Trade costs, regional inequality, and the Home-Market Effect

ABSTRACT

This paper develops an economic geography framework with positive trade costs in both manufacturing and traditional sectors, mobile skilled workers, and unequal shares of unskilled labour in regions. It shows that partial agglomeration always features the Home-Market Effect (HME) regardless of whether regions trade only the manufacturing good or both. Moreover, spatial factor mobility is significant for the HME to arise, while intersectoral mobility does not play a crucial role. Furthermore, a decrease in the traditional sector trade costs makes the HME weaker and increases the likelihood of full agglomeration in the larger region. Finally, the paper shows that a small departure from Cobb–Douglas upper-tier utility towards gross substitutability of manufacturing and traditional goods reinforces the HME, while the opposite holds for gross complementarity of goods.

KEYWORDS:

• trade costs
• Home-Market Effect
• partial agglomeration
• regional inequality
• monopolistic competition

JEL:

• R12
• R13

ACKNOWLEDGEMENTS

The author is indebted to Evgeny Zhelobodko (1973–2013) for providing the initial idea for the paper. The author is grateful to the editor, Paul Elhorst, three anonymous referees, Krisitan Behrens, Alexander Tarasov, Jens Südekum, Jacques-François Thisse, and Philip Ushchev for numerous valuable comments and suggestions; as well as Darya Vertkina for help with the data. Kim Han Bock provided excellent research assistance. All remaining errors are the author’s alone.

DISCLOSURE STATEMENT

No potential conflict of interest was reported by the author.

ORCID

Sergey Kichko http://orcid.org/0000-0001-9191-8332

Notes

1 This intuition is also confirmed by Takatsuka and Zeng (2012), who observe HME for an arbitrary level of trade costs in the traditional sector, but a given mass of manufacturing firms within a footloose capital setting.

2 While consumers share the same preferences, their consumption bundle differs due to a wage gap between the skilled and the unskilled.

3 Behrens, Kichko, and Zhelobodko (2014) show that the spatial pattern is independent of the technology in the second sector.

4 More formally, a short-run equilibrium is a bundle of per capita consumptions with corresponding prices , masses of firms and wages in regions, and relative wage in the traditional sector satisfying the consumer’s and producer’s maximization problems as well as balances in labour markets, balanced trade flows, a consumer’s budget constraints and zero-profit conditions for differentiated sector firms.

5 Although this discussion refers to analysis conducted for constant shares, , use is made of continuity arguments, i.e., the continuity of given by (12), to obtain this result.

Additional information

Funding

The study was funded by the Russian Academic Excellence Project ‘5–100’.