Sunday, July 29, 2012

How the Elites Built America’s Economic Wall

From Bloomberg:
For a century, incomes became increasingly equal across the U.S., as poor states such as Alabama caught up to rich places like California.

Economists have long taught this history to their undergraduates as an illustration of the growth theory for which Robert Solow won his Nobel Prize in economics: Poor places are short on the capital that would make local labor more productive. Investors move capital to those poor places, hoping to capture some of the increased productivity as higher returns. Productivity gradually equalizes across the country, and wages follow. When capital can move freely, the poorer a place is to start with, the faster it grows.

“That’s one of the central relationships in macroeconomics,” says Daniel Shoag, an economist at Harvard University’s Kennedy School of Government. “It’s an extremely strong one, and we teach it in introductory macro because it’s one of the few macro facts that are predicted by a model that isn’t a tautology and that holds extremely well.”

Or at least it used to. Over the past 30 years, the convergence has largely stopped. Incomes in the poorer states are no longer catching up to incomes in rich states.

Mobile Labor
In a new working paper, Shoag and Peter Ganong, a doctoral student in economics at Harvard, offer an explanation: The key to convergence was never just mobile capital. It was also mobile labor. But the promise of a better life that once drew people of all backgrounds to rich places such as New York and California now applies only to an educated elite -- because rich places have made housing prohibitively expensive. (Shoag and Ganong visualized these changes in a series of excellent animated graphics.)

The states with the highest incomes also used to have the fastest-growing populations, as Americans moved to the places where they could earn the most money. Over time, that movement narrowed geographic income differences. In 1940, per-capita income in Connecticut was more than four times that in Mississippi. By 1980, Connecticut was still much richer, but the difference was only 76 percent. In the two decades after World War II, Shoag and Ganong find, migration explains about a third of the convergence of average incomes across states....MORE