Spatial Inequality, Geography and Economic Activity
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A Service of Leibniz-Informationszentrum econstor Wirtschaft Leibniz Information Centre Make Your Publications Visible. zbw for Economics Achten, Sandra; Leßmann, Christian Working Paper Spatial inequality, geography and economic activity CESifo Working Paper, No. 7547 Provided in Cooperation with: Ifo Institute – Leibniz Institute for Economic Research at the University of Munich Suggested Citation: Achten, Sandra; Leßmann, Christian (2019) : Spatial inequality, geography and economic activity, CESifo Working Paper, No. 7547, Center for Economic Studies and ifo Institute (CESifo), Munich This Version is available at: http://hdl.handle.net/10419/198907 Standard-Nutzungsbedingungen: Terms of use: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Documents in EconStor may be saved and copied for your Zwecken und zum Privatgebrauch gespeichert und kopiert werden. personal and scholarly purposes. 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Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, If the documents have been made available under an Open gelten abweichend von diesen Nutzungsbedingungen die in der dort Content Licence (especially Creative Commons Licences), you genannten Lizenz gewährten Nutzungsrechte. may exercise further usage rights as specified in the indicated licence. www.econstor.eu 7547 2019 March 2019 Spatial inequality, geography and economic activity Sandra Achten, Christian Lessmann Impressum: CESifo Working Papers ISSN 2364-1428 (electronic version) Publisher and distributor: Munich Society for the Promotion of Economic Research - CESifo GmbH The international platform of Ludwigs-Maximilians University’s Center for Economic Studies and the ifo Institute Poschingerstr. 5, 81679 Munich, Germany Telephone +49 (0)89 2180-2740, Telefax +49 (0)89 2180-17845, email [email protected] Editor: Clemens Fuest www.cesifo-group.org/wp An electronic version of the paper may be downloaded · from the SSRN website: www.SSRN.com · from the RePEc website: www.RePEc.org · from the CESifo website: www.CESifo-group.org/wp CESifo Working Paper No. 7547 Category 6: Fiscal Policy, Macroeconomics and Growth Spatial inequality, geography and economic activity Abstract We study the effect of spatial inequality on economic activity. Given that the relationship is highly simultaneous in nature, we use exogenous variation in geographic features to construct an instrument for spatial inequality, which is independent from any man-made factors. Inequality measures and instruments are calculated based on grid-level data for existing countries as well as for artificial countries. In the construction of the instrumental variable, we use both a parametric regression analysis as well as a random forest classification algorithm. Our IV regressions show a significant negative relationship between spatial inequality and economic activity. This result holds if we control for country-level averages of different geographic variables. Therefore, we conclude that geographic heterogeneity is an important determinant of economic activity. JEL-Codes: R120, O150. Keywords: regional inequality, spatial inequality, economic activity, development, geography, machine learning. Sandra Achten Christian Lessmann* Technische Universität Braunschweig Technische Universität Braunschweig Carl-Friedrich-Gauss-Faculty Carl-Friedrich-Gauss-Faculty Institute of Economics Institute of Economics Germany – 38106 Braunschweig Germany – 38106 Braunschweig [email protected] [email protected] *corresponding author This version: March 2019 This research was supported by the German Research Foundation (grant BL1502/1-1). We would like to thank the participants of the 8th ifo Dresden Workshop ‘Regional Economics’ for helpful comments. 1 Introduction This paper studies the relationship between spatial inequality and economic activity. Inequality is one of the main topics of research in economics and other social sciences, and researchers study different types of inequality. Vertical inequality describes inequality between persons or house- holds within a particular social group, e.g. within a country. In contrast, horizontal inequality is concerned with differences among individuals of different groups that may be based on race, gender, ethnicity or place of habitation (Stewart (2000), Stewart (2005)). Our analysis is con- cerned with the latter issue, i.e. the regional or spatial inequality between groups of individuals living in different regions. This particular type of inequality has been attracting increasing interest from academics, given that inequality between groups may cause serious problems in a society – from inefficient redistribution politics to separatist movements and internal conflict (Østby (2008), Lessmann (2016)). These threats are, of course, more pronounced in ethnically heterogeneous countries due to the coincidence of ethnic inequality and spatial inequality (Kanbur and Venables (2005), Alesina et al. (2016)). From a theoretical viewpoint, there are various channels through which different types of inequality may effect development and economic activity. In the literature on personal inequality, many authors stress the socio-political or the political instability channel (see Alesina and Rodrik (1994), Alesina and Perotti (1996), Perotti (1996), Benabou (2000) and Galor and Moav (2004) and Galor (2009) for an overview). Some of the arguments, particularly the redistribution channel or increased political instability, can easily be transferred into the context of spatial inequality. Redistribution policies are often accompanied by the higher taxes that are needed to finance equalization programs (Alesina and Rodrik (1994)). This may cause a decrease in the efficiency of factor allocation, which might ultimately harm overall economic development. Political stability often has a regional dimension not only in ethnically divided countries (one might think of the separatist movements in Catalonia) but also in relatively homogeneous countries like Great Britain, where lagging regions tend to vote for nationalist policies. This division harms economic integration and long-run development. In Great Britain, these movements fuelled the decision for Brexit, which might be very costly, with up to 2.6% of income losses as measured by the national GDP (Dhingra et al. (2016)). Andr´es Rodr´ıguez-Pose calls these effects the ”revenge of the places that don’t matter” (Rodr´ıguez-Pose (2018) p. 189). Therefore, regional inequality is of interest not only for reasons of equity but also for the development of an economy as a whole. Empirical research on this topic can be divided into two branches. The first branch examines the shape of the relationship between inequality and growth. Its origin is the hypothesis of Kuznets (1955), stating that the relationship has the shape of an inverted U. Williamson (1965) transfers Kuznets’ considerations to the case of regional inequality. The main argument is the following. At early stages of economic development, inequality increases with growth, since growth usually takes place in a particular region of a country, e.g. due to differences in factor endowments. In the progress of economic development, people migrate, wages adjust and redistribution takes place; therefore, inequality tends to decrease again. It is obvious that in this theory, there is a mutual 2 dependence between growth and inequality. Inequality affects economic outcomes and vice versa. Empirical studies find some evidence of an inverted U (Barrios and Strobl (2009), Lessmann (2014)) or even an N-shaped relationship with increasing inequality at very high levels of development (Amos (1988) and Lessmann and Seidel (2017)). However, the Kuznets hypothesis is ultimately a statement on a correlation between inequality and development. The existing empirical studies do not take the simultaneity of both variables into account. Therefore, they cannot make any statement on causality. Addressing this gap is the main point of the current analysis. The causality issue brings us to the second strand of the literature, which focuses on the question of whether there is a causal relationship between inequality and growth. Concerning vertical inequality, the results are quite ambiguous. Some empirical studies support an insignificant or even a positive impact of inequality on growth (Li and Zou (1998), Barro (2000), Forbes (2000)), whilst others find a negative relationship (Alesina and Rodrik (1994), Persson and Tabellini (1994)). Neves et al. (2016) conduct a meta-analysis on this relationship and find a negative effect of inequality on growth that is stronger in less developed countries and that weakens if regional dummies are included. Importantly, concerning our topic of spatial inequality, no serious attempt has been made to study a causal relationship. Alesina et al. (2016) investigate correlations between regional as well as ethnic inequalities and national development. Their regressions show that both types of inequality are significantly negatively related to national income. However, they do not go beyond presenting partial correlations in a cross-section