Is Distance Dead?

Nick Crafts

Globalization

• Integration of markets from falls in transport/communication costs and reduction of policy barriers to trade and foreign investment

• Gains from trade potentially significant

• Re-deployment of labour central to this

• Requires sectoral and spatial adjustment

Source: Maddison (2001)

World Trade/World GDP (%)

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10

12

14

16

18

1820 1913 1950 1973 2000

Source: Obstfeld & Taylor (2004)

FOREIGN ASSETS/WORLD GDP%

0 20 40 60 80 100

1870

1914

1930

1945

1960

1980

2000

Death of Distance: Implications

• Transport and communications costs melt away

• Economic activity disperses

• Cheap labour on your doorstep

• Jobs offshored

• Race to the bottom

BLS (2004)

Employer Wage Costs, 2003 ($ per hour)

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5

10

15

20

25

30

35

Germany UnitedStates

UK Czech R. India China

Race to the Bottom

• Welfare state developed in immobile capital era

• High welfare spending and mobile capital is unprecedented

• Tax competition and death of distance would undermine big government

Source: Lindert (2004), OECD (2005)

Social Transfers in Old OECD (%GDP in median country)

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5

10

15

20

25

1910 1930 1960 1980 2001

Transport/Communication Costs

• VERY HIGH: activity is dispersed

• VERY LOW: activity is dispersed

• INTERMEDIATE: agglomeration with feedback effects based on large markets and linkages

Factors in Industrial Location Decisions

• Market Access

• Unit Costs

• Human Capital

• Institutional Quality

Agglomeration Benefits(Venables, 2001)

• External economies of scale

• Lots of the right people in the same place

• Productivity advantages of bigger cities

• Cannot easily be replicated

Taxing CapitalAverage OECD Corporate tax rates have fallen since early 1980s by about 15% points (statutory), 10% points (effective) (Devereux et al., 2002)

BUT

No downward trend in corporate tax revenues which in any case are only about 3% GDP

AND

Continuing importance of agglomeration and market access underpins Europe’s ability to carry on taxing capital (Baldwin and Krugman, 2004)

Changes in World Economic Geography

• Industrialization and de-industrialization

• Concentration of world manufacturing production and, even more so, exports

• Changes in location influenced by transport costs and agglomeration benefits

• Not steady convergence of poor to rich but rapid transition of select few

Source: Crafts and Venables (2001)

World Manufactured Exports (% Shares)

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10

20

30

40

50

60

1880 1913 1955 2000

UK Rest W. Europe North America Japan S + SE Asia China

Economic Geography and International Inequality (Redding and Venables, 2004)

• Most (60-70%) cross-country income variation accounted for simply by location relative to other countries

–market access (export demand)

–supplier access (import supply)

• Move 50% closer to trading partners would raise income by about 25%

More Results from Redding & Venables

• Moving Sri Lanka and Zimbabwe to Central Europe would raise income by 67% and 80% respectively

• Making Sri Lanka and Zimbabwe ‘open economies’ would raise income by 21% and 28% respectively

• Other variables do affect income levels including institutions

Steam Power and Industrial Location

• Reduced transport costs for goods rather than services both on land and at sea

• Industry moved closer to natural resources

• Manufacturing cities proliferated in Europe and North America

• Centralizing not dispersing

Mass Production and Mass Distribution (Chandler, 1977)

• Developed in a subset of American industry in late 19th century

• Based on integration of the market following completion of main rail network

• Changed American industrial geography …. centralizing rather than dispersing

Lancashire Textiles and Globalization (Leunig, 2005)

• Lancashire a high wage industry: 6 x India and Japan in 1910

• But continued to dominate world trade (60% world market share in cottons in 1910)

• Unit costs lower than India or Japan even before adjusting for output quality

• Lancashire flourished because of agglomeration benefits ..... its productivity exceeded other British locations by 33%

Distance Still Matters for Trade

• CIF-FOB margin has halved since 1960 (Clark et al., 2004)

• Elasticity of trade with respect to transport costs at least -2 (Limao and Venables, 2001)

