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Trade liberalization and economic geography in transition countries: Can FDI explain the adjustment patterns of regional wages?

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  • Joze P. Damijan
  • Crt Kostevc

Abstract

Present paper studies the within-country regional effects of trade liberalization in transition countries. We argue that FDI inflows can be an important factor to accelerate the regional adjustment process in the home country. In order to underspin this theoretically, we first augment the new economic geography models by breaking the implied regional symmetry and by introducing capital as a second factor of production. Major contribution of our approach is that it allows for inter-regional as well as international capital mobility while labor is assumed to be immobile. Numerical simulations of our model indicate that this should contribute to faster convergence of relative regional wages in the smaller region. In addition, we examine the exact adjustment pattern of relative regional wages in five transition countries in the period 1990-2004 after they have liberalized their trade with the EU. First, we show that in four out of five transition countries there is a significant u-shaped adjustment pattern of regional wages after they opened up to foreign trade. And second, we find robust econometric confirmation that in three of the five countries FDI has contributed significantly to faster adjustment of relative regional wages.

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Bibliographic Info

Paper provided by LICOS - Centre for Institutions and Economic Performance, KU Leuven in its series LICOS Discussion Papers with number 22208.

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Date of creation: 2008
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Handle: RePEc:lic:licosd:22208

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Keywords: economic geography; trade costs; wages; transition countries; foreign direct investment;

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  1. Mion, Giordano, 2003. "Spatial Externalities and Empirical Analysis: The Case of Italy," ZEW Discussion Papers 03-38, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
  2. Puga, Diego, 1999. "The rise and fall of regional inequalities," European Economic Review, Elsevier, vol. 43(2), pages 303-334, February.
  3. Hanson, Gordon H., 1996. "Economic integration, intraindustry trade, and frontier regions," European Economic Review, Elsevier, vol. 40(3-5), pages 941-949, April.
  4. Gordon H. Hanson, 1998. "Market Potential, Increasing Returns, and Geographic Concentration," NBER Working Papers 6429, National Bureau of Economic Research, Inc.
  5. Hanson, Gordon H, 1997. "Increasing Returns, Trade and the Regional Structure of Wages," Economic Journal, Royal Economic Society, vol. 107(440), pages 113-33, January.
  6. Giordano Mion, 2004. "Spatial externalities and empirical analysis: the case of Italy," LSE Research Online Documents on Economics 42663, London School of Economics and Political Science, LSE Library.
  7. J. Peter Neary, 2000. "Of Hype and Hyperbolas - Introducing the new Economic Geography," Working Papers 200019, School Of Economics, University College Dublin.
  8. Krugman, Paul & Elizondo, Raul Livas, 1996. "Trade policy and the Third World metropolis," Journal of Development Economics, Elsevier, vol. 49(1), pages 137-150, April.
  9. Steven Brakman & Harry Garretsen & Marc Schramm, 2004. "The Spatial Distribution of Wages: Estimating the Helpman-Hanson Model for Germany," Journal of Regional Science, Wiley Blackwell, vol. 44(3), pages 437-466.
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