Local & Regional Economics Regional and Local Economics (RALE) Lecture slides – Lecture 4b 1 Interregional Trade

Local & Regional Economics 2 Lecture 8 Last lecture: - Industrial Location Theory This lecture: - Interregional Trade Aim: To discover why regions specialise in certain commodities Outcomes: Awareness of Ricardian and Heckscher- Ohlin theories of regional trade Awareness of more radical explanations of regional trade and specialisation Regional and Local Economics (RALE) Lecture slides – Lecture 4b

Local & Regional Economics 3 Proposition - Regions need to trade if they are to be prosperous. All regions are becoming more open EU, GATT. Proportion of goods and services % GDP exportedimported Luxembourg 93%80% Belgium 75%69% Greece16%24% Success breeds Success. Regional and Local Economics (RALE) Lecture slides – Lecture 4b

Local & Regional Economics Regional and Local Economic Analysis (RALE) Lecture slides – Lecture 8 4 Ricardian Trade Theory - regions can gain from trade by specialising in production and export of goods in which they have a comparative advantage Possibility of mutually advantageous gains from trade. Exchange rate cars for wheat South 1:5 North 1:7 if world rate settles at 1:6 South exchanges one car for 6 tonnes of wheat can only get 5 tonnes at home North imports car for 6 tonnes of wheat but cost of home produced is 7 tonnes Possibility of mutually advantageous gains from trade. Exchange rate cars for wheat South 1:5 North 1:7 if world rate settles at 1:6 South exchanges one car for 6 tonnes of wheat can only get 5 tonnes at home North imports car for 6 tonnes of wheat but cost of home produced is 7 tonnes

Local & Regional Economics 5 Question - what is the source of comparative advantage? Labour productivity (is this realistic?) Technology or capital stock? Could it be wages? Regional and Local Economics (RALE) Lecture slides – Lecture 4b

Local & Regional Economics 6 Cars 1 unit Ratio of labour to capital L/K P of labour/ price of capital R c n R c s F c s F c n R w s Wheat 1 unit R w n Simple version only two factors of production K and L. Comparative advantage from initial factor endowment each region specialising in its rich factor. capital abundance in south leads to car production Labour abundance in north leads to wheat production. Heckscher- Ohlin Trade Theorem Regional and Local Economics (RALE) Lecture slides – Lecture 4b Adapted from Armstrong and Taylor (2000) pp 125

Local & Regional Economics Regional and Local Economic Analysis (RALE) Lecture slides – Lecture 8 7 Prediction South has an advantage in producing cars because it uses a lot of its cheaper factor (capital) North has advantage in Wheat because it uses a lot of its cheaper factor (Labour) The difference in the price ratios creates the opportunity for trade Prediction South has an advantage in producing cars because it uses a lot of its cheaper factor (capital) North has advantage in Wheat because it uses a lot of its cheaper factor (Labour) The difference in the price ratios creates the opportunity for trade Adapted from Armstrong and Taylor (2000) pp 125

Local & Regional Economics 8 Restrictive assumptions There are only two factors of production – labour and capital Factors of production are of the same quality in both regions Each regions endowments of capital and labour are fixed Production functions are the same in each region (no regional advantage from superior technology) Production functions have constant returns to scale There is perfect competition in each regions factor and commodity markets Trade is free of all obstructions (tariffs etc.) There is strong factor intensity at all sets of factor prices Tastes are identical in all regions and do not vary with regional income levels Regional and Local Economics (RALE) Lecture slides – Lecture 4b

Local & Regional Economics 9 Relaxing the assumption of fixed factor endowment More than two factors of production Factor quality (human capital) Strong factor intensities Constant returns to scale Factor migration Regional and Local Economics (RALE) Lecture slides – Lecture 4b Adapted from Armstrong and Taylor (2000) pp 130

Local & Regional Economics 10 Intra-industry trade theory (exchange of virtually identical products) Horizontal Wide range of choice may loose share in domestic market but openings in export markets Need high levels of output, economies of scale Highest in closely integrated economies Vertical In same industry but at different stages in the production chain Regional and Local Economics (RALE) Lecture slides – Lecture 4b

Local & Regional Economics 11 Competitive Advantage Mutually reinforcing competitive advantage Importance of interactions between elements Not a formalised model but draws on case studies - not all regions will have all elements in place. Regional and Local Economics (RALE) Lecture slides – Lecture 4b Adapted from Armstrong and Taylor (2000) pp 133

Local & Regional Economics 12 New Economic Geography Home market effect Footloose labour/industries model Vertically linked industries model Centripetal forces Market-size Thick Labour market External economies Centripetal forces Market-size Thick Labour market External economies Centrifugal forces Immobile factors Land rents External diseconomies Centrifugal forces Immobile factors Land rents External diseconomies Regional and Local Economics (RALE) Lecture slides – Lecture 4b See Krugman 1998

Local & Regional Economics 13 Conclusions - Why specialisation exists Ricardian opportunity cost advantage creates climate for trade. Heckschler-Ohlin theorem predicts local factor abundance as the reason for regional specialisation Intra-industry trade models explain observed behaviour Geography still matters. Next Week Inter-regional Labour Migration Regional and Local Economics (RALE) Lecture slides – Lecture 4b