The Economic Future of the Central Activity Zone (CAZ) Phase 1: Office use trends and the CAZ ecosystem Report to the Greater London Authority (GLA)
10. The CAZ labour pool may increase, and agglomeration will continue to play a role The CAZ’s draw as a place to locate is likely to persist after COVID-19 Why do businesses locate in the CAZ? The CAZ is an expensive area, so why are firms and workers willing and able to pay to locate there? From an urban economics perspective there are two answers to this – either agglomeration increases productivity or it provides benefits, such as amenities, which make firms and workers willing to pay a premium to locate there. Both factors are important and will continue to be so. Agglomeration benefits A large body of evidence suggests that economic density provides significant, but modest, economic benefits to firms and workers. These agglomeration economies were formalised by Alfred Marshall (1890) and there are three forms: • Matching of specialised customers and suppliers. Location in an area of economic mass provides access to specialised customers or suppliers. This provides an incentive to specialise, increasing productivity for firms. In London, this helps explain the historic tendency of law firms or specialised accountancy firms to locate near financial firms. • Labour pooling. Firms benefit agglomeration as they have a wider potential set of workers they can employ; workers benefit as they have more employers with whom they might be better January 2021
matched. This provides an incentive for workers to upgrade their skills, as they know there are more potential markets for these specialised skills; firms can upgrade the skills they use, upgrading production processes to respond to the greater availability of specialised skills. • Knowledge spillovers. Workers learn from colocation in dense urban agglomerations like London, with this ‘learning effect’ increasing productivity for workers particularly in the early stages of their career. Jacobs (1961) suggested that cities allow unplanned interactions, and that this serendipity increased productivity. Marshall’s studies of industrial districts suggested that local innovation was caused by these knowledge spillovers as: “The mysteries of the trade become no mysteries; but are as it were in the air” (Marshall, 1890). These benefits mean that firms with strong access to economic mass are more productive, even when accounting for the sectoral composition and skills of the workforce. But while there are effects, they are not large. In one UK study, Rice et al. (2006) show that once controlling for occupation and sector, “A doubling the population of working age proximate to an area is associated with a 3.5% increase in productivity in the area”.
As we have explained earlier, the economic costs of working from home also come from the reduced access to density (or economic mass): workers have fewer interactions, fewer new business connections and fewer opportunities to develop their business and social capital both within and outside their organisations. There is little hard evidence yet on how home-working may affect productivity, and the impact may be markedly different across sectors. One reason the CAZ matters is that agglomeration economies are often very highly localised. While labour pooling is likely to operate at the level of the travel to work area (i.e. there are benefits from locating in the wider South East).
In the US advertising industry, benefits of agglomeration fall away within around 750 metres (Arzaghi and Henderson, 2008). Evidence using the construction and later demolition from the Berlin Wall suggests benefits of agglomeration only extend for around ten minutes of travel (Ahfeldt et al., 2015). There are even studies which show there are agglomeration effects within large office buildings, with benefits of being located near similar firms (Liu, Rosenthal, and Strange, 2020). This desire for proximity has driven the high concentration of businesses in the CAZ, delivering an economic mass, and prices, that are unmatched in the UK. 96
