Are cities really the heart of Australia's economy?

The Grattan Institute has published a new report entitled Mapping Australia’s economy: cities as engines of prosperity, which maps the Australian economy by the location of economic activity, defined as the dollar value of goods and services produced by workers within a particular area.

The Grattan Institute argues that a “great reshaping of Australia’s economic geography is underway”, whereby “the nation has moved from prosperity coming from regional jobs in primary industry a century ago, to suburban jobs in manufacturing after World War Two, to city centre jobs in knowledge-intensive businesses today”.

The report finds that the lion’s share of economic activity takes place in Australia’s cities, whereby “eighty per cent of the value of all goods and services produced in Australia is generated on just 0.2 per cent of the nation’s land mass – mostly in cities”:

Today, cities are the engines of economic prosperity…

The intense economic contribution of CBDs occurs partly because of the concentration of jobs in these areas. But CBD businesses are also much more productive on average than those in other areas. Inner city areas and secondary commercial hubs, such as those around large cities’ airports, also tend to be more productive than other locations. For example, in 2011-12 the Sydney CBD produced $64.1 billion worth of goods and services: about $100 for every hour worked there. Employing only 13 per cent of Sydney’s workforce, this small area generates almost a quarter of the value of the Greater Sydney economy…

The combined central business districts of Sydney and Melbourne alone – 7.1 square kilometres – generate nearly 10 per cent of the value of goods and services produced in all of Australia, three times that produced by the agricultural sector.

And according to Grattan, the Australian economy doesn’t need to make things anymore:

Today the Australian economy is no longer driven by what we make – the extraction and production of physical goods – but rather by what we know and do…

Australia’s cities are the backbone of our economy, with CBDs and inner city areas critically important to the nation’s prosperity. Their predominance reflects the economy’s evolution from one based on primary industry, then manufacturing, then increasingly knowledge-intensive services.

Grattan also seems concerned by the level of sprawl in Australia’s cities, which is making it harder for citizens to access cushy CBD jobs:

If current settings remain unchanged, Australian cities are likely to continue to spread outwards, further increasing the distance between where many people live and the most productive parts of large cities, with implications for both productivity and opportunity.

Thankfully, however, the report doesn’t explicitly recommend greater urban consolidation, although implicitly it does seem to make such a case:

Governments need to understand and respond to our economy’s spatial dimension, including by:

1. Enabling people to choose to live in areas with access to large numbers of jobs, thereby also giving employers a wide choice of employees.

2. Ensuring transport networks better connect employees with employers, and support connections between businesses and their customers, suppliers and partners.

3. Minimising barriers to highly productive activity in CBDs and inner city areas. These include land availability, traffic congestion and public transport access.

While the Grattan Institute has done a good job mapping economic activity across Australia, I believe it has failed to understand the underlying drivers of Australia’s city-centric economic structure and whether it is desirable. In effect, Grattan has focused on the quantity and distribution of growth in economic activity, rather than the quality and sustainability of that growth.

For example, that Australia’s cities – particularly Sydney and Melbourne – contribute the largest shares of economic activity is unsurprising given they are also home to Australia’s finance and insurance industries, whose activity has exploded on the back of Australia’s record high mortgage debt and inflated housing market, as well as compulsory superannuation (see below charts).

The rapid growth in the finance and insurance industries has come about through deliberate government policies, including tax lurks such as negative gearing and capital gains tax concessions, as well as urban consolidation policies, which have inflated land/house values and household debt. Compulsory superannuation has also driven resources to the funds management industry primarily operating out of Sydney and Melbourne. In both cases, economic rents have been transfer to the CBD from elsewhere.

But is this outcome desirable, and should it be celebrated, as Grattan appears to have done? Many, including me, would argue that the financial sector is now far too large and is in fact a parasite that has created structural imbalances and damaged Australia’s longer-run productivity.

Would Australia really be worse-off if the median house price was instead $300,000 rather than $500,000, mortgage debt was 70% of disposable incomes instead of 135%, and the banking sector was smaller and less profitable? In a similar vein, would the nation be worse-off if superannuation concessions had been much smaller and didn’t favour high income earners, and the funds management industry was smaller and less profitable? The answer is obviously no. And yet these types of questions have been completely ignored by Grattan in its city-centric report.

Grattan has also failed to acknowledge that rural and regional areas provide Australia with not only its food, but also the lion’s share of its export revenue, which is effectively what pays for Australia’s imports (consumed mostly by city dwellers):

As noted by Prosper’s David Collyer today:

Australian Services – the CBD clusters the Grattan Institute is drooling over – are simply not globally competitive…

If Australia’s Services sector had any merit whatsoever, the world would queue up and bang on the doors to buy our wares. They are doing no such thing…

The Grattan Institute has been sold a pup by well-coiffed and expensively groomed city professionals who simply don’t make the grade by international standards. Many of our best educated simply take their skills where the best price is paid and the rest focus on rent-seeking in the FIRE sector…

If the Grattan thinkers wanted to reignite prosperity and national competitiveness, they would look at the cost of land – for Rural, Manufacturing and Services, for business and for workers alike. Inexpensive land de-risks all economic activity. We have been bloody fools to abandon this vital natural advantage to the ticket –clippers.

Precisely. Bigger CBDs mean a less competitive economy and a wider current account – hardly a desirable situation.

I am also concerned that policy makers will embrace the Grattan Institute’s report, and divert even more of the nation’s resources into Australia’s CBDs – precisely the opposite of what Australia should be doing.

Measuring progress based merely on the value of economic activity is not particularly useful. Australia needs a well-diversified, balanced, economy with a wide range of industries. Not an economy increasingly based on ticket-clipping and rent-seeking, whereby the spoils flow to a small group of CBD elites at the expense of everyone else.

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Are cities really the heart of Australia’s economy?