The Motu Institute recently published new research into the urban productivity premium in New Zealand, or the degree to which firms and workers in big cities tend to produce more and earn higher wages. This is an essential issue for urban and transport policy as it gets to the heart of why we have cities. As we’ve discussed in the past, cities offer opportunities for better connections between firms, workers, and customers, leading to better economic outcomes. (Economists usually describe this as agglomeration economies.)
In the paper – with the enthralling title of “Urban productivity estimation with heterogeneous prices and labour” – researcher Dave Maré sets out to update and extend some of his previous work on the topic. His new research investigates two issues that might bias estimates of the urban productivity premium:
- Imperfect competition in small markets: Firms in large cities face more competition and hence will tend to have less market power (ie ability to jack up prices) than firms in small cities. This tends to result in low estimates of the urban productivity premium.
- “Sorting” of skilled workers into cities: People with higher skill levels – which could mean more education, more experience, or better ideas – tend to gravitate towards cities. (Similarly, cities tend to have different mixes of firms and industries.) Not controlling for this can result in a high estimate of the urban productivity premium.
Even after controlling for these factors, Maré finds evidence of a non-negligible productivity premium in Auckland. That is,
We document an urban labour productivity premium, with Auckland firms having labour productivity that is 17.9% higher than that of firms in other urban areas, and 17.0% higher than firms in rural areas. Some of this premium is due to the mix of industries in different cities. Auckland has a disproportionately high share of employment in industries that have above average labour productivity. Adjusting for this composition reveals a smaller, but still sizeable, premium of 13.5% relative to other urban areas, and 11.3% relative to firms in rural areas.
Here’s a chart showing how other parts of New Zealand compare to Auckland in terms of productivity, after controlling for industry mix, workers’ skill levels, imperfect competition, and a range of other factors like firm size. (This chart is based on the first column in Table 3 of the paper.) As you can see, firms in Auckland are more productive than firms in other parts of NZ, with Wellington (4.2% less productive) and Tauranga (9.4% less productive) being closest to Auckland.
It’s worth noting that Maré’s new estimates of Auckland’s productivity premium are considerably smaller than his previous ones. In a 2008 paper, he estimated that firms in Auckland were around 51% more productive than firms elsewhere in New Zealand. These are obviously very different numbers! But, as explained in an appendix, the majority of the differences are due to different procedures regarding data selection and processing.
Notwithstanding the exact number, Maré’s new analysis raises a few important conceptual questions about the urban productivity premium. His analysis shows that a large share of the difference in productivity between big cities, small cities, and rural areas is down to the fact that skilled workers tend to sort themselves into cities. When we control for workers’ skill levels, we tend to get lower estimates of the urban productivity premium. Or, if you prefer that in economese:
The meta-analysis by Melo et al. (2009, Table 4) reports that studies that control for labour quality generally yield agglomeration elasticities that are 5 to 6 percentage points lower than studies that do not. In the current study, labour quality adjustment lowers the estimated agglomeration elasticity by 0.057 (from 0.079 to 0.022).
However, I’m not sure it is totally appropriate to adjust for skill levels, as it’s possible that cities’ ability to attract and retain talented, innovative, and motivated people (and productive firms) is in fact a type of agglomeration economy. In other words, we might be controlling away the effect of interest!
Open migration between Australia and New Zealand means that people who can’t find an appropriate place (urban and economic) in New Zealand can easily go to Australian cities. So the alternative for skilled people who are dissuaded from living in Auckland isn’t necessarily that they’ll go and start up a business in Hamilton. Instead, they might head across the Tasman, where their skills are totally lost to New Zealand.
What does this mean for urban policy in New Zealand? I’d tentatively identify two key ideas we might want to focus on in order to allow our cities to get better at attracting and retaining productive people and firms.
First, we need to think hard about whether our policies make it attractive for mobile people to come to (or stay in) our bigger cities. This is a key consideration for, say, urban planning reform, as high housing prices driven by constraints on housing development are an important barrier to people coming or staying. Evidence from the US suggests that, if left unaddressed, high house prices can systematically dissuade people from moving to productive places where they can put their skills to best use.
Second, we also need to think about how to preserve and enhance the amenities that are on offer in New Zealand cities. Our relatively clean air, reasonably well-preserved coastal environment (clean beaches, marine reserves, etc), and accessible forests and natural parks are important attractions, but other areas are letting us down. For instance, rural and small-town water quality is rapidly declining due to expanding dairy farming.
More relevant to transport, street design in New Zealand is pretty retrograde, leading to a lack of high-quality public spaces where people actually want to be. All too often, we insist upon shoving cars down corridors, heedless of the fact that some streets have higher value as places to be. But we know we can do better: places like O’Connell St and Wynyard Quarter give many people joy on a daily basis.
What do you think about the urban productivity premium? And how can we get more of it?
In the 1990s, in the early years of the information technology revolution, economist Robert Solow famously commented that “you can see the computer age everywhere but in the productivity statistics.” Two decades on, that still rings true. Social life has been profoundly transformed by new technology: It has altered the way we communicate with friends and family, how we entertain ourselves, and even how we date.
When I read Douglas Adams’ Hitchhiker’s Guide to the Galaxy in the early 2000s, the titular device still seemed like a fantastical idea: a handheld device you could use to access information (much of it inaccurate or incomplete) on anything, from anywhere.
Now, we all have smartphones. But productivity growth has stubbornly failed to take off over this period. Does this mean that technological progress has failed to deliver?
Journalist Ezra Klein (Vox) recently reviewed the current debate over technological progress. One perspective he discusses is that the benefits of information and communication technologies (ICTs) have largely accrued to consumers rather than producers:
Measures of productivity are based on the sum total of goods and services the economy produces for sale. But many digital-era products are given away for free, and so never have an opportunity to show themselves in GDP statistics.
Take Google Maps. I have a crap sense of direction, so it’s no exaggeration to say Google Maps has changed my life. I would pay hundreds of dollars a year for the product. In practice, I pay nothing. In terms of its direct contribution to GDP, Google Maps boosts Google’s advertising business by feeding my data back to the company so they can target ads more effectively, and it probably boosts the amount of money I fork over to Verizon for my data plan. But that’s not worth hundreds of dollars to Google, or to the economy as a whole. The result is that GDP data might undercount the value of Google Maps in a way it didn’t undercount the value of, say, Garmin GPS devices.
As Klein goes on to observe, ICTs have transformed our leisure time more than our work time – in large part, by giving us many more choices about where to dine, what television shows to watch, and who to talk to.
Interestingly, what’s true for technology might also be true for cities. The conventional narrative about agglomeration economies – the economic benefits of scale and density – is that their main effect is to lift productivity. But, as Stu and I have discussed in the past, there’s an increasing body of evidence that suggests that agglomeration also has significant benefits for consumers.
