Thursday, 14 May 2015

Local regs, macro effects

What's the cost of bad urban planning policies? About 9.5% of GDP as a first cut, according to new work by Chang-Tai Hsieh and Enrico Moretti at NBER.

What's the mechanism? When productive cities make it hard to accommodate new workers, whether because of restrictive zoning downtown preventing densification or restrictions on the urban fringe, workers who could otherwise be more productive in moving to the more productive place instead can't; they're priced out and have to stay in less productive centres.
When we quantify the output and welfare cost of this increase in dispersion of the marginal product of labor, we find that aggregate output in 2009 would have been significantly higher if the dispersion of nominal wages had not increased. Holding the distribution of local TFP fixed at 2009 levels, we hypothetically reallocate labor from high wage to low wage cities such that the hypothetical wage in each city (relative to the average wage) is equal to the relative wage in 1964. Intuitively, this scenario involves setting amenities and housing supply at their 1964 level, while keeping labor demand constant at its 2009 level, and allowing workers to reallocate across cities in response. Under this scenario, aggregate yearly GDP growth from 1964 to 2009 would have been 0.3 percentage points higher. In levels, U.S. GDP in 2009 would be 13.5% or $1.95 trillion higher. This amounts to an annual wage increase of $8775 for the average worker.
The effect is driven by housing supply constraints rather than by compensating differentials due to disamenity effects from larger populations.
We estimate that holding constant land but lowering land use regulations in New York, San Francisco and San Jose to the level of the median city would increase U.S. output by 9.7%. In essence, more housing supply would allow more American workers to access the high productivity of these high TFP cities. We also estimate that increasing regulations in the South would be costly for aggregate output. In particular, we estimate that increasing land use regulations in the South to the level of New York, San Francisco and San Jose would lower U.S. output by 3%. 
And if central government is looking for justification for heavy-handed approaches to dealing with cities with restrictive zoning:
We conclude that the aggregate gains in output and in welfare from spatial reallocation of labor are likely to be substantial in the U.S., and that a major impediment to a more efficient spatial allocation of labor is the growing constraints to housing supply in high wage cities. These constraints limit the number of US workers who can work in the most productive of American cities. In general equilibrium, this lowers income and welfare of all US workers and amount to a large negative externality imposed by a minority of cities on the entire country.  
What sorts of policies?
In principle, one possible way to minimize the negative externality created by housing supply constraints in high TFP cities would be for the federal government to constrain U.S. municipalities’ ability to set land use regulations. Currently, municipalities set land use regulations in almost complete autonomy since the effect of such regulations have long been thought as only local. But if such policies have meaningful nationwide effects, then the adoption of federal standard intended to limit negative externalities may be in the aggregate interest. 
An alternative is the development of public transportation that link local labor markets characterized by high productivity and high nominal wages to local labor markets characterized by low nominal wages. For example, a possible benefit of high speed train currently under construction in California is to connect low-wage cities in California’s Central Valley -- Sacramento, Stockton, Modesto, Fresno -- to high productivity jobs in the San Francisco Bay Area. This could allow the labor supply to the San Francisco economy to increase overnight without changing San Francisco housing supply constraints.
So fix Auckland land supply, or put in a 200kph bullet train from Hamilton to Auckland CBD.

Update: to make very clear, whenever I say "land supply", I mean both allowing increased density in town and allowing expansion at the fringes. Land supply means land where you're not banned from doing what's economically appropriate. Height regulations block economically appropriate uses as can metropolitan urban limits.


  1. I wonder if there is a link between this and David Lilian's work on sectoral shifts and random variations in the pace of job reallocation as a source of large variations in the natural unemployment rate.

  2. All of this makes me think of two other questions.

    1) Take this result at face value, and that the movement of people from low wage areas to higher wage areas inevitably leads to higher GDP - no surprises there, but what of the cost of providing infrastructure to service that increased population movement? As those cities get ever larger, the marginal cost of infrastructure of all types goes up steeply as development heads to further afield and into hills and valleys (or much higher densities in CBDs).

    Presumably at some point the marginal cost of infrastructure will equal the marginal increase in productivity, and the movement of people into those cities ought to stop. The only other catch is that often the costs of that infrastructure aren't borne by the person moving to the new city or the developer, they're cross subsidised by the state and smoothed across all tax payers. If those costs are smoothed, then too many people will move, because they're not facing the marginal cost/marginal benefit trade off, they're only facing the marginal benefit side of the equation.

