The San Francisco Bay Area (the nine counties bordering San Francisco Bay) can boast one of the world’s strongest economies, thanks in large measure to the technology companies based in Silicon Valley. Hoping to understand the roots of this success, McKinsey teamed up with two organizations that aim to promote economic growth, the Bay Area Economic Forum and the Bay Area Council, to learn how the region stacked up against eight other parts of the United States as measured by 35 economic indicators. These eight—Austin,¹ Boston, Charlotte, Houston, Los Angeles, New York, Phoenix, and Seattle—were chosen because they resembled the Bay Area in size, industry cluster composition, and international trade status, or because they enjoyed excellent reputations and high growth. The resulting study shows that despite problems of growing concern, the Bay Area has completed its transformation from an industrial and defense-heavy economy into a predominantly knowledge-based one that ranks among the most productive in the world.

Indeed, in the knowledge-intensive business clusters of bioscience, computers and electronics, environmental technology, multimedia, and telecommunications, the Bay Area is the global economy’s leader in productivity (output per employee), with an absolute advantage (Exhibit 1) and a faster rate of productivity growth (Exhibit 2) than the regions with which it was compared. In computers and electronics, for example, the Bay Area produces nearly $16,000 more per employee than Austin, the second-ranked region. In environmental technology, it leads the second-ranked region, Houston, by nearly $52,000 per employee. In addition, it ranks first in productivity in more traditional sectors of the economy—such as business services, retail trade, and wholesale trade—and ranks ahead of Boston (but behind New York) in banking and finance. The Bay Area also benefits from intangibles such as the global movement of talented people, particularly vital for a knowledge-based economy.

Notwithstanding these powerful advantages, the Bay Area faces a number of challenges to its continued growth and well-being. It has the second-highest cost of living among the regions compared in the study, largely because rising wages, equity-rich buyers, and a housing shortage (particularly for lower-income people) have sharply driven up housing prices. Together with increased "returns to talent" for workers in the Bay Area, the high cost of living makes labor significantly more expensive. And traffic congestion is worse there than in any other region covered by the study but Los Angeles.

Even so, the study concludes that the Bay Area enjoys a self-reinforcing cycle of economic prosperity: high business performance in knowledge-intensive industries raises personal incomes and improves the quality of life, and this helps the region attract and keep human and financial capital, thus promoting further investment and growth. But, the study notes, for this cycle to continue, employers, governments, organized labor, community organizations, educational and research institutions, and policy groups must cooperate to solve the region’s housing, educational, and transportation problems.