WHILE Europe's austerity-minded governments and inflation-averse central bank must take much of the credit for the euro area's current economic problems, the crisis has been fanned by failures of regulatory reform and integration that have made adjustment much harder than it needs to be. Those failures also operated prior to the crisis, contributing to growth in imbalances, and without much more in the way of structural reform they will continue to be an economic albatross when the crisis is finally put to rest.
This week's Free exchange column looks at an underappreciated way in which regulatory burdens and incomplete integration have prevented the euro area from taking full advantage of the size of its market and growing richer: by constraining the growth of its cities:
Although America and the euro zone have similar total populations, America’s 50 largest metropolitan areas are home to 164m people, compared with just 102m in the euro area. This striking disparity has big consequences.
Differences in metropolitan populations may help explain gaps in productivity and incomes. Western Europe’s per-person GDP is 72% of America’s, on a purchasing-power-parity basis. A recent study by the McKinsey Global Institute, the consultancy’s research arm, reckons that some three-quarters of this gap can be chalked up to Europe’s relatively diminutive cities. More Americans than Europeans live in big cities: there is a particular divergence in the size of each region’s “middleweight” cities, those that teem just a little less than the likes of New York and Paris (see chart). And the premium earned by Americans in large cities relative to those in the countryside is larger than that earned by urban Europeans.
In highly skilled societies, bigger cities are associated with higher levels of productivity and income, the column explains. This seems to be due to the ways in which cities facilitate innovation in an age of rapidly increasing economic and technological complexity. Prosperity now requires lots of skilled individuals in reasonably close proximity to each other, to learn from and occasionally partner with as part of the process of coming up with and spreading new ideas. America appears to be better able than Europe to accomplish this across a wide range of places.
But why? The piece explains:
Regulatory barriers to growth may be to blame. Tight zoning rules limit housing supply and raise prices by driving a wedge between construction costs and market prices. This “regulatory tax” amounts to over 300% in the office markets in Frankfurt, Paris and Milan, according to a 2008 study by Paul Cheshire and Christian Hilber of the London School of Economics, but is just 50% in Manhattan and, in effect, zero in fast-growing places like Houston. Taxes that add to transaction costs also help explain low European mobility.
Comparatively smaller cities also reflect incomplete European integration. Paris is large by national standards, for instance, accounting for around 30% of French GDP and boasting incomes per person some 59% above the western European average. But if there was genuine freedom of movement within Europe, big-city wage premiums should trigger a flood of migrants from outside national borders. There are linguistic barriers in the way, of course, but other obstacles, like the portability of pensions and the recognition of professional qualifications, make it even harder for Europe to match America’s urban jungles.
Language and cultural differences are obstacles to intra-euro-area migration, but Europeans are also move less across regions within individual countries than Americans do across state lines. And even if Europeans did become more mobile, they'd often be discouraged from moving to larger places thanks to the high cost of real estate.
Reform of these obstacles wouldn't immediately spark growth and lead the euro area out of recession. But they would help with fiscal crisis by buoying long-run growth prospects. Certainly clearing away such rules would make a great deal more sense as part of current reform packages than a continued focus on mostly counterproductive short-term austerity.
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So countryside nostalgia will not help build the new ages. You may take a break there ok but let's not stand against the metropolian areas where science and culture flourish.
Regards,
One could almost imagine from this article that Houston is a better city than Manhattan, which is in turn better than Paris. I suppose it depends whether you believe that everything worthwhile is included in GDP, or whether regulations sometimes trade GDP for other things.
This phrase "Prosperity now requires lots of skilled individuals in reasonably close proximity to each other" seems to be a contradiction since we live in an Era of instant communication and how distance have been considerate irrelevant for business by several books, business articles and consultants?
What about work time? Europeans work some 20-30% less hours per year than Americans. Wouldn't that be a better explanation for the difference in GDP? Of course both may be somehow related.
In what way are organizational differences important?
The Ruhrarea is a giant blop of medium sized cities. Together they form a conglomeration of more than 5m people. If you include the Rhineland, which isn't even an hour's drive away, you are closing in on 10m people though it turns up as a bunch of small to medium sized cities in the statistics.
I don't want to dismiss the idea of the importance of cities. I think one big reason why Bavaria in the last 50 years turned from an agricultural backwater to the richest German state were generous zoning laws (at least compared to other parts of West Germany).
