The Productivity of Cities

Author(s): Leo Sveikauskas

Source: The Quarterly Journal of Economics, Vol. 89, No. 3 (Aug., 1975), pp. 393-413
Published by: Oxford University Press
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 THE PRODUCTIVITY OF CITIES *

LEO SVEIKAUSKAS

I. The increase in productivity with city size, 393. -I. The labor pro-
ductivity of cities, 396.- III. The contributions of Hicks-neutral productivity
and capital intensity, 401.- IV. The direction of causality, 406.- V. Conclu-
sions, 410. Appendix A: choice of the industries included in this study, 411.-
Appendix B: evidence relating to the capital-labor ratio in cities of different
size, 412.

Why are modern economies so highly urbanized, despite much

concern about the disamenities of city life? This paper examines one
possible reason for the prevalence of large cities; we consider the
possibility that productivity may be systematically higher in large
urban centers.' The empirical evidence indicates that a doubling of
city size is typically associated with a 5.98 percent increase in labor
productivity. These productivity gains are likely to be a central
influence on the existence and prevalence of large cities.

I. THE INCREASE IN PRODUCTIVITYWITH CITY SIZE

As a city grows in size, both static and dynamic factors can be

expected to increase productivity. In the static sense a larger city
permits more specialization and a greater division of labor and thus
brings about an increase in productivity. There are many different
levels at which this specialization may be important. Economies of
scale may be fundamentally related to average plant size, to average
industry size, to the total volume of economic activity, or to various
combinations of these factors.2
However, in my judgment, the more important productivity
advantages of cities are probably not the static advantages of

*The analysis in this paper does not represent the conclusions of the
Bureau of Labor Statistics. Most of this paper was written at Michigan State
University.
1. The Standard Metropolitan Statistical Area is used throughout this
paper as clearly a preferable measure of a city to the central city. Of course,
a strong argument can be made for the urbanized area concept of a city, but
the SMSA measure is used in this paper because productivity information
is available only for SMSA's.
2. Attempts to determine the degree to which urban productivity is due
specifically to higher average plant size, larger industry size, or a greater
volume of economic activity have not proved successful. The available data
are not precise enough to isolate the effect of each of these influences. Of course,
some of these concepts of scale may be important for dynamic reasons as well
as in a static sense.

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394 QUARTERLY JOURNAL OF ECONOMICS

specialization, but rather the dynamic benefits of urban concentra-

tion. Cities are centers of activity where business is concentrated.
The new impressions and new ideas that are the heart of technologi-
cal progress are probably most likely to occur in such a setting.
The dynamic advantages of cities can perhaps be understood
more clearly when it is remembered that our society and our culture
and economy are in a rapid state of change. Creativity, or the suc-
cessful adaptation to change, can be thought of as the rearrange-
ment and recombination of hitherto separate elements. If this is the
nature of successful response to change, it is important for those
who are to cope with and manage change to be exposed to as many
different impressions and stimuli as possible so as to be able to
recombine these elements most effectively for the future. Allen
Pred and Jane Jacobs have stressed these dynamic advantages of
cities, and Higgs has presented empirical evidence indicating that
patents have historically been more frequent in urban areas. Mera
has also considered the productivity advantages of urbanization.3
We shall summarize the potential stimuli and learning impres-
sions of a city, together with the degree to which the static advan-
tages of specialization may work themselves out, by SMSA popula-
tion.
The remaining discussion of this section outlines the produc-
tion function framework used. Each two-digit manufacturing in-

3. Much of the work of Pred and Jacobs stresses the dynamic advantages
of diversity and communication. See A R. Pred, The Spatial Dynamics of
UJ.S. Urban-Industrial Growth, 1800-1914 (Cambridge: MIT Press, 1966); and
J. Jacobs, The Economy of Cities (New York: Random House, 1969). Higgs's
work is presented in R. Higgs, "American Inventiveness, 1870-1920," Journal of
Political Economy, LXXIX (May-June 1971), 661-67.
K. Mera ("Urban Agglomeration and Economic Efficiency," Economic
Development and Cultural Change, XXI (Jan. 1973), 309-21) has recently
shown that productivity is higher in areas in which population is more dense.
The Mera work is conducted in a production function context and so is most
closely similar to the present paper.
The present article differs from Mera's work in the following respects.
First, we use SMSA population as a city size variable, rather than population
density. This is a better focused and sharper measure of city size than Mera's
density concept, which applies more closely to regional data. In particular,
SMSA population is a much more appropriate concept of city size than density
in the United States, where different cities have developed relying on different
modes of transportation. Second, and related to the choice of the city size
variable, we are to obtain more specific and more easily interpreted econo-
metric estimates of the productivity benefits associated with production in
large cities. Third, the present work investigates urban productivity by ex-
amining the production function at an extremely disaggregate level as is the
usual procedure, for sound reasons, in the study of technological matters.
Finally, the present paper includes explicit analysis of labor quality and re-
gional price differences and is of course based on United States data.