In recent years, economists have used micro-data on household consumption patterns to build a much richer picture of the impact of city size and structure on consumption choices. In short, larger cities don’t always offer lower prices – as you’d expect if higher productivity made it cheaper to produce goods and services. But they do offer a much greater variety of goods and services, which in turn translates into higher wellbeing for households.
A 2015 paper by Jessie Handbury and David Weinstein uses barcode data on retail sales in 49 large US cities to analyse prices and product varieties. They find that:
There are approximately four times more types of grocery products available in New York [metro population 21 million] than in Des Moines [population 456,000].
Because people in larger cities tend to buy a wider range of goods, including more expensive products, a naïve comparison of average retail prices would suggest that larger cities are more expensive. But Handbury and Weinstein’s analysis shows that, after accounting for product variety, prices in large cities are no more expensive than smaller cities. If anything, they tend to be lower:
When we use the data to construct a theoretically rigorous price index that corrects for product, purchaser, and retailer heterogeneity and accounts for variety differences across locations, we find that the price level is actually lower in larger cities. Consumers spend less, on average, to get the same amount of consumption utility in larger cities.
Moreover, what’s true in grocery stores is also true in restaurants. In a 2012 paper, Nathan Schiff took a look at the impact of city size and population density on restaurant markets in 726 urban places in the US. His key finding is that:
For the 182 cities in the top quartile by land area of my data (mean population 331,000), a one standard deviation increase in log population is associated with a 57% increase in the count of unique cuisines. A one standard deviation decrease in log land area–which increases population density without changing the size of the population–is associated with a 10% increase in cuisine count, equivalent to increasing the percentage of the population with a college degree by one standard deviation and larger than the effect of increasing the ethnic population associated with each cuisine by one standard deviation.
In other words, cities that are larger or denser offer people more choices about where and what to eat. Density is especially crucial in large cities, as people generally don’t travel long distances to dine. (Incidentally, relatively open migration policies are also an important enabler of restaurant choice in cities, as migrants bring new cuisines with them.)
What does this mean for urban policy? I think there are two main lessons.
The first is that although agglomeration economies in production are important to long-run economic outcomes, we might be looking for the benefits of cities in the wrong places. They might not always appear in productivity statistics or price indices, but in the consumption choices that cities offer people. Measuring variety – and how people respond to it – is therefore crucial to understanding agglomeration economies.
The second is that conventional urban policy might be based on false premises. Ever since the “dark Satanic mills” of the Industrial Revolution, policymakers have assumed that cities are good for businesses but bad for people. Accordingly, they designed transport systems and planning policies that aimed to disperse the city and to separate people from their workplaces and from each other.
That made sense when cholera was a major cause of death, but it’s increasingly illogical in today’s world. Urban disamenities such as air quality, crime rates, and infectious diseases are all improving, and the evidence increasingly shows that the consumer choices offered by cities (and dense urban places) have benefits for households. In this context, policies that enable urbanisation are likely to have larger benefits than commonly assumed.
What do you think about the role of consumer choice in cities?
Last week, I took a look at the contribution of agglomeration to Auckland’s recent economic growth. Based on observed changes to employment density over the period, plus agglomeration elasticities calculated by David Maré and Daniel Graham, I estimated that 11-12% of Auckland’s recent productivity growth was due to increased urban scale and density.
The gains from agglomeration since 2000 are significant: Auckland’s GDP is approximately $1.4 billion larger as a result. Ultimately, productivity gains are good for everyone. If you’re retired, they help to pay your pension. If you’re in school, they help pay your teachers and living costs. In between, they help fund your health care and pay for your neighbourhood library.
But is agglomeration simply a consequence of urban scale, or does urban form also matter? In other words, are there any reasons that we should prefer one distribution of employment within cities to another?
There are a couple of ways we can address it. One would be to gather data on the spatial distribution of employment in a range of cities, and examine the impact on productivity. This is, implicitly, what Maré and Graham (and other economists studying productivity) have done by measuring effective job density and productivity at a highly detailed level and comparing outcomes within and between cities.
Other papers use a slightly different methodology but also come up with suggestive results. For example, a 2014 paper by Daniel Chatman and Robert Noland finds that public transport provision can encourage agglomeration economies in dense city centres. From the abstract:
Using data on US metropolitan areas, this paper traces the links from transit service to central city employment density, urbanised area employment density and population; and from these physical agglomeration measures to average wages and per capita GMP. Significant indirect productivity effects of transit service are found. For example, in the case of central city employment density, estimated wage increases range between $1.5 million and $1.8 billion per metropolitan area yearly for a 10 per cent increase in transit seats or rail service miles per capita. Firms and households likely receive unanticipated agglomeration benefits from transit-induced densification and growth, and current benefit–cost evaluations may therefore underestimate the benefits of improving transit service, particularly in large cities with existing transit networks.
Another approach would be to simulate the impact of alternative employment distribution on effective density and hence on productivity. Last week, I looked at how Auckland’s job density had changed from 2000 to 2015. This week, I’m also going to consider a simple simulation: What if the city had grown in a different way between 2000 and 2015?
According to Stats NZ’s Business Demography data, Auckland added approximately 174,000 jobs – a 33% increase – over this period. Here’s a chart showing how they were distributed at a local board level. Waitemata local board added the most jobs (almost 41,000) followed by Upper Harbour (22,000) and Howick and Maungakiekie-Tamaki (both around 19,000).
By contrast, the rest of the isthmus and lower North Shore saw exceptionally low rates of change. (A pattern that is matched in population growth: high growth in the city centre, Howick, and Upper Harbour, where planning rules have enabled growth, and low growth in other areas where they’ve prevented it.)
But what if Auckland’s recent employment growth had followed a different pattern? For example, what if we’d chosen to decentralise employment growth to a new “edge city”?
Let’s set aside, for a moment, the fact that creating new employment centres by planning fiat tends to disappoint. (As demonstrated by Manukau’s underwhelming history, and possibly also the new NorthWest mall.) If businesses don’t see an advantage in locating there, it won’t happen.
As a benchmark, consider a new “edge city” in Drury, which is currently a set of paddocks that are conveniently located along the Southern Motorway and the unelectrified portion of Auckland’s Southern Rail Line. Let’s assume that we succeeded in relocating a bit over 25% of Auckland’s recent employment growth to Drury – creating a new employment centre with 50,000 jobs. (Around half the size of the Auckland city centre.) All other areas of Auckland would have seen proportionately lower rates of growth.
What would that do to the city’s potential for agglomeration?
Here’s a map comparing the effective density of employment under this “edge city” scenario with the actual effective density of employment in 2015. (Remember, effective density is a measure of an area’s potential for agglomeration economies, as areas that are accessible to more jobs are likely to be more productive.)
Areas shaded in yellow would experience reductions in agglomeration potential, while areas in green and blue would be more accessible to jobs under the “edge city” scenario. Notice how most of the city is coloured yellow. The only places to benefit from this change are the areas immediately around Drury.
