Dynamic Cities as Engines of Growth

As countries move through the development process, agriculture declines as a share of gross domestic product and manufacturing and services begin to dominate the economy. Goods and services are often produced most efficiently in densely populated areas that provide access to a pool of skilled labor, a network of complementary firms that act as suppliers, and a critical mass of customers. For this reason sustained economic growth is always accompanied by urbanization. Globalization and localization have not diminished the importance… or the pace… of the urbanization process. Globalization promotes economic growth, which is the driving force behind urbanization. But communication and information technologies now allow firms to market their goods in distant countries and to incorporate into their production chain firms located halfway around the world. If globalization is lauded precisely because of its ability to make great distances seem much smaller, why does urbanization remain such an important trend? Although globalization opens up new possibilities for linkages around the world, it also reinforces certain advantages of proximity. Firms competing in the global economy (and their suppliers) still benefit considerably from access to a sizable pool of labor, materials, services, and customers. As a result, globalization is likely to contribute to further urbanization. This is particularly true in developing countries, where access to the opportunities offered by globalization is much greater in cities. The growth of urban populations in both large capital cities and smaller municipalities feeds demand for increased localization of political power. It puts pressure on national institutions of governance and encourages them to take the steps toward decentralization. It makes the success of decentralization perhaps even more important. When urban governments have the power and ability to enact a development agenda, they can help the citizens of their cities hook up with the global economy. These cities then become reliable links in the global production chain and attractive destinations for foreign investment. Urbanization is integral to development, but it also presents difficult challenges. This article reviews the economic forces underlying urbanization and discusses what national governments can do…. and should not do… if they want to foster urban economic growth. The article in turn, focuses on what makes cities livable, including essential services like housing, sanitation, and infrastructure. What makes cities grow? Healthy, dynamic cities are an integral part of sustained economic growth. As countries develop, cities account for an ever-increasing share of national income. Urban areas generate 55% of gross national product in low-income countries, 73% in middle-income countries, and 85% in high-income countries. The growth sectors of the economy… manufacturing and services…. are usually concentrated in cities, where they benefit from agglomeration economies and ample markets for inputs, outputs, and labor, and where ideas and knowledge are rapidly diffused. The way cities manage development, including the arrival of industries, goes far in determining the rate of economic growth. Urban governments can foster economic development, or they can slow it down. Examining the urbanization process… the agglomerative forces and locational inducements that shape cities—is a useful way of identifying what role governments should play. Agglomeration economies…the source of urban efficiency: Why is economic activity concentrated in urban areas, where land prices are often 50 to 100 times higher than they are 30 or 40 miles away? Why do so many individuals and firms settle in large metropolitan areas where the cost of living is typically twice as high as it is in smaller urban areas? The answer must be that these costs are more than offset by the economic benefits cities offer…benefits that are generally the result of agglomeration economies. Agglomeration increases the productivity of a wide array of economic activities in urban areas. Productivity rises with city size, so much so that a typical firm will see its productivity climb 5 to 10% if city size and the scale of local industry double. Urban wages are also higher than rural wages……two to four times as high in middle-income countries… reflecting the higher productivity levels obtained from urban agglomeration economies. Urban areas have historically been more efficient than rural areas because cities had markets for inputs and outputs big enough to support good-sized plants and thus could take advantage of economies of scale. In smaller towns the economies of scale such plants provided were offset by high transportation costs to consumers or from input sources. The relationship between plant size and city size has all but disappeared, however. Transportation costs have also declined (and become much less important) as services and light industries increasingly dominate the world economy. In a modern economy the benefit of the kind of proximity urban areas offer is that firms, regardless of size, are able to experience economies of scale and scope. The presence of a common pool of labor, materials, and services allows large and small firms alike to profit from scale economies. Economies of scope emerge when the presence of one activity makes carrying out a complementary activity cheaper by fostering diversity in supply and specialization among firms. Proximity also facilitates the diffusion of knowledge. Firms operating in proximity to each other benefit from information spillovers, in some cases by observing what neighboring firms are doing. Evidence from patent citations shows that information flows actually deteriorate with distance. When firms are concentrated in cities, transaction costs also fall, most notably the search costs involved in matching workers with employment opportunities. Agglomeration economies come in various forms. Benefits that derive from firms locating close to firms in the same industry are known as localization economies. Benefits that derive from proximity to many different economic actors are known as urbanization economies. Evidence from around the globe shows the benefits of localization economies. If a plant moves from a location shared by 1,000 workers employed by firms in the same industry to one with 10,000 such workers, output will increase an average of 15%, largely because the pool of specialized workers and inputs deepens. Whether an industry benefits most from urbanization or localization economies depends on how innovative it is. New, dynamic industries are likely to locate in large urban centers where they can benefit from the cross-fertilization provided by diverse actors. Older, mature industries concentrate in smaller, more specialized