Talent, clusters and scale: Identifying European office markets in the era of knowledge capitalism

The role of a city is vastly different to fifty years ago. Chris Urwin, Director of Research – Real Assets, and Vivienne Bolla, Research Analyst – Real Assets explain why talent, clusters and scale are key factors in determining which cities – and therefore European office markets – will thrive in the years ahead.

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The changing role of cities

The role of a city is vastly different to fifty years ago. Many of Europe’s great cities grew up in an era of industrialisation when competition was heavily driven by input costs. Locations benefited from qualities such as a natural harbour, access to a navigable river, proximity to sources of fuel (usually coal) and access to labour, suppliers and consumers. With such qualities, cities enjoyed a durable comparative advantage.  

But as global markets opened up, the pace of transportation accelerated, and the cost of communication fell, such qualities no longer provided cities with a competitive edge. Global sourcing rendered the old notion of comparative advantage less relevant.

Yet location matters no less than it did in the past. As leading urban economist Ed Glaeser puts it, “a central paradox of our time is that cities, industrial agglomerations remained remarkably vital, despite easier movement of goods and knowledge across space.” Today, a city’s success is driven by its ability to facilitate knowledge exchange and information sharing to nurture idea creation. Competitive advantage no longer rests on access to inputs but on making more productive use of inputs and this requires continual innovation.

Talent, clusters and scale

So the characteristics that make a city successful have changed entirely. In an era of knowledge capitalism, cities need talent, clusters and scale. All of which are inter-related and somewhat co-dependent. Cities with clusters of excellence attract talent, which in turn leads to growth and scale. As the urbanist Richard Florida says, “access to talented and creative people is to modern business what access to coal and iron ore was to steel-making.” Large agglomerations of highly-skilled people are therefore critical to a city’s prospects.

Being part of a cluster provides companies with easier access to information and technology, while providing efficiencies in sourcing inputs such as labour. This enables a city’s firms to be more productive.

Stockholm, Berlin, Amsterdam and Copenhagen are cities with world-renowned clusters in digital and biotech fields. Each enjoy a positive dynamic and the liveability of the city attracts highly skilled talent, pools of highly skilled labour attract businesses and foster firm creation and this, in turn, encourages more qualified people to choose to live in the city. Berlin, for example, is home to 38,000 digital and creative companies and it is estimated that a start-up is founded every 20 minutes there.

Equally, Munich, Frankfurt and Dublin are cities that compete globally as headquarter locations and are supported by strong labour market credentials. They have vibrant clusters in financial, automotive, ICT and media, cultural and creative industries, and engineering sectors.

Working population
Source: Oxford Economics, April 2019

Lyon, Stuttgart and Hamburg are examples of well-rounded cities that host knowledge intensive business activity and boast strong demographic credentials. They are regional powerhouses set to drive growth in some of Europe’s most successful regions. While Stuttgart is home to several major companies including Daimler AG, Porsche, Mercedes-Benz, Bosche and Mahle, Hamburg is the economic centre of northern Germany and transportation hub for both Scandinavia and Eastern Europe.

Total students
Source: QS, April 2019

Agglomeration benefits when firms and people locate near one another as co-location makes the exchange of goods and ideas easier and cheaper. The larger the agglomeration, the greater the benefits. Indeed, these benefits tend to increase at an exponential rate as cities increase in size. So larger cities are more productive simply because they are larger.

Europe’s two megacities, Paris and London, stand out as magnets for global talent and their scale gives them a major competitive advantage. They have the right credentials to drive growth in an era of knowledge capitalism and both have office markets characterised by significant constraints to new development, signalling scope for sustained rental growth over the long run.

Cities of the future

Such characteristics are the most important drivers of cities’ success. Of course, in an era of globalisation, cities that have an ability to attract global talent and capital will also benefit from an international profile and global connectivity. An appropriate level of autonomy combined with visionary leadership can also improve a city’s prospects.

Selecting cities for office investments requires focus. All told, there are 800 cities in the EU, including over 100 with a population of over a quarter of a million.

While some cities do seem well placed to drive growth in an era of knowledge capitalism, they offer limited opportunities for office investors, either because they are small markets – such as Oslo or Helsinki – or because there are very few barriers to entry, as is the case in Warsaw. Each of the cities we have identified for office investment have either significant barriers to entry or have specific submarkets in which supply risks are low.

More notable, perhaps, is the exclusion of some major European cities including, for example, Madrid and Milan. While both cities are very established office markets, neither city looks particularly well placed to succeed as knowledge economies. The overall educational attainment levels of both cities compare unfavourably with northern Europe. Emigration of young talent is a key concern in both Spain and Italy, undermining their talent credentials. Furthermore, Madrid’s working age population is set to gradually decline in the years ahead, while Milan’s prospects are hindered by relatively high long-term macroeconomic risks in Italy.

Cities set to thrive, particularly in an era of knowledge capitalism, are those that manage to attract talent, establish or maintain clusters of value-add economic activity and leverage the agglomeration effects that occur when firms and people locate in close proximity. 

Strategic target office markets
Source: Aviva Investors, May 2019

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