Edited by Bernard Fingleton
Chapter 2: Models of ‘New Economic Geography’: Factor Mobility vs. Vertical Linkages
Gianmarco I.P. Ottaviano 2.1 INTRODUCTION This chapter presents a theoretical contribution to the empirical testing of ‘new economic geography’ (henceforth, NEG) models.1 At the moment such testing is generally crippled by identiﬁcation problems due to two types of observational equivalence. The ﬁrst type concerns the comparison between the implications of NEG models and those of alternative models mainly based on technological externalities (‘between-equivalence’). The second type concerns the comparison between the implications of NEG models based on vertical linkages among ﬁrms and those on NEG models based on factor mobility (‘within-equivalence’). The focus of the chapter is on within-equivalence. Its meaning is described in Section 2.2 by comparing the two most popular simple NEG models due to Krugman (1991) and Krugman and Venables (1995). These models deal with labour mobility and input–output linkages respectively. The relevance of within-equivalence is usually not fully understood. A possible explanation is that models with vertical linkages are typically very diﬃcult to deal with analytically. This has not only hampered the exploitation of their full analytical potential but has also concealed their observational equivalence with models based on factor mobility. For this reason, Section 2.2 compares the analytically solvable versions of Krugman (1991) and Krugman and Venables (1995) as proposed by Forslid and Ottaviano (2003) and Ottaviano and Robert-Nicoud (2005) respectively. Closed form solutions reveal the fundamental equivalence of the equilibrium and stability properties of the two types of models. These equivalence results raise doubts on the possibility of empirically testing the...
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