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Fridays Academy: Urbanization and Growth

Ignacio Hernandez's picture

Megacities and Urban Agglomeration

Dramatic decreases in costs of transport, communication and information technology should have reduced spatial disparities in economic activities and moved us to a ‘global village’.  Yet, we find that in both industrial and developing countries, economic activities are concentrated in a few centers and there are regional disparities.  For example, about 15 percent of world population live in temperate zones but produce 50 percent of world GDP.  In United States, counties that take up 2 percent of the land area produce more than half of U.S. GDP. Similarly, poverty is concentrated in a few pockets in many countries.  It was Krugman (1991) who deduced that agglomeration economies accrue at plant level and hence firms are located in a single area nearer to consumer demand in urban areas with large populations and minimal transport costs.  In other words, location of economic activity matters and a tiny (initial) difference may soon lead to a concentration of economic activity around a center and ultimately to a formation of industry cluster in the same space.  Agglomeration economies accrue at plant level, industry level or city and regional level.

Successful cities are centers of entrepreneurship and innovation that attract talented and skilled workers and foster greater productivity and growth. However, as cities grow bigger and develop into mega cities—those with more than 10 million people - they can also develop mega problems. Most of the megacities are presently located in Asia (figure below). The concentration of population, which partly accounts for a metropolitan area's dynamism, also causes congestion, environmental degradation, housing shortages, and the formation of ghettos. And governance of a sprawling metropolitan area can become complex and difficult.


Global Distribution of Megacities

                                                                                                                                                                                                             Source: UN Population Division


The Commission on Growth and Development (2008) has noted that “cities thrive because of….agglomeration economies. When activities are clustered closely together, they can reap economies of scale and scope”. There is substantial evidence that urban agglomeration does improve productivity and promotes economic growth. Au and Henderson (2006) used aggregate data on 285 Chinese cities to estimate the effects of urban agglomeration on productivity. As expected, the authors find that the aggregate productivity relationship exhibits an inverted U shape in metropolitan size and scale. The estimated urban agglomeration benefits are quite high, and it appears that a large fraction of cities in China are undersized due to migration controls imposed at the national level. The evidence from India includes an analysis using plant level data by Lall, Koo, and Chakrovorty (2003). The authors provide strong evidence in support of the importance of urbanization economies in reducing costs per unit of output. This finding is consistent across all industries and size classes of Indian plants. This paper provides important evidence on urbanization economies in India, and perhaps in other developing economies as well.

The increasing population in urban areas however can lead to decreasing returns over the longer period. Quigley (2008) suggests that while larger cities facilitate greater complementarities and specialization, the main sources limiting the sizes of cities and affecting the efficiency of city sizes are land and transport costs and unpriced externalities of urban life like greater congestion, pollution and the risks of epidemics. In addition, urban agglomeration requires concomitant huge increases in urban infrastructure especially in Asia. It is estimated that by 2030 nearly USD 4.5 trillion will need to be invested in Asia’s energy networks and power stations alone (figure below). This represents nearly half of the global investment required in this sector.


Investment needs for energy and water sector during 2005-2030, by region (trillion US dollars)


                                                                                                                                                                                                             Source: Deutsche Bank Research. “Megacities: Boundless Growth?” March 12, 2008


With increasing urban agglomeration, Duranton (2008) explores the idea of whether cities do actually favor economic efficiency. He concludes that while cities provide large efficiency benefits and there is no evidence that they systematically hurt particular groups, however, mega cities can be a drag on growth. Duranton’s recommendations to the Commission of Growth and Development is to broaden the focus of public policy from within-city efficiency to between-city efficiency by favoring the mobility of resources across cities and regions, while avoiding their concentration in only one primate city. This would enable a more efficient and equitable distribution of scarce public funds over a longer time horizon.


(From Raj Nallari and Indira Iyer's lecture notes)

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