10 1111@grow 12340 PDF

Received: 12 February 2019
| Revised: 16 September 2019

| Accepted: 18 September 2019
DOI: 10.1111/grow.12340
ORIGINAL ARTICLE
Explaining urban economic growth through cluster

complementarity
Scott A. Brave | Richard H. Mattoon
Economic Research, Federal Reserve Bank

of Chicago, Chicago, Illinois
Abstract
Economic development strategies centered on the presence
Correspondence of industry clusters have become quite popular with local
Scott A. Brave, Economic Research,
Federal Reserve Bank of Chicago, 230 S. policy makers. With this in mind, we test whether or not
LaSalle St., Chicago, IL 60604. the degree of cluster complementarity in a given urban area
Email: sbrave@frbchi.org
does in fact lead to it having a persistent economic advan-
tage over its peers. Using a spatial factor model built on
growth accounting principles, we show that this is indeed
the case by identifying key agglomeration factors influenc-
ing urban growth. However, our results suggest substantial
heterogeneity exists in the types of policies that are likely
to best support local economies based on their cluster
complementarity.
1 | IN T RO D U C T ION
Industry clusters have become the organizing concept around which much local economic develop-
ment policy has converged in recent years.1 Although its use for this purpose is controversial, as this
is what is often being used by policy makers to understand the economic structure of urban areas, it
is important to understand its implications for economic growth. The use of clusters by economic de-
velopers to formulate policy recommendations stems from the intuitive advantages that clusters offer,
supported by theories of economic growth that focus on the agglomeration benefits of dense urban
space. With this in mind, we set out in this paper to estimate a spatial factor model built on growth
accounting principles and cluster data in order to examine whether or not the relationships between
clusters might explain why cities with similar cluster structures grow at differing rates. In particular,
we focus on the complementarity of a city's clusters as a potential source of competitive advantage
relative to its peers.
The methodology that we develop offers several advantages over alternative approaches used to
understand clusters by accounting for the endogenous relationships between local industry wages,
prices, and output with latent variable estimation methods extended to incorporate spatial dependence
Growth and Change. 2019;00:1–30. wileyonlinelibrary.com/journal/grow |

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and identified with restrictions derived from a stylized model of urban economic growth. Our result-
ing three‐dimensional spatial factor analysis exploits similarities in real wage growth rates (which can
serve as a proxy for measuring underlying labor productivity) across types of clusters (traded vs. non-
traded) and metropolitan statistical areas (MSAs) over time in order to identify three factors driving
urban growth: Co‐agglomeration (or the overall level of integration of an MSA’s cluster structure),
Specialized Local Agglomeration (reflecting the performance of an MSA’s clusters conditional on
their level of integration), and Specialized External Agglomeration (or the relative performance of an
MSA’s traded clusters).
An important takeaway from our results is that a detailed knowledge of cluster composition is nec-
essary in order for policy makers to better understand what types of development policies are likely to
best support their local economies. To illustrate, we provide several examples where similar‐looking
cluster structures are interpreted very differently by our model based on the observed heterogeneity
in MSA labor productivity. Furthermore, we classify the MSAs in our sample based on the charac-
teristics of their urban growth factors and detail the defining features of their cluster composition in
order to demonstrate the resulting implications of our analysis for local development policy relative
to traditional cluster analysis.
Porter (1990) developed the industry cluster paradigm to investigate why some firms achieve dis-
proportionate success, introducing in the process his four‐part “diamond of competitive advantage.”
First are factor conditions which focus on the factors of production such as labor force, infrastruc-
ture and educational institutions. Second are demand conditions, which are largely defined as having
demanding customers that force firms to innovate. Third are related and supportive industries and, in
particular, suppliers that are integrated into the production process and, therefore, are more respon-
sive and innovative. The fourth factor is firm strategy and rivalry: Do the firms in the cluster upgrade
and invest to remain competitive? At its core, the diamond is a self‐reinforcing system which drives
productivity and innovation, explaining how competitive advantage can be sustained by focusing on
conditions that influence a firm's competitive position.
As Rosenthal and Strange (2004) note, however, there is a long tradition dating back as far as
Marshall (1920) that identifies similar productivity‐enhancing urban growth factors such as labor
market pooling, supplier specialization, and knowledge spillovers as sources of competitive advantage
for firms located within a specific geography. This tradition has since been expanded by Duranton and
Puga (2004), among others, to include modern concepts, such as the gains from industrial specializa-
tion and a greater variety of inputs, the common use of local indivisible goods and amenities, and the
pooling of risk (“sharing effects”); the quality or quantity of the matching process between firms and
workers (“matching effects”); and the generation, diffusion, and accumulation of knowledge (“learn-
ing effects”). Part of the attraction of using clusters to map a city's economy is that they are themselves
a broad measure of such agglomeration economies.
In their refinement of the agglomeration concept, Helsley and Strange (2014) provide compel-
ling evidence that the strength of urban economic performance is also likely to be dependent on the
business relationships across industries. Their work identifies cases where urban areas feature the
co‐agglomeration of some but not all industries, and demonstrates that the more tightly interconnected
business relationships are among an urban area's industries, the more supportive they are of economic
growth. Similarly, Porter (2003) singles out the benefits that accrue to an urban economy from its
traded clusters, comprised of its wealth generating export industries supporting business relationships
across urban areas. Both works fit within the larger context of a growing literature examining the
spatial organization of trade and its impact on local economic growth (e.g., Allen & Arkolakis, 2014;
Caliendo, Parro, Rossi‐Hansberg, & Sarte, 2014).
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The use of a spatial factor model to identify the strength of business relationships across clusters
is our primary contribution to this literature. The concept of industry co‐agglomeration developed in
Helsley and Strange (2014) closely relates to the definition of cluster complementarity that we explore
in this paper. Delgado, Porter, and Stern (2014) suggest that clusters best support urban economic
growth when they complement rather than compete with each other. The complementarity of clusters
maximizes their beneficial agglomeration characteristics and strengthens business relationships. In
contrast, when competing clusters are added to an urban area, they may simply cause congestion,
reducing agglomerative benefits. This notion of cluster complementarity is central to our contention
that measuring the complementarity of an urban area's clusters is key to explaining why a particular
cluster may be more productivity enhancing in one urban location than another and, hence, lead to
differences in economic performance.
To validate our contention, we use our spatial factor model to identify whether certain cluster
structures (traded vs. nontraded, specialized vs. diverse, etc.) may lead to an urban area having a per-
sistent economic advantage over its peers. Here, we rely on the industry clusters described in Delgado,
Porter, and Stern (2016), and made available by the U.S. Cluster Mapping Project, summarizing the
employment, wages, and patent activity of related industries.2 However, rather than focusing on em-
ployment or patent activity, as is common with cluster data, we instead follow Beeson and Eberts
(1989), Notowidigdo (2013), Albouy (2016), and others in focusing on differences in wages across
metropolitan statistical areas (MSAs). To motivate this choice, we present a growth accounting frame-
work for urban areas and demonstrate how to isolate local labor productivity growth drivers matching
the features of this framework from variation in cluster‐MSA real wage growth rates. This then allows
us to assess the importance of various aspects of urban labor productivity, reflected in our three urban
growth factors, in explaining differences in local economic performance arising from different types
of cluster structures.
For example, by incorporating our urban growth factors into a panel vector autoregression (VAR)
framework, we show that orthogonalized shocks to our Co‐agglomeration and Specialized Local
Agglomeration factors on average lead to economically and statistically significant permanent in-
creases in the levels of real per capita income, output per worker, and employment of MSAs. This
is true even after controlling for local and aggregate fixed effects and other commonly cited drivers
of agglomeration economies. Such a result is consistent with the notion that the degree of comple-
mentarity of an MSA’s cluster structure can indeed lead to a persistent economic advantage over its
peers. Furthermore, the source of this competitive advantage is linked through our growth accounting
framework back to differences in urban multifactor productivity growth arising from variation in local
labor quality and capital deepening.
Given the lack of observable data on the sources of MSA multifactor productivity growth, our
latent variable approach to urban growth accounting also satisfies a need for both researchers and
policy makers interested in understanding the drivers of local economic performance. In following
this approach, we were motivated by the advice of Donaldson and Hornbeck (2016) to exploit relative
geographic variation in order to address a question that is inherently aggregate in nature. Growth
accounting in the tradition of Solow (1957) is typically performed at an aggregate level. Doing so,
however, obscures the large amount of variation that exists across MSAs and fails to recognize their
growing importance in explaining aggregate growth, both of which make them an ideal laboratory for
this purpose. With cities also increasingly at the leading edge of economic development policy, the
efficacy of such an analysis is clear.
The remainder of the paper proceeds as follows. First, we motivate our spatial factor model in
Section 2 with a stylized model of urban economic growth. Then, we present results based on a
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reduced form estimation of this model in Section 3. Finally, in Section 4 we compare and contrast the
cluster structures of several classes of MSAs, followed by concluding remarks in Section 5.
2 | A N U R BA N G ROW T H AC COUNTING FRAM EWORK
In this section, we present an urban growth accounting framework that motivates our spatial factor
model. We then discuss the identification of our model in relation to this framework.
2.1 | A stylized urban growth model

