Knowledge Spillovers: Cities' Role in the New Economy

By Carlino, Gerald A. | Business Review (Federal Reserve Bank of Philadelphia), Winter 2001 | Go to article overview

Knowledge Spillovers: Cities' Role in the New Economy


Carlino, Gerald A., Business Review (Federal Reserve Bank of Philadelphia)


Most countries make sustained economic growth a principal policy objective. Although many factors contribute to economic growth, recent research has found that innovation and invention play an important role. Innovation depends on the exchange of ideas among individuals, which economists call knowledge spillovers. For example, a given company's innovation may stimulate a flood of related inventions and technical improvements by other companies.

Recently, some economists have suggested an important link between national economic growth and the concentration of people and firms in cities. The high concentration of people and firms in cities creates an environment in which ideas move quickly from person to person and from firm to firm. That is, dense locations, such as cities, encourage knowledge spillovers, thus facilitating the exchange of ideas that underlies the creation of new goods and new ways of producing existing goods.

Cities and their dense inner-ring suburbs play an important role in the "new economy." In the not-too-distant past, the national economy was based on the production of goods. At the time, cities were good locations for firms because the production of goods was more efficient inside cities than outside them. (1) But manufacturing activity has continually shifted from dense to less dense parts of the country. Consequently, today, our densest cities are important not as centers of manufacturing but as centers of innovation. As economist Janice Madden has pointed out: "To the extent that there is a `new economy,' it can be described as one in which creativity has become more important than the production of goods." Economist Leonard Nakamura has demonstrated that during the past century, increasingly more workers were "employed in creative activities such as designing, inventing, and marketing new products, and more and more economic activity [was] devoted to creating technical progress." (2) Data from the U. S. Patent Office show that annual applications for patents increased dramatically between the mid-1980s and the mid-1990s. In fact, as we'll see later, most of the patents granted in the 1990s originated in metropolitan areas.

As far back as 1890, Sir Alfred Marshall described cities as "having ideas in the air." In earlier times, cities and their environs contributed to economic efficiency when the economy was based on the production of goods. Today's cities, despite well-publicized drawbacks such as congestion, contribute to the efficient production of knowledge in the new economy.

TWO TYPES OF KNOWLEDGE SPILLOVERS

Economists have identified two types of knowledge spillovers thought to be important for innovation and growth: MAR spillovers and Jacobs spillovers.

MAR Spillovers. (3) In 1890 Alfred Marshall developed a theory of knowledge spillovers that was later extended by Kenneth Arrow and Paul Romer -- hence, the name MAR spillovers. According to this view, the concentration of firms in the same industry in a city helps knowledge travel among firms and facilitates innovation and growth. Employees from different firms in an industry exchange ideas about new products and new ways to produce goods: the denser the concentration of employees in a common industry in a given location, the greater the opportunity to exchange ideas that lead to key innovations.

Often, the latest information about technological and commercial developments is valuable to firms in the same industry, but only for a short time. Thus, it behooves firms to set up shop as close as possible to the sources of information. For example, many semiconductor firms have located their research and development (R & D) facilities in Silicon Valley because the area provides a nurturing environment in which semiconductor firms can develop new products and new production technologies.

Sometimes, information about current developments is shared informally, as has happened in the semiconductor industry. …

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