Work time doesn't make a difference. Productivity makes a difference. The Greeks work some of the longest hours in Europe and are some of the least productive workers. The Irish in comparison work some of the shortest hours and are right in the middle of the productivity tables. We also have to measure quality of life. Americans work longer hours because they're not entitled not to. Comparing America's working habits to Europe's doesn't hold any value because Americans don't enjoy the same worker's rights and holiday entitlements that Europeans do.
On top of that, Purchasing Power is a poor measure of actual wealth. America is unbelievably de-regulated in comparison to most of Europe and as a result a lot of wealth is concentrated among a relatively small portion of the population. That PPP figure means little to you if you exist outside of that small portion.
What? If GDP per capita is 30% less in Europe and work time per year is 30% less then productivity per hour is more or less the same compared to the US. I'm not sure if productivity per hour is really the same but I think the difference is less than the pure GDP per capita number.
No quality of life does not come into it that is a different topic, the next step.
I agree that Europe should learn to grow it's cities(I am in fact a big supporter of YIMBY), but I don't think the US proves a perfect example to follow, with a lot of cities being relatively spread out, and impossible to live in without a car. Many European cities were built before the 20th century, which makes expansion more difficult if you wish to create a whole out of the old and the new. And these "language and cultural barriers" are big. Europe isn't a country, it's a continent. We're never going to be as integrated as the US, even with the best regulation in the world(which isn't going to be handed down from Brussels, I'd wager)
I wonder if specialized small cities wouldn't be as productive as big cities or more so. I'm thinking of San José which is probably a European sized city but where the guy at the gas station is selling an app.
Don't think so. The higher productivity of cities, I think, is mainly a demand-side phenomenon. High population density permits a larger range of services and allows more of them to reach economy of scale. The restaurant business is a good example. Consider a small town of 10,000 with one restaurant versus a city of a million with 100 restaurants. The resident-to-establishment ratio is the same, yet we wouldn't expect the small-town dwellers to eat out as often as the city dwellers. Going to the same restaurant over and over again gets boring after a while. Even if the small-town chef is highly efficient at his job, he can't be highly productive unless his production finds willing consumers.
But the premise of this article is that the difference in productivity is about - to take a stylised caricature - European cities of 1 million people versus American cities of 1.3 million people. And that is also more relevant to Doug Pascover's point, which is that San José is highly productive, not (say) Kennebunkport. 100 versus 130 restaurants is harder to explain as a structural failure.
Berlin certainly has a booming population - though it remains tiny by comparison to London or Paris, and small for Germany's population.
Nonetheless, there is a massive construction boom ongoing, with mass immigration from across Eastern Europe (adding to existing large Turkish, Russian and Serbian & Croat populations). Not to mention a decent smattering of Brits, Scandinavians, French and plenty of Spanish, Greeks & Italians.
On the down side, Berlin isn't yet a high productivity city (as measured by cash - that would be Hamburg, Munich, Bremen, Stuttgart & Frankfurt). Given the dynamism of its entrepreneurs, density of graduates, diversity of backgrounds and high quality of its transport infrastructure, it seems destined for a much richer (and more densely populated?) future.
Berlin doesn't have a booming population. It's pretty stagnant, despite the influx from the rest of Europe. http://en.wikipedia.org/wiki/Berlin_population_statistics
Very surprising to hear.
My first guess is that official numbers are inaccurate (I've lived a total of 28 months in Berlin, without ever registering as living there - as is formally required).
On second thought, it's certainly possible that there is continued large scale emigration of Germans, from the Soviet blocks in the outer East of the city to other parts of Germany.
There is however an enormous net influx of young students from across Germany, young professionals, Eastern Europeans and (perhaps on a smaller scale) entrepreneurs from across Western Europe (and a decent number of Americans & Asians).
True, it sure feels like there's a lot of new people coming in. I felt it when I visited a few years ago. Great city too.
But I guess the better economic shape of western/southern German cities is still a big draw for Berliners. That and the very low fertility rate (it's not as if Germany is booming, in a demographic sense, on the whole).
Yeah - fertility's one hell of a drag.
Germany has entered the phase where it's population is shrinking faster than Japan's (and should continue to do for decades, migration not withstanding). From 1968 onwards its fertility has been much lower than Japan's, and as boomers age that's really starting to pass through into growth numbers.
