Housing, Productivity, and Nerds

NOTE: The Growth Economics Blog has moved sites. Click here to find this post at the new site.

A quick comment about Krugman’s last NYT op-ed about housing costs, mobility, and productivity. He starts with several facts that are, I think, uncontroversial at least in a broad sense.

1) On net, people are moving from NY and SF to Atlanta and Houston
2) Housing prices are higher in NY and SF than they are in Atlanta and Houston
3) Wages are higher in NY and SF than they are in Atlanta and Houston

Great. What Krugman concludes is that this represents a loss of productivity. The high wages in NY/SF must capture high productivity in those places compared to Atlanta/Houston, so the movement of people is lowering productivity. If housing prices were not so high in NY/SF, then people would not move, and they would stay in these those high-productivity areas – and perhaps people would even move from Atlanta/Houston back to NY/SF. So making housing more affordable in NY/SF would be a boost to productivity.

This argument is basically the slimmed down version of what Chang-tai Hsieh and Enrico Moretti study in a recent working paper that I saw presented at NBER this summer. Here’s the core concept, simplified from my casual reading of the Hsieh/Moretti paper, but hopefully capturing the basic idea. Each city has some productivity level. For the moment, let’s assume that productivity is highest in San Fran, and lower everywhere else. If each city had constant returns to scale in production and produced an identical good, then the optimal allocation of labor is for everyone to move to San Francisco, to work in the highest-productivity place. That allocation would maximize output.

Of course, this might not be the optimal allocation for welfare. The geographical space is limited, and furthermore there are lots of restrictions on building in the greater Bay area, so real estate prices would go to something approaching infinity if all of us moved there. For Hsieh and Moretti, and by extension Krugman, this what keeps us from achieving the allocation of labor that maximizes output. The sensitivity of housing prices to population is so high in the Bay area that it isn’t worth the higher wages to live there any more. So people leave for Houston and Atlanta. This raises movers welfare, but at the cost of lower overall output because we move farther away from the output-maximizing equilibrium.

[This, of course, is leaving out completely the concept that not everyone might want to live in San Francisco. There is a high danger of running into 49ers fans in San Francisco, which we can all agree is equivalent to getting a root canal. But in the Hsieh/Moretti set-up, people don’t have idiosyncratic preferences over cities, and it’s actually not crucial to their findings. This is also probably a good spot to mention that I live in Houston, but as you’ll see below I’m not going to argue that Houston or Atlanta are demonstrably better places to live than SF or NY. Preferences actually aren’t the story here.]

Let’s take the Hsieh/Moretti/Krugman setting as given. The implication is that we should act to lower the house price elasticity in SF (e.g. allow skyscrapers in Palo Alto), so that prices are not so sensitive to population, and then people can move from Atlanta and Houston back to SF where they will all be more productive. Output and welfare will rise.

Of course, there is an equivalent solution – move everyone in SF to Houston or Atlanta. The reason SF is the most productive city is not because of some fixed, inherent quality of the location at 37.78 degrees North, 122.41 degrees West. It’s certainly not because of it’s fantastic summer climate. San Fran is the most productive city because it so happened that a unique collection of nerds coalesced there starting in the 1960’s. More nerds were attracted to the bright, shiny things that the original nerds were making, and now I have an iPhone. But here’s the thing about nerds – they are easy to move. You can easily strap one to a dolly and wheel them anywhere you want.

If you want to maximize welfare in the Hsieh/Moretti/Krugman model, then you want the cost of housing to be relatively insensitive to city size. This allows all the people to congregate in the most productive city without driving up costs so much that people no longer want to live there. So you can either lower that sensitivity in places like NY or SF, or you can make Houston or Atlanta the most productive city. It’s non-obvious which is the right solution. Arguably, it is far easier to incent Bay area nerds to relocate south than it is to convince existing Bay area home-owners (a much larger group) to take a massive capital loss on their houses.

What do we make of the steady shift south, then? Perhaps for right now, it is productivity-lowering for all those people to leave San Fran and NY. But if housing prices remain so fantastically high in those places, then eventually Houston and/or Atlanta will become the high-productivity city, because at some point even the nerds will move. Maybe the right answer is to speed up this movement, not try to reverse it as Krugman suggests.