Our analysis of urban economic growth is based on the model economy described below. Here, we de-
scribe only the main features of this stylized urban growth model, relegating its details to the accom-
panying Appendix in supplementary information. In this model, there exists both industries organized
into “clusters” (denoted by c) and metropolitan statistical areas (MSAs, denoted by m). Clusters be-
long to one of two sectors (tradeable and nontradeable), where the sector to which an industry cluster
belongs determines in which perfectly competitive markets it can sell its goods. Clusters in the trade-
able goods sector are assumed to have access to a technology which allows them to transport goods at
a fixed cost to other MSAs for sale, while clusters in the nontradeable goods sector do not.
Introducing a time dimension (denoted by t ), each cluster makes use of MSA capital (Kcmt) and
labor (Lcmt) resources to produce a good Ycmt given Cobb–Douglas production technologies.
Ycmt = Act (𝛽mt Kcmt )𝛼c (𝜌mt Lcmt )(1−𝛼c ) , (1)
where labor's share of cluster income (1 − 𝛼c) is constant across MSAs and time and 𝛽mt Kcmt and
𝜌mt Lcmt are the effective local capital stock and labor force and Act is a cluster‐specific Hicks‐neutral
technology parameter.3 Capital‐augmenting MSA production amenities, 𝛽mt, benefit disproportion-
ally an MSA’s capital‐intensive industries, while labor‐augmenting MSA production amenities, 𝜌mt,
benefit disproportionally a city's labor‐intensive industries. The former can be thought of as invest-
ment‐specific technology (e.g., Greenwood, Hercowitz, & Krusell, 1997), while the latter has a clear
connection with labor quality (e.g., Jorgenson & Griliches, 1967). Taking logs and first differences of
Equation (1), one obtains cluster‐MSA labor productivity growth,
Δycmt − Δlcmt = Δact + 𝛼c Δ𝛽mt + (1 − 𝛼c )Δ𝜌mt + 𝛼c (Δkcmt − Δlcmt ), (2)
where lowercase denotes the logarithms of uppercase variables and Δ is the difference operator.
To close the model, a representative household is assumed to consume all goods in the aggregate,
∑M ∑C
Yt = m=1 c=1 Ycmt, at local prices Pcmt given constant elasticity demand functions of the form.
( )
Ycmt −𝜂c
Pcmt = Pmt , (3)
Ymt
where 𝜂c are industry cluster demand elasticities. To purchase these goods, it sells/rents its labor and
capital resources in local markets at nominal wages Wcmt and rental rates Rcmt , where we assume that
all income is spent by the household in the same city in which it is earned. The details of the represen-
tative household's problem can be found in Section A1 of the Appendix in supplementary information.
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As shown in Section A2 of the Appendix in supplementary information, industry cluster profit

maximization then implies that differences in local labor productivity growth are capitalized in clus-
ter‐MSA real wage growth,
Δwcmt − Δpmt = Δact + 𝛼c Δ𝛽mt + (1 − 𝛼c )Δ𝜌mt + 𝛼c (Δkcmt − Δlcmt ) −𝜂c (Δycmt − Δymt ).
⏟⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏟⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏞⏟ (4)
Δycmt −Δlcmt
Equation (4) demonstrates that after accounting for cluster total factor productivity (TFP) growth
(Δact) and local cluster capital deepening (𝛼c (Δkcmt − Δlcmt )) and demand growth (𝜂c Δycmt), we are left
with two MSA‐specific determinants of cluster‐MSA real wage growth: local multifactor productivity
growth (𝛼c Δ𝛽mt + (1 − 𝛼c )Δ𝜌mt ), or growth in production amenities, and cluster demand weighted out-
put growth (𝜂c Δymt), reflecting in part growth in urban consumption amenities (see Section A1 of the
Appendix in supplementary information).
2.2 | A spatial factor model of real wage growth

Equation (5) can be rewritten as a factor model with MSA‐time factors, Fmt, and industry cluster factor
loadings, Λc, where
Δwcmt − Δpcmt = Λc Fmt + 𝜀cmt

� �
Λc = 1,𝜂c ,𝛼c
⎡ Δ𝜌mt ⎤
⎢ ⎥ (5)
Fmt = ⎢ Δymt ⎥
⎢ Δ𝛽 − Δ𝜌 ⎥
⎣ mt mt ⎦
𝜀cmt = Δact + 𝛼c (Δkcmt − Δlcmt ) − 𝜂c Δycmt .
The factors capture growth in local labor quality, output, and capital deepening, respectively. Of
the three, only the second is potentially directly observable. Therefore, the other two factors must be
estimated. Following Combes and Gobillon (2015), traditionally their estimation is predicated on ei-
ther a priori knowledge of cluster labor income shares 𝛼c and demand elasticities 𝜂c or an instrumental
variable that would allow for the consistent estimation of Δ𝜌mt and Δ𝛽mt given their likely correlation
with 𝛼c (Δkcmt − Δlcmt ) and 𝜂c Δycmt in the reduced form residual 𝜀cmt. In contrast, the confounding in-
fluence of the industry cluster TFP growth component Δact in 𝜀cmt can be addressed by re‐writing the
model in terms of deviations from national cluster average real wage growth rates to exclude cluster‐
year fixed effects. We follow this practice, as described in the next section.
In principle, one could also estimate all three factors shown in Equation (5) MSA‐by‐MSA using
principal component (s) or factor analysis (e.g., Engle & Watson, 1981). While largely reduced form
in nature, this approach has several advantages. For example, as discussed in the next section, identifi-
cation is largely predicated on determining the correct number of factors to estimate. However, doing
so on an MSA‐by‐MSA basis is both inefficient and ignores the implicit spatial equilibrium of our
urban growth model. With mobile labor and capital resources, real wages must adjust across MSAs to
reflect differences in their production and consumption amenities (e.g., Roback, 1982). This implies
that for any two MSAs m and m’ it will necessarily be the case that Cov(𝜀cmt , 𝜀cm′ t) ≠ 0, which is likely
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to pose a problem for principal components and factor analysis in that they require that this degree
of cross‐correlation be sufficiently limited in order to recover consistent estimates of the factors.
Typically, this is guaranteed only on large dimensional panels.
We address these concerns by instead stacking cluster real wage growth rates across MSAs into
a large MT × C panel and spatially filtering them prior to estimation. In matrix form, our resulting
spatial factor model is given by
(I − 𝜌A)−1 (Δw − Δp) = (I − 𝜌A)−1 FΛ + (I − 𝜌A)−1 𝜀 (6)
where (Δw − Δp) is an MT × C matrix of MSA‐time by cluster real wage growth rates (in logs) with T
measured in years, A is a MT × MT spatiotemporal matrix of MSA‐year weights, 𝜌 is a scalar spatial
correlation parameter, F is an MT × 3 matrix of MSA‐year factors, Λ is an 3 × C matrix of industry
cluster factor loadings, and 𝜀 is an MT × C matrix of idiosyncratic errors.o
In constrast to an MSA‐by‐MSA application of factor analysis, our approach to extracting the
factors relies on similarities in industry cluster production functions both across MSAs in order to
uncover relative factor shares (i.e., 𝛼c) and differences between the real wage growth rates of traded
and local clusters within MSAs in order to identify relative demand sensitivities (i.e., 𝜂c).
However, it also requires that we first obtain the spatial filter (I − 𝜌A)−1, where we must specify
the spatiotemporal matrix A and estimate or calibrate the spatial correlation parameter ρ. To specify
A, we find it intuitive to think of the clusters in New York and Chicago, for example, as being more
intricately connected through shared capital and labor markets than the clusters in New York and
Cleveland. Focusing on physical distance would, therefore, not be appropriate for our model. Instead,
we follow a procedure similar to Conley and Dupor (2003), setting the elements of A equal to a mea-
sure of economic distance between MSAs, captured by differences in their shares of national labor
income in each time period, and rescaling the matrix to impose that its rows sum to one and restricting
its elements to be between −1 and 1.4
From an econometric perspective, our urban growth model can also be viewed as arising from a
panel spatial autoregression (SAR), which allows us to obtain an estimate of 𝜌 rather than calibrate it.5
To see this, consider the moving average representation of a panel SAR for our stacked MT × C matrix
of real wage growth rates with residual matrix 𝜐,
(Δw − Δp) = (I − 𝜌A)−1 𝜐.
The above expression sets cluster real wage growth rates in each MSA‐year to be spatially weighted
averages across time (years) and space (MSAs) of the unobserved 𝜐. Defining 𝜐 ≡ (I − 𝜌A)FΛ + (I − 𝜌A)𝜀
, it is shown to be equivalent to our factor model in Equation (5). We exploit this alternative repre-
sentation to obtain an estimate of 𝜌 from the separate estimation of a panel SAR on our MSA‐cluster
real wage growth rates. To then estimate our spatial factor model, we apply spatial principal compo-
nents analysis (spatial PCA) as described in Demsar, Harris, Brunsdon, Fortheringham, and McLoone
(2012) to recover the factors and loadings given A and 𝜌.
Spatial PCA is equivalent to an eigenvector–eigenvalue decomposition of a spatially weighted
covariance matrix into a sequence of eigenvectors (factors) associated with the eigenvalues of this
matrix. In our case, this matrix takes the following form
((I − 𝜌A)−1 (Δw − Δp))� ((I − 𝜌A)−1 (Δw − Δp))

