Office clusters are as crucial to productivity as they ever were

Office clusters are as crucial to productivity as they ever were

The Prime Minister is now demanding that offices reopen to revive economic activity in the centres of towns and cities.

But there is not much sign of a return to work.

The preferences of the workforce are an important factor in the very slow pace of return. Fears expressed about the safety of public transport may or may not be genuine, but it is certainly true that many prefer to avoid the time spent commuting and enjoy the extra leisure time this brings.

But why do offices cluster together in urban centres anyway?

It is easy to see that in the old days industries such as steel and coal clustered geographically. One was a key supplier of the other. Being near at hand minimised transport costs.

Today’s offices span a wide range of diverse industries, from consulting to law to oil companies. The reasons why they locate in close proximity are more subtle.

The views of economists on this are still shaped by the writings of Alfred Marshall. He established the faculty of economics at Cambridge in 1903 and was then probably the world’s leading economist.

Marshall described the tendency of businesses to cluster near each other as “agglomeration”. He gave three key reasons why this colocation is observed.

In addition to the savings on the costs of transporting the materials needed in industrial processes, Marshall developed a theory of labour market pooling, in which firms located near one another can share labour.

Further, he believed that “intellectual spillovers” were important. Firms locate near each other in order to learn and speed up the process of innovation. Think of Silicon Valley, formed nearly a century after Marshall wrote.

A large number of detailed studies in recent decades confirm that these are not just mere theories. They have strong empirical support. The Harvard economist Ed Glaeser, for example calculated that in the US in the 2000s each of Marshall’s three reasons were of roughly equal importance.

There have been very distinct benefits to agglomeration. Throughout the developed world, the greater the density of employment in an area, the higher is its productivity. Head offices contain more highly skilled staff and so will be more productive than the average. But in city centres, their productivity is even higher than their skill levels suggest they should be.

Has Covid-19 changed all this? Or more specifically, has the crisis enabled people to see that new technology could overturn two centuries of experience in urban centres in industrialised countries?

Certainly, tech platforms such as LinkedIn offer the potential for efficient hiring of relevant skills and for employees to discover opportunities through their networks. But new recruits need to be integrated. And younger people probably still need a combination of social and remote interaction to develop their own professional networks.

It is less clear that remote working can encourage innovation in the same way. Much of the informal contacts needed for this cannot be captured by video conferences.

Yes, there will be an increase in working from home. But Marshall’s insights into the benefits of agglomeration still hold true.

Paul Ormerod
As published in City AM Wednesday 15th July 2020
Image: The City of London via Wikimedia CC BY-SA

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