From Neighborhoods to Nations: The Economics of Social Interactions

By Yannis M. Ioannides | Go to book overview

CHAPTER 6
Social Interactions and Human Capital
Spillovers

6.1 INTRODUCTION

Locations where the population and the economic activity are most dense are almost always the most productive. Economists explain this as the product of two forces: one, people concentrate in areas where natural amenities and resources lead to high productivity; two, people are more productive in places where they are concentrated in space. A high density of people and firms generates urban production economies that make agglomeration productive. Urban production economies are external effects that benefit producers and workers. They have been described by Marshall (1920) as technological externalities due to knowledge spillovers and to sharing of inputs at the local level. Of course, the concentration of economic activity also has costs, urban production diseconomies such as congestion and pollution, that affect both producers and consumers. Wages, prices, and rents reflect agglomeration effects (Roback 1982). In large, dispersed economies each of the high concentrations of economic activity likely has its own individual character. Some are more friendly to firms, others are nicer places to live, and some are both. Each mix of characteristics appeals to particular types of people and firms (Gabriel and Rosenthal 2004).

Some facets of these phenomena are still not fully understood, theoretically and empirically. Still we do know that relatively weak agglomeration effects can explain many of these spatial differences in productivity. Firms’ investments in physical capital and choices of tradable intermediate inputs can amplify increasing returns to density as they dominate the effect of urban production diseconomies. Proximity itself can magnify these positive effects of city size by reducing shipping costs. It is inherently difficult to separate the effects of mere proximity from those of the externality due to city size, especially when economic decisions are reflected in market outcomes. Economic theory predicts and empirical work seeks to confirm that spatial concentration of economic activity actually causes higher productivity. Causality is generally quite hard to establish, and this chapter argues that a social interactions perspective can help to integrate many seemingly diverse approaches and findings in this area of economics.

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