Week 3-4 Topic 3

Specialization and agglomeration: why are some industries so concentrated in a few

places?

Classic Classification (Marshall, 1890)

- Labour market interactions
- Linkages between intermediates and final good suppliers
- Knowledge Spillovers
Puga and Duranton’s classigication
- Sharing
- Matching
- Learning

Duranton, Gilles and Puga, Diego, 2004, “Microfoundations of Urban Agglomeration

Economies.” In JV Henderson and JF Thisse, eds, Handbook of Regional and Urban
Economics, v. 4, pp. 2063-2117, Amsterdam: Elsevier

 Regard cities as the outcome of a trade-off between agglomeration economies or

localised aggregate increasing returns and the costs of urban congestion.
 Urban agglomeration economies are commonly classified into these arising from
labour-market interactions, from linkages between intermediate- and final goods
suppliers, and from knowledge spill-overs; loosely following the 3 main eamples
provided by Marshall (1890)

Sharing, Matching and Learning

Sharing
o Sharing indivisible facilities
 Once large fixed costs associated with this facility have been incurred,
it provides an essential good to consumers at a constant marginal
cost. E.g. Ice hockey
 Large indivisibility argument motivates increasing returns by directly
assuming increasing returns at the aggregate level.

Cities facilitate sharing many indivisible public goods, production

facilities and marketplaces. However, it would be unrealistic to justify
cities on the basis of a single activity subject to extremely large
indivisibilities.

o The gains from the wider varieties of input suppliers that can be sustained by
a larger final-goods industry
 Aggregate increasing returns arise from the productive advantages of
sharing a wider variety of differentiated intermediate inputs produce
by a monopolistically competitive industry
 Cross sector interactions – incorporating non=tradable goods
produced in all cities or by assuming economies of scope that result in
 cost savings when several sectors operate in the same city [urban
diversity]
 Urban diversity arises in the presence of transport costs – trade-off
between the gains from urban specialisation due to localisation
economies and the transport costs incurred when other goods have
to be shipped to a specialised city.

o Gains from the narrower, specialisation that can be sustained with larger
production
 Productivity gains from an increase in specialisation when workers
spend more time on each task- Adam smiths division of labour
 To justify this Adam gives three main reasons
 Performing the same task- improve their dexterity at this
particular task (learning by doing)
 Not having workers switch task saved some fixed costs (e.g.
changing location, tools)
 Labour-saving innovation because simpler tasks can be
mechanised easily
o Risks
 Marshall (1890)- labour pooling – a localised industry gains a great
advantage from the fact that it offers a constant market for skill
 Each firm benefits from sharings it labour market with more firms in
the face of idiosyncratic shocks – these benefits also decrease with
the intensity of decreasing returns because labour demand by firms
becomes less elastic with respect to the idiosyncratic shocks.
Matching
o Matching externalities are common in the labour market- an increase in the
number of agents trying to match improves the expected quality of each
match
o Good examples –
o Salop (1979)
 Firms locate in a circle
 The more firms the closer consumers are to one of them, and
so the lower the transport costs they pay to buy
 Can be applied to a variety of contexts and leads to better
quality of matches
o Another Approach uses random matching and leads to a higher frequency of
matches – based on a matching function the depends on a number of
unemployed and vacancies.
Learning
 Generation, the diffusion and the accumulation of knowledge
o Cities facilitate learning by bring together a large number of people –
face-to face interaction.
o Marshall (1890) emphasised how cities favour the diffusion of
innovations and ideas
o Jacobs (1969)- environment offered by cities improves the prospects
for generating new idea
Kemeny, T. and Storper, M. 2014. “Is Specialization Good for Regional Economic
Development?” Regional Studies

http://www.tandfonline.com/doi/pdf/10.1080/00343404.2014.899691

Diversification
o Economic development- spreads the risk from economic fluctuations – virtue of not
putting all your eggs in one basked
o Urbanization economies supply general inputs at efficient scales that are useful to
many activities in a region – therefore a big metropolitan economy has reason to be
diversified – reflected in its high average total productivity (diversification however is
an outcome of being big)
By definition, urbanization economies do not provide specialized resources dedicated to
particular outputs; localization economies do, and localization economies are a force not
for diversification, but for specialization
o Concerns the dynamics of the regional economy- For an economy to move into, or
capture, new activities, it needs to be able to draw quickly and easily from a shifting
set of inputs and factors. This is a kind of ‘mix and match’ view of the dynamics of
economic development
o Increasing the size of a localized activity should positively affect productivity through
the three main mechanisms specified by models of the New Economic Geography:
sharing of input suppliers; matching of specialized labour demand and labour supply,
especially in a context of high-turnover industries; and technological learning or
spillovers, especially where innovation involves many different types of actors
spread across different organizations (DURANTON and PUGA, 2004; ROSENTHAL and
STRANGE, 2004).

Having a high share of an activity doesn’t necessarily imply economic performance –

over the years, 3 principle notions have been developed suggesting that growing relative
specialization will produce economic benefits.
o Competition between sectors for resources in the regional economy
o The idea that an agglomeration of producers is simultaneously an interacting
supply system; a local labour market matching system; and a context for
knowledge exchange and spillover.
o