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The Reinventive City

July 13, 2009

By Edward L. Glaeser

In 1981, Michael Bloomberg was fired. The mayor-to-be had enjoyed a meteoric career, becoming a partner at Salomon Brothers at the precocious age of 31. But in 1979, he was exiled from the exciting trading floor to hang out with the geeks in systems development, and two years later Salomon dispensed with his services altogether. Bloomberg’s $10 million severance package was admittedly a lot better than what most of Manhattan’s unemployed workers received. Still, he was out of a job in the middle of a severe national recession.

But Bloomberg’s experience, both on the floor and with the geeks, had taught him something valuable: Wall Street traders wanted computer terminals with jargon-free keyboards that would give them constant information on the yield curve. Despite being a continent away from Silicon Valley, Bloomberg created his own computer firm. New York had provided him with the critical requirements for entrepreneurship: skilled workers, financing, access to customers and knowledge.

The success of Bloomberg’s company reflects the great advantages of being in New York even during a recession. Today, Gotham’s strengths--competition, diversity, access to the world, and, most of all, human capital, made even more potent through proximity--will enable the city to reinvent itself, as it has done several times in the past, and survive the current economic storm.

Over the centuries, New York City has survived crisis after crisis--the British defeat of the Dutch, Leisler’s Rebellion, the 1863 draft riots, the 1929 crash, the attack on the Twin Towers. But none of these shocks struck as hard as the American Revolution. New York’s recovery from that shock stands as a testament to the importance of human capital in reinventing a city.

Before 1776, New York merchants had followed a trading pattern, pioneered in Boston, of exporting basic commodities, like flour, to feed the cash colonies of the South and the Caribbean, where land was too valuable to waste on such necessities. During the Revolutionary War, New York became the center of English operations and a haven for loyalists. But after Cornwallis’ defeat at Yorktown led to the Treaty of Paris in 1783, the loyalists and redcoats evacuated, and New York’s population declined by roughly 60%. The city’s trade model was also under attack, as British and Spanish colonies imposed severe restrictions on American commerce, leaving New York’s large shipping community empty-hulled.

The Revolution had, however, freed American merchants from the British East India Company’s monopoly on trade with China. One of them, Daniel Parker, learned that the Chinese were mad for ginseng, allegedly an aphrodisiac. He also knew that American ginseng, grown in Appalachia, cost far less than European, giving American shippers a decided advantage. Armed with this information, he launched a successful venture that, by sending a ship from New York to Canton and back in 1784 and 1785, established the viability of the China trade--a big part of the reason that New York recovered from its Revolutionary malaise, perhaps doubling its population between its low point in 1783 and 1786. By the first U.S. census in 1790, it had finally surpassed Philadelphia as the nation’s largest city, with 33,000 inhabitants.

Like today’s businessmen, the entrepreneurs who made America were rarely saints. Parker--one of the many colonial-era Bernie Madoffs--had borrowed far more than he could pay back and fled to Europe one step ahead of his creditors. Nevertheless, he was one of the remarkably skilled people who came to New York and helped the city reinvent itself. Another was Alexander Hamilton, who helped create the Bank of New York in 1784. No variable better explains the ability of cities to thrive than human capital--whether attracted from elsewhere, as in Parker’s and Hamilton’s cases, or fostered locally.

The city’s second great reinvention happened in the 19th century, when New York became a manufacturing powerhouse. By 1850, its population had increased to 515,000 residents, 43,000 of whom worked in manufacturing (vs. 11,000 in commerce). Until the mid-20th century, New York would be an industrial city.

New York owed its industrial rise to its place as America’s foremost port. The port was more central than Boston’s, had easier access to the ocean than Philadelphia’s or Baltimore’s and benefited from a deep river that was eventually connected by canal to a water network that crossed America. The Chinese trade that Parker had started was important, but ultimately less significant than New York’s dominance of transatlantic commerce. As ships grew bigger, American commerce with Europe moved from a point-to-point system to a hub-and-spoke system, with big ships crossing the Atlantic and transferring their goods to smaller ones. New York’s superb harbor was the system’s natural hub.

