Manufacturing production in both developed and developing economies tends to be highly geographically concentrated in cities and industrial clusters. Firms are drawn together for a variety of reasons, mostly motivated by the desire to reduce the costs of transporting goods, people, and ideas. In Vietnam, for example, large firms are surrounded by thousands of small enterprises in two major industrial clusters near Hanoi and Ho Chi Minh City. In Africa, the "Suame Magazine" near Kumasi, Ghana is home to thousands of small metalworking firms. Arusha, Tanzania is the site of several clusters of furniture manufacturers. Empirical evidence shows that there are productivity benefits for firms that locate in clusters like these; these benefits are referred to as "agglomeration economies." However, not all firms benefit from agglomeration equally. As such, spatial industrial policies that influence the location choice of firms may be an effective tool in accelerating the pace of industrialization but also in ensuring an equitable distribution of the gains.
Drivers of agglomeration
Some geographic areas have obvious natural advantages that result in cluster formation. For example, proximity to a large port will attract exporting firms or areas rich in minerals will attract clusters of mining firms. In addition, there are three well-established reasons why firms choose locate in close proximity. First, the cost of transporting goods is reduced when firms are located close to their customers or suppliers. Input suppliers can exploit economies of scale in large clusters of downstream firms who, in turn, benefit from timely delivery and lower inventory costs. Second, when firms locate in a cluster, a pool of workers emerges, making it easier to hire new workers when labor demand increases and facilitating better matching of workers to jobs. Third, knowledge spillovers, in particular informal exchanges of ideas, are more likely when firms are in close geographic proximity. In a more dense concentration of economic activity, workers and entrepreneurs are more likely to learn from each other. Close proximity to competitors can facilitate information sharing or allow firms to engage in collective action to overcome common constraints such as contract enforcement.
Despite the importance of agglomeration for industrial development there is little evidence of the extent to which agglomerative forces are at work in developing country contexts. Through a...