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 THE PRODUCTIVITY OF CITIES 395

dustry is studied by a cross section in which the observations are

individual city values.4 Data are for 1967.
Consider a particular two-digit industry in which each city
faces a production function of the form,
(1) Q-=gj(dKj-1+(1-d)L-t)-11teuoi.
Q is output, K is capital input, and L is labor input. d is the distribu-
tion parameter and 1/(1+t) =s, the elasticity of substitution. g
is Hicks-neutral productivity. i runs from 1 to n, where n is the
number of cities for which data are available in the industry. As the
subscripts imply, d and t are assumed to be the same for all cities
in the industry, but gi differs from city to city.5 euot is the random
element in the production function.
The main argument of the initial paragraphs of this section,
that productivity increases with city size, can be expressed formally
as
(2) log gi =a+b log Popi+u i,
where Pop, is the population of the SMSA in question, uji is a random
term, and b is hypothesized to be significantly greater than zero.
No information on capital in the various cities is available, so
it is difficult to estimate the production function outlined in equa-
tions (1) and (2). The obvious way of analyzing the model might
appear to be through a slight modification of the method outlined
in Arrow, Chenery, Minhas, and Solow.6 Equating the marginal
product of labor to the wage rate and rearranging terms gives
w
(3) log( 2 sflog (1-d)+(s-1) log gi
+ (1-s) log wi+random term.
V is value added, used as a measure of output, and w is the wage
rate. Substituting equation (2) in equation (3) gives

(4) log( s log (1-d ) + (s-1) a+ (s-1) b log Pope

+ (1-s) log wi+random term.
4. N. Kaldor ("The Case for Regional Policies," Scottish Journal of
Political Economy, XVII (Nov. 1970), 340) has stressed that manufacturing is
particularly important in the process of urbanization.
5. The production function in equation (1) is written with constant re-
turns to scale. Thus, any economies of scale to the industry are assumed to be
included in the gi term.
6. K. J. Arrow, H. B. Chenery, B. S. Minhas, and R. M. Solow, "Capital-
Labor Substitution and Economic Efficiency," Review of Economics and Sta-
tistics, XLIII (Aug. 1961), 225-48, especially p. 244. This method of estima-
tion is emphasized in the discussion because some readers have suggested that
this was the appropriate method of estimation. Equation (3) of this paper is
equation (34) of the ACMS article.

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396 QUARTERLY JOURNAL OF ECONOMICS

Clearly a regression based on equation (4) could provide estimates

of -b (1-s) and of (1-s) from the coefficients of log Popi and
log wi.
However, estimation of the elasticity of substitution from equa-
tion (3) or equation (4) depends on the assumption that gi is inde-
pendent of wi. Sveikauskas 7 has demonstrated that gi is related to
wi among statewide data for United States manufacturing; estimates
of the elasticity of substitution from the log (V/L) vs. log (w)
relationship that ignore the connection between g and w are shown
to be subject to serious bias. This same source of bias is also apt
to invalidate estimates of b and s obtained from equation (4) and
metropolitan data.
Because of the unreliability of equation (4), we examine instead
the productivity of cities in a different way. Section II first estab-
lishes that labor productivity is in fact systematically higher in
large cities. Then Section III uses the CES framework outlined
above to consider the different possible combinations of Hicks-
neutral productivity or capital intensity, which could bring about
the observed labor productivity advantage of cities.

II. THE LABORPRODUCTIVITY OF CITIES

The most direct way of establishing the labor productivity
advantages of large cities might appear to be through regressions
relating log (V/L)i and log Popi. However, because labor quality
generally increases with city size, it is necessary to allow for this
effect by also including a labor quality term in the analysis. Thus,
the equation examined is
(5) log (V/L)i=a+b log Popi+c log Educi+random term,
in which Educ is the median years of education completed by per-
sons aged twenty-five or over within each metropolitan area and is
included as an index of labor quality. The coefficient of central in-
terest is b, which is hypothesized to be significantly greater than
zero. This coefficient expresses the percentage increase in labor
productivity that is associated with a doubling of city size.
Table I presents empirical results based on equation (5) for
fourteen industries in 1967.8 The coefficient b is significantly greater
7. L. A. Sveikauskas, "Bias in Cross-Section Estimates of the Elasticity
of Substitution," International Economic Review, XV (June 1974), 522-28.
8. Data used are as follows:
From the U. S. Department of Commerce, Bureau of the Census, 1967 Census
of Manufactures, state volumes, Table 6:
V=value added by manufacture

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 THE PRODUCTIVITY OF CITIES 397
TABLE I
THE EFFECT OF CITY SIZE AND EDUCATION ON PRODUCTIVITY

b c Number
r2 of obser-
Industry a Coefficient t ratio Coefficient t ratio corrected vations

20 -0.47 0.0752 3.95+ 0.95 3.11+ 0.12 212

22 -0.08 .0454 1.41 0.59 0.94 .03 66
23 0.05 .1238 5.75+ 0.42 0.92 .23 130
24 0.37 .0967 4.17+ 0.39 0.66 .15 111
25 -1.99 .0495 2.03+ 1.42 2.03+ .09 91
27 -1.53 .0546 3.91+ 1.33 3.92+ .15 198
30 1.23 .0495 1.85+ 0.16 0.25 .02 86
31 0.97 .0668 2.66+ 0.12 0.26 .14 41
33 1.28 .0252 1.07 0.25 0.45 .00 93
34 -1.06 .0211 1.18 1.16 2.87+ .06 162
35 -1.39 .0535 2.86+ 1.27 2.69+ .09 167
36 0.30 .0503 1.91+ 0.58 1.07 .04 101
37 -2.35 .0997 4.24+ 1.60 2.69+ .26 87
38 -2.09 .0838 2.21+ 1.49 1.10 .12 53

+ Significantly greater than zero at the 95 percent level.