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22 thoughts on “Housing, Productivity, and Nerds

  1. It can’t be easy producing low tech widgets competitively in San Francisco, given the high cost of living and therefor high salaries. Doesn’t it make more sense for un-nerdy workers and industries to move out of the Bay Area to take advantage of lower costs elsewhere?

    Existing Bay Area homeowners can sell their space and move to mansions in other places; more and more of them may think that is an attractive option, opening up Bay Area housing for us nerds.

  2. The problem with this suggestion is that what makes San Francisco productive is not just the presence of certain people there. It’s the presence of people and their social networks. First, there are a lot of nerds in one place, which creates social networks that are conducive to technological invention. Second, the social networks in the Bay Area (and in Boston) steer people with STEM degrees toward the tech sector; the same networks in other cities steer them toward other activities, such as finance in New York, petroleum engineering in Houston, and so on.

    Moving the nerds out of the Bay Area is going to have the same socially disruptive effect, then, as moving working-class neighborhood residents out of their traditional ethnic enclaves. The nerds aren’t all going to move to Houston; some are, but others will move to Atlanta, others to Dallas, and so on, diluting the nerd presence in each city, and weakening those social ties. Historically, on the level of ethnic groups this sort of mixing was deliberately promoted by various elites to foster assimilation of ethnic whites, and isolation of blacks. Both succeeded. This is exactly what needs to not happen if nerd productivity is to be retained: the subculture has to remain unassimilated – assimilated nerds already exist in all sorts of environment, without the productivity of the Bay Area.

    • Alon – right. But social networks are not geographically fixed. If you picked up the Bay area and plunked it down in central Texas, the networks would still exist. Krugman’s argument is that the strict zoning the Bay area is causing people to move out, harming the social networking that can occur. So either (a) make it cheap enough to live in the Bay area so that social networks can continue to grow or (b) move the social network. If SF continues to be expensive, eventually enough people will move that the network will collapse in SF, but if those people rebuild the network in Atlanta (or Raleigh, or wherever) then you can still have the network. I’m not saying that’s easy to do, but it may be easier than making the Bay area cheap.

      • Sure, but what’s happening is not that the Bay Area is being moved wholesale to central Texas. Instead, bits of it are dispersed among various cheap metro areas, which are often widely separated from one another: the various Texas metros, but also Portland, Phoenix, Atlanta, Raleigh, etc. Dispersal is never as focused as you want it to be. The entire industry is not going to move at once: the big players have the money to pay climbing rents (and corporate campuses are effectively rent-controlled via Prop 13), so the people leaving would necessarily be the more marginal and less socially connected companies, which could not make any concerted effort to move a chunk of the industry somewhere else. They’d move alone, and then find themselves in Houston or Atlanta or wherever, in a hostile social climate in which they have to adapt to different local norms just to get Rice and Georgia Tech grads to come work for them.

        Tellingly, re the comment you made in response to Lewis, about Boston, what happened in Boston is not that people moved there because they were priced out of the Bay Area. Boston’s tech network actually predates the Bay Area’s, but the Bay Area’s grew larger because of more favorable institutional factors; now Boston is catching up, by adapting various Bay Area norms to its huge native base of local STEM grads. Austin and Raleigh are doing the same, but do not have the same base as Boston or the Bay Area, and so their incomes are lower, and so far not even keeping up with inflation, according to BEA metro area per capita income statistics.

      • Absolutely, Alon, you cannot just scatter everyone randomly across different urban areas. You want to move the nerds sort of en masse to a new single spot.

        But if agglomerations economics matter, then the continued exodus of workers from SF/Boston/NY means that they are progressively becoming *less* productive. Again, there is nothing inherently more productive about the Bay area. It has this incredible network/collection/agglomeration of nerds, universities, and finance. But that doesn’t mean this is indelible.

        Let’s take one area where Houston did create an agglomeration from scratch – the Houston Medical Center. Depending on exactly how you rank it, it is either the best or 2nd-best medical center in the world (along with Mass General in Boston). It was started from basically nothing by throwing big checks at a bunch of top doctors all at once – ensuring them that they would have a network around them. My point remains that it could actually be easier to do this (throw tax breaks and incentives at Apple or Google) to relocate to Austin/Houston/Atlanta/Raleigh than it would be to change the institutional structure of housing in the Bay area (or Boston or NY).

