W O R KI N G PA P E R N O . 6
Will Cities Continue
Driving Economic Growth?
Shahid Yusuf
WORKING PAPER NO. 6
Will Cities Continue Driving Economic Growth? Shahid Yusuf © 2014 The Growth Dialogue 2201 G Street NW Washington, DC 20052 Telephone: (202) 994‐8122 Internet: www.growthdialogue.org E‐mail: [email protected] All rights reserved 1 2 3 4 15 14 13 12 The Growth Dialogue is sponsored by the following organizations: Canadian International Development Agency (CIDA) UK Department for International Development (DFID) Korea Development Institute (KDI) Government of Sweden The findings, interpretations, and conclusions expressed herein do not necessarily reflect the views of the sponsoring organizations or the governments they represent. The sponsoring organizations do not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of the sponsoring organizations concerning the legal status of any territory or the endorsement or acceptance of such boundaries. All queries on rights and licenses, including subsidiary rights, should be addressed to The Growth Dialogue, 2201 G Street NW, Washington, DC 20052 USA; phone: (202) 994‐8122; e‐mail: [email protected]; fax: (202) 994‐8289. Cover design: Michael Alwan Contents About the Author ............................................................................................................. v Abstract .......................................................................................................................... vii 1. The Industrial City Ascendant ................................................................................. 10 2. The New Economy and Urban Development ........................................................ 13 3. How Cities Could Drive Growth ............................................................................. 18 4. Concluding Observations ......................................................................................... 26 References ....................................................................................................................... 26 Will Cities Continue Driving Economic Growth?
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About the Author Shahid Yusuf is Chief Economist of the Growth Dialogue. Dr. Yusuf brings many decades of economic development experience to the Dialogue, having been intensively involved with the growth policies of many of the most successful East Asian economies during key periods of their histories. Dr. Yusuf has written extensively on development issues, with a special focus on East Asia and has also published widely in various academic journals. He has authored or edited 26 books on industrial and urban development, innovation systems, and tertiary education. Among his five most recent books are: Some Small Countries Do It Better (co‐authored with Kaoru Nabeshima, 2012); Frontiers in Development Policy (co‐authored with Raj Nallari and others, 2011); Development Economics through the Decades (2009); Tiger Economies under Threat (co‐authored with Kaoru Nabeshima, 2009); Two Dragonheads: Contrasting Development Paths for Beijing and Shanghai (co‐authored with Kaoru Nabeshima, 2010); Changing the Industrial Geography in Asia: The Impact of China and India (co‐authored with Kaoru Nabeshima, 2010); and China Urbanizes (co‐edited with Tony Saich, 2008). Dr. Yusuf holds a PhD in Economics from Harvard University and a BA in Economics from Cambridge University. He joined the World Bank in 1974 and during his tenure, Dr. Yusuf was the team leader for the World Bank‐Japan project on East Asia’s Future Economy from 2000–09. He was the Director of the World Development Report 1999/2000: Entering the 21st Century. Prior to that, he was Economic Adviser to the Senior Vice President and Chief Economist (1997–
98), Lead Economist for the East Africa Department (1995–97), and Lead Economist for the China and Mongolia Department (1989–1993). Dr. Yusuf lives in Washington, DC and consults with the World Bank and with other organizations. Will Cities Continue Driving Economic Growth?
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Abstract Archaeological evidence suggests that cities as recognizable entities arose in the Fertile Crescent between the Tigris and Euphrates rivers around 3,200 BCE—
some 10,000 years after the domestication of rye (and other grains later), and 5,000 years after the emergence of village communities that prioritized intensive agriculture over hunting and gathering. Shortly thereafter, or perhaps simultaneously, cities appeared in China and in Mesoamerica. The spread of intensive agriculture enabled cities to multiply and flourish. Ideas and innovations that germinated in cities served as the nuclei of civilization and, more recently, in the making of modern societies. Cities may have been the drivers of change in earlier times. However, as recently as 1800, only 3 percent of the world’s population was urban. A century later, the urban share was still only 14 percent. Not until 2012 did urban dwellers—more than 3.6 billion in total—outnumber their rural counterparts (52 percent). The trend line points toward 6.3 billion urban inhabitants out of a projected total world population of 9.3 billion in 2050. People born in the 1920s have witnessed, in less than a blink of the historical eye, an extraordinary elongation of life spans, a staggering increase in demographic numbers, and a triumph of the city over the countryside. As we look toward the future, we can anticipate equally significant—and surprising—changes. Will Cities Continue Driving Economic Growth?
