Economics 5/7/2010: Future of our cities

This is an unedited version of my current article in Business & Finance Magazine:

Global recovery, no matter how tenuous, is poised to present a new set of challenges and opportunities for smaller open economies, such as Ireland. These challenges relate to the changing nature of economic growth and competition worldwide.

Starting with the early 2000s, there is a new ‘brain-and-creativity’ economic growth paradigm that is emerging across more dynamic globally-integrated economies. In this new paradigm, cities and larger urban-centred regions are increasingly competing for highly mobile and diversified human capital, and creativity and innovation capabilities associated with it. This trend represents a far wider change than the much-talked-about ‘knowledge’ economy. In fact, according to our research at the IBM’s Institute for Business Value, it represents a re-orientation of the core sources for future growth away from the traditional ‘bricks-and-mortar’ economy based on physical capital (e.g. buildings and equipment) and financial capital, and toward human capital or talent-intensive growth.

Last month, Dublin-based IBM’s Global Centre for Economic Development that forms a part of the Institute for Business Value (IBV) published a study titled Smarter Cities for Smarter Growth: How cities can optimise their systems for the talent-based economy. Co-authored by Susanne Dirks, Dr Mary Keeling and myself, the study looked at the changing nature of competitiveness that cities and larger urban areas around the world will be facing over the next 10-20 years.

It offers important policy and investment priorities insights not only for world’s leading cities, such as New York, London, Tokyo, Shanghai, but also for smaller open economies, such as Ireland.

The core insight from the study is that creativity, knowledge and skills, together with technological innovation are becoming the key drivers of economic growth and activity.

For example, the share of overall economic value added attributable to creativity, knowledge and skills-intensive sectors of the economy (e.g. internationally traded and other higher value-added services, design and innovation-centred manufacturing, etc) is expected to increase by 8.2% over the current decade.

Cities are natural hubs for this growth for two reasons.

Globally, leading cities have GDP shares of their national economies that are up to 5 times higher than their share of national populations. Top 100 cities worldwide accounted for roughly 25% of the world’s GDP in 2005. By 2008 this had increased to over 30%. As charts 1 and 2 in my earlier post (here) on cities weights in domestic economies illustrate, Dublin clearly falls within this category of cities that represent a leadership flank in their respective domestic economies.

Second, cities, and greater urban areas, are at the forefront of global competition in higher value-added, and creativity and knowledge-intensive sectors. Between 1999 and 2007, skills and knowledge intensities of some 350 urban economies comprising OECD member states have increased dramatically.

In 1999 average urban area in the OECD had 25% of its population holding third level degrees or higher. By 2007 this number increased to 29%. Over the same time, the degree of skills and knowledge utilization in urban economies also increased. Modern services – a sector that is at the forefront of the new economic paradigm – saw its share of overall employment rise from 34% to 38% in 8 years to 2007. With these changes, income per capita rose from the average USD27,400 to USD36,050, expressed in constant dollar terms.

A similar dynamic took place in Ireland, where Greater Dublin region, inclusive of commuter belt, saw its proportion of the workforce with tertiary or higher education rise from 25% to 39% between 1999 and 2007. Contrary to most of the commentary on Irish development model, the Greater Dublin area has moved from being average in terms of skills presence in the OECD at the cusp of the new Millennium, to above average by 2007. Over this period, the share of modern services in total regional output rose from 34% to 38% in Dublin, while per capita income rose from USD31,900 to USD46,300.

Our data analysis clearly shows that urban income per capita has been strongly positively correlated with rising importance of skills, innovation and knowledge in the economy. Our forecasts also indicate that this trend is going to strengthen over time. For example, there is a rapid change in the relationship between technological innovation and talent contribution to productivity that is emerging across all industries. Instead of technological innovation serving as a strong substitute for labour, it is becoming a supportive enabler for people and their skills. This relationship is forecast to strengthen by over 70% by the end of this decade in modern sectors and is set to become positive for the first time in over 40 years in traditional sectors as well.

For cities this transformation means new model of development and growth – a model focused primarily on the need to build a diversified, highly skilled and creative workforce capable of developing and absorbing technological, managerial and creative innovation.

Change in demand for skills in EU27
Net increases in excess of demographic factors, millions of jobs
Source: CDEFOP, 2009 and 2010, and IBV analysis

Forecasts show that demand for talent, creativity and skills is expected to accelerate dramatically over the next 10-20 years (Chart above). In the EU27 alone, growth in demand for higher skilled workers is expected to double from 10.1 million in 2007 to 20.1 million in 2020, according to the European Commission. At the same time, demand for low skilled workers is expected to contract by 28.3 million by 2020 having fallen by 8.5 million in 2007.

