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The Nobel Prize in Economics and Africa

Shanta Devarajan's picture

The awarding of this year’s Nobel Memorial Prize in Economics to Paul Krugman is a tribute not just to the elegance of Krugman’s pathbreaking contributions to international trade and economic geography, but also to his ability to apply cutting-edge economics to real-world problems.  Two pieces by Arvind Panagariya and Arvind Subramanian explain Paul’s varied contributions to economics.  Simply put, he turned traditional trade theory on its head by showing that countries trade with each other not just because they have different endowments of factors such as labor and land, but also because people like variety (Germans buy French cars; French people drink German wine). 

Also, production could be concentrated in some regions within countries (or even between countries) because of economies of scale and “agglomeration externalities”—clusters can be more productive if located near each other, as happened in Silicon Valley, California.  In thinking about their implications for Africa, I was struck by how many of Paul’s ideas were brought to life in this year’s (forthcoming) World Development Report, Reshaping Economic Geography.   Although the report will be published in November, earlier drafts show how Africa, especially those parts that consist of many small countries, could gain by concentrating production in certain locations, while ensuring goods and people can move easily among locations. 

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The 2009 World Development Report Reshaping Economic Geography distills the main insights of a quarter century of research, including several of Krugman's, and uses them to reframe policy debates in urbanization, territorial development, and international integration. Here is an excerpt from the Report that describes one of Krugman's insights ------

The sharpest insights sometimes come from piecing together bits of information that separately can be innocuous and unsurprising.

In the mid-1970s overseas transport costs had fallen to a fraction of their levels in 1900, due to such inventions as steam power and the telegraph. And the share of trade between neighboring countries in Europe had risen relative to their trade with countries more distant. For example, in 1910, British exports were spread quite evenly between Europe (35 percent), Asia (24 percent), and other regions (31 percent).

By 1996 60 percent of Britain’s exports went to Europe and only 11 percent to Asia. Singly, neither fact was surprising. Together, they were exactly the opposite of what standard economics would predict. So a fall in transport costs should have meant more trade with distant partners than with neighbors, not less. What had happened?

Research in the 1980s provided the answer. (Krugman (1991) and Krugman (2007)). Two waves of globalization—a euphemism for falling transport and trade costs—were responsible. During the first wave from about 1840 to the First World War, transport costs fell enough to make large-scale trade possible but between places based on their comparative advantage. So Britain traded machinery for Indian tea, Argentine beef, and Australian wool; trade increased between distant and dissimilar countries.

During the second wave, after 1950, transport costs fell low enough that, at least in Europe and North America, small differences in products and tastes fuelled trade between similar countries. Neighbors traded different types of beer and different parts of cars such as wheels and tires. Trade in parts and components grew to take advantage of specialization and economies of scale.

Intraindustry trade—the exchange of broadly similar goods and services—is perhaps the most important new development since the Second World War. Countries trade Samsung, Motorola, and Nokia phones, casings for television remotes, and buttons and stitching for textiles. Such trade is now more than half of global trade, up from a quarter in 1962. The share of intraindustry trade has gone up for all types of goods and services, from such primary goods as oil and natural gas, from such intermediate inputs as auto parts and computer help-lines, to such final goods as food and beverages

Why is this important? Because with the border-related divisions identified in Chapter 3 of the Report, there are barriers to movements of capital and labor. If all that countries could trade were final goods, such as televisions and cars, the convergence in living standards would at best be slow. With trade in intermediate inputs, the potential for specialization and trade increases significantly. The efficiencies generated through specialization and scale economies in production and transportation have indeed benefited the world. But these benefits have not been shared evenly. East Asia, North America, and Western Europe, account for much of the world’s intraindustry trade. Chapter 6 of the Report explains why, and shows what this means for developing countries, and especially Africa.

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