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Will Cities Continue Driving Economic Growth1 Shahid Yusuf Archaeological evidence suggests that cities as recognizable entities took root in the Fertile Crescent between the Tigris and Euphrates rivers, a region known as Sumer, around 3,200 BCE. This was some 10,000 years after the domestication first of rye (Pringle 1998) and later of emmer, einkorn, barley, and corn; and 5,000 years after the emergence of village communities that gave primacy to intensive agriculture over hunting and gathering.2 Shortly thereafter, or perhaps simultaneously, cities made an appearance in China and in Mesoamerica as local communities began exploiting the potential of settled agriculture based on cereals (including millet) as well as flax, peas, lentils, beans, squash, and later rice (in China). The spread of intensive agriculture enabled cities to multiply and flourish and to become key points of reference in the historical record. Ideas and innovations, which germinated in cities, served as the nuclei of civilization, and as we come closer to the present, the making of modern societies. History resounds with the names of cities—we may misplace the names of kings, battles, and treaties but not those of the cities that anchored civilizations, empires, and eras. Cities may have been the drivers of change and the points of light3 in earlier times. However, the overwhelming majority of humankind remained caught up in rural pursuits until virtually a stone’s throw from the present day. As recently as 1800, a mere 3 percent of the world’s population was classified as urban and a century later, the urban share was still only 14 percent. Fast forward to 2012, and for the first time, urban dwellers—more than 3.6 billion in total—outnumbered their rural counterparts (52 percent), with the trend line pointing toward 6.3 billion urban inhabitants out of a projected total world population of 9.6 billion in 2050 (United Nations 2013). Recall that the world population in 1800 was approaching 1 billion and it was less than a century ago, in 1927, that it crossed the 2 billion mark. In demographic terms and with respect to urbanization, those born in the 1920s have witnessed something unprecedented: in less than a blink In 1984, Allen Kelley and Jeffrey Williamson co‐authored a volume entitled What Drives Third World City Growth that ascribed the growth of cities to government policies, including pricing policies, global developments, and urban‐centered industrialization. 2 Agriculture may have arisen in what is now the Ilam province of Iran some 9,800 years ago, with proto‐agriculturists that domesticated barley, lentils, peas, and then emmer wheat (Riehl, Zeidi, and Conard 2013). 3 Now satellite mapping actually uses light pixels to gauge urbanization and economic growth (Henderson and others 2012). 1
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of the historical eye, they have experienced an extraordinary elongation of life spans,4 a staggering increase in demographic numbers, and a triumph of the city5—economically and in every other respect—over the countryside.6 Urban centers are responsible for more than 80 percent of economic activity (90 percent in the United States) and urban dwellers have far greater access to drinking water, sanitation, and health and education services (World Bank 2013). As we look toward the future, we can anticipate equally significant—and surprising—
changes. The balance of this paper is divided into four sections. Section 1 briefly explains why urbanization began accelerating two centuries ago in Western Europe and discusses its spread to the developing world up to the present day. Section 2 examines developments that have been gathering momentum during the past three decades that could crucially affect the pace and geography of urbanization, the design and physical infrastructure of cities, and the composition of economic activities. Section 3 discusses the implications for urban strategy and more broadly for economic growth, employment creation, and income distribution. Section 4 concludes. 1. The Industrial City Ascendant Two revolutions account for the remarkable acceleration in the tempo of urbanization and the salience of cities as drivers of growth: (i) a gradual, dispersed, continuing, and still diffusing agricultural revolution that commenced many centuries ago; and (ii) a more rapid industrial revolution that began acquiring traction in the early nineteenth century. The Agricultural Revolution
The agricultural revolution was a slow process at first. Through trial and error spanning decades if not centuries, farmers raised yields in tiny increments through selective breeding of plant varietals, progressive refinement of cultivation techniques, and a diversification of crops produced courtesy of a creeping agricultural globalization. Modern science led to a quickening of the agricultural revolution7 and by increasing the productivity of land and of labor, began generating ever‐larger agricultural surpluses. These, in conjunction with From about 30 years in 1900 to approximately 67 years in 2012. (http://en.wikipedia.org/wiki/ Life_expectancy). 5 Celebrated in Edward Glaeser’s 2011 book, Triumph of the City. 6 Cohen (2006) notes that in 1950, one third of the world’s population was urban based—a total of 733 million people. In 60 years, it has grown almost fivefold. 7 Evenson and Gollin (2002) assess the gains conferred by the green revolution across a number of crop varieties between 1960 and 2000. 4
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Shahid Yusuf developments in surface transport, facilitated the growth of urban centers.8 Labor released from farming streamed toward cities, with Western European countries leading followed by other industrializing regions and, after a long lag, by newly independent developing nations. Although crop yields in the advanced countries appear to be approaching a high water mark and agriculture now employs less than 5 percent of the labor force, this revolution has far from run its course. Most developing countries are making slow progress toward the technological frontier that continues to expand outwards and, depending upon the region,9 between 30 and 65 percent of the population is rural based. In other words, technological catching‐up in agriculture will render tens of millions of agricultural workers redundant, potentially fuelling decades of rural‐to‐urban migration in Asia, Africa, and parts of Latin America. The industrial revolution that harnessed the energy locked in fossil fuels was much quicker off the mark (Wrigley 2011).10 The century extending from the mid‐
1800s saw the industrialization of much of Europe, North America, and Japan and the emergence of pockets of industry in a number of Asian and Latin American countries. By the 1970s, industrialization had peaked in the advanced countries and has since been in retreat. Statistical analysis reveals a tight interlacing of urbanization with industrial development (Henderson 2010; Kim 2012). There is also evidence showing that the agricultural and industrial revolutions reinforced each other: industry greatly enlarged the demand for certain agricultural products, while industrial chemicals, fertilizers, farm machinery, and transport equipment enhanced agricultural land and labor productivity. Causation is not easy to establish; however, it can be argued plausibly that most of the scientific advances and innovations responsible for the revolutions were nurtured in cities. In turn, entrepreneurs and skilled artisans (Meisenzahl and Mokyr 2011) transformed innovations into manufacturing establishments increasingly located in cities, once the widening use of fossil fuels ended the reliance on rural sources of waterpower and wood. As urban industry expanded, it gave rise to demand for labor that in turn was fed by migrants from the rural sector made redundant by mechanization and other advances in agricultural technology. This virtuous spiral was responsible for the structural 8 Herrendorf and others (2013: 78) maintain, “The growth rate of labor in the non‐agricultural sector is completely determined by the exogenous growth rate of labor productivity in the modern agricultural sector. Countries that use modern technology in agriculture but have low productivity in it will have to devote more labor to agriculture. This leads to less labor and capital in non‐
agriculture, and hence to less aggregate output (accounting) for a large part of the cross‐country differences in aggregate output.” Gollin and others (2002) also emphasize the contribution of agricultural productivity to structural transformation. 9 Gollin and others (2012), after adjusting the data for household consumption of food, hours worked, and human capital inputs, estimate that value added in agriculture is one half that in the non‐agricultural sector. 10 Pomeranz (2001) ascribes the success of the industrial revolution in England and Europe to the easy access to large deposits of coal. Will Cities Continue Driving Economic Growth?
