Urban Agglomeration: More Growth, More Benefits

Can urban areas grow too much? The answer is subject to people’s lifestyle preference, based on where they want to live and what tradeoffs in time and money they’ll accept. But according to one theory, the answer, economically speaking, is no. The bigger an area gets in space and population, the more that businesses and people increase their productivity. The name of the theory is “economies of agglomeration”, or for this column’s purposes, “urban agglomeration.”

Economist Edward Glaeser, a proponent of the theory, defines urban agglomeration as “the benefits that come when firms and people locate near one another together in cities and industrial clusters.” Similar to network effects and economies of scale, agglomerations develop through proximity. Continues Glaeser:

The only real difference between a nearby firm and one across the continent is that it is easier to connect with a neighbor. Of course, transportation costs must be interpreted broadly, and they include the difficulties in exchanging goods, people, and ideas. The connection between agglomeration economies and transport costs would seem to suggest that agglomerations should become less important, as transportation and communication costs have fallen. Yet, a central paradox of our time is that in cities, industrial agglomerations remain remarkably vital, despite ever easier movement of goods and knowledge across space.

Agglomerations happen, adds Chuanglin Fang, an urban planner for the Chinese Academy of Sciences, “when the relationships among cities shift from mainly competition to both competition and cooperation.”

That is to say, it happens when separate urban areas have enough outward growth and collaboration that they become part of the same region. Or it occurs through further growth within a given metropolitan area. The agglomeration in either case provides four benefits, writes Nicolae Sfetcu, of the consulting blog Setthings.com.

1. It lowers transportation costs, since local supply chains are closer to each other.
2. It develops local markets, by bringing a larger customer base into an area.
3. It gathers a labor force that is larger, more specialized, and easier to access.
4. It creates knowledge spillovers between firms, sparking ideas and innovation.

Here are microeconomic examples of how agglomerations work: fast food chains locate (as Americans have probably noticed) near each other. People who like McDonalds also likely enjoy Burger King and Wendy’s, and by clustering, the chains benefit from each other’s customers. Or a tech startup locates in Silicon Valley to access educated workers and advanced machinery, which is already there thanks to existing tech firms. Or a poor rural migrant emigrates to an urban area to find a menial job, and after working awhile, develops more advanced skills due to tutoring from her co-workers. At macroeconomic level, urban agglomerations infuse whole regions or countries with this economic complexity, in ways that benefit everybody.

“The effect of a city’s population on wages is highly significant and large in magnitude,” writes economist Harry Krashinsky. “Various studies have demonstrated that doubling the population of an individual’s city would cause wages to rise by three to seven percent, and moving from a city of less than 500,000 people to one with more than half-a-million residents would increase wages by over 20 percent.”

The downside of urban agglomerations is that they can be victims of their own success. The population increase inflates housing costs (perhaps offsetting the higher wages); creates congestion (perhaps offsetting the proximity advantages); and leads to the growth of large, unaccountable governments. Some economists think urban regions become less productive once growing above a certain population.

Some of the world’s largest agglomerations include places like Jakarta and Manila, perhaps validating that point. In America, our agglomerations aren’t as intense, and vary in size. For example, metro Charleston, WV (pop. 211,000) is one place not in full agglomeration mode; it’s hemmed in by mountains, reliant on the state government, and does not intensively partner with nearby rival metros like Pittsburgh and Columbus.

The Big Four metros in Texas – Houston, Dallas, Austin and San Antonio – may have once viewed each other as rivals. But they’ve now nearly grown into each other, and are now thought of as the “Texas Triangle” megaregion. When a big corporation moves to Dallas, it doesn’t hurt the other three metros; they too attract many corporations, which is partly a spillover result of Dallas’ growth. By contrast, Oklahoma City, which is 200 miles north of Dallas, still views itself as a competitor to the Texas Triangle. It would not be surprising, though, if a decade from now, the further growth of both areas causes them to merge, creating an informal Texas-Oklahoma megaregion.

America’s more long-standing agglomerations – New York City, Southern California, The Bay Area, Washington-Baltimore-Northern Virginia – have larger economic output than others nationwide. But they are also where the disadvantages are clearer, as they have higher home prices and more congestion. Much of my work is dedicated to figuring out how they can continue to grow while mitigating these problems. It will mostly involve letting markets work, so that housing supply meets population growth, and transport infrastructure uses price mechanisms to manage congestion and increase capacity.

But either way, these urban agglomerations are crucial. They may be sprawling, congested, and somewhat ugly. But they drive our economy and create opportunity. Their further growth should be encouraged.