cities, where congestion costs are low and localization economies can be high. A final benefit of agglomeration in large urban areas is that these locales are less vulnerable to economic fluctuations because of their diversified economic base. Employment can flow from one sector to another; keeping average unemployment low. The number and variety of consumers offer firms some protection, allowing them to apply the law of large numbers to inventory management (a practice that results in substantial savings). For consumers, large cities provide a variety of services and shopping and entertainment opportunities. Rural areas can tap into these benefits by building links to the urban sector. Systems of cities: Although productivity is higher in large metropolitan areas, almost 65% of the world’s urban residents continue to live in small and medium-size cities. This pattern reflects the degree of agglomeration that works best for firms and industries and the kinds of benefits agglomeration provides. Large metropolitan areas provide some firms with enough benefits to justify the high labor and land costs. But other industries find smaller cities more lucrative bases. Economies can support a range of cities of different sizes and the accompanying variations in production patterns. And the effects of city size on workers are often minimal. A typical worker is generally as well off in a small city with low wages and low living costs as a worker in a large urban area where wages and living costs are as much as 100 % higher. The biggest metropolitan areas provide a large, diverse economic base for modern services and other innovative industries that derive important benefits from such an environment. In contrast, small and medium size metropolitan areas tend to specialize in the production of goods that are exported outside the city, focusing on a single standardized manufacturing or service area such as primary metals, food processing, textiles, pulp and paper, machinery, or transportation. By specializing in one set of activities, smaller metropolitan areas exploit localization economies while conserving on the congestion costs that affect larger cities. Specialized cities grow with the economies of scale and local intermediate input linkages their activities generate, and with the size of regional markets and city-specific amenities. The dynamics of city formation: The relationship between a country’s industrial organization and its system of cities helps explain emerging patterns of urbanization. During the early stages of industrialization in most developing countries, modern industries… particularly in sectors that are influenced primarily by the location of consumers… often cluster in one or two large metropolitan areas. The first site for agglomeration is usually the national capital or a large city near the coast. This clustering saves on scarce resources and helps industries cope with initial shortages of skilled labor, technical knowledge, business and financial services, and modern telecommunications and transportation infrastructure. For foreign investors and industrial exporters, the national capital may be a prime location for entering the country and the best place to find modern services. Capitals have the added advantage of proximity to government decision makers and regulators. As industrialization proceeds, manufacturing activities begin to move to smaller cities outside the capital. This shift occurs because congestion costs increase and because, to some extent, the benefits of agglomeration decrease as production standardizes in mature plants. The spread of effective telecommunications and transportation, the devolution of bureaucratic processes to local governments, and the opening of capital markets also encourage the movement of industries out of major cities. In the future, the forces of globalization, including trade liberalization and financial integration, will continue to reinforce the importance of urban agglomeration economies. Because international firms and investors seek low-cost, accessible locations for their plants, localized production networks will be essential to a country’s global competitiveness. Manufacturing is placing increasing emphasis on high effective capital labor ratios and light, high-tech materials, often in connection with intermediate service inputs such as software, programming, and engineering services that can be supplied at a distance. Openness to the world economy will increase the volatility of urban economies and heighten competition among cities within the same country. Cities that are able to exploit a comparative advantage in global tradables will thrive, but those that have depended on protected industries will struggle. Technological change has enhanced agglomeration economies in the past and should continue to do so in the future. Commuter transportation, automobiles, and metropolitan highway systems have all contributed to urban growth in industrial economies during the 20th century. In the future, local human capital and the accumulation of knowledge will also affect city size. Estimates for 1940–90 suggest that an increase of one standard deviation in the percentage of college educated residents in a country’s city is associated with a 20% increase in size, even after accounting for growth trends and specific city characteristics. Recent evidence suggests that telecommunications is a complement to, rather than a substitute for, face-to-face interaction. In a world of extraordinary technological gains, one of the most effective mechanisms for transmitting knowledge and conducting business may still be geographic proximity. Most of the world’s urban population will remain in small and medium-size cities, since they are growing faster than large urban areas. But sizes are relative. In the developed world in the 1970s a medium-size city was defined as one with a population of anywhere from 250,000 to 500,000. Today a medium-size city is defined as one with a population closer to a million. The same is true for large cities. In 1950 the average population of the world’s 100 largest cities was 2.1 million, but by 1990 it had reached more than 5 million. In 1800 it was only about 200,000. The number of cities will also continue to grow. In 1900 the United States alone had 75 metropolitan areas, which were defined as areas with a population of over 50,000. Today the number of metropolitan areas has reached almost 350. As these urban centers grow, the number of very large agglomerations will also increase. In 1970 some 163 metropolitan areas worldwide had more than 1 million people. Today there are about 350 such areas. Having more metropolitan areas in a country means having more centers of political power that feed the forces of localization and raise the stakes for good urban governance. Email : bbazimya@yahoo.co.uk