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transformation of advanced economies: the urban sphere decisively and irreversibly eclipsed the rural, the latter being reduced to a minor appendage of a predominantly urban economic system. Starting in the 1960s, a succession of developing countries embraced the Western model of urban industrialization and began building (import substituting) manufacturing capacity behind tariff barriers. Their initial focus was on light industry, although more ambitious countries (e.g., China, India, the Republic of Korea, and Brazil) quickly began pursuing backward linkages to machinery, chemical, and metallurgical industries. A loosening of the constraints on development imposed by colonial rule and the enthusiastic embrace of long‐
delayed industrialization triggered urbanization, but it soon acquired a momentum of its own. In some East Asian economies such as Korea and Taiwan, China, the pull exerted by rapid industrialization was stronger than the forces pushing labor out of agriculture. However, in most other developing countries, industrialization was a weak force creating relatively few jobs. The growth of cities soon became detached from the process of industrialization—a break from the pattern observed over the preceding century. Exploding Cities
Three factors contributed to the growth of cities. One was the surge in populations following the widespread dissemination of cheap and effective medications that dramatically reduced mortality; these complemented advances in water and sanitation services. Rural overcrowding generated pressures that induced an increasingly underemployed workforce to look beyond the confines of the traditional rural environment. Second, the promise of better paying jobs11 and “bright lights” pulled the young and the adventurous to cities. Once having made the leap and incurred the adjustment costs (Herrendorf and others 2013), they stayed whether or not employment in factories materialized or not. For the vast majority, jobs in industry proved elusive and migrants were increasingly absorbed by other activities that proved far more expansive than manufacturing, which brings us to the third factor. With urbanization decoupled from industry in developing countries, the economy of cities is now largely reliant on services, formal and informal, public and other, with nontradable services dominating the potentially tradable ones. In 2010, the share of manufacturing in GDP in South Asia, Sub‐
Saharan Africa, the Middle East, and Latin America was 17 percent or less. Only East Asia maintained a 29 percent of GDP share, comparable to industrialized countries in their twentieth‐century heyday.12 The share of the workforce employed by industry in the larger cities in developing countries is generally 10 percent or less. It is 3 percent in Lagos, 5 percent in Kinshasa, and 15 percent in The so‐called Harris‐Todaro gradient based on expected earnings drew migrants to cities (Harris and Todaro 1970). 12 This average is biased upwards by the high share of manufacturing in China’s GDP—32 percent. 11
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Shahid Yusuf Karachi. The absence or smallness of a leading sector producing tradables and the paucity of “decent” jobs that could help grow the urban middle class poses one of the biggest challenges for cities. 2. The New Economy and Urban Development The empirical growth literature and development policies continue to give primacy to industrialization (UNIDO 2009) as the principal source of productivity gains, innovation, exports, and decent jobs. And it is widely assumed that industrialization will be urban focused, with some fringe activities in periurban areas as in China. This persistent conviction is grounded in the experience of the advanced countries and the more recent, meteoric development of several resource poor East Asian economies. The conviction is reinforced by two additional assumptions. First, there is a vast untapped market for light manufactures and white goods in low‐ and lower‐middle‐income countries to support the spread of industrialization throughout Asia and Africa. Second, the “unbundling” of production process—which led to the fragmentation of manufacturing activities and the dispersion of labor‐intensive, relatively low‐
skilled, technologically codified activities to industrializing East Asian economies with abundant human resources—will continue and enter a new phase (Baldwin 2012). This view holds that industrial fragmentation and intensive trade in intermediates as well as final products orchestrated by global value chains (GVCs) is here to stay (Accetturo and others 2012). Furthermore, many labor‐
intensive industrial activities currently concentrated in East Asia will transfer to South Asia, Africa, and Central America. The widening of the value chain and a further dispersion of production activities—a replication of the East Asian “flying geese” model13—will, it is believed, bring export‐led growth to “late starters” that are primed to exploit the opportunities presented by GVCs—
assuming that these continue to unbundle and fragment.14 Once such a growth spiral is firmly in place, cities will acquire the industrial core with its multiplicity of linkages that can serve as the engine of job creation and a fairly equal distribution of income, as was the case in East Asia more than two decades ago. Proposed in the 1930s by Kaname Akamatsu (http://www.grips.ac.jp/forum/module/prsp/ FGeese.htm) and elaborated by countless others thereafter. 14 The readiness to engage in export‐led industrialization using GVCs as points of entry depends on the emerging ecosystem of firms—new and established; the business environment hospitable to FDI, logistics capabilities; and an open trade regime that facilitates imports even as it incentivizes exports (see Cattaneo and others 2013). How much more fragmenting is in store remains a moot point. Intermediates already account for 60 percent of trade and some observers see GVCs heading toward a process of consolidation (see Draper 2012; Fally 2012; Lamy 2013). 13
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Another Industrial Revolution
While compelling, this model of urban development is of diminishing relevance for resource‐rich late starters and is being rendered obsolete by a third industrial revolution. The notable characteristic of cities in late starters, especially resource‐
rich countries, is that they are “consumer cities” with a dense concentration of mainly nontradable services and dependent on the imports of manufactures. Some cities’ economies may be supported by rents from the export of minerals or cash crops,15 by remittances, or by official development assistance. Resource rents finance imports, create demand for services, and drive up wages.16 In too many instances, they also encourage governments to buy political peace by expanding employment in the public sector, a practice that further bids up wages, absorbs some of the most talented workers, and inculcates preferences for service sector jobs (preferably white collar) over employment in manufacturing. Consumer cities with the weakest industrial prospects are increasingly the norm in resource‐rich Middle Eastern countries. However, the anti‐industrial bias is apparent in resource‐endowed African countries as well. Consumer cities reliant on services and small‐scale industrial activities (often of an artisanal nature and serving the local market) are becoming the norm in less resource–abundant developing countries as well. These cities are skipping the industrial stage and their labor market entrants are moving directly into service occupations. Even more striking is the trend in the industrialized countries toward a preponderance of services, including services affiliated with manufacturing activities and the decline of industry in cities. Services are increasing their share of world trade and already account for a third of the total value (and this may partially account for the rising share of tradable services in advanced countries such as the United States) (Francois and Hoekman 2010). In fact, the future of urbanization, of urban development, urban jobs, urban income distribution, and the urban middle class began changing slowly in the 1980s and 1990s; the change has suddenly accelerated during the past decade.17 A technological revolution appears to be at the root of the change we are witnessing although other factors have undoubtedly contributed. Digital, electronic, information, engineering, and materials technologies are transforming the entire manufacturing and distribution value chain.18 They are also dramatically increasing the diversity and electronic distribution of services, even Henderson, Roberts, and Storeygard (2013) find that the impact of resource price shocks on urbanization is weak and that rents might be a small part of the story. 