X � ΩX = ,
MT
where our parameterization of A weights the covariances of cluster real wage growth rates of MSAs
based on the similarity of their labor income shares in estimating the MSA‐year factors. Note that this
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procedure embeds a characterization of the model's covariance structure both within (serial correlation
in time) and across (serial correlation in space) MSAs, reflected in the scalar MT in the denominator
of the above formula. In general, the elements of A that are most similar will be adjacent observations
in time of each MSA given the relative stability of labor income shares over our sample period. The
similarity of observations of different MSAs within or across time periods is then measured on a rel-
ative basis and the overall degree of correlation is captured in 𝜌 which is restricted to fall between −1
and 1 to ensure that spatial correlations are not explosive. Traditional principal component analysis is
then a special case when 𝜌 is set to zero.
2.3 | Identification
Identification of our spatial factor model in Equation (6) hinges on the assumption that its idiosyn-
cratic errors 𝜀 are orthogonal to the factors F and that applying the spatial filter (I − 𝜌A)−1 to them
produces a homoskedastic variance–covariance structure. Satisfying the former assumption largely
boils down to whether or not the first three spatial principal components of cluster‐MSA real wage
growth are sufficient to span the space of relevant MSA‐level factors, in which case we can appeal to
a diversification argument that the number of clusters is sufficiently large for this to be true.6 In other
words, a single cluster among many is not expected to dominate the variation in real wage growth
rates at the MSA level enough to cause the factors and idiosyncratic errors to be correlated.
The three factors of our spatial factor model are considered separately from the first three estimated
spatial principal components (SPC ≡ (I − 𝜌A)−1 F ) in the analysis that follows. However, without put-
ting further restrictions on the reduced form factor loadings Λ = [Λ1 ,Λ2 ,Λ3 ]� we cannot be sure that
what is extracted by spatial PCA at all resembles our stylized urban growth model. To address this
concern, we impose factor loading restrictions when performing spatial PCA consistent with the clus-
ter‐specific constants of proportionality (Λc) between MSA‐cluster real wage and labor productivity
growth embodied in Equation (5).
The first factor (referred to henceforth as Co‐agglomeration) is restricted to load equiproportion-
ally onto all clusters in each MSA, for example, Λ1 = 1, so that it affects all clusters within an MSA
equally. The second and third factors (Specialized External and Local Agglomeration) instead differ-
entially impact the clusters in each MSA. The second factor has loadings Λ2 = [Λtraded2
,0], such that it
exploits the variation that exists between the real wage growth rates of traded and local goods clusters
in each MSA to identify a common element that exists across MSAs. The loadings for the third factor
are then left unrestricted, such that this factor captures residual differences in all cluster real wage
growth rates that are common across MSAs.
Borrowing from terminology used in a similar example from Reis and Watson (2010), one way
in which to interpret the factors from each other is that Co‐agglomeration captures absolute changes
in MSA real wage growth, while Specialized External and Local Agglomeration capture changes in
relative real wage growth rates in each MSA across clusters. Based on our urban growth model, we can
think of an absolute increase in MSA real wage growth as stemming from an increase in local labor
quality. Shared labor force needs are commonly thought of as a driver of co‐agglomeration; hence, our
choice of naming convention for this factor. In contrast, relative wage growth rates across clusters in
our urban growth model are driven by either changes over time in an MSA’s consumption amenities or
its rate of capital deepening. Imposing zero restrictions on the factor loadings of the local clusters for
the second factor while leaving the factor loadings of the third factor unconstrained then serves as our
empirical identification strategy for uncovering the relative demand elasticities responsible for differ-
ences in the impact of external demand effects and labor income shares responsible for differences in
the impact of local capital deepening on the cluster real wage growth rates observed in each MSA.7
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We cannot rule out, however, that other similar forces not included in our stylized urban growth
model may be captured empirically in our estimated MSA‐time factors; and, therefore, we do not
claim to recover the structural parameters of our urban growth model.8 For instance, with our identi-
fication strategy what we call the Specialized External Agglomeration factor will capture any change
affecting real wage growth for traded, but not local, goods industries that is common across MSAs.
The factor that we refer to as Specialized Local Agglomeration will then reflect any common causes
of MSA real wage growth after accounting for the traded/local differential and the MSA‐wide effects
that we refer to as Co‐agglomeration. The latter will capture anything that drives an equiproportional
wedge between growth in real wages and the marginal product of labor across clusters in all MSAs.
To ensure then that what we are capturing in real wage growth is in fact associated with broader
MSA performance in a meaningful way, and how one might expect based on our growth accounting
framework, we estimate a factor‐augmented panel vector autoregression (VAR). Here, we assume that
our spatial principal components (SPCmt), a vector of additional MSA‐level control variables (Zmt),
MSA real per capita income (PImt), real private sector output per worker (YWmt), and private sector
payroll employment (Emt) growth jointly evolve over time according to,
Ymt = 𝛼t + 𝛿m + 𝛽Ymt−1 + 𝜂mt , (7)
with Ymt ≡ [Zmt , SPCmt , PImt , YWmt , Emt ] and MSA and year fixed effects noted by 𝛿m and 𝛼t, respec-
tively. The MSA fixed effects allow us control for potentially omitted time‐invariant MSA determi-
nants of growth from our urban growth accounting framework, such as differences in trend growth
related to differential rates of convergence. The year fixed effects then ensure that variation over time
within MSAs instead of across them, that is, local versus national determinants of urban growth, is the
focus of our analysis consistent with the cluster‐year fixed effects of our factor model.
Equation (7) offers a relatively concise description of the endogenous relationships between most
of the variables typically associated with MSA economic performance. To assess the impact of our
spatial principal components on these relationships requires that we then impose some additional
structure in order to identify exogenous variation consistent with our factor model in each of them.
Here, we rely on a Wold causal ordering assumption embodied in a Cholesky decomposition of the
variance–covariance matrix of the panel of shocks 𝜂mt. The control variables Zmt, which may be ex-
pected to be correlated with SPCmt, are ordered ahead of them in the panel VAR in order for us to ex-
amine orthogonalized shocks to each spatial principal component. These variables are: Bartik (1991)
shift‐share measures for MSA real wage and employment growth, changes in MSA unemployment
rates and educational attainment (captured by the percentage of the adult population with a bachelor's
degree or higher), and MSA real home price growth. The shift‐shares and unemployment rates control
for local labor market conditions; while educational attainment is our proxy for the stock of human
capital and real home prices for consumption amenities.9
Because SPCmt are by construction contemporaneously orthogonal across MSAs, the order in
which they appear next in the Cholesky decomposition does not affect the estimation of their shocks.
Following SPCmt then are MSA real per capita income (PImt), real private sector output per worker
(YWmt), and private sector payroll employment (Emt) growth, ordered last such that they may respond
to orthogonalized shocks to SPCmt on impact. Their inclusion allows us to verify that the identification
restrictions of our factor model align with the growth accounting principles that underlie them with
regard to anticipated effects on welfare, productivity, and labor usage, as well as validate their policy
relevance in explaining overall MSA economic performance. For example, an orthogonalized shock to
the spatial principal component related to our Co‐agglomeration factor should impact these variables
in much the same way as a total factor productivity shock, leading to increases in the level of all three.
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Furthermore, if these effects are highly persistent and large in magnitude they may be expected to be
of relevance to policy makers, insofar as local development policy is able to support the co‐agglom-
eration of clusters.
3 | E X P LA I N ING MSA P E R FORM ANCE
In this section, we describe our estimation of the spatial factor model, its decomposition of cluster‐
MSA real wage growth, and explore the economic and statistical significance of our urban growth
factors in explaining MSA economic performance with a factor‐augmented panel VAR.
3.1 | Data and estimation

To estimate our spatial factor model, we use data on the average wages for traded and local clusters
made publicly available by the U.S. Cluster Mapping Project and described in Delgado et al. (2014)
for the 23 largest MSAs in the continental United States for which consumer price indexes (CPIs)
exist. We focus only on nationally representative clusters, or those defined by nonmissing observa-
tions for at least half of our sample of MSAs over the period from 1998 to 2015. In total, this criteria
resulted in the use of 59 out of 67 clusters, of which 16 are defined as local and 43 are defined as
traded. After deflating cluster‐MSA average wages by their respective MSA CPIs, we take log first
differences to transform them to growth rates. Additional information and summary statistics for our
data set can be found in Section A3 of the Appendix in supplementary information.
Estimation of Equation (6) proceeds in stages. First, we remove cluster‐year means from the clus-
ter‐MSA real wage growth rates. Then, we estimate 𝜌 following the procedure for a panel SAR de-
scribed in Lesage and Kelley Pace (2009).10 Given A and 𝜌, we then proceed with spatial PCA, scaling
the spatial principal components to have a unit variance and be contemporaneously uncorrelated with
each other (SPC� SPC = I ), imposing factor loading restrictions as described above, and requiring that
the second and third columns of Λ sum to zero, aiding in their interpretation as relative wage growth
drivers.11 Factor loading restrictions and missing values in our panel are handled by the expectation–
maximization (EM) algorithm as described in Section A4 of the Appendix in supplementary informa-
tion.12 To estimate the factor‐augmented panel VAR in Equation (7), we use the generalized method
of moments (GMM) method described in Abrigo and Love (2016) over a sample period from 2002 to
2015, where limited degrees of freedom necessitate that we use only one lag.13
3.2 | Spatial factor model results

