Economic Growth in Cities (and policies to promote it)

Economics 312 Martin Farnham

Basic Questions

•  What causes growth/decline of cities? •  What are labour market implications of

growth? •  How can public policy promote/manage

growth? •  What are the costs and benefits of

growth?

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Sources of Urban Growth •  More fixed capital (investment)

–  More physical capital makes workers more productive; causes output to rise

•  More human capital –  Smarter workers are more productive; may boost

each other’s productivity; more educated workers may generate more technological improvements (i.e. smarter workforce may cause higher long-term growth)

•  Technological change –  Innovation can enhance productivity; local

innovations will boost local output •  Agglomeration externalities

–  Growth may beget growth, if spillovers increase with growth.

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City-Specific Innovation and Income

•  Assume 2 identical cities with 6 mill pop –  Equilibrium –  All workers identical

•  Now assume tech change boosts wages in one, but not other –  Wages rise in innovative

city –  Migration from non-

innovative city to innovative city brings about equilibrium (innovative city grows, other shrinks)

•  Urban Growth From Technology Change

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U($)

5 6

75

7

80

Both Cities Initially on this curve

New Curve for Innovative City •

• • •

i

j s b

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City-Specific Innovation and Income

•  Both cities initially start in equilibrium at i. Initially the innovation occurs in one city. This shifts the utility curve up for that city. Population changes slowly, so people in the innovative city are initially at j.

•  Now utility is higher from living in innovative city; this brings migration pressure. People move from non-innovative city to innovative city. Non-innovative city shrinks in population; innovative city grows, until utility across cities is equalized (at s and b). This is new equilibrium

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Human Capital and Growth •  How does having smarter workers boost

output? –  Direct effects

•  Workers are more productive so their own output rises –  Effects through other workers

•  Smarter workers make their coworkers more productive, so output of coworkers rises

–  Effects through technological change/innovation •  Smarter workers probably generate new ideas at a faster

rate than average workers; these new ideas become the source of technological change.

•  Note: Effects above basically have one-time effect on output. This effect is ongoing. It can actually affect the long-term growth rate of a city.

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Evidence on Human Capital and Growth

•  Moretti (2004, US study): 1 percent increase in city’s share of college-educated workers appears to cause wages to rise 1.9% for high school dropouts 1.6% for high school graduates 0.4% for college graduates

•  Why this difference across education groups?

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Evidence on Human Capital and Growth

•  A study in China suggests that increased enrollment in secondary school boosts local growth rate

•  Another study suggests presence of research “superstars” promotes high-tech startups –  An argument for the importance of universities for

local growth –  Stanford-Berkeley-Silicon Valley axis

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Growth and the Urban Labour Market

•  Note that these are all items that increase local GDP by shifting the output supply curve

•  If something causes demand for output in an urban area to rise, this will also have effects on local employment, income and output

•  Now we’ll turn and think (mostly) about the labour market

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Growth and Urban Labour Market

•  Assume free mobility –  Firms and workers can relocate between cities –  Each household locates in city that maximizes

utility –  Each firm locates in city that maximizes profits

•  Wage and employment in each city are determined by labour supply and labour demand –  Note: we’re focusing on supply and demand for

labour in the city, not supply and demand for goods produced in the city.

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Labour Demand

•  Shows relationship between wage and number of workers firms want to hire

•  Long-run labour demand slopes down for two reasons –  Substitution effect –  Output (scale) effect

•  Change in w or N causes move along D; other changes cause shift in D.

•  LR Labour Demand Curve

w

N

D

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Things that Shift Labour Demand

•  Recall that labour demand tells us the aggregate willingness-to-pay (by firms) for extra units of labour. So anything that affects WTP can shift curve –  Changes in demand for exports –  Changes in labour productivity –  Changes in taxes paid by firms –  Changes in local infrastructure –  Changes in land use policies (do firms have room

to expand? Are rents being kept high or low?)

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Labour Supply

•  Shows relationship between wage and number who choose to work.

•  Labour supply slopes up because as wage rises in city, more workers migrate from other cities.

•  Change in w or N causes move along S; other changes cause shift in S.

•  LR Labour Supply Curve

w

N

S

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Things that shift Labour Supply

•  Local amenities –  Environmental quality –  Weather –  Recreational opportunities

•  Local taxes on residents –  Property/income taxes

•  Local public services used by residents –  School quality –  Parks, museums, etc.

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Labour Market Equilibrium

•  Equilibrium wage and quantity of labour are determined by intersection of S-D –  Increased LS causes

wage to fall, employment to rise

–  Increased LD causes wage to rise, employment to rise

•  Mkt Equilibrium

w

N

S

D

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Labour Supply Shifts

•  Increase in labour supply has two effects –  Wage falls –  Employment

increases

•  Labour Supply Increase

w

N

S

D

S’

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Labour Demand Shifts

•  Labour demand increase has two effects –  wage rises –  employment rises

•  Demand Increase

w

N

S

D

D’

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Policies To Affect Urban Employment Growth

•  City policy may be used to shift labour demand curves –  Subsidies to new firms

•  Tax breaks, industrial bonds, loans and guarantees, site development

•  By lowering cost of doing business in City A vs. City B, may attract firms to choose City A.

