Agglomeration Economies: Microdata Panel Estimates from Canadian Manufacturing

This paper identifies the main sources of urban increasing returns, after Marshall. The geographical distance across which externalities flow is also examined. We bring to bear on these questions plant-level data organized in the form of a panel across the years 1989 and 1999. Plant-level production functions are estimated across the Canadian manufacturing sector as a whole and for five broad industry groups, each characterized by the nature of its output. The panel data overcome selection bias resulting from unobserved plant-level heterogeneity that is constant over time. A related set of estimates using instrumental variables allay persistent concerns with endogeneity. Results provide strong support for Marshall’s claims about the importance of buyer-supplier networks, labor market matching and spillovers. We show that spillovers enhance plant productivity within industries rather than between them and that these spillovers are highly localized.