Source: Regressions of the form log (V/L),=a+b log Pop,+c Log Educ, as in equation
(5).

than zero, at the 95 percent level, in eleven of the fourteen industries

considered.9 The implied effect of city size on productivity is very
great; the average unweighted value of b in the fourteen industries
is 0.0639, which means that productivity increases 6.39 percent each
time a city doubles in size. When one recalls that cities double in
size almost eight times between the 50,000 population, which char-
acterizes the lower limit of an SMSA, to the New York SMSA, the
implied productivity gains due to the process of urban agglomera-
tion are extremely substantial.
Education is a significant influence on productivity in only six

L= manhour input, defined as production worker manhours+ ((all

workers-production workers) times 2,000)
w=payroll divided by L.
From the U. S. Department of Commerce, Bureau of the Census, 1970 Census
of Population, state volumes, Table 40:
Pop=Population in each SMSA
Educ= Median education of persons aged twenty-five or over.
The labor input concept used above is often used in production function
studies. No information is available on the administrative and auxiliary labor
employed in each industry-city. Omission of such personnel may overstate the
productivity of cities somewhat, since such workers are often concentrated in
larger cities. We believe that this bias may be somewhere in the range of 1.0
percent.
9. The fourteen industries included, and the reasons for their choice, are
discussed in Appendix A.

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398 QUARTERLY JOURNAL OF ECONOMICS

of the fourteen industries. However, c, the coefficient of education,

is positive in all fourteen cases. In addition, the relatively weak
performance of the education variable is consistent with the con-
clusions of earlier work.'0 The corrected r2 in Table I is typically
quite low. In many industries, V/L is exceptionally high or low for
some individual cities; such extreme observations tend to reduce r2.
In our judgment, much of this extreme variation in V/L results from
product-mix differences. An individual city can easily come to
specialize in especially productive or unproductive commodities
within a specific industry." Nevertheless, behind all this variation
the effect of city size expresses itself quite clearly and strongly.'2
The analysis so far has implicitly assumed a national market in
manufacturing, so that output price is the same throughout the
country. If output price is the same nationally, value added is an
indication of output, and V/L can be used as an indication of pro-
ductivity.'3
10. S. M. Besen, "Education and Productivity in U. S. Manufacturing:
Some Cross-Section Evidence," Journal of Political Economy, LXXVI (May-
June 1968), 494-97. Besen found the coefficient of education significantly greater
than zero, at the 95 percent level, in six of eighteen industries.'
11. Chapter V of L. A. Sveikauskas, "Capital-Labor Substitution and
Economic Efficiency in U. S. Manufacturing," Ph.D. thesis, Yale University,
1969, shows that productivity often varies widely among the three-digit and
four-digit components of each two-digit industry. However, it is not possible
to examine the effect of product-mix variation in detail because disaggregate
data do not exist for each SMSA.
12. Location theory has frequently stressed the development of hierarchies
of cities in which larger cities perform specialized services for smaller nearby
areas. See, for example, M. J. Beckmann, "City Hierarchies and the Distribu-
tion of City Size," Economic Development and Cultural Change, VI (1957-
1958), 243-48. This train of thought suggests that there might be systematic
product-mix differences between cities of different sizes.
We have tried to minimize the effect of product-mix variation by study-
ing the most disaggregate data available. No doubt concentration on two-
digit manufacturing industry does succeed in removing much of the differences
in the structure of production between cities at various stages of the urban
hierarchy. However, much product-mix variation probably remains even in
these two-digit data. Therefore, it is entirely possible that some of the ob-
served advantages of large city urban production arise from a tendency for
such areas to specialize in particularly productive subcommodities.
If the opportunity to specialize in particularly productive commodities
turns out to be a central source of urban productivity, than a city's position
in the urban hierarchy, which determines the pattern of specialization, becomes
the dominant influence on productivity instead of merely city size. This is
an important distinction that bears future empirical examination. However,
such a study would require either a hierarchical ranking of all United States
SMSA's or data at such a fine level of disaggregation that specialization differ-
ences cease to be a problem. Neither of these types of information is now
available.
13. Value added might also give a misleading impression of output if
there are systematic regional differences in raw materials prices. We note that
the same procedure followed in the text to guard against the possibility of

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 THE PRODUCTIVITY OF CITIES 399