BUT

• Gravity coefficient implies distance impeded trade 24% more in the 1990s than in the 1960s (Didier and Head, 2004)

• Trade costs have fallen less than transport costs and have fallen fastest among nearby countries (Novy, 2006)

Source: Venables (2001)

Economic Interactions and Distance

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1000km 2000km 4000km 8000km

Trade FDI

UK Bilateral Trade Costs: Tariff Equivalent (%) (Novy, 2006)

1960 2002

Germany 57.7 38.9

France 64.7 41.6

USA 60.3 54.1

Australia 44.5 66.9

Canada 47.5 67.8

Japan 81.8 70.9

Average Trade Costs: USA, 1999(Anderson & van Wincoop, 2004)

• Policy barriers to trade now quite low but other costs still high

• Tariffs and NTBs equivalent to import tax of 8%

• Total barriers to international trade equivalent to import tax of 74%

Gravity Models

• Empirical models to explain volume of trade flows

• Bilateral trade flows explained by incomes and population and distance as explanatory variable that reduces trade ceteris paribus

• Augmented gravity models can be used to estimate impact of other variables such as common language, common currency etc.

Breakdown of Trade Costs

Border-Related Costs1.08 (Tariffs & NTBs) x 1.07 (language) x 1.14 (currency) x 1.06 (information) x 1.03 (security) = 1.44

Transport Costs1.08 (direct) x 1.09 (time) = 1.21

Total Trade CostsBorder-related x transport = 1.44 x 1.21 = 1.74

Offshoring: Evidence

• 14 million US service sector jobs “vulnerable” (96 million not) (Garner, 2004)

• Offshoring of business services will increase 20-fold in five years to 2007; typical cost savings 20%-40% (UNCTAD, 2004)

• Payroll services, IT services, transaction processing, software development, telemarketing etc. etc.

• Offshoring works for activities that are routine, where performance is easy to verify, for impersonal rather than personal services (Blinder, 2006)

Top 10 Offshoring LocationsSource: A. T.Kearney (2005)

1. India

2. China

3. Malaysia

4. Philippines

5. Singapore

6. Thailand

7. Czech Republic

8. Chile

9. Canada

10. Brazil

Offshoring: Evaluation

• It is win-win when markets work well

• Social gain of 17 cents on each $1 spent by US (McKinsey, 2005)

• Re-employment of displaced workers less likely in France and Germany so offshoring much less attractive

Service Offshoring and ProductivityAmiti & Wei (2005)

• Service offshoring raised American manufacturing labour productivity by 3-4.5% between 1992 and 2000

• Represents about 1/8th productivity growth

• Adverse effects on employment at micro but not macro level

London as a Financial Centre

• Agglomeration where size matters

• Benefits from thick labour markets and importance of proximity for deal-making

• Clerical jobs will increasingly be offshored

• This will strengthen the core business

UK Asset Management: Core BusinessOXERA (2005)

Importance Score

Financial Infrastructure 4.00 3.96

Size of Labour Pool 3.96 4.24

Quality of Life 3.77 3.36

Market Liquidity 3.69 4.29

Regulatory Regime 3.69 3.40

UK Asset Management: Back-OfficeOXERA (2005)

Importance Score

Total Labour Cost 4.00 2.74

Size of Labour Pool 3.92 4.08

Flexibility of Labour Market 3.89 3.22

Property Rentals 3.59 2.11

Financial Infrastructure 3.42 3.85

The Beveridge Curve

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UV2

Unemployment rate

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Beveridge Curves(Nickell et al., 2001)

• Shift out everywhere in 1970s, 1980s

• This has been reversed in UK but not in France or Germany

• Reflects labour market institutions especially those important for search and matching efficiency in context of globalization

• Geographic mobility, regional wage flexibility, ALMPs help

Source: OECD (2005)

Long Term Unemployment Rate, 2004 (% unemployed 1 year or more)

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EU15 USA FRANCE GERMANY UK

Distance is Still Alive and Well

• ICT is rearranging geography not abolishing it

• Race to the bottom fears are countered by agglomeration benefits and advantages of proximity

BUT

• Those who benefit most from globalization will be the most successful at re-deploying labour