Regional inequality: also a housing supply problem

Over the past few years compelling evidence has come out suggesting that housing policy errors are behind slow productivity growth, wealth inequality, and the cost of living crisis. But a raft of new work suggests housing policy errors might also be a key explanation for rising regional inequality in the West, and more specifically the rise of the Englands South East and the relative decline of the Midlands and North.

A speculative and controversial new working paper from Greg Clark and his collaborator Neil Cummins looks far back to determine why the North, the site of the UK’s industrial revolution, has declined relative to much of the country, especially London. He looks at a genealogy of 78,000 people and finds that people with distinctively Northern surnames actually have not lost out relative to those with distinctively Southern surnames.

But many of the best and brightest have moved to London, and this has accelerated in recent years, even into the late 2000s, just as the productivity gap has opened up. He links these two phenomena together: being unable to keep their smartest has hampered the success of commerce and industry there. Large fiscal transfers make relatively little long term difference if they don’t attract people. And one-size-fits-all policies (like national pay bargaining) that might be thought to help poorer areas actually worsen the problem, incentivising people to queue for the far more generous pay that the public sector offers in poorer areas.

What Clark’s work lacks is an explanation. Why has the migration South been skill-biased? Why has it sped up so much recently? A recent literature suggests that restrictive housing supply, which raises rents (and house prices), deters low-skilled movers much more than high-skilled movers, raising the average talent in the host city and cutting it in the sending city. This compounds itself, because the move itself affects the desirability of the places to live in, especially for the high-skilled.

The data comes from the USA, but the situation is the same. Between 1880 and 1980 per capita income between US states converged steadily and significantly. If you heard that things were better somewhere else, you upped sticks and moved. It’s the point of America! But convergence fell from nearly two percent per year to under half of that in the last two decades. And a new NBER working paper points the finger directly at falling migration.

The mechanism we propose for explaining the decline in income convergence can be understood through an example. Through most of the twentieth century, both janitors and lawyers earned considerably more in the tri-state New York area (NY, NJ, CT) than their colleagues in the Deep South (AL, AR, GA, MS, SC). This was true in both nominal terms, and after adjusting for differences in housing prices. Migration responded to these differences, and this labor reallocation reduced income gaps over time.

Today, though nominal premiums to being in the New York area are large for these two occupations, the high costs of housing in the New York area have changed this calculus. Lawyers continute to earn much more in the New York area in both nominal terms and net of housing costs, but janitors now earn less in the New York area after subtracting housing costs than they do in the Deep South.

This sharp difference arises in part because for lawyers in the New York area, housing costs are equal to 21% of their income, while housing costs are equal to 52% of income for New York area janitors. While it may still be worth it for lawyers to move to New York, high housing prices offset the nominal wage gains for janitors.

This effect only appears in places that regulate land use and housing supply tightly. Another paper, by Andrii Parkhomeno, puts 23% of the rise in wage dispersion down to housing issues. In the forty years to 1940-1980 inequality both regional and overall income inequality fell, with migration explaining a huge chunk of this. The opposite has happened more recently both in the USA and the UK, as the incentive and ability to move has crashed.

The world of 2017 has a lot of big problems. Clearly some of them (dealing with new technology, North Korea, and terrorism) are things that reforming housing has little to do with. But many of the most important issues today are almost entirely driven by housing problems. At Berlin or Tokyo rents per square metre my life would be completely transformed. I could save go on an extra holiday a year, save up for a house, put more into my pension, and go out for dinner more—all at the same time.

If this flow were driven by inevitable socio-economic factors then maybe the infamous paper would be right: we should just abandon declining places and move their residents. But it looks like regional decline is a policy choice just as the productivity puzzle, wealth inequality, and high rents are a policy choice. We abosolutely can do something about them.

Authored and published by the contributors of the Adam Smith Institute which I support (and you should too) Charles Hugh Smith: