02The geography of economic complexity in Britain
What is economic complexity?
The creation and use of knowledge drives economic growth, whether through the invention and adoption of new technology, or improvements to the ways that we work and live.
‘Economic complexity’ as a concept attempts to capture this process of knowledge creation and diffusion. The amount of knowledge and know-how (in particular ‘tacit’ knowledge, which is mainly communicated face-to-face, as opposed to codified knowledge, which is written down) within an economy determines which activities exist and how complex they are.
Large amounts of accumulated knowledge enable economies to be more complex, which is associated with productivity. Meanwhile, places with low amounts of knowledge often specialise in activities that are associated with low complexity, which tend to compete on low-cost production by locating where production costs (e.g. labour and land) are cheaper.
Consequently, complex areas are more likely to generate networks of knowledge, which in turn drive new innovations and growth within existing industries, and aid transitions to new types of high-value activity.
For example, a place is more likely to move from computer software development to smartphone app development, than it is to go from shirt production to app development.2 Moving from one complex activity to another is important for places that wish to sustain their prosperity and economic success over the long run, and indicates the importance of access to knowledge in creating and attracting new types of work and production. Box 2 discusses the definition of economic complexity in more detail.
Box 2: Economic complexity, definition and methodology
Definition – The concept of economic complexity, developed by Hidalgo and Hausmann in 2009, examines countries’ exports and identifies in which products an economy has a competitive advantage by analysing international trade data. A country is considered specialised in a product if it holds a revealed comparative advantage (RCA): its export share of a product is higher than the product’s share in overall world trade. 3
Revealed Comparative Advantage (RCA) = Sector’s weights in one place is higher than its weight in the overall economy
Under this approach, economies are defined on how diverse (how many products it has a specialisation in) they are; and how ubiquitous (number of places that are able to make a product) their areas of specialisation are.4 As a result – by interacting diversity with ubiquity – it is possible to assign an Economic Complexity Indicator (ECI) for each geography, built upon Product Complexity Indicators (PCI) for each product, industry or activity. This idea is connected to the capabilities approach and the cross-industry “knowledge spillovers” ideas described by Jacobs.5
As economic complexity is a relative concept, there will always be cities and large towns which are more complex than others, and other places which are less complex. This is because the choices facing workers and firms are also relative – they face trade-offs between different locations which offer varying combinations of costs and benefits, and they ultimately make a relative choice between these available options.
What is complex economic activity?
The economic complexity concept, by comparing activities across geographies, can identify how complex one activity is by simultaneously analysing its individual ubiquity (number of places that are able to make a product) but also how common the remaining activities in that economy are.
Rare activity is not necessarily complex. For instance, a product or activity that is rare only because of its geography (e.g. diamonds and oil) is likely to be located in a place that produces several non-rare (high ubiquity) goods (e.g. agricultural products). At the opposite end of the spectrum, a rare and complex activity is usually bundled next to other rare (low ubiquity) activities, suggesting that its production requires a certain level of accumulated knowledge in the economy. Complex activities such as software development are likely to be located next to other high-knowledge (complex) activities like pharmaceuticals or marketing.
A complex economy is generally characterised by having competitive advantages in several high complexity activities. Such a combination reflects both economic diversity and the existence of the accumulated knowledge which the complex activity requires.
The productivity of an economy is also linked to the size of its most complex activity. If two economies have comparative advantages in the same sectors, the one with a higher employment share in the most complex jobs tends to be more productive as it has achieved greater specialisation.
Applying economic complexity at the urban level
In recent years, economic complexity has been applied at the urban level in several countries including the UK and US.6 Unlike cross-country comparisons, revealed comparative advantages are measured using employment data, instead of international trade data. A city or town has an RCA in a particular sector if employment in that activity is more prevalent than the overall average. For example, if mining represents 2 per cent of total employment in one country/region, all cities and large towns with more than 2 per cent of their workers working in mining will have a competitive advantage in that specific sector.