The harbor also encouraged the growth of industry, such as sugar refining, the city’s primary industry in the early 19th century. New York’s port was the entry point for vast quantities of unrefined Caribbean sugar. Refining in the Caribbean made no sense, since refined sugar crystals coagulate during a long, hot sea voyage. Refining in New York made it possible to exploit scale economies in a city that was near sugar-loving American consumers.

Manhattan’s largest industry today, printing and publishing, also grew out of its port. It wasn’t just that books, like any other good, had to be shipped to their customers. It was also that European ideas came to the United States by sea. For example, New York’s shipping prominence allowed the Harper brothers to get pirated British books before their Philadelphia competitors could. The Harpers’ ability to access bootlegged books easily was an early example of Gotham’s role as America’s most international city--a role that it still plays.

For most of the past two centuries, though, New York’s most important industry was neither sugar refining nor printing but the garment business. In the 18th century, rich families patronized tailors, and poor families made their own clothes. In the early 19th century, New York entrepreneurs like Brooks Brothers started making ready-to-wear clothing for ordinary people. By the mid-20th century, more than one-quarter of New York’s manufacturing workers made clothes. And since that seldom required a huge factory, hundreds of immigrant entrepreneurs could get their start in the garment business.

The dominance of the garment industry highlights two important lessons. First, urban success is built on the maelstrom of competition. Cities with abundant small firms have done much better than cities with stagnant giants. While Pittsburgh’s steel industry created industrial behemoths, New York’s garment industry, a mosaic of small and midsize firms battling for customers, made competition part of Gotham’s DNA.

Second, the competitive maelstrom ignites industrial diversity and innovation. Forty years ago, Jane Jacobs pointed out that the brassiere was invented not by lingerie specialists but by an experimenting New York dressmaker who soon recognized the demand for her new creation. Similarly, the greatest skyscraper builder in 1920s Manhattan was A.E. Lefcourt, formerly the owner of a small clothing business, who got his start as a developer by erecting safer buildings for the garment industry.

Or consider the story of Chester Carlson, a young scientist who was laid off from Bell Labs (then in New York) in 1933, found work with a patent attorney, and then moved to the company that would become Duracell. Carlson’s patent work had shown him that there was an enormous need for a way to make clean copies. His scientific background convinced him that photoconductivity could do the trick. So he partnered with an Austrian physicist who had fled Hitler and come to America’s gateway city. Together, in the depths of the Great Depression, they produced the copier and company that would become Xerox. Such stories abounded in New York, where density, competition and an international presence combined to spark the fire of innovation.

By the 1960s, however, the city’s great industrial base was eroding. In the 19th century, access to waterways was a crucial competitive advantage; every one of America’s older cities grew up around ports and railyards. But in the 20th, that advantage disappeared as the real cost of moving a ton a mile by rail dropped by 90% and as trucking increased. Manufacturing fled the older cities, first to suburban factories like Henry Ford’s River Rouge plant, then to low-cost right-to-work states, and finally to other countries. Between 1967 and 1987, New York’s garment industry declined by 70%--almost 170,000 workers.

At the same time, Ford’s cars and the interstate highway system set off a massive wave of suburbanization, as Americans flocked to enjoy auto-based living in tract houses that dwarfed their old tenements. With the exception of Los Angeles, every one of the country’s 10 largest cities lost at least 10% of its population between 1950 and 1980.

It’s important to recognize that the 1970s were a much darker time for New York than the current crisis. The whole economic model of big cities was in doubt. The city’s unemployment rate hit 11.6% in 1976. Social distress turned Mayor John Lindsay’s “fun city” into an urban nightmare known more for rampant crime than for economic vitality. The Bronx burned. City government seemed unable to provide decent services, much less balance its books. Not just President Ford, but history itself, seemed to be telling New York to drop dead.

But once more the city reinvented itself, lifted above all by the financiers, the heirs of Hamilton. Urban density has a remarkable ability to set off chains of innovation, in which one smart person learns from another and collectively they create something huge. In 15th century Florence, Brunelleschi passed his understanding of linear perspective along to Donatello, who introduced it into low-relief sculpture and taught it to Masaccio, who used it to paint Saint Peter on the walls of a chapel and taught it to his student, that unsaintly monk Fra Filippo Lippi, who taught Botticelli. The rebirth of New York reflected a similar chain of innovators, each riffing off one another and coming up with new ways to make money in finance.

