What are the Causes of Urbanization: Economic Efficiency (Neoclassical)

By Kevin Coll

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In the past forty years, the rapid trend towards urbanization has emerged as an inevitable consequence of the proliferation of capitalistic, market-oriented economies. Specifically, the growing national proportion of urban dwellers indicates large shift in capital and labor from predominantly agrarian to higher productivity, industrial modes of production. It was expected that in year 2000, more than 45 percent of the 5.1 billion people in developing countries would be living in urban areas (Oberai, 58). According to a recent United Nations (U.N.) estimate, between 1960 and 1990, the rural populations in developing countries grew at a rate of 1.7 percent. By contrast, urban populations in these countries grew at 3.7 percent, tripling their size over the same period (Peterson, 9). What are the primary causes for this large-scale transfer of labor and capital from rural areas to high-density cities? Accordingly, this short paper explores the main causes of urbanization from perspective of economic efficiency (neoclassical).

The Economic Efficiency Model

According to the neoclassical school, people choose to migrate to cities in search of better employment or wages. The pattern of urbanization is explained as such: Increases in industrial productive output leads to relatively higher wages in urban areas. Higher incomes lead to higher savings, which is converted into productive investment capital. Higher incomes also lead to changes in the composition of demand from agricultural to manufactured goods. The demand for manufactured goods increases technology and productivity growth. The real wage differential between rural and urban areas leads to rural-urban migration, thereby increasing the urban costs of living (rent, food, and services). The attenuating costs of urban life decrease the real rural-urban income differential, thereby reducing migration and urbanization. This leads towards a diffusion of economic activity and urbanization into other areas (Oberai, 60-61).

Sources of Urbanization

The labor source for urban centers is provided through net migration, natural increase, and reclassification, the first two of which have the greatest effect (Oberai, 62). Oberai posits that net migration has a greater effect in early stages of economic development, when "urbanization is low and urban and rural natural increase is moderately high." In the second, intermediate stage, natural increase becomes the main source. This was reflected in a 1985 U.N. study of 26 major "third world" cities, which showed that between 1960 and 1970, 37 percent of urban population growth came from migration and 63 percent from natural increase (Oberai, 62). When urban centers are highly developed and have low levels of natural increase, net migration becomes the predominant source.

Determinants of Urbanization

In this sense, as Oberai argues, the primary determinants of urbanization depends on: (1) the nature and pattern of industrialization; (2) the pace of agricultural development; and (3) the growth of transportation and communication networks (Oberai 63). The nature and pattern of industrialization is conditioned by rational, cost-benefit considerations of productivity levels, access to capital, labor, and markets. Urban centers are more suitable to lower-density areas because they provide productive advantages that the latter cannot. Specifically, this arises because urban areas can provide three distinctive advantages, namely, economies of urban scale, economies of agglomeration, and other location-specific attributes related to increased productivity such as natural resources or access to foreign markets (Peterson, 7).

Central to the economic efficiency model is that markets are efficient at allocating labor, capital, and determining prices. Economies of scale are provided the relatively lower overhead outlays linked with expense such as electricity, water, communication, and transportation costs (Oberai, 67). At the same timer however, studies also indicate that economies of scale rapidly increase as a city enlarges up to an uncertain threshold. In the simple equilibrium model, the size of urban centers grows up to a limit where economic efficiency across all cities is equivalent (Peterson, 18). Economies of agglomeration provide additional benefits to manufacturers by the concentration of suppliers and consumers in a market. In a related manner, subsidies that protect domestic industries from foreign competition, as demonstrated by import substitution policies in Latin America, tend to favor urban areas at the expense of agriculture. Although critics argue that the economic efficiency model fails to account for the damaging environmental costs (diseconomies) associated with urban growth, supporters of the economic efficiency model explain it away by saying that market forces take these costs into account (Peterson, 20). Supporters of the economic efficiency model compare rural-urban productivity differentials by measuring up the concentration of national output in cities with its concentration of national employment or population (Peterson 17). A study by Ljung and Farvacque (1988) estimates that around 60 percent of Gross National Product (GNP) in developing countries is created in urban areas--even though they constitute only around 30 percent of the total population. In some countries it is even centered in individual cities. In Brazil, for example, the industrial city of Sao Paolo contributes to 36 percent of the country’s Net Domestic Product (NDP), even though it only has 9 percent of the national population (Peterson, 18).

