By Gianmarco Ottaviano, Professor of Economics, Bocconi University. Originally published at VoxEU
Economic geography strikes back. After a couple of decades of easy talk about the 'death of distance' in the age of globalisation, the promise of a world of rising living standards for all is increasingly challenged by the resilience of regional disparities within countries. As long as many people and firms are not geographically mobile – and those who are tend to be the most skilled and productive – easier distant interactions can actually strengthen rather than weaken agglomeration economies. Recent electoral trends in Europe can be understood to a surprisingly large extent from this angle.
Econometric analysis reveals that the Leave vote in the British referendum on EU membership can be explained to a remarkable extent as a vote against globalisation much more than immigration, in particular against the perceived unfair distribution of the associated costs and benefits (Colantone and Stanig 2018a). In Ottaviano (2019) I discuss how Brexit and other recent electoral trends in Europe can be understood through the lenses of the lack of regional convergence.
The vote for Brexit was a protest vote by those who think they have experienced only the negative effects of globalisation: foreign competition, factory closures, persistent unemployment, stagnating purchasing power, deteriorating infrastructures and public services, rising social exclusion, brain drain, dwindling local tradition and identity, and growing uncertainty about the future. It is revealing that the Leave vote gathered more support among people who feel they have limited outside options: low-skill workers, as they are less employable both locally and elsewhere, and older people, as time is not on their side in the search for alternatives.
Even more revealing is that such a vote has a relevant 'sociotropic' dimension: people resent negative outcomes not only when individually hit but also when their local community is harmed. In this respect, the Leave vote was a request for 'protection' by those who think that others (i.e. the so-called elites in London and Brussels) have hijacked the right to make decisions in the common interest, which on paper should be good for everybody but ends up being good only for those who make the decisions. From this lack of redistribution of the gains and losses from globalisation rises the demand for protection that explains a large part of recent electoral outcomes in the UK and the rest of Europe (Colantone and Stanig 2018a).
European Integration and New Economic Geography (at Last)
Brexit will likely have a cost – sizable for the UK and more limited for the other member countries except Ireland (Dhingra et al. 2017). The reason is that the Single Market is beneficial to the average citizen of each member state. This was one of the reasons behind its creation. The European project of integration was born from the post-war belief that, as peace peddles prosperity, free trade can promote peace and thus activate a virtuous circle of peace and prosperity.
While the debate on the positive role of international trade for peace, in general, is still open, that European integration led to an unprecedentedly long period of peace in the Old Continent is a matter of fact. Some of the current members did experience war before joining the EU, but there have been no conflicts between any EU countries once they have become members.
Unfortunately, growing regional disparities within countries accompanied by dwindling redistribution of gains and losses are reinforcing the public impression that the virtuous cycle of peace and prosperity is not there for everybody to enjoy, but that it actually works selectively for areas that were already skilled and productive to start with. That European integration could have this unexpected outcome was a point raised by the so-called new economic geography in the late 1980s and early 1990s of the last century (Fujita et al. 1999, Baldwin et al. 2003), originally associated with Nobel Prize-worthy work by Krugman (1991).
At the time, the process that eventually led to the creation of the Single Market and the introduction of a common currency was predominantly informed by the traditional neoclassical paradigm of perfectly competitive markets and constant-returns-to-scale technologies. It typically predicted that, following economic integration, market forces would naturally lead to economic convergence in living standards across European regions.
Krugman's point was instead that firms' market power and increasing returns to scale in production are more realistic features of the modern world, and these could lead to the opposite outcome of integration causing divergence between flourishing 'core' regions and fading 'periphery' regions. However, new economic geography was thick in theory and thin in empirics, so its message got lost as European integration deepened without major traumas.
Things started to change dramatically with the Global Crisis as evidence started mounting about globalisation's two offspring. Globally, due to offshoring and technology transfer, manufacturing and GDP shares have shifted from the G7 to a few developing countries (first of all China); this is the 'Great Convergence' (Baldwin 2016). Locally, due to skill-biased technological change and skill-biased globalisation, the economic geography of G7 countries has become more polarised between outward-looking dynamic growth centres and inward-looking stagnating backwaters; this is the 'Great Divergence' (Moretti 2012). Krugman might have been right after all.
The 'China Syndrome' and the 'East Wind'
In Western Europe, the growing electoral disappointment with the European dream has indeed a strong geographical dimension, and the trend is more pronounced in local economies that have suffered more from two parallel developments (Colantone and Stanig 2018a,b): the 'China syndrome' (Autor et al. 2013), due to the competition shock associated with the rise of China and other low-wage emerging economies as global players; and the 'East wind' associated with the accession of low-wage Eastern European countries to the EU.
The more a local economy has been negatively affected by the two shocks, the more its electors have shifted towards the radical right and its policy packages. These packages typically combine the retrenchment against international openness and the liberalisation of the internal market and more convincingly address the demand for protection by an electorate that, after the austerity following the Crisis, no longer trusts alternatives based on more liberal stances on foreign relations and the parallel promise of a stronger welfare state.
A big reason why liberal democracies in Europe have remained relatively stable since WWII is that most Europeans have had hope that their lives will improve. A big reason why the radical vote has recently been on the rise in several European countries is that part of the electorate has lost this hope. People are increasingly worried that not only their own lives but also the lives of their children will not improve and that the playing field is not level.
On the one hand, despite some progress in curtailing 'tax havens' in recent years, there has never been as much wealth in tax havens as there is today (Zucman 2015). This is seen as unfair because, if public goods and services (including those required to help the transition to a 'green economy') have to be provided in the regions where such hidden wealth comes from, lost tax revenues have to be compensated for by higher taxes on law-abiding households.
On the other hand, fairness is also undermined by dwindling social mobility. In the last decades, social mobility has slowed down across large parts of the industrialised world (OECD 2018), both within and between generations. Social mobility varies greatly across regions within countries, correlates positively with economic activity, education, and social capital, and negatively with inequality (Güell at al. 2018). Renewed migration from the South to the North of Europe after the Crisis (Van Mol and de Valk 2016) is a testimony of the widening relative lack of opportunities in the places that have suffered the most from competition from low-wage countries.
Globalisation has come accompanied by the Great Convergence between countries around the world but also the Great Divergence between regions within several industrialised countries. The same holds within the EU. In recent years, redistributive policies have had only a very limited impact in terms of reversing growing regional inequality. As a result, the traditional liberal package of external liberalisation and internal redistribution has lost its appeal with the electorate, conceding ground to the alternative package of the radical right that consists of external protectionism and internal liberalisation. This is both inefficient and unlikely to lead to more regional convergence. What the political and policy debate in Europe is arguably missing is a clearer focus on two of the main underlying causes of peoples' growing distrust in national and international institutions: fiscal fairness and social mobility.
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