However, Weiss has concluded, "Manufactured goods seem

generally to sell on broad markets, though only a minority are un-
equivocably national in scope. The more typical markets extend
over a half, a third, or a quarter of the country." 14 These findings
suggest that output prices may vary in different regions of the
country. Some readers of this paper have suggested, for example,
that output prices may be lower in the South and that cities may also
be smaller in the South. In this event the increase in V/L with city
size may partially reflect the presence of low-price small Southern
cities.
We have examined this possibility by dividing the country into
four areas, the East, Midwest, South, and West in line with Weiss's
suggestion that there may be as many as four regional markets.15
Then equation (5) is supplemented by regressions of the form,
(6) log (V/L) i = a+ b log Popi+ c log Educi
+ dDE!+ eDMWj+fDe) ,
in which DE is a dummy representing the East, DMW is a Midwestern
dummy, and Dw is a Western dummy. Southern productivity is in-
cluded in the constant term.
Table II shows, however, that the inclusion of regional dummies
does not substantially alter conclusions regarding the effect of city
size on productivity. The coefficient of population from equation
(6) is still significantly positive in the same eleven industries as in
Table I. Furthermore, the implied productivity effect of a doubling
of city size only decreases slightly, from 6.39 percent in Table I to
5.98 percent in Table II. This evidence clearly shows that the ob-
served productivity advantages of cities are essentially not a proxy
for regional differences in prices or productivity.
We note that the coefficient of education is more affected by the
regional dummies than the population effect. Education is significant
in only three of fourteen industries in Table II, as compared to six
cases in Table I. The regional dummies, d, e, and f frequently show
that V/L is significantly higher in areas outside the South. How-
ever, detailed discussion of regional differences in production extends
beyond the main line of development in this paper.
regional differences in output price also serves to remove the impact of possible
regional differences in the price of raw materials.
14. L. W. Weiss, "The Geographic Size of Markets in Manufacturing,"
Review of Economics and Statistics, LIV (Aug. 1972), 253.
1.5. The states included within each region are the same as used in con-
sumer budget studies, such as J. C. Brackett, "New BLS Budgets," Monthly
Labor Review, XCII (April 1969), 3-16.

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400 QUARTERLY JOURNAL OF ECONOMICS

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 THE PRODUCTIVITY OF CITIES 401

III. THE CONTRIBUTIONS OF HICKS-NEUTRAL PRODUCTIVITY

AND CAPITAL INTENSITY

We now consider the possible combinations of Hicks-neutral

productivity advantage or higher capital intensity that could gen-
erate the higher labor productivity found in large cities. Rewriting
the production function of equation (1) 16 gives
(7) (VIL)i= gi(d (KIL) j-P+ (1 -d) ) -1.
We utilize estimates of s from a previous paper 17 to investigate the
different combinations of g and K/L that could bring about the
V/L advantages of cities.18
Table III lists various combinations of increases in g and in-
creases in K/L that could generate the observed V/L advantages
of large cities. The fifth entry in each batch of possibilities lists the
increases in K/L that are necessary to account for the V/L advan-
tages of cities if there is no g increase. The increase in K/L, which is
needed under these circumstances, is very considerable. If s = 0.9,
K/L would on the average have to be 14.9 percent higher with each
doubling of city size to account for all the V/L increase that occurs
with such population differences.19 Of course, if s is assumed to be
lower than 0.9, even more substantial increases in K/L would be
necessary to bring about the requisite V/L increases.
Table III clearly indicates that, if capital intensity alone is to
explain the observed high labor productivity of large cities, ex-
tremely large increases in the capital-labor ratio with city size are
necessary. Can such extreme increases in K/L, of the magnitude

16. The error term in the production function is not included because the
subsequent discussion refers to overall differences in city size rather than to
individual observations of the production function.
17. Sveikauskas, "Bias in Cross-Section Estimates of the Elasticity of
Substitution."
d is obtained from the marginal productivity side condition,
w 1-d1K\'t 1
-=1-i ~~or d
r d L or 1+((Wlr)I(KIL)'+')
r is the price of capital. w, r, K, and L all refer to industrywide values in this
note. In the present study r is defined by including all elements of Census
value added except wages and supplements in the capital share. "Capital"
therefore includes such items as inventories, working capital, and those pur-
chased inputs included in Census value added as well as plant and equipment.
In terms of the results given in Table III, it would take a 15 percent increase
in all of these items, and not just plant and equipment, to generate the ob-
served labor productivity patterns. All data are from the 1967 Census of
Manufactures and the 1968 Annual Survey of Manufactures.
18. Since the CES function is nonlinear in KIL, the effect of capital
deepening is evaluated at the industrywide average value of KIL.
19. This 14.9 percent figure is computed from Table III.