Fertility in both countries has now converged - at 1.39 per women. If that continues, even if life expectancy rises to 90, Japan's population would be smaller than the Netherlands is today in just 6 generations; Germany's would be smaller than Sweden's is.
In context, 6 generations would take us to about 2150 or later. But even in our lifetimes, we're going to see a transformation in population distribution and economic power.
However dynamic our cities are, they can't really escape the fact that women aren't giving birth. There won't be enough young professionals to support scale economies. Perhaps not even enough to provide networking benefits across the number of large cities we have today...
So you're German? I was wondering why Germany, being a fairly left of center country (at least compared to the US) hasn't put in place the same level of incentives to, well, procreate that France, for example, put in place. France sure has problem, but from a democgraphic point of view, they're actually doing great for a developed country.
There's clearly a demographic problem. Germany isn't in bad economic shape. Why not do more about that enormous issue?
Actually Scottish.
The UK, France and Sweden all have good demographics (fertility in the 1.9 to 2.0 range). But that is mostly obtained through high immigration, and especially high fertility rates among Arab, Indian & African immigrants.
In Germany, the political debate has been far more focussed on reducing population - the green party was in government recently, and they had the explicit goal of reducing Germany's population to "sustainable" 19th century levels (where everyone can eat well on local organic food, there is enough hydro, solar & biomass power for a decent life, etc).
If political attitudes did shift, it isn't at all clear how rates would be lifted. Expanded school hours & free after school care/ activities? Guaranteed subsidised full-day preschool care for all kids? Free public transport for kids? Increased tax free allowance? A marketing campaign to promote the merits of combined work and motherhood?
I can't say for Sweden or the UK, but the high fertility rate of France is only marginally affected by the fertility rate of immigrants. If you take them out of the equation, the fertility rate would go from 2.0 to 1.9 (or something similar). The high fertility rate is in a large part the result of a concerted effort to make life easier for parents.
And yes, measures like some of the ones you listed would help. It can have an impact. The implementation of extremely subsidized childcare in Quebec in the last decade has, most probably (always hard to find the cause and effect in those kind of things), increased the fertility rate substantially in that province (although it's still lower than in France or the US).
Interesting piece. I'm more familiar with the UK than the eurozone but the comments about the impact of restrictions on housing supply certainly make sense. It's probably the number one factor limiting London's growth.
I'd like to mention two other possible factors.
One is the history of settlement in Western Europe vs the US (and maybe Canada and Australia). I now live in Australia and I am struck by how dominant our big cities are. In Western Australia and South Australia, roughly 75% of the population live in Perth and Adelaide respectively. Imagine London with three quarters of the UK's population in it. Does Western Europe have fewer big cities because it was settled (by whites) long before the US, Canada and Australia? I'm not sure why that would be. Transport? The industrial revolution? Is it more to do with geography?
The second factor is welfare. In the UK, the relatively (and I mean relatively) generous provision of benefits (funded on a national basis) reduces the incentives for people to move from declining cities such as Glasgow or Newcastle to London. Indeed, there may be a broader point about nationally-funded public spending making life more bearable in economically-struggling cities in the UK than would be the case in somewhere like Detroit.
The welfare point is salient. As recently as the 1930s, America had the dustbowl clearances - where creditors appropriated land & evicted nearly a million independent farmers, sending them to the cities, devastating local towns and sending the rest of the inhabitants to the cities too.
That is, America's more competitive agricultural market, lower food prices, history of credit & land seizures, and the absence of that welfare system you mentioned, have all contributed to clearing much of America's rural population.
Another important factor, is large land owners, ranches & plantation owners in the Southern states. When market conditions changed and agriculture became more capital intensive, they evicted their black labourers & sent them packing for the cities (no real small town economies).
And separately from that, as you point out, small towns across Europe are bolstered by net income to residents through welfare transfers (perhaps the biggest reason why welfare reduces economic output over the long term, by encouraging inefficient behaviour). The US doesn't really have that.
I think public housing policy can have a significant adverse impact on growth of cities. A typical European city is surrounded by a ring of housing estates built by the state for low income families. Such neighborhoods are characterized by high level of crime and juvenile delinquency. Even if salary is higher in the city, people will be hesitant to move into if it means having to live in an unsafe area. Life in small-town France might be lacking but it beats living in the Parisian banlieue, for instance.
