Agglomeration Economies and Localisation Effects: What Makes Being Located In The City of London A Competitive Advantage for Start-ups

While the City of London is just over 1 square mile in size, the sheer amount of economic output generated from such a small area would be hard to find even if the same amount of economic activity was spread across a whole region in the UK. In 2024, London recorded a GDP per capita of £7.33 million - the highest per capita income of any area in the world. In addition, London has over 22,485 businesses operating within the City. Professional service firms make up over 35% of the businesses operating within the City and more than 500,000 people commute to work in the City of London every week. These figures alone are impressive, but the economic theory underpinning them is really what makes the City of London interesting. The figures are not coincidental and arise as a result of agglomeration economies. For anyone looking for private offices to rent within the City of London, a solid understanding of agglomeration economies is very helpful in understanding the full nature of what is at stake with respect to a location decision.

Why Do Firms Cluster? – Economics of Agglomeration

As previously mentioned, agglomeration economies represent a type of external scale economy. They are a result of firms being located in proximity to each other and not reliant on their own internal operational decisions; however, this is not the entire story. Alfred Marshall identified three separate, distinct reasons for agglomeration economies in the 1890s. The first reason provided by Marshall for agglomeration economies is the pool of labour within a given industry. The fact that companies operating within an area are close together allows for the creation of a dense concentration of firms operating in that sector within a specific geographical area. This concentration of firms creates a thick, localised labour market making it easy for any one company to recruit highly skilled talent or to find employment opportunities for skilled workers without having to move from their existing residence. The second reason is that clustering drives the attraction of affordable specialist suppliers and service providers — resulting in lower search and transaction costs for all user companies. The third reason — and probably the most relevant to knowledge-based industries — is the sharing of knowledge.

Knowledge spillovers represent positive externalities (benefits that accrue to a third party due to another company's actions), which cannot be priced into any transaction. Knowledge spillovers occur within concentrated financial and professional services districts. They take place informally through professional networks, happenstance, and mutual advisors. Founders operating in the Square Mile absorb ambient knowledge through daily proximity — accelerating relationship-building in ways that are difficult to replicate elsewhere For example, in 2022, London's Gross Value Added (GVA) per hour worked was 26% above the UK average (this difference can be explained by agglomeration effects).

The City of London's labour pool effect is particularly significant for technology- and professional-services-based startup companies. According to the Global Startup Ecosystem Index 2025, London comprises approximately 65% of the total number of startups within the UK and supports nearly 1,000 startups for every million residents of London, making it the highest density of startup activity in any city in Europe. This density of startups is also self-reinforcing because the City of London is home to a concentration of experienced entrepreneurs, investors, and skilled professionals, which facilitate the hiring, investment, and sales processes for early-stage startup businesses. The ability to grow and scale your business through a location that has an abundance of talented people to draw from (known as the talent pool) is a structural advantage that is not available to companies in other areas.

The Denial of Cowboy Capitalism

The City of London has always provided an excellent business model due to its many benefits to businesses. However, it has historically been difficult to demonstrate the economic value of having an office located in the City. The historical leasing model made it very expensive for many small and mid-sized businesses to acquire office space: leases were for five or ten years; fit-out costs were high; and deposits were set at amounts that were appropriate for established businesses. The result was a market structure designed to allow large corporate businesses to take advantage of agglomeration benefits while restricting access to those benefits for early-stage businesses that need them the most.

Barriers have reduced significantly; for example, The Work Project at 1 Leadenhall Street provides private offices for teams of 5 or more and also provides enterprise-level space for companies that have 25 or more employees. This allows early-stage companies at varying stages of growth to have access to the value of a prestigious office location in the City on terms that are proportionate to their size. In 2024, London's startup ecosystem was valued at $342 billion; that year alone, $3.5 billion in venture capital (32% of the total VC funding in the City) was invested in AI startups. Those startup companies will be competing in highly competitive, credibility-sensitive industries that have historically had barriers to entry, namely long-term, committed capital — that barrier is now less of a constraint in the office market as it once was.

It is important to highlight the opportunity costs associated with the alternative option. While a less expensive office outside of the core business district saves on rent, there is a much larger cost to be incurred by selecting that location over the labour pool, access to your investors, and the informal knowledge networks that only exist in the City. A startup that requires rapid hiring, enterprise contracts, and subsequent capital raises incurs an economic cost from the lost positive externalities associated with operating in the City, which are typically not captured in financial models but are reflected in slower growth timeline

The theory of agglomeration economies was developed to provide an explanation as to why industry aggregation geographically as opposed to evenly spreading themselves out across regions.

The Square Mile (the City of London) stands out as one of the best real-world examples of agglomeration theory, and therefore the availability of flexible office solutions makes access to the traditional business district (the City) for all startups that are preparing to enter into the next phase of their business fundamentally different.