Agglomeration effects

How transport can bring firms, workers and households closer together to increase productivity

Key Summary

It seems clear that transport networks will continue to play an increasingly crucial role in supporting the success of these urban agglomerations: enabling commuting journeys to support deep labour markets; facilitating rapid business to business contacts; and providing international connections to support the export of high productivity services.

The Eddington Transport Study

The link between transport investment and economic performance

The link between transport and the economy has attracted growing interest from researchers over the past two decades. A key turning point was the work by Aschauer in the late 80s, who attempted to demonstrate that the difference in performance between the Canadian and US economies over the preceding decade could be attributed to differences in public sector investment. This work has stimulated a fertile area of research known as new economic geography, which accepts that imperfect competition exists in many areas of the economy, and goes on to demonstrate that this is a key factor in explaining the growth of cities .

How does transport infrastructure generate wider economic benefits? Why are firms and households attracted to cities?

There are two key mechanisms through which transport investment can produce wider economic benefits beyond those that would arise under perfect competition conditions: agglomeration economies and labour market effects.

Agglomeration economies occur where lower transport costs bring firms closer together, resulting in lower unit costs and higher productivity (Venables, 2004). There are two main forms of agglomeration economies (Henderson, 2003, Venables, 2004):

  • Localisation economies, where firms within the same industry benefit from proximity through larger specialised labour pools, shared R&D, knowledge spill-overs and greater opportunity for interaction along the supply chain.
  • Urbanisation economies, whereby firms from a range of industries are able to benefit from the concentration of shared resources, competitors and clients more generally. Shared resources can include physical infrastructure, centres of knowledge and research, labour pools as well as shared intangible goods such as information, knowledge, business culture and technological innovation, all of which can have a cumulative effect on productivity.

“interaction between activities produces agglomeration forces which [in turn] preserve [and reinforce] the local concentration of activities”. (Vickerman 2007).

But lower transport costs can also have a significant impact on labour markets by promoting the relocation of jobs to more accessible, higher productivity areas, by widening labour search areas and by encouraging more people into work through reduced commuting costs. These effects can have a positive impact on taxation revenues and total economic output which is not fully quantified in conventional economic appraisal, as demonstrated by Venables (2004).

Empirical evidence of agglomeration effects and their impact on productivity

There is a growing consensus that transport infrastructure can have a significant impact on productivity. A comprehensive literature review by Rosenthal and Strange (2004) suggested that a doubling of city size would increase productivity by somewhere between 3-8%, implying an elasticity of productivity with respect to city size in the range 0.04-0.11. More recent analysis of UK data by Rice and Venables (2004) indicates a value towards the lower end of this range.

In what is probably the most disaggregate and comprehensive study to date, Graham (2006) obtains average elasticities of 0.04 for manufacturing and 0.12 for service industries as a whole. The impact of economic density on productivity is shown to be highest for financial and business services, with a weighted elasticity of 0.2. The impact of economic density on productivity is even higher for specific sub-sectors such as business and management consultancy.

This growing body of research was reflected in the findings of the Eddington report, which recognized that transport investment has the potential to grow GDP, productivity and employment at a faster rate than is typically assumed in standard transport analysis. Leading on from Eddington, the UK Department for Transport published TAG Unit 2.8 on Wider Impacts and Regeneration (general or for the expert), which provides guidance on how to quantify wider economic benefits from transport. For a summary of the DfT methodology see Feldman et al. (2008).

How important are agglomeration effects relative to conventional transport user benefits?

Following Eddington, there have been a handful of attempts at applying the new DfT WEBs methodology. Here we provide a brief summary of key results.

Analysis of the Leeds trolleybus proposal by Steer Davies Gleave shows impacts on job creation and economic output of approximately the same order of magnitude as the direct benefits to transport users purely in terms of travel time savings.

Analysis by CEBR in the West Midlands shows that the job creation benefits of the Coventry Spirit Bus Rapid Transit and of phase 1 of the Midland Metro light rail scheme are, on their own, 30% and 50% higher than the capital cost of these schemes, respectively.

These findings are echoed by SDG’s analysis of the Northern Rail Hub scheme in Manchester and the Centre for Cities work on agglomeration and growth in the Leeds City Region. These reports agree that public transport schemes improving city centre accessibility can generate wider economic benefits corresponding to 20-25% of total benefits.

Feldman et al. (2008) have attempted to compare the relative weight of wider economic benefits for a variety of transport projects. Crucially, their results suggest that wider economic benefits can typically represent 30% of conventional user benefits, where interventions can substantially change accessibility within existing urban areas.

Key Reads

  1. DfT (2006) Agglomerations in the UK and the role of transport policy

    This paper sets out empirical evidence on the general relationship between the density of a location and the productivity of firms and uses new simulation analysis to explore where transport
    interventions might be most effective at delivering agglomeration benefits.

  2. Graham (2006) Investigating the link between productivity and agglomeration for UK industries

    This report presents findings of research commissioned by the Department for Transport (DfT) into the relationship between agglomeration and productivity. It presents results for different industrial sectors that estimate how productivity varies with the level of agglomeration in the UK.

  3. DfT WEBs Guidance

    Provides guidance on how to quantify wider economic benefits from transport.

  4. Venables (2004) Evaluating Urban Transport Improvements

    The paper draws out the implications of the relationship between city size and productivity for evaluations of urban transport improvements. It develops a theoretical model to derive a wider cost-benefit measure that includes productivity effects. The order of magnitude of such effects is illustrated by calculations in a simple computable equilibrium model. It is argued that productivity effects, particularly when combined with distortionary taxation, are quantitatively important, substantially increasing the gains that are created by urban transport improvements.

  5. Rice and Venables (2004) Spatial Determinants of Productivity

    This paper analyses the determinants of spatial variations in income and productivity. It decomposes the spatial variation of earnings into a productivity effect and an occupational composition effect. For the former (but not the latter) it finds a robust relationship with proximity to economic mass, suggesting that doubling the population of working age proximate to an area is associated with a 3.5% increase in productivity in the area. It measures proximity by travel time, and shows that effects decline steeply with time,ceasing to be important beyond approximately 80 minutes.

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