The economic development of rural areas is an important factor for affecting the growth or decline of urbanization. It is also at the center of the debate of resource allocation between rural and urban areas--where there has been the predisposition to favor the latter. The ability of the agricultural sector to absorb labor is dependent upon "climate; availability and distribution of land; agricultural technology; demand for agricultural products; credit availability; fertilizers and technical assistance." (Oberai, 64). The relationship between agricultural productivity and economic growth (and the concomitant increase in urbanization) is positive. This is because the increasing urban demand for foodstuffs and other agricultural products stimulates growth in the agriculture production. A study by Bose (1978) of 8 "less-developed countries" showed that an increase in real wages in private-sector manufacturing was also met by increases in agricultural wages (Peterson, 15). Other studies in Africa found that food productivity was higher in countries with rapid urbanization. Moreover, cash income per farmer increased relatively higher in countries where urban markets for their goods have developed. Demand for agricultural products has the effect of engendering economic development in rural areas because it creates the demand for marketing, transportation facilities; agricultural inputs such as fertilizer, seeds and farm machinery, and other related goods or services.

Government policies can also affect migration from rural to urban areas. It can help to reduce migration by increasing agricultural labor productivity and lessen rural-urban income differentials by increasing the distribution of land, building transportation and communication infrastructures, reducing market barriers, increasing education levels, and finally, establish policies to reduce rural population growth. In many instances, governments created urban biases through developmental policies such as ISI in Latin America. Foreign exchange policies and tariffs can also be used to increase the terms of trade of manufactured goods relative to agricultural goods, encouraging participation in the industrial sector. (Williamson, 252).

Finally, transportation and communication networks are important because they affect the "movement of people, commodities, and information between regions." (Oberai, 66) This is because it facilitates economies of agglomeration by creating a clustering of businesses with higher accessibility to capital, labor, and other business-to-business relationships. Since building these networks (ports, airports, roads, transport etc) can be prohibitively expensive for many developing nations, the ability to create a variety of urban centers is limited. In many respects, the high costs associated with creating new transportation and communication networks attests to the few number and high density of urban centers in developing countries.

The various social, political, and economic causes and consequences of urbanization give rise to several different policy conclusions. First, since it is difficult to ascertain the proper growth and size of cities, and likewise tough to limit migration to them, governments should focus their efforts on reducing urban bias from their national and regional policies (Oberai, 73). On the urban level, they should work on improving the internal efficiency and organization of cities. As such, governments should make price levels in urban markets more reflective of the costs and benefits of urban living. (Oberai, 72) Together, these policies should not only improve the welfare of urban dwellers, but reduce urban congestion, and encourage the efficient spatial allocation of capital and labor within an economy.

WORKS CITED:

A.S. Oberai, "Urbanization, Development and Economic Efficiency", in John D. Kasarda and Allan M. Parnall (editors), in Third World Cities: Problems, Policies and Prospects, Sage Focus Editions No. 148, Sage Publications, Newbury Park, California, 1993, Chapter 3, pp. 58-73.

George E. Peterson, G. Thomas Kingsley and Jeffrey P. Telgarsky, "Rethinking the Role of Urban Areas in National Economic Development" in Urban Economies and National Development, editedby George E. Peterson, G. Thomas Kingsley and Jeffrey P. Telgarsky, Policy Research Series, USAID Washington, D. C., 1991, Chapter 1, pp. 5-21.

Jeffrey G. Williamson, "The Macroeconomic Dimensions of City Growth in Developing Countries: Past, Present and Future" in Proceedings of the World Bank Annual Conference on Development Economics, 1991, 1992, pp. 241-266.