Brandon Donnelly

Daily insights for city builders, delivered every morning at 6 AM ET. I’m Brandon Donnelly — a Toronto-based real estate developer and founder of Globizen. I’ve been writing here since 2013.

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Tag: agglomeration economies

  • In-person vs. WFH might become a critically important distinction

    I’ve been thinking more about yesterday’s post and what it might mean for cities, and I’d like to add some additional thoughts. The report that I linked to looks at what the fiscal implications of WFH have been on a number of US cities (at least so far). That is the chart that I shared summarizing New York City’s “agglomeration losses.”

    But along with this, there is an important assumption that we have not yet reached a new equilibrium. In other words, we are still in a period of adjustment, which feels right, especially if you talk to anyone in the commercial real estate industry. And that means that there are alternative and largely unknowable scenarios for the future.

    In the report, they study the following three:

    • Doom loop prevails (current state where city finances get worse)
    • Recovery (cities regain their pre-pandemic levels of agglomeration economies)
    • Virtuous boom loop arises

    Obviously the objective with their recommendations is to help cities achieve this last one. This is the scenario where cities regain prosperity because firms are able to simultaneously increase their concentration of high-value in-person workers (who benefit from agglomeration economies) and shift all the other stuff to WFH (which allows firms to save money and drive efficiencies).

    More specifically, this scenario assumes that agglomeration economies start to grow again; that wages increase because of it; and that firms, overall, become 10% more productive. It also assumes that office real estate values recover to pre-pandemic levels.

    The future is, of course, notoriously difficult to predict. But I am optimistic that the best and most desirable cities will figure out how to create a new virtuous boom loop. History has shown us that cities are remarkably resilient.

    However, implicit to this discussion seems to be the creation of two classes of workers: workers who are expected to show up in-person and do innovative things with their colleagues, and workers who are encouraged to stay at home and do the tasks that do not benefit from co-location. Of course, lots of people do both of these things. But for the purposes of this post, let’s just compare and contrast these two.

    Importantly, these two types of workers are expected to have different wage outcomes (in the above report). For WFH workers, wages are initially modeled to fall because of the loss in agglomeration-related productivity. But interestingly enough, before this wage decline happens, WFH workers are unambiguously better off — they have the same salary and none of the direct costs of going into the office.

    On the other hand, in-person workers are modeled to have their wages increase because of the gains in agglomeration-related productivity. The authors of the report have calibrated their models so that these two types of workers eventually become equally well off, once you adjust for changes in wages and things like the direct costs of commuting. But what would this really mean in practice?

    To oversimplify, we’re talking about two different types of workers:

    • An in-person worker who is expected to have higher wages, be more productive, and live closer to a city center because of their need to be physically present
    • A WFH worker who is expected to have lower wages, be less productive, and live further out (or in a different city) in order to equalize their lower earnings by way of less expensive real estate

    If this is how our labor markets evolve, then it strikes me that there could be far-reaching socio-economic implications. What I worry about is further segregation within our cities. The above scenario means doubling down on the role of big cities as centers for innovation and agglomeration economies. But in doing this, how do we ensure that we don’t exclude everyone else?

    Once again, I suspect that a good place to start would be lowering the cost of new housing and increasing the pace of production.

    Photo by Lerone Pieters on Unsplash

  • Doom loop or boom loop?

    One of the interesting things about return-to-office trends is that there’s a meaningful difference between smaller and larger cities. In smaller cities, most people have returned to working in their offices. But in larger cities, this hasn’t been the case. This makes intuitive sense. Larger cities tend to have more expensive real estate (which forces people to decentralize) and, in turn, longer and more punishing commutes. So in a larger city, the individual benefits of WFH (i.e. having zero commute costs) tend to be far greater.

    However, in-person interactions are critical to what are known as agglomeration economies. This is why we have things like financial districts — because there are real economic benefits to even competing firms locating proximate to each other. WFH arguably reduces these benefits. And in this recent report called, Doom Loop or Boom Loop: Work from Home and the Challenges Facing America’s Big Cities, the authors, Richard Voith, David Stanek, and Hyojin Lee, have tried to estimate what these agglomeration losses might be for cities like New York, San Francisco, and Philadelphia.

    Here’s New York City:

    If you agree with their assumptions, then you might also agree with their policy recommendations. Among other things, the report argues that larger cities, like New York City, should be focused on promoting themselves to industries/jobs that benefit the most from in-person interactions, recognizing that WFH isn’t going away. At the same time, cities should understand that reducing the cost and increasing the pace of housing production also helps to reduce agglomeration losses. It keeps more people centralizing around a particular place.

    To download the full report, click here. It’s an interesting read.

  • Japan pays people to leave Tokyo

    We have spoken over the years — here, here, and here — about the centralizing and decentralizing forces that play out within our cities. Agglomeration economies, for example, are a centralizing force. There are real economic benefits to people and firms clustering together in cities.

    However, there are also many decentralizing forces. Traffic congestion is one. And of course, the pandemic also proved to be a powerful one for many cities.

