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Industry Diversity in Cities

Regional Matters
May 9, 2018

Some cities are known for particular industries. Wall Street in New York is synonymous with finance. Detroit was known for its automobiles and Pittsburgh for its steel. But many other cities aren't known for anything in particular, and even the cities named above have jobs in a variety of industries. New York City is undoubtedly an important financial center, and yet most people there don’t work for banks. Industry diversity, and its opposite, specialization, are important topics of study in economics. A recent Econ Focus article looked at previous economic research and found some interesting facts about industries in cities.

Measuring industry diversity is not a simple task. Since every city has a different mix of industries, it is helpful to compare them to a single area. One way to do this is with the relative diversity index (RDI), which compares the share of total employment in each industry in a city to the same share in the nation. These differences are added together to create a single number that measures industrial diversity, allowing a comparison across very different cities. (Note that the discussion of "cities" here refers to metropolitan areas with a shared economy, so it might technically include multiple cities.)

Research by the economists Duranton and Puga pointed out the interesting fact that, from the 1970s to the 1990s, the economies of larger cities have a wider range of industries, while smaller cities are more specialized. As shown below, this still holds in 2015, and the results are striking. When grouping together cities by population, the larger a city is, the more diverse its economy tends to be.

But why is this the case? There are many benefits to firms locating close together, called "agglomeration economies," caused by lower costs of doing business when people and firms are closer together. These forces are explored further in our 2016 annual report, as well as in other work by Duranton and Puga, but transportation costs provide a simple example. It will be cheaper for a baker to buy flour if he doesn’t have to pay extra to have it shipped from far away.

These forces help create cities, but they can operate in different ways that lead to more diverse or more specialized industries. Urbanization economies arise when firms benefit from having a variety of other industries nearby. For example, corporate headquarters might prefer to locate in a city where they can easily access marketing, legal, and IT services all in the same area.

On the other hand, localization economies encourage firms of the same industry to locate together. For example, car manufacturers might want to locate close to a steel manufacturer in order to get cheaper steel, and this will in turn attract related businesses, like tire or airbag manufacturers, to the same location. Urbanization and localization forces interact to create the balance of industries in a city.

This broad pattern of diversity is present within the Fifth District as well as the nation. Industrial diversity seems to increase with the size of a city, measured here with employment instead of population. (See chart below.)

Notably, the Washington, D.C., metro area is less diverse than you would expect for a city of its size. However, considering the concentration of federal government employees and contractors in the nation's capital, this is not so surprising. Aside from that, the pattern appears quite strong. Charlotte, N.C., has the most diverse industrial mix of any Fifth District city, while Bennettsville, S.C., is the least diverse.

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Views expressed are those of the authors and do not necessarily reflect those of the Federal Reserve Bank of Richmond or the Federal Reserve System.