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How Does Urbanization Affect Economic Growth

How Does Urbanization Affect Economic Growth

How Does Urbanization Affect Economic Growth?

Introduction

            The increasing number of people living in cities and towns in many countries around the world has attracted the attention of scholars and policymakers to decipher how urbanization influences economic growth. While there is a consensus that urbanization and economic growth are significantly related, policymakers view urbanization ambivalently and derisively (Singh et al 2). Such views are likely to be a consequence of a poor understanding of the relationship between concentration, knowledge spillovers, policy formulation, agglomeration, and spatial relationship of economic growth and activities. In addition, the socio-economic challenges that have resulted from the rapid growth of urbanization in countries such as India, China, Mexico, and Brazil have made policymakers and economists to have less appreciation of the phenomenon (Singh et al 2). On the other hand, few countries have achieved rapid social development and sustained economic growth without urbanization. Even in the traditional setting, urbanization was an important element that drove economic growth.  Based on the highlighted examples, it is clear that there is no consensus on how urbanization affects economic growth and how the two variables are related. As such, the question that persists is how urbanization affects the economy and how urbanization is related to economic growth.

Literature Review

A number of studies have been carried out on urbanization and economic growth.  One of them is by Chen et al (2014), which study analyzes the urbanization and economic growth.  The data used in the study is from 1980 and 2011, a 30 year period. It was established that the urbanization level and economic growth changed significantly over the period. Empirical findings from the collected data show a lack of a relationship between the variables.

In another studyby Ivan Turok and Gordon McGranahan, the authors analyze the relationship between urbanization and development. The main finding of the study is that urbanization has a significant effect on development. However, Turok and McGranahan established that there is no simple linear relationship between urbanization and economic growth and that the potential of urbanization to positively affect economic growth is dependent on institutional settings and favorable infrastructure.

Similarly, Conditional Convergence: Evidence from the Solow Growth Model by Wilson analyzes the conditional convergence. Wilson uses data from 85 countries to determine whether there is convergence as predicted by Solow Model. Wilson establishes that there is no absolute convergence but there is conditional convergence on population growth and investment.

The empirical studies above agree that there lacks a relationship between urbanization and economic growth. Such a conclusion appears controversial, considering how important cities and towns are important to the economy of most countries. The question such findings raise is why there is no relationship between the two variables.

Data

There is significant data on urbanization and economics from the various studies carried out by the World Bank and organizations such as the UN-Habitat. For example, data from the UN-Habitat shows that cities contribute significantly to countries GDP. Cities contribute over 80% of the global GDP despite holding only 54% of the world’s population (UN-Habitat 31). For instance, Paris accounts for 16% of the French population but contributes 27% of the country’s GDP (UN-Habitat 31). On the other hand, Kinshasa accounts for 13% of the population in DRC but contributes 85% of the income in the country (UN-Habitat 31). It is important to examine urbanization and compare it with economic growth over a period of time to determine the relationship between the two. Over the last three decades, urbanization has increased from 39 percent in 1980 to 52 percent 2011 (Chen et al 2). In low-income and middle-income countries, the level of urbanization increased significantly from 31 percent to 47 percent between 1980 and 2011 (Chen et al 2). The level of urbanization over the period affected low, middle, and high-income groups with the urbanization level rising from 72 percent to 80 percent (Chen et al 2). However, the level of urbanization differs among regions. For example, developed nations such as the US, Australia, and many European countries are more urbanized than developing nations (Chen et al 2). Urbanization has coincided with increased population in urban areas across various levels. In 1980, the population concentration was significantly high in the urbanization level between 10% and 30% in developed countries with 2.45 billion individuals (Chen et al 2). Between 1980 and 2011, the global population in the 90-100 percent range rose by 223 million (Chen et al 2). The economic growth in terms of GDP also changed significantly between 1980 and 2011. There was economic growth but the pace differed. For example, the GDP per capita was modest in the 0-40% range of urbanization but dramatic in the 40-70% range (Chen et al 3). However, while it was expected that the rate of economic growth would follow the same trend over all the urbanization levels, it was not the case. In the 40-50% urbanization level, the GDP per capita in 2011 was 3344 dollars (Chen et al 3). On the other hand, the GDP per capita in the same range in 1980 was 5507, which was similar to the 50-60% range (Chen et al 3). Based on the hypothesis that urbanization drives economic growth, it was expected that there would be a higher GDP per capita value in 2011 for the same urbanization level as compared to 1980 (Chen et al 3). The change in GDP per capita showed varying trends for different urbanization levels. For the 60-100% urbanization level, there was a growing trend in the period between 1980 and 2011. However, in the urbanization level ranging from 0 to 50%, there was a complicated change in the GDP per capita level (Chen et al 3). Lastly, there was a huge difference in the GDP per capita between the urbanization levels of 60-70% and 70-80% in 1980 (Chen et al 3). The same level of difference was observed in the urbanization levels of 60-70% and 60-70% in 2011 (Chen et al 3). In 1980, the GDP level in the 70-80% urbanization level was almost twice that of the 60-70% urbanization level despite the difference in the two levels being only 10% (Chen et al 3).

