Creative Class

Here’s the abstract from a new paper by Ed Glaeser and Matthew G. Resseger (thanks to David Ptak for the pointer).

There is a strong connection between per worker productivity and metropolitan area population, which is commonly interpreted as evidence for the existence of agglomeration economies. This correlation is particularly strong in cities with higher levels of skill and virtually non-existent in less skilled metropolitan areas. This fact is particularly compatible with the view that urban density is important because proximity spreads knowledge, which either makes workers more skilled or entrepreneurs more productive. Bigger cities certainly attract more skilled workers, and there is some evidence suggesting that human capital accumulates more quickly in urban areas.

Full text is here.

Michael Lind argues New York and London are in for the biggest fall:

New York, London, and other financial centers were heavily dependent on financial-sector profits. Throw in the technology-driven collapse of the publishing and broadcast industries headquartered in such places, and those cities are likely to suffer devastating blows. Capitals of both politics and commerce, such as Paris and Tokyo, will adjust the best in the new state-capitalist world. Purely commercial centers such as New York and Frankfurt will suffer the most. Without the obscenely rich investment bankers and the legions of well-paid retainers who supported their lifestyles, formerly flourishing parts of these former financial capitals may become as derelict as Detroit or the crumbling industrial towns of northern Britain and Germany’s Ruhr region.

Not so fast.

NYC and London are much more than financial centers – and always have been. Sure, finance generated a lot of income, especially in the top ranks, but the data show that greater NY is not overly dependent on finance and has significant capabilities across a broad range of creative industries. Ed Glaeser has advanced several compelling explanations for why NYC’s unemployment has remained relatively low in the face of what was supposed to be devastating losses from the financial crisis, With Washington, D.C. in its mega-region gambit, New York will do just fine even if you believe Lind about the coming era of “state capitalism.”

London is admittedly more finance-dependent, but it too has considerable capabilities in media, entertainment, fashion, and as a draw for global talent. How many other cities around the world can say that? And both NYC and London have withstood far more serious blows and and emerged stronger and more resilient, as Youssef Cassis’ landmark study of global financial centers shows.

Paris and Tokyo are much more likely to lose as the global city system consolidates. This year’s edition of the Global Financial Centres Index shows NYC and London consolidating their hold on global finance in the heat of the crisis, while Paris and Tokyo are getting clobbered.

The winners in the new era of capitalism are more likely than not to share the same fundamental characteristics that have defined leading-edge global cities in previous capitalist epochs – the economic benefits of diversity and openness in attracting talent, and of density and speed in mixing to create new innovations, new firms, and new industries. Those advantages will only compound in the future.

Ed Glaeser asks: “If the world is so flat, then why are cities growing so quickly, especially in the third world?” He explains:

In the developing world, urbanization has often taken the form of exploding populations in megacities. Mumbai’s population increased to 19 million in 2007 from 10.8 million in 1985. Bangalore, the urban symbol of the flat world, has had its population double over two decades, to 6.8 million today from 3.4 million in 1985.

The growth of these cities and the continuing strength of older urban areas – like New York, London and Paris – is no accident. Globalization and new technologies attract people to big cities, by increasing the returns to urban proximity …

Globalization and technological change have increased the returns to being smart; human beings are a social species that get smart by hanging around smart people.

This powerful clustering force – identified by Jane Jacobs and Robert Lucas, among others – is making the world more geographically concentrated everyday.

Figuring out ways to adjust to it – especially how to address the huge costs being borne by people and places being left behind – remains one of the most pressing domestic and international public policy questions of our time.

What can be done to kick-start the housing industry, and also make housing more affordable for the poor and middle class buyers? A new book by economists Ed Glaeser and Joseph Gyourko takes on these questions and more. Here’s a blurb from the American Enterprise Institute which commissioned the book:

Even after the burst of the housing bubble, homes remain unaffordable for the poor and the middle class in many parts of the country. In a new NRI-commissioned book, Rethinking Federal Housing Policy: How to Make Housing Plentiful and Affordable (AEI Press, December 2008), Edward L. Glaeser and Joseph Gyourko examine why. They show that local building restrictions are the cause of much of the continued high cost of housing.

