This paper explores the relationship between employment density and productivity, using two theoretical models: one based on local geographical externalities and the other on the variety of locally available intermediate services. The authors find that agglomeration effects more than offset congestion effects in denser areas, with a small but significant elasticity of productivity with respect to density. This elasticity explains over 50% of the observed state productivity differences, given the large variations in density. The study uses state-level data on gross state output for the U.S. and employs bothOLS and instrumental variables estimation methods. The results suggest that density, measured as the intensity of labor and capital relative to physical space, has a positive impact on productivity, contrary to neoclassical expectations. The paper also discusses the implications for growth theory, suggesting that externalities and locally tradable services can weaken the link between output per worker and returns on capital, and that rising density over time is a significant factor in economic growth.This paper explores the relationship between employment density and productivity, using two theoretical models: one based on local geographical externalities and the other on the variety of locally available intermediate services. The authors find that agglomeration effects more than offset congestion effects in denser areas, with a small but significant elasticity of productivity with respect to density. This elasticity explains over 50% of the observed state productivity differences, given the large variations in density. The study uses state-level data on gross state output for the U.S. and employs bothOLS and instrumental variables estimation methods. The results suggest that density, measured as the intensity of labor and capital relative to physical space, has a positive impact on productivity, contrary to neoclassical expectations. The paper also discusses the implications for growth theory, suggesting that externalities and locally tradable services can weaken the link between output per worker and returns on capital, and that rising density over time is a significant factor in economic growth.