Nick Gillespie notes in a recent post:
[I]f working on Reason Saves Cleveland taught me one thing, it’s that there’s no simple solution to urban decline. Some of it is simply historical – the Northeast is not going to dominate American business and culture that way it did 100 years ago and cities such as Cleveland or Buffalo or Detroit will never regain their earlier populations or the density at which they lived…
But it’s also clear that private and public sector boosters are always more interested in laying big bets on giant development deals that won’t transform a city or region even if they happen to work out perfectly. What makes and keeps places livable and attractive are the smaller-ticket items, such as quality of basic services such as roads, law enforcement, business climate, schools, taxes, and regulations. These aren’t sexy items but they are the things that actually keep cities thriving.
I think Nick’s right that policy fixes will not be enough to restore places like Buffalo to past glories, though New York’s high-cost regulatory regime does harm upstate New York. International economic factors have made most of the U.S. Rust Belt uncompetitive: their legacy industries are in long-term decline.
This observation might seem to pose a problem for economic theory. The theory of comparative advantage shows that every economy benefits from free trade with the rest of the world, a conclusion that “new trade theory” has not overturned. But what about America’s former industrial heartlands? Surely they have lost out to competition from Japan and China (and Tennessee).
But in fact, Buffalo has benefited from comparative advantage and trade with the world. If Buffalo enacted trade barriers to Japanese and Chinese goods, Buffalo’s people would be worse off. Buffalo’s industrial decline happened not because Buffalo firms could no longer sell to Buffalo consumers, but because Buffalo firms could no longer sell to American consumers. The Rust Belt used to have a captive consumer audience; their potential Asian competitors were shut out of a relatively sheltered U.S. market (in part not because of trade barriers or even high shipping costs, but because in global context in the 1950s, Buffalo’s economy was capital-intensive and its labor force highly skilled). In that environment, Buffalo firms could compete. So yes, Buffalo might well be better off if the U.S. shut out foreign trade in automobiles, cereal, and other goods still manufactured in the area. In the same way, the U.S. might be better off if all of the Americas, say, shut out non-U.S. imports of semiconductors and wheat, but that does not mean the U.S. would be better off shutting out those imports on its own. (Arguably, preferential trade agreements like NAFTA and CAFTA are precisely aimed at giving U.S.-made goods an advantage over the Japanese and Europeans in nearby countries.) In the end, then, there seems to be no problem for the theory of comparative advantage. The theory does not say that the best of all possible worlds for every economy is a situation in which every other economy is free-trading. The terms of trade still matter.
But there remains a subtler problem for comparative advantage in the experiences of Buffalo, Detroit, Cleveland, and Pittsburgh. Why have these cities seen net out-migration as a response to changing economic fortunes? The theory of comparative advantage suggests that in response to growing trade, people will retool and start to specialize in new lines of business. Moving away just isn’t part of the model. So why has the Buffalo metropolitan area lost people in every decade since the 1960s?
To answer this question, we need to look to transaction cost economics. A transaction cost is the cost associated with a particular exchange, the toll you have to pay just to be able to make a trade, in addition to the price you pay for the good or service itself.
Trade in goods and services, movement of capital, and movement of labor (migration) are all substitutes, in that they have essentially the same distributional and aggregate consequences, in the absence of transaction costs. But each of these types of transactions does face some costs. Trade in goods and services faces shipping costs, but there are also problems with trading goods when contracts are unenforceable or there are monopoly markets. In these cases, you might be better off investing rather than trading. For instance, Nike knows something special about designing and marketing footwear. Why don’t they just sell their good ideas to startup manufacturers in Vietnam? Because it’s difficult to enforce that kind of contract in ideas: what ideas exactly would the startup be buying, how could it evaluate their worth without examining them before buying, and if they examine them before buying, what’s to stop them from using the ideas without paying? Because of these problems, Nike chooses instead to direct-invest in Vietnam, building its own factories.
Direct investment faces transaction costs too: risks of expropriation, difficulties in managing across continents, etc. So sometimes firms trade rather than invest.
And workforces migrate. Why? Because transaction costs in trade and investment limit the extent to which those mechanisms of globalization can raise workers’ incomes. In the 19th century, European workers moved en masse to the New World because globalization wasn’t raising their wages fast enough. Shipping costs were high, though falling, and multinational investment was rare outside a few industries like railroads, mines, and large-scale agriculture concerns. Moreover, total factor productivity was lower in many European countries because of their dysfunctional political systems. It’s no accident that so many Italians, Germans, Irish, and Poles fled their homelands in the latter half of the 19th century, while comparatively few French, Swiss, Dutch, and even British (considering their common language with their former colonies) did so.
So why have workers fled Buffalo? The introduction of air conditioning has made southern climates more pleasant, to be sure, but Sioux Falls, South Dakota is colder than Buffalo and has actually attracted people. Buffalo has a comparative advantage now in relatively low-tech, labor-intensive manufacturing, by developed-world standards, rather like, say, Tennessee. But Tennessee attracts foreign direct investment, while upstate New York does not, even though upstate New York has had a workforce already trained in industries like auto parts manufacturing. Here we can look for policy explanations: politicians impose transaction costs that prevent workers in upstate New York from exploiting their comparative advantage. Favorable conditions for collective bargaining and expensive business regulations may not hamstring the financial economy of Manhattan, but they do harm upstate New York. Tennessee and South Dakota lack those regulatory obstacles.
So there we have it: in the absence of New York’s heavy regulatory burden, globalization would still have caused upstate New York incomes to decline, but net outmigration probably would have been significantly less.