The Benefits of Transportation Infrastructure More Market Integration

by | Aug 20, 2013 | Uncategorized

“Between 2007 and 2013 alone, the Trans-European Transport Network programme funded 348 projects at a cost of €7billion (TEN-T Executive Agency 2013). The goal of this investment has been to increase the integration of European markets.”1

What are the benefits of transportation infrastructure? Increased market integration and lower transportation costs is how recent investments have been justified. This article takes a historical perspective. The benefits identified and tested are for the British Industrial Revolution. The turnpike road network 1760s, canal network 1790s and railway network 1840s changed the way business was done. The benefits highlighted are:

  1. More integrated markets lead to lower transportation costs;
  2. Prices in different locations converge; and,
  3. Price changes in different locations are correlated, are of similar size and take the same time to happen.

The problem comes in disentangling the benefits of the transportation infrastructure from the spread of technologies that speed information transfer and from other disruptive market forces (such as a war or financial crisis).

Market Integration

“What exactly do we mean by market integration? How should we measure it? To what extent did transport have a significant impact on market integration? Answering these questions is not as straightforward as one might suppose.” The first benefit identified is that better transportation infrastructure leads to lower transportation costs. Lower costs mean that prices in different locations should be converge over time. This is the Law of One Price:

“a Fiat car should cost the same in the north of Scotland as it does in southern Italy, after adjusting for taxes. In reality, price differences will never be totally eliminated owing to transport costs; but lower transport costs – resulting from improved infrastructure – may compress price dispersion across Europe, for a given product. If it cost less to move Fiat cars to Scotland then the Scottish price would fall closer to the Italian price.”2

The second manifestation of market integration and benefit of transportation infrastructure is that price changes in different locations move together, are of similar size and take the same time to happen. The main effect of improved transport identified in the paper was to make price shocks more similar in size.

“When a price shock hits one market — where a shock could be the arrival of new information, such as a change in government policy, or a real shock, such as a crop failure – then it will be transmitted to neighbouring markets. If transmission is fast then we say that markets are integrated.”3

Why is this a benefit? The paper argues that it is a form of insurance:

“So falling transport costs (from infinity to zero) generate price shocks of increasingly similar magnitudes in different markets. This benefits consumers because it is a form of co-insurance: consumers lose more utility when prices rise very high than they gain when prices fall very low. So consumers benefit when trade is sufficiently low cost that shocks are spread more evenly across markets.”

What is What?

Deciding what effect is due to what is tough. Disentangling the benefits of mart integration effect from better information transmission and other market disruptions is difficult, in the case of the Industrial Revolution:

“the increase in the correlation of shocks over time in England was due to faster information transmission, rather than improved transport. It was stimulated by the spread of newspapers.” “What all this shows is that market integration was indeed increasing during the Industrial Revolution: shocks were becoming more highly correlated across markets; shock sizes were more similar; and adjustment speeds (half-lives) were shorter. This raised welfare by lowering the real cost of doing business (physically moving goods) and by improving risk-sharing for consumers. But these improvements were completely masked by the increased turbulence of the wartime economy between 1793 and 1815.”

And this is likely the case today too:

“it seems highly likely that the positive benefits of improved transport will have been masked by the disruptive impact of increased market turbulence since the financial crisis.”

Bumps in the Road

The conclusion, as with most attempts to dissect micro-economic benefits from macro-economic data, is rather disappointing:

“Improved transport may well have increased the speed of adjustment between markets, made shocks of more similar size and increased the correlation of shocks. These are all benefits to firms and consumers. Thus it may pay us to look at the data a little more carefully before deciding whether there might be further benefit from another round of infrastructure improvement.”

Making the business case for infrastructure is tough. I don’t think that one shouldn’t try, but expect some bumps on the transportation infrastructure road.

1 All quotes are from: “Transport infrastructure and market integration: Lessons from the British industrial revolution” source URL: http://www.voxeu.org/article/transport-infrastructure-and-market-integration-lessons-british-industrial-revolution

2 In statistical terms this means that the standard deviation of the cross section of prices falls.

3 Again in statistical terms market integration is measured using cointegration analysis (i.e. estimating an Error Correction Model for pairs of cities.

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