Overall, the job density gains around Drury are far outweighed by the “deglomeration” experienced by the rest of the city. Shifting employment growth to an “edge city” in Drury would have reduced the city’s overall job density by 9%. (In 2015, the average Auckland employee was accessible to around 92,000 other jobs. Under the “edge city” scenario, they’d only be accessible to around 84,000 jobs.)
This would in turn reduce the city’s economic productivity. Based on Maré and Graham’s measured agglomeration elasticity of 0.065, I estimate that Auckland’s productivity would be 0.6% lower under the “edge city” scenario. (Again, using an arc elasticity formula: (92,000/84,000)^0.065-1.)
Because Auckland’s GDP was $88.3 billion in 2015, the productivity losses from deglomeration would equate to roughly half a billion dollars a year. That’s a lot of money. For comparison’s sake, $0.5 billion is roughly equivalent to:
Of course, more centralisation is not always optimal. In a large city, there are good reasons for businesses to spread themselves around a bit. Retailers want to be close to local shoppers, warehouses want to be on cheap land close to transport infrastructure, and so on and so forth. And, from a policy perspective, adding peak transport capacity to enable existing centres to grow may be costly.
But, as this simulation of a Drury “edge city” shows, forcing decentralisation is likely to be highly sub-optimal. Auckland would be less productive if it had chosen to push employment growth into outlying centres, rather than accommodating it in the city centre and other locations throughout the city. Over time, that would translate into lower competitiveness for local businesses, lower wages for Auckland workers, lower living standards for residents, and worse public services and infrastructure.
Do you think urban form can contribute to a productive, happy city?
We’ve written quite a bit about agglomeration economies, as they’re one of the most important forces shaping urban life. Agglomeration economies refer to the benefits of proximity for economic and social interaction – when you’re around more people, it’s easier to meet the right person (for business or relationships!), easier to share knowledge, and easier to do things in general.
One “stylised fact” from the economic literature is that cities that are larger and better connected – i.e. denser and/or easier to get around – tend to be more productive. When it comes to economic performance, size matters. This benefits firms and workers, of course, but it is also good for consumers. For example, if you want to see a lot of rugby tests, you’re better off locating in Auckland than in Taupo, because test matches tend to go to where the people are. And if you want more restaurants and groceries, live in a denser neighbourhood.
However, economists have focused on agglomeration economies in production as they’re often easier to measure. For example, a few years ago the New Zealand economist David Maré estimated an “Auckland productivity premium” of around 50%. That means that firms located in Auckland are around 50% more productive than similar firms located in other regions. The premium was even higher for Auckland’s city centre.
In subsequent work, Maré and a collaborator, Daniel Graham, estimated that New Zealand had an “agglomeration elasticity” of around 0.065 (averaged across all industries). What this means is that places that are 10% denser tend to be around 0.65% more productive, all else equal.
But what does this mean in practice? How much does agglomeration contribute to the New Zealand economy? Is it a big deal, or not that important in the grand scheme of things?
To get a rough idea, I calculated changes in the “effective density” of jobs in Auckland over the period 2000-2015, taking into account the location of jobs within Auckland (from Stats NZ’s Business Demographics data) and the distance between job locations (calculated using GIS tools). I followed Maré and Graham’s formula for job density as a function of weighted distance to jobs in nearby areas – for the precise formula see equation 2 on page 12 of their paper.
Here’s a map showing how effective density of jobs changed over the whole period. Darker blues indicate higher percentage increases.
Almost everywhere in the Auckland urbanised area became more accessible to employment over this period – the rising tide of urban development lifted all boats. On average across the region, effective density rose by 29%. However, increases were faster around Albany and the upper North Shore, which saw rapid development, and slower in the western isthmus and west Auckland.
So things have changed quite a lot. The following chart shows that these changes happened incrementally over time. It shows the effective density of employment for the average job in Auckland. In 2000, the average job was proximate to around 71,000 other jobs. In 2015, that had risen to slightly less than 92,000 jobs.
So job density has gone up quite a lot over the last 16 years as a result of Auckland’s growth. What effect has this had on productivity?
As a point of comparison, I estimated changes in GDP per employee over the same period. (I used Stats NZ’s employment data, regional GDP statistics, and GDP price deflators for the whole country. This isn’t a perfect estimate, as I’ve excluded self-employed people and haven’t corrected for part-time employment, but it’s not miles off.) Here’s what that looks like. Over the entire period, GDP per employee has risen by approximately 14.4%. The city’s economy currently produces around $88.3 billion in output.
By comparison, Maré and Graham’s agglomeration elasticity of 0.065 implies that a 29% increase in job density is associated with a 1.7% increase in productivity (calculated using an arc elasticity formula: (92,000/71,000)^0.065-1). The true figure may be higher, as Auckland is specialised in industries that benefit more strongly from agglomeration economies.
- Roughly 11-12% of the total productivity growth in Auckland over the last 16 years is due to increased agglomeration economies
- In the absence of increased agglomeration economies from scale and density, Auckland’s economy would be around $1.4 billion smaller.
A wide range of other factors – increased skills, investment in capital goods, improved business practices, and changes to the composition of Auckland’s economy – also make important contributions to productivity growth. However, the contribution of agglomeration is significant – both in dollar terms and as a share of the city’s overall productivity growth. In the long term, those tenths of a percent add up to quite a lot. If we want a wealthier New Zealand, we need better, more productive cities.
Policymakers can do a lot to enhance – or undermine – agglomeration economies. For example:
What do you think about agglomeration economies in Auckland?
This article was originally posted on Making Christchurch, a group blog set up by Barnaby Bennett in the wake of the 2011 Canterbury Earthquake, at the invitation of Transportblog commenter Brendon Harre.
Why do cities grow and change? And how can cities harness those dynamics?
Last month, I took a look at agglomeration economies, which describe the productivity and innovation gains arising from urban scale and density. The advantages that cities offer for production have underpinned urban success throughout history.
Economic productivity is important. To paraphrase Paul Krugman, in the long run, productivity growth underpins our ability to consume more of everything from electronics to healthcare, and to have more of the non-economic things that make life enjoyable. All else being equal, people tend to move towards more productive places in search of higher living standards. But economic productivity isn’t the only thing that matters for wellbeing — or for growth and change in cities.
Urban economics tackles urban amenities
For a long time, people assumed that cities offer advantages for production but disadvantages for consumption. This assumption, which shaped a lot of economic analysis and policymaking, was understandable. After all, modern cities first arose as manufacturing centres at a time when manufacturing was a dirty business. People could get jobs in the city’s “dark Satanic Mills”, but they had to suffer bad air, choleric water, and high crime rates to do so.
But things appear to have changed over the last half century, at least in developed countries. The bad aspects of cities, such as crime and pollution, have improved, and the good parts have also gotten better. Cities have become attractive for consumers as well as producers.