In terms of the general trend, evidence indicates that urbanization has coincided with economic growth. For example, between 1960 and 2004, the urbanization level of China increased from 16% to 39% (Annez, Robert, and Michael 5). In this same period, the country’s GDP per capita increased from 448 dollars to 5,333 dollars. In Brazil, the urbanization level increased from 45% in 1960 to 83% in 2003 (Annez, Robert, and Michael 5). In the same period, the country’s GDP per capita increased from 2,644 dollars to 7,205 dollars (Annez, Robert, and Michael 5). In Kenya, the urbanization level in 1960 was 7% while the GDP per capita was 1,179 dollars while in 2003, the country’s urbanization level had increased to 20% and the GDP per capita to 1,219 dollars (Annez, Robert, and Michael 7). It is important to analyze more detailed data of the changes in the urbanization overtime to get the exact picture of the relationship between urbanization and economic growth.

Data picture

Urbanization level19802011
General39%52%
Low-income economies31%47%
Urbanization levelChanges in population between 1980 and 2011
10-30%2.45 billion (developed nations)
90-100%223 million (global population)
UrbanizationGDP (1980)GDP (2011)
40-50%5507 dollars3344 dollars
China448 dollars5,333 dollars

Theories

There are a number of theories that can explain the effect of urbanization on economic growth. However, the most prominent ones are the theory of agglomeration economics and the Solow model.

The Theory of Agglomeration Economics

The theory of agglomeration economics indicates that while the urbanization results in agglomeration economics which, in turn, leads to economic growth, the benefits realized can be offset by the negative effects of urbanization, which include overcrowding, pressure on infrastructure, high labor an property costs, and high cost of living (Turok and Gordon 468). The theory is underpinned on the understanding of economies of scale and division of labor. Division of labor looks at the productivity and growth benefits derived from specialization. While specialization is focused mainly on companies, it is also applicable at the city level. It means that there are gains of focusing on particular functions in which a city derives particular advantages. Economies of scale are divided into internal and external economies (Turok and Gordon 467). Internal economies of scale focus on the benefits that companies get because of being close to other firms in the market. It looks at the unit efficiencies and reduced cost of production due to agglomeration economies as well as large-scale production (Turok and Gordon 467). Such closeness reduces communication and transport costs and allows companies to benefit from network effects. External economies of scale, on the other hand, are focused on how close a firm is to suppliers, the labor market, and consumes.

The benefits of agglomeration economies as a result of urbanization are increased level of matching, improved learning by companies, and enhanced sharing of information and other resources among companies. Cities allow companies to match their needs of material inputs, labor, and premises because markets are bigger and the firms have the freedom of choosing from various options (Turok and Gordon 467). In volatile markets, cities allow companies to be more adaptable, leaner and focused on core competencies. A company is not compelled to sell a variety of products in the market because there are other firms that deal in the same areas. The second function is cities allow companies to have access to a broad range of infrastructure and shared services (Turok and Gordon 467). Urban areas, especially towns and cities, enable companies to easily connect with customers and suppliers in the market because of the superior transport system as well as effective supply chain and logistics systems. Lastly, companies gain more from a better communication network, which promotes the flow of information. Consequently, firms are able to learn and innovate, thereby, developing more valuable products and processes.

The theory of agglomeration economics acknowledges the benefits and limitations of urbanization. It shows that urbanization can bring about economic growth since it provides companies with access to markets and valuable information that enable them to enhance the quality of products and services. On the other hand, it implies that if urbanization is unchecked, it can easily reverse the benefits gained by putting pressure on the existing resources in cities. For example, it is common for cities to experience water shortages, power cuts, and housing problems.

Solow Model

The Solow model is an economic growth model that focuses on the changes in the output level in an economy over a period of time due to changes in savings rate, technological progress, and population growth rate. The model links the population growth rate to economic growth. Under the Solow model, the human resource is an important factor of production. The model implies that an increase in population results in improved economic growth (Wilson 112). Applying the model to urbanization indicates that the process supports economic growth because it provides the much-needed human resource. According to this model, the increase in population does not only provide the necessary workforce but also increases the level of saving.

