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The Economics of Agglomeration

Throughout history, industrial hubs have been major engines of successful economic development. These hubs (and clusters) bring together firms that compete and collaborate at the same time, therefore generating the so-called Marshallian or agglomeration externalities: knowledge spillovers, labour pooling, and close proximity of specialized suppliers. As a result, the spatial concentration of entrepreneurship and innovation in specific locations within cities or within urban areas has now become a popular topic of research on the dynamics of economic development. This chapter revisits theories of agglomeration in light of the successful creation ex nihilo of industrial hubs and new clusters in countries like China, often as the result of strong and deliberate government action that defied conventional wisdom. It discusses rationales for the agglomeration of economic activities in countries with suboptimal or even poor business environments, where reforms are likely to take time. It identifies and discusses institutions and policies that, to stimulate economic agglomeration, encourage local entrepreneurship and innovation in industrial hubs and clusters.