Created on 2024-04-18 20:07
Published on 2024-04-18 20:09
Our paper, published seven yeara ago and written 13 years ago, provides insights into how barriers impeding mobility of capital and labor across regions within a country could reshape economic geography and regional inequalities. While focused on regions rather than countries, the analysis is highly relevant for understanding potential impacts of rising divisive forces that fragment the global economy.
In that paper, my co-authors Robert Townsend, Ben Moll and I looked at detailed data from households, firms, and regional economies across Thailand. We found that rural agricultural areas faced a "limited commitment" friction, where households and firms were constrained by their current wealth levels in accessing capital and investing. In contrast, urban industrial areas contended more with a "moral hazard" problem, where entrepreneurs' efforts were difficult for lenders to monitor.
Remarkably, we showed that these regional differences in financial frictions alone could explain the massive observed flows of capital from rural to urban areas and migration of labor in the same direction that concentrate economic activity. Our quantitative model predicted substantially higher usage of the economy's capital stock and labor supply in urban areas compared to rural areas.
The paper then explores a counterfactual scenario that eliminates all inter-regional factor movements, moving to a state of complete regional autarky. This exercise aims to understand the impacts if rising fragmentation forces created barriers to flows of capital, labor, goods and services across regions.
In the shift to autarky, rural areas experience increases in consumption, income, wealth as well as higher usage of local labor and capital compared to the open equilibrium baseline. However, this comes at the cost of lower wages, interest rates and productivity losses. Inequality within rural areas declines.
The impacts are more severe for urban areas - despite higher wages and interest rates under autarky, they suffer substantial drops in income, consumption and wealth levels compared to the open baseline. Inequality rises sharply within cities.
The reason that rural prodictivity decreases is simple:
Because rural capital and labor can no longer be used in urban areas, the supply of these factors in rural areas is roughly 80% higher than in the integrated baseline economy. Although regional income in rural areas increases it increases by considerably less than 80% and therefore producitivity falls.
Put differently, rural areas absorb the increased resource supplies by allocating them to somewhat less-efficient firms. For urban areas it is the reverse, although notably the change in each of these outcomes is much more extreme for areas under the moral hazard regime.
At the national level, moving to regional autarky reduces overall consumption, wealth and capital stock for the economy. However, labor supply, income and aggregate productivity modestly increase. But these gains come with a surge in overall inequality, particularly at the bottom of the income distribution.
While focused on regions within one country, this modeling exercise is highly relevant for understanding potential impacts if rising divisive political and economic forces created new sustained barriers fragmenting the global economy along national or regional lines. Possible fragmenting forces could include financial sanctions regimes, climate policies asymmetrically impacting different regions, immigration restrictions, trade protectionism or partisan conflicts.
The core insight is that even seemingly localized spatial frictions, if divergent enough across locations, can generate large reallocations of capital and labor over time as mobility barriers emerges. These economywide compositional shifts then reshape the relative economic performance and inequalities across regions or countries.
The findings caution that our increasingly divided world, if it raises cross-border barriers to factor mobility, risks geographic concentration of economic activity. Some regions may experience modest gains in productivity and incomes, but others face severe contractions in economic activity, incomes and wealth.
While provocative, the study as pubnlished is a simplification as it explores the extreme case of complete regional autarky. More relevant may be emerging moderate barriers making capital and labor mobility more sluggish across borders rather than entirely shut off. But the core lessons about the power of fundamental information frictions and incompleteness of markets observed in data to drive large economy-wide reallocations remain highly salient and invariant to all feasible variation in our model specifications.
Sustaining healthy symbiotic integration forces to facilitate efficient cross-border factor mobility is crucial to prevent such centrifugal forces from further dampening economic activity. Coordinating financial systems, investing in connective infrastructure, and aligning climate policies could pay large dividends.
At the same time, some degree of "place-based" policies nurturing economic development in lagging regions may be necessary to counterbalance concentration forces. But getting this balance right between integration and place-based support will be vital for inclusive, productive and sustainable economic geography going forward.