While the Solow model highlights the importance of higher population during the urbanization process, it fails to point out the negative effects of an uncontrolled increase in population in urban areas. For example, many urban areas around the world cannot support the populations due to the shortage of resources such as electricity, water, and housing (Wilson 115). The model also fails to appreciate the fact that an increase in population can only contribute to economic growth if there are opportunities in the market and people have the right skills. There are cases in which a country may have a shortage of employees in a particular occupation despite the high population, especially in cases in which the demanded skills are unavailable.

Estimation

            To determine how urbanization is related to economic growth, a number of statistical analysis techniques were used, including geographic information system, panel estimation, and cross-sectional technique. Regression estimation method was used for the data collected; the use of the various estimation methods aimed to establish how urbanization affects economic growth and the factors that influence the correlation.

Results

            After carrying out cross-section estimation, it was established that there was a close association between urbanization and economic development, with Pearson’s coefficients of 0.837 and 0.752. However, there was no relationship between urbanization speed and economic growth rate, with a coefficient of only 0.133. The results from panel estimation indicate a significant correlation between urbanization and economic process. However, as in the case of cross-sectional estimation, it also revealed that there is no relation between urbanization and economic growth rate.

Discussion

From the results and analysis of data, it can be concluded that the level of urbanization has increased significantly over time. Similarly, there has been significant economic growth as demonstrated from the GDP per capita of various regions. It is for this reason that the correlation analysis of the data at specific points shows a positive relationship between urbanization level and economic development. However, when the growth of the two variables is considered, a correlation analysis reveals a lack of relationship. The results indicate that the increase in urbanization does not necessarily result in economic growth.

The results reveal that the relationship between urbanization and economic growth is not linear but a complex undertaking that involves other factors such as the human capital, investment, and infrastructure (Turok and Gordon 467). For example, urbanization is unlikely to positively influence economic growth if the human capital is unskilled. On the other hand, while there might be human capital, infrastructure to explore the talent must be available to influence economic growth. There is also the case of overpopulation in urban areas, which overstretches resources needed for economic growth (Turok and Gordon 468).

The results in this study still do not provide conclusive answers to the question of how urbanization influences economic growth. It is possible that the urbanization and its relation to economic growth is a complex subject that requires a broader analysis rather than focusing on the linear relationship between the two variables (Chen et al 3). In addition, it is possible that urbanization and its relation to economic growth are contextual with respect to time and place. The argument can be made based on the contextual data between urbanization and economic growth (Chen et al 3). An analysis of the data within a particular time shows that the growth of urbanization coincides with better economic performance.

Conclusion

Essentially, urbanization is a common phenomenon that has attracted significant attention from researchers. One of the points of contention the way the process influences economic growth. In this study, it has been established that while urbanization is closely linked to economic development, it does not necessarily influence it. The reason for the lack of a relationship between the two variables could be due to the complexity of the phenomenon as well as the effect of other factors such as the skillset of the population, infrastructure, and the availability of opportunities in an urban area. Future studies should thereby take into consideration these factors to determine the exact effect of urbanization on economic growth.

Works Cited

Annez, Patricia Clarke, Robert M. Buckley, and Michael Spence. Urbanization and growth.         Commission on Growth and Development: World Bank, 2009. Accessed from             https://siteresources.worldbank.org/EXTPREMNET/Resources/489960-            1338997241035/Growth_Commission_Vol1_Urbanization_Growth.pdf

Chen, Mingxing, et al. “The Global Pattern of Urbanization and Economic Growth: Evidence from The Last Three Decades.” PloS one 9.8 (2014): e103799.

Singh, Rup, et al. Urbanization and Economic Growth” An Empirical Study of Pacific Island       Economies. Working Paper 2014/01. School of Economics Working Paper Series. Suva:          University of the South Pacific, 2014. Accessed from             https://www.researchgate.net/publication/308914277_Urbanization_and_Economic_Gro            wth_An_Empirical_Study_of_Pacific_Island_Economies

Turok, Ivan, and Gordon McGranahan. “Urbanization and Economic Growth: The Arguments and Evidence for Africa and Asia.” Environment and Urbanization 25.2 (2013): 465-482.

UN-Habitat. “Urbanization as a Transformative Force” Accessed from http://wcr.unhabitat.org/wp-content/uploads/2017/03/Chapter2-WCR-2016-1.pdf

Wilson, Reginald. “Conditional Convergence: Evidence from the Solow Growth Model.” The Journal of Applied Business and Economics 19.6 (2017): 111-120.

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