Expert Commentary

Economic growth and developing world cities: The benefits of urban clustering

2014 study from the University of Pennsylvania showing how urbanization can foster economic growth in the developing and developed world.

Today, a majority of the world’s population lives in cities. By 2050, two-thirds of all people on the planet are projected to call urbanized areas their home. This trend will be most prominent in developing countries in Africa, Asia and Latin America: More than 90% of the global urban growth is taking place in these regions, adding 70 million new residents to urban areas every year.

For the many poor in developing countries, cities embody the hope for a better and more prosperous life. The inflow of poor rural residents into cities has created hubs of urban poverty. One-third of the urban population in developing countries resides in slum conditions. On the other hand, urban areas are engines of economic success. The 750 biggest cities on the planet account for 57% of today’s GDP, and this share is projected to rise further. It is thus unsurprising that rapid urban growth has been dubbed one of the biggest challenges by skeptics and one of the biggest opportunities by optimists.

One reason for this disagreement is that the relationship between economic development and urbanization is complex; causation runs in both directions. In the study “Growing through Cities in Developing Countries,” published in the World Bank Research Observer, Gilles Duranton from the University of Pennsylvania examines this relationship in depth. The strong positive correlation between the degree of urbanization of a country and its per-capita income has long been recognized. Still, the relationship between these two variables is only partially understood in the context of developing countries. In reviewing studies that focus on the impact of cities both in developed and developing countries, Duranton tries to identify the extent to which urbanization affects economic growth and development. (“Agglomeration” economies refers to physical clustering.)

The key findings include:

  • Studies both in developed and developing countries find a positive, robust statistical association between productivity outcomes and the size of a city. The studies reviewed by the author suggest that “a city that is 10% larger in population offers wages that are 0.2 to 1% higher.”
  • Taking into consideration two possible sources of bias — that more productive cities attract more workers, and that more productive workers are self-selected into bigger cities — this effect shrinks. “The conclusion of the agglomeration literature is that there is a causal static effect of cities and urbanization on wages in more advanced economies, but this effect represents only approximately half the measured association between city population or density and wages.”
  • For developing countries, the effect is also smaller after controlling for potential bias, but it remains much higher than the effect in developed countries. A 2013 study by Pierre-Philippe Combes, Sylvie Démurger and Shi Li finds agglomeration externalities of 10% to 12% for China compared to 2% to 4% in more advanced countries.
  • In the theoretical literature, resource sharing, quicker and better matching and more learning have been put forward as the drivers of higher productivity in bigger cities. However, Duranton notes that very few empirical studies have been looking at the sources of agglomeration effects in developing countries.
  • Studies about both developed and developing countries such as a 2009 study by Carlino and Hunt show that urbanization has a positive effect on innovation. Duranton concludes that “though the issue for developing countries is more about absorbing existing knowledge than generating completely new knowledge, large cities in developing countries should still have an important role to play in innovative activities by absorbing foreign knowledge and making sure it diffuses to the rest of the country.”
  • Big cities in developing countries act as centers of innovation but fail to relocate the production of mature products to secondary specialized cities, as is the case in advanced economies. The author concludes that “both more advanced and mature products are produced in the largest cities. This situation likely makes these cities larger than they should be and increases congestion. Mature products also end up being produced in the most expensive cities at a higher cost. Smaller cities may suffer even more from this because they are stuck with the production of the most backward products without receiving a constant inflow of new goods to produce from their metropolises.”
  • Cities function as small open economies and create “urban systems,” which impact economic growth and development. But cities in developing and developed countries exhibit a number of key differences that might prevent cities in developing countries from exploiting their full potential. First, the labor markets in cities in developing countries involve a large informal sector alongside the formal sector. The same is true for the land markets in cities in developing countries, where land is divided into parcels owned with appropriate property titles and leases, and land which is illegally squatted. A third key difference involves the provision of infrastructure, especially road infrastructure. Because developing world cities may not specialize in sectors as well, and may not be able to reinvent industries as quickly, all of these factors “may limit the dynamism of cities in developing countries.”

Duranton concludes that “the economic gains from urbanization are significant, and urbanization should be embraced rather than resisted. Cities offer both short-term benefits by raising worker productivity and longer-term benefits in the form of more worker learning.” The author notes that “one may be tempted to go further and attempt to ‘foster agglomeration effects.’ This temptation should nonetheless be resisted. We are too far from knowing enough about the sources of agglomeration to implement any meaningful policy in that direction.”

Related research: Also see the 2013 study “The Economics of Slums in the Developing World,” published in the Journal of Economic Perspectives.

Keywords: economic development, entrepreneurship, informal economy, infrastructure, agglomeration effects


Editor’s note: An image that previously appeared on this post came from Wikimedia. It has been removed because, according to the owner of the image, it should not have been available for public use.

About The Author