A report issued this week by the Grattan Institute finds that, these days, 80 per cent of the dollar value of all goods and services in Australia is produced on just 0.2 per cent of the nation's land mass. Just about all of that is in our big cities, as close in as possible. The report, by Jane-Frances Kelly and Paul Donegan, finds that big cities are now the engines of our prosperity. If you take just the central business districts of Sydney and Melbourne – covering a mere 7.1 square kilometres – you have accounted for almost 10 per of Australia's gross domestic product. What do workers do in all those city offices? Nothing you can touch. That's how much the economy's changed. To find the economy as many people still imagine it to be, you have to go back 50, even 100 years. About 100 years ago, almost half Australia's population of 4 million lived on rural properties or in small towns of fewer than 3000 people. Many of these would have been market towns serving the agricultural economy. Agriculture and mining accounted for a third of the workforce. And only about one in three Australians lived in a city of at least 100,000 people.

These days, agriculture employs only 3 per cent of workers and contributes only 2 per cent of GDP. Our two biggest CBDs contribute at least four times that much. By the end of World War II, manufacturing had become Australia's dominant industry. At its height in 1960, the report reminds us, manufacturing employed more than a quarter of the workforce and accounted for almost 30 per cent of GDP. The rise of manufacturing shifted much of our economic activity – our prosperity – to the big cities, but mainly to the suburbs. Suburbs away from city centres had lower rents and less congestion. Postwar growth in car ownership made possible the shift to a manufacturing economy with a strong suburban presence. It also led to the demise of many small towns and the rise of regional centres. Today, however, manufacturing employs only 9 per cent of the workforce and accounts for just 7 per cent of GDP. The thing to note is that this seeming decline in manufacturing has involved only a small and quite recent fall in the quantity of things we manufacture in Oz.

Similarly, the decline in agriculture's share of employment and GDP has occurred even though the quantity of rural production is higher than ever. The trick is that these industries didn't contract so much as other parts of the economy grew a lot faster than they have, shrinking their share of the total. One of those other parts is mining, of course. But get this: "While Australia's natural resource deposits are typically in remote areas, workers in cities make a critical contribution to the industry’s success," the report says. "For instance, in Western Australia, where the most productive mining regions are located, more than one third of people employed in mining work in Perth." That's partly because of fly-in fly-out, but mainly because many of these workers are highly skilled engineers, scientists, production managers, accountants and administrators. So what explains the greater and still-growing economic significance of big cities, so that Sydney, Melbourne, Brisbane and Perth now contribute 61 per cent of GDP? The rise of the knowledge economy.

Increasingly, our prosperity rests not on growing, digging up or making things, but on knowing things. Our workforce is more highly educated than ever, and this is the result. "Knowledge-intensive jobs are vital to the modern economy. They drive innovation and productivity, and are a critical source of employment growth. In the last 15 years there has been much higher growth in high-skilled, compared to low-skilled, employment," the report says. Knowledge-intensive activities aren't confined to jobs in the services sector, but are also increasing in mining and manufacturing. They often involve coming up with new ideas, solving complex problems or finding better ways of doing things. But here's the trick: it suits many of the knowledge workers, and the businesses that employ them, for those workers to be crowded into big cities, as close in as possible. When you're all packed in together, there's more scope for the transfers of expertise, new ideas and process improvements known as "knowledge spillovers". Such spillovers come particularly through face-to-face contact. Large cities offer employers knowledge spillovers and a large potential skilled workforce. They also offer people greater opportunities to get a job, move to a better job, build their skills and bounce back if they lose their job.

Ross Gittins is economics editor.