I agree that physical colocation of users is important for cohesive social media, but I don't think this is how it should be done. I also don't think it could ever take off.
People also want to participate in larger stuff sometimes (national news, international news). I think honestly the reddit model has already showed us how to handle this - just split stuff into separate communities.
You can have communities for the local stuff and people can go there. You can have communities for the bigger stuff and people can also go there if they want and they don't even need to make another user on another platform or anything.
I think honestly we just need more lemmy users to join instances that match their physical location. That's part of why I made Feddit.dk, to serve as the Danish hub of the Fediverse. We have communities for each city and you could have for each town as well once there's enough users to warrant that.