May 8, 2017

Open the Gates

Emily Hamilton

Research Fellow

Adam Millsap

Assistant Director, L. Charles Hilton Jr. Center for the Study of Economic Prosperity and Individual Opportunity, Florida State University

Building more housing in productive cities will help boost economic growth.

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It's been a disappointing decade for economic growth and mobility. While the unemployment rate is down to its pre-recession level, discouraged workers have dropped out of the labor force, and the percentage of people between 25 and 54 who are working is still below its pre-recession level. Unravelling this puzzle in a changing economy might be the biggest policy question of our time – and geography is a key piece.

In a recent New York Times piece, Ross Douthat argues that the rise of coastal cities – those with high-paying jobs and high housing costs to match – has corresponded with a decline in innovation and a rise in dysfunctional politics. Douthat mistakes correlation for causation. The key to growth and innovation is not to break up cities as he suggests, but rather to open up these prosperous places to a broader range of people.

Since the 1970s, policies that increase housing costs have been on the rise. Cities have implemented increasingly binding zoning rules that prevent new housing development. At the state level, policies make it difficult for developers to expand cities outward. The result has been rapidly increasing housing costs in America's most productive and appealing cities.

The primary economic role of a city is to foster innovation. As urbanist Jane Jacobs put it, cities are places where "new work is created out of old work." In the simplest sense, though, cities are merely clusters of people and businesses. This clustering provides benefits to both. Within cities, people have access to many employment opportunities, and firms have access to a large and diverse labor force. The result is better employment matches and more productivity.

Clustering provides other benefits as well. Economies like Silicon Valley's are possible because as workers move between firms, they take what they know with them. This spreads knowledge and results in serendipitous innovation. People socialize with others both within and outside their industry, which creates another avenue for spreading ideas and learning across people.

The benefits of better job matching and knowledge sharing – what economists refer to as "agglomeration benefits" – are increasing. More jobs than ever depend on knowledge, innovation, and connections, making it important to live and work in large cities to access the best job opportunities and to earn higher wages. While commentators once speculated that the internet would allow people to work from anywhere, the benefits of cities have more than kept pace.

Even as the economic benefits of living in large cities are increasing, the most productive areas are not seeing large population increases. San Francisco, San Jose and New York City are the three most productive cities in the country. Each is experiencing rapid wage growth and housing price increases without taking in many more residents. Zoning rules in these cities make it so difficult for developers to build new housing that their housing stock hasn't kept up with demand over the past few decades. Rather than growing to accommodate more people, the existing housing is just getting more expensive.

The result is that zoning regulations, by effectively gating off the most productive places in the country, are contributing to inequality and decreased income mobility. People are staying in places where they're less productive but housing is more affordable.

One estimate finds that if productive cities reduced their land-use regulations to allow for more population growth, gross domestic product would increase by over $1 trillion annually as people moved to locations where they could secure better jobs and contribute more to economic output.

Many service sector workers could make more money in the Bay Area than in inland California, but the higher wage may not be enough to make up for the higher cost of housing. It's often just too impractical for workers to move to the places with the best economic opportunities.

Of course, even significant land-use liberalization would not cause everyone to leave their small town and head off to the big city to earn more money. People live in places for a variety of non-financial reasons, and some prefer a life in the country over an urban lifestyle and higher wages.

Fortunately, we don't have to break up cities to ensure that people have several different lifestyle options to choose from. Cities don't, and shouldn't, have all of the jobs. Declining transportation costs over the last 100 years have made it economically viable to locate manufacturing and even distribution centers away from expensive urban downtowns and in smaller and medium-sized cities that are often within an easy commute of rural areas.

The spatial separation of activities – product development and research in one place, assembly and distribution in another – means that cities and small towns don't need to view themselves as competitors. Instead they should be seen as complements, as each region is best suited for a different purpose.

Providing incentives for organizations that rely on the agglomeration benefits of cities to locate elsewhere is a recipe for even less economic growth, much like putting an auto plant in Midtown Manhattan would be. In a well-functioning economy, firms would locate in the areas best suited for future success, and people would be able to move freely based on their tastes for the different lifestyle and employment options.

The role for policy makers is to make such movement as easy as possible by reducing the barriers that currently prevent workers from moving to opportunity. Zoning reform, not breaking cities up, is the key to opening up our cities and generating economic growth, and the data show that it works.