Finance had long existed in New York, of course, even before the Buttonwood Agreement formalized the stock exchange’s rules in 1792. The city’s financial community started as a means of funding the ships coming into and out of the harbor, since even the richest men didn’t want to bear the risks of an ocean voyage by themselves. The agglomeration of New York investors then made the city a natural place to buy and sell other securities, such as U.S. Treasury obligations. Later, forging industrial America required vast amounts of money, and people laying down railroads across the country came to Manhattan for capital. Many titans of Gilded Age finance, such as J.P. Morgan and August Belmont, specialized in connecting American borrowers with English investors.

In the age of Morgan, investors cared about character, helping Wall Street become a tight-knit community bound by ties of society and blood. However, after World War II, that increasingly seemed like an arbitrary and archaic means of allocating capital. Mathematical finance appeared to offer an alternative. Starting in the early 1970s, Michael Milken began convincing money managers that high-yield corporate debt, though it looked like junk, had high returns relative to its historical risk when bundled together into diversified portfolios. His ability to sell such debt enabled Jerome Kohlberg and Henry Kravis to finance bigger and bigger deals.

Meanwhile, Robert Dall was pioneering mortgage-backed securities at Salomon Brothers. By the 1980s, Dall’s protégé Lewis Ranieri was at the center of a multitrillion-dollar market in these securities. (Ranieri, immortalized in Michael Lewis’s Liar’s Poker for his gargantuan appetite for both food and risk, is a classic example of a poor kid who acquired his skills not in college but by hanging around smart people in Manhattan.) Collectively, these innovators reinvented the financial-services industry and turned it into a wealth-creating dynamo that reinvigorated New York.

In the middle of a great financial crisis, we are likelier to see the problems with these innovations than the advantages. After all, mortgage-backed securities are at the center of the current crisis. Milken served time. But financial booms have usually been followed by painful crashes. Good ideas usually get pushed too far. The nature of capitalism is that opportunity creates both real achievement and misbehavior, sometimes--as in the case of Daniel Parker--in the same person.

The market for high-yield debt is fundamentally a good thing: It enables riskier firms to get financing and to allow the risk to be widely held. Even the much-maligned mortgage-backed securities have made it easier to buy homes and share risks. Mortgage initiators were unquestionably lending to people to whom they shouldn’t have and selling securities to people who shouldn’t have bought them. But that doesn’t mean that the innovation was fundamentally mistaken, and in the future, the world will continue to take advantage of the ideas created in New York in the 60s, 70s and 80s.

Ideas, in fact, will play a major role in New York’s next great reinvention. Back in the 1970s, New York was still primarily in the business of making goods, which was a bad business for cities to be in. Today, New York thrives by making ideas, which will remain a good business for urban areas. Wall Street’s traders are in the knowledge business, earning profits by predicting price changes better than anyone else. The city’s publishing world, as well as its management consultants, lawyers and doctors, also thrive by creating information. The future of New York seems secure because the demand for knowledge isn’t going away.

Right now, the returns for such ideas look pretty bleak, but that’s a temporary downturn, not a global trend. In the longer run, the world is likely to return to becoming ever more connected and ever more complicated. A complex global economy provides tremendous opportunities for people who come up with new ideas, since those ideas can be exploited on a vast stage. In that long run, it isn’t even certain that New York’s financial industry is going to shrink. After all, the world will still need people to manage its money, and it will still want those managers to be at the center of things, where they can acquire the most information.

Further, New York will continue to have a comparative advantage at producing ideas. That advantage occurs because big cities are, at their heart, the absence of distance between people and firms. Talent, whether painterly or financial, gets magnified because of urban concentration. Cities thrive by connecting people. That’s why Bloomberg insisted on open offices at his company--cities writ small, places where people could constantly exchange information--despite techno-prophets’ repeated predictions that technology would make human proximity obsolete. Here was a firm on the cutting edge of information technology that chose to locate at the heart of a great city and did as much as possible to eliminate the physical barriers among its workers.

