France economy

The economic benefits of cities in the developing world

Dulani Chunga moved from a safe, quiet but poor village in Malawi to Blantyre, the main business town, in hopes of changing her fate. He was drawn to the stories of streetlights, the opportunity to earn money and the chance to send his children to school. He lives in Ndirande, a huge slum with sordid conditions. Although his income is higher than that of his village, it is barely enough to feed his family of four – food and shelter cost a lot more in Blantyre.

The fortunes of many Dulanis are stuck in the trap of poor development in cities in developing countries. Yet there is growing evidence of the productivity benefits of living and working in dense cities, especially in developing countries. While the productivity benefits of density, measured as the elasticity of wages with respect to density, are significant for cities in developed countries – 0.043 in the United States and 0.03 in France – some recent estimates for countries developing countries are several times higher: 0.19 in China, 0.12 in India and 0.17 in Africa. What do these estimates tell us? A 10 percent increase in density increases productivity by 1.7 percent in Africa compared to 0.4 percent in the United States. These estimates seem implausible if we put Dulani’s experience into perspective. More generally, 54 percent of Africa’s urban population lives in slums and 38 percent in South Asia.

How to reconcile these elasticity estimates with reality? In a recent rough draft, we examine over 1,200 estimates of urban productivity from 70 studies covering 33 countries from 1973 to 2020. In addition, we have constructed new estimates to show how urban costs, with respect to crime, congestion and pollution, have changed with density. To do this, we collected data from hundreds of cities around the world, including several in developing countries.

A quick glance suggests high-agglomeration economies in developing countries

A quick glance at productivity estimates measured through wage premiums shows that they are on average nearly 5 percentage points higher in developing countries (Figure 1).

Figure 1. People in developing countries seem to enjoy city life more

Source: Agglomeration economies in developing countries: a meta-analysis.
To note: This figure calculates unweighted average wage elasticity estimates for each country using data on individual workers for the non-service sector (reflecting either the manufacturing sector or the economy as a whole). This includes two-thirds of developing country estimates. It reflects 271 raw elasticity estimates (144 in non-rich countries), aggregated across different studies with different methodologies.

A larger review tells a different story

A meta-analysis is a technique that helps explain differences in estimates between studies based on their attributes, including methodology, study period, etc. For example, studies estimating the benefits of agglomeration using nominal wages or labor productivity have elasticities that are 6.3 and 4.3 percentage points higher than those using total factor productivity (TFP) . This suggests that part of the wage premium is driven by higher capital intensity, perhaps the result of denser capital markets, in urban areas, rather than efficiency or spillovers per se.

Some studies also control whether skilled workers are attracted to dense cities which make them productive. These studies include controls on human capital such as an individual’s education, reducing agglomeration gains. Finally, econometric analysis, which uses fixed panel effects, thus controlling for the selection of the best workers or firms, lowers the estimates by around 1.8 percentage points. Once these study specificities are taken into account, the elasticity estimates for developing countries are only 1 percentage point higher than those for developed countries (Figure 2).

Figure 2. The agglomeration premiums on labor productivity almost disappear after controlling urban costs

Agglomeration bonuses on labor productivity almost disappear after controlling urban costs

Source: Agglomeration economies in developing countries: a meta-analysis.
Note: The figure uses a chord scale representation of a subset of the coefficients estimated from the meta-analysis model. The meta-analysis explores the factors (methodological, data-related, controls) that influence the estimates of agglomeration elasticity. The methodology of the meta-analysis minimizes the Bayesian information criterion. Using the standard errors of the coefficients, it also plots the 90 percent confidence intervals, where the standard errors are grouped at the study level. Similar estimated coefficients are obtained by model selection using the Akaike information criterion or Bayesian model mean methods.

Agglomeration bonuses should reflect the higher cost of working in cities (such as higher housing costs or time lost in transport) or compensation for urban inconvenience such as pollution and crime. But most empirical work ignores these costs. Our meta-analysis shows that studies controlling for urban costs would estimate the net benefits of agglomeration at 0.1% for high-income countries and 1% for low-income countries using labor productivity as the result. These results are consistent with French and Colombian data, suggesting that the net benefits of city size are close to being stable.

Our estimates of the extent of urban inconvenience in terms of pollution, congestion and crime suggest that urban inconvenience is highest in developing countries. For the average density of cities, in high-income countries, 19-30% less hours are spent in traffic jams, pollution is 16-28% lower, and the homicide rate is about four times lower. In particular, the elasticity of the homicide rate is positive and very high (24%) in developing countries and negative (56%) in developed countries. This suggests that if the urban costs of crime are taken into account, the magnitude of the net agglomeration elasticity in developing countries would be lower or even negative.

Are Cities in Developing Countries Different?

The results of our systematic meta-analysis and the cost elasticity estimates support Dulani’s point of view in the field. People in developing countries concentrate, but not because they reap the productivity benefits of urbanization. Cities in developing countries are generally dense but unproductive, and they are plagued by crime and polluted on top of that. This development is consistent with what has been called “premature urbanization”.

In the light of these observations, can we really hope that the migration of populations from villages to dysfunctional cities will lift them out of poverty? The experiences of China and South Korea suggest that cities become productive when urbanization is accompanied by industrial dynamism and a broader structural transformation of the national economy. Developing countries should focus on removing the distortions that limit the structural transformation that creates the impetus for spatial transformation. Only then will cities achieve economic density, higher productivity, and live up to the hopes of many more Dulanis to come.