Cities foster economic growth???

Relaxing land use regulations in our largest cities could be the key to boosting Australia’s economic growth.

Cities are important engines of economic growth in the modern economy. The density of cities, clustering workers and firms together, generates increasing economies of scale known as ‘agglomeration effects’. There are various channels behind agglomeration that cities provide, one primary benefit is learning. Large cities facilitate the faster transmission of new ideas across workers, which translates to increases in human capital and permanent wage gains.

But what role does this learning channel play in driving the level of aggregate growth in an economy? Is there some way that policymakers can exploit this to increase growth by improving the allocation of workers across space?

e61 Institute and Macquarie University recently hosted exciting new research on these questions by Levi Crews, Assistant Professor of Economics at UCLA, at the Micro 4 Macro conference – which featured frontier research using micro data to highlight the importance of microeconomic heterogeneity on macroeconomic outcomes.

Professor Crews’ research constructs a spatial endogenous growth model. What does that mean? The model encompasses the dynamic choice that individuals face in where to work throughout their lifetimes over cities across the United States. Decisions on where to work are also related to decisions on where to live. So, within the model, workers make decisions over their lifetime about whether to move to different cities as well.

Large cities, such as New York City, are attractive to workers when deciding where to live and work despite higher housing costs. Why? ?The model assumes that a key factor is city “vibrancy” – the presence of many other workers nearby to learn from. By locating themselves in New York City a worker more quickly ‘upskills’ by learning from their colleagues and neighbours. In this setup, this new knowledge delivers the worker a permanent increase in their productivity and wages – one that sticks with them even if they leave New York City.

For this process of human capital accumulation to occur, it matters where and who the workers’ neighbours are. Learning from neighbours isn’t necessarily something sought out by workers but spills over naturally through everyday interaction with others.

For instance, cooks exchange better cooking techniques, and software engineers exchange code for faster algorithms. This process is particularly important for young workers in large cities, as the greater "vibrancy'' of workers means that they learn more quickly, generating larger returns over their entire lifetime.

The model concludes that the spatial distribution of human capital matters for aggregate growth, suggesting a role for spatial policies.

Crews examines this by conducting an exercise in place-based policy. Under the model’s assumptions, he analyses how economic growth in the United States would evolve if land-use regulations were relaxed in cities which act as ‘brain hubs’. These cities include New York City and San Francisco, which possess some of the most restrictive land-use regulations across the country.

What does the research find?

Reducing urban costs in these brain hubs to the median city level results in these cities growing larger and more productive. However, this isn’t primarily a result of labour re-allocating away from smaller cities. Instead, allowing these cities to become denser generates greater spillover of human capital onto other workers. And this produces more productive workers faster, which has the effect of boosting overall economic growth.

How relevant are these dynamics to Australia?

Recent research by e61 highlights that the forces of agglomeration generated by cities also appear to be present in Australia. Individuals who move from the regions to a capital city experience faster wage growth relative to both their old and new neighbours. Younger workers experience the greatest wage gains from moving to the city.

Further, high housing costs may be affecting the decision of workers on whether to live in our largest cities. As research by my colleague Elyse Dwyer has highlighted, over the past two decades young people have consistently migrated away from Sydney to other parts of Australia. Importantly, net out-migration is greater in areas that have experienced faster growth in housing costs. Through the lens of Professor Crews’ model this could be reducing the level of Australia’s economic growth, by subduing the role that Australia’s largest city plays in upskilling young workers.

As policymakers seek to tackle housing affordability challenges in our major cities, one tool they have at their disposal is land use regulation. Notably, the NSW government is already considering?relaxing land-use planning controls around transport hubs through its Transport Oriented Development plan. ?This new research would conclude that increasing density has the potential to ease the burden of housing costs on individuals while simultaneously enhancing economic growth.

by Matthew Elias

Matt is a pre-doctoral economist at the e61 Institute, using big data to answer applied economic questions. He has previously conducted research on a broad range of topics including household finance, inequality, competition and monetary policy.

He graduated from the University of Sydney with a Bachelor of Economics with Honours in Econometrics, earning First Class Honours and the University Medal.

For more information, please reach out to Matt via email at [email protected]

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