External economic integration is often argued to be an important driver of economic development, as it raises income through specialisation in comparative-advantage sectors, provides low-cost access to imported goods, and shapes the pattern of structural transformation from agricultural into non-agricultural activities. These relationships are typically examined at the aggregate level, implicitly treating each country as a point in space. In reality, however, countries differ substantially in terms of their internal geography, and internal trade costs hamper the ability of interior regions to participate in world markets. How important is geographic heterogeneity within countries for the aggregate impact of external integration?
In policy circles, the role of domestic infrastructure in enabling countries to participate in world markets has received renewed attention, and a growing body of evidence suggests that internal trade costs can be large.1 Yet, there is relatively little quantitative evidence on the role of internal trade costs in shaping the effects of external integration on the pattern of economic development and welfare within countries.
Integration into world markets: The case of Argentina
In our research, we make use of the natural experiment provided by Argentina's integration into world markets in the late 19th century (Fajgelbaum and Redding 2014). This large-scale increase in external integration was driven by a cluster of related technological innovations that reduced international transport costs. Increases in the size of ships and the spread of steam navigation made it profitable to ship wheat, corn, and other cereals from Argentina to European markets. New technologies, such as meat refrigeration – first invented in Australia in the 1860s to serve British colonial markets – made it possible for the first time to trade frozen and chilled meat from Argentina to Europe. These reductions in external transport costs propelled an export boom and an ‘agricultural revolution on the pampas,’ as Argentina's traditional production of animal hides, salted meat, and wool was progressively replaced by specialisation in the new comparative-advantage products of cereals and frozen and chilled beef. This increase in external trading opportunities stimulated an expansion of the railroad network to connect the agricultural hinterland with ports such as Buenos Aires, mass immigration that enlarged the labour force, and increased imports of manufacturing goods.
We combine historical censuses, official trade statistics, and railway records, among other sources, to assemble a new dataset on rural and urban employment, specialisation patterns across agricultural goods, and railway shipments of these goods for 386 Argentinian districts from 1869-1914. To study these data, we develop a tractable general equilibrium model that determines the distribution of economic activity across regions and structural change across sectors which is sufficiently tractable as to be amenable for quantitative analysis.
One of the key predictions of our analysis is a spatial Balassa-Samuelson effect, according to which locations with low trade costs to international markets, such as regions close to ports or railway lines, have a high relative price in the nontraded sector and high land rents relative to wages. These differences in relative prices govern the pattern of economic development. As long as traded and nontraded goods are complements in final consumption, the high relative price of nontraded activities in well-connected locations drives large shares of employment in the non-traded sector. In turn, because labour is cheap relative to land and sectorial specialisation is biased toward the labour-intensive nontraded activities, output in well-connected locations is produced with labour-intensive techniques, leading to high labour density. Thus, the model offers a unifying rationale for patterns of spatial development within countries observed in the historical Argentinian data and today in developing countries – proximity to trade hubs is associated with high employment density, high land rents relative to wages, and structural transformation away from agriculture.
We find strong empirical confirmation of the spatial Balassa-Samuelson effect in both the cross-section and time-series. At the beginning of our sample period, population density and the urban population share are both sharply decreasing in measures of geographical remoteness from world markets. Over time, despite the fall in internal trade costs from the construction of the railroad network, there is a steepening of the gradients of both population density (see Maps 1-3 below) and the urban population share with respect to remoteness.
Map 1. Population density 1869
Map 2. Population density 1896
Map 3. Population density 1914
We link the steepening of the spatial gradient of economic activity to geographically uneven investments in transport infrastructure and technology adoption that were concentrated in locations close to world markets. Thus, our analysis points towards the role of these complementary internal investments in mediating the economy's response to external integration.
Pablo Fajgelbaum, P and S J Redding (2014), "External Integration, Structural Transformation and Economic Development: Evidence from Argentina 1870-1914", NBER Working Paper No. 20217.
Inter-American Development Bank (2013), Too Far To Export: Domestic Transport Costs and Regional Export Disparities in Latin America and the Caribbean, Washington DC: IADB.
United Nations Economic and Social Council and United Nations Economic Commission for Africa (2009), The Transport Situation in Africa, Addis Ababa: Ethiopia, Sixth Session of the Committee on Trade, Regional Cooperation and Integration.
World Bank (2009), World Development Report: Reshaping Economic Geography, Washington DC: World Bank.
World Trade Organization (2004), World Trade Report: Exploring the Linkage Between the Domestic Policy Environment and International Trade, Geneva: World Trade Organization.
1 See, for example Inter-American Development Bank (2013), United Nations (2009), World Bank (2009), and World Trade Organization (2004).