How To Raise GDP 10%, And Reduce Inequality Too

by: John Cochrane

Chang-Tai Hsieh and Enrico Moretti have a very nice new working paper "Why do Cities Matter?"

..increased wage dispersion lowered aggregate U.S. GDP by 13.5% Most of the loss was likely caused by increased constraints to housing supply in high productivity cities like New York, San Francisco and San Jose. Lowering regulatory constraints in these cities to the level of the median city would expand their work force and increase U.S. GDP by 9.5%.

Roughly, the same worker, working the same job, in San Jose or San Francisco, earns double what he or she earns somewhere else in the country. Here is their plot of wages across cities:

Sure: Chang-Tai Hsieh and Enrico Moretti

The right tail there isn't just missing - it was absent in 1964. There weren't any cities (MSAs) with 50% higher wages than average in 1964. That's New York, San Francisco and San Jose now.

What does this have to do with growth?

Suppose there are good opportunities, for high productivity employment in an area like Silicon Valley. Businesses start, try to expand, and bid up wages to match the higher productivity. That's all good, but with strong housing restrictions, it stops there. New people can't move in to take those high wage jobs. They try to, but they bid up house prices until the higher house price matches the higher wage.

Now suppose there are fewer restrictions on building new houses or more dense houses. Then lots of new workers can move in, the businesses can expand. Eventually, a much larger group of workers gets the higher wages, and the business expands a lot.

So, productivity-enhancing ideas mixed with housing restrictions don't do nearly as much for growth as those ideas with more open housing markets - especially markets open to newcomers. Housing restrictions also hurt measured inequality, by creating this large wage gap. (Inequality measures typically do not control for local housing costs. Rent controls and "affordable housing" lotteries may seem to help low income people, but only those who have been there for a while, not workers moving in for new and better jobs.)

The paper has a clear model and careful calculation of this effect. Their bottom line is that US GDP would be overall about 10% higher than it is now - and not just in some free-market nirvana, just if New York, San Francisco and San Jose were "only" as restrictive as the typical US city.

This fits in to the long simmering issue of how much microeconomic distortions and rent-seeking are hindering long-run growth. My view, here for example, holds that microeconomic regulation is holding back growth a lot. The contrary view is that regulation is a small-potato annoyance, 1-2% growth is as good as it gets, go back to slicing up the smaller pie. The trouble is that for all the regulation horror stories, it's hard to put together solid numbers.

Here is one. 10%. Just from zoning laws and other building restrictions.