    But the fact that we even have cities in the first place should tell you that the centralizing forces do tend to win out over the decentralizing ones. And a perfect example of this is Tokyo. Usually considered to be the largest metropolitan area in the world, Tokyo has about the population of Canada in one city region.

    And here, the centralizing forces are so great — even for families — that the government actually pays people to relocate to places outside of Tokyo’s 23 wards (and its immediately surrounding areas). Previously the maximum figure was ¥300,000 per child (~CA$3,056), but this has now been increased to ¥1 million per child (~CA$10,188).

    A key driver of this is surely Japan’s demographic problem (namely a shrinking and aging population base). But it doesn’t change the fact that lots of people appear drawn to the world’s largest city.

  • A headquarters in the cloud

    Venture firm a16z just announced that it will be “moving its headquarters to the cloud.” At the same time, it announced 3 new offices in Miami Beach, New York, and Santa Monica. These will be in addition to their existing offices in Menlo Park and San Francisco.

    Part of their argument is that hybrid work is weakening the network effects and agglomeration economies associated with being right in Silicon Valley. So they’ve deiced to be virtual, but still have offices where they can “materialize physically” when needed.

    They acknowledge that physical presence is important for developing a company’s culture, building relationships, and helping entrepreneurs (their core business).

    What’s interesting about all of this is that it’s further validation for Miami (Beach). Here is one of the most important venture firms out there saying that when they quickly materialize in real life, they want to be able to do that in Miami Beach.

    It also raises some interesting questions. Because even if the network effects of Silicon Valley are weakening when it comes to tech, this announcement still speaks to the importance of agglomeration economies. These three new office locations were chosen for a reason.

  • How clustering makes us all more productive and innovative

    Earlier this year, Enrico Moretti, who is a professor at UC Berkeley, published this research paper looking at the effect of high-tech clusters on productivity and innovation. (I am unclear if there is any relationship to the Italian brewing company Birra Moretti.)

    One of the things he looks at in the paper is the decline of Kodak. Headquartered in Rochester, New York, Kodak famously missed the transition to digital photography. And so by the late 1990s, they were forced to start letting people go. The result was an almost 50% decline in the size of the entire “high-tech cluster” in Rochester.

    But what Moretti goes on to test in his paper is the impact that this employment decline had on productivity and innovation outside of Kodak and outside of the photography sector (but within Rochester). And what he found was that between 1996 and 2007, the productivity of non-Kodak inventors dropped by about 20%!

    This, of course, is one of the great features of cities. Even if you’re not working at some big company with lots of smart people, just being in the same city, on the same block, or within the same office building, can make you more productive. It turns out that business ecosystems are pretty interconnected. Spillovers are important.

    For more on this topic, check out this recent Wired article by Viviane Callier. In it she makes the case that remote work is going to negatively impact productivity and innovation over the long run.

    Photo by Yassine Khalfalli on Unsplash

  • How new technologies spread (and what that means for superstar cities)

    We know that innovation and economic growth tends to be unevenly distributed. This is the bull case for living in cities and, more particularly, for living in certain cities. But of course, the big question these days is whether or not our little work from home experiment has proven that, for the first time ever, work can now decentralize.

    Well here is a unique study that looked at 29 disruptive technologies over the last two decades in the United States. Using three main sources — patents, job postings, and hundreds of thousands of earnings calls — the team traced where new innovations/technologies have tended to emerge and then how they spread (or didn’t spread) across the rest of the US.

    Their initial findings won’t surprise regular readers of this blog. There are indeed a certain number of pioneering superstar cities. Within their list of new disruptive innovations, the team found that about 40.2% of them came from California. The next “super-cluster” was along the Boston-Washington corridor in the northeast with ~21.2%. By narrowing down their list to “disruptive patents”, as opposed to all patents, innovation looks even spikier.

    Next the team looked at how these disruptive technologies tend to diffuse across the country. This is where job postings and earnings calls come into play. New technology gets created in California garage. Cool. But at what point do CEOs across the country start talking about it and hiring people who are capable of doing things with it? This next figure shows that diffusion at various time intervals.

    Now here are the important takeaways. New disruptive technologies clearly take time to spread. However, high-skilled hiring tends to spread much more slowly than low-skilled hiring. This kind of makes sense as you’ve got a built up and entrenched knowledge base in these pioneering locations.

    But what this also means is that pioneering locations tend to maintain their hegemony for quite some time — decades. The high-paying jobs stick closer to home for much longer, presumably because geography makes it harder to transfer knowledge. This is, of course, based on historical data. But I remain highly suspect that Zoom calls can really disrupt the importance of our superstar cities.

    Maps: Vox

  • Is entrepreneurship contagious? (And a bull case for urban clustering)

    The research isn’t absolutely conclusive, but Matt Clancy — who is an assistant teaching professor of economics at Iowa State — makes an interesting case (over here) about entrepreneurship being mostly contagious.

    The article cites a long list of studies that have more or less found that being around entrepreneurs can have a measurable positive effect on whether you yourself might also become one.

