Distance, skill deepening and development: will peripheral countries ever get rich?

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Abstract

This paper models the relationship between countries' distance from global economic activity, endogenous investments in education and economic development. Firms in remote locations pay greater trade costs on both exports and intermediate imports, reducing the amount of value added left to remunerate domestic factors of production. If skill-intensive sectors have higher trade costs, more pervasive input–output linkages or stronger increasing returns to scale, we show theoretically that remoteness depresses the skill premium and therefore incentives for human capital accumulation. Empirically, we exploit structural relationships from the model to demonstrate that countries with lower market access have lower levels of educational attainment. We also show that the world's most peripheral countries are becoming increasingly economically remote over time.

Introduction

Why some nations are rich and others are poor is perhaps one of the oldest and most fundamental questions in economics. In 1996, the per capita income of the country at the 90th percentile of the world income distribution was more than 30 times higher than the country at the 10th percentile. The persistence of such differences is surprising in light of the increasing integration of goods and financial markets in the post-war period. Economists have pointed to a number of factors which may have prevented these income differences from being arbitraged away, including institutional ineffectiveness, sluggish technology diffusion and endowment disadvantages.2

A more recent line of research has highlighted the potential importance of trade costs in reducing per capita income.3 These trade costs include not only the expense of physically moving products between locations but also all information, communication, monitoring and policy (e.g. tariff) costs associated with transacting at a distance. Because firms in remote locations pay greater trade costs on both their sales to final markets and their purchases of imported intermediate inputs, they have less value added available to remunerate domestic factors of production.

In this paper, we focus on an additional penalty of remoteness. We demonstrate that being located on the economic periphery can reduce the return to skill, thereby reducing incentives for investment in human capital accumulation. This penalty magnifies the effect that economic geography can have on cross-country per capita income. Increasing a country's relative trade costs not only reduces contemporaneous factor rewards, but also lowers gross domestic product by suppressing human capital accumulation and decreasing the supply of high-income skilled workers.4 This result emerges from an extension of the standard two-sector (agriculture and manufacturing) Fujita et al. (1999) economic geography model to allow unskilled individuals to endogenously choose whether to invest in education. Our framework shows that the distribution of world economic activity has important implications for incentives to acquire skills. We believe this effect of economic geography to be important and largely neglected in the existing literature.5

The paper reports three main theoretical results. First, we show that countries located further from global economic activity have a lower skill premium if manufactured goods are relatively skill intensive and face relatively large trade costs. The intuition for this result can be conveyed via the well-known Stolper–Samuelson theorem: increased remoteness has the same effect as a reduction in the relative price of the manufactured good. Because manufacturing is relatively skill intense, the relative wage of skilled workers—and the incentive to educate—falls.

Second, we demonstrate that this result is robust to more general assumptions regarding trade costs. In particular, because of input–output linkages and increasing returns to scale in manufacturing, remoteness reduces incentives to accumulate skill even if relative trade costs in manufacturing are lower.6 Input–output linkages are important because trade costs must be paid on both imported intermediates and exported output, with the result that even relatively small trade costs can be magnified into a large share of value added. Increasing returns to scale, on the other hand, mean that proximity to large as opposed to small markets becomes especially important. Firms that are remote from large markets have to charge a lower price net of trade costs in order to export sufficient quantity to cover fixed costs. As a result, the equilibrium skill premium depends upon both physical remoteness (i.e. bilateral trade costs) and economic remoteness (i.e. the spatial distribution of economic activity).

Third, we show how our model can be used to formalize the role of a number of other determinants of human capital investment, including agricultural productivity and technology. We demonstrate that higher agricultural productivity (or, more generally, an abundance of natural resources) hinders manufacturing development and reduces incentives to invest in human capital. We also show that a transfer of manufacturing technology from developed to developing countries not only raises output per capita directly but also has a positive indirect effect through induced human capital accumulation. In general, the indirect effect will not be internalized by private sector agents, and the existence of this pecuniary externality provides a potential rationale for policies designed to accelerate technology transfer.

While the main focus of the paper is theoretical, we exploit structural relationships from the model to provide empirical evidence that countries located far from centers of world economic activity are characterized by relatively low levels of educational attainment. We also provide evidence that the world's most peripheral countries are becoming relatively more remote from global economic activity over time.

The paper proceeds as follows. 2 Theoretical model: geography and skill acquisition, 3 Geography and skill deepening outline the theoretical model and explore the relationship between remoteness and equilibrium investments in skill. Section 4 extends the analysis to allow for a more general specification of trade costs. Section 5 examines the role of other determinants of human capital investments. 6 Empirical measurement of market and supplier access, 7 Empirical relationship between geography and human capital use the structure of the model to derive empirical measures of market access and examine the link between market access and educational attainment. Section 8 concludes.

Section snippets

Theoretical model: geography and skill acquisition

This paper builds upon existing theoretical research on new economic geography as synthesized in Fujita et al. (1999).7

Geography and skill deepening

The general equilibrium of the model combines consumer optimization, education optimization and producer optimization with the market clearing conditions to solve for equilibrium prices, equilibrium expenditures and the equilibrium location of production.

In this section, we use structural equations of the model to characterize the nature of the relationship between location and incentives to invest in skills that must hold in general equilibrium. We follow Redding and Venables (2001) in using

Equilibrium with trade costs in manufacturing and agriculture

To introduce agricultural trade costs in as tractable way as possible, we modify consumers' utility function slightly. Specifically, we assume that each country produces a single differentiated agricultural good.19

Other determinants of human capital investment

The discussion so far has emphasized the importance of geographical location for incentives to invest in human capital. In this section, we return to the baseline model of Sections 2 and 3, and examine the effects of changes in other parameters of the model which are related to potential determinants of human capital investment emphasized in the existing literature. To isolate the effects of these other variables, we consider the effect of parameter changes holding constant a country's market

Empirical measurement of market and supplier access

Using bilateral trade flow data compiled by Feenstra et al. (1997), we construct theoretically consistent measures of MA and SA for all countries at five-year intervals from 1970 to 1995 using , . To ensure that these measures are not driven by small countries that trade very little with the rest of the world, we restrict our sample to the 137 countries that trade with at least 5 partners.

From the trade equation (T), the model predicts that bilateral trade flows depend upon exporting country

Empirical relationship between geography and human capital

In this section, we check whether the human capital implications of the model are supported by the data. Consistent with the model, we provide evidence that educational attainment is higher in countries with greater market access. Data on educational attainment for a large cross-section of developed and developing countries in 1990 is available from Barro and Lee (2001). These data record the percent of each country's over-15 population that has attained secondary and tertiary education.24

Conclusion

We present a model which ties a country's human capital accumulation to its distance from global economic activity. If skill intensive sectors are relatively trade-cost intensive, feature more pervasive input–output linkages, or are characterized by stronger increasing returns to scale, relatively peripheral countries will experience a lower skill premium and reduced incentives to educate their workers. Consistent with the predictions of theory, we provide empirical evidence that countries with

Acknowledgements

We thank anonymous referees, Joshua Aizenman, Mary Amiti, Andrew Bernard, Sebastian Edwards, David Hummels, Jon Temple, Henry Thompson and Tony Venables for valuable comments. We are also grateful for feedback received during seminars at the EIIT9, the London School of Economics and the NBER IASE conference in Monterrey Mexico. Marco Schonborn and Martin Stewart provided able research assistance.

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