Economic success increasingly depends on the ability to create all kinds of new ideas. As Jane Jacobs famously observed decades ago, a core strength of cities is their tendency to juxtapose juxtaposition different people and firms in a way that stimulates the formation of new ideas. Physical proximity, the built environment, institutional characteristics and social norms found within cities influence this process of idea creation.
Economists, led by Paul Romer and other New Growth Theorists are coming to the conclusion that the creation of new knowledge, including everything from fundamental scientific breakthroughs to better ways to sew a shirt, is the driving force behind long-term economic growth . Far from being random, the knowledge creation process hinges on the density of interaction in cities to generate new ideas. Cities mix different people together, and the resulting interactions are a fertile ground for the creation of all kinds of new work. As Jane Jacobs observed, this process of creating new work helps drive economic growth, not just in the city, but in the larger world as well.
In sharp contrast to claims that were made about technology producing a death of distance, in fact, the process of new knowledge creation remains highly concentrated and occurs primarily in cities. While new ideas are difficult to measure, but one good indicator is the location of patents. Patent data show that, far from being a flat world, the geography of new idea generation is highly concentrated in a few cities around the world.
In the United States, our key assets for creating new ideas are highly concentrated, especially in larger cities. As the Brookings Institution has documented, the 100 largest cities account for 78 percent of patents issued, 81 percent of research and development jobs and 94 percent of all venture capital investments.
Large firms can rely on an internal network of resources to develop and refine new ideas. The abundance of complementary skills in small firms and professionals in a city enables small firms located in cities to tap the same kind of resources. The resources afforded to firms by city locations substitute for the same capacities that larger firms have to create internally. Similarly, the line between entrepreneurs and customers in innovation is increasingly blurred in cities. The depth and diversity of customers in cities is attractive and advantageous to entrepreneurs because as Eric von Hippel has observed, many important innovations are the result of user modifications and close interactions between producers and consumers.
Cities are places that toss different people and ideas together in ways that generate new work and new firms. This process is at work in many urban economies and in many different industries. Its influence is not the exclusive province of so-called creative sectors of the economy (though they may be more prolific and obvious). Cities are good places for consumers to try new things, which make them good places for entrepreneurs to try new ideas and start new businesses.
Cities are great places for entrepreneurs, and entrepreneurship is a key factor in city growth. The number of small firms in an industry is strongly correlated to later employment growth in that industry in that city. Studies by Ed Glaeser and his colleagues show that a city’s level of self-employment in 1970 predicted growth in population and income over the next three decades.
For many industries, entrepreneurship is a highly localized process. Even within cities, entrepreneurship varies by neighborhood. Localization economies are important. Other studies show that new firms in an industry tend to be born close to existing firms in the same industry, and the effect of an industry concentration declines sharply with distance.
In theory, we believe that entrepreneurship is a key mechanism for promoting economic mobility. Entrepreneurs can create new businesses that give themselves—and their employees—the chance to improve their economic position. We already know that entrepreneurship is one of the critically important factors in stimulating metropolitan economic growth. Job growth is strongly correlated with an abundance of small firms. Across metropolitan areas, metro areas with more small firms relative to the size of their population see faster employment growth (Glaeser, Kerr, & Ponzetto, 2010).
Fast growing, entrepreneurial firms may be particularly important for providing opportunities for upward mobility because they tend to hire more younger workers (Ouimet & Zarutskie, 2013). Having a large number of young, small, entrepreneurial firms may create more opportunities for young workers from all economic strata to progress through the economic spectrum.
In this post and this post, we outline the role that both venture capital and small businesses can have in increasing economic mobility. We see a positive correlation between both the amount of venture capital and small businesses per capita and Raj Chetty’s measure of economic opportunity (the probability that children born in the bottom quintile rise to the top quintile as adults). The correlation between venture capital and economic mobility can be seen below:
(To learn more about this correlation and our analysis, go here.)
The correlation between small businesses and economic mobility is weaker, but still relevant:
(To learn more about this and our analysis, go here.)