Figure 1 summarizes the cluster‐level features of our spatial factor model in a bi‐plot of the estimated
factor loadings assigned to each cluster across our Specialized External and Local Agglomeration
factors. The four quadrants of the figure provide a taxonomy for identifying clusters with similar
characteristics, where we have normalized their sign so that the factors each exhibit a positive correla-
tion coefficient with real gross metropolitan product growth. The larger a factor loading is in absolute
value (i.e., the further an observation is from the origin) the greater its importance in explaining vari-
ation in cluster‐MSA real wage growth rates along each dimension.
It is important to keep in mind, however, that this figure captures only the relative importance of
each cluster and not its absolute importance. The latter will also be reflected in the Co‐agglomeration
factor. By regressing national average cluster wage growth rates deflated by CPI inflation (Δwct − Δpt
) on our cluster factor loadings (Λc) in each time period we can get a sense of the overall importance
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10 BRAVE and MATTOON
F I G U R E 1 Industry cluster factor loadings. Notes: This figure is a bi‐plot of the estimated factor loadings
from a spatial factor model describing MSA industry cluster real wage growth rates. The x‐axis captures variation
explained by an industry cluster along the factor dimension of Specialized External Agglomeration of MSAs, while
the y‐axis captures variation explained by an industry cluster along the factor dimension of an MSA’s Specialized
Local Agglomeration. The distance of each ray from the origin reflects the relative importance of each industry cluster
in explaining variation along each MSA factor dimension. The sign of the factor loadings have been normalized to
reflect a positive correlation with gross metropolitan product growth
BRAVE and MATTOON
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11
of our three urban growth factors for an “average” MSA’s cluster structure in our sample.14 From these
regressions, we then define a cluster's Agglomeration Score,
[ ]
AS = Et 𝛽t Λc .
This metric captures the average combined explanatory power of each cluster in explaining the
cross‐sectional variation in cluster real wage growth rates common across MSAs in our sample.
Figure 2 plots our Agglomeration Scores in descending rank order, with the business services clus-
ter representing the median score. Of the 28 clusters with scores above the median, 20 are what Porter
(2003) classifies as traded clusters, comprised of wealth generating export firms, with the remaining
eight classified as local clusters. The traded clusters with above‐median scores include prominent
export industries such as information technology, finance, and oil & gas; while the local clusters
include examples such as household goods, food, and logistics. Conversely, of the remaining clusters
with scores below the median, 22 are of the traded type and 8 are of the local type. Prominent export
industry examples here include education, agriculture, and biopharmaceuticals, with local examples
being health, retail, and hospitality services.
By next regressing MSA real wage growth on our Co‐agglomeration, Specialized Local, and
Specialized External Agglomeration factors, we can gain an initial sense of how important the com-
plementarity of an MSA’s cluster structure is in explaining its economic performance. For instance,
F I G U R E 2 Agglomeration scores. Notes: This figure depicts the Agglomeration Score that we assign to
each cluster (traded and local) in descending rank order. These scores capture the overall importance of our urban
growth factors (Coagglomeration, Specialized External Agglomeration, and Specialized Local Agglomeration) for
an “average” MSA’s cluster structure based on regressions of national industry‐average real wage growth on the
estimated factor loadings of our spatial factor model. The median score corresponds to the value assigned to the
Business Services industry cluster
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a low R2 value for an MSA may indicate that its real wage growth is driven primarily by either the
national industry‐specific factors that we remove from our analysis or local industry‐specific factors
that are idiosyncratic to our spatial factor model, while a high R2 value signifies a potentially large role
for the urban growth factors of our growth accounting framework.
As a robustness check, we also perform this analysis using MSA real wage growth differentials,
constructed using the Bartik shift‐share methodology to subtract counterfactual wage growth rates
for each MSA using national average cluster wage growth and MSA‐cluster income shares. The ad-
vantage of working with the regression in this form is that we are able to control for legacy sources
of MSA‐cluster variation beyond our sample period related to industry composition that could poten-
tially cause our initial regressions for MSA real wage growth to be biased.
Table 1 demonstrates considerable variability along this dimension across MSAs. The columns
of the table report R2 values from adding our three factors one at a time to the regression for each
MSA noted by the row, with the final column containing the overall R2. Differences across columns
reflect the explanatory power from a particular factor. Qualitatively, the fit of both sets of regressions
are very similar, with the Co‐agglomeration and Specialized Local Agglomeration factors generally
contributing more to explaining MSA real wage growth than Specialized External Agglomeration.
There are also a number of MSAs where Co‐agglomeration and Specialized Local Agglomeration
appear significantly more important when explaining MSA real wage growth on a differential basis.
In these instances, a strong case could be made that legacy industry composition factors play a large
role, confounding our initial regressions. However, both sets of results strongly suggest that our urban
growth factors have both economic and statistical significance.
Understanding the sources of the heterogeneity in Table 1 is likely to be key in helping policy
makers tailor development policies to the strengths and weaknesses of their local economies. To un-
derstand why, consider the low R2 values for the Chicago and Milwaukee MSAs. This would seem to
suggest that either national or local industry factors have been predominant in explaining their recent
economic performance. Consistent with this is the fact that the cluster composition of Chicago is
highly representative of the national industry average. Looking at the composition for Milwaukee,
however, reveals a much more idiosyncratic local economy with a large industrial base at its center.
Now, contrast these two examples with that of Boston where our urban growth factors explain close to
75% of the variation in MSA real wage growth, with almost all of the explanatory power coming from
the Co‐agglomeration factor. We further discuss the implications of Table 1 for local development
policy in the next section.
3.3 | Factor‐augmented panel VAR results

Next, we examine impulse responses and forecast error variance decompositions of MSA real per
capita income, real private sector output per worker, and private sector payroll employment to orthog-
onalized shocks to each of our three spatial principal components from the factor‐augmented panel
VAR described in Section 2.3. These results are useful both in providing support for the identification
restrictions of our stylized urban growth model and its implications for welfare, labor productivity,
and employment as well as in capturing the policy relevance of our factors and whether or not the
degree of cluster complementarity in a given urban area can lead to it having a persistent economic
advantage over its peers.
While we estimate the factor‐augmented panel VAR in growth rates, we present impulse responses
to the level of each variable in what follows in order to assess whether the shocks have persistent or
transitory effects. Figure 3 depicts impulse responses for the levels of MSA real per capita income,
BRAVE and MATTOON
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T A B L E 1 MSA real wage growth regression R2 values
Real wage growth Real wage growth differential
MSA CoAgg SpExtAgg SpLocAgg All CoAgg SpExtAgg SpLocAgg All