16 Jedwab (2012) links urbanization in Ghana to booms in cocoa demand and prices, with city formation following the westward movement of cocoa farming. Gollin, Jedwab, and Vollrath (2013) model the emergence of consumer cities in Africa aided by resource rents. 17 Sachs and Kotlikoff (2012: 5) warn, “Brainier machines pose not just an economic threat to the welfare of today’s unskilled workers. They also pose a threat to tomorrow’s workers whether unskilled or skilled.” 18 One manifestation with far‐reaching consequences for employment in bricks and mortar retailing is the rise of business‐to‐consumer (B2C) and business‐to‐business (B2B) transactions. 15
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Shahid Yusuf as they reduce their labor intensity. In just a few years, information and communication technology (ICT)19 has changed the mode and density of urban interaction.20 Furthermore, digital and transport technologies are beginning to make cities “smarter” through the cost‐effective delivery of urban services, energy conservation, better environmental quality, and the increasing connectedness of people and of things.21 The Digital Urban Economy
For cities in developing countries, the most consequential development will likely be the much smaller share of manufacturing in GDP at any level of income. This will occur because of (i) increasing productivity and the declining relative prices of manufactures; (ii) the dominance of services from the very outset; and (iii) the impact of digital technologies, computerization, and artificial intelligence/neural networks on the production and distribution of services (Brynjolfsson and Saunders 2009). These three developments, which are spreading from advanced to lower‐income economies, have implications for the composition of urban economic activities, the pace of productivity growth, and the number and skill level of urban jobs. Nontradable services, both formal and informal, will contribute less to the growth of per capita GDP because they incorporate few of the advances in ICT.22 Sectoral labor elasticities with respect to GDP growth illuminate the structural changes that are afoot and reinforce the point made above on the contribution of industry to employment (Kapsos 2005). Globally, for the 1991–
2003 period, elasticities for agriculture, industry, and services were 0.24, 0.21, and 0.61, respectively. In other words, for every 1 percent increase in GDP, employment in industry (for example) rose by 0.21 percent. However, elasticities were lower in comparator Eastern and Central European countries and in East Asia. In the former, the industry and services elasiticities were 0.09 and 0.47 respectively; in East Asia the labor elasticity of industry was just 0.06 although for services it was 0.5. Although the elasticity of services exceeds that of industry, 19 By generating mountains of data, the devices for storing it in the cloud and the techniques for analyzing it, ICT and computerization is transforming urban living. 20 There are downsides to the revolution in communications however, some believe that it can help counteract the loneliness and isolation that people can experience in a megacity by enabling individuals to connect and to better navigate within the urban space. 21 The Internet of Things looks toward “A world where physical objects are seamlessly integrated into the information network, and where the physical objects can become active participants in business processes. Services are available to interact with these ‘smart objects’ over the Internet, query and change their state and any information associated with them, taking into account security and privacy issues.” (See http://en.wikipedia.org/wiki/Internet_of_Things; http://www.mckinsey.com/insights/high_tech_telecoms_internet/the_internet_of_things.) 22 The role of ICT capital in enhancing productivity and growth is reviewed by Pilat and others (2002). Vu (2004) points out that the contribution is dependent upon the education of the workforce, the openness of the economy, the efficacy of market institutions and fluency in the English language. Will Cities Continue Driving Economic Growth?
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the scope for labor‐saving productivity gains in tradable services, education, and health is substantial. Moreover, retail, wholesale, warehousing, and logistical services that employ millions of urban workers in developing countries can potentially trim a large part of their workforces by adopting digital technologies. Retail productivity in developing and industrializing countries—including East Asian ones—is between 10 percent and 40 percent of that in the United States. Digital and new manufacturing technologies,23 mass customization of certain consumer products (e.g., garments), the growing preference for small lot production, and the transaction costs of managing sprawling global production networks are threatening not just the consolidation of value chains but also the insourcing of items the manufacture of which was dispersed across East and Southeast Asia. Whether a major reflux of manufacturing back to the advanced countries is likely remains to be seen. However, a tightening of GVCs is likely and digital technologies are reducing labor intensities and increasing the skill quotient of both industrial and services activities. The upshot of this for cities in developing countries, particularly late starters, could be serious indeed. Escaping the consumer city mode could become even more difficult, particularly if promoting export oriented manufacturing and tradable services is constrained by weakening overseas demand; shrinking labor coefficients for well‐paid jobs in tradable sectors squeeze employment opportunities, even for college graduates; and the bulk of employment is channeled into public and personal services, security, hospitality, catering, and informal occupations. Substantial resource rents or transfers from external sources can help sustain the tempo of urban demand. However, in the absence of these flows, cities with small tradable sectors and few exports will struggle to achieve economic growth and create good, formal‐sector jobs.24 Dark Side of the Third Revolution
The technologies undergirding the third industrial revolution have surely contributed to prosperity. By accelerating growth, particularly in East Asia, they have hastened the growth and urbanization of resource‐rich nations. But there are downsides to these technologies that are beginning now becoming apparent. The mechanization of agriculture, an increasing use of fertilizer, and the gains in yield made possible by biotechnology have drastically reduced the numbers that can be gainfully employed in farming. It now seems that manufacturing employment is declining in the advanced countries and is unlikely to ever comprise more than a small fraction of the workforce in Additive or 3D manufacturing, while still in its infancy, has begun attracting widespread attention because it could change the way many items are produced and the volume of each production run. (See http://www.technologyreview.com/featuredstory/513716/additive‐manufacturing/.) 24 Haussman (2013) indicates why the informal economy disassociated from production networks can remain stuck in a low‐level trap. Rodrik (2013) discusses the implications of slow structural change for growth. 23
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Shahid Yusuf developing countries. These two key sectors, which once encompassed the lion’s share of economic activity, will probably account for no more than a third of GDP in developing economies25 and possibly 40 percent of the workforce—
