Increasing Returns and Economic Geography

This paper develops a two-region, two-sector general equilibriun model of location. The location of agricultural production is fixed, but ionopolistcally competitive manufacturing finns choose their location to maximize profits. If transportation costs are high, returns to scale weak, and the share of spending on manufactured goods low, the incentive to produce close to the market leads to an equal division of manufacturing between the regions. With lower transport costs, stronger scale economies, or a higher manufacturing share, circular causation sets in: the more manufacturing is located in one region, the larger that region's share of demand, and this provides an incentive to locate still more manufacturing there. Thus when the parameters of the economy lie even slightly on one side of a critical "phase boundary", all manufacturing production ends up concentrated in only one region.

International Trade and Income Distribution: A Reconsideration

The postwar expansion of trade among the industrial countries has not had the strong distributional effects which standard models of trade would have led us to expect. This paper develops a model which attempts to explain this observation, while at the same time making sense of some other puzzling empirical aspects of world trade. The basis of the model is a distinction between two kinds of trade: "Heckscher-Ohlin" trade, based on differences in factor proportions, and "intraindustry" trade, based on scale economies and product differentiation. To incorporate intraindustry trade into the model it is necessary to drop the usual assumptions of constant returns to scale and perfect competition; instead the paper deals with a world where economies of scale are pervasive and all firms possess some monopoly power. Surprisingly, it is nonetheless possible to develop a fully-worked-out general equilibrium model which remains simple and can be used to compare autarky and free trade. Two main results emerge from the analysis. First, the nature of trade depends on how similar countries are in their factor endowments. As countries become more similar, the trade between them will increasingly become intra-industry in character. Second, the effects of opening trade depend on its type. If intraindustry trade is sufficiently dominant the advantages of extending the market will outweigh the distributional effects, and the owners of scarce as well as of abundant factors will be made better off.

Real Exchange Rate Adjustment and the Welfare Effects of Oil Price Decontrol

Conventional analysis of the welfare effects of U.S. oil price regulation in the 1970's focuses on the deadweight losses in the oil market. This paper argues that such analysis substantially understates the benefits from decontrolling prices, because decontrol will lead to an improvement in the U.S. terms of trade with respect to other oil importing countries. A simple model of the relationship between oil decontrol and the terms of trade is developed, and the impact is calculated for plausible parameter values. The results suggest that the terms of trade benefits are several times larger than the benefits as conventionally measured.

Financing vs. Forgiving a Debt Overhang

This paper examines the tradeoffs facing creditors of a country whose debt is large enough that the country cannot attract voluntary new lending. If the country is unable to meet its debt service requirements out of current income, the creditors have two choices. They can finance the country, lending at an expected loss in the hope that the country will eventually be able to repay its debt after all; or they can forgive, reducing the debt level to one that the country can repay. The post-1983 debt strategy of the IMF and the US has relied on financing, but many current calls for debt reform call for forgiveness instead. The paper shows that the choice between financing and forgiveness represents a tradeoff. Financing gives the creditors an option value: if the country turns out to do relatively well, creditors will not have written down their claims unnecessarily. However, the burden of debt distorts the country's incentives, since the benefits of good performance go largely to creditors rather than itself. The paper also shows that the tradeoff itself can be improved if both financing and forgiveness are made contingent on states of nature that the country cannot affect, such as oil prices, world interest rates, etc.

Integration, Specialization, and the Adjustment

In the United States, many industries have a Silicon Valley-type geographic localization. In Europe, these same industries often have four or more major centers of production. This difference is presumably the result of the formal and informal trade barriers that have divided the European market. With the growing integration of that market, however, there is the possibility that Europe will develop an American-style economic geography. This paper uses a theoretical model of industrial localization to demonstrate this possibility, and to show the possible transition costs associated with this shift.