While pressures of rising demand for skills will be acute, the supply side – represented by demographics and higher education capacity – is going to be strained to deliver sufficient inflow of new skilled knowledge and creativity-enabled workers. Assuming current demographic trends, demand for international students in the OECD will be expected to rise from 6% of total third level student population in the mid-1990s to 30% by 2020, based on our forecasts.

Cities are increasingly competing for internationally mobile and highly diversified workers of the future. For example, between the 1990s and 2020 net international migration flows of highly skilled workers will more than triple from 29.5 million to 98.6 million, according to our forecasts. Majority of these flows will continue to be attracted to Western European and North American economies. However, in a departure from the previous decade, next ten years will see acceleration in the net demand for highly skilled international migrants from the emerging economies of Asia Pacific, India and Latin America. These developments imply that previously taken for granted inflows of talent to the advanced economies are now wide open to competition.

The entire notion of competitiveness will be reshaped by the new growth paradigm. Our research shows that in the near future cities will have to focus their attention on attracting, retaining, creating and enabling people with diversified and high quality skills and knowledge, capable of generating and absorbing creative and technological innovation.

Highly-skilled individual’s location decisions are directly influenced by the quality of core services provided by the cities. And these decisions, in turn, increasingly influence location of FDI. In 2008, according to data for OECD, 69 percent of companies have identified availability of the high quality human capital as a major determinant of their decision to invest in a specific economy. Urban centres will need to change the nature of their core services away from focusing on standardized services aimed at the homogenized populations, toward services that are more citizen-centric: tailored and individualized, green and lean in line with the demands of the internationally mobile highly-skilled employees.

Our research has identified four core services areas that will need to be prioritized for investment with the greatest expected impact on highly skilled, knowledge, creativity and innovation-enabled workers. These are Government Services and Education, Public Safety, Health and Transport.

Given the constraints on fiscal spending, faced by many Governments around the world, including the Irish Exchequer, such investments will have to deliver optimal gains in quality of life while demanding minimal public outlays. Based on our analysis of the best practices around the world, this can be achieved by deploying advanced technologies to understand, predict and intelligently respond to services systems behaviour and demand.

For example, cities like Singapore, Tokyo, Amsterdam, London and Stockholm have been able to successfully leverage real-world data generated by their public transport providers. This allowed not only to optimize the existent city services, but to simultaneously increase both capacity and demand for public transport. Several cities worldwide are currently building new modes of public transport that attempt to seamlessly integrate the concept of mass public transit across various modes of transport while delivering extensive customization of routes and modes.

In Singapore, creation of a seamless, smarter national transport fare system has resulted in $40 million annual savings from reduced congestion on expressways alone, as well as gains in workforce productivity equivalent to more than 5 million man-hours. Singapore’s Land Transport Authority can now optimize routes, schedules and fares based on the insights from the 20 million trip-related transactions generated each day. As the result, usage of mass public transport increased by 14.4% between 1996 and 2007.

Congestion negatively impacts on the quality of life in a city by decreasing personal and business productivity. It also imposes negative externalities on the overall quality of life. The cost of congestion ranges between 1.8% of GDP in Kuala Lumpar to a massive 4.1% in Dublin.

Smarter transport systems can integrate traffic, weather, business and traveller information to provide real time services to users to create more efficient and user-friendly services. A number of cities in Japan are now moving to new models of delivering public transport that aim to bring greater degree of routes flexibility, on-demand capacity and more organic links between daily demand changes, external factors, such as weather and seasonality of demand, and the supply of public transport.

Of course, public transport is just one area of services where the Greater Dublin area and other cities in Ireland will be facing significant competition. Health, education, government services and public safety are also important determinants of the quality of life in the city and thus city’s ability to attract, create, retain and enable the workforce of the future. And we have quite a distance to travel in these terms. If in 2007 Dublin ranked 20^th in the world in terms of overall quality of living the city delivers to its citizens, this year it has slipped to the 26^th place. These rankings do not reflect even poorer quality of services delivered in the commuter belt of the Greater Dublin area.

The core conclusion that emerged from our report is that cities that adopt a pro-active approach to investment in citizen-centric services will position themselves to thrive in the new age of human capital-intensive growth. Those that continue to invest in traditional infrastructure designed for mass population are set to struggle.