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402 QUARTERLY JOURNAL OF ECONOMICS

TABLE III
DIFFERENT COMBINATIONS OF INCREASES IN 9 AND IN K/L THAT COULD ACCOUNT
FOR THE OBSERVED V/L OF CITIES

Corresponding implied K/L increase if:

Industry g increase s=0.9 s=0.7 s=0.5
20 7.5 0 0 0
5.6 3.3 3.3 3.3
3.8 6.6 6.6 6.7
1.9 10.0 10.1 10.2
0 13.4 13.5 13.8
22 1.9 0 0 0
1.4 1.2 1.2 1.2
1.0 2.4 2.4 2.4
.5 3.6 3.6 3.6
0 4.8 4.8 4.8
23 12.1 0 0 0
9.1 7.9 8.0 8.1
6.1 16.3 16.5 17.0
3.0 25.0 25.7 27.0
0 34.2 35.4 38.0
24 8.0 0 0 0
6.0 5.4 5.4 5.5
4.0 10.9 11.1 11.3
2.0 16.7 17.0 17.5
0 22.7 23.2 24.3
25 4.7 0 0 0
3.5 2.9 3.0 3.0
2.4 5.9 6.0 6.0
1.2 9.0 9.1 9.2
0 12.1 12.3 12.5
27 5.6 0 0 0
4.2 3.1 3.1 3.1
2.8 6.2 6.2 6.3
1.4 9.4 9.5 9.6
0 12.6 12.8 13.0
30 5.5 0 0 0
4.1 3.1 3.1 3.1
2.7 6.2 6.2 6.3
1.4 9.4 9.5 9.6
0 12.6 12.8 13.0
31 6.0 0 0 .0
4.5 3.9 3.9 4.0
3.0 7.9 8.0 8.1
1.5 12.1 12.2 12.5
0 16.3 16.6 17.1
33 1.9 0 0 0
1.4 1.1 1.1 1.1

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 THE PRODUCTIVITY OF CITIES 403
TABLE III (continued)
Corresponding implied K/L increase if:
Industry g increase s=0.9 s= 0.7 s== 0.5

.9 2.2 2.2 2.2

.5 3.3 3.3 3.3
0 4.4 4.4 4.4
34 1.8 0 0 0
1.4 1.1 1.1 1.1
.9 2.2 2.2 2.2
.5 3.3 3.3 3.3
0 4.4 4.4 4.4
35 5.4 0 0 0
4.1 3.2 3.2 3.2
2.7 6.5 6.5 6.6
1.4 9.8 9.9 10.0
0 13.2 13.3 13.7
36 5.0 0 0 0
3.8 3.1 3.1 3.1
2.5 6.3 6.3 6.4
1.3 9.5 9.6 9.8
0 12.9 13.0 13.3
37 10.2 0 0 0
7.7 6.8 6.9 6.9
5.1 13.9 14.1 14.5
2.6 21.4 21.8 22.8
0 29.2 30.0 31.9
38 8.1 0 0 0
6.0 4.0 4.0 4.0
4.0 8.0 8.1 8.2
2.0 12.2 12.3 12.5
0 16.4 16.7 17.1

This table shows the different combinations of increases in g and in KIL that could ac-
count for the VIL increase observed with a doubling of city size. All figures are expressed
in terms of the percentage increase in each variable. The VIL increases are those found in
Table II.

of 15 percent with a doubling of city size, be expected as a result of

the higher wages paid in large cities?
We analyze the higher wages paid in large cities, and their
effect on the capital-labor ratio, in the following fashion. First, by
an analysis parallel to that conducted in equation (6), the increase
in money wages with city size can be determined from regressions
of the form,
(8) log w,=zza+b log Popi,+c log Educi+dDEf
+ eDMwf+fDwj,
in which b expresses the increase in money wages with city size.

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404 QUARTERLY JOURNAL OF ECONOMICS

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 THE PRODUCTIVITY OF CITIES 405

Table IV, based on equation (8), shows that money wages in-
crease significantly with city size in eleven of the fourteen industries.
The implied average increase in wages with city size is 4.77 percent
with each doubling of city size.20
What increase in capital intensity do these wage increases im-
ply? The increase in K/L implied by the higher wages paid in larger
cities can be determined from

(9) (K/L)=( W )B

WA is the wage paid in a large city, and WB is the wage paid in a

smaller city one half the size of the first city. Consequently, the
ratio of factor costs in the first city to factor costs in the second,
WA . 21

WB

WA

WB

in which b is the coefficient from equation (8). The ratio of K/L in

the two cities, from equation (9), is therefore
(K/L)A = (l+b)s,

so the percent increase in K/L with city size, for any value of s, is

(10) (K/L)A -1.0 = (1 +b)s 1.0.

(K/L)B
Table V shows the percent increase in K/L with city size, as
determined from equation (10). The higher wages paid in cities
would typically increase K/L by about 2 to 6 percent with a dou-
bling of city size. However, this implied increase in K/L is typically
nowhere in the neighborhood of the 15 percent increase in capital
intensity that would be necessary to explain the observed increases
in V/L. Only in industries 22, 33, and 34 is the implied K/L increase
20. W. D. Nordhaus and J. Tobin (Economic Growth, New York; Na-
tional Bureau of Economic Research, 1972, pp. 47-56) have recently investigated
the increase in incomes with urbanization as an indication of the disutility of
city life. Mera, op. cit., has also studied the increase in wages with city size.
As these authors point out, the observed relationship between income and city
size reflects both the inconvenience and the productivity of cities, and so cannot
be identified solely with either one of these factors.
21. The increase in relative factor costs with city size is assumed to be
the increase in money wages. If capital costs are systematically higher in those
areas where wages are higher, as seems possible, then the ratio of labor to
capital costs will increase less rapidly with city size than wages do. Conse-
quently, the assumption of equation (9) may overstate the degree to which
KIL increases with city size. Since the main point of the discussion is that even
such an artificially high figure has little impact, this error does not affect the
basic conclusion.

