The link between cities and economic growth is well established.
Rosenthal and Strange (2004), and Melo et al. (2009), review the literature that establishes that firms and workers are more productive in larger cities. Estimates of the elasticity of productivity with respect to city size range between 0.02 and 0.10, depending on the sector and the details of the estimation procedure. The higher average productivity of firms and workers in larger cities has been attributed to “agglomeration economies.”
These economies are thought to arise from a variety of mechanisms, such as the possibility for similar firms to share suppliers, the existence of thick labor markets which smoothen firm-level shocks, or the possibility to learn from the experiences and innovations of others.
Coombs et al. (2012) distinguish firm selection from the other motives behind the productive advantages of cities commonly considered, and argue that selection is the inability of weak firms to survive when faced with tougher competition in larger markets. Using French establishment-level data they argue that firms in denser areas, on average, are about 9.7 percent more productive than in less dense areas. This result holds across sectors, city size thresholds, establishment samples, and area definitions.
Chauvin et al. (2016) examine whether the facts about urbanization in the United States are also true for the developing world. They find that while in Brazil and China, the implications of the spatial equilibrium hypothesis are not rejected, the India data, however, repeatedly reject tests of the spatial equilibrium assumption.
The testing of the spatial equilibrium hypothesis involves these four aspects: do costs of living rise with wages? Are real wages lower in places with better amenities? How much internal migration is there in a country? And is happiness higher in places with higher income?
What does this mean for India? If a city’s population was 1 log point higher in 1980, then it grew on average by .052 log points less over the next 30 years. Chauvin et al. (2016) argue that this negative coefficient does not imply that India has once-great cities that are declining, but rather that growth was particularly robust in smaller agglomerations. This is also borne out by data from the Census of India in 2011 and Tewari et al. (2015).
When Indian growth is spilt by decades, Chauvin et al. (2016) observe that the 1980s were marked by positive serial correlation, where higher populations led to faster growth, while this trend disappeared in the 1990s and the 2000s. One possible explanation for this shift, they argue, is that prior to the economic liberalization in the early 1990s, regulation tended to keep the urban hierarchy in place.
Is entrepreneurship getting inhibited in India due to there being too few cities? Ghani et al. (2014) examine the spatial determinants of entrepreneurship in India in the manufacturing and services sectors. They find that local education levels and physical infrastructure quality play a role in promoting entry. They also find evidence that strict labor regulations discourage entrepreneurship, and better household banking environments are associated with higher entry in the unorganized sector.
One hypothesis is that the spatial equilibrium only emerges with economic development as markets replace social relationships and as human capital spreads more widely (Chauvin et al. 2016). In all four countries they find that there is strong evidence of agglomeration economies and human capital externalities. The correlation between density and earnings is stronger in both China and India than in the U.S., and strongest in China. In India the gap between urban and rural wages is huge, but the correlation between city size and earnings is modest.
The cross-sectional relationship between area-level skills and both earnings and area-level growth are also stronger in the developing world than in the U.S. The forces that drive urban success seem similar in the rich and poor world, even if limited migration and difficult housing markets make it harder for a spatial equilibrium to develop.
Chauvin, J. P., Glaeser, E., Ma, Y., and K. Tobio (2016) What Is Different About Urbanization In Rich and Poor Countries? Cities in Brazil, China, India And The United States? NBER Working Paper 22002.
Coombs, P. P., Duranton, G., Gobilion, L., Puga., D., and S. Roux (2012) The Productivity Advantage of Large Cities: Distinguishing Agglomeration from Firm Selection. Econometrica, Vol. 80, No. 6 (November, 2012), 2543–2594
Ghani, E. Kerr, W.R., and S. O’Conell (2014) Spatial Determinants of Entrepreneurship in India, Regional Studies 48 (6), 1071-1089.
Melo, P.C., Graham, D.J. and R. B. Noland (2009): A Meta-Analysis of Estimates of Urban Agglomeration Economies, Regional Science and Urban Economics, 39 (3), 332–342.
Rosenthal, S. S., and W. Strange (2004): Evidence on the Nature and Sources of Agglomeration Economies, in Handbook of Regional and Urban Economics, Vol. 4, ed. by V. Henderson and J.-F. Thisse. Amsterdam: North-Holland, 2119–2171.
Tewari, M., Aiz, A., Cook, M., Goldar, A., Ray, I., S. Ray, Roy Chowdhury, S., and Unnikrishnan, V., 2015. Reimagining India’s Urban Future: A Framework for Securing High Growth, Low Carbon, Climate Resilient Urban Development in India. ICRIER Working Paper 306, August, 2015.