ECONOMY

746 economic geography
Real
wages,
w N , w S
1.0
w N
0.9
w N = w S
0.8
w S
A
1.0 1.2 1.4 1.6 1.8
Trade costs
Fig. 41.1 History of the world
through trade rather than local production develops, and clustering forces become
relatively more important. At point A clustering forces come to dominate, and the
equilibrium with equal amounts of manufacturing in each country becomes unstable;
ifonefirmrelocatesfromStoNthenitraises the profitability of firms in N and
reduces the profitability of remaining firms in S, causing further firms to follow.
Four forces are at work. Two are dispersion forces: by moving to N the firm raises
wages in N and increases supply to N consumers, these forces tending to reduce
profitability of firms in N. But against this there are two agglomeration forces. A
firm that moves increases the size of the N market (the backward linkage, creating a
demand for intermediate goods). It also reduces the costs of intermediates in N (the
forward linkage, since it offers a supply of intermediates). The last two effects come
to dominate and we see agglomeration of industry in one country, raising wages as
illustrated. 5
For a range of trade costs below A, the world necessarily has a dichotomous
structure. Wages are lower in S, but it does not pay any firm to move to S as to
do so would be to forgo the clustering benefits of large markets and proximity to
suppliers that are found in N. However, as trade costs fall it becomes cheaper to ship
intermediate goods; linkages matter less so the location of manufacturing becomes
more sensitive to factor price differences. Manufacturing therefore starts to move to
S and the equilibrium wage gap narrows. In this model wage gap goes all the way to
factor price equalization when trade is perfectly free—the “death of distance.”
⁵ There is a range in which agglomeration (with w N >w S ) and dispersion (with w N = w S )areboth
stable equilibria. See Fujita, Krugman, and Venables 1999 for details.