policymakers demonstrate

340 Stef Proost and Jacques-François Thisse
case, when trade costs fall enough, some firms choose to produce in the North,
say rather than in the South in order to benefit from a lower marginal cost while
maintaining a high volume of export. As trade costs keep decreasing, a growing
number of firms choose to set up in the North where the marginal cost decreases
further. Note that firms tend to gather in one region despite the fact that the two
markets where they sell their output are the same size. What now drives firms’
agglomeration is no longer the size of the product market but the endogenous
level of agglomeration economies.
But where does agglomeration occur? Will it be in the North or in the South?
Consider an asymmetric shock that gives a region a small initial advantage. If
this shock remains fixed over a long period, firms will attune their behaviour
accordingly. The region benefiting from the shock, however small, will accommodate
the larger cluster. Hence, regions that were once very similar may end
up having very different production structures as market integration gets deeper.
Once more, lowering trade costs drives the economy toward more agglomeration
in one region at the expense of another.
Are growing regional disparities necessarily bad in this context? The answer
is no. A planner whose aim is to maximize global efficiency sets up more asymmetric
clusters than the market delivers. To explain, at the first-best optimum
prices are set at the marginal cost level while locations are chosen to maximize
the difference between agglomeration economies and transport costs. In contrast,
at market equilibrium, firms take advantage of their spatial separation to
relax price competition and do not consider the positive externalities associated
with their location decision. So the optimal configuration tends to involve
a more unbalanced distribution of firms than the market outcome. If agglomeration
economies become increasingly important in some sectors, their uneven
geographical distribution need not signify a wasteful allocation of resources.
On the contrary, the size of the clusters could well be too small. However, the
region with the larger cluster benefits from lower prices through larger agglomeration
economies, more jobs, and a bigger fiscal basis.
8.3.3 The Core–Periphery Structure
The mobility of capital and the mobility of labour do not obey the same rules.
First, while the movement of capital to a region brings with it production capability,
the returns to capital do not have to be spent in the same region. In contrast,
when workers move to a new region, they take with them both their production
and consumption capabilities (putting aside remittances). As a result,
migration affects the size of the labour and the product markets in both the origin
and the destination regions. Second, while the mobility of capital is driven
by differences in nominal returns, workers care about their real wages. In other
words, differences in costs of living matter to workers but not to capital owners.