Cities and Cronyism

Recent developments in the global system of cities present a curious paradox. Globalization is supposed to render location virtual, and has done so for much of the economy. But instead of scattering, some key portions of the economy, most notably large corporate headquarters and leading financial service firms, are concentrating in particular cities.

As the cost of communications declines almost to zero alongside falling transport costs, there is now little reason for most kinds of production to be undertaken in any particular location. And elements of production chains no longer need to be located close to one another. This is the new, borderless, frictionless global economy we keep hearing about. This fact has had dramatic consequences for the organization of manufacturing industry. Simple production chains involving the import of raw materials, usually from developing countries, for processing in a specialized center, have been replaced by far more complex structures. The production of a pair of shoes might involve physical and design inputs from a dozen different countries, and they’ll be sold in a dozen more.

Even within countries, specialization has declined greatly. “Detroit” is still shorthand for the U.S.-owned section of the motor vehicle industry, but Michigan now accounts for only a quarter of U.S. production and, because of imports, an even smaller share of U.S. consumption. The remorseless decline of the great manufacturing cities of the developed world shows that the historical aggregation of large numbers of skilled workers and large infrastructure investments does not determine where world-class cities grow.

Yet, in the economy’s top echelon, the dominance of a small number of “global cities” has never been greater. A recent study by Arthur S. Alderson and Jason Beckfield of Indiana University examines power relations between three and a half thousand cities by plotting headquarters and branch locations of the world’s 500 largest corporations. They find, not surprisingly, that the core of the global city system is the bloc made up of London, New York, Paris, and Tokyo. These four cities are the most powerful, with the greatest number of connections to other cities. This new system of dominant global cities is based on the concentration of corporate headquarters and financial markets in a small number of places.

But of all parts of the economy, corporate headquarters and financial market functions should have been most transformed by the reductions in communications costs. Nearly all the work of financial markets can be performed electronically and remotely. It is now possible for corporations and their workers to be dispersed, settling wherever they want to live. There is just no technological reason for corporations and markets to be as geographically concentrated as they are.

There is little evidence to support the view that putting corporate headquarters in global cities is an economical choice. A mid-1990s study examined investors’ perceptions of the advantages and costs of headquarters relocations. The stock market reacts positively when relocation decisions are attributed to cost savings, while decisions prompted by managerial self-interest and desire for luxurious offices elicit an adverse reaction. According to investors, at least, efficiency should be pushing corporate headquarters away from, not towards, high-amenity, high-cost urban centers.

The other standard rationale for geographical concentration, that it provides access to a pool of skilled workers, is equally suspect. For this to be economically relevant, workers with the relevant skills would have to offer their services more cheaply in the global cities than anywhere else. This would be true if the workers thought that connections available in a global city outweighed the higher cost of living. There doesn’t appear to be systematic evidence on this, but the anecdotal evidence is that lots of people make a temporary move to global cities, attracted by the opportunity to earn big money, before returning home to less-connected places.

In these circumstances, the most plausible explanation of “global cities” is that they facilitate cronyism of various kinds (this pejorative phrase could gently be replaced by “relationship capitalism” or rendered even more bluntly as “corruption”).

As regards financial markets in particular, most of the tasks they supposedly perform do not rely on personal contacts–in some situations, personal contact is illegal. And some researchers have found that where finance is allocated on the basis of personal relationships (“relationship capitalism”), it becomes a tool for creating and protecting monopoly.

Virginia Postrel, a vigorous and eloquent defender of modernization and technology, uses these ideas to attack the idealized, and largely mythical, small-town bankers of the past in favor of today’s more impersonal system. It’s certainly true for retail borrowers that relationships with bankers are no longer important. But Postrel misses the irony that personal relationships remain important–while distancing themselves from most of their customers, members of the financial sector have gathered together ever more closely with their colleagues in centers like New York and London.

Similarly, a recent Buttonwood column from the Economist deplores the fact that house prices in London are being bid up by City types who, the pseudonymous pundit suggests, have enriched themselves at the expense of their customers. He’s referring to the mutual funds scandals, but these are just the latest of many moments of cronyism. He doesn’t, however, ask the obvious question: why do these City types crowd together in London (and New York)? After all, the same City types are busy telling us about a globalized world, linked instantaneously by the Internet. As Warren Buffett has shown, they are right. You can get all the information you need to formulate market-beating investment strategies while sitting in Omaha, Nebraska. But most of today’s global capitalists prefer to live in London, not Omaha. Ask them why, and they’ll cite restaurants, and theater, and those lovely houses that worry Buttonwood.

Long before electronic markets and just-in-time freight, Adam Smith recognized the connection that Buttonwood misses: “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.” The quality of life that the financiers will tell you brings them to London and Paris is not separate from the “relationship capitalism” that allows them to afford it.

The antiparticle equivalent of Warren Buffett is Jack Grubman, the telecommunications analyst for Salomon Smith Barney who provided favorable coverage for AT&T as a favor for Sanford Weill of Citigroup. In return, Grubman got the leverage he needed to place his children in a desirable New York preschool. This is kind of transaction where location is all-important.

The work that financial institutions are supposed to perform, trading assets and allocating risk in transparent markets, can be done anywhere on the planet. The other work–the stuff that must be done without any inconvenient records and that requires the kind of trust that’s needed for conspiracy–requires a central location where social bonds can be cemented by eating, drinking, and sleeping together.