Agglomeration economies

The study of agglomeration economies started with Marshall who argued that the existence of ‘external economies’ leads to the concentration of activities. Marshall defines external economies as ‘economies arising from an increase in the scale of production, dependent on the general development of the industry’ (Marshall, 1890 p. 266). Marshall further argues that ‘external economies can often be secured by the concentration of many small businesses of a similar character in particular localities’ (Marshall, 1890 p. 266).

The term ‘agglomeration economies’ (see Asheim, 1994) is used for all external economies that foster geographical concentration. A widely accepted distinction divides agglomeration

economies in ‘localization economies’, for specific industries and ‘urbanization economies’, forces towards the concentration of economic activities in cities. Examples of urbanization economies include the presence of business services and a large (consumer) market.

For clusters, the localization economies are more relevant, since clusters are concentrations of activities with a distinctive economic specialization. However, since the distinction between localization economies and urbanization economies is not crystal clear, we stick to the term agglomeration economies. In line with Krugman (1995), we discuss three

‘Marshallian’ agglomeration economies.

A first agglomeration economy already discussed by Marshall is a shared labor market. In a geographical cluster, labor is widely available because of the presence of a variety of firms with a similar labor demand. Marshall terms this a ‘constant market for skill’ (Marshall, 1890, p. 271). Skilled workers are attracted to the cluster and clusters also provide a sufficiently large scale for providing specific types of education and training. Because of the ‘constant market for skill’, it is relatively attractive for workers to invest in specific training and education. Search costs to find qualified labor are relatively low, because of the large labor pool. Intermediaries that specialize in recruiting labor arise in many cases.

A final relevant aspect is the costs of firing labor. Since alternative employment opportunities inside a cluster are relatively high, employees are in general less dependent on one particular employer and therefore firing costs in general are likely to be relatively low. In clusters, job mobility is generally speaking high (see Panniccia, 1999 and for the case of Silicon Valley, Saxenian, 1994).

The second agglomeration economy is the presence of customers and suppliers within a cluster. Locating in a cluster is attractive for firms ‘downstream’ in the value chain, when other firms in the cluster can provide specialized inputs. For firms ‘upstream’ in the value chain, the presence of (potential) customers is attractive. The presence of suppliers and customers is an advantage since ‘trade costs’ are higher for transactions with firms outside the cluster. Furthermore, a concentration of similar firms allows for specialization of firms in the cluster. Specialization enhances the performance of a cluster since firms in the cluster are offered better, tailor-made products and services.

Chapter 5 – Cluster Structure 41

The third agglomeration economy is termed ‘knowledge spillovers’ (see Marshall, 1890, p.

271 and Krugman, 1995)¹⁶. Knowledge and information is cheaper and earlier available inside clusters than outside, because it flows more easily locally. This factor has been widely discussed and has become popular among regional policy makers.

Empirical research has demonstrated the positive effect of clustering on innovation (see Baptista and Swann, 2000, Audretsch and Feldman, 1996 and Nooteboom, 1999) and the positive effect of clustering on knowledge diffusion (Baptista, 2000). Audretsch and Feldman (1996, p. 637) empirically prove that ‘industries where new economic knowledge tends to play a more important role have a higher propensity to cluster together’. This demonstrates that knowledge spillovers are an agglomeration economy¹⁷.

Apart from the agglomeration economies, ‘dispersion forces’ exist. Without these forces all activities would be concentrated in one place. Two dispersion forces are widely acknowledged: land scarcity and congestion (see Fujita and Thisse, 1996). Agglomeration forces foster concentration. Since space is limited, land in clusters becomes scarce. This leads to high land prices. Such high land prices in a cluster decrease the attractiveness of locating in a cluster. High land prices - even though they reflect the strength of agglomeration economies - are a dispersion force.

Congestion is a second dispersion force. In general, clusters need investments in transport infrastructure. Given the scarcity of land and concentration of economic activities, congestion is likely to develop. This decreases the attractiveness of a cluster, compared to locations without congestion. Table 6 shows the above-mentioned three agglomeration economies and two dispersion forces.

16 The argument that proximity influences the diffusion of knowledge does not really fit in Krugman’s neo-classical framework, because this is hard to reconcile with arguing that distance influences the diffusion of innovations, since ‘transport costs’ are irrelevant for the diffusion of ideas, information and knowledge. The importance of proximity is thus at odds with the assumptions of rational actors and perfect information.

17 Even though these spillovers are beneficial for the cluster, they are not necessarily beneficial for firms in the cluster. In many cases, firms would rather control and limit the spillover of their knowledge. In clusters this is difficult because information is ‘in the air’.

Table 6: Agglomeration and dispersion forces

Agglomeration forces Dispersion forces

Labor pool Land rent

Suppliers Congestion Knowledge spillovers

Source: based on Fujita et al, 1999, p. 346

The presence and importance of the three agglomeration economies enhance the performance of a cluster. Such economies increase the attractiveness of locating in a cluster. The presence and importance of dispersion forces in a cluster reduces cluster performance. The balance between these two opposing forces changes over time. When the importance of agglomeration forces increases, the performance of a cluster improves, a growing effect of the dispersion forces reduces the performance of a cluster¹⁸.

The strength of these forces differs between clusters and changes over time. For instance, land scarcity depends on expansion projects and congestion depends on initiatives to improve the transport infrastructure.