A pioneering 2000 paper by Ed Glaeser, Jed Kolko and Albert Saiz explored these dynamics. They argued that the availability of “four critical urban amenities” would shape future urban growth:
- The availability of a rich variety of consumer goods and services — which, in the era of Amazon.com and the iTunes store, means “non-tradables” like restaurants, live bands, bars, and dating opportunities
- Aesthetics and natural settings — in other words, the quality of the city’s architecture, public parks, natural environment, and climate
- Good public services such as schools and low crime rates
- The quality and speed of transport systems — cities that make more destinations accessible are more likely to be attractive to residents.
In their view, the rise of the “consumer city” opens up other pathways for urban growth. If cities want to attract new residents and businesses, they don’t have to focus only on providing “producer amenities” like convention centres. Supplying great “consumer amenities” can also foster ongoing vibrancy and growth.
Here, I want to look at the prospects for New Zealand cities, and Christchurch in particular, to become successful “consumer cities”. I’m going to focus on the first two dimensions — variety in goods and services and aesthetics and natural settings — and leave a discussion of transport for a future post. (Public services are a bit less relevant to urban growth in New Zealand, as education and law enforcement are run by central government.)
Goods and services
New Zealand cities are coming around to the importance of consumption. It hasn’t always been thus. In the middle of the 20th century, when my parents were growing up in Auckland, the country was firmly in the grips of what historian James Belich called the “tight society”:
homogenous, conformist, masculist, egalitarian and monocultural, subject to heavy formal and informal regulation. There were no licensed restaurants, little weekend shopping, one supermarket (opened in Auckland in 1958) and a very limited range of goods and foods to buy in the shops and unlicensed restaurants that did exist… School milk was free, but you had to drink it.
A lot has changed since then, economically and demographically. While the wholesale deregulation of the 1980s was not an unmixed blessing, it certainly expanded the consumption choices available to New Zealanders. A more liberal migration policy brought new migrants with, thank goodness, new cuisines. And since the advent of mass-market international air travel, Kiwis returning from OEs have come back with new ideas for things to do in cities — from rock bands to restaurants to cycle lanes.
The result is a favourable climate for the adoption, invention, and proliferation of a variety of goods and services in cities — especially when it comes to bars, restaurants, and entertainment.
Christchurch has been instrumental in shaping a key part of the hospitality market: beer. When I started to be able to afford to drink nice beer in bars, the best thing on tap was often from craft breweries in Christchurch like Harrington’s and Three Boys. Their success has fostered competition: craft brewing has since taken off in Wellington and, more recently, Auckland.
In short, New Zealand cities have potential, but they may have to do a few things differently in order to fully realise it.
The first is simple: get some of the barriers out of the way. For example, minimum parking requirements can be a major impediment to opening new restaurants and bars, or converting old warehouse space to retail. They often require restaurants to devote more space to parking than to dining areas, which can be the kiss of death for hole-in-the-wall eateries.
The second is to understand — and take advantage of — positive feedback loops between population density and consumer amenities. Neighbourhoods with more people support a greater variety of consumption choices. While density isn’t for everyone, cities need some medium-to-high density, mixed use neighbourhoods to supply a rich variety of urban goods and services.
In medium-sized cities, city centres have traditionally filled that role. As the following population density maps (darker blue = higher density) show, that’s an area where Christchurch lagged behind Auckland and Wellington even before the earthquakes. The destruction caused by the 2011 Canterbury Earthquakes has created an opportunity for revitalisation on different lines — but government bungles seem to have delayed the process. It’s important that it get back on track.
Aesthetics and natural settings
Christchurch, like many other New Zealand cities, has some intrinsic aesthetic advantages as a result of the natural landscape. Here’s the view west across the city:
New Zealand’s environment has always drawn migrants, who often come for the landscape and live in the cities. Take, for example, novelist Eleanor Catton’s description of what drew her family to Christchurch:
I grew up on the South Island of New Zealand, in a city chosen and beloved by my parents for its proximity to the mountains — Christchurch is two hours distant from the worn saddle of Arthur’s Pass, the mountain village that was and is my father’s spiritual touchstone, his chapel and cathedral in the wild. For many years while I was growing up my parents did not own a car. We rode around town on two tandem bicycles and one single (a source of considerable embarrassment to me at the time) and at weekends we would occasionally rent a car in order to drive into the alps, and go hiking.
However, urban aesthetics also matter — even if you go tramping on the weekend, you still spend your weekdays in the city. This is an area where Christchurch has some strengths and some challenges.
From the start, Christchurch had a reputation as a “garden city” as a result of its large public parks and street trees. Although the idea of parks as a city’s “lungs” is less salient today than in Industrial Revolution cities, parks and street trees are still public amenities. They make people better off simply by existing in the vicinity.
The earthquakes seem to have opened up some opportunities to enhance the garden city — particularly along the Avon River, where many houses have been red-zoned. In addition to the central government-promoted Avon River Precinct, some community groups are calling for a forest park out to New Brighton. Others have simply gotten on with creating something new.
The built environment, however, is more problematic. Central government oversaw the demolition of over 1200 buildings in the city centre in the years following the earthquakes, including many of the city’s historic buildings.
This has been controversial and at times acrimonious. As I am neither an architect nor a Cantabrian, I’m not in a good position to weigh in on the debate. But as an economist from Auckland I’d observe that heritage buildings have a definite public value — not one that trumps all other costs, but one that should be accounted for in decision-making. At the very least, it would be smart to replace any demolished buildings with more attractive and usable ones.
Prospects for population growth in Christchurch
Thus far, I’ve considered — in a thematic way — some of Christchurch’s challenges and opportunities as a “consumer city”. But what would success look like?
Let’s take a look at a few data points. First, here’s a chart showing Statistics NZ’s latest (2015) regional population projections. The Canterbury region, which includes Christchurch and its satellite towns, is projected to grow faster than all regions other than Auckland over the next three decades.
In other words, Stats NZ expects Christchurch to be relatively successful at attracting and retaining people. But look at the range on their estimates: the city could grow faster than Auckland, or it could hardly grow at all.
Without digging into Stats NZ’s forecasting methodology, it’s difficult to say why they’ve picked such a wide range. But perhaps it reflects uncertainty about the future attractiveness of Christchurch as a consumer city. Wages in Christchurch tend to be lower than in Auckland and Wellington, meaning that urban amenities potentially have a stronger role to play in fostering urban growth.
A second data point. A few months ago, I took a look at the sources of Auckland’s population growth. I found that natural increase accounted for the majority of growth but that net migration — more people arriving than departing — fluctuated wildly from year to year. Here’s what the picture looks like for Canterbury:
Net migration to Canterbury has followed a very similar trend as net migration to Auckland — the peaks and the troughs coincide remarkably well. However, the troughs are just a little bit deeper in Christchurch, as substantial numbers flow out of the region in a bad year. In Auckland, by contrast, net migration seldom turns negative.