      • I think eds and meds are different from clusters of production for export. For some evidence, look to the Gulf cities, which are flush with oil revenues: they are building satellite campuses for top global universities, to say nothing of glamorous towers, but they do not have any significant tech industries, or really anything else that’s exportable other than oil. If you want to see tech in the Middle East, go to Israel, which has people with the same skills as Americans earning half the wage, and social networks that, through military units that involve programming, encourage the formation of small tech clusters.

        As for tax breaks, they’re problematic, because they’re very easy to game. Providence is paying app developers to live in it and write apps. It’s getting nothing out of it, and will keep getting nothing, because the local political culture is toxic to any small business that wants to become big. Preexisting big businesses can lobby, and small businesses that stay small don’t have to deal with as many regulations, but growing businesses are a problem.

        Of course, Texas is not like that, but there are presumably tech-specific obstacles there. After all, Dallas, like Boston, has a very old tech cluster (the integrated circuit was invented there), and yet Silicon Valley far surpassed it, and unlike Boston, Dallas doesn’t seem to have a growing tech cluster today.

        But even if the problem is solved, it doesn’t deal with the question of agglomeration. Right now, the only Schelling point for US tech companies is the Bay Area, and secondarily Boston, Seattle, and New York. If one of the Sunbelt cities manages to grow its own cluster then it can take over, but that would have to come from internal changes; expensive housing in the Bay Area would not favor Houston over Dallas, Raleigh, etc., and the result is that it’s very likely different tech sectors would end up in different cities, and the primary cluster would remain in the Bay Area because the companies have the money to be there, same way big finance isn’t leaving Manhattan.

  3. Any discussion of welfare should take into account the fact that the Bay Area has nearly perfect weather, whereas Houston and other sunbelt metros are so intensely humid that it is difficult to be outside in daytime for part of the year. Nor is it necessary that everyone crowd into San Francisco proper, which is less dense than Queens. The suburbs and Oakland would all be much more developed without land use and building restrictions. They are dense now, but they could be much denser, perhaps to the detriment of incumbents and the benefit of outsiders. There is an asymmetry in these decisions, whereby votes are cast by local incumbents who do not account for the welfare of would-be residents.
    The nerds might move south one day, but there is no evidence of this happening nor any reason to believe it will. Housing prices are rising because nerds are arriving, and this drives out non-nerds. Thus, the total stock of nerds in the Bay is rising, and the nerd share of population is as well. Since the nerds help make it expensive, it’s a stretch to imagine that they could make it so expensive that they leave: “nobody goes there, it’s too crowded.”

    • A couple of things:
      1) It’s not true that nerds won’t move. Neither Boston nor Austin were tech hubs twenty years ago. Now they are. If costs are high then even the marginal nerds will move out of the Bay area to some new hub (maybe Austin or Boston, maybe someplace new).

      2) The actual amenities of the Bay area are irrelevant here. Good weather will drive down wages, as everyone is willing to live there but earn less. And for the record, not everyone likes SF’s weather. I, for one, prefer to not have to wear a parka in June.

      3) Yes, the Bay area could be more dense, but that is blocked by incumbents. That’s entirely Krugman’s point. My point is that overcoming that incumbent resistance is likely to be very, very hard. So hard that it may make more sense to move people into other cities, rather than fight the incumbents. As I replied to Druce, changing local zoning rules loads a big loss onto a small group, while the benefits of doing this are very diffuse. That’s a hard political case to make.

      • I do not know about Austin, but Boston started becoming a tech hub almost 50 years ago. For example,Boston suffered more than most other cities in the 1970 recession because that recession was centered in the tech sector.

  4. “Here’s the thing about nerds – they are easy to move.” Well, nothing prevents nerds from moving, and that’s exactly why all the startups are migrating from everywhere else to the Bay Area and putting pressure on real estate. The Bay Area has a network and infrastructure of research universities, venture capital industry, technology and support services, legal, HR etc. A lot of would be “Silicon Alleys”, “Silicon Prairies” and whatnot have been trying very hard to get that infrastructure to move, and it doesn’t. The nerds keep moving to the Bay Area. It turns out that (surprise!) moving or duplicating that entire complex of infrastructure, culture, people is actually quite hard. And fewer restrictions on development would, on the whole, result in greater overall wealth and value creation in the entire economy and in real estate as well. There may be winners and losers, but the owners who get rezoned for high rises are much better off and can compensate the losers. I can’t even think down to the level of an abstract model that doesn’t take the network effects and infrastructure into account and could come up with the outcome of a “massive capital loss.”

