Technology companies tend to cluster, and the cities where they do have reaped major economic benefits. But there’s a downside — many of these cities suffer from profound inequality. San Francisco, Seattle and Los Angeles are leading tech hubs, and all are unaffordable for many residents. It’s not a coincidence. Tech is one of the forces that drives it.

“The location of technology firms is a big part of their ability to compete,” says Ruben Gaetani, an assistant professor of strategic management at the University of Toronto Mississauga, with a cross-appointment to the Rotman School of Management. “It helps attract talent, and develop new innovations. It’s part of their competitive advantage. But it also contributes to income inequality. Firms in knowledge-intensive sectors cluster together. This drives up commercial rents because they are willing to pay more. It also creates demand for nearby housing, which generates upward pressure on residential rents. But that’s not the end of the story. It’s where the income segregation effect kicks in.”

As nearby areas become less affordable, people relocate.

“Lower income workers could say, ‘I'm leaving the city,’ but as the sector grows, demand for service sector jobs also increases,” Gaetani says. “So, they cannot necessarily relocate outside the city. Instead, they move to another neighbourhood. It often has fewer parks, lower quality schools and longer commutes. Some service workers commute for hours.”

To study this phenomenon, Gaetani examined U.S. cities between 1990 and 2010 — a period in which tech moved from the margin to the centre of the economy. Working with Enrico Berkes, a post-doctoral researcher at The Ohio State University, Gaetani used a dataset of U.S patents that included the associated geographical coordinates to identify areas that experienced an “innovation shock,” which they defined as the expansion of local innovation activities. They correlated this with measures of economic segregation by income, education, and type of occupation. When patent activity increased, so too did economic segregation.

Then, to show that consumption activities also clustered near these locations, they used an economic database called the National Establishment Time Series, which tracked indicators like employment and establishment type during the time period of the study. Both housing rents and local consumption amenities like restaurants and fitness centres increased in neighbourhoods that are less than a 20-minute commute from the innovation shock.

Yet inequality within a city can undermine the reasons why tech companies chose to locate there to begin with.

“It is important for firms to take responsibility for their impact on local economies, and contribute to managing it,” says Gaetani. “Cities should not try to stop the innovation economy’s development because it is a good thing, as far as we know. But policies can help mitigate the negative impacts. The number one thing is to invest in public transit.”

Poor transit contributes to upward pressure on rents by incentivizing tech workers to live near their workplace. It also worsens commute times for those forced to move. But there are other steps cities can take. 

“Investing in libraries, parks and other residential amenities can help mitigate the divergence of amenities across neighbourhoods,” Gaetani says. “Cities have control over these things, and when tech sector development accelerates, companies can help avoid a divergence of amenities. The effects of this can be severe, and lead to crime and social problems. Eventually, it can undermine these cities' competitive advantage.”

This has already played out in Seattle, where Amazon and Microsoft propelled a tech boom that has driven up cost of living. There has been a backlash. Seattle’s City Council even voted to impose a US$275 “head tax” for each employee of high-revenue firms. It would have funded affordable housing and homelessness services, but was repealed when council was faced with a well-funded campaign for a referendum.

Still, when Amazon sought to expand its head office, it looked outside Seattle. The company launched a site selection process for a second headquarters in another city — called HQ2. But even elsewhere, Amazon wasn’t welcomed. The company selected a location in the New York borough of Queens, but backed out before HQ2 was built there following local backlash.

In particular, the community was concerned that residents wouldn’t share in the prosperity — and that there would be negative effects on public schools, which are already plagued by overcrowding. U.S. schools are funded largely through property taxes, and the quality of education can be far inferior in low-income neighbourhoods. Because of this, the effects of income segregation are particularly pernicious across the country.

“When access to high-quality schooling is guaranteed, income segregation is less costly in terms of social gains,” says Gaetani. “But when your parents’ wealth determines the quality of your schooling, income segregation will have extremely negative effects. It reduces intergenerational mobility, and this is something we really want to avoid.”