Comments on: Cities and cronyism

By: Ian Whitchurch

Ian Whitchurch — Fri, 27 Feb 2004 23:15:26 +0000

This is interesting for me, because I am at the pointed end of all this. Despite my .uk address, I live in Canberra, and I am working on taking a Perth-based oil company public on the Sydney-based Australian Stock Exchange. Our CEO is in Perth, our board comes from Perth, Sydney and Melbourne, and our assets are in South Australia and the Northern Territory. Needless to say, I’ve been doing a lot of travelling lately. An example of the issues involved with distance is our dealings with a Swiss-based brokerage house with offices in Sydney and Melbourne. In Australia, they are mostly based out of Melbourne, but their oil and gas guy is in their subsiduary Sydney office. Thus, we first went to Sydney to sell their oil and gas guy on our company, and he likes us. But as he was based in Sydney, he never got to talk to Melbourne face-to-face, and that meant that the Melbourne people were less enthusiastic about the company than they could have been. Would this have been different if they had all been working out of the one building, or at least the one city ? My guess is “Probably”. My reply to Adam Smith’s comment is that trade is about relationships, and that meeting people face-to-face and socially helps build trust relationships – there is stuff you just cant do over the phone or via the net. Ian Whitchurch PS D-squared, or anyone else involved in the finance scheme – can I talk to you about the AIM, and it’s possible role with a Brisbane-based oiler that controls (among other assets) the oil lease for the Falkland Islands ?

By: David Foster

David Foster — Wed, 25 Feb 2004 15:52:09 +0000

Geographical clustering happens in all sorts of industries, not just finance. People in firm “A” decide to go off on their own and start firm “B”; they don’t want to move (and want to be able to conveniently recruit former associates), so they put it in the same city. The same happens when people from “B” go off and start “C”. In some industries, the process is further encouraged by the presence of local suppliers and support companies.

By: Chris Bertram

Chris Bertram — Wed, 25 Feb 2004 14:47:50 +0000

Unless you want to end up living in Nebraska …

By: dsquared

dsquared — Wed, 25 Feb 2004 13:24:30 +0000

I have a number of views on this, but since I’m a financial professional working in a major cluster, I suppose I’d better be careful what I say!

By: John Quiggin

John Quiggin — Tue, 24 Feb 2004 22:31:25 +0000

If investors are rational, they will take these effects into account when the mark a company up or down for relocation decisions. After all, the cost savings would be illusory if the company could not hire good workers for the same wages in the new location. The test question here is whether wages for workers in a given occupation and with comparable skills are higher in NY or in competing non-global-city locations. If workers value the opera more than they dislike high rents, wages in NY should be lower. My perception is that the opposite is true, but the proviso about comparable skills is important and hard to check. If investors aren’t rational, are characterized by short-term bias etc, then there’s no general reason to think that location decisions will be optimal. In particular, if investors aren’t fully rational, the constraints on managers pursuit of their own self-interest will be weaker. I think, for the reasons you mention, it’s clearly in the self-interest of managers to locate in NY and other global cities. Note that high wages for skilled staff benefit managers, in view of the general corporate rule that the supervisor must be paid more than the supervised.

By: Chris Bertram

Chris Bertram — Tue, 24 Feb 2004 22:13:34 +0000

John, I think your Warren Buffet point was a bit misleading since corporate relocation raises different issues from, say, homeworking. But even if investors would like Acme Bank Inc to relocate to Omaha, Nebraska on cost grounds, where’s the evidence that the people Acme Bank needs to work for them and to make those decisions are happy living there? After all, cities do a lot more for people than provide locations for enterprises. I doubt that Omaha, Nebraska has many decent restaurants and I’ve never heard of their opera house … Presumably if Acme Bank moves to Nebraska and Acmecompetitor Bank stays in New York and takes all their best people, Acme Bank is screwed (or am I missing something).

By: John Quiggin

John Quiggin — Tue, 24 Feb 2004 21:38:03 +0000

You can download the paper I referred to here (2.8 MB Word doc).

