Recent changes in the patterns of world production are driven by trade liberalization, technological change and economic reforms. Economists have a set of tools for understanding these changes. Theories of comparative advantage suggest that differences between countries determine what they produce: Countries with, say, lots of skilled workers produce skill intensive goods. New Trade Theory downplays differences between countries emphasising instead differentiated goods and economies of scale: Globalisation leads countries to specialise in varieties (Germans make BMWs; Swedes, Volvos), allowing longer production runs and lowers costs; trade allows consumers greater choice. While these tools are useful for understanding current changes, key issues remain unexplored. Our project addresses two of these issues: the response of firms and regions to globalisation.
Existing research on the impact of globalisation at the firm level has focused on entry and exit or on changes in the composition of industry output. Less attention has been given to a key business decision: changes in production technique and product mix. We will use data from the US LRD, FAME and AMADEUS data sets to quantify the extent to which differences in productivity across firms and over time may be explained by different product mix. The analysis will document the role of international trade by connecting the firm-level data to highly disaggregated data on trade flows and tariff barriers from the UN's COMTRADE and TRAINS databases.
In addition to product mix, we will consider a second margin of adjusment: How globalisation changes firms' organisational structure. Falling communication costs allow fragmentation of production processes. Routine tasks can be undertaken in poor countries while more complex activities remain in rich ones. Thus, we may see functional instead of sectoral specialisation with countries focusing on different stages of production. The literature that considers this fragmentation has ignored the fact that activity is spatially concentrated within countries. Firms do not face a simple choice between rich and poor countries but instead between urban and non-urban locations in those countries. This may change how globalisation affects firm location: Falling communication costs allow firms to offshore routine tasks to low wage countries without losing the advantages of locating complex activities in rich country cities. We will develop a model to examine this trade-off and its implications for the distribution of economic activity and welfare.
The fact that activity is spatially concentrated also has implications for the distribution of the gains from trade. Specifically, the literature that studies the impact of international trade on wages completely neglected the fact that industries affected by trade are often spatially concentrated within a country. As a result of this concentration, large local effects may be felt even when the aggregate national effect is small. We will revisit this issue by combining the trade data base developed for our work on product mix with production data for UK firms. Using this data, we will examine the extent to which UK employment and wage adjustments to changes in international trade flows are spatially concentrated. This work will also address important, yet relatively unexplored, policy questions about the interaction between trade and urban/regional policy.
Spatial concentration also plays a role in determining the impact of trade liberalisation in developing countries. Using data from India and empirical and theoretical tools developed in the first three stages of the project, we will examine the forces that shape the urban structure of a developing economy and what happens to regional inequalities and the location of particular sectors during development. We will assess the role that globalisation plays in shaping these location outcomes.