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Ryan Avent writes:
A while back, Richard Florida took to the Wall Street Journal to explain why he thought that mega-regions (the Washington-Boston corridor, for instance) were relevant units for economic analysis and policy making. Paul Krugman disagreed ... I pointed out, at the time, that this contradicted Krugman’s own (excellent) work on economic geography ...
Well, today I have additional support for my argument, courtesy of … Paul Krugman:
Our conversation concerned an empirical problem with the Eaton-Kortum model of international trade, which was the basis of the big lecture.
E-K attempts to explain an empirical relationship known as the gravity equation, which says that the volume of trade between any two countries is proportional to the product of their GDPs, and inversely related to the distance between them. It’s an elegant model — I wish I’d come up with it, which is the highest form of praise — but has one implication that just isn’t true: it says that a country like China should export a wider range of products to a small country, like Ecuador, than it does to a big country, like the US. Why? Because Ecuador, being small, probably has fewer industries that are cost-competitive with Chinese exports. In fact, however, China seems to export a wider range of stuff to bigger economies.
A possible explanation is the lumpiness of transport costs: there are more container ships heading from China to US ports than to Ecuadorian ports, so that it’s worth sending over a bigger range of stuff. It’s like the reason there are fewer food choices in supermarkets on St. Croix (where we spent our last vacation) than in New Jersey — there’s just one boat with groceries coming over every once in a while, so you can’t keep, um, arugula in stock.
In other words, distance absolutely matters. What’s more, infrastructural connections really matter. If the Northeastern corridor is tightly linked by road and rail, then trade volumes between places within that corridor are likely to exceed those predicted by a simple gravity model (which itself should predict that distance is a good indicator of trade volumes).
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