assuming conservatively that the release of labor from agriculture is a gradual process because of modest rates of investment and technological absorption.26 If so, cities will need to accommodate not only the majority of the population in any country—rich or poor—but also find ways for them to earn a decent living. In addition to compressing labor coefficients in all sectors, technological change (and globalization) during the past three decades has favored capital over labor. Technology has been skill and IT capital biased. Owners of capital and workers with high‐level analytic, managerial, and technical skills have done exceedingly well, while others lower down the food chain have experienced a decline in their share of the income pie. There are exceptions, but throughout the urban world, income distributions are becoming highly skewed. Middle classes are losing ground in the advanced countries and nascent middle classes in the developing countries are confronting stronger headwinds. Although poverty continues trending downwards27 and life expectancies are inching higher, urban income polarization28 and joblessness, especially of the youth, could increase (UN‐Habitat 2010). The great recession of 2008–09 and its lingering aftermath offer a foretaste of the kind of challenges that lie ahead. With the world’s urban population projected to increase by 70 million annually over the coming decades and with 90 percent of the growth in developing countries, job and infrastructure creation are high on the list of priorities. Urban housing and infrastructures are stretched with between 860 million and 1.3 billion people living in slums—between a quarter and a third of the urban population worldwide in 2012 and 70 percent of the African urban population.29 The recession has worsened worldwide unemployment, which reached 197 million in 2012 (with an additional 39 million having withdrawn from the job market); unemployment is projected to rise by another 9 million through 2014 (ILO 2013). Close to 74 million youths are unemployed and their numbers are also on an upward trend. Financing infrastructure and creating jobs In 2010, agriculture and manufacturing together accounted for 39 percent of GDP in low‐income countries and 33 percent in lower‐middle‐income countries. In high‐income countries their combined share was a paltry 17 percent (World Bank 2012). 26 A rapid modernization of agriculture—or shrinkage of farming activities resulting from climate change—could greatly accelerate the exodus from rural areas. 27 Data presented in the Global Monitoring Report (World Bank 2013: 9) shows that worldwide rural and urban poverty declined between 1990 and 2008 from 52.5 percent and 20.5 percent to 29.4 percent and 11.6 percent respectively. In Sub‐Saharan Africa the decline was from 55 percent and 41.5 percent to 47.1 percent and 33.6 percent respectively. 28 See Autor (2010) on polarization trends in jobs and incomes—and the loss of mid‐level and middle‐class jobs of a routine nature—in the United States. 29 See http://www.citiesalliance.org/node/2195. The number of slum dwellers is estimated to be increasing by 6 million per year (UN Habitat 2010). 25
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calls for rapid and sustained growth, primarily of tradable activities with export prospects, spearheaded by the entry and growth of firms. Africa’s 5+ percent per annum GDP growth since 2000 belies the state of its enterprise sector. It is crowded with micro enterprises with three or fewer workers and includes a tiny number of large firms, mostly engaged in finance, construction, transport, or retailing (Aré and others 2010). According to a data collected by David McKenzie, large firms, with 100 or more workers, numbered 80 in Tanzania, 114 in Uganda, and 251 in Ghana (McKenzie 2011). An important finding by Glaeser and others (2012) is that U.S. cities that grew the fastest were not doing so through the endless replication of small businesses; instead, much of the employment was due to the growth of firms that became large employers. In the past, a dynamic, fast‐growing, urban industrial system was one that “pushed firms through an up‐and‐out process” (Chatterji and others 2013). The weakness of urban growth engines is not peculiar to Africa: it is widespread in the Middle East, South Asia, and Latin America. Smaller cities are performing more poorly than larger ones and have to cope with higher rates of poverty, informality, and unemployment. African urbanization might slow as estimated by Potts (2012a,b) but there is little likelihood of a reversal, and the rural sector will offer meager job prospects for urban returnees or for those who forego the option to migrate. For cities that cannot rely upon resource rents or transfers, survival depends upon the harnessing of growth engines that are productive and competitive. Without these, an eventual downward spiral is inevitable. Many mining and mono‐
industry cities in Europe are in the grip of such a spiral as the principal economic activities wind down and are not replaced. Detroit is an example of what can happen to a formerly thriving industrial city in a leading economy once its principal industry loses competitiveness and migrates to locations where production costs are lower. An urban economy supported by low‐wage manufacturing, myriad informal activities, and stagnant productivity can eke out an existence at a low‐level equilibrium. However, such an economy is fragile and a hostage to shocks. Too many cities in South Asia (e.g., Karachi and Dhaka) and in Africa are in such a low‐level equilibrium. Recent experience suggests that a globalized world in the grip of climate change is likely to be exposed to an unending succession of natural and economic shocks. 3. How Cities Could Drive Growth What then are the minimum necessary conditions for cities in the developing world to drive adequate growth over several decades? Adequate growth would create enough well‐paid jobs to accommodate both the natural increase of the workforce and migrants; and it would enable a city to eventually realize much‐
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Shahid Yusuf touted but distant objectives, such as becoming smart, green, and resilient.30 The following six conditions are arguably the most important for growing cities: location and urban design, governance, quality and growth of the workforce, economic engines/sources of growth, size, and adequacy and autonomy of finances. Location and Design
Throughout history, most cities that prospered were established at choice spots alongside rivers and trade routes, or were favored by coastal locations commanding natural harbors. Prosperous cities also were frequently blessed by a rich and expansive hinterland—a source of agricultural commodities and/or mineral resources and a market for the goods or services produced in the city. Easy access to water for drinking purposes, to flush away urban waste, and to reduce the costs of transporting goods (including construction materials for the city) was another factor that induced cities to grow in river valleys. And because prosperity attracted the envious attention of invaders from near and far, cities tended to be compact so as to lessen the cost of fortification, and an easily defensible topography was always prized. City location was also influenced by climatic and health considerations: severe climates discouraged urban development as did the prevalence of diseases such as malaria, yellow fever, sleeping sickness, and others. Technological advances in transport, climate control, and in the building of infrastructures to convey water over long distances and to manage human waste31 greatly widened locational choices, allowing cities to grow in places and in climatic zones that would have been shunned in the past. However, we are now on the threshold of an era in which location will impinge even more decisively on the viability of cities—including the increasing numbers of megacities.32 The growing size of urban populations and the worsening relative scarcity of potable water (exacerbated by energy costs of transporting it over long distances or extracting it from the sea) advantages cities that are close to abundant supplies of water. A tendency for urbanization to sprawl with built‐up areas expanding at a significantly faster rate than populations33—three times faster—means that growing cities need plenty of These three encompass energy efficiency, livability, walkability, environmental quality, innovativeness, cultural richness, diversity, and the capacity to recover from destructive shocks—
