Wednesday, June 8, 2016

How to raise GDP 10%, and reduce inequality too

Chang-Tai Hsieh and Enrico Moretti have a very nice new working paper "Why do Cities Matter?"
..increased wage dispersion lowered aggregate U.S. GDP by 13.5%  Most of the loss was likely caused by increased constraints to housing supply in high productivity cities like New York, San Francisco and San Jose. Lowering regulatory constraints in these cities to the level of the median city would expand their work force and increase U.S. GDP by 9.5%. 
Roughly, the same worker, working the same job, in San Jose or San Francisco, earns double what he or she earns somewhere else in the country.  Here is their plot of wages across cities:

Sure: Chang-Tai Hsieh and Enrico Moretti

The right tail there isn't just missing -- it was absent in 1964. There weren't any cities (MSA's) with 50% higher wages than average in 1964. That's New York, San Francisco and San Jose now.

What does this have to do with growth?

Suppose there are good opportunities, for high productivity employment in an area like Silicon Valley. Businesses start, try to expand, and bid up wages to match the higher productivity. That's all good, but with strong housing restrictions it stops there. New people can't move in to take those high wage jobs. They try to, but they bid up house prices until the higher house price matches the higher wage.

Now suppose there are fewer restrictions on building new houses or more dense houses. Then lots of new workers can move in, the businesses an expand. Eventually, a much larger group of workers gets the higher wages, and the business expands a lot.

So, productivity-enhancing ideas mixed with housing restrictions don't do nearly as much for growth as those ideas with more open housing markets -- especially markets open to newcomers. Housing restrictions also hurt measured inequality, by creating this large wage gap. (Inequality measures typically do not control for local housing costs. Rent controls and "affordable housing" lotteries may seem to help low income people, but only those who have been there for a while, not workers moving in for new and better jobs.)

The paper has a clear model and careful calculation of this effect.  Their bottom line is that US GDP would be overall about 10% higher than it is now -- and not just in some free-market nirvana, just if New York, San Francisco and San Jose were "only" as restrictive as the typical US city.

This fits in to the long simmering issue of how much micro-economic distortions and rent-seeking are hindering long run growth. My view, here for example, holds that micro economic regulation is holding back growth a lot. The contrary view is that regulation is a small-potato annoyance, 1-2%  growth is as good as it gets, go back to slicing up the smaller pie. The trouble is that for all the regulation horror stories, it's hard to put together solid numbers.

Here is one. 10%. Just from zoning laws and other building restrictions.


  1. Houston, Austin, Dallas, Phoenix...FTW!

    You've hit the nail on the head

  2. Jerry Brown has that is a step in the right direction, but even then leaves significant barriers to development.

    "To spur growth, Brown wants to wipe away local and state rules on parking, height, density and environmental reviews beyond those already required through zoning. "

  3. OK. So why don't they move. If the housing costs are that daunting, why don't employers move to some where where they are cheaper. The US has plenty of places where housing is mor reasonable and there is a skilled workforce.

    1. They do move where the housing is cheaper. So do companies. Lots of companies relocating or expanding in Southern or Midwestern cities, instead of North East or West Coast. Toyota just moved their headquarters to Texas. Bank of America is expanding in Tampa. etc.

      You'd expect the wages in these cities to be lower too, and they are too some degree. But not by much, and on a cost of living basis, they are considerably higher than the high wages in SF or LA or NYC.

      The problem is essentially that when adjusted for cost of living, that high wage in SF may actually be no better, or worst, than a much lower wage in Austin TX. There's other considerations that keep companies from having a wage in Austin that's 50% that of SF, for the same job, so they will still need to offer a nominally comparable wage, which means the workers will benefit much more in these cheaper cities.

    2. Because of so called "economies of agglomeration": there seem to be huge economic benefits is cramming people and businesses into a small space - i.e. big cities.

    3. Same with London in the UK. Anyone living within 100 miles of London who wants a really well paid job has to physically go and work in London, even if it means a 1 hr commute. It’s strange: seems face to face meetings are still essential despite the internet.

    4. Because of the what is perhaps the biggest demographic force of our time: Young, professional, tech savvy people want to live and work in 24/7 urban places.

    5. What I have seen is that employers start out in these high paying cities, because that is where there is an abundance of highly skilled talent. As they grow, they decentralize, putting more people in less expensive locations over time, but keeping their headquarters in the high priced location.

    6. "Because of the what is perhaps the biggest demographic force of our time: Young, professional, tech savvy people want to live and work in 24/7 urban places"

      There's lot of urban areas in the US besides SF and NYC.

      SF and Boston have below-average growth in "young college graduates". NYC's growth (which is just average) is mostly due to growth in foreigners (who basically have never heard of other cities besides NYC)

      The comparison isn't between urban and suburban. But between different urban areas. The big growth in this demographic is happening exactly in the places where cost of living is cheaper.

  4. It seems that the 1964 pattern is caused by a combination of suburbanization, White flight, and the Great Migration. This is really intriguing.

  5. Property zoning and other stipulations against development are a much bigger hindrance to national economic growth than trade laws and minimum wage edicts.

    Worse, maybe people who own land in Southern California or Boston, of SF or NYC have the right to develop it as they see fit? Have property rights disappeared altogether?

    I can tell you this: If, say Newport Beach, CA ripped away all zoning and property use edicts, and legalized gambling, they would boom for decades, eclipsing Las Vegas and Miami Beach put together.

    The problem is, the residents of Newport Beach (a GOP stronghold) do not want development.

    So...let's talk about the minimum wage....

  6. Is there an assumption in there that if we increase the supply of labor in San Francisco by reducing housing costs through de-regulation, wages will still remain the same? Seems sketchy.

    1. The salaries will be lower, but not by much. Most salaries are relatively similar across cities for the same job, and are more a function of the particular company operating there.

      But on a cost of living basis, that $10k lower salary for a software engineer in Austin TX vs. San Jose, is actually about 40% higher. A lot more disposable income left over for the person working in Austin than the one working in San Jose.

  7. A lucid article from nine years ago on the micro-side of how these building restrictions create different growth patterns and make some places very expensive to live:

  8. The right tail matters but so does the left one - San Francisco and New York both have vast numbers of illegal aliens paid cash wages off the books or employed with no prior document verification.

  9. billionn

  10. If their were no cities in 1964 with wages greater than 50% higher than the national average and now New York, San Francisco and San Jose are over 50% higher than the national average, it strongly implies that growth in those cities has been much stronger than in the rest of the economy. In other words locations with policies and institutions you claim stifle growth are the fastest growing economies in the country.

    Maybe you should reconsider your recommendation as the sample you selected did just the opposite what your beliefs implied.

    Milton Friedman said the test of a theory is its ability to make correct projections and your beliefs obviously failed this standard

  11. If in 1964 no city had wages more than 50% above the national average and now San Francisco, New York and San Jose have wages more than 50% above the national average it implies that theses three cities have been growing much faster than the national average. Isn't that just the opposite of what your beliefs imply should happen? In other words the three cities with what you characterize as very bad policies may have the strongest economic growth in the country.

    Maybe you should reconsider your beliefs as the sample you directly contradicted the results you expected.

    Milton Friedman argued that the test of a policy is its ability to make projections and on that basis you analysis fails miserably.


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