•  Policy may also shift labour supply –  City may provide services or amenities attractive

to certain workers –  Example: might attract high-skilled workers with

good schools. 18

Example: Environmental Policy

•  Note that some local policies may shift both labour supply and demand – Tighter air-quality restrictions directly

increase costs to polluting industries •  Shifts labour demand down (left)

– Better air-quality attracts residents •  Shifts labour supply out (right)

– Overall effects? Employment effect ambiguous; clear wage decrease

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Environmental Policy •  Stricter clean-air laws

increase costs for firms –  Shifts down labour

demand

•  Cleaner air attracts more residents –  Shifts out labour supply

curve

•  Overall effect depends on relative shifts

•  Remember what Glaeser says about nice places having low real wages?

Some policies shift both curves

w

N

S

D’

D

S’ W0

N0

W1

N1 20

Export vs. Local Employment •  To have some external force that can

generate changes in demand (other than policy), helps to have an export sector in our model –  If the city lived in isolation and didn’t trade, then it

would often be strange to talk about shifts in demand for local goods (unless we had big shifts in productivity from things like technology shocks)

–  Otherwise big changes in income don’t just happen.

–  With an export sector we can think about something that shifts the labour demand curve, but is not endogenously determined within the city. 21

Export vs. Local Employment

•  In our model, export employment is employment within the city that produces goods consumed outside the city.

•  Local employment is employment within the city that produces goods consumed within the city.

•  A rise in export demand has two effects: –  Directly causes employment rise in export sector –  Puts more money in pockets of export workers,

which they spend (in part) on local goods; so causes additional increase in employment in local sector (multiplier effect)

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Problems with policy to attract business

•  City needs to do a careful cost-benefit analysis to make sure what they give away is worth what the firm brings – Enticements to firms mean giving

something else up (e.g., tax revenues) – Cities can engage in a “race to the bottom”

with other cities (everyone offers enticements until nothing is gained, but much is lost)

– On the other hand, if cities compete to be efficient, uncorrupt, etc. that’s a good thing 23

Problems with policies to boost labour demand

•  Stadiums are often billed as ways to boost local employment –  But do they really, in the long run? –  Short run employment boost to build: much of that

money leaves the city –  Then local people substitute away from other

diversions to attend games; local businesses lose out to stadium (unless it brings lots of visitors from outside city—who wouldn’t have come otherwise)

•  Mayors like trophy construction projects –  Often don’t pay off –  e.g. Renaissance Center in Detroit

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Multiplier Effects of Increased Export Employment

•  Assume city wage is fixed (LS perfectly elastic)

–  Implies perfect mobility •  D: original demand

–  D’: demand with direct effect of export demand increase

–  D’’: demand with direct effect plus multiplier effects.

•  Can also get such multiplier effects from agglomeration externalities

–  Urbanization economies –  Localization economies

•  Effects of Increase in Export Demand

w

N

D

1000

D’

D’’

N N’ N’’ 25

Multiplier Effects of Export Employment Increases

•  Cities often promote (labour) demand-side strategies for boosting growth, by trying to attract exporting manufacturers (auto plants, etc.) to locate there –  The previous diagram gives some sense of their

motivation ∆Total Employment= ∆ Export Employment

x Employment Multiplier Table 5-1 in optional text gives examples of calculated

multipliers for different industries. Some cities make it a practice of trying to attract high multiplier export industries.

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Problems with Export Multiplier Focus

1) Wage is assumed to be constant, regardless of city size –  In estimating labour demand shift, they assume

labour supply is perfectly elastic –  Not true if mobility takes time; LS slopes up –  If LS slopes up, wages will rise, which will partly

offset the positive employment effects of the outward shift in LD.

•  Suggests that a simplistic multiplier approach will overestimate employment effects.

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Problems with Export Multiplier Focus

2) Suggests growth can only come from increasing exports –  Growth can come from decreased imports –  Increased labour productivity (education, etc.) –  Increased trade within urban area (which leads to

more specialization, higher productivity) –  Better environment for local business to operate

(less corruption, sensible infrastructure) –  If it were true that growth could only come from

exports, then the overall world economy could never have grown.

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Problems with Export Multiplier Focus

3) Trying to attract high multiplier industries ignores synergies that may come from a “good” industrial mix -Remember, some industries may have big spillovers to each other (urbanization economies) -Estimated multiplier effects for industries are averages across cities that may not apply to your particular city (software probably won’t thrive in Whitehorse) -If you want to attract business, probably makes sense to attract business that will work well in your city

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Is Employment Growth Always Good? •  Depends

–  Recall outward labour supply shifts can increase employment growth while lowering wages

–  Also, current residents may not benefit from job growth, if new jobs go to people who move in

•  Bartik (1991) simulations suggest less than 10% of new jobs go to currently unemployed people. ~75% of new jobs go to outside residents who move in.

–  Current residents may experience costs in terms of rent increases, congestion, competition for public services

–  On the other hand, increased demand boosts wages/incomes, promotion opportunities, agglomeration externalities

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