People, Places and Public Policy: Some Simple Welfare Economics of Local Economic Development Programs

From Pat Kline and Enrico Moretti:

Most countries exhibit large and persistent geographical differences in wages, income and unemployment rates. A growing class of “place based” policies attempt to address these differences through public investments and subsidies that target disadvantaged neighborhoods, cities or regions. These programs are widespread in the U.S. and throughout the world, but have only recently been studied closely by economists. Place based policies have the potential to profoundly affect the location of economic activity, reshaping population, employment, wages and the industry mix of communities and regions. We consider the following questions: Who benefits from place based interventions? Do the national benefits outweigh the costs? What sorts of interventions are most likely to be effective? To study these questions, we develop a simple spatial equilibrium model designed to characterize the welfare effects of place based policies on the local and the national economy. Using this model, we critically evaluate the economic rationales for place based policies and assess the latest evidence on their effects. We conclude with some lessons for policy and directions for future research.

They conclude:

Though our empirical knowledge is limited, there are a number of policy relevant insights that emerge from our theoretical discussion. First and foremost is that policy makers should be careful to consider the unintended consequences that can arise from worker (and firm) mobility. Subsidizing poor or unproductive places is an imperfect way of transferring resources to poor people. Whether it is more or less imperfect than transfers based on personal or household characteristics is an open question, but a first order consideration of any place based policy should be the mobility response it will generate and the likely consequences of that mobility. As we saw in the idealized model of Section 2, the most efficient demand side subsidy was one that yielded no mobility response at all and simply raised local wages. For this to occur, workers had to be unusually attached to their communities for idiosyncratic reasons – that is, they had to be totally unresponsive to prices.

In reality, households will respond to prices, and policymakers need to factor these re- sponses into their planning process. Mobility responses may lead the local cost of living to change, which in turn can lead landlords, some of whom may not live in the community, to capture some of the benefits associated with a policy. This is more likely when the housing market is already tight or when there are sharp restrictions on building. For this reason, it may be advisable to target areas with depressed housing markets and high vacancy rates that have enough slack to absorb a demand increase without a large increase in the cost of living.

It also seems advisable to design subsidies that are difficult to arbitrage via mobility. For example, the Empowerment Zone program offered wage credits to firms that were contingent upon the employment of local residents. Because moving to very depressed areas is burden- some, this seems to have induced a limited household mobility response, at least in the short run (Busso, Gregory, and Kline, 2013). It may be possible to design even more stringent eligibility criteria that are easy to enforce and target the desired populations. For example, one can imagine a spatially targeted subsidy with, say, a five year residency requirement. Efficient policies would target heavily distressed areas into which outsiders are unlikely to migrate. Yet even when subsidies are designed carefully, they need to be assessed relative to the potential effectiveness of person based alternatives such as the EITC.

A potentially compelling case for place based policies can be made based upon the re- mediation of localized market imperfections. When private and social returns diverge, local governments may be able to raise the welfare of their residents by re-aligning private incen- tives through taxes or subsidies or the provision of local public goods.

However, the presence of localized market imperfections does not, in itself, imply that spatial targeting is necessarily socially desirable. While place based policies may be welfare enhancing for the target community they may be welfare reducing for the nation as a whole. Before devoting resources to such programs, national policy makers should compare the welfare benefits enjoyed by the target locality to the cost of welfare losses in the localities from which economic activity is diverted.

For instance, the presence of agglomeration economies does not imply that every state or country should attempt to generate a Silicon Valley equivalent from scratch via spatially targeted subsidies. In the case of manufacturing, the productive advantages of concen- tration appear to be rival (Kline and Moretti, 2014), meaning that little is to be gained from redistributing economic activity from areas with dense manufacturing bases towards less developed areas (or vice-versa). Whether other sectors exhibit equivalent behavior is an important open question. But at this time, economists do not have enough information to reliably suggest strategies that can raise aggregate welfare via agglomeration forces.

Perhaps the most obvious areas where place based policies can raise efficiency is in off- setting clearly distortionary prior policies. For example, the spatial bias in income taxes (Albouy, 2009) and the existence of important labor market rigidities can justify offsetting spatially targeted policies. In an ideal world, efficiency would be achieved by directly re- moving existing distortions. But this is not always feasible, politically, institutionally or technologically. Therefore, second best may, in practice, be very attractive relative to the status quo.

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About ozidar

I'm an Assistant Professor of Economics at the University of Chicago Booth School of Business and a Faculty Research Fellow at National Bureau of Economic Research. You can follow me on twitter @omzidar. http://faculty.chicagobooth.edu/owen.zidar/index.html
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3 Responses to People, Places and Public Policy: Some Simple Welfare Economics of Local Economic Development Programs

  1. Pingback: The right kind of growth: boosting UK cities in the global economy : RSA blogs

  2. Joel N. says:

    Outside of equilibrium conditions, climate change: rising oceans, droughts etc. likely also suggest a benefit to heterogeneous spatial development plans (I’m looking at you New Orleans).

  3. Pingback: The right kind of growth: boosting UK cities in the global economy | City Growth Commission

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