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LOGOLOGOThe Increasing Returns Revolution in Trade and Geography By Paul KrugmanJune 2009，AERYour site here Paul KrugmanvFebruary 28,1953,American economist,a new generation of the free school of economics,the field of theoretical research is the pattern of trade and regional economic activities.a professor of economics at Princeton University and Massachusetts Institute of technology,won the Nobel Prize in Economics in 2008.Your site hereoverviewsIncreasing Returns and TradeGeography IgnoredNew Economic Geography3Trade Puzzles124 World Becoming MoreClassical?5Your site here.In my first year as an assistant professor,I remember telling colleagues that I was working on international trade theoryand being asked why on earth I would want to do that.“Trade is such a monolithic field,”one told me.“Its a finished structure,with nothing interesting left to do.”Yet even before the arrival of new models,there was an undercurrent of dissatisfaction with conventional trade theory.Why did the trade counterculture flourish despite the apparent completeness of conventional trade theory?Trade PuzzlesYour site here Trade Puzzles.vTrade in the first great age of globalizationthe age made possible by steam engines and telegraphsv was mainly dissimilar-dissimilar:v trade in dissimilar goods between dissimilar countries.v Comparative advantage,which one may define as the idea that countries trade to take advantage of their differences,clearly explained most of what was going on.Your site herev It was only with the recovery of trade after World War II,that the more puzzling trade patterns that fed the counterculture became prominent.v Call it the similar-similar problem:v the huge role in world trade played by exchanges of similar products between similar countries,exemplified by the massive two-way trade in automotive products between the United States and Canada Trade PuzzlesYour site here Trade Puzzles.Figure 1 shows the commodity composition of British exports and imports on the eve of World War I.The pattern of trade made perfect sense in terms of classical comparative advantage:Britain,a densely populated nation with abundant capital but scarce land,exported manufactured goods and imported raw materials.By contrast,Figure 2which shows comparable data for 1990 offers no comparably easy interpretation:Britain both imported and exported mainly manufactured goods.Your site herev Figure 3 illustrates trade,as reconstituted after World War II,did take place to a large extent between similar countries,comparing Britains trade with Europe and with rest of the world in 1913 and 1990.Trade PuzzlesYour site here Increasing Returns and TradevIt shouldnt have been that hard to make sense of similar-similar trade.v The answer was that unexhausted economies of scale at the firm level necessarily imply imperfect competition,and there were no readily usable models of imperfect competition to hand.v Your site herevThen came the new monopolistic competition models:Kelvin J.Lancaster(1979),Michael Spence(1976),and above all Avinash Dixit and Joseph Stiglitz(1977).All of these papers were intended by their authors as ways to address the classic welfare questions about whether monopolistic competition led to inefficient scale,or perhaps to production of the wrong mix of products.Increasing Returns and TradeYour site here Increasing Returns and Tradev It quickly became apparent(Norman 1976;Krugman 1979;Lancaster 1980)that one could use monopolistic competition models to offer a picture of international trade that completely bypassed conventiona arguments based on comparative advantage.v In this picture,countries that were identical in resources and technology would nonetheless specialize in producing different products,giving rise to trade as consumers sought variety.Your site here Geography Ignoredv In fact,however,as late as 1990 international economists took virtually no notice of trade within countries,or of the location of production in space.Nor was there really a strong independent presence of economic geography within the economics profession as a whole.vWhy was geography ignored by trade theorists?Your site here Geography Ignoredv A large part of the explanation is the obvious centrality of increasing returns to geographical patterns:nobody really thinks that Silicon Valley owes its existence to exogenously given factors of production or Ricardian comparative advantage.v As long as trade theorists shied away from increasing returns in general,economic geography wasnt an inviting field.Your site here New Economic Geographyv To lay out the logic of the“new economic g eography,”I find it helpful to talk in terms of a“cheat”modela sort of model of the modelI originally devised to get some intuition about the home market effectYour site hereNew Economic Geographyv In this model we consider the location decision of a single producer serving two markets.vWe assume that the producer has fixed sales of S,S*units of a good in the two markets,with S S*.v And it must pay a transport cost of for each unit shipped from one location to the other.The producer has the option of having either one or two plants;by opening a second plant,the producer can eliminate transport costs but must pay an extra fixed cost F.Your site herevClearly,if the producer opens only one plant,it will be in the larger market.But will it concentrate production?Only if F S*.vIt goes without saying that this little exposition ignores market structure,pricing,the elasticity of demand,and more.vif economies of scale,as captured by F/S*,are large enough compared to transport costs,production will be geographically concentrated,and that concentration will,other things equal,be in the larger market.New Economic GeographyYour site herev Think now of a world in which there are many firms making the same kind of choice I just described,and also in which some but not all resources are mobile.v Let S be the size of the overall market,be the share of that market attributable to“footloose”production,and suppose that there are two symmetric locations.Then we can think of a possible equilibrium in which all the footloose factors concentrate in one place.In that case the other locationthe smaller marketwould demand S(1 )/2 units of our representative good.New Economic GeographyYour site herev And this concentration of production would be self-sustaining if F S(1 )/2,or F/S(1 )/2.So thats our criterion for the creation of a self-sustaining concentration of production in space.New Economic GeographyYour site here (i)A self-sustaining concentration of production in space can occur if economies of scale(F/S)are large,transport costs low,and enough production is mobile.(ii)Which location gets the concentration of production is arbitrary,and can be presumed to be a function of initial conditions or historical accident.New Economic GeographyYour site herev This“core-periphery”model,essentially a model of agglomeration,was the starting point for the new economic geography.New Economic GeographyYour site herev Sometimes the progression of economic ideas mirrors changes in the real economy.v Thus,macroeconomics emerged as a discipline at least in part because the business cycle became more severe over the first several decades of the twentieth century.Is the World Becoming More ClassicalYour site herev heres good reason to believe that the world economy has,over time,actually become less characterized by the kinds of increasing-returns effects emphasized by new trade and new geography.Is the World Becoming More ClassicalYour site herev In the case of geography,in fact,the peak impact of increasing returns probably occurred long before the new theorists arrived on the scene.v Work by Kim(1998)seems to confirm the notion that the peak importance of increasing returns in industry location occurred circa 1930.Is the World Becoming More ClassicalYour site herev Figure 4 shows his calculation of an index of regional manufacturing specialization(first proposed in Krugman 1991a),using manufacturing censuses.From a peak in the interwar years,this index has since declined dramatically.Is the World Becoming More ClassicalYour site herev And nobody doubts that trade between the United States and Mexico,where wages are only 13 percent of the US level,or China,where they are only about 4 percent,reflects comparative advantage rather than arbitrary,scale-based specialization.v The old trade theory has regained relevance.Is the World Becoming More ClassicalYour site herev Whether the influence of increasing returns on trade and geography is rising or falling,one thing is clear:much was learned from the intellectual revolution that brought increasing returns into the heart of how we think about the world economy.vIt wasnt just that economists could make sense of previously puzzling data,we found ourselves able to see things that had previously been in an intellectual blind spot.Is the World Becoming More ClassicalLOGOLOGOThank You!