Research: Agglomeration and firm-level efficiency Reply

Our Research posts are about the latest academic research being done in the School of Economics. This week:

AGGLOMERATION AND FIRM-LEVEL EFFICIENCY IN SOUTH AFRICA

by Waldo Krugell & Neil Rankin (Wits)

Economic activity has dimensions of density and distance.  Cities are characterised by external economies that benefit firms through access to a pool of labour and specialised suppliers of intermediate inputs.  Also, cities host spillovers from infrastructure and the sharing of ideas and technology, while home-market effects expand the process of agglomeration.  Our paper asks whether location can explain differences in the efficiency of South African manufacturers.  Understanding the significance of location may be important for the spatial inequality that characterises economic activity in South Africa and the implications that this has for policies and institutions.

Earlier research in South Africa has not examined location as an explanation of productivity at firm level.  On the one hand, research at firm level has focused mainly on the influence that exports and the regulatory environment have on efficiency.  Although many of these studies control for location, often in a broad sense at the provincial level, in their estimation procedures they do not specifically take the importance of location for firms’ efficiency into consideration.  On the other hand, research on the location of economic activity has examined the determinants of output growth, but at the level of regions.  This line of work did not extend the analysis to the level of the firms in those regions.  This paper combines the two approaches to determine whether agglomeration economies explain differences in output per worker at firm level.  Data from the 2003 and 2007 World Bank Enterprise Surveys provide firm-level information that can be combined with city-level data describing the location of the firms to test whether agglomeration explains efficiency.

The analysis consists of a description of the possible sources of agglomeration from the two firm surveys and a regression model of productivity and location that used the firm-level data and indicators of city-level agglomeration forces.  The description of the firm-level data provides tentative evidence of the existence of agglomeration economies per city and reflects the size and significance of the inland Gauteng economy.  The firms there are sellers of intermediate inputs, they hold fewer days of inventory, and are able to sub-contract production.  The firms in Gauteng employ more workers with higher levels of education and pay higher wages.  The results of the estimation of the regression models show that the firm-specific determinants of output are significant and the location-specific explanatory variables supported the notion that location does help to explain differences in the efficiency of manufacturers.  Across the two datasets, the size of the home market has a positive relationship with output per worker.  The share of exports in local value added is also positively related to productivity.  Manufacturing specialisation in a particular city was found to be negatively associated with efficiency.  This may indicate that firms are currently getting more benefits from diversity and urbanisation economies than from specialisation and localisation economies.

The key recommendation for further research is a call for dedicated firm-level surveys that investigate the sources of agglomeration economies from literature, namely intermediate inputs, the labour market, infrastructure and access to knowledge.  When policymakers know more about how firms are rooted in their local economies, it may guide the direction of policies at national, provincial and local level.  The 2009 World Development Report argues that markets shape the economic landscape, but spatially targeted interventions tend to dominate policy discussions.  The report argues that in the face of market forces such interventions tend to be inefficient.  Policymakers should rather focus on creating and supporting spatially blind institutions and spatially connective infrastructure.  This ties also ties in with the 2011 State of the cities report which emphasises the resilience of cities.  Local governments will have to be more responsive to the needs of residents and firms and this requires an integrated approach towards transport, housing and land-use.  The next round of South African research will have to focus on the distance over which agglomeration economies work.  That will, however, only be possible when everyone knows more about firms and their location.

The complete article has recently been published in Urban Forum, 23(3): 299-318.

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