Economic Growth in Cities. Economics 312 Martin Farnham

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1 Economic Growth in Cities Economics 312 Martin Farnham

2 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? 2

3 Sources of Urban Growth Capital deepening (investment) More physical capital makes workers more productive; causes output to rise 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 longterm growth) Technological change Innovation can enhance productivity; local innovations will boost local output Agglomeration externalities Growth may beget growth, if spillovers increase with growth. 3

4 City-Specific Innovation and Income Assume 2 identical cities with 6 mill pop U($) Equilibrium All workers identical 80 Now assume tech change boosts wages in one, but not other Wages rise in innovative city Migration from noninnovative city to innovative city brings about equilibrium (innovative city grows, other shrinks) Urban Growth From Technology Change j s i 5 6 b 7 New Curve for Innovative City Both Cities Initially on this curve 4

5 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 5 new equilibrium

6 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. 6

7 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? 7

8 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 8

9 Supply Side versus Demand Side Sources of Growth Note that these are all items that basically shift 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 about the demand side (though we ll include a couple supplyside twists). 9

10 Growth and Urban Labour Market (demand-side approach) Assume free mobility Firms and workers can relocate 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. 10

11 Export vs. Local Employment To have some external force that can generate changes in demand (other than policy), our model needs an export sector If the city lived in isolation and didn t trade, then it would be kind of artificial to talk about shifts in demand for local goods These shifts would have to come from something like big changes in income, but it would be unrealistic to have big changes in income just happening to people in the city. If we have an export sector we can think about something that shifts the demand curve, but is not 11 endogenously determined within the city.

12 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) 12

13 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 w LR Labour Demand Curve D N 13

14 Movements Along Demand Curve vs. Shifts of Demand Curve A change in wage or quantity of labour causes a movement along the demand curve. A change in something else (not on the axes) may cause a shift in demand curve This is a crucial distinction! 14

15 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?) 15

16 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. w LR Labour Supply Curve S N 16

17 Things that shift Labour Supply Local amenities Environmental quality Weather Recreational opportunities Local taxes Property/income taxes Local public services School quality Parks, museums, etc. 17

18 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 18

19 Labour Supply Shifts Increase in labour supply has two effects Wage falls Employment increases Labour Supply Increase w S S D N 19

20 Labour Demand Shifts Labour demand increase has two effects wage rises employment rises Demand Increase w S D N D 20

21 Policies To Affect Urban Employment Growth City policy may be used to shift labour demand curves Subsidies to new firms Tax abatement, 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. 21

22 Example: Environmental Policy Note that some local policies may shift both 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 22

23 Environmental Policy Stricter clean-air laws increase costs for firms Shifts in labour demand curve Cleaner air attracts more residents Shifts out labour supply curve Overall effect depends on relative shifts Some policies shift both curves w W 0 W 1 N 0 N 1 S S D D N 23

24 Evidence on Policies Cities have tried to attract firms in a variety of ways Tax breaks (some success, but at what cost?) Subsidies to development (limited success) Big problem is that city needs to do a careful cost-benefit analysis to make sure what they give away is worth what the firm brings 24

25 Evidence on Policies Stadiums are often billed as ways to boost local employment But do they really, in the long run? Lots of employment moves to the city in the short run to build the thing: much of that money leaves the city Then local people substitute away from other diversions to attend ball games; local businesses lose out to stadium If it brings lots of visitors to city, this might cause a multiplier effect where extra money brought in gets spent locally, and raises prospects for local businesses 25

26 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 w 1000 Effects of Increase in Export Demand D N N N D D N 26

27 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 text gives examples of calculated multipliers for different industries. 27

28 Problems with Export Multiplier Focus 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 these approaches overestimate employment effects. 28

29 Problems with Export Multiplier Focus Suggests growth can only come from increasing exports Growth can come from decreased imports Increased labour productivity Increased trade within urban area (which leads to more specialization, higher productivity) If it were true that growth could only come from exports, then the overall world economy could never have grown. 29

30 Problems with Export Multiplier Focus Suggest only increase employment by increasing labour demand Increased labour supply can also increase employment (though it lowers wages) Suggest city s fate rests with export demand Policy can affect local economic outcomes Can make city more productive place to do business (improved infrastructure, reduced red tape) Can make city more attractive place to live (labour supply side) Improved education can raise skills, productivity, of local workers 30

31 Is Employment Growth Always Good? Depends Recall that outward 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 31

32 Is Employment Growth Always Good? Upward demand shifts cause employment and wage growth Employment growth leads to higher promotion rates and increased labour force participation among original residents; this increases real wage and real income per capita Other benefits include increased scale economies from growth in city size. But as higher wages attract outside workers, may be rise in congestion, rents, pollution, etc. 32