So why exactly does almost ALL tech live in Silicon Valley?

And how come the nerds get so much damn money?

Worstall @ the Weekend It was Ben Bernanke who pointed out that economics isn't really all that much good at predicting the next recession (and the long-standing joke is that economists have predicted 11 out of the past three), but it is pretty good at working out why the world is the way it is.

Which brings us to the cutting edge of modern economic research and an explanation of why the tech bit of the tech industry is so hugely concentrated in Silicon Valley, and also why the nerds get paid so damn much.

Our starting point is, as always when looking at the structure of firms and industries, Ronald Coase and his paper The Nature of the Firm. Essentially, he asked why do we have firms? The answer being that sometimes it is more efficient to do so than to have a network of contractors dealing with each other.

Modern research tries to look at why we have specific structures of firms, what is it about that efficiency argument that militates for, say, outside capital, or the workers owning the firm? And we can use this sort of thinking to explain both the Valley and also the vast equity grants that those top nerds get.

Firms in the same trade end up setting up alongside each other simply because it's more convenient to do so. That's where all the skilled workers you're going to poach are, after all. But more than that, that's where all the experienced suppliers are.

Lawyers who know their way around a software patent, the blokes who supply those 1s and 0s in the bulk so vital for programming, coffee shops up to date with the latest weird milk for that latte (have they got to badger or vole yet?).

And this is a more powerful force than many seem to realise: if you were to set up a pottery in the UK you'd still do it in Stoke and the last new one, a couple of years back, was there. And despite the steel works being gone for decades non-ferrous metals trades still set up around Sheffield and Rotherham. Clustering is a powerful source.

However, there's a new argument which comes purely from the knowledge aspect of it all. Knowledge is normally thought of as a “public good”, meaning that it's non-excludable (once someone knows it we can't stop them using it) and non-rivalrous (my using it doesn't reduce the amount available to you).

It's this that explains the whole world of copyright and patents, for we know that pure free markets don't work well with public goods. However, it might well not be true of all knowledge. The insight is to posit that some knowledge depends upon previous investment in knowledge.

A new string theory is only going to be understood by 25 mad physicists as there's only those 25 who actually understand string theory to start with. This makes such knowledge much closer to a “contribution good”, where being able to make use of the knowledge depends upon being part of the right club of people who can understand it.

And I'm certainly willing to believe that much of advanced computing and tech is like that. Maybe not how you rig up 50 items in MySQL, that might well be pretty much a public good but at the more esoteric end, perhaps a contribution good.

The point here about contribution goods being that clubs tend to be geographically based. Simply because it's the interaction of the people that leads to the dispersion of the knowledge and the membership of the club that understands it. We could see this just as an extension of the clustering argument but it's a bit more than that:

The non-rivalness of scientific knowledge has traditionally underpinned its status as a public good. In contrast we model science as a contribution game in which spillovers differentially benefit contributors over non-contributors.

This turns the game of science from a prisoner's dilemma into a game of "pure coordination", and from a "public good" into a "contribution good". It redirects attention from the "free riding" problem to the "critical mass" problem.