Glaeser and Gyourko argue that reform of the home mortgage interest deduction would provide incentives to local governments to reduce these barriers, allowing the market to provide more housing and reducing costs. Additionally, they believe that federal subsidies for the production of low-income housing should be eliminated and the funds reallocated to increase the scope of federal housing voucher programs, which allow poor households to relocate to areas of greater economic promise.

Here’s a link for the PDF of the entire book.

Andrew Sullivan points to Ed Glaeser’s Economix  post on the geography of unemployment and finds a common thread: “Edward Glaeser compares city to city unemployment numbers and affirms Richard Florida’s thesis.” Glaeser writes:

While the disparity in unemployment rates is enormous, it isn’t random. Some areas aren’t just miraculously better able to handle the downturn. Long-standing features of the urban landscape can explain the bulk of the variation in today’s unemployment rates.

Given the enormous gap in unemployment between skilled and unskilled workers, it isn’t surprising that skills best explain today’s metropolitan unemployment rates. The share of adults with college degrees in 2000 can, on its own, explain about one-half of the variation in the unemployment rate.Somewhat remarkably, the educational level of the metropolitan area before World War II can do almost as well.

Here’s his scatter-plot.

Source: Edward L. Glaeser, via Economix

Glaeser also finds that regional unemployment is “strongly linked to manufacturing.” Here’s his plot of the correlation between current unemployment and manufacturing’s share of the labor force in manufacturing in 1970.

Source: Edward L. Glaeser via Economix

Regional unemployment is also related to density, finding that “unemployment is lowest in those areas that are most centralized.” Sprawling places appear less resilient economically.

Source: Edward L. Glaeser via Economix

His conclusions: invest in skills and human capital; “beware industrial policies aimed at keeping America tied to heavy industry;” stop trying to breathe life back into declining regions; and encourage mobility.

While the regional diversity within the United States might prompt politicians to pursue policies that target aid to distressed regions, that seems likely to be counterproductive. America has always dealt with regional economic disparities through migration. … Today’s recession will also prompt mobility, probably toward more skilled, more centralized cities with less historical commitment to manufacturing.”

I could not agree more. Our urban policy, such that it is, is decidedly backward looking. It’s high time urban policy focus on leveraging the three key things – mobility, density, and human capital accumulation – that are real engines of prosperity.

At the 2008 Davos billionaire’s prom, Bill Gates gave a speech calling for “creative capitalism.” His message was roughly that corporations are good at solving problems, and the world has enormous problems. If companies would apply some of their researchers, expertise, and money to these problems they might be able to do things that have escaped governments and NGO’s.

If it were anyone but Gates, arguably the world’s best business strategist, this would have been only mildly interesting and a slightly mushy idea. And maybe it would have faded away but Michael Kinsey, founder of Slate among other publications, decided that there was a book here. Rather than write it, or assemble a collection of essays by invitation only, he set up a blog and publicized it among economists. The result was an ongoing conversation among people like Ed Glaeser, Robert Reich, Larry Summers, and lots of people I’ve never heard of but I’ll bet most economists have.

The resulting dialogue was all published as a book (Creative Capitalism) last December that I picked up and read last weekend (some of it anyway). It’s not a fully formed argument and doesn’t reach any conclusions but it’s a great argument and seems appropriate to this blog. You don’t have to buy the book, the blog is live again.

Ed Glaeser says it’s time to kill – or at least maim – the tax deduction for interest paid on mortgages.

The Great Depression provided an opportunity to rethink old policies in a major way. In the current morass, everything should, once again, be open for debate. One sacred cow that has long been in need of a good stockyard is the home mortgage interest deduction. So, in the spirit of libertarian progressivism, I suggest gradually reducing the upper limit on the deduction to loans of up to $300,000, and then refunding the tax revenues in a more productive manner.

He’s right – especially on the broadest point. Do away with the mortgage interest deduction. But the reset provides the opportunity to really rethink and restructure the housing system more broadly.

The only way toward long-run and sustainable recovery is a dramatic change in where and how we live. What ultimately got us out of the Long Depression of the late 19th century and the Great Depression of the 1930s wasn’t just new technology, or creative destruction, or government spending, it was a phase-shift in the way we live – in our economic geography. The recovery after the Long Depression took shape around the rise of the industrial city and its streetcar suburbs. The recovery after the Great Depression was powered by suburbanization. We need a massive shift not just in our infrastructure but in our housing system.

