_1. INTRODUCTION_

# **1 Introduction**

The Belt and Road Initiative (BRI) is an effort to improve regional cooperation and connectivity on a trans-continental scale. The initiative aims to strengthen infrastructure, trade, and investment links between China and 70 other economies. It consists primarily of the Silk Road Economic Belt, linking China to Central and South Asia and onward to Europe, and the New Maritime Silk Road, linking China to the nations of South East Asia, the Gulf Countries, North Africa, and on to Europe. Trade and transport costs are envisaged to reduce through a mix of "hard" and "soft" projects, including rehabilitation of major transport corridors and building missing links in the network across Africa, Asia, Europe and the Middle East, alongside policy, institutional and governance reforms to facilitate trade. By promoting trade across countries with thick borders, especially in places that have been physically and economically distant from global markets, large transport investments can improve welfare, but it also creates internal challenges for countries participating in the projects. Because of transport costs and labor mobility frictions within countries, not all regions and workers will evenly benefit from a better integration with global markets. Workers move towards better opportunities, benefiting the regions that can offer better amenities and higher wages. Labor mobility frictions prevent workers to equally benefit from these new opportunities, with some having a better access to new economic gains than others.

In this paper, we develop a quantitative economic geography model to examine how regions within countries adjust to trade and transport shocks. Policymakers understand the salience of within country regional adjustments very well as achieving spatial equity in development outcomes is an important barometer of political success. However, insights from New Economic Geography predict that, other things equal, regions with inherently less costly access to foreign markets, such as border or port regions, stand to reap the largest gains from trade liberalization. Improvements in connectivity are likely to be associated with more spatial concentration, not dispersion of economic activity within countries.<sup>12</sup> In the absence of mechanisms to compensate places that face "net economic losses" from connectivity improvements, policymakers are likely to see considerable risks in supporting initiatives that exacerbate spatial inequalities and pose fiscal burdens as some sub-national regions may simply see trucks and rail wagons pass by whilst having to service the debt associated with infrastructure investments.

Our focus on spatial adjustment to BRI induced trade and transport effects complements other recent papers that examine how BRI related shocks affect distribution of firms and sectors

> 1See survey paper by Brulhart (2011); World Bank (2008); Hanson (1998); Fajgelbaum and Redding (2018) 2Standard economic analysis is based on diminishing returns, the more of an activity is undertaken, the lower is the value of doing still more. Applying this in a spatial context yields the prediction that economic activity will be smeared smoothly across space, a prediction contradicted by the existence of large cities. From a spatial perspective, this thinking needs to be revised as proximity is valuable and where economic activity clusters and is unevenly distributed across space. There are two drivers: (1) direct efficiency saving of being close together (savings in transport and communication costs, and economies of scale arise as firms and infrastructure operate at scale); and (2) agglomeration economies that are generated by close and intense economic interaction.

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