n the well-established correlation between growth and agglomeration, it is not obvious whether growth spurs agglomeration or vice versa, or whether causality runs both ways. Another stylized fact of growth – the strong resemblance between the geography of production and the geography of innovation – is well illustrated by the role of cities in economic growth and technological progress. A good example of the tendency for innovative activity to be even more spatially concentrated than production itself is afforded by the computer industry and Silicon Valley.

In Discussion Paper No. 1529, Philippe Martin and Gianmarco Ottaviano construct a model which is consistent with these two stylized facts and illustrates some of the economic mechanisms behind them. In their model, growth and geographic agglomeration of economic activities are mutually self-reinforcing processes. Industrial agglomeration in one location spurs growth, because it reduces the cost of innovation in that location through a pecuniary externality due to transaction costs. Growth fosters agglomeration because, as the sector at the origin of innovation expands, new firms tend to locate close to this sector. The model can be interpreted as illustrating one mechanism behind the emergence of cities seen as centres for production and innovation, and is consistent with the episodes of simultaneous increases in growth rates and spatial agglomeration.

Growth and Agglomeration
Philippe Martin and Gianmarco I P Ottaviano