August 2001 The benefits to Indian manufacturing firms of locating in dense urban areas do not appear to offset the associated costs. Improving the quality and availability of transport infrastructure linking smaller urban areas to the rest of the interregional network would improve manufacturing plants' access to markets and would give standardized manufacturing activities a chance to move out of large, costly urban centers to lower cost secondary centers. "New" economic geography theory and the development of innovative methods of analysis have renewed interest in the location and spatial concentration of economic activities. Lall, Shalizi, and Deichmann examine the extent to which agglomeration economies contribute to economic productivity. They distinguish three sources of agglomeration economies: * At the firm level, from improved access to market centers. * At the industry level, from enhanced intra-industry linkages. * At the regional level, from inter-industry urbanization economies. The input demand framework they use in analysis permits the production function to be estimated jointly with a set of cost shares and makes allowances for nonconstant returns to scale and for agglomeration economies to be factor-augmenting. They use firm-level data for standardized manufacturing in India, together with spatially detailed physio-geographic information that considers the availability and quality of transport networks linking urban centers--thereby accounting for heterogeneity in the density of transport networks between different parts of the country. The sources and magnitudes of agglomeration vary considerably between industrial sectors. Their results indicate that access to markets through improvements in interregional infrastructure is an important determinant of firm-level productivity, whereas the benefits of locating in dense urban areas do not appear to offset the associated costs. Improving the quality and availability of transport infrastructure linking smaller urban areas to the rest of the interregional network would improve market access for manufacturing plants. It would also give standardized manufacturing activities a chance to move out of large, costly urban centers to lower cost secondary centers. This paper--a product of Infrastructure and Environment, Development Research Group--is part of a larger effort in the group to understand the role of economic geography and urbanization in the development process. The authors may be contacted at [email protected], zshalizi @worldbank.org, or [email protected].