# **5 POLICIES FOR PLACES: INSTITUTIONAL QUALITY AND CONNECTIVITY**

Economic activity is not distributed evenly in a geographical sense: it has a natural tendency to agglomerate in particular places, and that process can be beneficial in terms of generating local spillovers (World Bank, 2009b). It is likely that trade liberalization reinforces that process, in particular for geographical areas that are relatively close to international markets (Crozet and Koenig, 2004). The analysis above, in which trade policy changes give rise to a migration decision, makes clear that there is the potential for people to move from one sector and location to another, which has direct implications for the dispersion of economic activity within countries. This also has implications for other labor market outcomes.

Evidence for Mexico confirms a strong geographical concentration of trade activity in Northern Mexico, driven by GVCs, close to the U.S. border. The export expansion between 2004 and 2014 affected labor markets in the North through higher total labor incomes and increased inward migration, while it affected municipalities in Mexico’s South through higher employment and reduced informality rates. The lack of effects through the employment channel in the North is partially explained by the increase in labor supply due to larger net migration compared to the South. The absence of the employment channel in the South may be explained by fewer job opportunities and lower labor demand. The informality rate could reflect worker preference for the benefits of being formal (such as contributions to pensions or retirements) over the prospect of higher incomes (Vazquez and Winkler, 2023).

On the one hand, an important part of the structural change process inherent in development is fostering increasing returns to scale and local spillovers. Agglomeration is therefore an important part of that effort, which explains why cities in low and middle-income countries have seen rapid growth over recent decades. This growth poses challenges but also opportunities, in particular in terms of job creation (World Bank, 2015). In this context, this section discusses the role of two key policies for places, namely (i) institutional quality to increase competitiveness and (ii) connectivity to facilitate movement of traded goods and services. While both facilitate the reallocation of resources – capital, and labor – towards export sectors of comparative advantage, thus creating more and higher-paid job opportunities, institutional quality has also been shown to shape comparative advantage directly and thus increase competitiveness.

At the same time, a development path that is too unbalanced between cities and the hinterland risks not only generating migration pressures that are difficult to manage, but also may be less than ideally inclusive from a social point of view. So in the context of reforming trade policies, it is important to think about how those changes will play out in terms of changes in economic activity, and employment rates and conditions, across different parts of the national territory.

## **5.1 Institutional Quality to Increase Competitiveness**

Institutional quality, which includes competition policy, contract enforcement mechanisms, and the protection of property rights with the aim of increasing market efficiency and investor confidence, shapes how countries engage in trade and GVCs in the first place. Several studies confirm the role of institutional quality for comparative advantage and thus export patterns (Acemoglu et al. 2007, Levchenko 2007, Nunn 2007, Costinot 2009, and Chor 2010). While a large part is determined by institutional quality at the country level, countries with stronger institutional quality have a comparative advantage not only in exports but also in GVC participation in contract-intensive sectors.

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