Transport Investment, Geography, and Growth

A substantial part of the economic growth literature suggests that historically, geographic features such as decreasing trade costs have improved not only output but also growth. However, this literature lacks an analytical motivation for lower trade barriers, and assumes their decrease to obtain exogenously and at no cost. This paper attempts to address the issue by investigating how endogenous investment in transport infrastructure may affect growth. For that purpose, I propose a way to integrate transport investment in the problem of the typical manufacturing firm in a New Economic Geography model consisting of two regions. The model implies that the relation between geography and growth depends crucially on population dispersion: Regions with low population density abstain from investment in transport infrastructure, which locks their growth path in an ’isolation trap’. For intermediate population density, regions will invest to improve trade freeness, but lose out on growth in order to sustain their transport capital. Finally, for high values of population density, the endogenous construction of transport infrastructure will incite firms to cluster in one region and thus boost growth due to localized knowledge spillovers. JEL codes: F43, F12, N70, O41