Tuesday, December 13, 2016

Trade and Cities


One sentence summary: Following the Uruguay Round, a significant and robust correlation exists between tariff reductions and declines in urban concentration.

The corresponding paper by Cem Karayalcin and Hakan Yilmazkuday titled "Trade and Cities" has been published in World Bank Economic Review.

Many developing countries display remarkably high degrees of urban concentration that are incommensurate with their levels of urbanization. The cost of excessively high levels of urban concentration can be very high in terms of overpopulation, congestion, and productivity growth. One strand of the theoretical literature suggests that such high levels of concentration may be the result of restrictive trade policies that trigger forces of agglomeration. Another strand of the literature, however, points out that trade liberalization itself may exacerbate urban concentration by favoring the further growth of those large urban centers that have better access to international markets. The empirical basis for judging this question has been weak so far; in the existing literature, trade policies are poorly measured (or are not measured, as when trade volumes are used spuriously). Here, we use new disaggregated tariff measures to empirically test the hypothesis. We also employ a treatment-and-control analysis of pre- versus post-liberalization performance of the cities in liberalizing and non-liberalizing countries. We find evidence that (controlling for the largest cities that have ports and, thus, have better access to external markets) liberalizing trade leads to a reduction in urban concentration.

Non-technical Summary
In 2000, Port-au-Prince and San Juan accounted for 62 percent of the urban population respectively of Haiti and Puerto Rico. Though they tied for number one in the world rankings as those urban agglomerations that had the highest percentage of their countries urban populations, they were by no means exceptions. Luanda had 57 percent of the urban population of Angola, while Brazzaville had 54 percent of that of Congo. The list goes on to include many developing countries in Africa, Asia, and Latin America.

These remarkably high concentrations of urban populations in one dominant city were a long time in the making. Around 1930, when developing market economies had an average level of urbanization of 13 percent, 16 percent of their urban population lived in fourteen large cities (cities that had populations of more than half a million). Such high urban concentrations in the developed world had been attained in 1880, when its average level of urbanization stood much higher at 23 percent. The number of the large cities in the developing world as well as their share of the total urban population increased dramatically between 1930 and 1980, by which date they had 43 percent of the urban population, a number which paralleled that of the developed countries. However, the level of urbanization in the latter stood at 65 percent whereas developing market economies had an urbanization level closer to 30 percent.
Policymakers and international agencies are concerned about the cost of overpopulation, congestion, crime, and big urban wealth disparities in these megacities. Though a high degree of urban concentration might be useful in early stages of development by conserving on economic infrastructure and enhancing information spillovers at precisely the point when infrastructure and information are at a premium, it results in a misallocation can be profound. This is because once a certain level of urban concentration is attained, economies of scale get exhausted and megacities transform into sites that are excessively congested with high infrastructure costs. The consequences of this misallocation are not only static but also dynamic. There is evidence that supports the notion that excessive urban concentration has significant negative effects on productivity growth.

Given the consequences of excessive urban concentration, the natural question to explore is its causes. One possible explanation, which we test in a recent paper (Karayalcin and Yilmazkuday, 2014), is that megacities may arise from the restrictive trade policies adopted. To see why, keep in mind that, with high trade barriers, imports and exports play a marginal role in the location choices of firms and consumers, with the result that backward and forward linkages and, thus, agglomeration forces come into full play. However, trade liberalization is at times also associated with a weakening of the dispersion forces in urban systems.  One reason this may occur is that trade liberalization could shift resources and population to relatively small cities located closer to the coast or border regions with better access to foreign markets, leading to internal dispersion and a reduction in urban concentration. Thus, whether more trade reduces urban concentration or not is an empirical question.

Any attempt to answer this question must recognize that the causal mechanism that links trade to urban concentration may run both ways. In our paper, we take this issue seriously and differ from the existing literature by avoiding the use of endogenous “outcome” measures (like trade volume) that do not correspond to trade policy tools under the direct control of the policymakers. Using newly available detailed trade data on consumption, capital, and intermediate goods gathered from primary sources (digital for recent years, archival for the 1980s), our study implements an improved methodology. The identification strategy includes partitioning of countries into treatment and control groups depending on whether they liberalized their trade in the Uruguay round. The study uses first a continuous treatment measure (changes in various tariffs) with a difference-in-difference design and then constructs two instrumental variables to address the endogeneity problem.

We find that, following the Uruguay Round (and controlling for such factors as which big cities have ports, and therefore better access to external markets), a significant and robust correlation exists between tariff reductions and declines in urban concentration.

The accompanying figure shows that before the Uruguay round, the level of urban concentration of the treatment group (liberalizers) tracks that of the control group (non-liberalizers) very closely. With the Uruguay round of liberalization there starts a dramatic divergence in the levels of urban concentration of the two groups, with the treatment group of liberalizers seeing a significant decline in its level of urban concentration relative to that of the control group of non-liberalizers.

Great Liberalization and Percentage of Urban Concentration in the Largest City
Notes: The average percentage of urban population in the largest city for non-liberalizers has been normalized to the corresponding average value for liberalizers between 1970-1985 for comparison purposes. Liberalizers: Argentina, Australia, Bangladesh, Bolivia, Brazil, Chile, China, Colombia, Ecuador, Indonesia, India, Japan, South Korea, Sri Lanka, Mexico, New Zealand, Pakistan, Peru, Philippines, Thailand, Trinidad and Tobago, Taiwan, Uruguay, Venezuela. Non-liberalizers: Algeria, Austria, Belgium, Canada, Cote d'Ivoire, Denmark, Finland, France, Germany, Ghana, Hong Kong, Iceland, Israel, Italy, Malaysia, Morocco, Nepal, Netherlands, Paraguay, Singapore, Spain, Sweden, Turkey, United Kingdom, United States.

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