Identifying Agglomeration Spillovers: Evidence from Winners and Losers of Large Plant Openings

We quantify agglomeration spillovers by estimating the impact of the opening of a large manufacturing plant on the total factor productivity (TFP) of incumbent plants in the same county. We use the location rankings of profit-maximizing firms to compare incumbent plants in the county where the new plant ultimately chose to locate (the “winning county”), with incumbent plants in the runner-up county (the “losing county”). Incumbent plants in winning and losing counties have similar trends in TFP in the seven years before the new plant opening. Five years after the new plant opening, TFP of incumbent plants in winning counties is 12% higher than TFP of incumbent plants in losing counties. Consistent with some theories of agglomeration economies, this effect is larger for incumbent plants that share similar labor and technology pools with the new plant. Consistent with a spatial equilibrium model, we find evidence of a relative increase in skill-adjusted labor costs in winning counties. This indicates that the ultimate effect on profits is smaller than the direct increase in productivity. Introduction In most countries, economic activity is spatially concentrated. While some of this concentration is explained by the presence of natural advantages that constrain specific productions to specific locations, Ellison and Glaeser (1999) and others argue that natural advantages alone cannot account for the observed degree of agglomeration. Spatial concentration is particularly remarkable for industries that produce nationally traded goods, because the areas where economic activity is concentrated are typically characterized by high costs of labor and land. Since at least Marshall (1890), economists have speculated that this concentration of economic activity may be explained by cost or productivity advantages enjoyed by firms when they locate near other firms. The potential sources of agglomeration advantages include: cheaper and faster supply of intermediate goods and services; proximity to workers or consumers; better quality of worker-firm matches in thicker labor markets; lower risk of unemployment for workers and lower risk of unfilled vacancies for firms following idiosyncratic shocks; and knowledge spillovers. The possibility of documenting productivity advantages through agglomeration is tantalizing, because it could provide insights into a series of important questions. Why are firms that produce nationally traded goods willing to locate in cities like New York, San Francisco, or London that are characterized by extraordinary production costs? In general, why do cities exist and what explains their historical development? Why do income differences persist across regions and countries? Beside an obvious interest for urban and growth economists, the existence of agglomeration spillovers has tremendous practical relevance. Increasingly, local governments compete by offering substantial subsidies to industrial plants to locate within their jurisdictions. The main economic rationale for these incentives depends on whether the attraction of new plants generates agglomeration externalities. In the absence of positive externalities, it is difficult to justify the use of taxpayer money for subsidies based on economic efficiency grounds. The optimal magnitude of incentives depends on the magnitude of agglomerations spillovers, if they exist. The existence and exact magnitude of agglomeration spillovers are considered open 1 See Duranton and Puga (2004), Glaeser and Gottlieb (2009), and Moretti (forthcoming) for recent surveys. 2 We discuss in more detail the policy implications of local subsidies in Greenstone and Moretti (2004). See also Card, Hallock, and Moretti (2007), Glaeser (2001), and Glaeser and Gottlieb (2008).