Net migration will always be a bit of a rollercoaster in New Zealand — it’s followed a boom-and-bust cycle for a very long time. But it’s possible — with the right combination of a resilient economy and good consumer amenities — to reduce the depths of the troughs and raise the height of the peaks. It might not be an inspiring mission statement for a city, but perhaps it’s the right one for Christchurch.
This is the first half of a two-part series of posts. It summarises a few ideas that have been banging around the back of my head for a while – basically, an attempt to answer the question: “What can economics do for cities?” In this part, I discuss a couple of important concepts: agglomeration economies, which underpin cities’ existence and ongoing success, and the potential role of pricing mechanisms for managing urban ills.
What do cities do?
Cities mean different things to different people. They are places to work, places to play, places to invest, places to consume, places to conduct politics, places to realise one’s individuality, places to blend into the crowd. (And many, many more things beside.)
In fact, one of the features of a successful city is that it can mean different things to different people, and attract and retain them for different reasons. Cities exist because they are efficient and diverse.
Economists use the term agglomeration economies to describe the advantages of urban scale and density. If you operate a business, locating in a city will allow you to access more workers, more customers, and more new ideas. But even if not, an urban location still offers advantages – more restaurants and retailers, a larger dating pool, better access to education and healthcare, and more choices about how to work, live, and get around.
New research from the Netherlands finds that agglomeration economies in both production and consumption are important, albeit to a different extent in different cities. Furthermore, ignoring agglomeration economies is a risky proposition for cities:
As history has shown (see, for example, what happened to Detroit or the decline in the population of Amsterdam and Rotterdam referred to above), current successes provide no guarantees for the future. This is what Gibrat’s law tells us, growth is independent of current size. Future growth is therefore largely independent of past success. The chances for policymakers that try to row against the tide are small. A successful policy requires to ‘go with the flow’. Large investments in infrastructure in a declining city do not satisfy any real demand but lead to large financial burdens for the local population, making these cities even less attractive. However, policy can make a difference in growing cities. In order to remain on the short list of hot spots, policymakers in these cities have two margins to work on.
- First, the city has to be attractive for innovative entrepreneurs and enterprises to locate their business.
- Second, the city has to be an attractive choice for high-educated top talent as a place to live in.
In other words, urban success is a dynamic process. Cities can’t stand still – they must be capable of attracting new people and generating new ideas and opportunities. Simply identifying some things that people like about a city and then freezing them in amber is a recipe for long-term urban failure.
1. Incentives and prices matter, so it’s important to get them right
We need change, but we don’t necessarily need change at all cost. Most development is good, but some has deleterious side-effects. A new factory may contaminate local air and water quality. A coal-fired power plant will damage our climate. A new subdivision may pump traffic onto congested roads. A new retailer may attract more people to park on already-crowded streets.
Policy responses to these challenges can heavy-handed and inefficient. While negative (and positive!) spillovers are abundant in cities, some cures may be worse than the disease. A good example is minimum parking requirements, or MPRs, which require new developments to provide a defined minimum amount of parking. The aim of this policy is to prevent parking from spilling over onto neighbouring streets and properties.
Unfortunately, MPRs tend to be both inefficient and ineffective. They are inefficient because (a) there is usually poor evidence for choosing minimum ratios, meaning that many businesses and households are compelled to purchase more parking than they need and (b) they tend to be more costly than alternative approaches to parking management. Furthermore, they are often ineffective, as people continue to complain about a lack of parking even in places where MPRs have led to a major oversupply.
Better pricing is often a better alternative to blunt policy instruments. As any economist will tell you, if you want less of something, put up the price! This approach is applicable to a wide range of policy areas, especially in cities. For example:
There are several important advantages to using prices, rather than regulations or construction, to discourage negative spillovers. First, pricing respects people’s ability to make good choices. If we had a carbon tax, it wouldn’t prevent someone from burning petrol or farming cows. But it would make them pay the full social cost of those choices.
Second, prices can change in response to new information. AT’s new parking policy is a good example of this – they will monitor demand for on-street parking and tweak the prices up if occupancy is too high. This reduces the risk of screwing things up due to forecasting errors.
Third, and most importantly, prices provide governments, businesses, and households better information, which can enable them to make better decisions. Over time, this will result in significant dynamic efficiencies. For example, congestion pricing will help transport agencies plan infrastructure upgrades. Rather than having to guess whether people will value expanded roads – which frequently leads to errors – they will be able to measure the actual value that people place on travel.
Tomorrow: Part 2.
I have been pondering a comment in William Fischel’s generally excellent new book on zoning to the effect that:
…suburbanization and reduced urban density are worldwide phenomena. All but 16 of the 120 urban areas on every continent grew outward and reduced their overall population densities in the last decade of the previous millennium, even as almost all of them grew in total population.
This is an interesting claim, but one that I find very difficult to reconcile with the evidence on other “big picture” changes observed in cities over the last three decades.
In recent decades, agglomeration economies have gotten stronger and the structure of advanced urban economies has changed. This has in turn increased the premium that people place on proximity and centrality – a phenomenon well illustrated by Grimes and Liang (2007), who show how close proximity to the city centre shifted from being a “disamenity” to an “amenity” during the 1990s:
Relatedly, regulations limiting density are increasingly binding (and, in places like Auckland, San Francisco and New York, more costly than regulations limiting sprawl). This was nicely illustrated by three recent pieces of research that showed that (a) Auckland’s legacy planning regulations imposed twice as many costs on apartments as standalone houses, and that (b) the cost of legacy councils’ building height limits were higher than the cost of the city’s former urban growth boundary:
So colour me perplexed. On the one hand, I have a very respected and knowledgeable economist telling me that cities are getting less dense. On the other hand, I have a mass of evidence, often compiled by other respected and knowledgeable economists, that suggests that densities should be increasing, not decreasing.
As it turns out, Fischel’s claim is what my mathematician friends describe as “true but trivial”. It’s not inaccurate, but it doesn’t tell you anything interesting about the world either. The idea that urban densities are getting lower is in fact a statistical artefact – i.e. it’s a “fact” that arises from the way that Fischel has calculated population densities.
Calculating population densities is a slightly arcane subject. Last year, I wrote a short paper that explored alternative measures and explained why we should prefer a population-weighted density measure to a simple average density:
The most common approach to measuring population density is simply to divide the total population of a city by the total land area of the city. As shown above, this approach will tend to underestimate the density of cities with large expanses of lightly populated exurban land. However, this approach is commonly used for international comparisons due to the fact that it relatively straightforward to calculate…
The population-weighted density measure was introduced by Barnes (2001) to correct for the weaknesses of the simple average density measure. This measure was recently used by the US Census Bureau to produce consistent and meaningful data on American cities (Wilson et al, 2012). As the example above suggests, it more accurately reflects the density at which the average city resident is living (Eidlin, 2010).
