Transportation, freight rates, and economic geography

a r t i c l e i n f o We investigate the role of competitive transport markets in shaping the location of economic activity and the pattern of trade. In our model, carriers supply transport services for shipping manufactured goods, and freight rates are set to clear transport markets. Each carrier must commit to the maximum capacity for a round-trip and thus faces a logistics problem as there are opportunity costs of returning empty. These costs increase the freight rates charged to firms located in regions that are net exporters of manufactured goods. Since demand for transport services depends on the spatial distribution of economic activity, the concentration of production in one region raises freight rates to serve foreign markets from there, thus working against specialization and the agglomeration of firms. Consequently, a more even spatial distribution of firms and production prevails at equilibrium when freight rates are endogenously determined than when they are assumed to be exogenous as in the literature. Factor mobility and transport costs are the two key ingredients that set apart the New Economic Geography (NEG) from more traditional trade theory. While the implications of factor mobility for trade and the spatial structure of the economy have been analyzed in depth, transport costs have been a more neglected topic. Most of the recent theoretical research in New Trade Theory (NTT) and NEG indeed heavily relies on restrictive assumptions about transportation: transport costs are assumed to be incurred in the goods shipped ('iceberg'), they are symmetric irrespective of the shipping direction, and they are independent of the spatial organization of the economy. 1 The most restrictive assumption is, however, that transport costs for goods are treated as being exogenenous parameters and not prices set by the interplay of supply and demand. Although this parametric treatment is a good starting point that has allowed to break new ground in the rigorous formalization of 'old stories' about trade patterns and agglomeration in the presence of spatial frictions, it leaves a good deal of those stories unexplained. How are transport costs set by the market? How do they react to changes in supply and demand? And how do changes in supply and demand ultimately feedback on transport costs, trade patterns, and the location of industry? The study of these questions is not merely an academic exercise. Consider, for example, the growing imbalance in manufacture trade between China and …