Edited by Bernard Fingleton
Chapter 4: From Theory to Estimation and Back: The Empirical Relevance of the New Economic Geography
4. From theory to estimation and back: the empirical relevance of new economic geography Steven Brakman and Harry Garretsen 4.1 INTRODUCTION The development of new economic geography (NEG) in the past 15 years has renewed the interest among economists in the spatial distribution of economic activity.1 NEG can best be seen as a natural extension of the new trade theory that was developed in the late 1970s and early 1980s. The small step taken by Krugman (1991), but the giant leap for the rest of the economics profession, was that in Krugman the assumption of factor immobility between countries or regions was dropped. This allowed factors of production to migrate to those locations where welfare or real income is maximized. As a result, it became possible to explain or endogenize the existence of agglomerations because the Krugman model gave rise to core-periphery equilibria. For international trade theorists this was a novel approach because, traditionally, the whole ﬁeld rested basically on two pillars: location does not matter in neo-classical Heckscher-Ohlin-type models, because without factor mobility the integrated equilibrium can be restored by trade alone (incentives for migration are absent), or factor mobility is simply ruled out by assumption, as in the new trade theory. Similarly, for urban and regional economists, the NEG approach was also novel to the extent that the latter is based on a general equilibrium approach, whereas the former by and large uses partial equilibrium models. Krugman’s 1991 model led to an outburst of theoretical NEG papers in...
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