Atlanta, GA 0.27 0.11 0.12 0.40 0.47 0.00 0.32 0.55
Boston, MA 0.71 0.04 0.23 0.73 0.71 0.01 0.35 0.77
Chicago, IL 0.00 0.03 0.00 0.04 0.14 0.00 0.13 0.22
Cincinnati, OH 0.02 0.00 0.35 0.43 0.05 0.04 0.19 0.36
Cleveland, OH 0.27 0.01 0.14 0.49 0.24 0.00 0.15 0.46
Dallas, TX 0.22 0.02 0.16 0.42 0.35 0.00 0.03 0.39
Denver, CO 0.41 0.03 0.35 0.49 0.41 0.03 0.34 0.49
Detroit, MI 0.21 0.00 0.16 0.27 0.17 0.00 0.23 0.30
Houston, TX 0.52 0.08 0.14 0.81 0.67 0.03 0.01 0.75
Kansas City, 0.04 0.00 0.07 0.12 0.10 0.00 0.04 0.14
MO
Los Angeles, 0.03 0.07 0.13 0.16 0.05 0.04 0.12 0.16
CA
Miami, FL 0.43 0.00 0.02 0.45 0.47 0.01 0.02 0.50
Milwaukee, WI 0.00 0.00 0.03 0.03 0.00 0.00 0.09 0.11
Minneapolis, 0.24 0.04 0.01 0.34 0.22 0.02 0.00 0.26
MN
New York, NY 0.26 0.00 0.07 0.30 0.44 0.00 0.06 0.47
Philadelphia, 0.38 0.06 0.05 0.43 0.53 0.05 0.10 0.65
PA
Pittsburgh, PA 0.11 0.14 0.00 0.22 0.23 0.05 0.12 0.27
Portland, OR 0.14 0.08 0.03 0.27 0.11 0.10 0.09 0.29
San Diego, CA 0.06 0.00 0.25 0.33 0.22 0.11 0.18 0.32
San Francisco, 0.48 0.12 0.00 0.49 0.44 0.13 0.00 0.47
Seattle, WA 0.06 0.03 0.00 0.10 0.06 0.05 0.00 0.13
St. Louis, MO 0.05 0.14 0.00 0.19 0.20 0.18 0.02 0.29
Tampa, FL 0.46 0.33 0.00 0.58 0.38 0.40 0.07 0.56
2
Notes: This table contains R values from regressions of MSA real wage growth and real wage growth differentials, expressed rela-
tive to a “Bartik shift‐share” using MSA‐cluster income shares and cluster national average wage growth rates, on our urban growth
factors. For each of the wage growth measures, each column uses one of our three urban growth factors (Co‐agglomeration (CoAgg),
Specialized External Agglomeration (SpExtAgg), and Specialized Local Agglomeration (SpLocAgg)) in the regression, with the last
column using all three factors together in the regression.
real private sector output per worker, and private sector payroll employment to a one standard devi-
ation orthogonalized shock to each of our spatially filtered Co‐agglomeration, Specialized External,
and Specialized Local Agglomeration factors. The shaded regions in the figure correspond to 90%
confidence intervals based on 200 Monte Carlo draws from the factor‐augmented panel VAR assum-
ing normally distributed coefficient and error variance–covariance matrices. All responses are shown
in percentage terms, such that a value of 1 indicates a 1% increase.
Looking first at the responses to a shock to our Co‐agglomeration factor, a one standard deviation
shock leads to a statistically significant 1% permanent increase in the level of both real per capita
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F I G U R E 3 Cumulative impulse response functions to urban growth factor shocks. Notes: This figure depicts
cumulative impulse response functions from a panel VAR with MSA and year fixed effects and one lag. Each graph
contains the estimated impact over five years to the level of private sector payroll employment (Emp), real private
sector output per worker (Y/W), or real per capita personal income (Inc/Pop) in percentage terms to one standard
deviation orthogonalized shocks to one of our three spatially filtered urban growth factors (Co‐agglomeration
(CoAgg), Specialized External Agglomeration (SpExtAgg), and Specialized Local Agglomeration (SpLocAgg)).
Point estimates are denoted by red solid lines and 90% confidence intervals by gray shaded regions
income and real private sector output per worker and a 0.5% increase in private sector payroll employ-
ment after a period of 5 years. The direction of these effects matches quite well with our urban growth
model's motivation for this factor as being related to local labor quality. It is also the most econom-
ically significant of the three shocks that we examine, explaining roughly 10% of the variability in
MSA real per capita income and private sector payroll employment and 3% of the variability in real
private sector output per worker at a forecast horizon of 5 years.
Similar, but more muted, responses can be seen as well to a one standard deviation shock to our
Specialized Local Agglomeration factor. In this case, we observe a 0.5% permanent increase in the
level of both real per capita income and real private sector output per worker and a 0.25% increase in
private sector payroll employment. Our urban growth accounting motivation for this shock focused on
capital deepening. As the impact of capital deepening depends on the relative substitutability of labor
and capital, its effects should be expected to be muted in comparison to a Co‐agglomeration shock.
Consistent with this, we find that roughly only 2%–3% of the variability in MSA real per capita in-
come and real private sector output per worker and 1% of the variability in private sector employment
can be explained by this shock at a forecast horizon of 5 years.
Finally, we find that a one standard deviation shock to our Specialized External Agglomeration
factor has a small positive effect on the level of real private sector output per worker that dies out
BRAVE and MATTOON
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after 1 year and has no effect on real per capita income or private sector employment, suggesting that
it is not likely to be a persistent source of economic advantage for an MSA. It does, however, explain
roughly 2% of the near‐term variability in real private sector output per worker. Recall that in our
urban growth accounting framework Specialized External Agglomeration was associated with the
relative demand for an MSA’s goods. One possible explanation for this result then is that whatever
productivity advantage is provided by such a shock it is also quickly competed away.
While the results above largely support the intuition provided by our urban growth accounting
framework, they also hold broader relevance for policy makers as a nontrivial portion of the differ-
ences in performance across MSAs can be attributed in our factor‐augmented panel VAR to our three
urban growth factors. In particular, their sizeable impacts on real per capita income demonstrate that
insofar as policy makers can reinforce or enhance the positive aspects of an MSA’s cluster struc-
ture captured in our factors, such policies could be significantly welfare enhancing. Furthermore,
of the three, Co‐agglomeration appears to be the most policy relevant, emphasizing our contention
that the integration of an MSA’s clusters is potentially the most important way that industry com-
position can contribute to persistent differences in economic performance. In contrast, Specialized
Local Agglomeration appears to have potentially more moderate returns to local policy makers, while
Specialized External Agglomeration has very little effect on welfare and its impact on labor produc-
tivity appears to be much less persistent than the other factors.
3.4 | Local development policy implications

Below, we take a closer look at several of the MSAs in our sample with an eye toward how our results
can be used to refine the policy implications of an MSA’s cluster composition. The use of clusters to
explain a city's economic competitiveness and guide local development policy is not without criticism.
Perhaps the most common critique of using clusters for this purpose is their lack of a precise defini-
tion. Practitioners often use differing criteria for defining a cluster and/or measuring its effectiveness,
and at a certain level the assignment of industries to clusters can appear arbitrary. At its worst, some
have suggested that the use of clusters is open to abuse and can simply support a dominant industry
(e.g., Feser & Lugar, 2002; Martin & Sunley, 2003).
One of the strengths of our analysis, however, is that it overcomes some of the concerns associated
with using clusters by highlighting the heterogeneity that can still exist across MSAs that have out-
wardly very similarly cluster structures and instead focusing on the sources of the degree of integra-
tion of an MSA’s clusters in order to guide local development policy makers. For example, for an MSA
where real wage growth is best explained by Specialized External Agglomeration, a focus on policies
that support the growth and performance of the existing traded clusters such as specialized tax poli-
cies, developing the appropriate workforce and adding trade relationships would potentially have the
highest returns. For an MSA where Specialized Local Agglomeration holds the highest explanatory
power, access to and development of local labor markets and the local capital stock might instead be
the best course of action. If, on the other hand, Co‐agglomeration is dominant, it may suggest that the
MSA is already instituting best practices. This is in line with Delgado, Porter, and Stern (2016), who
find that policies that support complementarity across related economic activities offer better returns
than prioritizing high‐wage or high‐tech clusters where the MSA has little preexisting strength, and
is important since it suggests that current policy can be tailored to supporting that cluster structure.
To demonstrate this, we discuss in this section four classes of MSA cluster structures derived from
decompositions of MSA real wage growth based on the regressions previously discussed in Table 1:
(a) Nationally Representative or Locally Idiosyncratic, (b) High Urban Amenity, (c) Diverse Local
Economies, and (d) Specialized Local Economies.
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3.5 | Nationally representative or locally idiosyncratic economies

These economies are those for which our urban growth factors demonstrate little explanatory power
for real wage growth. As examples, we show in Figures 4 and 5 predicted values for real wage growth
from our spatial factor model for the Chicago and Milwaukee MSAs broken down by the contribu-
tions from each of our three urban growth factors. While the model fit for both MSAs is rather low, the
reasons for this are very different, as evidenced in the factors that do seem to hold some explanatory
power in each MSA. For instance, Chicago's status as a trading hub of the Midwest is apparent in the
Specialized External Agglomeration factor playing a large role in its predicted value; whereas, the
Specialized Local Agglomeration factor plays a similar role in Milwaukee, consistent with the more
localized nature of its economy. Neither MSA, however, displays substantial variation explained by
the Co‐agglomeration factor. We interpret this as suggesting that the clusters are not necessarily in-
tegrated in these MSAs. The issue this raises is then whether or not their clusters end up leading to
congestion rather than enhancing productivity. In these instances, an MSA may have what appears to
be a desirable set of industries; but if they operate independently from each other, the full benefits of
agglomeration may not materialize.
Chicago, in particular, presents an interesting test case for our model. Despite having a diverse
cluster structure that closely mirrors the United States, it has been growing at a subnational rate. Our
spatial factor model points to some possible explanations for this. First, given that its Specialized
External Agglomeration factor has some explanatory power, it should be noted that Hewings et al.
F I G U R E 4 Nationally representative or locally idiosyncratic economies. Notes: This figure decomposes

