How the Elites Built America’s Economic Wall

Bloomberg View , July 18, 2012

For a century, incomes became increasingly equal across the U.S., as poor states such as Alabama caught up to rich places like California.

Economists have long taught this history to their undergraduates as an illustration of the growth theory for which Robert Solow won his Nobel Prize in economics: Poor places are short on the capital that would make local labor more productive. Investors move capital to those poor places, hoping to capture some of the increased productivity as higher returns. Productivity gradually equalizes across the country, and wages follow. When capital can move freely, the poorer a place is to start with, the faster it grows.

“That’s one of the central relationships in macroeconomics,” says Daniel Shoag, an economist at Harvard University’s Kennedy School of Government. “It’s an extremely strong one, and we teach it in introductory macro because it’s one of the few macro facts that are predicted by a model that isn’t a tautology and that holds extremely well.”

Or at least it used to. Over the past 30 years, the convergence has largely stopped. Incomes in the poorer states are no longer catching up to incomes in rich states.

In a new working paper, Shoag and Peter Ganong, a doctoral student in economics at Harvard, offer an explanation: The key to convergence was never just mobile capital. It was also mobile labor. But the promise of a better life that once drew people of all backgrounds to rich places such as New York and California now applies only to an educated elite -- because rich places have made housing prohibitively expensive. (Shoag and Ganong visualized these changes in a series of excellent animated graphics.)

The states with the highest incomes also used to have the fastest-growing populations, as Americans moved to the places where they could earn the most money. Over time, that movement narrowed geographic income differences. In 1940, per-capita income in Connecticut was more than four times that in Mississippi. By 1980, Connecticut was still much richer, but the difference was only 76 percent. In the two decades after World War II, Shoag and Ganong find, migration explains about a third of the convergence of average incomes across states.

But migration patterns changed after 1980. “Instead of moving to rich places, like San Francisco or New York or Boston, the population growth is happening in mid-range places like Phoenix or Florida,” Shoag says. Lower-skilled people, defined as those with less than 16 years of education, are actually moving away from high-income states.

The problem isn’t that they can’t find “good-paying” jobs. Even people without college degrees still make more in high-income states. But that money buys less than it would elsewhere. The high cost of housing more than eats up the extra earnings a mechanic, medical-billing clerk or hairdresser can make in a place such as New York or Los Angeles. More-educated people also pay more to live in such cities, but their higher salaries mean that housing costs consume a smaller percentage of their income. They still come out ahead.

“My brother-in-law is a waiter,” Shoag says, “and he could earn a lot more money being a waiter in Boston than he could in Ohio. But it’s so expensive here that it doesn’t make sense to move to Boston if you’re going to do a job that doesn’t require a degree.”

Housing prices have always been steeper in high-income places, but the difference is much greater than it used to be. In their paper, the economists set out to measure the cause of the change. They create an index of regulation based on how often the phrase “land use” occurs in state appellate court cases over time. This proxy turns out to predict housing prices well. It also closely matches results from surveys of regulation from 1975 and 2005, suggesting that it’s picking up real changes in the legal environment, not merely word choice.

The news isn’t all bad. Less-educated workers may not have the opportunities they once had in places such as California and New York, but they can still raise their real incomes, factoring in housing costs, by migrating to states like Nevada, Florida and Texas. “Places that didn’t have this increase in regulation still have the old process that worked,” Shoag says, “where people move to the richer areas, human capital levels converge, incomes converge -- the whole chain that used to exist for the whole country is still true if you focus just on the areas that haven’t had as large an increase in regulation.”

As I have argued elsewhere, there are two competing models of successful American cities. One encourages a growing population, fosters a middle-class, family-centered lifestyle, and liberally permits new housing. It used to be the norm nationally, and it still predominates in the South and Southwest. The other favors long-term residents, attracts highly productive, work-driven people, focuses on aesthetic amenities, and makes it difficult to build. It prevails on the West Coast, in the Northeast and in picturesque cities such as Boulder, Colorado and Santa Fe, New Mexico. The first model spurs income convergence, the second spurs economic segregation. Both create cities that people find desirable to live in, but they attract different sorts of residents.

This segregation has social and political consequences, as it shapes perceptions -- and misperceptions -- of one’s fellow citizens and “normal” American life. It also has direct and indirect economic effects. “It’s a definite productivity loss,” Shoag says. “If there weren’t restrictions and you could build everywhere, it would be productive for people to move. You do make more as a waiter in LA than you do in Ohio. Preventing people from having that opportunity to move to these high-income places, making it so expensive to live there, is a loss.” That’s true not only for less-educated workers but for lower earners of all sorts, including the artists and writers who traditionally made places like New York, Los Angeles and Santa Fe cultural centers.

In their paper, Shoag and Ganong don’t look at why high-income states tightened their regulations, thereby increasing segregation by education level. One possible explanation is that as people get richer and cities get more crowded, the tradeoffs between cheaper housing for newcomers and a pleasant (or at least stable) environment for current residents look different. When postwar developers were turning California orange orchards into suburbs, residents focused on the new houses rather than the lost landscape. Now opposition to new construction is not only common but institutionalized. Well-organized residents fear losing the amenities that attracted them in the first place.

Another consideration is the difference between housing as consumption -- a nice place to live -- and housing as an investment, promising high returns over time. Making it hard to build new housing in a place people want to live drives up the price of the existing housing stock. Old-timers reap capital gains. Regulation, Shoag notes, “takes what should be the gain for the worker who wants to move in and turns it into the gain for the owner of the house.”

Finally, there’s the never-mentioned possibility: that the best-educated, most-affluent, most politically influential Americans like this result. They may wring their hands over inequality, but in everyday life they see segregation as a feature, not a bug. It keeps out fat people with bad taste. Paul Krugman may wax nostalgic about a childhood spent in the suburbs where plumbers and middle managers lived side by side. But I doubt that many of his fervent fans would really want to live there. If so, they might try Texas.