Spatial Market Integration

Abstract

Markets aggregate demand and supply across actors distributed in space. At the international level, monetary policy, exchange rate adjustment and the distribution of the gains from trade depend fundamentally on how well prices equilibrate across countries, as vast literatures on the law of one price and purchasing power parity emphasize (Froot and Rogoff 1995; Anderson and van Wincoop 2004). At the national level, well-functioning markets ensure that macro-level economic policies (for example, with respect to exchange rates, trade, and fiscal or monetary policy) change the incentives and constraints faced by micro-level decision-makers. Macroeconomic policy commonly becomes ineffective without strong market transmission across space of the signals sent by central governments. Similarly, well-functioning markets underpin growth stimuli originating in micro-level phenomena. For example, without good access to distant markets that can absorb excess local supply, firms’ adoption of improved production technologies will tend to cause producer prices to drop, erasing the gains from technological change and thereby dampening incentives for firms to adopt new technologies that can stimulate economic growth. Poorly integrated markets thereby choke off the prospective gains from technological change. Markets also play a fundamental role in managing risk associated with demand and supply shocks in that well-integrated markets facilitate adjustment in net export flows across space, thereby reducing price variability faced by consumers and producers. Finally, the spatial extent of markets has profound implications for antitrust policy (Stigler and Sherwin 1985).