For the purpose of this paper, economic complexity for Britain as a whole considers all local authorities separately; while urban economic complexity solely covers the 62 Primary Urban Areas. A place will be considered complex if its respective Economic Complexity Indicator (ECI) is above zero. Moreover, Product Complex Indicator (PCI) is based on employment data by occupation. This approach assumes an equal PCI score for the same occupation in different cities and large towns, and so is conservative in its estimates.7
In terms of economic sectors, economic complexity is only based on exporting activities. Because they are not tied to a local market, these exporters could, in theory, locate anywhere but in reality cluster in certain places, and so it is these activities that are of particular interest. 8
What are exporting businesses?
Exporting businesses (also known as business to business (B2B) or tradable businesses) sell to regional, national or international markets (including manufacturing, software, advertising etc.). They form the export base of the local economy and bring money into it to be spent on local services (such as shops, cafes and barbers). The market these businesses sell to does not tie them to a specific location, and they are free to set up wherever they want so long as they can access their target market and access what they need to remain internationally competitive. Such exporting economic activities choose their location based on the respective competitive advantages. Given their different needs, high-value-added exporting activities and low-cost production activities are likely to be in different locations. For this research exporters and local services firms are defined using Standard Industrial Classification (SIC) codes.
Some economic activity is more complex than others
Understanding the complexity of local economies first requires a measure of the complexity of the type of activity located within each place. By measuring the rarity of exporting occupations, and whether they are located alongside other rare activities, it is possible to rank all kinds of exporting activity and assign each a score, or Product Complex Indicator (PCI). The top and bottom ten occupations by complexity are shown in Table 1.
Table 1: Exporting occupations by complexity, 2019
|Top 10 occupations||Bottom 10 occupations|
|Reinsurance||Mining of hard coal|
|Fund management activities||Manufacture of refractory products|
|Trusts, funds and similar financial entities||Manufacture of basic iron and steel and of ferro alloys|
|Advertising||Processing and preserving of meat and production of meat products|
|Manufacture of magnetic and optical media||Manufacture of tanks, reservoirs and containers of metal|
|Computer programming, consultancy and related activities||Manufacture of basic chemicals, fertilisers and nitrogen compounds, plastics and synthetic rubber in primary forms|
|Market research and public opinion polling||Manufacture of basic precious and other non-ferrous metals|
|Passenger air transport||Manufacture of other products of first processing of steel|
|Television programming and broadcasting activities||Casting of metals|
|Data processing, hosting and related activities; web portals||Manufacture of other fabricated metal products|
The most complex activities – typically rare activities that cluster next to other rare activities – such as finance, advertising and programming are services that are mostly located in city centres as they need pools of highly-skilled workers.9 On the opposite side, activities with low complexity are more likely to be found in non-urban areas, suburbs, and poorer cities and large towns.
Urban economies are more complex
The concentration of complex activity in sectors which value the benefits of cities can be seen in the geography of economic complexity across the UK. As Figure 1 shows, in 2019, urban areas were, on aggregate, substantially more complex than non-urban areas.
Figure 1: Urban areas are more likely to be complex than non-urban areas
Cities provide deeper labour markets for firms, which allow them to achieve greater levels of specialisation and complexity. This is linked to firms’ desires to access knowledge. As tacit (as opposed to codified) knowledge is best transmitted face-to-face, cities in principle have an inherent advantage in attracting more complex activities as they make it easier for people to exchange ideas and information (‘knowledge spillovers’).10 11 These features are known as ‘agglomeration effects’ and put cities in a better position to attract complex businesses.12 In 2015, city centres in Britain collectively accounted for 0.1 per cent of all land,but they accounted for 14 per cent of all jobs and 25 per cent of all jobs in more productive services businesses.13
Economic complexity is linked to productivity
The geography of economic complexity does not just differ across urban and non-urban areas. It also varies between cities and large towns, as different urban economies offer different benefits to exporting firms. If complexity is associated with economic performance as a reflection of the type of exporters present within a local economy, then we would expect to see more prosperous places to be more complex.
