Why and how geographic differences matter in economic well-being?

Superb interview of University of California, Berkeley economist Enrico Moretti.

He explains why despite the internet people continue to work in select concentrated locations:

EF: During perhaps the first decade or so of the World Wide Web, there were numerous predictions that geography would disappear or almost disappear as an issue in knowledge work. It seemed as if white-collar workers, if one believed the predictions, would be able to work from anywhere.

Moretti: Yes.

EF: What happened?

Moretti: It’s one of the main paradoxes of our times. The explosion of the internet, email, and cellphones democratizes the access to information. In the 1990s, people thought it would also make the place where the company is located or where workers live much less important.

The idea of The World Is Flat by [Thomas] Friedman was indeed that location would lose its importance. Because I can sit in front of a laptop in rural Tibet and have access to the same information that I have if I am in the center of Silicon Valley in downtown Palo Alto, location was expected to matter less for workers and firms.

But what we have seen over the past 25 years is that the opposite is true: Location has become more important than ever before, especially for highly educated workers. The types of jobs and careers that are available in some American cities are increasingly different from the ones available in other American cities.

There’s nothing new in the fact that some areas are economically more dynamic than others and offer better labor market opportunities; that’s always been the case. What is different today is how large the difference between the most successful labor markets and the least successful labor markets has become and how fast they are growing apart. It’s a paradox because it is true that we can have access to a lot of information and communicate easily from everywhere in the world, but at the same time, location remains crucial for worker productivity and for economic success.

In the first three decades after World War II, manufacturing was the most important source of high-paying jobs in the United States. Manufacturing was geographically clustered, but the amount of clustering was limited. Over the past 30 years, manufacturing employment has declined, and the innovation sector has become a key source of good jobs. The innovation sector tends to be much more geographically clustered. Thus, in the past, having access to good jobs was not tied to a specific location as much as it is today. I expect the difference in wages, earnings, and household incomes across cities to continue growing at least for the foreseeable future.

EF: Alfred Marshall, as you know, wrote about so-called agglomeration economies as long ago as 1890. Presumably, he was thinking about manufacturing when he wrote about that. Why are the trends you’re describing becoming so much more important now? What is different about these “innovation sector” industries?

Moretti: The microeconomic foundations of agglomeration economies represent an area of active research right now. We have a general sense of the magnitude of the economic benefits of agglomeration. We are still trying to empirically assess the relative importance of the microeconomic channels that may generate those benefits. There are three that have been identified in the literature and are likely to play a significant role in practice. The first one is the existence of knowledge spillovers, also known as human capital spillovers: the fact that our human capital depends not only on where we go to school and how much schooling we get, but also on the people who surround us and from whom we learn.

The second one is the matching advantage offered by thick labor markets. In the case of specialized workers, who often have idiosyncratic skills, thick labor markets allow for a better match with firms. For example, if you are a biotech engineer specialized in, say, biofuel and you work in Silicon Valley, where at any moment in time there are a thousand biotech firms looking for biotech engineers, you are more likely to find the one that studies biofuels than if you are the same biotech engineer located, say, in Chicago, where at any moment in time there are fewer biotech firms looking for engineers. A better match means a better career for the workers. At the same time, it is advantageous for firms because it results in higher productivity.

The third channel is the thickness of the market for specialized services. Again, if you are in an area where there are many other firms like yours and they all need a very specialized type of vendor, you are more likely to find it in an area where there’s a big agglomeration of firms in the same sector.

All three factors exist in manufacturing, of course. But they are much stronger for firms and workers that engage in innovation.

That is why we see some agglomeration of traditional manufacturing firms, but when we compare it to agglomeration of firms in the innovation sector, the latter is much stronger. I have just finished a new project where I study how locating in a high-tech cluster improves the productivity and creativity of inventors. If you look at the major fields — computer science, semiconductor, biology, and chemistry — you see a concentration of inventors that is staggering. In computer science, the top 10 cities account for 70 percent of all the innovation, as measured by patents. For semiconductors, it’s 79 percent. For biology and chemistry, it’s 59 percent.

This means that the top 10 cities generate the vast majority of innovation in each field. Importantly, the share of the top 10 cities has been increasing since 1971, indicating increased agglomeration.

In a world where all the information is available online, you would expect the opposite to happen, and yet we see more concentration of inventors today, as measured by my data, compared with the early ’70s. I think it’s because the three channels are particularly strong for these types of workers and firms.

Read the whole bit as it has really interesting insights.

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