The global economy is another advantage for New York--which remains the primary gateway between America and the world, just as it was in the Harper brothers’ day. As enterprises in India and China rebound, many of them will want offices in Manhattan. The offices will ferry American ideas to those growing economies and move their ideas, in turn, to America. New York’s next reinvention will surely rely heavily on the city’s continuing edge in connecting with America’s increasingly important trading partners.

If rapid technological change and globalization continue to be the world’s great trends, then New York’s employment seems likely to become not just more international but more technological as well. The relative isolation of Silicon Valley was perfect when the computer industry was focused on living up to Moore’s law and producing faster and faster computers. Nowadays, profits are more likely to be in applications, like Bloomberg’s, that link up with other industries. New York’s ability to connect engineers with their consumers will be an advantage here.

The proliferation of competitive New York firms is another reason to be optimistic about the city’s ability to reinvent itself again, since the innovative diversity that Jane Jacobs described remains a New York hallmark. In 2006, the Census Bureau reported that Manhattan’s 2 million workers were spread among 100,000 different establishments. Even in the giant and awkwardly named area of “securities, commodity contracts, and other financial investments and related activities,” which paid $50 billion to 160,000 workers, there were 4,500 different establishments--not just giants like Citibank and Merrill Lynch but hundreds of smaller boutique firms and few barriers to entrepreneurship.

And the financial crisis is likely to increase, not reduce, the diversity of New York businesses. Declining real estate prices will enable firms and industries that had been priced out to move into Manhattan. While the city remained diversified across many firms, by 2006, it was starting to be overly concentrated in a single industry: finance. As the sad story of Detroit illustrates, industrial diversity beats monoculture. Manhattan won’t attract a lot of manufacturing, which needs too much space to operate on an expensive, narrow island. But it will attract other idea-intensive sectors that can take advantage of the city’s ability to connect people.

Innovation is always unpredictable, but some obvious trends are likely to continue. The demand for health care isn’t going down, and New York’s tremendously strong research hospitals will probably continue to grow. The demand for first-rate education will also keep rising, which means that Columbia and NYU will keep expanding. Still, don’t think that Manhattan will become Boston on the Hudson, dominated by these two nonprofit sectors. The city’s heart will still be its for-profit entrepreneurs.

New York’s strength will depend on its continuing ability to attract such entrepreneurs. And that, in turn, will hinge on delivering a decent quality of life at a reasonable price. If city streets become unsafe or unclean, the skilled will leave.

New York’s government faces three additional challenges to keeping the city attractive to smart innovators. One is the public school system, whose problems have long pushed people out of New York. Another is local taxes, which are among the highest in the nation and constitute another incentive to leave. The tax burden didn’t seem like a problem during the boom, but its costs will be more evident during a bust. Slapping a millionaire’s tax on the state will be a sure way to repel the human capital that the city so badly needs.

The third challenge is New York’s housing prices. Despite the current real estate crash, New York still has some of the highest housing prices in the nation, and only new construction will lower them significantly. The city’s leadership must continue fighting the regulatory barriers that make it hard to build in New York.

It’s true, of course, that the city’s financial-services industry will be less lucrative, at least until the next boom. For many years, income in the city is likely to be substantially reduced. Lower financial earnings will ripple through the system, causing a reduction in demand for pricey eateries and fancy boutiques. The crash also means a major reduction in tax revenues, which makes Bloomberg’s job harder.

Despite these challenges, there are plenty of reasons for optimism. As of April 2009, the unemployment rate in New York City was 7.8%--below the national average. The quality of New York City government is far higher than it was in the early 1970s, and its leaders are more aware of what needs to be done. Above all, New York remains crammed with smart, entrepreneurial people who will lead the city’s next reinvention. I don’t know, of course, which laid-off financiers will be the next Michael Bloomberg and come up with the unbelievably productive new firms of the future. But I’m confident that there are plenty of them.

Original Source: http://www.forbes.com/2009/07/12/new-york-bloomberg-human-capital-opinions-contributors-edward-l-glaeser_print.html

 

 
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