# **_Understanding agglomeration of economic activity_**

The cost of living in cities in table 1 is higher than in cities in table 2, so salary differences adjusted for local prices are smaller than nominal differences. While this explains why people still live in Flint and Merced and why everyone has not moved to Austin, Raleigh-Durham, and San Jose, it does not explain why there are still employers in Austin, Raleigh-Durham, and San Jose. Why should employers, especially those who compete nationally and internationally, put up with such high labor costs to be in these locations? A crucial question, because it holds the key to understanding why some cities are more economically successful than others.

If you visit these cities, you will not find many visual clues to why salaries should be so high there. Take San Jose. Most of the iconic Silicon Valley companies are in anonymous office buildings or office parks. Like many other U.S. metropolitan areas, San Jose 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. Local companies like eBay and Adobe must pay a skilled worker with a college education $87,033 a year in San Jose, but a similar company 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 they are paying now to hire a high school graduate, which is $68,009.

The same puzzle arises in other countries. A large fraction of the Indian high-tech sector is in Bangalore, where real estate costs and salaries are higher than in other Indian cities. France, Japan, and the Republic of Korea exhibit even more geographical concentration, as cities like Paris, Tokyo, and Seoul absorb the lion’s share of their nations’ most innovative activities and talent. The same is true in China, where Beijing and Shanghai have become magnets for the country’s highest achievers. With high wages and office rents, these cities are among the costliest places in China to operate a business. One would expect these cities to be unattractive for firms, especially those that compete globally. A comprehensive study by the Organisation for Economic Co-operation and Development finds that 57 percent of all patents in developed countries are generated by 10 percent of metropolitan areas, and this concentration has been increasing over time.

What is so special about cities like Bangalore, San Jose, Seoul, and Shanghai? 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, and they do not explain a big part of the geographical distribution of economic activity. For high tech, the transportation costs are essentially zero, since one can ship software code instantly and cheaply through any modem. If all Bangalore software companies moved to the state of Bihar, where real estate and wages are much lower, no user would notice.

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