    There is evidence to suggest that this is true whether you’re a scientist working with someone who has previously commercialized a piece of research, a community with entrepreneurial neighbors, a student with an entrepreneurial mentor, or a child with parents who have started their own business(es).

    According to one Swedish study, the children of entrepreneurs are about 12 percentage points more likely to start a business at some point in their life compared to people with non-entrepreneur parents.

    But as I said at the beginning of this post, the research isn’t entirely conclusive. Could a proclivity for risk and independence be instead genetic? Could it be that entrepreneur types simply seek out other entrepreneurs to hang out with? Perhaps these associations aren’t causal. Maybe.

    But my gut tells me that there has got to be some contagiousness. Here’s an excerpt from Matt’s article:

    …being around someone who has done it plants the seed in your mind that it’s a possibility, something you really could do. For most of the studies, the population exposed to entrepreneurship is a population that wouldn’t normally consider it. For them, exposure has a measurable positive effect.

    What this once again tells me is that there’s immeasurable value in people clustering in cities, local communities, offices, coffee shops, and many other spaces. It’s a hard (probably impossible) thing to replace. And it could be the difference between taking initiative and starting a business, and not doing that.

  • From office to residential in London

    It was recently announced that the City of London — the historic town center and primary CBD of the region — is aiming to create at least 1,500 new residential units in the Square Mile by 2030. Part of its strategy is to convert disused office buildings into residential. Currently, the City has about 7,850 residences, which is a drop in the bucket and whole lot smaller than its 19th century population of 125,000.

    Tony Travers, director of LSE London, is quoted in FT saying that the City is really facing “twin challenges.” You’ve got Brexit, which caused prime office cap rate rates to stagnate in the UK, and you’ve now got the whole work from home thing. Nobody really knows how this latter piece will fully shake out when it’s all said and done, but we shouldn’t forget the power of agglomeration economies. It’s what powers cities.

    Calgary is another example of a city that is looking to encourage change. Last month a $1-billion plan was approved to help convert office buildings into housing. (Shout out to Steven Paynter of Gensler who is quoted in the article talking about what makes for a suitable office conversion project.)

    What’s interesting about these announcements is that oftentimes cities cling to their non-residential spaces out of fear that once that supply gets converted it will never come back. That is certainly the case here in Toronto with its office replacement policies, although many years ago when downtown living wasn’t nearly as cool, there was a similar push to encourage more residential development in the core. Looks like that idea worked.

    We know that office space isn’t going away. Zoom is an awful substitute for in-person interactions. People need to congregate (and tend to like doing it). Urban agglomeration economies drive innovation. Bigger cities with higher population densities tend to create more wealth for their inhabitants. So perhaps the takeaway from these announcements should be that, yeah, office space is vital, but it’s okay to do a little rebalancing once in a while.

  • Why urban density is good for innovation

    One of the reasons why I remain so bullish on cities is because we know that new ideas disproportionately come from cities (typically big and dense ones). Matt Clancy does an excellent job of explaining this in a recent post. In it, he cites a number of studies that suggest density is pretty good. It’s good for not only increasing innovation, but also for increasing the diversity of innovation.

    One of the studies found that, all else being equal, doubling the number of jobs per square mile resulted in 20% more patents per capita. Matt argues that the reason for this is that density allows us to meet and collaborate with new people. With this is mind, what do you think that working from home (which is the opposite of job density) might do to innovation/patents?

    Another one of the studies that Matt cites in his article deals with the correlation between patents and street grids. Denser street networks seem to have a marginally positive relationship with innovation.

    But Matt surmises that this may not be because it means we’re all serendipitously bumping into each other all over the place; instead a denser street network is likely symptomatic of other things — namely an increase in “third places.” Because if you consider which census blocks have a concentration of restaurants, cafes, and bars, the number of patents then goes up meaningfully.

    As further evidence of this, Matt cites a fascinating paper from 2019 which looked at the effects of early 20th century prohibition on patents. Turns out that this is a pretty good experiment, because you can examine the impacts of prohibition, as well as compare counties that were already dry (i.e. unaffected by prohibition) against counties that were wet prior to prohibition.

    What the study found was that (1) prior to prohibition wet counties were producing more patents per capita (where they bigger and denser?) and (2) wet counties saw a meaningful drop in patents right after prohibition. Previously dry counties went unchanged in terms of innovation.

    If you’re skeptical of the relationship between bars and innovation, I would encourage you to check out Matt’s full post. But know that there is overwhelming research to suggest that new ideas tend to flourish in the big and dense places that we call cities.

  • Economies of agglomeration in London

    The Financial Times is running a series right now on the future of the City of London. In their latest article, they looked at “How London grew into a financial powerhouse,” while at the same time comparing it to other global financial centers. It’s interesting to see how much of a banner year this was for companies going public. Companies listing on the Nasdaq and the NYSE raised a record $150 billion in 2020. This is compared to about $6 billion raised in London (both the London Stock Exchange and AIM). But what I really want to draw your attention to are the below maps from FT showing the clustering of banks, hedge funds, asset managers, insurers, and professional services firms in London. This is what urban agglomeration economies look like.