Professor Mario Polèse wrote an excellent essay for City Journal on the Seven Pillars of Agglomeration. Pillar four is representative of some of the less obvious incentives:
Scale economies are only part of the urban-expansion story. Most city dwellers work not in massive plants but in small and midsize firms in a wide array of industries: legal services, shirt-making, financial counseling, and on and on. Why should these companies set up shop in cities? Pillar four—the need for proximity with other firms in the same industry—provides part of the answer.
Proximity brings numerous advantages. To name just one: face-to-face contacts remain essential for the most valuable and sensitive information. Finance, among the most spatially concentrated of industries, is an obvious example. Trust must be constantly renewed; millions of dollars will be committed based on a brief encounter. The greater the risks and sums involved, the greater the need for relationships built on something more than e-mail exchanges. Body language, facial expressions, and eye contact are among the signals that financial workers use to judge others.
Personal contact is also crucial in industries where creativity, inspiration, and imagination are vital inputs. For firms working in these rapidly evolving industries—high fashion, say, or computer graphics—the surest way to stay on top of the latest news is to locate near similar firms. The more that information can be transmitted electronically, it seems, the more valuable becomes information that cannot be so transmitted. Electronic and face-to-face communications tend to be complements; business travel, for example, has accelerated since the advent of the Internet. The more people communicate, the more they want to meet in the flesh.
Lower recruitment and training costs are additional advantages of proximity, particularly in highly specialized fields. A firm clearly benefits if it can hire from a pool of available workers with relevant training acquired at previous employers. The chances of finding a first-rate, experienced screenwriter will be a lot better in Los Angeles than in Baton Rouge.