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CityReads│ How economists study cities
Edward Glaeser.2007. The economic approach to cities, NBER Working Paper No. 13696. Source: http://www.nber.org/papers/w13696.pdf Cover picture source: http://t1.ftcdn.net/jpg/00/47/31/58/240_F_47315863_XWUnJsDkaMja7UnK4sG2mxYnb0orm7H9.jpg
Why are some cities so much more productive than others? What are the environmental and social costs of density? Why are there ghettos? How does living close to others change us? Why do cities rise and fall? Why is housing so expensive in some places? Urban economics addresses all of these disparate questions and all of them can be seen as components of urban economics’ great puzzle: why do so many people cluster next to each other in cities? That question is itself one part of the even grander quest of economic geography to understand all of the location decisions of people and firms. This essay explores the key elements of the economic approach to cities and how they reflect the core elements of my discipline. Economics has three great pillars, two of which help us to understand the world and one of which helps us to offer policy advice. The first pillar of economics is that people respond to incentives. The second pillar of economics is our concept of a no arbitrage equilibrium. This pillar enables us to not only examine individual decision, but also to make predictions about how an entire system will look. In urban economics, there are three key no arbitrage relationships. First, individuals must be indifferent across space, which has been taken to mean that the flow of wages plus amenities minus housing costs is roughly equal in every location. Second, firms must be indifferent over space and over hiring new workers. This condition implies that differences in wages must be offset by differences in productivity. Third, builders must be indifferent about building or not building new units. Economics’ third pillar is the assumption that good policies increase the range of choices that an individual can make. These three pillars have shaped the economic approach to cities. Next, I discuss the central theoretical construct of economic geography and urban economics: the spatial equilibrium. The powerof the spatial equilibrium assumption is that it predicts that if something is particularly good in one location, then we should expect to see something bad offsetting it. In the intra-urban Alonso-Muth-Mills model, high prices close to the city center are offset by short commutes. In the inter-urban Rosen-Roback model, high incomes are offset by either high prices or disamenities. The spatial equilibrium assumption has been particularly effective in making sense of urban housing markets. Then I turn to the empirical approaches favored by urban economists.There are two different styles of empirical research. One style of structural empirical research focuses on using data to estimate formal models. A second style of research emphasizes exogenous sources of variation. Finally, I discuss the economic approach to urban policy-making. The core insight of the field is the primacy of person over place. Urban economics has two other themes that run through its policy prescriptions. First, urban economics has often assumed that governments only imperfectly represent their constituencies. As a result, individual economists have offered favored institutions that might increase competition across governments and mitigate this problem. Second, since urban economics starts with the mobility decisions of people and firms, urban economists tend to argue that policies need to be designed not just on the basis of current location patterns but also with an understanding of how new policies will alter individual location choices.
The theoretical centerpiece of urban economics is the concept of a spatial equilibrium which assumes that there are no free lunches to be gained by changing location. While the spatial equilibrium assumption is obviously a simplification, it has had a remarkable ability to generate hypotheses that have been in accord with the evidence. There are two classic spatial equilibrium models in urban economics—the intra-urban Alonso-Muth Mills model and the inter-urban Rosen-Roback model. Within metropolitan areas, the Alonso-Muth Mills model assumes that income is constant and looks at whether high housing costs are offset by low amenities or low transport costs. Across metropolitan areas, the Rosen-Roback model looks at the tradeoff between income, amenities and housing costs. Alonso’s model looks within a metropolitan area and assumes that both income and amenities are constant. These assumptions then imply that housing costs plus transport costs are constant across space, which means that housing costs will decline as transport costs rise with distance to the city center. The application of the spatial equilibrium concept in the Alonso-Muth-Mills model is useful not only in predicting housing prices and density levels, but also in predicting the locations of different population groups. In particular, the model has been particularly effective at looking at the location decisions of the rich and the poor. Figure 1 shows the relationship between median housing prices across 187 cities in the greater Boston region and distance between those cities and downtown Boston. On average, an extra mile from the city center is associated with housing prices dropping by $1100. The relationship is far from perfect. Distance explains only 15 percent of the heterogeneity in prices among those towns. Other factors, including housing quality and both exogenous and man-made amenities, differ across towns. Such amenities, like school quality, are often far more important in determining housing prices than proximity to downtown. Still, the model has made a prediction that is certainly not rejected by the data. Thousands of variants of this regression have been run by economists since Alonso’s model was first published, and almost all of them have found this general pattern. Figure 1 Housing value on distance to Boston, 2000 Figure 2 shows the relationship between the logarithm of people per square mile and distance to Boston across the same 187 cities and towns. Again, there is a robust positive relationship and distance explains 45 percent of the variation in density levels across those cities and towns. Figure 2 Log population density on distance to Boston While the Alonso-Muth-Mills model is the core tool for understanding prices and density levels within metropolitan areas, the Rosen-Roback model is economics’ core tool for understanding prices across metropolitan areas. The core prediction of a spatial equilibrium across metropolitan areas is that high housing prices must reflect either high income or high amenities or both. Figure 3 shows the basic empirical value of this approach by graphing housing costs on incomes across metropolitan areas. Forty percent of the variation in metropolitan area prices is associated with differences in income. On average, a one thousand dollar increase in income is associated with a $3,700 increase in housing values Figure 3 Housing value on median income across MSAs-2000 Figure 4 shows the relationship between real incomes and median January temperature across metropolitan areas. Across the sample of approximately 200 metropolitan areas, median January temperature explores 23 percent of the variation. As January temperature rises by 10 degrees, real income drops by 720 dollars. People do seem willing to require higher real income to live in places that are colder, which certainly does support the idea that places with higher real income levels are worse in other dimensions, just as the spatial equilibrium assumption predicts. Figure 4 Real income on January temperature across MSAs-2000 Figure 5 shows the relationship between income and commute times across a sample of approximately 230 cities with populations of 100,000 or more. As income increases by 10,000 dollars, median commute time increases by 1.5 minutes. This relationship confirms the view that high income places also have other negative amenities which offset high financial returns. Figure 5 Commute times on Income per thousands of dollars across MSAs-2000
