Trade Costs and Income in European Regions

Using a New Economic Geography (NEG) model, this study estimates the relationship between regional per capita income levels and the proximity of regions to large markets. Market access cannot be observed directly, so it has to be constructed. We follow a two-step-procedure of Redding and Venables (2004) and use results of a spatially-filtered gravity model to infer market access. To this end, we make use of a new dataset of constructed bi-regional trade flows between (and within) 240 European NUTS-2 regions (from 25 European countries excluding Bulgaria, Croatia and Romania) for the year 2010 (Thissen et al. 2014, IPTS). In a second step we test the hypothesis that access to large markets increases factor incomes. We find robust evidence that supports this hypothesis on a regional level. Controlling for a variety of factors that drive income differences, our findings highlight the robustness of the role of market access in explaining the uneven spatial distribution of income.