Insights
This blog is the seventh in our series on the key concepts to consider when thinking about local economic growth policies. We’re using the series to test-drive a way of explaining concepts in economic growth that we hope to use in new training and resources. We are keen to hear from readers, particularly those in local and central government, about whether they find these useful and accessible, and if there are other topics you would like to see us cover.
What is agglomeration?
Firms and workers get benefits from locating close one another. This geographic concentration of economic activity is often referred to as agglomeration and these benefits as agglomeration benefits or agglomeration economies.
Agglomeration can be driven by geographic advantages such as easier access to better or cheaper inputs (e.g. fertile land for agriculture, water for power) or other locational advantages (e.g. deep water for a port). But agglomeration economies refer specifically to the benefits that arise when firms and workers interact – either because they can better share resources (e.g. the costs of infrastructure), better match supply to demand (e.g. specialist suppliers to their customers) or better exchange ideas (e.g. software firms in Silicon Valley).
These agglomeration benefits can lead to lower unemployment, higher wages and higher productivity for firms and workers.
Why do we need to think about agglomeration?
Agglomeration benefits firms, workers, and regions. Firms benefit from networks of suppliers and collaborators, infrastructure, and technological spillovers between firms (i.e. the unintentional technological benefits to firms that come from innovation by other firms). The concentration of workers, increases the density of worker skills, making it easier for firms to find workers that align with their skill requirements. Workers also benefit from this better matching, because it makes it easier to find a job and because using one’s specialist skills increases labour productivity and wages.
Agglomeration can be self-reinforcing. Higher productivity attracts more firms. More job opportunities attract more workers.
Agglomeration of firms in the same or similar industries can facilitate the movement of specialist workers between firms, resulting in more job opportunities. Similarly, agglomeration of lots of different firms can facilitate movements if they need workers to do similar tasks (e.g. provide IT support).
Agglomeration can be self-reinforcing. Higher productivity attracts more firms. More job opportunities attract more workers.
Agglomeration can also have negative effects. For instance land prices and rents became more expensive, congestion increases, and air quality worsen as concentration increases.
Understanding agglomeration benefits and costs can help local policymakers understand a key economic force that drives local economic performance. It can also influence the effectiveness of a wide range of policies. For example, some innovation policies (such as accelerators) may work better in already innovative clusters. Similarly, efforts to attract inward investment may be more successful if an area already has lots of firms in related industries. Considering these effects can help policymakers to better assess outcomes and make better decisions.
Understanding agglomeration benefits and costs can help local policymakers understand a key economic force that drives local economic performance. It can also influence the effectiveness of a wide range of policies.
What to consider when thinking about agglomeration?
There is a large empirical evidence base that points to the positive effects of agglomeration on productivity and wages for firms and workers. The evidence is also clear that innovative activities benefit from significant agglomeration economies, particularly from co-location with other innovative activities.
The benefits of agglomeration increase with scale because, as the size of markets increases, opportunities to achieve better economic outcomes also increase. However, the costs also increase as economic activity concentrates. The location of firms depends on how they balance the trade-offs between the access to the benefits that agglomeration offers and the increased costs it creates, and similarly for workers. Keeping these trade-offs in mind when thinking about policy interventions to boost business investment and innovation in the local economy is key.
The benefits of agglomeration increase with scale because, as the size of markets increases, opportunities to achieve better economic outcomes also increase. However, the costs also increase as economic activity concentrates.
Context also matters! To take advantage of the benefits of agglomeration, it is important to consider the regional advantage in particular industries or activities, and the concentration of industries that already exist in the region. Agglomeration economies mean that building on existing strengths is much easier than generating new activities. This is an important lesson, often forgotten in many initiatives to create the next Silicon Valley.
How can I learn more?
In their paper Agglomeration, clusters, and industrial policy, Max Nathan and Henry Overman discuss the spatial scale for industrial policy and the role for agglomeration
Centre for Cities analyses the impact of agglomeration on the economy in their report Office politics: London and the rise of home working.
Centre for Cities discusses agglomeration effects in British cities in the context of levelling up in this blog.
Henry Overman talks about innovation agglomeration effects and investment zones in the blog From Investment Zones to Innovation Zones? Innovation and Levelling up.
Up next
The next blog in our understanding key concepts in local economic growth series will be on efficiency vs inequality. Sign up to our newsletter to get an update on our next blogs, briefings and events.