As a Glaswegian I am generally irked by your comments.
Firstly, Glasgow's population is actually growing again.
Secondly, London is seen as a massive problem by the rest of the country. It sucks in investment and wealth from the rest of the country and central government policy is always skewed towards London's priorities even when they are directly at odds with the rest of us.
I don't think it's a coincidence that Glasgow started growing again after devolution to Scotland.
Not a great way to think about the topic. For one thing, like many mega-cities, Paris is characterised by medium-density commuter settlement up to around 50km away, which is hardly small-town. For another thing, people commuting to Paris should clearly be counted as residents of "Paris" for the purposes of this study, since that is where their economic activity is.
London doesn't really suck investment and wealth from the rest of the country. It sucks it from the rest of the world. Those Russian and Arabian petro-oligarchs were not living in East Kilbride before London. That is why London is much wealthier.
True believers in metropolitan virtue simply refuse to consider the possibility that rent-seeking could be the factor that sustains and grows cities.
Their simplistic argument is:
a) agglomeration efficiencies exist;
b) cities are agglomerations;
therefore
c) cities exist, survive and grow because of agglomeration efficiencies.
But the income effects cited here could also be due either to i) populations gathering around centres of windfall rent, or ii) the greater effectiveness of concentrated populations in political rent-seeking, working together to benefit themselves at the expense of others.
It is tedious trying to explain to True Believers things they have no intention of ever acknowledging. So rather than go over it all again (which would be as futile as ever) I simply post the links to previous discussions of this topic:
generalised (meta-stability) definition of rent, including the distinction between rent and quasi-rent;
windfall rent, including windfall rent from technological development;
incumbency rent, including the incumbency rents extracted by established financial centres and political rents extracted by politically powerful metropolises; and
other discussion of metropolitan rent-seeking here and here and here (state sponsored sport) and here (transport infrastructure) and here (state sponsored culture) and here (fuel taxes - i.e. distance-based taxes - often used to cover the externalities of urban traffic congestion).
This is not to suggest that agglomeration efficiencies do not exist in some cases and to some sizes of town or city, but the fundamentalist spruikers of metropolitan virtue have failed to separate out the contributions of productivity and rent-seeking in the broadest sense.
Keep in mind that RA isn't spruiking subsidies to improve or expand cities. He's proposing that regulatory barriers that restrict the size of cities be pulled back. Rent seeking allegations aside, are you in favour of these regulatory barriers remaining?
Keep in mind that RA isn't spruiking subsidies to improve or expand cities.
If cities grow and are sustained by rent-seeking then they may already be bigger than they would be in the absence of rent-seeking, without further subsidies or assistance.
Rent seeking allegations aside, are you in favour of these regulatory barriers remaining?
My individual preferences are a matter of complete irrelevance. The Almighty has granted me no Charter from Heaven to decide these matters on behalf of humanity.
It may be noted, however, that by the principle of Coasian Symmetry, the removal of such “barriers” is itself a “barrier”. Some people may support barriers to development on the grounds of intangible externalities or for other reasons. Enforcing the removal of development barriers is itself a barrier to those who wish to preserve them.
Leaving aside human beings’ solipsistically narrow-minded tendency to favour their own individual opinions over those of other people, there is no self-evident reason to privilege the preferences of those who favour one policy over those who favour the symmetrically opposite policy. This article - like so many that appear in The Economist - is a pseudo-logical attempt to “prove” such privilege.
The logically coherent solution to this controversy - as with all controversies – is:
a) to pursue the policy reflecting the aggregated preferences of the individuals concerned, where the “aggregation device” is itself chosen directly or recursively from an initial non-privileging aggregation device (i.e. a “democracy eigenfunction”); and
b) to choose “the individuals concerned” using a non-privileging polity market which has itself been constituted using a democracy eigenfunction.
- - - - -
p.s.
The Economist has posted a new article (here) on the irrational value attributed to “presenteeism”.
It would seem that people are rewarded for being present, even by those who profess to prefer them absent. This is one of the mechanisms by which rent-seeking promotes the growth of cities.
Historically, courtiers had to be present at Court to be sure of capturing some of the rents distributed by the monarch. For a courtier, being absent from Court was fatal. Around those primary rent-seekers were arrayed the secondary rent-seekers who provided the lifestyle of the courtiers. And around the secondary rent-seekers were the tertiary rent-seekers, their employees and suppliers, and so on, like the layers of an onion. Thus did cities grow around the fountainhead of rents.
