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Organizations in the Aggregate Economy

Economists generally agree that an important feature of any modern macroeconomic theory is an explicit aggregation of the microeconomic behavior of all agents in the economy. In the last century, the profession has gone from the formulation of some general aggregate relationships governing the evolution of the economy to detailed theories that explicitly incorporate the observed heterogeneity in many characteristics of agents and firms. Adding these microeconomic details has resulted in new insights on policy, as well as better and more detailed descriptions of modern economies. Although it is obviously important to recognize that an aggregate economy is formed by individual agents making explicit decisions, the standard aggregate models still abstract from a precise description of how these agents interact in small (or not so small) groups to produce, live, and consume. Most economic activity occurs in intermediate levels of aggregation: organizations. Firms or plants, but also cities, families, international production chains, political parties, and religious organizations, among many others, are examples of such organizations. Most of my recent research has concentrated on incorporating these organizations into general equilibrium theories in order to understand their implications for aggregate outcomes. A starting point of this agenda is an understanding of how organizations affect economic growth. There is a set of fairly consistent facts for developed economies that suggest that the longterm growth rate of these economies is fairly stable over time. This suggests the need for theories that exhibit constant returns to scale in the factors that can be a ccumulated over time — a fe ature that most endogenous growth theories share. How can intermediate levels of organization affect the required linearity in aggregate production? Mark Wright and I argue that the organization of agents in cities is closely related to aggregate technologies with constant returns to scale. 1 Agents organize production and their lives in cities because they obtain benefits from agglomeration: there are increasing returns at the local level. We claim that to reconcile the increasing returns at the local level with constant returns at the aggregate level, one must understand the role of cities. We thus propose a theory by which the number and sizes of cities react to industry productivity shocks in a way that exhausts the increasing returns at the local level and yields constant returns in the aggregate. According to our findings, cities are the reason to obtain aggregate balanced growth, but our mechanism also yields a size distribution of cities that very closely resembles the one observed in the data. This is a stark example in which considering intermediate organizations (in this case, spatial agglomeration in cities) is fundamental to understanding aggregate outcomes. A similar argument can be made