Undercover Economist

It’s not what you know, but who you know and where they are

Alfred Marshall didn’t have to wait for Silicon Valley to evolve before concluding that some places are hubs of intangible knowledge. In 1890, the renowned Cambridge economist opined that “great are the advantages which people following the same skilled trade get from near neighbourhood to one another. The mysteries of the trade become no mysteries; but are as it were in the air … if one man starts a new idea, it is taken up by others and combined with suggestions of their own; and thus it becomes the source of further new ideas.” Marshall knew that where you live and work affects what you learn and what you earn. One question that economists have struggled to answer, though, is exactly how and between whom knowledge spreads.

Marshall emphasised the spread of ideas between similar companies, but there are other plausible possibilities. Jane Jacobs, author of The Death and Life of Great American Cities, was more excited by the spread of ideas across industries, citing examples from the invention of the bra by Ida Rosenthal to the development of Scotch tape by 3M, originally a mining company.

More mundane forces could also be at work: maybe innovative cities are innovative because, with so many jobs and so many workers, it is easier for each worker to find the perfect job. City-dwellers may become smarter just because they are surrounded by some well-educated people.

I recently rediscovered an interesting working paper published in 2005 by Shihe Fu, then at Boston College but now working in Southwestern University in China. Fu used very detailed data from the 1990 Massachusetts census in an effort to track knowledge “in the air”; specifically, he looked at wages, block by block, and tried to work out whether he could find evidence of knowledge spillovers traced out by patterns of higher wages.

Recall the four possible hypotheses: knowledge spreads within industries; ideas are generated when different industries rub together; people learn from being around lots of smart people; or people benefit from the density of a labour market, which helps them find the perfect job.

Fu found evidence that all are true, but intriguingly, they operate at different distances and on different professions. For example, wages tend to be high near densely occupied blocks, but tail off within a mile or two. But Jacobs-style benefits from diversity raise wages at a distance of nine miles and more. Managers benefit from all four types of urban spillover, while hi-tech workers particularly benefit from the spread of ideas described by Marshall and Jacobs. Artists thrive on the pure diversity that Jacobs celebrated.

The big question hanging over Shihe Fu’s research, it seems to me, is that the data supporting it are nearly 20 years old. Have e-mail and social networking changed the way that knowledge flows through cities? It seems that they must have, but quite how is far from obvious. After all, enhanced communications technology could simply concentrate wealth and innovation in fewer, world-dominating hubs.

My reading of the evidence is that technology has not killed distance – at least, not as far as the spread of ideas goes. Research in 2007 by Charles King, a political scientist, and two economists, Neil Gandal and Marshall Van Alstyne, found that e-mail’s real value seemed to be communicating with colleagues in the same office. And two years ago I described research at Google – not exactly a technological dinosaur – which found that the best predictor of who knew what was where they sat. For all the wonders of the internet age, location is as important as ever.

Also published at ft.com.