real wage growth (black solid line) for the Chicago, IL MSA in standard deviations from the mean over the period
from 1999–2015. Overall (black solid dot) and separate (blue, red or orange bars) contributions by year are based
on regressions of MSA real wage differential growth within the U.S. on our three growth factors, with the R2 of the
regression noted in the top corner of each plot
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F I G U R E 5 Nationally representative or locally idiosyncratic economies. Notes: This figure decomposes real
wage growth (black solid line) for the Milwaukee, WI MSA in standard deviations from the mean over the period
from 1999–2015. Overall (black solid dot) and separate (blue, red or orange bars) contributions by year are based
on regressions of MSA real wage differential growth within the U.S. on our three growth factors, with the R2 of the
regression noted in the top right‐hand corner of each plot
(1997) establishes that trading in the Midwest is still highly concentrated within the region. Given the
region's relatively slower growth rate, it can be hypothesized that Chicago does not maximize its ben-
efits from trade. When we use our Bartik shift‐share real wage growth differential to control for this
in estimation, the importance of the Specialized External Agglomeration factor goes away in Figures
4 and 5, leaving behind a much bigger role to be played by the Specialized Local Agglomeration and
Co‐agglomeration factors. The increased importance of these factors suggests that the agglomeration
benefits of Chicago's cluster structure are more similar to Milwaukee than it may seem at face value,
but also that its level of cluster integration is indeed unique given its diversity.
The nuance provided by our spatial factor model results for Chicago also yields two important
policy implications. First, Chicago's existing cluster structure appears to be more competitive than
cooperative, as the diversity of the clusters in Chicago without a dominant industry likely limits the
agglomeration benefits of specialized policy to attract specific types of labor and capital. Second, its
existing cluster structure also appears to be just less productive and less capable of generating positive
spillovers across industries. Consistent with this, Parilla and Muro (2017) note that in the period of
2004–2015 covered by our model, Chicago's annual productivity growth slumped to 0.43% versus the
United States average of 0.66%. In contrast, its peer MSAs that averaged much higher productivity
growth rates over the same period, such as San Francisco (0.89%) and Boston (0.72%), are charac-
terized by much higher levels of co‐agglomeration as shown below. Therefore, our findings tend to
confirm the work of others which suggests that Chicago does not make full use of its potential agglom-
erative benefits and point to avenues for local policy makers to explore.
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3.6 | High urban amenity economies

These economies are characterized in our analysis by a large degree of explanatory power for real
wage growth for our urban growth factors stemming primarily from the Co‐agglomeration factor.
In our thinking, Co‐agglomeration is a proxy for the overall strength of cluster relationships within
an MSA, and our results suggest that it plays a sizeable role in explaining overall MSA economic
performance. From a policy perspective, maintaining the beneficial co‐agglomeration across high
productivity and related industries will re‐inforce growth. The challenge for these economies is that
productivity growth must remain significantly above the national average to support the high wage
and high cost characteristics of these economies. Policy needs to ensure that key firms continue to
be dominant in their industries or eventually costs will outstrip productivity and growth will decline.
The first such economy that we consider is San Francisco. Figure 6 demonstrates that the Co‐
agglomeration factor is most responsible for explaining year‐to‐year variation in San Francisco's real
wage growth during our sample period. Based on our earlier results, this suggests that its cluster struc-
ture is highly integrated and, thus, has the potential to have a persistent competitive advantage relative
to its peer MSAs that will help support the higher wages and higher cost of living that would choke off
growth in a less productive city. Anecdotally, the importance of the technology sector in San Francisco
given the presence of Silicon Valley would suggest that the metro area is designed to support these
types of firms whatever the service or good being provided.
F I G U R E 6 High local amenity economies. Notes: This figure decomposes real wage growth (black solid line)
for the San Francisco, CA MSA in standard deviations from the mean over the period from 1999–2015. Overall (black
solid dot) and separate (blue, red or orange bars) contributions by year are based on regressions of MSA real wage
differential growth within the U.S. on our three growth factors, with the R2 of the regression noted in the top righthand
corner of each plot
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F I G U R E 7 High local amenity economies. Notes: This figure decomposes real wage growth (black solid line)
for the Boston, MA MSA in standard deviations from the mean over the period from 1999–2015. Overall (black
differential growth within the U.S. on our three growth factors, with the R2 of the regression noted in the top right‐
hand corner of each plot
Table 2 shows the top five traded and local cluster concentrations for the San Francisco (SF)
MSA based on wage income shares by cluster type and metro area. For instance, business services
accounts for roughly 30% of the wage income in the traded cluster segment and about 18% of the
total SF metro economy. Two observations emerge from this analysis. First, on the traded cluster side,
business service firms clearly comprise the dominant industry in SF, representing the largest share of
wage income in the MSA, and are arguably highly complementary to several of the other clusters in
the top five. This suggests that the SF MSA may support a more tailored type of local development
policy. The local clusters, on the other hand, are dominated by health services which is not surprising
given the presence of large health centers in SF. However, the relative strength of real estate and com-
mercial services also suggests the importance of two complementary local clusters that would also be
expected to be highly integrated with business services.
To further investigate the sources of possible complementarity across clusters, we next decom-
posed the dominant traded cluster for San Francisco—business services—into its subcomponents in
Table 3. What this table illustrates is that the business services cluster's dominance can be attributed to
four highly related industry groups—corporate headquarters, computer services, and engineering and
consulting services. What this more detailed industry analysis suggested by our spatial factor model
thus helps to identify is not only the presence of a dominant cluster, but also the strength of its com-
ponent parts. Given what we find in Tables 2 and 3, it is not surprising that the model sees the level of
Co‐agglomeration in San Francisco as being very high even after accounting for cluster‐year fixed ef-
fects in our model which would tend to devalue the isolated contribution of a single dominant cluster.
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T A B L E 2 San Francisco and Boston MSA largest traded and local income shares
San Francisco MSA Boston MSA
Cluster Within Total Cluster Within Total

Traded Business services 29.88 18.51 Business services 29.67 16.81
Marketing, design, and 12.45 7.72 Financial services 14.85 8.41
publishing
Financial services 11.83 7.33 Education and knowledge 14.69 8.32
creation
Distribution and elec- 10.89 6.75 Distribution and electronic 10.43 5.91
tronic commerce commerce
Info. Tech. and ana- 10.65 6.60 Info. Tech. and analytical 7.53 4.26
lytical instruments instruments
Local Health services 24.54 9.34 Health services 30.81 13.35
Real estate, Const., 17.41 6.62 Real estate, Const., and 14.50 6.28
and Dev. Dev.
Commercial services 14.64 5.57 Commercial services 13.54 5.87
Financial services 7.91 3.01 Financial services 8.04 3.49
Hospitality 7.73 2.94 Hospitality establishments 6.36 2.76
establishments
Notes: This table contains overall (Total) and within category (Within) nominal (wage) income shares for the five largest traded and
local industry clusters in the San Francisco, CA and Boston, MA MSAs.
T A B L E 3 San Francisco and Boston MSA business services cluster income shares
San Francisco MSA Boston MSA
Industry group 1998 2015 Change 1998 2015 Change

Architectural and drafting 3.6 2.4 −1.2 3.8 2.1 −1.7
services
Business support services 6.6 3.7 −2.9 6.0 3.9 −2.1
Computer services 25.0 42.6 17.6 23.7 31.2 7.5
Consulting services 11.9 8.8 −3.1 14.6 13.1 −1.5
Corporate headquarters 39.5 31.7 −7.9 39.6 36.9 −2.8
Employment placement 1.6 1.5 −.1 1.4 2.3 .9
services
Engineering services 11.4 8.8 −2.6 10.3 10.0 −.4
Ground passenger .4 .5 .1 .5 .5 .0
transportation
Notes: This table contains nominal (wage) income shares in 1998 and 2015 and the change between years for industries in the
Business Services cluster in the San Francisco, CA and Boston, MA MSAs.
A similar dynamic would seem to explain real wage growth in Boston, also seen in Figure 7. The
city's success has been linked to strong development in health care and pharmaceutical research as
well as its traditional role as a center for higher education. The fact that our Co‐agglomeration factor
also explains so much of the year‐to‐year variation in Boston's real wage growth suggests that it, too,
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F I G U R E 8 Diverse local economies. Notes: This figure decomposes real wage growth (black solid line) for the
Houston, TX MSA in standard deviations from the mean over the period from 1999–2015. Overall (black solid dot)
and separate (blue, red or orange bars) contributions by year are based on regressions of MSA real wage differential
growth within the U.S. on our three growth factors, with the R2 of the regression noted in the top right‐hand corner of
each plot
has an integrated cluster structure that generates above‐average productivity. However, Tables 2 and 3
show that Boston's clusters are rooted in a somewhat different dynamic than SF, even though they too
reflect a level of complementarity that suggests that development policies that support this specialized
cluster structure would best support future performance.
Table 2 demonstrates considerable overlap between the dominant clusters in SF and Boston; how-
ever, unlike SF, the importance of higher education in Boston is highly evident with nearly 15% of
traded cluster wage income concentrated in education and knowledge creation. Also different from SF
is the larger role that financial services play in Boston. On the local cluster side, like SF the impor-
tance of healthcare is clear, with health services accounting for nearly 31% of cluster wage income.
In Boston, however, healthcare, biopharmaceutical firms, and education are all highly integrated. As
was the case with SF, Boston also has a dominant business services traded cluster but when this is
decomposed by industry, we find a very different pattern from SF (Table 3). While Boston is similar in
having a large and growing computer services industry, it is corporate headquarters that dominate its
business services cluster. A dominant corporate headquarters cluster is likely, though, to draw heavily
on the computer, consulting, and engineering services also prominent in Boston, suggesting further
complementarity in its industry structure.
When looking at this city pair, it is important to recognize that while high value‐added and high
productivity service industries are driving growth, idiosyncratic factors specific to the types of firms
that are represented in the business services cluster need to be considered to develop appropriate
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F I G U R E 9 Diverse local economies. Notes: This figure decomposes real wage growth (black solid line) for
the Minneapolis, MN MSA in standard deviations from the mean over the period from 1999–2015. Overall (black
public development strategies. Local knowledge of the structure and firms in the economy are neces-
sary to fully understand the dynamics of a city's growth.
3.7 | Diverse local economies

