The housing wedge

By R.A. | LONDON

TYLER COWEN has written a big piece for Time on the state of Texas, and what it may portend for America's future. At his blog he publishes a brief excerpt:

Jed Kolko, chief economist for San Francisco–based real estate website Trulia, says that from 2005 to 2011, 183 Californians moved to Texas for every 100 Texans who moved to California. “Home prices, more than any other factor, cause people to leave,” Kolko says.

…the federal government calculated the Texas poverty rate as 18.4% for 2010 and that of California as about 16%. That may sound bad for Texas, but once adjustments are made for the different costs of living across the two states, as the federal government does in its Supplemental Poverty Measure, Texas’ poverty rate drops to 16.5% and California’s spikes to a dismal 22.4%. Not surprisingly, it is the lower-income residents who are most likely to leave California.

On the flip side, Texas has a higher per capita income than California, adjusted for cost of living, and nearly catches up with New York by the same measure. Once you factor in state and local taxes, Texas pulls ahead of New York—by a wide margin. The website MoneyRates ranks states on the basis of average income, adjusting for tax rates and cost of living; once those factors are accounted for, Texas has the third highest average income (after Virginia and Washington State), while New York ranks 36th.

There are all sorts of cost of living differences between Texas and California, but the housing cost gap dwarfs the others. Median household income in California is about $61,600. That's well above the national median, which is is $52,700, and even farther above the median in Texas, which is $50,900. But the value of the median owner-occupied housing unit in Texas is just $126,400, to $186,200 for America as a whole and a remarkable $421,600 in California. Now, a housing unit in California is not in all ways equal to a housing unit in Texas. A Texas home may be larger or newer. A home in coastal California, by contrast, is located in coastal California. But one can't miss the point that a household which is mostly interested in maximising its income net of housing costs is going to have a strong incentive to move to Texas.

There is a problem here, however. Money isn't everything, but when we think about disaggregated utility-maximising behaviour leading to positive macroeconomic outcomes we're generally assuming that folks are interested in raising their incomes. And we assume that it is because they want higher incomes (or at least partly for that reason) that they invest in human capital, seek out productivity-enhancing job matches, start businesses, and so on: do all the sorts of things, in other words, that are good for national output. In America, the income-maximising choice is typically to move to a place like California or the Northeast Corridor, where there are big concentrations of well-educated, highly productive workers. But the vast difference in housing costs across American cities mean that the housing-cost adjusted income-maximising choice is to move to Texas. There is a housing-cost wedge that is distorting household choices about where to live. The result is a pretty substantial net flow of people from more productive places to less productive places.

Now I don't want to be too down on Texas. It is to Texas' credit that it builds copious amounts of housing; adequate housing supply is critical to keeping housing affordable, and affordable housing is among the most important contributors to household welfare. Moreover, there are places in Texas with lots of well-educated people working in productive and innovative industries. Moving to Dallas is not exactly moving to Dhaka. Plenty of people there roll out from high-flying tech start-ups for cocktails and fine dining ahead of a night at the theatre. Moreover, if we are going to find fault, we should find fault with California.

But given the size of the housing-cost wedge and the magnitude of the population flows, it is hard to believe this does not matter. I can see two big ways in which it is likely to be important. One concerns the national economy as a whole. Productive clusters like the Bay Area are held together and benefit enormously from positive economic spillovers; they facilitate transfer of tacit knowledge, for example, about everything from which people to hire, how to get venture financing, which business models work best when, which technological breakthroughs are promising (and which are dead ends) and so on. These are growth-enhancing functions that markets underprovide in the best of circumstances. A stunted Silicon Valley represents a big deadweight loss to the American economy that shows up in growth, productivity, and income statistics.

I wonder whether the more important effect isn't on mobility. There is a sense in which Texas has become a part of America's welfare state. As Mr Cowen notes, it is lower income residents who are most likely to leave California for Texas. Rather than tax richer Americans to fund either investments to enhance the productivity of low-income workers or for straightforward redistribution, America is "taxing" richer Americans through expensive housing and raising the real incomes of lower income workers by diverting them to cheaper places.

But the impact on welfare gaps and mobility may be much less benign the way America has chosen to do it. The "tax" on rich households is not actually a tax, for one thing. The home-owning rich experience it as a rise in wealth. Real incomes in less productive places have to be higher to attract residents from elsewhere because they do have less amenity value—in terms of everything from climate to culture—to offer. A paper by Rebecca Diamond explains:

I find that cities which attracted a higher share of college graduates endogenously became more desirable places to live and more productive for both high and low skill labor. The combination of desirable wages and amenities made college workers willing to pay high housing costs to live in these cities. While lower skill workers also found these areas' wages and amenities desirable, they were less willing to pay high housing costs, leading them to choose more affordable cities. Overall, I find that the welfare effects of changes in local wages, rents, and endogenous amenities led to an increase in well-being inequality between college and high school graduates which was significantly larger than would be suggested by the increase in the college wage gap alone.

And of course, residents deflected away from the most productive cities are losing out on opportunities to raise their own productivity. It's worth noting that someone who moves to a rich city doesn't earn the rich-city premium all at once but gains it over time, through learned techniques and by moving to progressively better job matches. Those not in the city aren't on that ladder.

This population filtering is reinforcing a broader trend of increased concentration of income at the top of the distribution. It is possible that the effects of this geographic sorting—faster nominal wage growth and outsized welfare gains for the richest, and more intensive human-capital investment for the most productive—are not necessarily bad for overall economic mobility in America. The best available evidence is not encouraging, however. Recent work by Raj Chetty, Nathaniel Hendren, Patrick Kline, and Emmanuel Saez shows that there is less upward mobility among the poor in the Sunbelt areas that have used cheap housing as a magnet than in expensive coastal metros. Texas cities do better than many elsewhere in the South but meaningfully worse than cities in California or the Northeast Corridor. A child in Dallas with parents earning in the 10th income percentile will on average wind up in the 35th income percentile. In San Francisco, by contrast, such a child will on average find herself in the 41st income percentile. Interestingly, the gap between the two types of cities grows the poorer are the parents.

Some of the difference in mobility may be rooted in differing attitudes toward public investments and the welfare state. But that rather makes the point; an economy that addresses widening underlying productivity differences by shunting all but the rich off to where the cost of living is lowest is probably underperforming on growth and mobility metrics. If California made it as easy to construct new housing as did Texas America as a whole would be better off, but gains would be largest for lower-income Americans.

The rub, I suppose, is that housing regulations are not exogenous with respect to the strength of the local economy or the generosity of the welfare state. Texas may be happy to build willy-nilly because there is little public obligation to poorer Texans, while in California the quality and expense of public services may make residents reluctant to accommodate all comers. In that sense, America's geographic sorting may help illustrate the political danger of rising income inequality nationally: that it may threaten the sustainability of the social safety net.