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406 QUARTERLY JOURNAL OF ECONOMICS

TABLE V
PERCENTAGE INCREASES IN KIL IMPLIED BY THE W INCREASES WITH CITY SIZE
FOUND IN TABLE III

Industry S=0.9 s = 0.7 s_0.5

20 3.9 3.0 2.1

22 1.8 1.4 1.0
23 6.9 5.3 3.8
24 5.0 3.9 2.8
25 4.8 3.7 2.6
27 5.5 4.2 3.0
30 2.8 2.2 1.5
31 3.8 2.9 2.1
33 1.1 0.8 0.6
34 2.0 1.5 1.1
35 4.5 3.5 2.5
36 6.4 4.9 3.5
37 7.7 5.9 4.2
38 4.1 3.2 2.3
Source: Determined from equation (10), multiplied by 100.

due to higher wages in the vicinity of the K/L needed to generate

a sufficient increase in V/L.
Conceivably, KIL may be higher in large cities not because
of any response to factor costs but because the types of subcom-
modities produced in large cities, for essentially other reasons, are
strongly capital-intensive. Such a situation would go beyond the
present model, in which the CES parameter d is assumed the same
for all producers in an industry. In addition, since no actual data
on K/L in cities of various sizes are available, it is difficult to analyze
this possibility.22

IV. THE DIRECTION OF CAUSALITY

The evidence discussed above has shown that larger city size is
associated with substantially higher productivity. However, the
observed relationship between city size and productivity could come
about either because city size itself causes productivity to be high or
because individual cities systematically grow to large size because
22. Appendix B briefly examines the rough and incomplete evidence
bearing on the capital intensity of production in cities. We find no evidence
that the capital-labor ratio is appreciably higher in large cities. However, the
data are not reliable enough to support definite conclusions on the possibility
that KIL is systematically higher in large cities because such areas specialize
in strongly capital-intensive subproducts.

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 THE PRODUCTIVITY OF CITIES 407

they are already more productive. Under either the city size to
productivity chain of causation or the high productivity to city
size direction of causality, productivity would still be a fundamental
factor in the growth of large cities. However, there are important
policy differences between these two interpretations. If size brings
about productivity, investments in mass transit, which permit city
growth, would bring about important external economies in the
form of higher productivity. Similarly, much local boosterism in the
form of growth orientation would become rational behavior. On
the other hand, if high productivity leads to city growth, such pro-
ductivity benefits would not accrue to urban expansion.
In reality, large cities are probably productive both because of
their high initial productivity and because of the productivity
benefits derived from the growth process. Ideally we would investi-
gate the record of city growth over a very long time period and de-
termine how much of the observed high productivity of large cities
is innate and how much is obtained due to the growth process. How-
ever, information on SMSA productivity is only available for a
large number of SMSA's since 1954, and the industrial reclassifica-
tion revisions of 1958 mean that fully reliable information exists
only for 1958-1967. Because of these data limitations, we clearly
cannot expect to determine the degree to which high productivity
causes urban growth, or the converse, with any sort of precision.
However, we will examine the 1958-1967 data in an attempt to gain
some tentative evidence on this question.23
Figure I illustrates some different possible patterns of urban
growth over time. ABC represents the increase in productivity with
city size as shown by equation (5). XD represents an SMSA with
population of one million. Assume that a particular large city of this
size has productivity BD.

23. Future studies of urban growth will have to examine SMSA develop-
ment through a simultaneous system including equations describing industrial
expansion, migration, and wage determination. For a first step in this direction,
see J. M. Mattila and W. R. Thompson, "Towards an Econometric Model of
Urban Economic Development," pp. 63-80, in H. S. Perloff, and L. Wingo,
Issues in Urban Economics (Baltimore: Resources for the Future, Johns
Hopkins Press, 1968).
We do not attempt to construct such a model as part of the present paper.
Instead we are essentially concerned with demonstrating that any such com-
prehensive model of urban growth will eventually have to include productivity
factors in a central role.
The direction of causality in the city size-productivity relationship will
probably be finally resolved only when such a complex model of urban develop-
ment is studied with data extending over a long time period. The analysis of
Section IV represents merely a first step towards considering a few potentially
important elements of urban development over time.

