by Jeffrey Lin – Federal Reserve Bank of Philadelphia
Why do firms and inventors tend to locate in dense, costly areas? One intriguing hypothesis is that such geographic clustering lets them benefit from local knowledge spillovers. As nobel laureate Robert Lucas has noted, the benefits of one person’s knowledge spilling over to others play a central role in economic growth and the existence of cities:
What can people be paying Manhattan or downtown Chicago rents for, if not for being near other people?
Proximity may improve the sharing of knowledge, the matching of ideas to firms, or the rate of learning.1 if dense clustering indeed confers these benefits, then that raises the possibility that individuals and firms may not be fully taking them into account when deciding where to locate, resulting in underinvestment in new ideas.
Jeffrey Lin is an economic advisor and economist at the Federal Reserve Bank of Philadelphia. The views expressed in this article are not necessarily those of the Federal Reserve. This article and other Philadelphia Fed reports and research are available at www. philadelphiafed.org/research-and-data/publications.