These economies are characterized by significant overlap in the explanatory power of our three urban
growth factors for real wage growth. Policy in these cities need to recognize that at least part of the
growth that is occurring is because of rapid expansion of key, but unrelated, industries. This can lead
to significant short‐run growth but unless related industries can emerge to further promote co‐ag-
glomeration, these cities may suffer a similar fate as Chicago—diversified industry structures that fail
to promote productivity. Here, we examine Houston and Minneapolis. Houston, which is well known
for its concentration of oil and gas companies, would also be expected to demonstrate a high degree of
complementarity in its cluster structure. (For example, the Federal Reserve Bank of Dallas estimates
that 44% of the city's economy was dependent on oil and gas, although healthcare and education have
emerged as the largest employers). As the results in Figure 8 demonstrate, the Co‐agglomeration fac-
tor does indeed have a significant influence on Houston's recent performance; but in this case both the
Specialized External Agglomeration and Specialized Local Agglomeration factors also play a larger
role.
Obviously, the oil and gas sector would be heavily influenced by external demand factors, which
would explain why the Specialized External Agglomeration factor appears to play a larger role in
BRAVE and MATTOON
23
|
T A B L E 4 Houston and Minneapolis MSA largest traded and local income shares
Houston MSA Minneapolis MSA

Oil and gas production and 13.76 7.99 Distribution and electronic 13.69 7.56
transportation commerce
Distribution and electronic 11.83 6.87 Financial services 7.75 4.28
commerce
Construction products and 5.10 2.96 Insurance services 6.33 3.49
services
Financial services 4.93 2.87 Info. Tech. and analytical 5.71 3.15
instruments
Real estate, Const., and 18.55 7.77 Real estate, Const., and 16.72 7.49
Dev. Dev.
Hospitality establishments 7.14 2.99 Financial services 9.49 4.25
Motor vehicle products and 5.37 2.25 Hospitality establishments 6.32 2.83
services
local industry clusters in the Houston, TX and Minneapolis, MN MSAs.
T A B L E 5 Houston and Minneapolis MSA business services cluster income shares
Houston MSA Minneapolis MSA

Architectural and drafting 1.8 1.1 −.7 2.1 1.4 −.7
services
Business support services 7.7 3.5 −4.2 5.9 4.3 −1.7
Computer services 10.4 9.5 −.9 17.3 15.9 −1.4
Consulting services 6.8 6.1 −.7 5.4 5.6 .2
Corporate headquarters 51.8 60.1 8.2 63.4 66.2 2.8
Employment placement .8 1.1 .3 .7 .7 .1
services
Engineering services 20.4 18.4 −1.9 4.3 5.7 1.4
Ground passenger .2 .2 −.1 .8 .2 −.6
transportation
Business Services cluster in the Houston, TX and Minneapolis, MN MSAs.
Houston than in Boston, for instance. In terms of Specialized Local Agglomeration, Houston's emer-
gence as a major medical center is also apparent in the high share of income derived from health
services (Table 4). However, one could speculate that the complementarity between Houston's oil
sector and its growing healthcare sector is quite different from Boston where healthcare and pharma
|
F I G U R E 1 0 Specialized local economies. Notes: This figure decomposes real wage growth (black solid line)
for the Cleveland, OH MSA in standard deviations from the mean over the period from 1999–2015. Overall (black
can support each other. In fact, digging deeper into Houston's cluster structure in Table 5 reveals a very
different set of dominant industries that are indeed arguably less likely to be integrated to the same
degree that we found in Boston or San Francisco. As such, the Co‐agglomeration factor appears much
weaker at explaining changes in wages in Houston than in Boston or SF where a stronger and more
complementary cluster structure better supports the benefits of agglomeration.
Minneapolis has also experienced fast growth while diversifying its local economy. The MSA
population grew by 17.1% from 2000 to 2016 adding 519,000 residents. Historically, the Minneapolis
economy had been rooted in mill, grain and food processing industries as typified by companies such
as Cargill, General Mills and Land O Lakes. However, recent growth has seen the economy diversify
by adding the headquarters of large consumer goods retailers such as Best Buy and Target as well
as financial services firms such as US Bank, Ameriprise and Thrivent Financial. The Minneapolis
economy is ranked as the 13th largest in the US and second only to Chicago in the Midwest in terms
of gross metropolitan product. It is also the second largest medical device manufacturing center in the
country and the fourth largest banking center.
As Figure 9 shows, real wage growth in Minneapolis is influenced by all three urban growth fac-
tors. However, Specialized Local Agglomeration has a relatively more important role in combination
with the remaining factors than in the metro areas discussed above. When you examine Minneapolis’
cluster structure (Table 4), you find a dominant business service sector led by a growing corpo-
rate headquarters cluster and a dominant health services local cluster. On the local cluster side, the
four dominant clusters that define income shares are health services, real estate and construction,
BRAVE and MATTOON
25
|
F I G U R E 1 1 Specialized local economies. Notes: This figure decomposes real wage growth (black solid
line) for the Dallas, TX MSA in standard deviations from the mean over the period from 1999–2015. Overall (black
commercial services and finance. Within the traded cluster business services category, other than a
dominant corporate headquarters share, computer services is the only significant industry group in
Minneapolis.
3.8 | Specialized local economies

Finally, to demonstrate economies where Specialized Local Agglomeration plays a dominant role in
combination with Co‐agglomeration, we turn to the examples of Cleveland and Dallas. As Figures 10
and 11 demonstrate, Specialized Local Agglomeration explains far more of the year‐to‐year variation
here than in our other MSAs. The cluster structures (shown in Tables 6 and 7) can help explain this.
Unlike the previous MSAs, Cleveland has much larger wage income shares in local clusters, with
health services leading the way. Given that the Cleveland Clinic is located in the city, this perhaps isn't
surprising. However, when we take into account that while business services is still the largest traded
cluster by income share in Cleveland it is also far less dominant than health services, comprising only
13% of MSA income compared to the nearly 18% share in the local health services cluster, we see a
very different economic structure than the other MSAs.
When business services is broken out by industry in Table 7, we also find that this cluster is over-
whelmingly concentrated in corporate headquarters in Cleveland, with more than 60% of the business
services’ traded cluster income share in this category. The next closest industry is computer services
followed by consulting services, but both are a fraction of what is found in the case of Boston or San
|
T A B L E 6 Cleveland and Dallas MSA largest traded and local income shares
Cleveland MSA Dallas MSA

Distribution and electronic 13.98 6.83 Distribution and electronic 13.35 7.06
commerce commerce
Insurance services 7.06 3.45 Financial services 10.69 5.65
Financial services 6.10 2.98 Transportation and 6.58 3.48
logistics
Hospitality and tourism 4.59 2.24 Aerospace vehicles and 4.27 2.26
defense
Real estate, Const., and 14.35 7.33 Real estate, Const., and 18.00 8.48
Dev. Dev.
Financial services 6.98 3.57 Financial services 7.03 3.31
Hospitality establishments 5.62 2.87 Hospitality establishments 6.89 3.24
local industry clusters in the Cleveland, OH and Dallas, TX MSAs.
T A B L E 7 Cleveland and Dallas MSA business services cluster income shares
Cleveland MSA Dallas MSA