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408 QUARTERLY JOURNAL OF ECONOMICS

F L -

X H D
log (Pop)
FIGURE I
Some Different Possible Patterns of Urban Growth Over Time

ABC was of course lower in earlier periods of time, since pro-

ductivity increases over time. To simplify the analysis, however, we
abstract from this factor and assume that ABC also expresses the
productivity of cities in earlier years. In other words, ABC ex-
presses productivity relative to some industry average.
The city XD, with population one million, is assumed to have
had a smaller population, XH, in earlier years. At this earlier stage
the city might already have enjoyed productivity HF, which would
mean it had already reached its relatively high level of productivity
and probably grew essentially because of this high productivity.
Alternately, productivity in these early years could have been only
HA, in which case the city probably grew essentially for reasons
other than prior high productivity. Finally, of course, high pro-
ductivity could result from a combination of high initial productivity
and city growth, as implied by GB.
We first examine the possibility that cities that are about to
grow to large size start out initially already at their high levels of
relative productivity. Thus, growth occurs along FB of Figure I.
If this is the case, one can expect that there will be some smaller
cities with major metropolitan levels of productivity (defined as
productivity equivalent to that found in cities with a population of
one million) and that these smaller centers will be growing rapidly
into major cities.
In 1967, 66 percent of the industry-city observations in cities

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 THE PRODUCTIVITY OF CITIES 409

with a population of one million or more possessed major metropoli-

tan levels of productivity, defined as V/L equivalent to that pre-
dicted by equation (5) with a population of one million. In the same
year productivity information was available (for four or more in-
dustries) for 140 smaller SMSA's in which 1970 population was less
than one million. However, only fifteen of these 140 smaller SMSA's
possessed productivity advantages equivalent to those obtained by
the major metropolitan centers (in the same sense that V/L exceeded
the levels implied by equation (5) with a population of one million
in two thirds or more of the industries). In addition, population
in these fifteen productive smaller SMSA's increased an average of
only 15.2 percent from 1960 to 1970, as compared to the national
SMSA population growth of 15.1 percent.
In terms of Figure I there are relatively few cities along the
FB path, and even those cities along this path do not appear to be
growing especially rapidly. This evidence provides little support
for urban growth along the FB path and thus, indirectly, suggests
that at least some of the high productivity found in large cities
comes about because of the process of urban growth, as lines GB
or AB would indicate.
We have also explored the city size-productivity relationship
by comparing 1958-1967 productivity changes with 1960-1970 pop-
ulation changes.24 Over a time period as short as a decade, however,
even a 10 percent difference in the rate of population growth, which
is considerable, cannot be expected to have much productivity im-
pact; for example, with the 6 percent coefficient from Section II,
such a population increase would increase productivity only 0.6
percent, which can hardly be expected to be noticeable.
We have also explored the city size-productivity relationship
trends over the decade by concentrating on two different groups of
SMSA's, fast-growing cities (defined as those in which population
grew more than 30 percent from 1960 to 1970) and slow-growing
cities (in which population declined). Information is available for
102 industry-city observations from among the fast-growing group;
on the average, these observations are associated with a 39 percent
population increase. In 1958 V/L for these 102 cases was 97.8 per-
cent of the average value of V/L (normalized by industry).25 By
24. Population figures are from the 1960 and 1970 Census of Population.
Data from the 1958 and 1967 Census of Manufactures are regarded as com-
parable with these population figures, although the years involved are not
precisely the same and in fact the manufacturing data refer to only a nine-year
time span. (Preliminary figures were used for 1970 population.)
25. The text compares the rate of growth of productivity in fast- and

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410 QUARTERLY JOURNAL OF ECONOMICS

1967 V/L for these observations had increased to 100.3 percent of

average V/L, which represented a 2.6 percent gain in relative pro-
ductivity.
Similarly, information is available for sixty-three industry-city
observations from the declining areas; on the average, these observa-
tions are associated with a 3 percent population decline. In 1958
V/L for these sixty-three areas was 95.4 percent of average. By
1967 V/L for these observations was 94.6 percent of average, which
constituted a 0.8 percent decline in relative productivity.
Combining the information from these two groups of cities, we
see that a 3.4 percent differential in productivity is associated with
a 42 percent differential in population growth. Extrapolating, we see
that this would mean that an 8.1 percent increase in productivity
would be associated with a 100 percent population increase. Such a
result is not very different from the 6.4 percent productivity in-
crease associated with a doubling of city size in the results of Table
I.
This analysis of the relationship between city size and high
productivity is of course extremely tentative. The available evi-
dence does suggest that at least part of the productivity of cities
comes about because large cities have real productivity advantages,
rather than solely because productive small cities systematically
grow to major metropolitan status. However, investigation over a
much longer time span will be necessary before it is possible to
develop any conclusive understanding of the direction of causality
underlying the high productivity-city size relationship.

V. CONCLUSIONS

The modern economy is an urban economy, despite much dis-

cussion of urban discomfort and inconvenience. The patterns shown
in this paper make the prevalence of cities much easier to under-
stand. Observed wages are in fact considerably higher in large
cities. The evidence indicates that these high wages are feasible
essentially because productivity is higher in large cities. For ex-
ample, in the average industry the level of labor productivity is
5.98 percent higher with each doubling of city size.
The basic trend of the evidence examined in Section III indi-

slow-growing areas. The discussion uses VIL as the basic measure of produc-
tivity and does not correct for intercity differences in labor quality. The fact
that productivity increases more in fast-growing than slow-growing areas can
be shown not to be due to labor quality differences.

