The financial market space and the front-lines of regional science − on the discussion about regional science initiated by Imre Lengyel

Abstract

The combination of financial and geographical-regional analyses is a new and promising trait in the literature of regional science and financial geography. The paper shows the two most important contradictory features of financial globalisation and its markets, namely its relativising effect on geographical distance, on the one hand, and the growing importance of spatial effects of financial markets and their agglomeration, on the other.

Ubiquitous electronic markets and the expansion of geographical borders to trading through stock exchange mergers may give the impression that geographical distance has lost its significance. However, this is not so by far. The paper highlights the role of information in forming financial space. Money markets can be thought of as a huge information processing system, in which not only the volume of information, but also its costs and quality as well as its spatial concentration are determining factors. The seemingly more easily accessible information has become one of the most important factors influencing the selection of financial locations and the formation of global financial centres (agglomerations).

The paper argues that, nevertheless, informational asymmetry increases by distance: To acquire high-quality information continues to be very expensive and it still requires a refined organisational background. The once dominant efficientmarket theory suggested that all information is freely available to all rational market players, and that this information is fully integrated into financial product pricing, and that financial products reflect all market information. However, this paper suggests that key information is really accessible only at the international financial centres. While technical infrastructure can be created almost anywhere, the social connectivity necessary for the acquisition and processing of high quality information as well as for the concomitant complex control functions can only be provided at global financial centres. The paper highlights the decisive role of geographical distance in accessing soft and confidential information and shows that, by the same token, from greater distances only hard and public information is accessible. One reason is that soft information is difficult to transfer. Therefore non-standardised information with tacit knowledge continues to be concentrated in a few centres. The more tacit knowledge a transaction requires, the closer to each other the partners will set up their headquarters. The value of the information generated there decreases by distance.

Today's IT networks have created ‘a virtual world without distances’, and in this virtual space, it is not evident where business partners are at any given moment. The paper demonstrates that even virtual space has its control centres, which are essentially the same as the control centres of traditional geographical space; there are continual interactions between digital and real spaces of financial markets, and the processes of ‘cyber space’ continue to be determined by the economic and social processes of real space. As a consequence, the control centres of virtual space are essentially the same as the centres of traditional space.

The paper reflects Krugman’s theory of a new economic geography which focuses on the agglomeration and concentration processes of the world economy. The paper indicates some shortcomings of the theory: Krugman’s investigations focused mainly on industrial, innovation-driven spaces, while an investigation into financial markets was basically neglected. Krugman’s model failed to give an answer to a series of questions related to the spatial concentration of financial markets, including the problem of convergence, centre–periphery changes as well as related questions about the formation of financial centres.

In contrast, the author relies on the theorems of financial geography involving a more complex approach. It explains the concentrations and strong home bias of a financial space by means of information asymmetry and the difficulties in treating the agent problem, which grow with distance. The discussion includes the spatial dimensions of portfolio theory. Financial geography explains spatial differences of markets not only in terms of differing returns, risks and costs maps of global investment opportunities but, in addition, it deals with markets integrating the flow of simultaneous information.

The paper suggests that neither finances nor production can be concentrated only in a few centres. The increasing 'diseconomies of scale' caused by hypertrophying agglomeration are partly due to rising factor costs and the risk-weighted returns on assets. Countervailing trends are geographical dispersion and fragmentation of activities. However, the fragmentation involved in the trans-nationalisation of financial activities does not affect the controlling-power positions of traditional centres; on the contrary, it fosters further concentration of control functions and of financial highquality information and innovation.

The paper closes with an inverted-U model which can be applied to financial markets. It helps to explain both concentration and de-concentration processes that become apparent during the various stages of market development.