Population-weighted density is estimated by calculating the density of all individual neighbourhoods within a city, assigning each neighbourhood a weight equal to its share of the city’s total population, and summing up the weighted density of all neighbourhoods. In other words, if a dense inner-city neighbourhood has ten times as many people as an outlying suburban neighbourhood, the inner-city area would be weighted ten times as heavily as the suburban area.
In other words, average density measures the density of the average hectare of land in the city, even if hardly anyone lives there, while population-weighted density measures the density of the neighbourhood that the average citizen lives in. Average density is not, therefore, a very meaningful number if you want insight about how people are living in a city.
Moreover, it turns out that a city’s average density can be declining even though every part of the city is getting more dense! This sounds counterintuitive, so I’ve put together a simple model showing how it can happen.
You can download the model here in case you’re interested in playing with it. For simplicity, I’ve assumed a linear city that extends in one direction from a centre. (This readily generalises to a city that extends in multiple directions.) Population densities are highest near the centre and decline exponentially with distance. (The distance decay parameter I’ve used loosely approximates observed outcomes in big NZ/Aus cities.)
I’ve tested the impact of a 20% increase in the urban population. In the model, intensification accounts for around 60% of growth, meaning that all existing developed areas get ~12% denser. The remaining 40% of growth occurs in low-density greenfield areas, which expand the city’s footprint by 33%.
Mathematically-minded readers will see where this is going. But for the visual learners out there, here’s what it looks like on a graph:
Because the urban footprint has expanded by 33% while the population has only grown by 20%, the city’s average density has dropped by 10%. But if you look at the graph, you can see that it would be ridiculous to say that the city is spreading out and de-densifying. In fact, every part of the city is getting more dense, and most growth is occurring within built up areas.
In other words, Fischel is wrong to say that cities are getting less dense. Horizontal growth is certainly happening – but so is vertical growth.
I would argue that the latter trend – towards proximity, density, and efficient use of land – is the more significant of the two. We are currently seeing big changes in the function, structure, and use of cities. Recognising and responding to those changes is important, and policies that unwittingly stifle them will have large economic and social costs.
That’s why it’s important to measure density (and other urban phenomena) accurately – bad measures often contribute to bad policy decisions.
How do you think cities are growing?
In recent years the New Zealand economy has benefitted from tailwinds – strong Chinese demand for milk powder and raw logs, net inward migration driving up house prices, and, sadly, the need to rebuild our second-largest city. But should we be so happy to rest on our good fortunes, or are there long-term risks we need to manage? If so, how can we address them?
History teaches us that bad things can happen to small, wealthy agricultural exporting nations that don’t succeed in evolving up the value chain. Argentina is a great – and troubling – example. In 1900 it was one of the wealthiest countries in the world, with GDP per capita close to the US. At the time, Argentineans were living well off beef and wheat exports. But its agriculturally-based, heavily overseas-owned economy failed to generate new sources of wealth.
The result was a steady, century-long relative decline in living standards, punctuated by the occasional economic crisis:
Could the same thing happen here? It’s certainly a risk. Arguably, it is already happening. In the 1970s New Zealand’s GDP per capita began to slide below the OECD average, and it’s never really recovered in spite of the radical interventions of successive governments.
Can we do anything to avoid turning out like Argentina? In short: Yes, but it will take some re-thinking. Most importantly, it will require New Zealand to invest in better cities, as cities are the engines of future economic growth. Let me explain.
In 2008, a new National government promised that it would achieve two things by 2025. It would:
- Raise New Zealand’s economic growth rate to enable it to catch up with Australia in terms of GDP per capita
- Boost exports to 40% of GDP, a significant increase from contemporary levels of around 30%.
A lot of people welcomed this – it seemed like the sort of ambitious, long-term programme that could prevent us from becoming Argentina. Unfortunately, we haven’t heard much about the government’s 2025 targets in the last few years.
As it turns out, closing the gap with Australia and transforming New Zealand’s export mix is extremely hard. Here’s a graph of New Zealand’s exports of goods and services as a share of GDP. As you can see, there has been precious little export-led growth over the last six years:
In a recent column for the Herald on Sunday, business journalist Rod Oram diagnosed the reasons for the failure to lift exports. In essence, we’re increasingly reliant upon a small number of commodified agricultural products. Like Argentina, we are currently failing to generate new sources of wealth. Oram is worth quoting at length:
The trade data are revealing. In the year to June, the value of our exports to China rose 50 per cent, dairy exports were up 40 per cent, logs 20 per cent and our overall exports were up 12 per cent, thanks to the commodity spikes.
But net of spikes, the data show we are becoming increasing dependent on selling fewer, simpler products to one customer. China is our largest trading partner, taking 23 per cent of our exports in the year to June. While China accounts for some new business, a big chunk is merely redirected from other markets.
The growing dominance of commodity dairy exports is striking. They have doubled their share of our total exports over the past 20 years to about 27 per cent today.
However, the upside is limited. For example, Dairy NZ estimates milk production will grow at 2.5 per cent a year, below its long term average. This reflects farming limits imposed by new freshwater regulations and less land available for conversion to dairying.
We need a broader, more sophisticated range of exports to overcome our commodity constraints. But we’re going in the opposite direction. Manufactured goods have fallen from about 37 per cent of exports in 2003 to about 22 per cent today.
This increasing simplification of our economy towards low value commodities has accelerated in recent years, according to data from a long-term study of countries’ economic complexity run by Harvard and the Massachusetts Institute of Technology.
In 2008, we ranked 39th in the world in terms of economic complexity, in the company of countries such as Brazil, Russia and Greece. But by 2012 we had fallen to 52nd.
This is the kind of thing that sets off alarm bells in the minds of economists. But how can we fix it?
The one thing that will not work, long-term, is continuing to rely upon milk powder and raw logs to support our living standards. We can’t keep doing the same thing and hoping for different results.
Fortunately, New Zealand has a unique opportunity to do things differently. Investing in better cities can create an environment for the development of new ideas and the growth of new, innovative businesses. Agglomeration and productivity growth in large, dense cities is an integral part of economic growth in the 21st century.
If we look beyond our own dairy exports, we can see the role of agglomeration everywhere. Economists have extensively studied the role of cities in economic growth, and businesses are actively taking advantage of it. It’s why:
- One-third of the world’s major companies are headquartered in just 20 cities
- The tech revolution started in, and is still based in, Silicon Valley and San Francisco
- London and New York sell financial services to the rest of the world
- Auckland’s city centre is home to New Zealand’s most productive jobs – the average city centre job is 139% more productive than jobs outside Auckland.
Urban businesses are often innovative, highly productive, and actively looking for export opportunities. We’re already seeing how cities can create new sources of wealth for New Zealand:
- Cloud-based accounting software firm Xero (based in Wellington and Auckland) is growing rapidly and creating opportunities for other Kiwi software firms
- Video game developers are hiring fast and growing sales globally: “The New Zealand Game Developers Association’s 33 member studios collectively hiked their earnings to $36.3 million in the year to March, up 86 per on the previous year… Kiwi-made mobile games had been downloaded about 130 million times in the year.”
