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Archive for the ‘Economic geography’ Category

My latest for Learn Liberty looks at proposals for starting an equalization program to redistribute from rich to poor states in the U.S. and finds them wanting. Due to the audience for that blog, I kept that post nontechnical and brief. I’ll reproduce part of it here and then elaborate on some of the complexities and possible counterarguments.

[C]ritics of federalism point to one big disadvantage: federalism, they say, is unfair.

This criticism particularly applies to the fiscal aspect of federalism — that is, the ability of states to choose their own tax burdens and spending levels. The argument runs like this: states have different tax bases per citizen (some are richer than others), so richer states can tax their citizens at lower rates than poorer states, offer more benefits and better public services, or both. In this view, federalism is unfair because it helps the residents of rich states and hurts the residents of poor ones.

I will argue, by contrast, that fiscal federalism actually helps people living in poor states more than people living in rich states.

[…]

But there’s a more fundamental problem with the fairness argument for equalization: it ignores migration. Presumably, we care about the welfare of actual people, not the arbitrary geographic categories they live in. In a federal system in which people can easily move across state borders, migration accomplishes everything an equalization program might, without the negative side effects.

Think about a positive productivity shock, like the emergence of a new, highly profitable industry, which raises real wages in one state. Workers will move from other states to the state with the higher wages. The increase in the labor supply will return real wages to their normal level, at which point the migration flow will stop. Those who have moved have become better off, and even those who have remained in the initially poorer states are, at the end of the day, earning just as much as those in the initially richer state. Being able to pay a lower tax rate in a richer state will only accelerate this process — and ultimately eliminate the rich-state tax advantage.

[…]

[S]ome places are just more desirable to live in than others. These places will tend to have higher home prices and rents and lower wages. Think about it: if I take some of my compensation in the form of higher amenities, I’m willing to earn a lower real money wage. For this reason, nice places to live that don’t have a lot of industry, like New Mexico and Maine, have low real wages, while places that are less nice to live in but do have industry tend to have high real wages (see figure 1).

But New Mexico and Maine residents surely don’t deserve to be subsidized simply because they prefer to take their compensation in a nonpecuniary form, just as North Dakotans and Bay Staters don’t deserve to be taxed for choosing to live in unpleasant places where the market demands their labor.

[…]

Certainly, housing regulation is disrupting equalization through migration in the United States. An equalization program that specifically punished costly states and rewarded low-cost states might discourage excessive development restrictions and get migration flowing more freely again.

But housing regulation might end up being a self-correcting problem. As people flow from high-cost to low-cost areas, eventually the latter will enjoy more agglomeration economies that promote economic growth, and the high-cost areas will start to falter by comparison. By regulating housing so strictly, residents of coastal California, the Boston metro area, and elsewhere may be digging their own graves in the long run.

The argument I’m making here about how migration is a more effective equalizer than fiscal transfers makes some simplifications.

One simplification is that the major reasons why some states have higher per person incomes than others are exogenous productivity shocks and amenities (“desirability”). But there is another important reason: different places just tend to suit workers of different skill sets. If you have access to coal deposits and navigable rivers, you might have developed a steel industry and attracted manual laborers. If you have old, prestigious universities and a seaport, you might have developed high-tech export-oriented industries and attracted highly specialized workers. The latter sort of place will tend to have higher average wages, just because the average skill level of workers is higher.

So what changes about the argument if we relax this simplification and allow states to have different skill mixes? Very little. Yes, Massachusetts can have a lower tax rate than Mississippi because it has higher-skilled, higher-wage workers. But as a result, workers will tend to migrate to Massachusetts, driving pretax wages for Massachusetts workers below where they would be in Mississippi (adjusting for cost of living). Importantly, Massachusetts could still end up having much higher average wages than Mississippi, due to a higher ratio of high-skill to low-skill labor, but the posttax income of any particular worker will tend toward equality between the two states, leaving no benefit to moving from one place to the other. You can’t get around the fact that tax differences between jurisdictions will end up being incorporated into market wages and real estate values. (In real estate economics, this process is called “capitalization.”)

Now, what happens if we assume away labor migration? This is indeed an important change, and it may well make some sense once we talk about multinational federations like Canada. Anglophones might be willing to move to any one of the nine anglophone provinces, while Francophones are stuck in Quebec. Thus, a supporter of equalization could defend the program on the grounds that it is a legitimate way of preventing Francophones from being forced to migrate to anglophone areas or fall irretrievably behind the rest of the country economically.

Still, I wonder whether places like Montreal and Quebec City do not have very different economic profiles from, say, Chicoutimi or Trois Rivieres. There is ample room for labor migration within Quebec. If Quebec itself is large enough that some parts of the province tend to do well while other parts of the province do poorly, it may not need equalization to protect itself from economic shocks.

But let’s say it isn’t large enough. Let’s say there are economic shocks — like import competition, new technologies, and resource discoveries — that could cause Quebec either to race ahead of the rest of the country for 10 or even 20 years or fall behind for a similar length of time. Let’s say the Quebec economy is really volatile. If we don’t want Quebeckers moving out after every adverse shock (or Anglophones moving in when times are good?), an equalization program can help, right?

Possibly. But here’s another alternative: a rainy-day fund. If equalization is really supposed to be insurance against economic volatility, then don’t redistribute from rich to poor provinces, redistribute from rich to poor time periods. The provincial government itself could put away lots of money in cash or retire debt when times are good and take on debt or draw down cash when times are bad. Or if we think provincial governments aren’t competent and far-sighted enough to do this, we could have a program forcing provinces going through better-than-normal times for them to subsidize those going through worse-than-normal times, with the idea that each province comes out balanced over the long run. This insurance-type program might not have as bad incentive effects as equalization, not to mention the unfairness of subsidizing high-amenity places. Still, a publicly run insurance program for provincial budgets will likely create some moral hazard, a reluctance among provincial governments to take politically difficult steps to reduce economic volatility and therefore expected future payouts.

