Abstract
We analyze the effects of local market size and accessibility on the spatial distribution of economic activity and wages in general equilibrium trade models with many asymmetric countries and costly trade for all goods. In models with a homogeneous sector, local market size is generally more strongly correlated with a country's industry share, whereas accessibility better explains a country's wage. We analytically show that result in a simplified case and then confirm it using simulations with random trading networks. In models with only differentiated sectors, both local market size and accessibility are highly correlated with wages. The impact of local market size on industry location is more robust than the impact of local market size on wages in economic geography models.
Highlights
Do market size and accessibility matter for industry location and wages? This question has attracted attention since Krugman's (1980) and Helpman and Krugman's (1985) seminal contributions to new trade theory
In all models that we simulate, the equilibrium relationship between local market size and industry location is more robust than the relationship between local market size and wages
The results vary slightly depending on the type of trading network considered, they are fairly robust
Summary
Do market size and accessibility matter for industry location and wages? This question has attracted attention since Krugman's (1980) and Helpman and Krugman's (1985) seminal contributions to new trade theory. Davis (1998), in particular, shows that when trading the homogeneous good is as costly as trading the differentiated good, market size has no longer any bearing on country specialization This is one basic message of Hanson and Xiang (2004), who argue that—in the absence of a costlessly tradable good—not all increasing returns sectors can display a HME.. In accord with the theoretical results derived in lower-dimensional instances of the models and simulations on simple networks, the effect of local market size on equilibrium wages crucially hinges on the countries' specialization patterns in our numerical simulations. We derive a number of comparative static results using specific instances of those models and illustrate several key economic properties and specialization patterns for simple network configurations Most technical details are relegated to a set of appendices
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