- Weta Workshops and Weta Digital export expertise to the global film industry from Wellington
- I work for a company that exports public transport planning services from the Auckland city centre to Australia and the broader Asia-Pacific region.
As the late, great New Zealand physicist Paul Callaghan argued, in order to grow in the long term we need more firms like this. And in order to get them, we need to create an environment that attracts talented people and smart businesses and supports knowledge spillovers and innovation.
Cities are fantastic environments for generating new ideas and new sources of wealth.
We call that environment a city. If we want to get better economic outcomes, we need to invest in better cities, starting with Auckland.
That means delivering a great bus network and integrated ticketing (as Auckland Transport is doing). It means expanding transport choice by investing in the City Rail Link and the Congestion Free Network. It means enabling people to build the medium-density, mixed use neighbourhoods that the market’s crying out for. It means delivering great people-oriented public spaces (as Auckland Council and Waterfront Auckland are doing). It’s not that hard!
Last week I took a look at whether government policy to support regional economies could divert growth away from Auckland. Based on the historical evidence, the answer seems to be no – people want to live in Auckland and start businesses here, and it’s senseless to try and stop that.
Today, I want to look at this issue from a different angle, and ask: If we somehow succeeded in stifling Auckland’s growth, would we be better off as a result? Would New Zealand be richer if it cancelled the City Rail Link, banned any new dwelling construction in Auckland, and told newcomers to bugger off to Timaru (or, more likely, Melbourne)?
Once again, we don’t have to speculate, as we can examine the results of previous “natural experiments”. Paul Krugman suggests that we could learn from recent population growth in the United States. (In between gaining academic renown for his work in new trade theory and public notoriety as a harsh critic of the second Bush administration, Krugman helped develop the new economic geography literature, which explains why cities form and grow.) He takes a look at the rapid growth of the “sunbelt” states, including Arizona and Texas, and finds that it has probably reduced economic growth in the US:
It turns out, however, that wages in the places within the United States attracting the most migrants are typically lower than in the places those migrants come from, suggesting that the places Americans are leaving actually have higher productivity and more job opportunities than the places they’re going. The average job in greater Houston pays 12 percent less than the average job in greater New York; the average job in greater Atlanta pays 22 percent less.
So why are people moving to these relatively low-wage areas? Because living there is cheaper, basically because of housing. According to the Bureau of Economic Analysis, rents (including the equivalent rent involved in buying a house) in metropolitan New York are about 60 percent higher than in Houston, 70 percent higher than in Atlanta.
In other words, what the facts really suggest is that Americans are being pushed out of the Northeast (and, more recently, California) by high housing costs rather than pulled out by superior economic performance in the Sunbelt.
But why are housing prices in New York or California so high? Population density and geography are part of the answer. For example, Los Angeles, which pioneered the kind of sprawl now epitomized by Atlanta, has run out of room and become a surprisingly dense metropolis. However, as Harvard’s Edward Glaeser and others have emphasized, high housing prices in slow-growing states also owe a lot to policies that sharply limit construction. Limits on building height in the cities, zoning that blocks denser development in the suburbs and other policies constrict housing on both coasts; meanwhile, looser regulation in the South has kept the supply of housing elastic and the cost of living low.
In short, restrictions on population growth in productive places – i.e. large, relatively dense cities – force people to move to less productive places, and earn less. A recent working paper by American economists Chang-Tai Hsieh and Enrico Moretti put a figure on the economic cost of these restrictions: housing supply restrictions in high-productivity cities like New York and San Francisco over the last three decades has lowered the US’s GDP by an estimated 10-14%. That’s absolutely huge.
This is agglomeration at work – or rather, “deglomeration”. The economic literature has identified a strong relationship between the scale and density of cities and the productivity of firms that locate within them. But rather than recognising and taking advantage of this phenomenon – for example, by allowing more office space to be built in San Francisco for the expanding tech industry and more apartments to be built in Silicon Valley for urbanophile tech workers – some American cities have chosen to reject it.
So could the same thing happen in New Zealand? In a word, yes. It’s definitely a risk and one that we should be careful to avoid.
First, the facts. Firms based in Auckland are more productive than firms elsewhere in New Zealand, after controlling for industry and firm characteristics. And firms in the Auckland city centre are even more productive. The table below, compiled from data in Dave Mare’s great 2008 paper on the topic (“Labour productivity in Auckland firms”), shows that there is a substantial “productivity premium” in Auckland:
||Employment density (2006 jobs/sq km)
||Value added per worker (2006)
||Productivity relative to non-Auckland
|New Zealand excl. Auckland
|Auckland urbanised area
|Auckland city centre
I just want to say a brief word about the “productivity premium” of the city centre. A lot of people say that New Zealand’s an agricultural exporter, earning its way off the sheep’s back (or, more recently, the cow’s teats), and that downtown jobs are just an unproductive drain on farm revenues. However, service exports from urban businesses play an underappreciated role in NZ’s international trade picture. The two companies I’ve worked for in the Auckland city centre are both exporters of professional services. I’ve personally exported to Hong Kong, Australia, Fiji, and Papua New Guinea; my colleagues have also worked in Indonesia, Uganda, Canada, Saudi Arabia, the UK, and a whole host of other places. If we want to grow our exports in a smarter way, we need to encourage this sort of thing rather than deny that it’s happening.
As a result of the urban productivity premium, policies that stifle the growth of Auckland are likely to put a drag on New Zealand’s economy. In the US, a reluctance to let productive cities grow caused people to move to lower-wage cities like Phoenix, Houston, and Atlanta. Down here, the results are likely to be even worse, as New Zealanders are much more internationally mobile than Americans. If we put a lid on Auckland’s growth, some people will go to Hamilton or Tauranga instead, but many others will head to Australia or the UK.
Fortunately, we’ve got a much better option: Improve New Zealand’s cities rather than trying to smother them. Moreover, we’ve got some great opportunities to do just that. In Auckland, that means:
- Making cost-effective investments in more transport choices, including better walking and cycling
- Building the City Rail Link to unlock access to the city centre and allow firms to grow and benefit from the knowledge spillovers floating around
- Preserving and improving our parks and public spaces – Waterfront Auckland is a truly world-class waterfront development agency and we should build on its success
- And, as Krugman and Glaeser point out, it’s absolutely vital that we allow dwellings to be built in the places where people want to live – which increasingly means building more in places like Ponsonby and Mount Eden that are close to jobs and amenities.
We shouldn’t limit our vision to Auckland, either. While Auckland’s larger and faster-growing than Christchurch or Wellington, those cities also support agglomeration economies and interesting urban lifestyles. Investments in better cities will pay off there as well. Some of the same policies can also make small cities more liveable – although Hamilton will probably never need a CRL, look at the difference that NZTA’s Model Cycling Communities programme has made to Hastings and New Plymouth.
