What’s the mechanism? When productive cities make it hard to accommodate new workers, whether because of restrictive zoning downtown preventing densification or restrictions on the urban fringe, workers who could otherwise be more productive in moving to the more productive place instead can’t; they’re priced out and have to stay in less productive centres.
When we quantify the output and welfare cost of this increase in dispersion of the marginal product of labor, we find that aggregate output in 2009 would have been significantly higher if the dispersion of nominal wages had not increased. Holding the distribution of local TFP fixed at 2009 levels, we hypothetically reallocate labor from high wage to low wage cities such that the hypothetical wage in each city (relative to the average wage) is equal to the relative wage in 1964. Intuitively, this scenario involves setting amenities and housing supply at their 1964 level, while keeping labor demand constant at its 2009 level, and allowing workers to reallocate across cities in response. Under this scenario, aggregate yearly GDP growth from 1964 to 2009 would have been 0.3 percentage points higher. In levels, U.S. GDP in 2009 would be 13.5% or $1.95 trillion higher. This amounts to an annual wage increase of $8775 for the average worker.
The effect is driven by housing supply constraints rather than by compensating differentials due to disamenity effects from larger populations.
We estimate that holding constant land but lowering land use regulations in New York, San Francisco and San Jose to the level of the median city would increase U.S. output by 9.7%. In essence, more housing supply would allow more American workers to access the high productivity of these high TFP cities. We also estimate that increasing regulations in the South would be costly for aggregate output. In particular, we estimate that increasing land use regulations in the South to the level of New York, San Francisco and San Jose would lower U.S. output by 3%.
And if central government is looking for justification for heavy-handed approaches to dealing with cities with restrictive zoning:
We conclude that the aggregate gains in output and in welfare from spatial reallocation of labor are likely to be substantial in the U.S., and that a major impediment to a more efficient spatial allocation of labor is the growing constraints to housing supply in high wage cities. These constraints limit the number of US workers who can work in the most productive of American cities. In general equilibrium, this lowers income and welfare of all US workers and amount to a large negative externality imposed by a minority of cities on the entire country.
What sorts of policies?
In principle, one possible way to minimize the negative externality created by housing supply constraints in high TFP cities would be for the federal government to constrain U.S. municipalities’ ability to set land use regulations. Currently, municipalities set land use regulations in almost complete autonomy since the effect of such regulations have long been thought as only local. But if such policies have meaningful nationwide effects, then the adoption of federal standard intended to limit negative externalities may be in the aggregate interest.
An alternative is the development of public transportation that link local labor markets characterized by high productivity and high nominal wages to local labor markets characterized by low nominal wages. For example, a possible benefit of high speed train currently under construction in California is to connect low-wage cities in California’s Central Valley — Sacramento, Stockton, Modesto, Fresno — to high productivity jobs in the San Francisco Bay Area. This could allow the labor supply to the San Francisco economy to increase overnight without changing San Francisco housing supply constraints.
So fix Auckland land supply, or put in a 200kph bullet train from Hamilton to Auckland CBD.
Update: to make very clear, whenever I say “land supply”, I mean both allowing increased density in town and allowing expansion at the fringes. Land supply means land where you’re not banned from doing what’s economically appropriate. Height regulations block economically appropriate uses as can metropolitan urban limits.