As Figure 2 shows, more complex economies tend to be more productive. Those cities and large towns in the top right quadrant have high complexity and high output per worker, while those in the bottom left quadrant have low complexity and low output per worker. Places are considered complex in this report if their respective Economic Complexity Indicator (ECI) is above zero.
Figure 2: Highly complex economies are more productive
Cities in the South are more complex than cities in the North
Most cities and large towns that have both high complexity and productivity are located in the Greater South East. As Figure 3 indicates, cities and large towns with lower levels of complexity are generally located in the North and Midlands, where their competitive advantages, such as distribution, warehousing and storage, usually require access to a different set of benefits – namely low-cost land and pools of lower-skilled workers and lower wages.
Figure 3: Cities in the South and big cities elsewhere are complex
As previous Centre for Cities research has shown, highly skilled exporters – which tend to be more productive– are predominant in the Greater South East because cities have been able to offer both access to lots of skilled workers and networks of other highly–skilled businesses. Crucially for ongoing policy discussions around whether subsidies should be used to level up the economy, in order to access those advantages and the accumulated knowledge associated with them, these highly productive firms are willing to pay a premium in the form of more expensive commercial space and higher wages to locate in these parts of the country. 12
Big cities outside London are complex
Yet there is an exception to this North—South divide. A number of Britain’s biggest cities outside of London, such as Glasgow, Manchester, and Liverpool, are as complex as smaller cities in the South, as the map in Figure 3 shows, and as the scatter chart in Figure 2 does, highlighted in purple. This indicates that these cities do have qualities that appeal to firms and workers engaged in complex economic activity.
But these large cities are not very productive
However, big cities have productivity levels below the urban average, despite being relatively complex economies. The scatter chart in Figure 3 demonstrates that Bristol exceeds the urban average, whereas Manchester, Glasgow, Leeds, and Liverpool despite being highly complex are not especially productive. The observed mismatch – productivity underperforming relative to complexity – suggests that these cities have not been able to make the most of their most complex economic activities.15
The underperformance of most big cities is partly explained by the relatively small size of their most complex activities – it is possible for a city to have a competitive advantage in an industry but for that industry to only play a small role in the economy.16
Currently, most large cities have competitive advantages in some complex activities. However, those sectors employ a comparatively low share of workers when compared with the most successful economies in the Greater South East. Figure 4 demonstrates that these complex Southern cities tend to have more than 20 per cent of their exporting jobs in their five most complex activities, while the big cities are less specialised. As a consequence, big cities’ most complex activities – and therefore most productive – are not large enough to drive up overall productivity.
Figure 4: Unlike the most successful economies in the Greater South East, complex sectors in the UK’s biggest cities tend to employ less than 20 per cent of the total number of exporting workers
For example, Glasgow and Brighton are similarly complex but their productivity differs substantially. Brighton, a city that is highly productive, has 54 per cent of its exporting jobs in its most complex activities. In Glasgow – where productivity is below the national average – only 13 per cent of its exporting jobs are in its most complex occupations.17
Despite being relatively complex in the British context, big cities are less complex than their French and German equivalents
The picture is the same when comparing UK cities to their European peers. In line with their low productivity, the largest British cities lag their French and German peers in terms of economic complexity, as can be seen in Figure 5.18
Figure 5: Big cities significantly lag their German and French counterparts
Of the eighteen largest French and German cities identified, all of them have high complexity.19 In contrast, only three out of nine British cities (Bristol, Leeds and Manchester) had complexity levels above this average.20 Smaller cities and towns in Britain also lag their French counterparts, but the gap is much smaller than for large cities.
Complex activities have increasingly shown a preference to locate in Britain’s big cities, and the evidence shows that as complex local economies, big cities are places of knowledge creation and diffusion. While this has not yet been observed in high levels productivity, the experience of French and German cities provides grounds for optimism. Their big cities are yet more complex than those in the UK, suggesting that there is still room for the UK’s big cities to progress further.