Transport Investment and the Distance Decay of Agglomeration Benefits

Transport investments can induce positive productivity benefits via agglomeration economies by increasing the scale and efficiency of spatial economic interactions. In assessing the ‘agglomeration benefits’ of transport investments we need to understand the spatial scale over which these externalities are distributed. This report is concerned with the effect of urban agglomeration on productivity and with how agglomeration externalities diminish with distance from source. It draws on extensive firm level panel data to estimate the effect of access to economic mass on total factor productivity (TFP) for broad sectors of the economy. The econometric specification is based on a control function approach which addresses potential sources of endogeneity associated with the production function and with the agglomerationproductivity relationship, and which also allows for unobserved firm level heterogeneity. A non-linear least squares regression is used to provide a direct estimate of distance decay. The results show an overall agglomeration effect of 0.04 across all sectors of the economy. For manufacturing and consumer services we estimate an elasticity of 0.02, for construction 0.03, and for business services 0.08. The distance decay parameter is approximately 1.0 for manufacturing, but around 1.8 for consumer and business service sectors and 1.6 for construction. This implies that the effects of agglomeration diminish more rapidly with distance from source for service industries than for manufacturing. But the relative impact of agglomeration on productivity is larger for services than it is for manufacturing.