Forces of Attraction

AT FIRST GLANCE, the geographical location of America’s innovation hubs appears arbitrary and puzzling. In many traditional industries, location is tied to natural resources. The U.S. oil industry clusters in Texas, Alaska, and Louisiana because that’s where large oil reserves are. The wine industry is mostly concentrated in California because of good weather and favorable soil. The lobster industry is in Maine because lobsters don’t live in Kansas. In these cases, clustering is neither surprising nor particularly revealing. The geographical concentration of innovative industries, however, appears much harder to explain. There are no obvious natural advantages to explain why innovative industries are located where they are. After all, there is no silicon in Silicon Valley. In the past, firms established themselves near their customers because transportation costs were high. For example, during the industrial revolution, London companies could deliver their products at a cost advantage because most of their customers were in London. But today transportation costs are low, especially in high-tech industries. In the case of IT, they are essentially zero, since you can ship software code instantly and cheaply through any modem. If Google moved to Visalia—or to Tibet, for that matter—no user would ever notice.

 Thinking a little more deeply about the location question makes it even more baffling. Companies appear to locate in absolutely the worst places: they pick very expensive areas—the Bostons, San Franciscos, and New Yorks of the world. With sky-high wages and office rents, these are among the costliest places in America to operate a business. We would expect these cities to be unattractive for firms, especially those that compete globally.

Why do innovative firms cluster near each other in these expensive locations when they could be anywhere? What is so special about cities like San Jose? If you actually visit San Jose, you will not find it very different from other cities. Visual clues as to why salaries should be so high are hard to find. In fact, there is no “there” there. Most of the iconic Silicon Valley companies are located in anonymous office buildings or office parks. Like many other metropolitan areas in the United States, the San Jose metro area is made up mostly of parking lots, corporate campuses, and a few sterile-looking glass towers surrounded by an ocean of single-family homes. There is nothing distinctive about its urban form; freeways crisscross its vast expanse, and people drive everywhere. The city has been trying to redevelop its downtown and turn it into a more pedestrian-friendly destination, but it is an uphill battle. Among the tallest buildings, the Adobe tower stands out because it is visible from the 101 freeway. Situated just 3 miles southwest is eBay’s sprawling campus. Just a short drive away, you find Intel, Cisco, Yahoo, and countless less prominent high-tech corporations with arcane names that sound like prescription drugs—Progent, Xilinx, and Sanmina. To hire a skilled worker with a college education, eBay and Adobe must pay that worker $87,033 a year in San Jose, but a similar company based in Merced would need to pay only $62,411. In fact, if eBay and Adobe moved to Merced, they would end up paying less to hire a college graduate than what they are paying now to hire a high school graduate, which is $68,009. This seems truly puzzling.8

 If San Francisco Does Not Like Walmart, Why Does Walmart Like San Francisco?

The story of Walmart sheds some light on the matter. The company name is synonymous with low prices, so it is perhaps not surprising that ever since Sam Walton founded the company fifty years ago, Walmart has been based in Bentonville, Arkansas. Bentonville is a small town where running a business is remarkably affordable, embodying the company’s frugal corporate culture. Office space in Bentonville is among the cheapest in the nation, and the cost of living and average wages are also low. This is where Walmart’s CEO, all its top managers, and all the headquarters staff live. Bentonville is clearly the perfect fit for Walmart’s cost-cutting ethos.

But when Walmart set out to enter e-commerce twelve years ago, it did not choose to locate its Internet division, Walmart.com, in Bentonville. Nor did it choose Bangalore, where costs are even lower. Instead it chose Brisbane, California, just 7 miles from downtown San Francisco, one of the most expensive labor markets in the world. (It also happens to be an area that is politically hostile to Walmart, which makes it hard for the company to open many local stores.) What sense does this make, given how aggressive Walmart is in keeping the costs of every division under control? Has Walmart betrayed its own business model?9

 No. As it turns out, in the world of innovation, productivity and creativity can outweigh labor and real estate costs. Walmart saw three important competitive advantages to a San Francisco location, which economists refer to collectively as the forces of agglomeration: thick labor markets (that is, places where there is a good choice of skilled workers trained in a specific field), the presence of specialized service providers, and, most important, knowledge spillovers. Although not much discussed, these forces ultimately determine the location of innovative workers and companies and therefore shape the future of entire communities. Understanding these forces is critical, because they are the ones responsible for the Great Divergence of the past thirty years. Understanding them is also important because they hold the key to making struggling cities more economically successful. As we’ll see, they explain why eBay and Adobe find it profitable to remain in San Jose, and the seemingly illogical location decisions of many other companies, from Pfizer to IBM. These forces are growing stronger, and they will affect each and every American worker in the years to come.