Is Productivity Advantage of Cities Really Down To Mean and Variance?

TL;DR

This paper empirically tests whether the productivity advantage of cities is due to differences in mean and variance of TFP distributions, finding that agglomeration effects are the primary factor.

Contribution

It validates the assumption that TFP distributions are identical up to mean and variance across city densities, supporting agglomeration-focused policies.

Findings

TFP distributions are statistically identical up to mean and variance across city densities.

Differences in productivity are mainly due to agglomeration, not firm selection.

The approach extends to analyzing worker skill distribution differences.

Abstract

Firms in denser areas are more productive, a pattern attributed to agglomeration economies and firm selection. To disentangle these two channels, the popular approach of Combes et al. (2012, ECTA) critically assumes that total factor productivity (TFP) distributions between denser and less dense areas are the same up to mean, variance, and left-tail truncation. We empirically validate this assumption using Spanish administrative firm-level data and recent econometric methods adapted to noisy TFP estimates. Our results find that TFP distributions are indeed statistically identical up to these parameters, validating the use of such productivity decompositions. Furthermore, using only the mean and variance is sufficient to capture differences for all sectors. Accordingly, the productivity advantage of cities may be entirely due to agglomeration rather than stronger selection, suggesting that policymakers should focus on policies targeting agglomeration. Finally, our approach extends to related contexts like differences in worker skill distributions.