In modern times, especially where the Executive arm of government is strong, it is still necessary to be within “lunching distance” of the Cabinet. Ministers don’t do favours for people they’ve only ever spoken to over the phone. They do favours for those they know personally, whose children or grandchildren attend the same schools or are on the same sporting teams or other social organisations. Thus must rent-seekers crowd in close to share the spoils.
The same incentive applies to those seeking a share of windfall rents (from new technology for example) or incumbency rents (such as those which flow to entrenched financial centres). They must gather in close to those who are the primary recipients of such rents if they are to have a chance of getting a cut.
This is the kind of real-world behaviour that simplistic models of urbanisation ignore.
People are more productive in cities than in the countryside so we conclude that we should have bigger cities. Is that just dumb or the dumbest thing ever?
Observing that productivity is measured in the currency of the realm, perhaps the problem is that the urban folks are simply overpaid. So an alternate solution would be to improve markets for products of the countryside.
Given that urban folks mostly wash each other's cars and deliver pizza, and of course, shuffle money, maybe we should look to encourage a more basic form of productivity.
Ah yes, the urban folks also trade in the products of the countryside. That is going well now isn't it?
If there was wisdom in government we might see more action to encourage rural productivity, like for instance, a program to enable universal irrigation which would enable massive increase in land based productivity. Most of the land of the Western US is seriously under-used due to lack of water, but with a little creative thought we might look for ways to fix this.
For fun, I started a petition at the Whitehouse website to do such a thing. It got off to a rousing start with 12 signatures. Then they took it down in favor of petitions like the one to require seven slices of pepperoni on every slice of pizza which received 25,000 signatures instantly.
I am serious about improving land productivity, even if it is only lighting a candle in the scheme of things. Look at Miastrada Dragon on youtube to see one piece of the future.
Cute chart, but the list of world's biggest cities isn't exactly a who's who of economic powerhouses: http://en.wikipedia.org/wiki/World%27s_largest_cities
Studies like this are interesting but need to be thought about carefully: does Europe really want bigger cities?
What ran through my mind on reading the post and column was an analysis of Israel. If you adjust for a few factors, most of the disparity in earnings between Israeli Arabs and Jews goes away. These would be mostly family size and with that the lower participation of women in the workforce. If you adjust for location, all the differences basically go away; Israeli Arabs tend to live in their areas and thus they tend to have their own local economies. But here's where this kind of thing goes: how much of the participation of Arab women in the workforce is cultural? If some is cultural, is that something which should be respected or should the Israeli state help empower Arab women? Is some related to family size? If so, what does that mean? Is some a direct result of discrimination, meaning less opportunity is reflected in lower numbers working? The difficulty is not only in finding meaning but in determining what to do. This isn't even easy in more blunt cases: nearly all the birth defect issues in Israel are Bedouin. Why? Because they have too much close kin marriage. What exactly is the state supposed to do about that? Tell the Bedouin they can't do what their entire history tells them to do?
My point isn't about Israel but about the mixed meanings any of these "facts" or "perspectives" carries. Maybe the US has bigger cities because the distances are so large that concentration is a rational response, if only because cities aggregate resources that are otherwise spread over too large an area. Maybe the US having bigger cities has been a good thing in some ways but bad in other ways. Maybe the better course for the future is spreading out more of some things and greater density of others. Maybe Europe will have a longer term advantage because it can tie together smaller locales with transport and the internet. We don't know.
Right, a very compelling post but not compelling enough for me to want to live in town. Poor and quiet is a fine way to go through life.
Hey, soundproof your walls. That way you'll have quiet in the city too!
Must be a city gal. The point of quiet is all the things you can hear like bullfrogs and coyotes and the breeze.
And complaints about not being on the gold standard. That's when I hope for a soundproof apartment in the city.
If you come from the country, what gets you isn't just the noise -- for that you can get ear-plugs, as well as soundproofing. It's the constant rumbling vibration.
I sometimes wonder why folks from East Coast cities carry on so about earthquakes in California. At least most of the time you can stand on the ground (or lie in bed) and not feel any vibration at all. Just try that in NYC!
I don't really have that problem here in the D/FW metroplex...