Ryan Avent is The Economist's economics correspondent and the primary contributor to Free Exchange, an economics blog
It's high time to invest in the infrastructure cities need to foster new industrial clusters
Economist Herb Stein famously said of stubborn trade gaps that if something can’t go on forever, it will stop. He was counseling patience. Unsustainable trade deficits won’t be sustained, he argued, so there was no need to intervene in the economy to fix them. Some 30 years after the country last ran a trade surplus, Americans are tired of waiting for the inevitable. There is growing anger over trade practices—like China’s undervalued currency—which are perceived to be unfair, alongside calls to boost export industries. The difficulty is in finding policies that will support exports without harming American households or sparking a trade war.
This becomes less of a hardship once one understands the critical role cities play in export industries, and the ways in which America is under-investing in its metropolitan areas. Businesses that sell stuff all over the world are often geographically concentrated, while those that don’t spread out. One obvious reason for this is that goods that can’t be shipped can’t be traded internationally. Dentists offices can be found in most American neighborhoods, because dentists can only sell their services to people close enough for an office visit. Consequently, dentistry doesn’t figure prominently in the trade data. German workers go to German dentists.
Facebook accounts and iPhones are about as ubiquitous as dentist chairs; indeed, you might update your Facebook status on an iPhone while waiting to get your teeth cleaned. But while dentistry is practiced the world over, the Facebooks and Apples of the world concentrate in places like Silicon Valley (or, as we're now learning via Alexis Madrigal, the emerging mini-Silicon Valleys of the South). The important question for the American economy is why these producers, who can sell products anywhere they like, choose to locate in one metropolitan area and, more importantly, just a few miles away from each other. Why isn’t Apple headquartered in Topeka? Or Guangdong?
Apple and Facebook stay in Silicon Valley because it’s good for business. By setting up shop within a cluster of similar industries, these companies reap big benefits. They share local support infrastructure and one of the world’s deepest pools of tech-industry talent. And they profoundly benefit from locating within a city on the frontier of technological innovation, amid the almost audible buzz of experimentation. Go elsewhere, and they may fall behind, or miss the opportunity to see how competitors succeed or fail in informative ways. These benefits amount to what economists call increasing returns to scale; when firms group together in one place, the result may be a rise in overall productivity. The whole is greater than the sum of the parts. And because the concentration of firms itself creates value, businesses can’t do as well by leaving as by staying.
Silicon Valley is the clearest example of the dynamic. Steve Jobs was an enthusiastic off-shorer, who moved large chunks of Apple’s supply chain abroad. When it came time to plan a new headquarters for his company, however, he didn’t hesitate. Apple will construct a massive new base in Cupertino, California with space for 12,000 employees. Apple’s iPads may be manufactured abroad, but most of the value-added in the product is captured by the employees who will work there. The company’s new headquarters is a huge bet that Silicon Valley’s innovative climate will continue to make Apple a better business. And the promise of a major Apple investment in the Bay Area is an attractive force for other firms. Take Facebook: when the upstart social-media firm outgrew its space in Palo Alto, it was unwilling to move more than a few miles to find a larger base of operations in nearby Menlo Park.
Silicon Valley may be the apotheosis of the industrial cluster, but it’s far from unique. The Brookings Institution calculates that nearly two-thirds of American exports originate in the 100 largest metropolitan areas, and roughly one-third come from just the 12 largest metros. By boosting firm productivity, cities enhance the competitiveness of American goods abroad. And because there is great value embodied in the metropolitan clusters themselves, the firms that benefit from them are less likely to move critical operations abroad.
That value is at risk. In recent decades, America’s metropolitan export engines have succeeded despite government neglect. Deteriorating infrastructure raises the cost of doing business directly, requiring businesses to pay employees more to compensate for the burden of unpleasant commutes. Restrictions on dense development contribute to high real estate costs, which make it more expensive to do business and attract employees. Cuts to university and research funding undermine the talent centers around which many firms build their businesses. Now would seem to be an opportune moment to begin to reverse a generation of underinvestment.