Firm Productivity, Wages, and Agglomeration Externalities

This paper investigates the existence of local externalities in manufacturing. In contrast to many other studies that focus on aggregate employment growth, we examine the effect of externalities on firm-level productivity and wages. Our empirical results show that agglomeration externalities occur through both productivity and wage effects. Returns to specialization are strong and large in magnitude. In accordance with the views of Marshall, Arrow and Romer, the net effect of competition on productivity and wages tends to be negative. Large firms facing no local competition have higher revenues and pay lower wages. Competition tends to lower wages, however, probably because of thick labor market externalities. We also find some limited evidence in favor of the diversity argument put forth by Jacobs.