topics that are widely discussed in the literature. 31 A burdensome issue for most cities and one that is sure to worsen. 32 Megacities were largely a Western phenomenon until a few decades ago, however, the proliferation of megacities is now entirely in developing countries with cities in countries with large rural populations growing the fastest. Approximately 10 percent of the world’s urban population now resides in megacities—upwards of 25 and rising as of 2011 (Kotkin and Cox 2013). 33 Some megacities have grown into metacities such as Tokyo with upwards of 20 million people, and the list is expanding. Sprawl has made it increasingly difficult to demarcate urban boundaries in particular cases and what we see is the coalescence of cities into vast urban regions—e.g. the 30
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room to accommodate the outward shift of the urban fringe.34 This tendency could in future be mitigated by the benefits of compactness, but only time will tell. Thus far, the income elasticity of the demand for additional living space and the economic gains to city officials and developers in bringing rural land into the urban domain have resoundingly offset the long‐standing claims of compactness in countries ranging from China to the United States (Barringer 2011). A third and increasingly urgent factor that will impinge on geography of urbanization and the design of cities, is climate change. Rising sea levels will make many coastal cities exceedingly expensive to maintain.35 This cost (in the form of levees, sea walls, natural defenses, and insurance) will be further raised by the increasing incidence of extreme weather events striking coastal cities in tropical locations.36 Climate change will also impact inland cities, especially those in hot and dry regions, by reducing supplies of water37 and adding to the costs of cooling urban structures. Better urban design (surface geometries, green roofs, trees and shrubs, reflective color applied to buildings and roadways) and efforts to cut air pollution can contain heat island effects. But there are limits to mitigation, and greater reliance on air conditioning and refrigeration can offset some of these efforts by releasing heated air into the urban environment. Together, these three developments presage a reluctant, long‐drawn, costly, and, in many instances, inevitable abandonment of some cities and a greater concentration of urban populations in areas with space, water, and milder climate; the northern parts of Canada and Russia appear especially inviting. How cities in the more arid regions of Africa and China will cope, and what will happen in the Middle East and in the Indo‐Gangetic plain,38 is troubling to envisage. Governance
The economy, design, and livability of modern cities are inseparable from the quality of governance. This is an imprecise and elastic term39 that loosely includes the functioning of the political machinery; the efficiency of planning, Hong Kong‐Shenzhen‐Guangzhou region in South China (UN‐HABITAT 2006; Vidal 2010). Megacities are complex entities posing vast challenges for governance, services provision, environmental management, sustainability, security, and the quality of life. They also present opportunities for innovation and the application of new technologies (Siemens AG 2007; Helmholtz Association 2007). 34 While GDP per capita explains a part of the expansion in urban land use, the incentive for municipalities and developers to convert/rezone rural land for urban purposes accounts for much of the rest (Seto and others 2011). 35 The cities at greatest risk are listed in OECD (2007). The list includes Mumbai, Guangzhou, Shanghai, Miami, Ho Chi Minh City, Abidjan, Lagos, Alexandria, and many others. 36 The vulnerability of urban infrastructures in modern cities was cruelly exposed by hurricanes Katrina and Sandy. And the cost of protecting New York will be high. 37 http://www.un.org/waterforlifedecade/water_cities.shtml. 38 The groundwater underlying the plain is being rapidly depleted through excessive pumping. 39 See for example, Fukuyama (2013). 20
Shahid Yusuf regulation, and policy implementation; the simplicity and transparency of rules affecting businesses; the capacity of public and private stakeholders to work together; and the existence of a vigilant civil society and of institutionalized checks that minimize costly mistakes by public officials and the incidence of corruption. Singapore and a handful of European cities have set and maintain high governance standards; the rest aspire and try or merely pay lip service to the periodic calls for “better governance.” But casual empiricism and solid research both underscore the positive effects of good governance on the economic health and dynamism of a city and on the overall quality of life. It is no wonder that Singaporeans are pleased with their lot and others are envious of what the city‐state has achieved. City leadership that sets high standards of performance and accountability and is answerable to a demanding public is the bedrock of good governance. This is a tall order, but it is clearly what cities should strive after. Quality and Growth of the Workforce
The third industrial revolution will shape the economy for decades to come. Cities will need to be smart, innovative, and green to grow, compete, and thrive in a harsher global environment; therefore, becoming a “skilled city” is a must (Glaeser and Saiz 2003). The successful skilled city is one that can attract talent and is able to raise the quality of its workforce. Continuous entry contributes to labor market flexibility (Herrendorf and others 2013) and to the evolution of new lines of business. Furthermore, the quality and skill level of the workforce determines productivity via learning, technological absorption, progress up the value chain, and innovation. Research by Hanushek and Woessmann (2010) and others has demonstrated the relationship between educational outcomes and economic growth, and what is true at the aggregate level applies also at the city level. Skilled cities have been able to remake themselves after shocks that resulted in the demise of an established industry and create new sources of growth and jobs.40 Moreover, the technological bias of industry and services is boosting demand for workers with analytic, technical, vocational, and managerial skills. Thus, the skill composition of the workforce is the key determinant of business formation and growth and city competitiveness more generally. How does a city become skilled? How did Singapore, Helsinki, Shanghai, and Seoul become skilled cities? It is not something that happens endogenously or can be engineered overnight through policy interventions. Accumulating evidence suggests that education systems need to be improved from the ground up, possibly from the preschool stage (Heckman 2013).41 Furthermore, a skilled city cultivates an innovation system anchored to research universities that set high standards, embrace diversity among students and faculty, and network or See Glaeser (2003) on Boston. The importance of preschooling for a child’s later development remains contested. 40
41