Disciplines are divided not only by core theoretical assumptions, but by their empirical methods. Over the past 50 years, economics has particularly distinguished itself by a focus on statistical work with large data sets, as opposed to case studies. Over the past 15 years, empirical economists have become particularly focused on causal inference. The strength of empirical economics is in quantitative empirical methods, especially sophisticated methods that are focused on exogenous sources of variation. By contrast, only a few economists have real expertise in non-quantitative forms of research, like ethnography. Economists have rarely been so willing to invest in getting richer depictions of any particular neighborhood. Since economists tend to be interested more in common patterns than in unique features of particular locales, few economists have tried to comprehensively measure any particular place. Economists have a particular interest in financial variables like income and housing prices that do tend to be administratively available. While economists have not contributed much to either ethnography or rich environmental measurement, economists have focused on causal inference and exogenous variation. This focus comes from the strong attachment to formal economic theory. Economic models are generally geared towards predicting the relationship between an exogenous variable and endogenous variables. Over the past 15 years, economists have made much progress on using the tools of casual inference to examine urban issues. For example, Hoxby used the number of rivers across metropolitan areas to provide exogenous variation in the number of natural barriers which then predicts the number of governments in an area. Using this natural source of variation, Hoxby finds that more inter-governmental competition increases school performance. No one has been more successful in identifying exogenous sources of variation than Steve Levitt, whose popular book Freakonomics, made his work world famous. Levitt’s work often relies on exogenous events, like ACLU lawsuits against prisons, to identify important economic relationships, such as the impact of incarcerating criminals on crime and urban growth. Without such sources of exogenous variation, economists would find it difficult to say anything meaningful about the relationship between incarceration and crime. The attention to causal inference is one empirical by-product of economists’ focus on formal theory. Another by-product is the use of data to estimate formal models. Indeed, a common view in economics is that researchers should be able to justify any regression as an attempt to estimate the parameters of a formal model.
The economic approach to urban policy combines the use of cost-benefit analysis and the assumption that the goal of policy is to increase the choices available to people. The most important part of this assumption is that people, not places, are the important outcomes. A policy that yields a beautiful place, but does little to increase the welfare of individuals has little appeal to most economists. Policies make sense to economists if their benefits to people outweigh their costs. The economists’ desire to put people first might seem obvious, but it is often in conflict with much place-based urban policy. The economics approach to public policy pushes us to ask whether this money would be better spent on people, rather than place based policies. Economics does not give us a universal rule against place-based spending. People’s lives are certainly enriched when they live in a successful place and there surely are times when the best way to help people is to improve a place. However, there are other cases where place based systems do not seem so sensible. First of all, the beneficiaries of much place-based spending are often local landowners rather than current residents. A second issue with place-based policies is that they artificially distort migration decisions. One can easily argue that the best thing that can happen to the residents of a declining region is that they leave that region and move to areas with a brighter economic future. If place-based policies reduce the incentive to migrate, then they may reduce the beneficial process of moving from less productive areas to more productive areas. Economic policy that tries to stop that process is reducing efficiency. The third issue with place based policies is that these policies have often provided excuses for vast expenditures which benefit contractors more than target populations. For example, much of the urban renewal spending in the 1960s was seen as being a way of rebuilding cities, but few people actually bothered to ask whether this spending would deliver people benefits large enough to offset costs.
Urban economics is only one of the many disciplines that contribute to our understanding of cities. Among the social sciences, the economic approach to cities is distinguished by its strong ties to formal economic theory based on the concept of a no-arbitrage equilibrium. Economists seek to understand cities with a framework that requires people to be indifferent over space, employers to be indifferent over where to locate and how many people to hire and builders to be indifferent about whether or not to build more or taller buildings. This attachment to theory provides urban economics with discipline and with a clear structure. Almost everything urban economists do can be understood as part of the large question of understanding why people choose to locate in urban areas. While the economic approach to cities has many strengths, the economic approach also has profound limitations. Economists have never acquired the skills to study the built environment or the intricacies of individual neighborhoods. Our overwhelming focus on quantitative methods has left us poorly suited to treat historical narratives in a scientific fashion. While I believe that no one can make sense of cities without the tools of economics, I also believe that no economist can make sense of cities without borrowing heavily from other disciplines.