Academic journal article NBER Reporter

The Economics of Cities

Academic journal article NBER Reporter

The Economics of Cities

Article excerpt

The fundamental questions of urban economics are: Why do cities exist~ How does density - or agglomeration - affect people and firms? Why do some cities flourish and others decay? Why are social pathologies often more extreme in cities?

These questions address how spillovers actually operate. If the effects of agglomeration and local spillovers lie behind phenomena as important as economic growth, business cycles, and the formation of human capital (as many researchers now suspect), then urban economics has a special role to play in helping us to understand how these spillovers work in their rawest form. My work tries to use the evidence from cities both to understand urban density itself and to shed light on other topics that are hopefully of interest to the broader economics community.

The Causes and Extent of Agglomeration Economies

Cities now exist for three primary reasons: 1) they reduce transport costs for goods; 2) they eliminate the space between people; and 3) cities facilitate a faster flow of ideas. More precisely, dense agglomeration reduces the transport costs for goods, people, and ideas. These three different sources of "agglomeration economies" have equivalents in other literatures. For example, the role of reduced transport costs for goods in the formation of cities is similar to the idea that the comovement of output over the business cycle occurs because a productivity shock to one firm increases demand for other firms.

Albert Ades and I(1) measure causes of urban agglomeration using cross-county evidence by looking at the extent to which countries' populations are concentrated in a single city. We find that population is more spread out in countries where transport costs for physical goods are lower (measured by development of internal transport networks), and when external trade is smaller (which Paul Krugman and Raul Livas(2) argue is a further implication of transport cost models of urban agglomeration). While transport costs do matter, our results suggest that political factors, for example dictatorship and instability, are far more important in explaining which countries have concentration in a single city. For example, dictatorships have 50 percent more of the population in their largest cities than do stable democracies. When political systems are not stable and democratic, politicians respond to the rent-seeking activities of people who live in their cities by transferring rents to those cities, and population flows follow these rents.

To understand why people in the United States may be more productive in cities, David Mare and I(3) examine why workers are paid substantially higher wages in cities. The urban wage premium persists even after we control for a full battery of individual factors (education, race, age), job-related factors (industry and occupation dummies), and for differential selection into cities. Unless workers in cities were more productive, firms would leave. Thus, even though real wages seem to be constant over space (as evidence on real prices suggest that they are), we believe that there is a productivity premium in cities.

Surprisingly, and counter to many theories of agglomeration, the urban wage premium does not immediately accrue to workers who come to the city, and it does not disappear immediately (or at all) for workers who leave the city. Instead, there appears to be a slow but steady increase in the rate of wage growth for workers in cities relative to workers outside cities (the urban wage premium is also higher among older workers). One possible interpretation is that the urban wage premium works through faster skill accumulation in cities which accrues over time, and stays with workers when they leave cities. I(4) provide a theoretical analysis of this view and some suggestive evidence that shows that the individuals who choose to live in big cities are drawn disproportionately from groups who would presumably value the skill accumulation role of cities (that is, young, college educated persons). …

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