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partner with other leading universities around the world. An aspiring skilled city needs to observe an “O” ring rule (Kremer 1993): all parts of the education and research system must set and seek to attain roughly comparable high standards by investing in teachers42 and the physical infrastructure; using online delivery of material and courses to complement classroom teaching; inculcating attitudes of parents and students conducive to superior achievement; and mobilizing community involvement (Glewwe and others 2011). This is a high bar but not an impossible one. Finnish cities (Sahlberg 2011) have demonstrated success and Chinese cities such as Shanghai are aiming to reach these standards (OECD 2010). Research universities and a mix of general and vocational schools are one major element of a learning and innovation system that is at the heart of a skilled city. The entrepreneurial and managerial capabilities of the business community are of equal if not greater importance. In fact, to explain the performance of a Seoul or a Shanghai, one has to take account of the industrial activities that flourished before the effort to create a skilled city got underway. If one has to guess the direction of causation, the skilled city builds on the foundation provided by dynamic manufacturing activities by strengthening educational, training, and research institutions that promote technological deepening, innovation, and diversification. Note that skilled workers and technological/production/managerial capabilities are one part of the growth story; capital (including ICT capital) is a necessary complement. Cities (and economies) need both. Jorgenson and Vu (2010) show that capital has been the main source of growth, although in developed countries it is being gradually overhauled by total factor productivity. In developing countries, capital investment induced by macro stability, sound incentives, and a good business climate has maintained an edge over other sources of growth. What is true at the aggregate level is equally applicable at the level of the city. A skilled city needs to accumulate and put to productive use both high‐quality human and physical capital. Can consumer cities in developing countries with largely services‐based, inward‐looking economies morph into outward‐oriented skilled cities while skipping the industrial stage? Hyderabad and Bangalore in India approximately fit the mold but there are few other examples to draw upon. Clearly this is virgin territory with a lot of experimentation ahead. Success will depend on factors other than the three covered thus far (economic engines, size and global networks, and finances). Urban Economic Engines
As noted above, urban growth was traditionally a function of industrialization. This was not true in every case because mining, administrative functions, and Chetty, Friedman, and Rockoff (2011) show that high‐value‐adding teachers can greatly improve the test scores and long‐run earnings of students, and the attracting able teachers and replacing low‐value‐adding ones can be an investment with a high return. 42
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Shahid Yusuf trade also played a part. But in most major cities, industry was largely responsible for the emergence of a prosperous middle class. While industry is no longer predominant, its direct and indirect contributions can be substantial and cities neglect industry at their own peril. Two thirds of trade is comprised of manufactures, most applied research is focused on manufactures, innovation is more closely associated with manufactures than with services, and productivity gains are greater in manufacturing than in services. The manufacture of low‐end, commodified, light consumer items with limited scope for innovation and narrow profit margins can and does flourish in some developing countries. However, such an industrial base is proving to be a weak engine for sustaining long‐term growth. Such activities, although they do create jobs for the unskilled and produce exportables, offer few ladders to more sophisticated, higher‐value‐
adding industries. Worse, they do not inculcate much learning in the workforce or generate the demand for skilled and technical workers and for applied research; and they are failing to multiply the “decent jobs” that serve to expand the ranks of the middle class. Moreover the scope for innovation in these subsectors is limited. Three decades ago, light manufactures could be profitable stepping‐stones to a more diversified industrial base, but that time seems to have passed. Cities need to aim higher. Whether they train their sights on medium‐tech manufacturing or on services, what matters is that these are competitive in domestic and international markets. No city can thrive on mineral rents and transfers from the central government.43 New ventures are risky, and there is a paucity of risk capital in developing countries and few large firms that could take an entrepreneurial lead. Therefore, a combination of public and private entrepreneurship supported by a dose of public equity capital and public procurement may be a path to consider, notwithstanding the well‐founded wariness regarding state‐led industrialization, a picking of winners by bureaucrats, and the sorry track record of public venture capital. The alternative is to languish in low‐level development traps and face the consequences of increasing unemployment and widening income inequalities, which are what consumer cities are drifting toward. Scale and Connectivity
Bigger can be better if you are a city that is effectively managed and able to provide key services (including urban land management and design) with a modicum of efficiency. When an organism doubles in size, its resource consumption rises by 85 percent (Lehrer 2010). Thus as a city grows, it benefits from scale economies—that is, superlinear scaling. Its infrastructures serve more people and its metabolic activities—such as telecommunication traffic, patenting, and pedestrian speeds—all accelerate. See Katz and others (2012) on the contribution of leading export‐oriented metropolises to the performance of the U.S. economy. (See also Istrate and Marchio 2012). 43
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Size can also lead to rising productivity because of agglomeration economies from the size of the local market, the densifying of diverse activities, the thickening of labor markets, the emergence of industrial clusters,44 and a higher rate of innovation. Agglomerations arise from the easy circulation of knowledge and “collisions that happen when different fields of expertise converge in some shared physical or intellectual space” (Johnson 2010: 163).45 Research on agglomeration pegs the gains in productivity of labor and of firms at around 3 percent, although rates as high as 8–12 percent have been estimated (Melo and others 2009; Puga 2009; Rosenthal and Strange 2003). But the productivity advantages to be derived from the above are not a given that effortlessly accrue as a city grows. Much depends on the composition of economic activities, the entry and exit of firms, the position of a city in the global urban hierarchy, and the city’s harnessing of benefits accruing from “virtual agglomeration.” The latter comprises the linkages a city forges with other major urban centers via multimodal transport corridors that facilitate the flow of goods and services, as well as the circulation of ideas, capital, and “brains.” According to Saskia Sassen (2001) and Taylor and Lang (2005), this process of international networking, and the realizing of the benefits therefrom, is largely related to the growth and clustering of tradable services in some of the larger cities. Taylor and Lang (2005: 3) state that, “It is advanced producer service firms that have been largely responsible for creating and maintaining the network. These firms have offices in important cities across all world regions, and personnel, information, knowledge, intelligence, ideas, plans, instructions, and advice, flow freely among them. As such, these global service firms “interlock” the cities in which they have a presence.” Key cities are the sites of corporate headquarters and of research and prototyping facilities and they serve as test markets for new products and services. They are active participants in international events, host international organizations, and serve as crossroads for international symposia. In other words, cities that are prominent in the global city hierarchy underscore the salience of tradable services (including tourism of all varieties) and reinforce local agglomeration economies with the spillovers arising from nodal positions in the global network of cities. Not all megacities are so privileged. Across the world, there are too many examples of unchecked, unplanned, chaotic, and productivity‐subtracting increases in the girth of cities—cities such as Lagos, Karachi, and Cairo come to mind.46 Agglomeration economies accrue to skilled, smart, and well‐governed Clusters are most productivity enhancing when they give rise to local spillovers Johnson (2010: 162) also observes: “Cities are environments that are ripe for exaptation, because they cultivate specialized skills and interests, and they create a liquid network where information can leak out of those subcultures, and influence their neighbors in surprising ways.” 46 The AT Kearney Global Cities Index for 2012 gives each a low score: Cairo 50 down from 38 in 2008, Lagos 59 from 53, and Karachi 62 down from 57 four years earlier (AT Kearney 2012). On Karachi see Inskeep (2012). 44
