by Christopher Parsons, Faculty
In his influential book “The World is Flat,” New York Times columnist Thomas L. Friedman credited technology with a “flattening” of the economic landscape. Innovations like the Internet were making it virtually costless to transmit information, allowing people located across the world to communicate as though they were across the room. This transformation, Friedman argues, would eventually render physical distance (if not borders) irrelevant and, in so doing, redefine the concept of location – one based less on geography and more by position in a global lattice of information.
Perhaps the greatest strength of Friedman’s claim is its intuitive appeal. In my own work, email has reduced the cost of collaborating with co-authors from New York, Montreal, or Sydney to a few extra keystrokes. And how many of us have used Skype, Facebook, Twitter, or similar outlets to keep in touch with faraway friends and family? Even romance, presumably the least likely human activity to relinquish the faceto- face meeting, has partly surrendered. Dating websites such as match.com help electronically fan the flames of desire, while others (see, for example, www.idump4u. com) extinguish them virtually.
Yet, the main challenge facing the “flat earth” view is the evidence itself. Instead of geographical location mattering less, it seems to be mattering more. In developed economies, approximately four-fifths of people live in urban centers, up from 52 percent in 1950. The trend in developing economies is even stronger, with fewer than 18 percent inhabiting cities in 1950, compared with almost 50 percent today. Projections suggest that by 2030, less than two in five people will live outside a major metropolitan area.1 Mirroring trends are seen for firms, with increasing numbers, particularly those in high-tech industries, moving to urban centers such as Los Angeles’ “Silicon Beach” or London’s “Silicon Roundabout.”
The obvious question: When technology allows firms and people to spread out, why do they nevertheless prefer to squish together?
It turns out that the answer predates the Internet by more than a century. In 1890, English economist Alfred Marshall formalized the concept of “agglomeration externalities,” a mouthful for the simple idea that packing businesses and people in a tight location creates synergies. A good example is the formation of local labor pools. If you own a software company, it’s pretty clear that the Bay Area is a better place to look for workers than Indianapolis. Partly this is because high-quality educational institutions like Stanford and UC Berkeley pump out class after class of bright students. But another part of the story, and the one particularly interesting to economists, is akin to dating: Even if you are currently in a relationship, there may be benefits to living in a city with lots of other single people, just in case it does not work out.
Indeed, companies view the workers of local rivals as opportunities and also understand that their own – especially the best – are constantly being wooed. Over time, so goes the theory, firms and workers are more likely to successfully “match” when an area contains lots of both. Better matches in turn generate higher productivity and happier workers, creating a positive feedback cycle as more workers and firms move to the area. Together, this implies that cities are likely the best places for most workers to develop: Not only are their chances for simply finding employment the highest, but the prospect of finding quality jobs that also suit their skills seems to be the highest in dense industrial clusters.
And once quality workers flock to a city, additional dynamics come into play. One is that ideas tend to flourish when lots of smart people are batting them around. No matter how brilliant initially, virtually any idea improves with feedback, and cities offer the interactions required for such honing to occur. Consistent with this logic, innovations are disproportionately created in a stunningly small number of locations. For example, in 2002, about 85 percent of worldwide patent activity came from just five countries (Germany, Japan, South Korea, Russia, and the U.S.), and within each country, virtually all the activity came from urban centers.2 While it is recognized that workers with a high capacity for innovation may find cities attractive in the first place, economists generally agree that once they arrive, their natural abilities are enhanced even further by the interactions cities afford.
Insights like these have led to a minirevolution in how we understand cities and, consequently, how we can plan for their growth. Gone are the days when geographical features such as waterways (e.g., St. Louis or Buffalo) were the dominant consideration for a city’s health or even existence. Instead, cities are now being modeled as quasiliving organisms, with the most important ingredient – their lifeblood – being people and their ideas. Accordingly, urban planning is increasingly focused on designs that maximize interactions among residents in hopes of attracting innovative types and then making the most of their gifts.
