Why space matters

Place is becoming more important as the world’s economies are transformed by knowledge-intensive activities. At the recent GAP Summit Matt Wright, Partner at Deloitte Access Economics, discussed the need to reconsider the purpose of place following a Deloitte report.

When my colleagues and I at Deloitte Access Economics think about ‘creating spaces for Australian innovation’ we refer back to our 2015 thought leadership piece ‘Building the Lucky Country #5: The Purpose of Place Reconsidered’.

The prelude for that piece (and the link to the full report) were shared in the Summit materials, and began with the proposition that:

“Technology has trumped the tyranny of distance and place no longer matters.” 

In fact our research (and that of many prominent international economists) finds the opposite is occurring: Place is becoming more important as the world’s economies are transformed by knowledge-intensive activities.

This finding led us to prepare a report that we hoped would agitate individuals, communities, government and importantly business to reconsider the purpose of place in an evolving 21st Century Australia.

It’s my hope that through this brief address, and your read of our report, that we’re able to further that endeavour.

So with the time I have remaining I’d like to briefly cover three key points:

• Firstly: The key economic concept we’re appealing to here
• Secondly: Why this concept matters
• Finally: What we can do with this understanding.

So let me begin with the core concept…

That of Agglomeration Economies

• Agglomeration economies are the benefits that come when firms and people locate near one another in cities and industrial clusters.
• The benefits of that proximity are reduced ‘costs’ – broadly defined – in exchanging goods, people and importantly in this context, ideas.
• Now, while it’s not unreasonable to predict that as transport and communication ‘costs’ fall, agglomeration becomes less important, the paradox is that the evidence is suggesting otherwise…
  • Urbanisation continues to increase
  • Industry remains largely concentrated
  • Density remains highly correlated with high wages
  • Labour market pooling continues
  • Human capital levels strongly predict urbanisation
• Furthermore, among a host of high profile economists who have explored this phenomena:
  • Ed Glaesers’ presents simple models of learning: in person, from a written source, and over the phone, and finds that interactive communication dominates other forms of learning when ideas are complicated. And
  • Paul Krugman finds high-end functions benefit most from agglomeration economies – that is, ‘Specialised’ occupations are positively correlated with agglomeration
• If you’re interested, you can also see the related work of Alfred Marshall and Enrico Moretti

So, the relationship between place and prosperity continues, and is perhaps intensifying.

This brings me to my second point, why agglomeration economies matter?

The short answer is the potential to unleash growth in productivity.

• In our evolving economy, the most highly valued services are those intensive in ideas, knowledge and creative skill.
• And as such, productivity growth through agglomeration (or proximity) occurs via a couple of key channels:
  • Firstly through the transmission of ideas – or what economists call ‘knowledge spillovers’ – that is, our knowledge builds on what we learn from those around us. Again Ed Glaeser finds “the interaction of smart people in urban areas both enhances the development of person specific human capital, and increases the rate at which new ideas are formed”.
• The second channel is through what’s known as labour market pooling, which allows workers the freedom to more freely change jobs as their productivity changes, and/or as the productivity of particular industries changes, which leads to more efficient allocations of labour over time.
• As the Commonwealth Treasury’s Intergenerational Reports have demonstrated, we need to boost productivity growth to sustain rising levels of welfare in our country.
• However, growth in productivity through agglomeration is not without its challenges. Diseconomies can set in, predominantly in the form of social and environmental challenges such as expensive land, pollution, congestion and crime or conflict.

So, agglomeration economies could unlock the next wave of productivity growth for Australia and its enterprise, particularly where the costs of agglomeration can be mitigated.

This brings me to my final point, what can we do with this knowledge?

In our view the imperative is to connect it with other ideas and catalyse Australia’s next wave of productivity growth.

• The purpose of place in a knowledge economy is to facilitate the productive interaction of knowledge workers.
• With this concept we can:
  • Further promote agglomeration economies by growing and co-locating human capital; and
  • At the same time reducing the impact of the ‘costs’ typically associated with proximity and density.
• In this respect, people, technology and both public and corporate governance have important roles to play – each can smooth the sharp edges of agglomeration.
• For instance this might include using these mechanisms to promote the following dynamic forces:
  • People in appropriate numbers and with appropriate skills, experience and outlook, as the basic ingredient in catalysing the economies of agglomeration
  • The built environment affects people’s capacity to connect with one another and form relationships. For people to flourish in place they need to feel that they belong.
  • Local concerns may have to subordinate to wider interests (for instance when it comes to essential new infrastructure or unlocking greater density)
  • New ways for citizens to participate in public policy making need to be explored (good governance explores new ways to win the consent of the governed for the hard choices needed to unlock the potential of place)
• Finally, it’s also important to note that Australians have traditionally looked to governments for nation building, but the changing purpose of place should make business in particular think again about the potential of place as a driver of commercial success.
  • Businesses need increasing returns to drive growth in profits. Catalysing economies of agglomeration raises productivity, which in turn grows the return on capital invested.

I’ll conclude by saying that what we’ve covered in this piece are not new concepts. What we hope is that their connection creates the imperative and initial guide for progress, and what’s more, that this work calls this out as not just a matter for public policy, but rather that it’s both profitable and responsible business to act on this.

If you haven’t already, please take the time to review our report, which you can find at buildingtheluckycountry.com.au/