Keynes Prize: The Economics of Cities (1)

In this first extract of the winning essay in the 2011 Keynes Prize for Economics, Ross van der Watt asks “How important are Cities to Economic Growth?”

Cities are the building blocks of so much of human culture and innovation. Through people being brought together in dense urban conditions ideas are able to exchange freely from person to person and this exchange occasionally creates miracles of human creativity. Our cities are the centre point of our economic growth, concentrating the best of a country’s minds in close proximity so that the combination of their knowledge may drive forward the innovation that has seen the human race greatly raise its standard of living, health level, and productivity.

Perhaps the clearest reason as to why cities are so necessary to growth is that productivity, it seems, rises with density. On average, as the share of the country’s urban population rises by 10%, the country’s per capita output increases 30%¹. This may be due to many different urban aspects. For one, there are much greater employment opportunities due to the scale of urban markets and therefore individuals can discover what they’re best at. Secondly, modern statistical evidence also finds that individuals work longer hours if they live in metropolitan areas with numerous competitors in their own occupational niche². Thirdly, cities enable collaboration, and through the joint production of knowledge an innovative atmosphere is fostered,.

It is no surprise therefore that the contribution of cities to GDP is usually far greater than the proportion of the urban population in the national population. The key reason for this relationship between GDP growth and urbanisation is that the increased density of urban populations produces scale benefits that increase productivity, which in turn encourages growth³.

The urbanisation process enables a large number of individuals to have greater spending requirements and higher productivity. The division of labour between sectors and between urban and rural areas not only increases demand and productivity in the urban areas but also provides farmers with more markets for their produce. In this way, the growth of cities facilitates the growth of the economy.

A virtuous cycle is created in cities in which employers are attracted by the large pool of potential employees and workers are drawn by the abundance of potential employers. The concentration of a country’s industries and human capital in one place allows for the increased returns to knowledge that is best produced by people in close proximity to one other. Furthermore, cities allow upward mobility for those skilled workers who were previously disadvantaged. Hence an incentive is provided for creative innovation in order to provide social and financial freedom to those who couldn’t obtain either in more rural areas.

After reading Charles Dickens’s idyllic descriptions of rural life or watching the unfolding events of the London riots of august 2011 it may be surprising to learn that urbanites (in the developed world) are statistically much happier and healthier than their rural counterparts. The great strength of cities to provide proximity to its citizens and allow the fast transfer of information can also be a great stumbling block as human proximity becomes a catalyst for the spread of disease. However, the statistical evidence suggests that those who live in urban areas live a few years longer than their rural counterparts. Furthermore, in developed cities, accidents and suicides are both much rarer than in the population as a whole⁴. This means that healthy cities have fewer reductions in their human capital than in the countryside, allowing them to be more productive.

Increasingly metropolises are becoming places which enable consumption on a larger scale. Food, drama and fashion are all areas where cities have the edge; attracting a wealthy and educated population, eager to sample the delights of a city which specialises in innovative pleasures. Talent is mobile, and it inevitably seeks out good places to consume as well as produce. Therefore, these consumer cities help fuel the economy through rising consumer spending as well as through the innovations resulting from a greater stock of human capital.

Furthermore, by bringing people together, cities stimulate cultural innovation like the rise of the theatre in 16th century London, or Disk Jockeying in 70s New York which have many positive social and economic externalities. Moreover, in the countries where more than half the population is urban, 30% report being happy, while 17% are not. In contrast in nations with less than half of their population as urban, 25% report being happy, with 22% who are not¹. This ties in with productivity figures as people are more productive when they’re happy in their environment.

Cities also inspire education. As places where a large amount of skilled workers are to be found, cities experience migration from rural areas as migrants want to be surrounded by knowledgeable people in order to learn from them. The English economist Alfred Marshall described how in dense concentrations, “The mysteries of the trade become no mysteries; but are, as it were, in the air. . .”⁵ Educated people are generally inclined to value schooling more highly than those who are not educated and so will create a better education system through increased spending on schooling and parental involvement. The developed education systems found in cities also have a secondary effect of producing qualified and knowledgeable officials who are better informed to run a city and therefore foster growth.

Although perhaps not directly relevant to economic growth at this moment, the fact that urban, high density living is considerably more environmentally friendly than other alternatives could be increasingly important for future economic development. Urban living results in much less fuel consumption and energy use than the suburban alternative. The average suburban household consumes 27% more electricity than the average urban household⁶. Therefore, despite the fact that living in a leafy neighbourhood may feel environmentally conscious, the dense living of the city offers the most responsible way of looking after our planet. It is therefore particularly important that the newly formed middle classes of India and China follow the path to urbanisation rather than suburbanisation in order to reduce the possible damage that could be inflicted on the planet.

Cities can be damaging to economic growth through the emergence of unemployment, usually associated by a fall in demand for the city’s local product. The presence of a group of low-skilled, unhappy workers may cause the negative spill-over effect of riots, crime, and the emergence of political extremists which all drain economic resources