This paradigm shift offers some practical takeaways. First, a city’s “vibrancy” experiences ebbs and flows, as the quality of its labor force and rate of innovation fluctuate. Along with two co-authors, I recently completed a research paper that attempts to empirically measure the magnitude and frequency of these effects, examining cycles of corporate investment across 20 of the largest cities in the U.S.3 What we found surprised us. Though cities like Detroit or Houston, which are dominated by a single industry, might be expected to experience large year-to-year swings in employment or profits (think about what gyrations in the price of oil do to Houston’s energy industry), it is harder to imagine large fluctuations in diversified cities like Chicago or Philadelphia.
Yet, this is exactly what we found. Even across very dissimilar industries – take Detroit-based companies Kmart and Ford, for instance – firms headquartered nearby tend to exhibit large, persistent correlations in performance. Companies within 50 miles of one another tend to invest (e.g., build factories) together, raise capital (e.g., issue additional shares of stock) together, and hire and fire together. Even their stock price movements are correlated.
The main point of our research is to document and quantify these effects, but a secondary goal is to better understand the mechanism. For example, why specifically do San Diego’s Qualcomm and Petco seem to mirror each other’s year-to-year performance, while Dallas-based Texas Instruments and Petco do not exhibit any special relationship other than common exposure to the U.S. economy? Although the analysis here is more preliminary, the results are most consistent with the “peoplebased” explanations for urban vibrancy described above. For example, when demand for Qualcomm’s products is strong, Qualcomm is likely to hire more employees, to invest more in worker training, and to increase wages. All of these effects spill over beyond Qualcomm to benefit San Diego generally. For example, richer workers spend more, leading to the development of local amenities, which makes San Diego an even more attractive location for potential workers at peer firms. Likewise, investments in worker training or education have similar effects on the local community, helping to foster innovation and development of ideas.
Of course, the flipside is also true. In 1985, Detroit-based Unisys was the second-largest computer manufacturer in the world, ranking only behind IBM. Since that time, personal computing has exploded, and yet Unisys has languished, flirting with bankruptcy on more than one occasion. How much of Unisys’ struggles can be traced to its location, where the demise of the automotive sector ravaged Detroit? It is difficult to say with certainty, but the stark contrast with Dell, headquartered just outside thriving Austin, Texas, suggests that area dynamics are at least part of the explanation.
So what does all this imply for San Diego? First, it means that firms will increasingly flock to areas that offer their employees a high quality of life, for which San Diego is nearly unrivaled. Just as energy firms often locate near oil reserves, informationbased companies congregate near their most important resource – smart and creative people – meaning that attributes like good weather and reasonable commute times represent important competitive tools in the market for labor. Even under conservative assumptions, the number of companies that call San Diego home (or at least have a substantial presence here) is expected to grow rapidly over the next two decades.
However, growth is not all the same. Whereas higher employment is virtually always good news for an area, the types of jobs created are probably even more important. In particular, occupations that lend themselves to Marshallian externalities (e.g., knowledge spillovers) generate positive feedback, increasing productivity and wages at far higher rates than occupations lacking these effects.
This is where education becomes crucial. An institution such as the Rady School of Management have three distinct, welldefined, and (provided you are willing to slog through economics journals) measurable effects on the San Diego economy. First, it imparts training and knowledge to workers who already work and live here, which increases productivity, wages, property values, tax revenue, and so on. Second, by creating a perpetual stream of potential employees, Rady attracts employers to the region, particularly those in information-based industries. Third and finally, the accumulation of highly adept workers allows the fires of agglomeration to burn brightly, as increasing numbers hone the ideas and skills of their neighbors. Part of this is already visible, in the form of the more than 50 companies started by Rady graduates since 2003. But for the reasons described above, these tangible measures of progress are but a fraction of the total effect. Although they may take several years to emerge, they have large and lasting impacts on the local economy, even on those seemingly far removed from the institution itself.
Christopher Parsons is an assistant professor of finance. His research focuses on corporate finance, with a special interest in the interactions between firms and their local urban environments.
- Cohen, Barney. 2006. “Urbanization in developing countries: Current trends, future projections, and key challenges for sustainability.” Technology in Society: 63-80.
- World Intellectual Property Organization: U.S. Patent and Trademark Office.
- Dougal, C., Parsons, C., and Titman, S. 2012. “Urban Vibrancy and Corporate Growth.” Working Paper.