Agglomeration and Co-Agglomeration of Services Industries

Economic research on industry location and agglomeration has focused nearly exclusively on manufacturing. This paper shows that services are prominent among the most agglomerated industries, especially at the county level. Because traditional measures of knowledge spillovers, natural resource inputs, and labor pooling explain little of agglomeration in services industries, this paper takes an alternative approach and looks at co-agglomeration to assess why industries cluster together. By considering the location patterns of pairs of industries instead of individual industries, the traditional agglomeration explanations can be measured more richly, and additional measures – like the need to locate near suppliers or customers – can be incorporated. The results show that co-agglomeration between pairs of services industries is driven by knowledge spillovers and the direct trading relationship between the industries, especially at the zip code level. Information technology weakens the need for services industries to co-agglomerate at the state level, perhaps because electronic transport of services outputs lowers the value of longer-distance proximity. These results are in sharp contrast to results for manufacturing, for which labor pooling contributes most to coagglomeration, and the direct-trading relationship contributes more to state-level coagglomeration. These differences between services and manufacturing are consistent with simple models of transport costs. * Thanks to Davin Reed for excellent research help and to seminar participants at PPIC and the Kiel Institute Workshop on Agglomeration and Growth in Knowledge-Based Societies for comments. Services now dominate the US and other advanced economies, but little is known about the location decisions that services firms make. Empirical work in economic geography has focused almost exclusively on manufacturing even though there are many reasons to expect that findings from research on manufacturing industries cannot be generalized to services industries. This paper extends research on agglomeration in manufacturing to services industries. Services are prominent among the most agglomerated industries, especially at the county level. After showing that the traditional explanations for manufacturing agglomeration explain little of the agglomeration in services industries, the paper proposes that co-agglomeration provides a richer way to explain location patterns in both manufacturing and services. The analysis reveals that several forces, including the need to be near suppliers and customers, contribute to co-agglomeration in services. There are significant differences between services and manufacturing, some of which can be explained by how transport costs in the two sectors differ. Advances in information technology appear to lower transport costs and discourage co-agglomeration for services over longer distances while reinforcing the benefits of geographic proximity at very short distances. Background Theoretical work explaining the micro-foundations of agglomeration has drawn primarily on manufacturing industries as examples and for inspiration. Marshall (1892) wrote down his explanations for why firms in an industry cluster in an era when manufacturing dominated the economy. Recent theoretical work, however, has pointed to