NCPA - National Center for Policy Analysis

Urbanization And Economic Growth

October 20, 2000

Cities are engines of growth in industrializing nations, say economists. High population density in urban areas brings about better-functioning labor markets, lower transportation costs, faster diffusion of knowledge, larger economies of scale in production and a critical mass of adjacent consumers. However, a recent study claims that while a certain level of population concentration is desirable, there can be excessive urbanization.

Looking at the growth of 80-100 countries from 1960 to 1995, the study determined what would be the optimal proportion -- in terms of fostering economic growth -- of a country's population to have living in metropolitan areas.

  • Cities produce 55 percent of the Gross Domestic Product (GDP) in poor nations and 85 percent in rich nations.
  • The optimal proportion of the population to have living in metropolitan areas is 15 percent in a poor country (per capita GDP of $1,000), 25 percent in a median-income country ($5,000), and 22 percent in a high-income country ($17,000).
  • Excessive or insufficient urban concentration of more than one standard deviation from the optimal level can lower annual growth by as much as 50 to 75 percent.

Too much urbanization creates traffic congestion, and higher costs for both production and living. Too little urbanization prevents the synergistic effects of economies of scale and a dense customer base. The author also notes that nations with highly centralized governments have excessive urban concentration, including Chile, Korea, Greece, Portugal and Ireland. Nations with insufficient urban concentration include Belgium, Malaysia and the former Yugoslavia.

Source: "Urban Concentration and Economic Growth," Economic Intuition, Summer 2000. Based on J. Vernon Henderson, "The Effects of Urban Concentration on Economic Growth," NBER Working Paper No. w7503, January 2000, National Bureau of Economic Research, 1050 Massachusetts Avenue, Cambridge, Mass. 02138, (617) 868-3900.

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