Why do businesses grow faster in urban areas than in rural areas?

Abstract

We document that the growth rate of business earnings among young firms is significantly higher in metro areas than in non-metro areas. Agglomeration economies and firm selection (less productive firms are more likely to exit in metro areas) are known to explain a part of the productivity growth in urban areas, but less is known about the role of borrowing constraints. By developing a firm-dynamics model with a location choice, we show borrowing constraints interact with growth and location choices of firms, and contribute to a substantial part of the observed growth-rate difference between urban and rural young firms. Our model suggests the distortion in location choice due to borrowing constraints can induce non-trivial welfare loss.