Better and better

By R.A. | WASHINGTON

ONE of the fascinating recent developments in America's economic geography is what some economists have called a Great Divergence. Over the past thirty years, Americans have geographically sorted themselves along interesting lines. Cities that had relatively skilled populations in 1980 have become more skilled and more productive, and have generally featured fast-rising wages and housing costs. Places that were relatively less skilled, by contrast, have stayed that way and have mostly experienced a growing wage and productivity gap with the high flyers. The cause of this divergence is tricky to tease out. It seems to begin with a surge in the return to concentrations of skilled individuals. Globalisation and information technology may have increased the return to skill levels and the benefits of clustering among skilled workers, from "knowledge spillovers" to thicker labour markets.

At any rate, rising productivity in skilled cities has interacted with rigid housing supply—rich, skilled areas like San Francisco and Boston are hard places to get new buildings built, thanks largely to regulatory restrictions on growth. And so one could tell a story in which high housing costs are deflecting all but the most skilled, best paid households away from rich cities. Further, one could argue that this deflection is checking the growth of productive places, with nasty implications for economic growth.

An interesting new paper (a job market paper!) by Rebecca Diamond puts a twist on this story, however. She writes:

This paper examines the determinants of high and low skill workers' choices to increasingly segregate themselves into different cities and the welfare implications of these choices...I show that changes in firms' relative demands for high and low skill labor across cities, due to local productivity changes, were the underlying drivers of the differential migration patterns of high and low skill workers. Despite local wage changes being the initial cause of workers' migration, I find that cities which attracted a higher share of college graduates endogenously became more desirable places to live and more productive for both high and low skill labor. The combination of desirable wages and amenities made college workers willing to pay high housing costs to live in these cities. While lower skill workers also found these areas' wages and amenities desirable, they were less willing to pay high housing costs, leading them to choose more affordable cities. Overall, I find that the welfare effects of changes in local wages, rents, and endogenous amenities led to an increase in well-being inequality between college and high school graduates which was significantly larger than would be suggested by the increase in the college wage gap alone.

Ms Diamond reckons that changes in workers' relative productivity drove migration, and that cities that hoovered up more skilled workers became more productive and paid higher wages to high and low skill workers. But cities that attracted a large share of skilled workers then experienced a major improvement in their local amenities. The quality of local schools rose, for instance. Crime fell. Cultural and entertainment opportunities expanded. Thanks to slow housing supply growth, housing costs in these places soared. And because low skill households have been less willing to pay for the improvements in amenities, they've left for cheaper cities.

And here's the kicker: once one takes into account the rising amenity values in skilled places it turns out that growth in welfare inequality has been larger than growth in income inequality.

The improvements in quality of life that result when lots of really skilled individuals move in appear to large enough to compensate really skilled individuals for high housing costs—but not less skilled individuals. To take an example: someone working as a nanny in San Francisco will earn a lot more than someone working as a nanny in San Antonio, thanks to the higher overall productivity and wage levels in the Bay Area. But that higher wage might not be high enough to allow the nanny to regularly dine out at fancy small plates restaurants. So while the nanny's household may benefit from some of the improvements in local amenities, it doesn't get enough out of them to compensate for the extremely high San Francisco housing costs that come along with the city's overall wealth.

I think this is a really nifty way of looking at the Great Divergence which leads to some interesting questions. Such as: to what extent is a taste for "high skill amenities" or an insensitivity to their cost a reliable characteristic of highly skilled workers? Depending on the relationship, this could be seen as validation of Richard Florida's "creative class" story, in which certain amenities like tolerance or cultural riches can contribute to economic success.

Perhaps more important, it may suggest that high housing costs in productive cities aren't necessarily bad for overall economic growth (though they continue to be bad for the distribution of its gains). I worry that high housing costs deflect skilled individuals elsewhere, reducing the productivity impact of skilled clusters and potentially sowing the seeds of their demise. But if high housing costs, by tilting the labour market balance toward highly skilled workers, generate lots of the precise amenities skilled workers love, then they may become more effective at attracting the skilled types that contribute to spillovers, productivity, high wages and, apparently, high amenities levels. Perhaps they help generate a hard core of concentrated, well-remunerated human capital. At any rate, this certainly provides an even stronger economic rationale for NIMBYism in skilled cities.

A very interesting result, which has given me a lot to think about.