Architectural and drafting 2.0 1.5 −.5 2.0 1.8 −.2
services
Business support services 6.5 5.8 −.7 17.3 5.7 −11.6
Computer services 14.3 13.9 −.3 21.1 27.6 6.5
Consulting services 11.2 7.3 −3.9 8.1 7.5 −.6
Corporate headquarters 58.8 61.6 2.8 45.7 48.2 2.4
Employment placement .7 2.0 1.3 1.0 1.5 .5
services
Engineering services 6.1 7.5 1.5 4.5 7.4 2.9
Ground passenger .5 .3 −.2 .2 .3 .1
transportation
Business Services cluster in the Cleveland, OH and Dallas, TX MSAs.
Francisco. Thus, our results would seem to suggest that Cleveland's historic (but fading attraction) as
a center for corporate headquarters is not as likely to promote rapid future growth given its weaker
integration with other business services.
For Dallas, the presence of a large local health services cluster is also present (Table 6). While
business services makes the largest claim on local income shares, the next two largest clusters are
BRAVE and MATTOON
|
27
local—health services and real estate, construction, and development. Local clusters comprise the
largest income share for three of the top five clusters in Dallas. Furthermore, the business services
cluster is highly concentrated. Corporate headquarters captures a 45.7% income share (Table 7) and
are highly integrated with two supporting clusters (computer services, 21.1% share, and business sup-
port services, 17.3% share). As such, the Dallas economy can be characterized as having a significant
headquarters‐led business services sector and three important nontraded clusters.
In terms of policy, both cities favor Headquarters locations, although one is ascendant (Dallas) and
the other is possibly declining (Cleveland). Identifying industries that support headquarters operations
could help sustain this type of agglomeration as promoting growth. Another key difference is the
growth of Dallas allows it for the time being to be supported by robust local cluster industries while
such a strategy for Cleveland is less likely to provide similar benefits.
4 | CO NC LUSION S
The goal of this paper was to create an empirical model built on growth accounting principles that
would allow practitioners to better understand how local industry structures may influence urban
growth. We created a spatial factor model for this purpose that identifies three components of urban
economic performance based on the complementarity of an MSA’s clusters—Co‐agglomeration,
Specialized External Agglomeration, and Specialized Local Agglomeration. To test our model, we
used cluster data to map MSA performance across these three factors. The results presented above
demonstrate that the degree of complementarity of an MSA’s industry clusters can lead to it having a
persistent economic advantage over its peers, with this advantage stemming primarily from the level
of integration, or Co‐agglomeration, of an MSA’s clusters.
We believe that through this exercise local policy makers can gain greater insight into what public
policies may best support growth. A cautionary point that must be raised, however, is that even in the
case of MSAs with strong and highly integrated cluster structures, economic performance can still be
subject to the forces of convergence over time. A technological or first mover advantage can be hard
to sustain. As such, an MSA that is benefitting from these types of agglomerative advantages can have
its technological rents bid away over time. Based on our reading of our results, San Francisco may
currently have a particularly strong cluster structure, characterized by highly complementary indus-
tries which reinforce a strong agglomeration advantage; but as the economic outputs they produce
mature over time, this advantage may fade as other MSAs adopt similar technologies. One need look
no further than Detroit and the automotive industry to find a potential analogy.
Finally, our decomposition demonstrates that business services and other knowledge‐based in-
dustries tend to dominate the performance of metro economies. This has a direct implication for the
importance of understanding the underlying cluster strength of the local economy. Historically, ag-
glomeration was often correlated with the presence of a transportation or natural resource advantage.
The manufacturing firms that dominated traded activity exploited these advantages, but it also meant
that they were often tied to a specific geography. Today's knowledge‐based export firms do not need
natural resources to be successful. As such, these firms are more footloose and compete on their abil-
ity to concentrate and produce and distribute knowledge. The challenge for the economic developer is
how to make knowledge place‐based and sticky. Our results suggest that this is best promoted when
local policy makers try to integrate these knowledge‐producing clusters with their local economies to
ensure that they are most productive in their particular MSA.
|
ACKNOWLEDGMENTS
The views expressed herein are those of the authors and do not necessarily represent the views of
the Federal Reserve Bank of Chicago or the Federal Reserve System. The authors wish to thank Bob
Triest, Mark Partridge, Randy Eberts, Dan McMillen, and Matthew Notowodigdo for their helpful
comments on an earlier draft and Tom Haasl and Ross Cole for their excellent research assistance.
This research did not receive any specific grant from funding agencies in the public, commercial, or
not‐for‐profit sectors.
ORCID
Scott A. Brave https://orcid.org/0000-0002-6659-656X
Richard H. Mattoon https://orcid.org/0000-0001-7707-5754
ENDNOTES
1
See, for example, the cluster‐based development strategies described at http://icic.org/research/economic-development/
cluster-growth-toolkit/.
2
The U.S. Cluster Mapping Project defines an industry cluster as “…a regional concentration of related industries in a
particular location.” For more information, see https://clustermapping.us/content/clusters-101.
3
When we refer to capital in the model, we do not distinguish between its various forms, for example, physical capital,
human capital, or fixed capital resources such as land. The latter is commonly treated as a third input in the production
function. Our model could be extended to do the same without substantially altering the results that follow.
4
These normalizations are sufficient conditions for (I − 𝜌A)−1 to exist, that it is strictly diagonally dominant, or
�1 − 𝜌A � ≥ ∑ ��−𝜌A �� .
� ii � j≠i � ij �
5
For additional detail on the panel SAR, see Anselin, Le Gallo, and Jayet (2008). Brueckner (2003) also uses a similar
construct to characterize the spatial equilibrium of a model of strategic interactions among governments.
6
See, for example, the consistency arguments made in Stock and Watson (2002).
7
It is not possible to recover absolute cluster demand elasticities and labor income shares given that spatial PCA is only
identified up to a scalar parameter. To further enforce the relative nature of the loadings on the second and third factors, we
also restrict them to sum to zero.
8
Another reason why one might be skeptical that the factor loadings recover the structural parameters of our model is that
the factor structure in Equation (5) relies quite heavily on the functional forms we have chosen for production and demand.
If the cluster labor income shares or demand elasticities do in fact vary over time and MSAs, then this will produce resid-
ual variation in Equation (5) that may be expected to be correlated with our factors. The factors can still be consistently
estimated, however, as long as this correlation vanishes in the limit as the size of the panel grows.
9
Our educational attainment variable can also be viewed as another control for local labor demand, as Glaeser and Gyourko
(2005) find that the share of the adult population with a college degree tends to decline when a city experiences an adverse
labor demand shock.
10
We used the spatial econometrics Matlab toolbox available at www.spatial-econometrics.com for this purpose.
11
We scale the spatial principal components instead of the factor loadings so that our absolute and relative wage growth fac-
tors are separately identified and impose zero restrictions on the factor loadings for the second factor in order to separately
identify two relative wage growth factors.
12
Because spatial PCA is only identified up to a sign flip, that is, we can multiply both the factors and their loadings by −1
and arrive at the same joint effect, we normalize the sign of the factors and loadings such that each factor is positively
correlated with gross metropolitan product growth.
13
Data on real private sector output from the Bureau of Economic Analysis are not available prior to 2001, necessitating the
later start date.
BRAVE and MATTOON
29
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14
Because the Co‐agglomeration factor loading is restricted to be one for all clusters, it serves as the constant of this
regression.
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SUPPORTING INFORMATION
Additional supporting information may be found online in the Supporting Information section.
How to cite this article: Brave SA, Mattoon RH. Explaining urban economic growth through
cluster complementarity. Growth and Change. 2019;00:1–30. https://doi.org/10.1111/
grow.12340

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Received: 12 February 2019

| Revised: 16 September 2019

Explaining urban economic growth through cluster

Scott A. Brave | Richard H. Mattoon

Economic Research, Federal Reserve Bank

Growth and Change. 2019;00:1–30. wileyonlinelibrary.com/journal/grow |

2 | A N U R BA N G ROW T H AC COUNTING FRAM EWORK

2.1 | A stylized urban growth model

Ycmt = Act (𝛽mt Kcmt )𝛼c (𝜌mt Lcmt )(1−𝛼c ) , (1)

As shown in Section A2 of the Appendix in supplementary information, industry cluster profit

2.2 | A spatial factor model of real wage growth

Δwcmt − Δpcmt = Λc Fmt + 𝜀cmt

(I − 𝜌A)−1 (Δw − Δp) = (I − 𝜌A)−1 FΛ + (I − 𝜌A)−1 𝜀 (6)

(Δw − Δp) = (I − 𝜌A)−1 𝜐.

((I − 𝜌A)−1 (Δw − Δp))� ((I − 𝜌A)−1 (Δw − Δp))

Ymt = 𝛼t + 𝛿m + 𝛽Ymt−1 + 𝜂mt , (7)

3 | E X P LA I N ING MSA P E R FORM ANCE

3.1 | Data and estimation

3.2 | Spatial factor model results

3.3 | Factor‐augmented panel VAR results

Real wage growth Real wage growth differential

MSA CoAgg SpExtAgg SpLocAgg All CoAgg SpExtAgg SpLocAgg All

3.4 | Local development policy implications

3.5 | Nationally representative or locally idiosyncratic economies

F I G U R E 4 Nationally representative or locally idiosyncratic economies. Notes: This figure decomposes

3.6 | High urban amenity economies

San Francisco MSA Boston MSA

Cluster Within Total Cluster Within Total

San Francisco MSA Boston MSA

Industry group 1998 2015 Change 1998 2015 Change

3.7 | Diverse local economies

Houston MSA Minneapolis MSA

Cluster Within Total Cluster Within Total

T A B L E 5 Houston and Minneapolis MSA business services cluster income shares

Houston MSA Minneapolis MSA

Industry group 1998 2015 Change 1998 2015 Change

3.8 | Specialized local economies

Cleveland MSA Dallas MSA

Cluster Within Total Cluster Within Total

T A B L E 7 Cleveland and Dallas MSA business services cluster income shares

Cleveland MSA Dallas MSA

Industry group 1998 2015 Change 1998 2015 Change

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