Academic journal article Independent Review

Interregional Growth Divergence and Living Standards Convergence

Academic journal article Independent Review

Interregional Growth Divergence and Living Standards Convergence

Article excerpt

In integrated national economies, overall gross domestic product (GDP) and income per capita move in the same direction. Because of this association, observers often assume that the same relation holds at the regional level. We argue in this article that long-term adjustments to interregional growth differentials are realized by product and factor mobility, not by prices, with the exception of the price of land and of nontradable local services, such hairdressing. Quantities, not prices or incomes, adjust. Slow-growing regions, therefore, should have real income per capita as high as that of fast-growing ones, even though they grow at a lower rate. Growth differentials are capitalized into the prices of land and local services, the only prices that vary across the economy. Land-price differentials across the country thus provide an immediate and easy-to-observe measure of interregional growth. We bring out here the significance of this analysis for political institutions and policies.

The Paradox of Slow-Growth High-Income Regions

People choose to live in various environments. Researchers have identified features that people care about in selecting their place of residence, including the physical climate, zoning, the quality of schools, and so forth. We argue that these characteristics play a role in some people's selection of a place, but at the margin the distribution of the population in an integrated economy is determined by real standards of living.

Assume there are two cities in a free-trade area such as the national economy, and relative growth rates change in favor of City 1. People move in from City 2. Because land is a resource in fixed supply, its price increases in City 1. This adjustment process continues until real incomes have equalized for the two cities. In the long term, growth differentials are capitalized into the price of land so that the cost of living varies across regions. Why in these circumstances would anyone live in City 2? For one thing, it is cheaper. People like the higher monetary income in City 1, but they also like the lower house prices in City 2. Steven Landsburg (1993) has vividly expounded the mechanism that we here extend to interregional growth, calling it the Indifference Principle.1

Quantities (populations in this case) adjust to differential growth, not to prices or incomes per capita, except for the price of land and local services. William Nordhaus systematically establishes that land-price adjustments differ from other prices in an integrated economy in his recent assessment of " Baumol 's disease." In his study of sixty-seven U.S. sectors over half a century, he shows that "the differential impact of higher productivity growth on factor rewards is extremely small . . . [and] the fraction of productivity retained as higher factor rewards is very small. For the most part, industrial wage and profit trends are determined by the aggregate economy and not by the productivity experience of individual sectors" (2008, 21-22). This finding shows at the same time that most of the economic gains from higher productivity growth are passed on to consumers in the form of lower prices.

Because the supply of land is fixed, land prices are bid up in the more prosperous regions and bid down elsewhere. Over time, lagging regions' advantages in lower land prices compensate for their lower nominal income. Once the process has been completed, prices and incomes in each industry equalize across regions. Because people move from lagging regions to more prosperous ones, living standards tend to converge across all regions of an economically integrated economy, no matter what the growth rate is in specific regions. In deciding where to settle, people are ultimately indifferent between the two places. In the long term, thanks to population mobility, people of all regions gain equally from the accelerated growth in one region. Once the process has worked itself out, statistics on published real income per capita cannot reveal regional growth rates when only a national price deflator is used. …

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