So there you have it. Instead of equalization programs, federal systems should facilitate equalization through migration, or when that is not possible, encourage rainy-day funds or possibly intertemporal insurance for regional budgets.

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“Why did the autonomous city-state die?” asks political-economic historian David Stasavage in a new American Political Science Review article. He finds that new autonomous city-states enjoyed higher population growth rates than nonautonomous city-states, up to 108 years. After that point, their population growth was lower than that of nonautonomous city-states. His argument is that the fusion of political and guild power within autonomous city-states at first promoted growth, but as technology changed came to suppress growth, relative to more “inclusive” institutions.

A better interpretation is that political institutions deteriorate with age, the law of political entropy. After all, if changing technology meant that constant institutions became less efficient, then population growth in autonomous city-states should vary by century, not by age of the city-state. Since in fact population growth varies by age of the city-state, we have evidence that the institutions were not constant: they became less efficient.

HT: Chris Blattman

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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.

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I have just posted a couple of my working papers to SSRN for those who are interested. They are as follows:

  1. Public Policy and Quality of Life: An Empirical Analysis of Interstate Migration, 2000-2012
    Abstract:
    Individuals and households choose their political jurisdiction of residence on the basis of expected income differentials and jurisdiction-specific characteristics covered by the general term “amenities.” In addition to fixed characteristics like climate and terrain, amenities may include public policies, as in the well-known Tiebout model of migration. Do Americans reveal preferences for certain public policies by tending to migrate toward jurisdictions that offer them? This article tests whether state government involvement in fiscal policy, business regulation, and civil and personal liberties more often reflects an amenity or a disamenity for Americans willing to move. As identification strategies, the article estimates spatial, matched-neighbors, and dyadic models of net interstate migration for all 50 states, covering the years 2000-2012. The evidence suggests that cost of living, which is in turn strongly correlated with land-use regulation, strongly deters in-migration, while both fiscal and regulatory components of “economic freedom” attract new residents. There is less robust evidence that “personal freedom” attracts residents.
  2. Civil Libertarianism-Communitarianism: A State Policy Ideology Dimension
    Abstract:
    This paper investigates the existence of a second dimension of state policy ideology orthogonal to the traditional left-right dimension: civil libertarianism-communitarianism. It argues that voter attitudes toward nonviolent acts that are sometimes crimes, particularly weapons and drugs offenses, are in part distinct from their liberal or conservative ideologies, and cause systematic variation in states’ policies toward these acts. The hypotheses are tested with a structural equation model of state policies that combines “confirmatory factor analysis” with linear regression. The existence of a second dimension of state policy essentially uncorrelated with left-right ideology and loading onto gun control, marijuana, and other criminal justice policies is confirmed. Moreover, this dimension of policy ideology relates in the expected fashion to urbanization and the strength of ideological libertarianism in the state electorate. The results suggest that the libertarian-communitarian divide represents an enduring dimension of policy-making in the United States.

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In Freedom in the 50 States, we present some statistical results on the association between the three dimensions of freedom — fiscal, regulatory, and personal — and “net interstate migration,” that is, the number of movers into a state from other states minus the number of movers from a state to other states, divided by initial population. We found that all three dimensions are positively associated with net in-migration, usually statistically significantly so. Moreover, the substantive importance of the associations is large. A half-point increase in each of the three dimensions, measured in 2001, is associated with between two and five percentage points more in-migration from 2000 to 2011, as a percentage of 2000 population.

The results seem to imply that Americans value freedom and are willing to vote with their feet for it. Of course, some freedoms are not very plausibly related to migration. Tobacco, alcohol, and gambling laws can be evaded through travel or the black market. It seems unlikely that very many people at all will move from New York simply because of the high cigarette taxes. There are cheaper alternatives. And some freedoms with high symbolic importance, like eminent domain reform or legalization of sodomy (prior to 2003), are unlikely to drive anyone to move, simply because so few people are likely to suffer from their denial. Sodomy laws were almost never enforced, and eminent domain for private gain is rather rare even where totally unregulated.

But some other freedoms are plausibly related to migration. People definitely consider tax burden in their choice of a new home. Business regulation can dampen job opportunities, and people tend to move where the jobs are. Medical cannabis users move where their medicine is legal; gun enthusiasts move where their lifestyle is respected; same-sex couples move where they have legal rights; home-schooling parents move where they can educate with less state control.

In this blog post, I explore some other ways of testing whether the relationship between freedom and migration is causal. The first technique is something I call “matched-neighbors analysis.” The independent variables here, including freedom, represent the value of the variable for the given state minus the average value for its neighbors (technically, the weighted-average value, where the weights are the neighboring states’ populations — I’ve also tried using a pure average, with nearly identical results). This procedure is called “spatial differencing.” So the notion here is that states that are freer than their neighbors will be more likely to see net in-migration. Let’s see if that’s true.

First, some specs: regressions include all 50 states (unlike the results with just the Lower 48 included in the F50S study), all independent variables are standardized to mean zero and standard deviation one (so that the coefficient estimates represent the effect of a standard-deviation change in each variable), and the dependent variable, net migration, is measured over 2000-2012 instead of just 2000-2011 as in the original study. Here are the results: (more…)

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