February 23, 2006

Making Communities Prosper Economically.  As many of you know one of the things that I am interested in is helping my old home town, Racine, Wisconsin, with some of their “economic issues.”  Racine is an old-line manufacturing town.  Racine has had a rather difficult go of it over the last twenty years or so as it has lost a lot of its manufacturing jobs.

This week I was in Atlanta giving a speech to our MBA Alumni association chapter.  Atlanta is the process of losing a fair number of its manufacturing jobs as well.  Between the life long friends in Racine and the alumni in Atlanta I have been faced with the question:  how do cities replace manufacturing jobs?  That then begs the more general question:  how do cities create economic development?

For help in answering these questions I turned to the experts in “urban economics.”  Urban economics is a sub specialty of microeconomics.  The recent research in the field sheds some interesting light on the above questions.

Localization Economics

As with so many other issues, to address the present questions we must look at the past.  In the past cities developed in great part due to firms’ concern over production.  Cities developed as firms located in specific areas due to natural resources (oil in Pennsylvania or ports in Baltimore) or to be close to specific customers (Racine produce tractors for Midwestern farmers). 

Most often one of the largest driving forces for firm location was that they wanted to be close to similar producers.  This is what economists refer to as localization economies.  Thus, steel producers located in Gary, Indiana in part so that they could be close to other steel producers.  This clustering of similar producers made it easier for them to buy raw material inputs.  For example, in steel production, taconite would be floated down Lake Michigan on large barges in order so supply the multiple steel mills in Gary. 

Localization economies also impacted labor markets, this is what economists refer to as labor pooling.  Sticking with our steel example, an engineer who specialized in steel plants would be more likely to move to a city that had many steel producers instead of a town that had only one steel producer.  Having more than one producer in a town would make it easier for him or her to find a job.  From a producers’ stand point they too would like to be located close to similar producers.   These producers would not have to look very far to hire workers who had experience in their particular industry. 

Because of these various localization economic factors location of firms, and thus the development of cities were driven by production decisions.  Automobiles were produced in Detroit, beer was brewed in Milwaukee, movies were made in Hollywood, etc.

Localization Economics in the Information Age

Today localization economies still do play a role, but the times are changing. In the information age of the 21^st century similar firms still locate close to one another but for very different reasons.

Today, the urban economists tell us, city development hinges more on where workers want to live.  Firms are locating more and more often today in areas where young, well educated, highly skilled, highly creative workers have a desire to live.  Things like climate, quality of life, choices in entertainment and goods schools are key variables in which cities succeed and which falter.

What is happening in the information age is that knowledge and know-how matter.  So labor pooling is still an important variable, but it is the labor pooling of these “knowledge workers.”  Cities that can attract well educated, highly skilled workers will be able to attract even more, well educated, highly skilled workers.  When these workers combine with technology and capital they create new ideas and products which beget other new ideas and products and thus the economy grows.  This is what economists call knowledge spillovers.  These knowledge spillovers create new firms  and new jobs.  Thus economic growth occurs and jobs are created up and down the socio-economic ladder.

Power Couples

Think about this way:  if a city can attract these knowledge workers many, many service jobs will follow.  Take for example what have been labeled “Power Couples.”  Power Couples are a household where both spouses are college-educated, highly skilled and well paid.  These Power Couples will go out to eat at a variety of restaurants, go to the theatre, attend the symphony, go to sporting events, and shop…a lot.   When they go out to eat they will create demand for highly trained chiefs and waitstaff.  When they attend the arts and sporting events they create jobs for people in those industries. When these Power Couples choose to refurbish their houses they create demand for the skilled trades.  The snowballing effect continues on and on creating jobs along the way.

These Power Couples seek to work and live in communities where they can find other Power Couples.  They seek each other out for social contacts and interactions as well as shared interests.  Thus, if a city can attract a critical mass of these Power Couples the economy of the city will grow from the spillover effects.

Beyond the Power Couples

While I agree with the urban economists that Power Couples and other skilled workers are important, I also think there are important things that can (and should be done) to help the less skilled and less well educated…more about that in another Update.

The Role of Policy

If the urban economists are right, it raises some very interesting questions about the role of governmental policy in “creating” economic growth.  It suggests that the old and current policies of trying to “attract new companies to relocate in our area” may be the wrong policies to be pursuing.  Instead of giving tax abatements in trying to “attract” firms to locate in their communities, leaders should concentrate more on “quality of life issues” such as safe streets, decent transportation options, high quality schools, parks, etc. 

If the local leaders really wanted economic development they should look at ways of making it easier for local entrepreneurs to provide the goods and services their diverse communities want and need.  Good entrepreneurs will adapt and change to evolving needs of the community.  The role of the government should be to provide those things that the market will produce at a socially sub-optimal level.

In short, local governments should concern themselves more with providing high quality/low cost public goods in order to allow the local economy to grow.  If they do so, they will attract the Power Couples and other varieties of high skilled workers.  By providing pubic goods the local government will help in the creation of jobs across the socio-economic spectrum. 

However, many so-called political leaders don’t seem interested in the mundane tasks of providing garbage collection or making sure curbs and gutters are put in correctly. But that is what providing public goods is all about.  Instead many of our political leaders across the nation seem bent on “creating jobs.”  But maybe, as the urban economists seem to suggest…that really shouldn’t be their job at all.

-MBrandl