The reform and restructuring of the housing system needs to be much deeper and go much further than reigning in the mortgage interest deduction. We need to bring our mortgage-lending practices into line with those of other advanced countries, like Canada or Sweden or most of Europe. That means much larger downpayments and penalites on prepayments; shorter term loans; and all the rest – just like my very own mortgage in Canada. Sure that means increased cost and shared risk, but it comes with a much more stable  housing market (where you can still get a mortgage and buy and sell homes) and a much more stable banking system. And we have to encourage other forms of housing tenure, like renting, which are in sync with the labor market flexibility and residential mobility the adavnced creative economy requires.

Ed Glaeser:

The plan does too little to recognize that many homeowners are living in homes that they cannot afford. In one of the government examples, a family earning less than $44,000 a year has a $213,000 mortgage on a $190,000 house. By any reasonable standard, this family cannot afford that house. It would be far wiser for the government to facilitate the family’s move to rental housing than to provide a short-term subsidy aimed at keeping the family in the home. The plan should have been more forthright in acknowledging that America’s housing mess means new mortgage terms for some and new housing for others.

Tyler Cowen:

We should not be helping people stay in their homes if their mortgage payments are at 43 percent of their income.  (The bill requires banks, in such cases, to lower interest rates until monthly payments are at 38 percent of income.  The government then steps in to lower payments to 31 percent of income.)

Willem Buiter::

The extreme fiscal largesse bestowed on residential housing, directly and indirectly through mortgage interest deductibility, has led to a massive misallocation of investment in the US.  There has been overinvestment in the private residential housing stock and underinvestment in just about every other form of fixed capital: infrastructure, public amenities of all kinds (sports facilities, public recreational facilities, parks etc.), commercial structures, plant and equipment.  It is time to correct the distorted incentives that are at the root of this misallocation.  The easiest way to do this, in the current tax system, is to end the deductibility of mortgage interest in the personal income tax, close down Fannie and Freddie and end the role of the US government in the provision of residential mortgages.

Matt Yglesias:

But this impossible dream of re-inflating the housing bubble and making all the wealth reappear is going to die hard. Clever, but stupid, politicians are going to try to convince people that they have plans to make this happen, and they’ll criticize the Obama administration for not getting the job done. It’s important to understand, however, that we’re not talking about real assets that vanished. The houses are still there, and they’re still as good or bad or useful or non-useful as they ever were. What’s vanished is a speculative mania, and public policy can’t—and shouldn’t—create a new one.

Ed Glaeser has some very sensible things to say about the housing crisis:

[H]ousing should be more affordable rather than more expensive. We argue that credit subsidies, which artificially inflate prices and encourage over-borrowing, should be gradually reduced rather than increased … The goal of federal policy should be to eliminate the distortions that make housing unaffordable, not to bribe people to borrow and build.

UPDATE: Here’s his Wall Street Journal column on same:

Rich has already written about how 1930s New Deal stimuli projects will not help this country prepare for the 21^st century global economy. Bloomberg has an incredibly insightful article on the Obama stimulus package. In effect, all the funds that will be appropriated for infrastructure will go for fixing old roads and building new ones to open new open spaces to crackpot development. Whatever one believes about global warming, this is certainly environmentally irresponsible and a step in the wrong direction. Moreover, it will cost cities, which, as Rich, Ed Glaeser, and many others have shown, have subsidized suburban development in the past. Now, U.S. “leaders” want to give us another dollop of past solutions. Optimistically applying old solutions (like ever greater indebtedness) for a debt and insolvency crisis is definitionally “crackpot.”

Can Obama translate his vague promises of change into a real change of direction for this country? To those that responded to my posting about taxation decisions, thanks.

I hope you all have great holidays. Rest, have fun, and prepare to put your thinking caps on because next year will be the most important for the global economy since 1933. We need to be there with alternative solutions and open the space for debate. Otherwise, the economists with old failed theories, some of whom claim to understand the Great Depression, will continue to provide crackpot solutions… to be discussed in the next posting.