Cities and new sources of growth

by Josef Konvitz

Honorary Professor, University of Glasgow; Visiting Professor, Cities Group, Geography, King’s London; Former Head, Urban Affairs, Regulatory Policy Divisions, OECD, Paris

The prospect of a recovery gives the false impression that we can go back to 2008 as if the last six years had not happened.  But something dramatic has changed: the rate of growth expected in the West is below the long-term averages of the post 1945 era, which looks anomalous in long-term economic history. A low-growth economy extending years into the future will not be robust enough to make good the lost years of wealth, nor give millions of young people and their families hope. Let’s not blame everything on the crisis of 2008: Conditions for growth were already compromised when the crisis began.  The effects of massive stimulus packages have been so short-lived because governments, overlooking fundamental structural changes in the factors of growth and neglecting cities where these are concentrated, have been pushing on a wet string.

If cities are indeed the engines of the economy, they “run” on two inputs, innovation and infrastructure.  And these have been allowed to “run down” to inadequate levels.

Where we are

Four sets of figures – “killer facts” because they are so difficult to refute – speak volumes. The first is the sum in excess of 50 trillion dollars – 3.5 per cent of global GDP – which should be invested over the next 20 years to rebuild, expand and upgrade the infrastructures and water and  power systems on which cities depend, two-thirds in developed countries. This eye-blinking figure from the OECD is not a typographic error: surely billions, not trillions.  McKinsey, using a different methodology, reached the same conclusion in 2012, noting that this omits the cost of coping with climate change.  This is a critical point because cities as they are must be rebuilt if we are to make the transition to 21st century challenges and objectives.

Why has the bill exploded, decoupling infrastructure from growth in GDP or in capital formation? Many infrastructure systems are coming to the end of their useful life-cycle at the same time.  The demands of the security agenda since 9-11 have only underscored the cumulative effect of under-investment over decades.  Routine maintenance and repair were never enough to cope with what needed to be done. Water and sewer systems built in 1850s, the extension of network utilities across metropolitan regions between the 1890s and 1914, the modernization of infrastructure in the post-1945 era, and the last phase of building in the 1980s and early 1990s were all on different life-cycles. Older systems built to last 100 or 150 years, and newer ones built to last for 25 or 50 years have all come to the end of their useful life-cycle at the same time.  Nothing like this has ever happened before.

The third fact we cannot wish away: years of lost output, high unemployment and under-investment will not be made good, maybe for decades, and will in fact generate higher demands on social services because millions of people who have been unemployed for more than a year are likely to be employed less often, and at lower  incomes, in the years to come. How will cities and regions cope with the pressure to deliver more and better services when long-term fiscal pressures spell austerity? Doing more with less is not the answer when the problem calls for more innovation in and for the public sector.

Finally the crisis and subsequent recession show an alarming trend in disparities.

These facts remind us how difficult it is to get growth, let alone inclusive growth.

Things were not supposed to be this way. QE – quantitative easing, or stimulus packages – was supposed to channel billions into the economy through infrastructure projects.  Perhaps only half the funds allocated actually got spent as intended. The crisis has been an opportunity missed.  Why?

  • There were not enough sound, strategic plans waiting to be financed; and
  • Time-consuming regulatory and procedural frameworks impeded rapid approval.

But even these two explanations, important as they are, are trumped by a third:

  • the lack of vision by government for the future of the city.

How can there be urban projects (a noun) when efforts to project the future of the city (a verb) are so weak? The market can do a lot, but to rely on the market is a policy by default, ignoring the impact of policy on markets.  Governments and the private sector have been talking past one another: governments have been waiting for business, cash-rich, to invest; the private sector has been waiting for government to articulate a medium-term strategy for urban development. Uncertainty combined with a lack of strategic vision are holding back investment.

Where we should be headed

Cities have been missing from post-2008 strategies. The OECD’s 2014 Regional Outlook highlights “how cities work as engines for innovation, prosperity and growth” through concentration, diversification and specialization:

  • The ‘agglomeration benefits’ of cities are reflected in higher productivity and ‘wage premia’ of between 2 and 5 per cent. (p. 18).  This is huge, linking the size of labour markets to the quality of human capital.
  • A 10% increase in the share of university-educated workers in a city raises the productivity of other workers in that city by 3-4%. (p.51-52)

Educate more people, and at a higher level; attract and retain people with a better education; diversify and improve the range of skills at all levels of competence, and the sectoral mix of innovative. It sounds too simple.

To enhance the positive externalities of cities, consider questions about historic jurisdictions and the size of cities, sensitive issues culturally and politically:

  • Administrative fragmentation reduces per-capita GDP growth and lowers productivity. Municipal mergers (Denmark, France) address this.
  • Doubling the size of cities leads to gains of 2-5% in productivity – largely because there are more people offering more and more specialized skills in labour markets. This is a different challenge in France and the UK with growing populations, than in Germany, Italy, Japan whose populations are falling.
  • The effects of size on productivity can be realized through greater proximity and more and faster connections within and between smaller cities or in cities. In this case agglomeration effects due to infrastructure investment are mutualized. As a highly urbanized country for over two centuries, UK performance should be better – more like that of the Netherlands or Switzerland whose cities function in networks that rest on high-value infrastructure.