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 THE PRODUCTIVITY OF CITIES 411

cates that these labor productivity benefits of large cities come

about because Hicks-neutral productivity is substantially higher in
large cities. However, we cannot rule out the possibility that pro-
duction in large cities is extraordinarily capital-intensive.
Clearly, much work remains to be done on the interrelated
topics of urban growth and urban productivity. Nevertheless, the
present paper has demonstrated that there are very substantial
productivity advantages to urban production that are, no doubt, at
the heart of the urbanization process that has accompanied indus-
trialization. These substantial returns to city scale would have to be
considered carefully in the development of any national growth
policy that envisioned decentralization away from the large urban
centers.

APPENDIX A: CHOICE OF THE INDUSTRIES INCLUDED IN THIS STUDY

Since only data on labor productivity are available for metro-

politan areas, whereas we are interested in drawing inferences about
Hicks-neutral productivity, we limit the present study to fourteen
industries in which information on V/L provides a relatively close
approximation to g. A previous study of statewide productivity 26 is
used to determine those industries in which V/L and g patterns are
relatively similar. Data used in the above reference provide the fol-
lowing correlations between V/L and g patterns based on s=0.9
(d is determined as in note 17, p. 401):
SIC Industry Correlation between VIL and g

20 Food and kindred products 0.840

22 Textile mill products .916
23 Apparel and related products .708
24 Lumber and wood products .805
25 Furniture and fixtures .861
26 Pulp and paper products .004+
27 Printing and publishing .840
28 Chemicals and allied products .307?
29 Petroleum and coal products .577??
30 Rubber and plastics products .836
31 Leather and leather products .312
32 Stone, clay, and glass products .417?
33 Primary metal industries .904
34 Fabricated metal products .600
35 Machinery, except electrical .755
36 Electrical machinery .795
37 Transportation equipment .530
38 Instruments and related products .619

26. Sveikauskas, "Capital-Labor Substitution and Efficiency in U.S. Manu-

facturing."

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412 QUARTERLY JOURNAL OF ECONOMICS

Industries 26, 28, and 32, denoted by +, have been excluded

from the present study because it seems more difficult to draw rea-
sonable inferences about g from information on V/L in these cases.
In addition, industry 29, denoted by ++, has been excluded, and
industry 31 included, because of various tests based on other possible
shares concepts. If additional industries in which g is relatively
unlike V/L were omitted, overall conclusions would remain much
the same.

APPENDIX B: EVIDENCE RELATING TO THE CAPITAL-LABOR RATIO

IN CITIES OF DIFFERENT SIZE

There appear to be only two sources of information that can be

brought to bear on the question of how the capital-labor ratio varies
in cities of different sizes. These are the 1963 and 1958 Census of
Manufactures. However, the data from both of these sources have
severe disadvantages.
The 1963 Census provides information on horsepower per pro-
duction worker in individual industries for those SMSA's in which
there are 40,000 or more manufacturing employees.
However, there are two main disadvantages to this series. First,
horsepower per production worker is only a very limited measure of
the overall capital-labor ratio. Second, the limitation to cities with
40,000 or more manufacturing employees is an important defect for
several reasons. Clearly, relatively small SMSA's will not be repre-
sented within these data. In addition, only those medium-size cities
that have substantial manufacturing will reach the 40,000 mark and
appear in these figures; other cities of comparable population size,
but with less manufacturing, will be omitted. Thus, the medium-
size manufacturing centers that are included may not be typical of
all cities of the same size. On the other hand, the list of cities with
40,000 or more manufacturing workers is to a substantial extent the
same as the list of cities that have the highest population. Horse-
power information is available for 65 SMSA's in all. Fifty-three of
these sixty-five SMSA's are also among the sixty-five Standard
Metropolitan Statistical Areas with the highest population in 1960.
Thus, the cities with 40,000 or more manufacturing employees are
not severely unrepresentative of the nation's largest metropolitan
areas.
In three cases (industries 27, 31, and 33) horsepower per pro-
duction worker increases as much as 15 to 25 percent with a doubling
of city size. (The effect is significantly greater than zero, at the
95 percent level, in industries 27 and 33). However, in the eleven
other industries horsepower per production worker shows no sign of
increasing with city size. Thus, these data do not show any widely
prevalent tendency for the capital-labor ratio to increase with city
size.
A second source of information on the capital-labor ratio is
the widely used capital series contained in the 1958 Census of Manu-
factures. The 1958 Census contains data on the gross book value

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 THE PRODUCTIVITY OF CITIES 413

of depreciable and depletable assets, which is a more widely inclu-

sive concept of capital. However, these capital figures are available
only for states, not for metropolitan areas.
We have examined whether the capital-labor ratio is system-
atically higher in states that produce a large share of their value
added in SMSA's of 500,000 or more people. These investigations
have shown no tendency for the capitgl-labor ratio to rise with a
state's percentage of large city production. However, the percentage
of production in cities with a population of 500,000 or more is an
extremely rough indication of the city size in which production is
conducted. In addition, these gross capital figures also have certain
defects, especially because they refer to capital in money rather than
real terms. Therefore, we are forced to conclude that these data, too,
warrant no firm judgment as to whether the capital-labor ratio in-
creases with city size.
Existing information does not make it possible to give a con-
clusive answer to the question of whether the capital-labor ratio
increases with city size. Further data on this matter are badly
needed.

THE BUREAU OF LABOR STATISTICS

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