A smaller world?

Technology may have brought people and markets closer together, but distance and location still influence economic performance.
The growth of the information superhighway and the widespread use of advanced transport technology have led some to postulate that we are now witnessing what could be called the “end of geography,” and the “death of distance”.
Proponents point out that the world has become “flatter” and globalisation has blurred the favourable trade links that have always existed between close neighbours since the beginning of commerce itself.Not quite, says a recent OECD study, entitled “Economic Geography and GDP per Capita”. By analysing transport costs and the advantages accrued from proximity to markets, it shows that geographic factors still limit trade and can even lead to relatively lower living standards and growth.In fact, two principle factors in economic geography–closeness to dense economic activity and natural resource endowment–could go some way to explaining the variation in wealth across OECD economies. High-income countries cluster together, reaping mutual benefit, while natural resources tend to be associated with higher national incomes–although the latter is not always true for developing countries. Despite popular conceptions that technology is shrinking the world, place and distance can still be formidable hurdles to jump.Behind the “death of distance” hypothesis is the assumption that technological advances in transportation and communications have reduced the cost of moving products and information over long distances. Globalisation has created an inter-connected world and distance now plays a less constraining role for business, according to the theory.But with transport costs amounting to almost 20% of the total cost of a product (and rising!), distance throws sand in the wheels of trade in much the same way as a tax on exports or a tariff on imports. Distance also affects business efficiency. To be sure, there have been improvements in helping goods get from A to B. Transport systems have all benefitted from information technology. Logistics, satellite assisted shipping, inventory management: IT has helped manage all of these. Containerisation–the usage of universal cargo containers that can be transferred between ships, trains, planes and trucks–has boosted efficiency in maritime shipping while better jet engine technology has done the same for air transportation.The road-haulage industry has also seen improved equipment, with lighter trucks, more efficient engines and so on. Has this translated into decreased costs? Simple statistics on transport costs suggest that reports of the death of distance have been greatly exaggerated. Despite containerisation, maritime transport costs actually rose relative to the price of manufactured goods on all major routes from the mid-1970s to the mid-1990s, after which they eased back on many routes. Air transport costs on the other hand have remained broadly constant in real terms, while road transport costs have significantly increased. International transport costs the same, or more, than it did thirty years ago.The only area where distance seems to have really imploded is in international communications. A downward trend in the cost of a one minute international telephone call started in the 1980s, falling to its present rate of basically zero. This has facilitated recent innovations in financial services for instance, as well as outsourcing of call centres to countries in Africa, or business consulting to India. Regardless, this has not altered the main finding that there is little evidence that the cost of transporting goods has declined relative to their price during the past two or three decades.Furthermore, empirical evidence indicates that a 10% increase in distance still reduces trade by around 10%–the same rate as thirty years ago. With transport costs actually rising, it is not surprising that distance still poses the same impediments to business as in the 1970s and remains a main determinant of international trade patterns. Countries still by and large concentrate on trade with their neighbours, and trade less with distant partners.On the other hand, proximity to markets can have a positive effect on economic performance. Europe apart, OECD countries are generally spread out in their geographical locations and vary widely in their natural resource endowments. In its report, the OECD focused on 21 countries between 1970 and 2004, and found that access to markets has a significant impact on GDP per capita. Peripheral countries are left out from the advantages of closeness–exploitation of economies of scale, competitive pressures and greater specialisation.

For larger graph, see paper edition

According to the OECD study, two successful economies, Australia and New Zealand, appear to suffer from remoteness, with a reduction of GDP capita by as much as 10% relative to the OECD average. Belgium and Netherlands, smack in the middle of a cluster of European economies, might gain from their position by as much as 6% of GDP. To a lesser extent Greece, Portugal and Finland are also at a relative disadvantage.Economic geography may also determine differences in GDP per capita within countries. Regional economists have long stressed the importance of location in defining why certain regions in overall rich countries lack growth. Most of the OECD’s major economies suffer from some regional deficiencies with greatly varying levels of poverty, industry and growth in between regions. Some lags can be overcome by building better roads, for instance, though these can accelerate flows of labour and capital to the rich centres too. Much like rich countries, regions too tend to cluster, benefiting from the advantages of agglomeration.As for the other important factors in economic geography, findings show that OECD countries that are richly endowed with natural resources tend to have a higher GDP. This could be either renewable resources, such as fish and timber, non-renewables such as oil, or amenities that attract tourism. Rich natural resources may raise GDP per capita relative to the OECD average by as much as 8% in Norway with its oil and gas reserves and by around 2% in ore and mineral-rich Australia. Then what about countries such as Nigeria, oil-rich but with a desperately poor population? Economic development literature refers to the “resource curse,” where developing countries are not able to translate natural wealth into higher per capita GDP. This, the report suggests, is where governance comes in, since abundant natural wealth can lead to policies that reflect complacency and exuberance, or the wishes of stubborn lobbies, even corruption. In poor countries with weak institutional structures, it is easy to see how this curse can become a veritable barrier to development.Policymakers must still treat economic geography as a reality and compare economic performance across countries accordingly. The report “Economic Geography and GDP per Capita” is in fact part of the larger OECD study entitled Going for Growth, an evaluation of progress made in implementing reforms to improve living standards, and a set of recommendations of ways to make economies more productive. It concludes that for the time being, governments should not use their geographic advantages and disadvantages to justify inappropriate policy measures. If distance is a problem, policymakers should do their best to ensure that regulations do not keep transport costs at a further prohibitive level or add to other costs imposed by economic geography.  IM
References
  • OECD (2008), Going for Growth: Economic Policy Reforms–Structural policy, Indicators, Priorities and Analysis, Paris
©OECD Observer No 268 June 2008


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