    2) What's the driving force behind the increased wages provided by these larger cities like Auckland, Sydney or Melbourne? And is there an alternative way of meeting this demand, somehow? If this is created by some unintended consequence of another policy somehow, perhaps the easier way to address this would be to unwind that policy than treating the symptoms. (Alternatively, if it's the will of the market, then let's deal with that.)

  3. They have some model extensions dealing with things like whether there are amenities or disamenities in scale and what costs do as population changes. The base case has it neutral if I recall.

    But think of it another way: if the infrastructure is financed by a bond issue, you really just need that the new residents are adding at least enough in net contributions to cover the cost of that bond, right?

    The more difficult case is if the TFP differences are driven by cohort effects caused by the zoning rules.

  4. Yes and no. I'm saying that it's quite possible to have continued population movement driven by wage differences, while still having a net macro negative impact on total welfare.

    Suppose that I'm considering moving from a small city to a large one: the NPV of my wage increase is $250k, and the incremental costs I pay for infrastructure charges are minimal, circa $50k for water and power connection charges. But I pay nothing for the incremental costs I incur to the health system, the transport network, or the education system. Then also suppose that the actual costs of the per household costs for new transport, health and education assets is $300k - but I don't pay these when I move, these are smeared across all tax payers. I've moved because my personal cost benefit analysis is overwhelmingly positive, but I've imposed a large lump of costs on the state by moving, and although my end of year tax bill is marginally higher, it doesn't come close to changing my 'do I move' cost benefit analysis.

    So I've vacated a town with a passable school, little traffic, and a modest hospital to move to the big smoke, where a new road, a new school, and a new hospital will be required. And when I arrive at my new city, I immediately complain about the awful traffic, the clogged hospitals, and the woeful schools.

    Alternatively, if I had a connection charge for all those things in my decision, I may not have moved to begin with.

  5. I like the result a lot, and would love to think it applies to Auckland, but would be interested to see the evidence of high TFP in Auckland (and in particular, to see if the differences to the rest of the country are as large as those for San Francisco, NY or London.

  6. A bit slow off the mark, Eric... I picked up on this research last September!

    Productivity is certainly higher in Auckland, and especially for jobs in inner-city Auckland. So reallocating population growth from Auckland to elsewhere is likely to have a cost, and, as I discussed in my quick review of the research, we should definitely seek to avoid doing that in the future.

    However, I think it's necessary to be a bit cautious when making claims about how much Auckland would have grown in the absence of planning rules. A quick look at the Stats NZ data ( suggests that the city accounted for 53% of New Zealand's national population growth from 1996 to 2013. (Allegedly, this represents slightly faster growth than was projected.)

    In your view, would the city have grown faster in the absence of planning rules? By how much?

    I suppose another hypothesis is that Auckland would have grown in a more productive way in the absence of planning rules. What do you think that would that look like?

  7. Hi Peter,

    The Moretti paper is brand new and wasn't discussed in the Krugman post you're there citing; guess it's a case of accumulating evidence using vastly different methods all coming to the same conclusions here, which lends confidence to it.

    I've not run any counterfactual simulations for Auckland and I'm not really set up to do them either. I expect that a less regulated Auckland would have vastly more density close to downtown, and (somewhat) more sprawl on the fringes - ideally accompanied by congestion charging.

    Note that the productivity results from Moretti go in somewhat odd directions: the country becomes more productive by reducing the productivity of the most productive places - by bringing in more workers who, while becoming more productive by the move, also push the place down the marginal product of labour curve.

  8. Yeah, I would too; can't point to that work off the top.

  9. Alternatively, we could ask what the moral case is for the existing residents to have increased income based on publicly provided services, but to deny incoming residents that same opportunity at the same rate.

    Perhaps we could run a rotation system. We put a cap in Auckland's size, then people are told they can live in Auckland for 10 years then they have to move on to make room for someone else. (Yes, this is hopefully a reducto ad absurdum argument)

  10. The link to the Moretti paper was a bit buried - I'd run across a version of the paper they presented at a conference:

    On regional migration, I recently ran across a 2012 working paper on trans-Tasman migration by Steve Stillman (University of Otago):

    Stillman and his coauthor used data from the 1996-2006 Censuses in both countries to look at drivers of migration for workers with different skill levels. The key finding was that while higher incomes led to inward migration in both countries, and lower unemployment rates led to inward migration in NZ only, house prices did not seem to have any effect.

    Which is not what you would expect to find if Hsieh and Moretti's findings applied in NZ.

  11. You're looking for Dave Maré's 2008 paper on the Auckland productivity premium:

    Maré found that firms in the Auckland urban area were ~35% more productive than the rest of NZ even after accounting for industry composition.