45
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Shahid Yusuf cities, not to cities that expand uncontrollably mainly on the basis of informal, low‐productivity, service activities and informal housing and infrastructures. Agglomeration economies present opportunities for the many megacities in developing countries. However, this is not low‐hanging fruit that can be easily picked. Looking ahead, only the smart and skilled cities that invest in human and physical capital are likely to succeed. Financing
All of the necessary conditions would come to nothing without fiscal and financial resources to develop adequate infrastructure and services.47 A city’s resilience depends on both the robustness of the physical infrastructure and institutions and on deep pockets for rebuilding and repairing damage. The fiscal resources a city can mobilize depend on the scale of business activities, how these translate into taxable incomes, and the value of taxable assets. Hence how a city incentivizes business activity determines what it can potentially collect by way of revenues. Revenues actually collected are a function of tax autonomy conferred by the central government, local tax handles, and transfers from the center. The greater the fiscal autonomy and fiscal independence enjoyed by a large city, the better. Fiscally prudent cities combine attractive incentives for business with an effective apparatus for enforcing and collecting taxes and assessing/rating property taxes. For a large metropolis, coordinating tax instruments and rates across jurisdictions minimizes tax arbitrage and rate competition. Prudence means adopting fiscal responsibility laws, carefully measuring out pension and safety net benefits, and adopting mechanisms for evaluating performance on a regular basis. Fiscal resources are insufficient to finance long‐lived infrastructures; therefore, cities must seek recourse in borrowing against future income streams or complementing local resources through public private partnerships.48 Experience suggests that strengthening financial management at an early stage can be rewarding over the long haul. Starting with straightforward bond financing for infrastructures, cities have developed a multiplicity of instruments and institutions for financing setting up municipal funds, finance corporations, community development corporations, land banks, and partnerships. They have also deployed a number of innovative instruments including tax incremental financing and value capture finance.49 Henderson and Venables (2008: 1) observe, “city formation requires investment in non‐malleable, immobile capital in the form of public infrastructure, housing and business capital.” The latter can be long lived, with housing having a gross depreciation rate of 1 percent and a net rate with maintenance of close to zero. 48 The seamy past history of American cities, rife with bond defaults, is examined by Monkkonen (1995). 49 See Dethier and Morrill for details (2012). 47
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4. Concluding Observations The future success of city‐driven growth will depend on the design and execution of city‐level strategies and how these take account of the six elements discussed above. For virtually all cities in developing countries, a viable growth strategy will build in growth engines and avoid locking in dysfunctional urban design, infrastructures, and institutions. Achieving just this would be a huge plus and would enable cities to create jobs, maintain a reasonably equitable income distribution, and keep social tensions in check. Governance, financing, and skilling of the workforce will be major contributing factors. Cities are struggling to improve each of these, and one can only hope that the majority is blessed with a large dose of luck. If cities fall short, millions of people will lead nasty and miserable lives. As to the future geography of urbanization, given the inevitability of climate change that international policy inaction is bestowing on current and future urban inhabitants, municipal governments will need to take the lead.50 Cities will need to take bold and sometimes painful decisions to redraw the urban landscape, do away (Baron Haussmann like51) with legacy infrastructures, and seriously pursue greening. For the majority of politicians, such decisions are the exception. However, the severity of the impending climatic changes and the speed with which they are bearing down on us all might force the scaling back of urbanization in some areas and its scaling up in others. Most likely, these decisions will need to be taken in consultation with neighboring countries, because climate change could make it impossible for some countries to support much enlarged populations two and more decades hence. References Accetturo, Antonio, Anna Giunta, and Salvatore Rossi. 2012. “Being in a Global Value Chain: Hell or Heaven?” Vox, December 15. Available at: http://www.voxeu.org/article/being‐global‐value‐chain‐hell‐or‐heaven. Aré, Lionel, Sami Chabenne, Patrick Dupoux, Lisa Ivers, David Michael, and Yves Morieux. 2010. “The African Challengers: Global Competitors Emerge from the Overlooked Continent.” The Boston Consulting Group, June 2. Available at: https://www.bcgperspectives.com/content/articles/ globalization_mergers_acquisitions_african_challengers/. In fact, municipal level initiatives worldwide point to increasing grassroots awareness and are a source of considerable encouragement. 51 http://en.wikipedia.org/wiki/Georges‐Eug%C3%A8ne_Haussmann. 50
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Shahid Yusuf A
rchaeological evidence suggests that cities as recognizable entities arose in the Fertile Crescent between the Tigris and Euphrates rivers around 3,200 BCE—some 10,000 years after the
domestication of rye (and other grains later), and 5,000 years after
the emergence of village communities that prioritized intensive agriculture over hunting and gathering. Shortly thereafter, or perhaps
simultaneously, cities appeared in China and in Mesoamerica. The
VSUHDGRILQWHQVLYHDJULFXOWXUHHQDEOHGFLWLHVWRPXOWLSO\DQGÁRXUish. Ideas and innovations that germinated in cities served as the
nuclei of civilization and, more recently, in the making of modern
societies.
Cities may have been the drivers of change in earlier times. However, as recently as 1800, only 3 percent of the world’s population
was urban. A century later, the urban share was still only 14 percent.
Not until 2012 did urban dwellers—more than 3.6 billion in total—
outnumber their rural counterparts (52 percent). The trend line
points toward 6.3 billion urban inhabitants out of a projected total
world population of 9.3 billion in 2050. People born in the 1920s
have witnessed, in less than a blink of the historical eye, an extraordinary elongation of life spans, a staggering increase in demographic numbers, and a triumph of the city over the countryside. As we
ORRN WRZDUG WKH IXWXUH ZH FDQ DQWLFLSDWH HTXDOO\ VLJQLÀFDQW³DQG
surprising—changes.
Shahid Yusuf is Chief Economist with The Growth Dialogue, George
Washington University School of Business.
The Growth Dialogue is a network of senior policy makers, advisors, and academics. The participants aim to generate a sustained
stream of views and advice on policies that complements existing,
established sources of opinion; to be an independent voice on economic growth; and to be a platform for policy dialogue among those
entrusted with producing growth in developing and emerging market economies.
http://www.growthdialogue.org/
[email protected]