Factor mobility and transport costs are the two key ingredients that set apart the New Economic Geography (neg) from more traditional trade theory. While the implications of factor mobility for trade and the spatial structure of the economy have been analyzed in depth, transport costs have been a more neglected topic. Most of the recent theoretical research in New Trade Theory (ntt) and neg indeed heavily relies on restrictive assumptions about transportation: transport costs are assumed to be incurred in the goods shipped (‘iceberg’), they are symmetric irrespective of the shipping direction, and they are independent of the spatial organization of the economy.
The most restrictive assumption is, however, that transport costs for goods are treated as being exogenenous parameters and not prices set by the interplay of supply and demand. Although this parametric treatment is a good starting point that has allowed to break new ground in the rigorous formalization of ‘old stories’ about trade patterns and agglomeration in the presence of spatial frictions, it leaves a good deal of those stories unexplained. How are transport costs set by the market? How do they react to changes in supply and demand? And how do changes in supply and demand ultimately feed back on transport costs, trade patterns, and the location of industry?
The study of these questions is not merely an academic exercise. Consider, for example, the growing imbalance in manufactures trade between China and the U.S., which has become an issue for the transport sector as it creates important logistics problems associated with the ‘empties’. About 60% of the containers shipped from Asia to North America in 2005 came back empty, and those “that did come back full were often transported at a steep discount for lack of demand [...] shipping companies charge an average of $1,400 to transport a 20-foot container from China to the United States. From the United States to China, the companies charge much less: $400 or $500.” A similar picture emerges for air freight as “airlines had become so eager to put something in their cargo holds on the inbound journey to China that rates go as low as 30 to 40 cents a kilogram, compared with $3 to $3.50 a kilogram leaving China.”
The foregoing figures strongly suggest that the growing imbalance in China–U.S. merchandise trade is increasingly reflected in transpacific freight rates and that those rates are becoming increasingly asymmetric. The key objective of this paper is to formalize these ideas by endogenizing transport costs through a market mechanism in a model of trade and geography. In our setting, competitive carriers supply transport services for shipping manufactures across regions, and freight rates the prices for transport services are determined to clear transport markets.
Carriers must commit to the maximum transport capacity required for a round-trip and, therefore, face a logistics problem: there is an opportunity cost associated with returning empty (‘backhaul problem’), and that opportunity cost depends on the shipping direction. For instance, when a container ship returns partly empty to its harbor of origin, that ship has a very low opportunity cost of transporting additional goods in that direction. Carriers are then enticed to undercut the price set by any fully loaded ship so that there is downward pressure on freight rates in the direction of excess supply of transport services. By symmetry, there is upward pressure on freight rates in the opposite direction.
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Transportation, freight rates, and economic geography