    • Druce – I think Krugman’s column was that even *more* nerds (and others) should be moving to the Bay area than currently do. And so he wants there to be fewer restrictions on development there, as you mention. And yes, I fully agree that this would be productivity-enhancing. My point is that this is very hard to do (lower restrictions) – and that it could be potentially cheaper to accelerate the move out of the Bay area.

      For the Bay area, you say that the winners can compensate the losers – sure. But my perspective is that actually negotiating this and implementing it is close to impossible. As economists we tend to just assume that we can find a way to do this, but it is notoriously hard, and maybe even impossible. Even if possible, it could take decades to implement.

      The “massive capital loss” is the loss of the losers (which is presumably offset by the gains overall). But loading a massive capital loss onto a small group, while the gains are relatively diffuse, is incredibly hard to implement.

    • Just one small remark: fewer restrictions on development are not in fact good for owners, even ones who are zoned for high rises, unless the demand is extremely elastic. Obviously, if demand is inelastic then the total revenue generated under a free building regime is less than that generated under a zoned regime, but even if demand is moderately elastic, the profit remains lower.

      Concretely, let’s say that all apartments cost K to build including a rate of profit that’s really the developer’s wage, that there are no renters, that at price K the demand is for 20 floors, and that the elasticity is e. Let’s say that currently, zoning restrictions limit buildings to 5 floors, and all buildings in fact have 5 floors. The owner of an apartment in a 5-floor building has an asset that is worth K*4^(1/e). Now, let’s say the restrictions are repealed. If it is possible to add floors to buildings without additional marginal costs, then each apartment is worth K, because builders only break even on additional construction and do not make any profit.

      In a more realistic scenario, it’s impossible to add floors, and buildings have to be knocked down. Once a building is knocked down it’s best to spread the cost of the lost apartments among as many units as possible, and this means building as many floors as possible. Let’s set a limit at 20 floors again, to avoid dealing with situations in which the model says it’s more profitable to build one 80-floor building and keep four older 5-floor buildings than to build five 20-floor buildings; I want this model to assume constant construction costs, so might as well set the same limit as overall demand. The cost of replacing a building is 4K per apartment, which works out to (4/3)K per new apartment. If proportion x of buildings has been replaced, then the price per unit is K*(20/(5+15x))^(1/e), which is in equilibrium with construction costs at (20/(5+15x))^(1/e) = 4/3, or in other words x = (20(3/4)^e – 5)/15, and as long as $\latex e 0, i.e. there will be new construction, and profit per unit will fall, even in the replaced buildings, since by assumption the proportion of replaced buildings is such that owners are indifferent as to whether replace or not.

      • I fail at using LaTeX.

        The last paragraph of the above comment should read, “…as long as e > \log_{3/4}1/4 \approx 4.82, we will have x > 0, i.e. there will be new construction.”

  5. While preferences are not key to the economic analysis, I think they are pretty critical to the actual policy considerations. While nerds can easily be forced onto a transportation device, that has negative impacts on their productivity (Strapping them to a girl named Dolly may have other effects). Getting nerds to voluntarily move is more difficult (hence why Microsoft eventually gave up and opened an office in sillycon valley).

    I would further assert that making more (and hence smaller) housing in Palo Alto may not be welfare enhancing even if it was cheap(er) and productivity enhancing. Having a yard is nice, and perhaps much nicer than the difference between iPhone8 & iPhone9. Having a larger house also causes higher reproductivity. So from the viewpoint of the distant future, spreading nerds across multiple cities might be growth and productivity maximising.

    I write from Singapore (way too many tiny apartments) in desperate fear it will turn into Hong Kong.

  6. Several people have overlooked Krugman’s point: the movement from SF to Houston may not be welfare enhancing if the reason is better zoning laws in Houston than in SF.

    • That’s essentially what he said, yes. And the implied policy response is to make housing more affordable (i.e. make housing prices less sensitive to population) in SF and NY, according to Krugman. My point was that, alternatively, you could accelerate the move of people to Houston, which would raise productivity in Houston where housing prices are not sensitive to population. Either way, you want to make it very easy for workers to agglomerate.

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