Essays on Spatial Economics

Abstract

This thesis comprises three chapters, each studying optimal policy in a model of spatial economics. The first chapter considers the policy problem of a country looking to influence the geopolitical actions of another country. The second chapter considers how a central government should design place-based transfers to fight local recessions. And the third chapter considers how granularity affects the geography of economic activity and what that might mean for optimal place-based policy.

In the first chapter (joint with John Sturm Becko), we suppose a country anticipates that it may use trade as a point of leverage in future geopolitical conflicts. How should it develop domestic industries and international trading relationships today in order to strengthen its hand tomorrow? Domestically, we show that the country should abstain from peacetime industrial policies if it can credibly threaten trade taxes as geopolitical punishments during conflict, but not otherwise. Internationally, its peacetime trade policy should promote the accumulation of foreign capital that makes foreign prices---not foreign welfare---more sensitive to trade during conflict. We apply these insights to provide the first quantitative exploration of the US's optimal policies for building geopolitical power vis-à-vis China. The optimal policy promotes US-China trade on both the import and export margins.

In the second chapter, I note that many regions in the US experience depressed labor demand and high unemployment, even when the rest of the United States does not. How should the US government respond? In this chapter, I characterize optimal place-based transfers in a dynamic economic geography model with nominal wage rigidity and compare them to observed government transfers. I show that transfers not only have a stimulus effect—by boosting local demand—but also a migration effect—by encouraging local residents to stay. Analytically, I provide optimal transfer formulas that capture this trade-off and show, perhaps surprisingly, that the optimal transfer to a distressed region may be a tax due to the migration effect. All else equal, transfers should be larger in the short-run and when there are distressed regions nearby. Quantitatively, I find that observed transfers are both too small in the short-run and too large in the medium-run, achieving just over half of the gains from the fully optimal response to idiosyncratic local shocks. I conclude by exploring how the US government could have responded to the China trade shock in the 2000s.

In the third chapter (joint with Shinnosuke Kikuchi), we ask how does the fact that individual firms dominate labor markets affect the geography of economic activity? And what does it mean for the efficiency of firm entry? To answer these questions, we propose a new economic geography model featuring granular firms subject to idiosyncratic shocks. We show that average wages increase in the size of the local labor market due to that granularity, and provide a sufficient statistic for the contribution of our mechanism. We further prove that too few firms enter in equilibrium. Using Japanese administrative data on manufacturing, we provide evidence consistent with our mechanism and quantify it. Our mechanism implies that markets with around 2 firms per sector have an elasticity of wages to population of 0.05 and firms capture only 85% of their contribution to production in profits. In large markets like Tokyo, the elasticity is around 0.001, and firm entry is approximately efficient. Enacting optimal place-based industrial policy would increase the number of firms in modest-sized cities by more than 30% and actually decrease the number of firms and people in Tokyo. JEL Codes: F1, E3, R1.