Why don’t we get on with it then?
Debates over major transport investments often get caught up in arguments over benefit-cost ratios, or BCRs. In recent years, projects such as the Transmission Gully and Puhoi to Warkworth motorways and the City Rail Link have been criticised for their low BCRs. These debates have often raised more questions than they resolve. So it’s necessary to ask: What is a BCR, how is it calculated, and what does it mean?
The good news is that there is a manual that explains it – New Zealand Transport Agency’s Economic Evaluation Manual (EEM). The bad news is that it’s tediously long and not written for a general audience. This series of posts aims to provide a guide for the perplexed:
In part three of this series we take a look at agglomeration, which is a potential benefit of transport projects that isn’t captured in traditional evaluation procedures.
So we’ve gotten through the most boring part of this series – the previous post on conventional transport benefits. To briefly recap:
- Conventional transport appraisal focuses on monetary and non-monetary benefits for users – i.e. travel time savings and vehicle operating cost savings
- However, there are also externalities associated with transport behaviours
- Some of these externalities, such as health benefits and environmental externalities, are pretty simple to describe and analyse
- However, other externalities which have an effect on economic activity – the so-called “wider economic impacts”, or WEIs – are a little bit more complicated.
As I said last time, NZTA has sought to incorporate transport-related externalities into their evaluation framework. As part of this work, in 2011 they commissioned a report to identify and quantify the WEIs. The report (pdf), which was written by economists Duncan Kernohan and Lars Rognlien, found evidence for three main types of WEIs: agglomeration externalities, imperfect competition benefits, and labour supply benefits. Each externality arises as a result of changes to transport costs, as follows:
|Transport user benefit
|General transport time/cost reductions
||Effective density of employment increases; firms become more productive
|Business travel time/cost savings
||Firms pass on savings to customers, plus an additional amount to reflect price-cost margins
|Commute time/cost savings
||Labour supply effects
||Easier commutes encourage some people to enter the labour force; they pay more income taxes as a result
If you want to understand the WEIs in more detail, I suggest you take a look at their paper, which is technical but not totally inaccessible. Here, I’d like to focus solely on agglomeration externalities – what they are, how they happen, and why we might want to include them in transport evaluation.
Agglomeration has been a hot topic in urban economics in recent years – although, technically speaking, the theory of agglomeration goes back to British economist Alfred Marshall, who identified the phenomenon in the late 1800s. Agglomeration refers to the idea that larger and/or denser places are more productive. In other words, businesses operating in large cities tend to produce more output per worker than similar businesses operating in small towns. This isn’t just a theoretical argument – it’s an observed fact.
Conceptually speaking, agglomeration externalities arise due to the existence of increasing returns to scale in an economy. Essentially, the more people work in an area, the higher the potential for knowledge spillovers between them, the lower the cost to buy and sell goods and services, and the better the matching of workers to jobs. There’s a deep economic literature describing how this process occurs and developing theories of agglomeration, but if you’re interested in a non-technical introduction to the topic, I highly recommend Edward Glaeser’s book The Triumph of the City.
As a result of these processes, larger cities and denser, more accessible places tend to be more productive. There’s a lot of empirical evidence demonstrating this relationship. In New Zealand, papers by Dave Maré (2008) and Daniel Graham and Maré (2009) found that:
- In 2006, the Auckland urban area was 36% more productive than the rest of the country, after adjusting for industry composition. In other words, an Auckland business would be expected to produce much more output per worker than a similar business elsewhere.
- In 2006, the Auckland city centre was one of the most productive places in the country. After adjusting for industry composition, the city centre was 72% more productive than the rest of the country.
- There is a substantial positive relationship between density and firm productivity – firms located in areas that are twice as dense are 3.2-8.7% more productive on average, depending upon industry.
What does this “productivity premium” look like? My colleague Kent Lundberg came up with one way of visualising agglomeration by looking at land values in and around the city centre. His map shows a sharp differences between the value of city centre land and land in surrounding, less intensive environments, with a lower peak out in Newmarket. Essentially, firms see the benefit of locating in dense places, and they’re willing to pay more to do so:
Firms are willing to pay for proximity.
Graham and Maré’s 2009 paper was used to establish NZTA’s parameters for evaluating the agglomeration effects of transport projects. These parameters, or agglomeration elasticities, estimate the relationship between increases to the accessibility of jobs in an area and the productivity of that area. Agglomeration elasticities are highest in knowledge-intensive industries such as finance and business services, and lowest (or nonexistent) in resource-based industries like agriculture and forestry.
However, NZTA took Graham and Maré’s analysis of agglomeration one step further, arguing that what matters for firm productivity is not just physical proximity, but accessibility of jobs via transport. In other words, business productivity could potentially increase as a result of improvements to transport as well as increases in job density. There’s some empirical support for this idea –economists have tested a range of measures (pdf, technical) and found that both physical density and transport-weighted measures of density are associated with higher productivity.
That’s why agglomeration benefits are typically calculated for both public transport projects, which are expected to enable more intensive land use, and road projects, which tend to disperse economic activity throughout a greater area.
Is this what agglomeration looks like? (Source)
Is this a reasonable approach to project evaluation? I suppose my view would be: possibly. There are two reasons to be cautious about calculating agglomeration benefits for transport projects.
The first is that it’s conceptually difficult to define “density” really is. The economic literature presents a range of views about what measures matter most. Is it transport accessibility, even in relatively dispersed environments, as NZTA argues? Or is physical density, such as the number of jobs you can reach in a one-kilometre walk, as enthusiasts for urbanism suggest? Or is it something else entirely, such as the overall economic mass of an entire urban area regardless of whether it is compact or sprawling. Economists have studied this question from a number of angles, finding that various different measures of density and distance can predict productivity. (It’s also likely that agglomeration is nonlinear (pdf, technical), but let’s not get into that.)
The second and more serious reason for caution is that NZTA has assumed a causal relationship between effective density and productivity that might not exist in practice. Essentially, it’s not at all clear whether you can make a firm more productive by increasing the density or accessibility of the area where it operates. Do firms become more productive when they move into relatively dense areas, or do productive firms move into dense areas for other reasons?
The most likely answer is a bit of both. Research done in the UK by economists Patricia Melo, Daniel Graham and several co-authors (ungated pdf version) suggests that the causality between productivity and density runs in both directions. In other words, density breeds productivity, but productivity also breeds density. This makes logical sense, if you think about it. On the one hand, firms may be able to access knowledge spillovers and deeper labour markets in denser areas, which is likely to make them more productive. But on the other hand, more productive firms are also more likely to be successful firms. If you put a lot of successful firms in one place, that area will probably become denser as those firms hire more workers.
The upshot of this is that while there’s a good case to include agglomeration effects in transport evaluation, NZTA is using a method that probably overstates the benefits.
Next time: The dark art of demand forecasting.