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CHAPTER ONE

INTRODUCTION

1.1       Background of the Study

Urbanization and economic development have long been regarded as inter-connected processes. Urban economists sometimes determine the economic status of a nation by simply counting the number of large cities it has. In fact, the development history of many present-day developed nations has clearly demonstrated a dramatic rise in urbanization as their economies grew (Hughes and Cain, 2003). Studies have revealed that the simple correlation coefficient across countries between percentage of urban residents in a county and GDP per capita is about 0.85 (Henderson, 2003), which appears that urbanization is an inevitable part of a modern society. There has been an enormous literature on the role of urbanization for promoting economic growth (see Davis and Henderson, 2003 for a summary). It has been widely recognized by economists that urban places exist largely because of some sort of agglomeration economies in production that is not present in rural environments.

Thus, apart from firm-level internal scale economies, firms could also benefit from increasing returns to scale arising from larger urban concentrations. The term agglomeration economies can be further subdivided into two categories: localization economies (external to the firm but internal to the industry) and urbanization economies (external to the firm and external to the industry). The former exists because of industrial clustering in cities, whereas the latter arises due primarily to the overall size of the city. Some research studies have compared the two categories of agglomeration economies, measuring their relative significances on the economic performances of a country. Henderson (2003), and Ellison and Glaser (1997) suggested that both types of scale economies are vital to the growth of an economy, but localization, on the margin, seems to be more crucial to some mature industries.

Hochman (1996) theorized that firms could benefit economically by spatially concentrated in a smaller area. They could reduce search costs and information costs for labour, suppliers and potential customers. Knowledge about productions, sales strategies, marketing etc. could be shared extensively among the producers. Viewing the society as a whole, by crowding population into large urban areas, urbanization can enhance efficiencies in terms of provision of infrastructures, law enforcement, social goods and services. (Abdel-Rahman et al., 2006) David Segal (1976) statistically found that cities with populations greater than 2 million are on average 8% more productive than cities less than 2 million. Traditional debate on the relationship between urbanization and economic growth centre on whether urbanization level was excessive or “too disorganized” (Davis and Golden, 1954; Sovani, 1964; Kamerschen, 1969; McCoskey and Kao, 1998).

Some traditionalists such as Todaro(1995) claimed that today-developing countries are over-urbanized, while the modernists as represented in the work of Wheaton and Shishido (1982) advocated developing large cities in order to achieve economies of scale. Other strand of literature focused more on modeling a “best” degree of urbanization which fosters an optimal productivity growth (Bertenelli and Strobl, 2003; Henderson, 2003). Recently, studies tended to lay heavy emphasis on econometrically testing the impact of urbanization on economic development using more advanced mathematical techniques. 3 For instance, Moomaw and Shatter1 (1993) related growth and different measures of urbanization using regression techniques and concluded that urban concentration might stimulate economic growth. In their subsequent study (Moomaw and Shatter 1996), they revealed that urbanization not only increases with per capita GDP but also with industry share of GDP. Similar empirical evidences can be found in Abdel-Rahman et al. (2006),

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