What is striking is that it has taken so long in this crisis, which is now at least 6 years old, to return to basics. The IMF and OECD now call for more to be spent on infrastructure: six years after 2008, they see nothing else left in the policy toolkit.  In the short term, the call for greater infrastructure investment is only likely to lead to arguments about how much should come from the private and how much from the public sector, and particularly how much from different levels of government. The G20 meeting in November 2014 in Brisbane led to the creation of a Sydney-based infrastructure “hub” to help reduce barriers to investment, and match investors with projects through a database.  Taking account of the long lead time needed to design and get approval for large-scale projects, the benefits of this investment on the economy will only be visible in two or more years, a challenge for central bankers and macro-economists who must cope with things as they are, and especially if there is a further deterioration in the interim.

The key to greater productivity lies in getting cities – cities and urban regions – to perform better: raising living standards, building human and social capital, improving connectivity, supporting the creation and growth of firms, increasing the stock of affordable and safe housing, and keeping options for the future open which depend on economic diversification, innovation and social cohesion.  Constraints on these are the new limits to growth. Emerging economies grow at a fast rate because they have scope to converge with the levels of performance of countries at a high level of development. Urbanisation is critical to this process. Our challenge is different – to push back the productivity frontier in the cities that already exist.

Labels such as “competitive” or “smart” cities are simplistic, the equivalent of picking winners in a discredited industrial policy. Three considerations tell us why. (1) In the old manufacturing economy, goods for export mattered because they generated the income to pay for imports. This led economists to distinguish between the basic side of the economy, which produced, and the non-basic, which consumed. This no longer applies: the non-basic side is probably the larger of the two, and many goods and services previously defined as local are now tradeable, blurring categories. The cultural and design sectors are good examples. (2) The non-basic dimension of urban economic growth, including innovation as an activity, is more in tune with liveability as a composite of indicators; the basic side of the economy has more to do with competitiveness.  Liveability is less about market share – whether Hamburg has a bigger port than Rotterdam, whether the financial sector in London is bigger than New York’s – than about the attachment of people and firms to a particular territory.  Being liveable is a competitive advantage insofar as firms want to be in the places where they people they want to employ want to live. (3) Some parts of cities support liveability, others, competitiveness: this has implications for regulated land uses, infrastructure investment, public services.  Competitiveness fits better with a macro-sectoral logic; liveability calls for more holistic, cross-sectoral interventions.

How to go forward

An urban strategy at national level must cover both leading and lagging cities, not for reasons of political equity, but because it makes economic sense. This is about making best use of both exogenous opportunities and endogenous assets. The problem for policy is that these two strands are too often separated, whereas the strength of urban economies comes from how they are intertwined. Without an adequate strategy for endogenous development, cities are overly dependent on exogenous variables – including monetary and fiscal policy.

We know how cities fit into economic policy today:

  • Spill-over costs and benefits are ignored in a logic based on administrative boundaries;
  • Issues are defined as problems, making them unattractive politically;
  • Agendas are narrowly defined to a couple of problems;
  • Silo approaches fragment responses.

We know what an urban logic in economic policy would look like:

  • Cities are absorbed into functional economic areas, blurring administrative boundaries;
  • Area-based, holistic frameworks enable cross-sectoral, integrated interventions;
  • Place-based (i.e., immovable) assets are created, upgraded, valorized;
  • National and local priorities and budgets are aligned and synchronized across budget cycles and the time needed for capital projects;
  • Indicators and outcomes focus on a mix of qualitative and quantitative objectives, and are projected through effective communications.

Scotland’s cities help define and shape Scotland’s ties to and integration in the European, Atlantic and global economies.  Scotland’s great assets in the urban game are Glasgow and Edinburgh, forming a conurbation between the Atlantic and the North Sea. No two cities in Europe of their size and stature so near one another are so different, so complementary and so inter-dependent. Strategic spatial planning is essential to managing space better: what goes where makes a huge difference. This analytical framework will not tell you which projects in transport or energy will do the most good; it will not set out a sequence of projects, nor explain their dynamic effects. Nor can it tell you what kind of governance framework will help generate partnerships and compromises so necessary to success. What it can do is set out the objectives, which go beyond simple calculations of the cost of roads paved or of jobs filled. These should be to lift Scotland’s productivity above the UK average, endow Scotland’s economy with assets for 21st century growth, and provide its people, and especially its young people, with hopes for their future.

Much could happen quickly. Strategy calls for:

  • regulatory reform to deliver strategic infrastructure;
  • internal government regulations and personnel practices, realigned to promote innovation and leadership in the public sector, and to deliver cross-sectoral programmes;
  • innovation and bold, transformational projects;
  • targets for investment which promise to lift productivity and reduce negative externalities.

Consider the example of “Le Grand Paris”, to build a ring of fast, automated trains circulating around Paris and connecting to radial routes being improved between the suburbs and the centre (200 kms of new lines, 69 new stations). Based on the success of past investments, a bigger, better integrated labour market (larger than London’s) will more than pay for the cost of the infrastructure by lifting individual incomes and corporate profits.  This example also shows how difficult but important it is to tie these three things together: what should be done, how should it be resourced, and who should lead.  In the final analysis nothing much  happens without a sense of urgency. A recovery that is both socially and environmentally sustainable will not happen automatically; it is a policy choice.

– Josepf Konvitz