Agglomeration Economies

By clustering in close proximity to one another, firms can lower their production costs. This fact forms the basis of agglomeration economies, or the benefits derived from clustering together, one of the most important forces shaping the economic geography of different types of production. By forming dense webs of production and embedding themselves within them, firms usually can produce more efficiently and profitably.

Agglomeration economies take several forms. Production linkages accrue to firms locating near other producers that manufacture their basic raw materials. By clustering, distribution and assembly costs are reduced. Service linkages occur when enough firms locate in one area to support specialized support services. For example, the advertising industry in New York is concentrated within a short distance of Madison Avenue. By locating near one another in dense networks, firms can monitor up-to-date information and gossip on the latest trends, markets, clients, hires, and products. Marketing linkages occur when a cluster is large enough to attract specialized distribution services. For example, the firms of the garment industry in New York City have collectively attracted advertising agencies, showrooms, buyer listings, and other aspects of finished product distribution that deal exclusively with the garment trade. Firms within the cluster have a cost advantage over isolated firms that must provide these specialized services for themselves.

Agglomeration economies may be temporary, are found to different extents in different industries, and may offset through various forms of economic, technological, and geographic change. Typically, agglomeration economies reflect some kinds of firms' need for close interaction with clients and suppliers. Thus, they are most pronounced in vertically disintegrated types of production in which firms have many linkages “upstream” and “downstream” in the production process. (In contrast, vertically integrated firms, with relatively few external linkages, are less dependent on agglomeration.) Firms in markets with low degrees of uncertainty (usually due to slow rates of technical change, market structure, or the regulatory environment), in contrast, are less reliant on agglomeration to minimize costs and maximize profits. As firms grow, they often become more vertically integrated and more capital intensive, have fewer external linkages, and come to substitute economies of scale for agglomeration economies.

Because agglomeration economies provide powerful incentives for firms to locate in close proximity to one another, they are most heavily manifested in large metropolitan areas. The prime motivation behind the agglomeration of firms in metropolitan regions is the ready access they offer to clients, suppliers, and ancillary services, most of which is accomplished through face-to-face interaction. Often personal relationships of trust and reputation are of paramount significance. Thus, agglomeration maximizes access to information, much of which is irregular and unstandardized, and helps firms to minimize uncertainty. Firms in these locations have an advantage, within limits, over similar firms in more rural areas. Cities provide markets, specialized labor forces and services, utilities, and transportation connections required by manufacturing. Urbanization economies, therefore, are a combination of production, service, and marketing linkages concentrated at a particular location. Agglomeration forms the basis for the comparative advantage[Page 3] of cities in forms of production that typically consists of relatively small, vertically disintegrated firms in highly competitive markets with high degrees of uncertainty and change.

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