Big city, small firms

Urbanists often argue for better cities by appealing to our desire to be happier, healthier, or more environmentally sustainable. Cities, they argue, can improve our well-being in all sorts of ways. There is definitely something to this idea. As I’ve previously written, good urban policies, such as mixed-use developments, denser neighbourhoods, shared spaces, and useful public transport, can make us better off in all sorts of ways.

However, cities are not just places of consumption – they are also sites of production. As an economist, I’m particularly interested in how better cities can create greater economic opportunities for people. In a series of previous posts, I have observed that:

• New Zealand’s three large cities account for over half – 56% – of national GDP
• The existence of an “urban productivity premium” means that policies that stifle the growth of Auckland are likely to put a drag on New Zealand’s economy
• We must invest in better cities if we want to lift our economic performance in the long run.

In this post, I want to take a closer look at this issue. Why are cities important to economic growth? What makes them such good places to do business? How do they help people create, adapt, and commercialise ideas?

My starting place, as always, is what we can observe. Here’s my map of the NZ economy. The orange blobs on the map – Auckland, Wellington, and Christchurch – make up less than 1% of New Zealand’s land area, but over half of all economic activity. Businesses and workers, when offered the choice to disperse themselves widely over a wide rural expanse, have chosen instead to agglomerate in a few small areas. This is an immensely important fact.

Businesses are not doing this because they are irrational – they choose to locate (or start up) in cities because it offers them better chances of success. A good city, it turns out, is a fantastic ecosystem for firms. It offers them the inputs they need – employees, financing, ideas – and provides them with access to a range of customers. In addition, it surrounds them with other firms, who may act as competitors, collaborators, or suppliers.

In his book Triumph of the City, Harvard economist Ed Glaeser looked at how this process once worked in Detroit:

…there was an explosion in automotive entrepreneurship in Detroit in the early 1900s. Detroit seemed to have a budding automotive genius on every street corner. Ford, Ransom Olds, the Dodge brothers, David Dunbar Buick, and the Fisher brothers all worked in the Motor City. Some of these men made cars, but Detroit also had plenty of independent suppliers, like the Fisher Brothers, who could cater to start-ups. Ford was able to open a new company with backing from the Dodge brothers who were making engine and chassis components. They supplied Ford with both financing and parts. (p 48)

Glaeser’s account of Detroit illustrates some important features of successful cities. They are diverse yet connected environments in which ideas can travel. A good city should enable people to learn from each other by placing them in close proximity.

As a result, a city is an especially favourable environment for startups and small, innovative firms. Although Henry Ford’s company went on to dominate the car industry, he had to start somewhere – and was fortunate enough to begin in a city where he could access venture capital, suppliers, and cutting-edge ideas. That would have been hard to do in a small town or out in the countryside.

However, Glaeser’s account of Detroit’s economic rise and fall also suggests that large firms can lose touch with the urban environments that enabled their growth:

The irony and ultimately the tragedy of Detroit is that its small, dynamic firms and independent suppliers gave rise to gigantic, wholly integrated car companies, which then became synonymous with stagnation…

Successful car companies bought up their suppliers, like Fisher Body, and their competitors. By the 1930s, only the most foolhardy and well-financed businessman would have dared take on General Motors or Ford. The intellectually fertile world of independent urban entrepreneurs had been replaced by a few big companies that had everything to lose and little to gain from radical experimentation. (p 49)

Detroit’s economic fall from grace shows that cities need startups and small businesses just as much as small firms need cities. A healthy firm ecosystem is one in which there are a lot of firms competing with each other, selling to each other, and learning from each other.

Big corporations can’t sustain a dynamic urban economy on their own, as often use cities in different ways than small firms. For one thing, they tend to produce a lot of their own inputs to production. For example, a large company may have its own finance department, an in-house legal team, its own building management services, and so on and so forth. As a result, they can choose to do without other urban firms, and, in some cases, exit the city altogether.

Consequently, in the long term a country’s economic success depends on its ability to foster innovation, entrepreneurialism, and the growth of new firms. Good urban policies are essential to this process. A successful city will connect people and puts them in contact with new ideas and new opportunities. An economically dysfunctional city, by contrast, will sever them from each other or maroon them down the end of distant cul-de-sacs.

There is no substitute for an urban firm ecosystem. Governments often try other things, like subsidising agricultural and extractive industries or writing regulations that favour existing large firms. However, these activities all offer limited prospects for future growth. (To say nothing of the fact that the economic record of these policies in New Zealand is dismal.)

A focus on building better cities represents an alternative to the frustrations of economic development policy in New Zealand. Fortunately, we’re lucky enough to have many, many opportunities for building better cities. In Auckland, but also in Wellington, Christchurch, and smaller centres, we can do many things to improve the way our cities function, by:

• Investing in efficient and useful public transport networks, including rapid transit networks in major cities (CRL now!)
• Building streets that are safe and inviting for people to walk and cycle on – acknowledging that people, not cars, are the drivers of economic activity
• Enabling market-led intensification, including the construction of townhouses and apartment buildings in the places where people want to live
• Creating great public spaces that encourage people to get out and make fortuitous connections with each other.

Cities, small firms, and economic growth – what do you think?

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