Examining the growth of cities Roles of history, geography, and policy Somik V. Lall Development Research Group, The World Bank January 10, 2005

Background High degree of spatial concentration Differentials in economic performance across cities within a country Can policy offset the effects of unkind geography and history? Focus on micro foundations – behavior of firms and households Research on Brazil, India, Indonesia and Mexico

Spatial concentration of economic activity – some stylized facts Economic activity is inherently spatially concentrated Many cities have zero employment in any given industry and most have next to zero A few cities tend to account for most national employment in any given industry For many of these industries, their agglomerations are found in cities highly specialized in just that one activity, or set of closely related activities

location of economic activity across cities Some goods such as retail and personal services have extremely high transport/transaction costs. They are found in the same proportions in every city and are effectively non-traded across cities At the other extreme are standardized manufacturing activities, which cluster together to exploit localization economies. Manufacturing activities such as textiles, chemicals, primary metals, transport equipment (autos, rail equipment and aircraft), wood products, petroleum products, and computing are highly concentrated

Spatial Distribution of Indian Industry

INDIA Electronics and computers industry

INDIA Leather industry

Post Liberalization Investment Flows in India Source: Lall and Chakravorty, 2004

Employment rank: 1 Gini of employment: 0.91 INDONESIA: Manufacturing employment distribution Each dot represents 500 employees

Employment rank: 4 Gini of employment: 0.93 Manufacturing employment distribution Each dot represents 500 employees

Employment rank: 3 Gini of employment: 0.71 Manufacturing employment distribution Each dot represents 500 employees

Nondurables Garments and Textiles Leather Wood Products Brazil

Metals Mechanical Machinery Electrical and Electronics Transport Equipment

Factors influencing firm location across cities

Determinants of firm location Natural advantage & historical context (“first nature geographies”) Factor markets – e.g., labor, land, capital Productivity enhancing agglomeration economies (“second nature geographies”) Some of these can be influenced by government actions

Sources of agglomeration economies Localization economies: benefits from own- industry concentration Inter-industry linkages: benefits from co- locating complementary sectors (buyer/supplier networks) Urbanization economies: benefits from economic diversity and for activities where face to face communication is critical Self-reinforcing – until negative externalities dominate (e.g., congestion costs)

Public infrastructure can reinforce benefits from agglomeration economies Transport increases variety and density of interactions and thus effective size of agglomeration increases range and scale – market size (similar to lowering tariff barriers) Power, serviced land, etc. Differentiated effects by industrial sector

Results from India  Initial endowments in terms of economic activity (Lall and Mengistae, 2004a; Lall and Chakravorty 2004)  Access to domestic and international consumer markets (Lall, Deichmann and Shalizi, 2004)  Infrastructure and regulation (Lall, Deichmann and Shalizi, 2004)  Availability of specialized inputs ( Lall and Chakravorty 2004)  Social Structure – hometown effect (Lall and Mengistae, 2004b)  Differences in institutions and governance structures  Provision of basic services and amenities

Lower transport costs or improvement in access to markets are associated with reductions in firm level costs. –This means that firms located in areas with relatively better market access (measured as the equivalent paved road distance to São Paulo) tend to have lower costs compared to similar firms in that industry. In comparison, agglomeration economies have very small impacts on firm level costs Results from Brazil

Own industry concentration (localization economies) is most important in most sectors Proximity to suppliers is important for several sectors (e.g., food & beverage, garments, chemicals) Urbanization economies matter for only a few sectors such as garments and leather products (unlike in services where face to face is critical) Results from Indonesia Agglomeration economies

Output markets External – Proximity to ports is important for export oriented sectors (e.g. garments, wood and paper products) Internal – Road density is statistically important for seven industry sectors; considerable variance among sector in sensitivity to transport

Factor markets Labor – Indonesian manufacturing is sensitive to labor costs. Labor cost measured as non agricultural head of household wage rates (from SUSENAS) Statistically significant (negative) effects for nine industry sectors Consistent with results for standardized manufacturing where firms shop for cheap labor – current stage of low value added manufacturing, labor costs dominate productivity

Policy, geography, history New investment favors existing agglomerations – history matters Growth of economic activity is higher in cities with access to external and internal output markets – geography matters What can policy do to influence the dispersion of economic activity to smaller cities/ urban areas?

Example – transport policy Reductions in transport costs and other barriers to trade can reduce the cost penalty borne by remote cities and regions. Secondary cities, if accessible by transport and modern communications, offer lower wage and rent costs, improved congestion and environmental conditions. However, transport access -- eliminating natural tariff barriers -- for interior cities will eliminate interior markets for certain products, where interior producers become non-competitive with coastal or international producers

Potential growth strategies for secondary cities Traditional analysis would suggest that large cities can decongest and growth be diverted to secondary cities with adequate investments in infrastructure and improving local regulatory climate Agglomeration effects show that firms prefer to be near similar firms and are unlikely to relocate due to considerable benefits from localization economies In this case, strategies for secondary city growth include not competing in standardized industries that have already concentrated in primary cities – this may be futile and fiscally imprudent Strengthen institutions and investing in amenities are likely to attract skilled professionals which would lead to additional new investment