heinrich von Thünen, the father of spatial economics, laid out a basic principle of spatial economics. Producers who are remote from the market can succeed only if they bear the transport cost to the marketplace. But the mobile production factors have to be paid the same return, wherever they are used. Otherwise they leave. Therefore, pointed out von Thünen, the owners of immobile production factors (like land) must absorb the entire transport-cost disadvantage of remote locations.
This "Thünen principle" can be demonstrated at various levels of spatial analysis:
a. In a city or region, real estate rents drop as one moves from the center of activity. In the center, enterprises use a lot of capital to build high rises, saving on high land costs, and only space-saving offices, not large production plants, are located there. Cheap land on the periphery is devoted to land-intensive uses, such as for storage and dumps. If landowners on the periphery were to raise rents, they would soon be out of business.
b. Within a nation, landowners, workers, and the tax collector can reap high "location rents" if they operate in the central areas of economic activity, like Chicago or Los Angeles. There, mobile factors crowd in, so that intensive use is made of land, labor, and public administration, and high incomes are earned. High rental prices for the immobile inputs determine which goods and services are produced and which production methods are used. If, however, the differentials in land, labor, and tax costs between central regions and more remote locations exceed the transport costs from the remote locations to the central markets, producers migrate. That is how industry has spread out from historic centers like New York and Pittsburgh to new industrial regions.
c. On a global scale, as German economist Herbert Giersch recently pointed out, North America, Western Europe, and Japan are the central locations. World-market prices and product standards are determined there, and the highest incomes are earned. Both mobile and immobile inputs are most productive in these centers. Further away in economic space are the new industrial countries, such as Taiwan, Korea, Malaysia, and Mexico, where the immobile production factors are earning lower returns. And further still, on the periphery of the global economic system, are the underdeveloped countries with very low incomes.
The main production factors that tend to be internationally immobile are labor and government, although some countries have also attracted high legal and illegal labor migration. Because they are internationally immobile, labor and governments in noncentral countries that want to join in intensive world trade must absorb the transport-cost disadvantages. What matters in this context is "economic distance," which cannot necessarily be equated with geographic distance. Places with efficient transport connections, like Hong Kong or Singapore, are closer economically to Los Angeles than, say, a town in southern Mexico.
Technical, organizational, and social change has reduced global transport and communications costs (see table 1). This is now leading to an unprecedented degree of mobility of human, financial, and physical capital, of entrepreneurship, and of entire firms. The owners of these mobile production factors, who wish to supply world markets, are increasingly "shopping around" the world for the labor and the style of government administration that promise them a high rate of return (and low risks). Thus, more and more companies are becoming "locational innovators."
Internationally, this has led to the phenomenon of globalization, which makes it imperative for the immobile production factors to become internationally competitive. High labor costs, adversarial industrial relations, productivity-inhibiting work practices, a costly legal system, and a high tax burden are conditions that make countries unattractive to globally mobile factors of production. By contrast, low labor-unit costs and efficient administration are market signals with which the new industrial countries (especially in East Asia) have made themselves highly attractive to mobile resources. The influx of mobile Western firms has raised their productivity, which further enhances the attractiveness of these locations even if hourly wage rates are gradually rising there.
Producers who are losing their locational advantage of being near the central markets can react in one of two ways. They can be defensive by, for example, "Korea-bashing" in order to obtain political patronage, tariff protection, or "voluntary" import restraints. Or they can be proactive and competitive, raising the productivity in the center and specializing on those goods and services that still incur high transport costs and therefore still enjoy a degree of spatial monopoly. The mature high-income economies at the center of the world economic system tend to have the best innovative potential, and they can use this to remain attractive in the era of globalization. They are more likely to succeed if they abandon political and social regulations that impede innovation, such as a legal system that raises the costs of innovation (see Liability). In time, competitive producers in central locations of the global economy will also discover that the competitive new industrial countries will develop high import demand for many specialties produced by the advanced central economies.
Economic theory suggests, and history confirms, that defensive responses are very rarely sustainable over the long term. Indeed, economic openness to trade and factor mobility has been the most powerful antidote to "rent-seeking" (the use of restrictive political influence to secure artificial market niches). In open economies political and bureaucratic power has been channeled in support of mobile producers and to create an investment climate in which footloose production factors can thrive. This explains why modern industrialization took off in Europe, where small, open states were compelled by their citizens to develop institutions of limited government, the rule of law, property rights, and support for commercial competitors, whereas the closed economy of Imperial China stagnated under arbitrary despotism, despite the much more advanced state of Chinese technical know-how. Openness to trade and factor movements (with the help of the transport and communications industries that have made such movements increasingly feasible) have indeed been among the prime movers of economic progress.
Wolfgang Kasper is a Senior Fellow with the Centre for Independent Studies in Australia and was previously an economics professor at the University of New South Wales, Australia. He has served on the staff of the German Council of Economic Advisers, the Kiel Institute of World Economics, the Malaysian Finance Ministry, and the Organization for Economic Cooperation and Development.
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