By: Chirag Kasbekar

Chirag Kasbekar — Tue, 24 Feb 2004 20:53:52 +0000

For some reason, I thought the post was by Henry! But John, I’m probably missing something (it’s late in the night here—early in the morning, actually), but does that paper say anything about how benefits from clustering are got? (Though the ‘clubbiness’ that the Corp of London report actually touts is probably a pretty significant reason.) From the exec summ of the Corporation of London report: “In the sphere of financial services, the research informs us that large, medium and small-sized financial service firms have a tendency to cluster in metropolitan areas because of the need to: access large pools of specialist labour and support services (e.g. accounting, actuarial, legal etc.); be in close proximity to the markets; benefit from agglomeration economies, which reduce transactions costs; develop and innovate intrinsic skills through the sharing of knowledge and practice (Davies, 1990; Roberts et al., 2000). Financial service firms that locate in strong clusters grow faster than average and strong financial clusters attract a disproportionate volume of new firm entry (Pandit et. al., 2001).” Another major reason the report cites is branding. BTW, the whole report can be got from here: http://www.cityoflondon.gov.uk/business_city/research_statistics/research_publications.htm

By: John Quiggin

John Quiggin — Tue, 24 Feb 2004 19:49:06 +0000

In general, stock markets react favorably to investment projects if they expect positive returns (in NPV terms) from those investments. Even if justified in terms of cost-cutting, a reduction in, say, R&D expenditure won’t in general, produce a positive stock market reaction. Considered as an investment, a relocation to say New York produces a stream of [putative] benefits (those of proximity and spatial agglomeration) and costs (higher rents which raise costs both directly and through the need to pay higher salaries). The stock market reaction says that, in the view of investors, the costs outweigh the benefits. More precisely, the adverse stock market reaction to moves to global cities suggests that any net benefit is less than the initial cost of relocation. But the stronger result is implied by the positive reaction to relocations to cheaper locations. From what I can see from the paper, previous studies have found much the same thing.

By: Chris Bertram

Chris Bertram — Tue, 24 Feb 2004 19:31:38 +0000

I’m struggling a little to see the relevance of your last comment to the broader question. The fact that the stock market reacts positively to a cost-saving relocation decision is unsurprising, especially given short time-horizons.

By: John Quiggin

John Quiggin — Tue, 24 Feb 2004 19:14:37 +0000

I’ve updated the post with the following piece of evidence, which I should have chased down before posting rather than after. Gains from Corporate Headquarters Relocations: Evidence from the Stock Market,” Journal of Urban Economics, Vol. 38(3), November 1995, 291-311, Chinmoy Ghosh, Mauricio Rodriguez, and C. F. Sirmans. This paper provides empirical evidence on investors’ perceptions of the relative advantages and costs of spatial agglomeration. Specifically, we examine the stock price effects of headquarters relocations. The stock market reaction is significantly positive when relocation decisions are attributed to cost savings, indicating that cost savings available at less centralized locations outweigh any loss of enhancements associated with spatial clustering at urban centers. In contrast, decisions prompted by managerial self-interest and desire for luxurious offices elicit an adverse reaction from investors.(emphasis added)

By: pw

pw — Tue, 24 Feb 2004 17:30:21 +0000

Chris Bertram doesn’t go nearly far enough. It’s not just that many kinds of work can’t be done effectively at a distance, but also that when you restrict the universe of “interesting” work to those things that can apparently be done effectively at a distance, you’ve given the organization a case of ALS. Meanwhile, it’s quite possible that a mixed economy of face-to-face and low-latency remote interactons really isn’t viable in the long term, any more than a mixed economy of cash crops and food farming.

By: Chirag Kasbekar

Chirag Kasbekar — Tue, 24 Feb 2004 15:06:11 +0000

I agree with Chris that the potential for conyism is probably just one of the reasons. I found this on London: http://www.cityoflondon.gov.uk/business_city/research_statistics/pdf/clustering_exec_sum.pdf

By: paul

paul — Tue, 24 Feb 2004 15:00:53 +0000

Management of people, at least good management of people, requires face to face contact (at least sometimes). You manage things, but you lead people. And those aspects of the day-to-day running of, say, an academic department, that get achieved over lunch or in the corridor aren’t best represented as “conspiracy” (!). The relationships of the people involved is key here: an associate professor and the head of his department taking lunch is far different from the deans or two or more schools meeting. I think the quote from Smith was pointing out the risk of collusion when enough of the dominant players in a market get together. The whole notion of “location, location, location” and the death of distance is something I have been taking note of: living in a region defined by pronounced boom and bust cycles, I take a personal interest in it.

By: Chirag Kasbekar

Chirag Kasbekar — Tue, 24 Feb 2004 14:53:29 +0000

I also suspect there is some path dependence at work here. After all, these clusters were usually formed—and the financial firms were located in them—much before the internet came along, right?