Flashback Saturday: Better cities mean a wealthier New Zealand

Most Saturdays we dig into the archives. This post by Peter was originally published in September 2014.

Last week I took a look at whether government policy to support regional economies could divert growth away from Auckland. Based on the historical evidence, the answer seems to be no – people want to live in Auckland and start businesses here, and it’s senseless to try and stop that.

Today, I want to look at this issue from a different angle, and ask: If we somehow succeeded in stifling Auckland’s growth, would we be better off as a result? Would New Zealand be richer if it cancelled the City Rail Link, banned any new dwelling construction in Auckland, and told newcomers to bugger off to Timaru (or, more likely, Melbourne)?

Once again, we don’t have to speculate, as we can examine the results of previous “natural experiments”. Paul Krugman suggests that we could learn from recent population growth in the United States. (In between gaining academic renown for his work in new trade theory and public notoriety as a harsh critic of the second Bush administration, Krugman helped develop the new economic geography literature, which explains why cities form and grow.) He takes a look at the rapid growth of the “sunbelt” states, including Arizona and Texas, and finds that it has probably reduced economic growth in the US:

It turns out, however, that wages in the places within the United States attracting the most migrants are typically lower than in the places those migrants come from, suggesting that the places Americans are leaving actually have higher productivity and more job opportunities than the places they’re going. The average job in greater Houston pays 12 percent less than the average job in greater New York; the average job in greater Atlanta pays 22 percent less.

So why are people moving to these relatively low-wage areas? Because living there is cheaper, basically because of housing. According to the Bureau of Economic Analysis, rents (including the equivalent rent involved in buying a house) in metropolitan New York are about 60 percent higher than in Houston, 70 percent higher than in Atlanta.

In other words, what the facts really suggest is that Americans are being pushed out of the Northeast (and, more recently, California) by high housing costs rather than pulled out by superior economic performance in the Sunbelt.

But why are housing prices in New York or California so high? Population density and geography are part of the answer. For example, Los Angeles, which pioneered the kind of sprawl now epitomized by Atlanta, has run out of room and become a surprisingly dense metropolis. However, as Harvard’s Edward Glaeser and others have emphasized, high housing prices in slow-growing states also owe a lot to policies that sharply limit construction. Limits on building height in the cities, zoning that blocks denser development in the suburbs and other policies constrict housing on both coasts; meanwhile, looser regulation in the South has kept the supply of housing elastic and the cost of living low.

In short, restrictions on population growth in productive places – i.e. large, relatively dense cities – force people to move to less productive places, and earn less. A recent working paper by American economists Chang-Tai Hsieh and Enrico Moretti put a figure on the economic cost of these restrictions: housing supply restrictions in high-productivity cities like New York and San Francisco over the last three decades has lowered the US’s GDP by an estimated 10-14%. That’s absolutely huge.

This is agglomeration at work – or rather, “deglomeration”. The economic literature has identified a strong relationship between the scale and density of cities and the productivity of firms that locate within them. But rather than recognising and taking advantage of this phenomenon – for example, by allowing more office space to be built in San Francisco for the expanding tech industry and more apartments to be built in Silicon Valley for urbanophile tech workers – some American cities have chosen to reject it.

So could the same thing happen in New Zealand? In a word, yes. It’s definitely a risk and one that we should be careful to avoid.

First, the facts. Firms based in Auckland are more productive than firms elsewhere in New Zealand, after controlling for industry and firm characteristics. And firms in the Auckland city centre are even more productive. The table below, compiled from data in Dave Mare’s great 2008 paper on the topic (“Labour productivity in Auckland firms”), shows that there is a substantial “productivity premium” in Auckland:

I just want to say a brief word about the “productivity premium” of the city centre. A lot of people say that New Zealand’s an agricultural exporter, earning its way off the sheep’s back (or, more recently, the cow’s teats), and that downtown jobs are just an unproductive drain on farm revenues. However, service exports from urban businesses play an underappreciated role in NZ’s international trade picture. The two companies I’ve worked for in the Auckland city centre are both exporters of professional services. I’ve personally exported to Hong Kong, Australia, Fiji, and Papua New Guinea; my colleagues have also worked in Indonesia, Uganda, Canada, Saudi Arabia, the UK, and a whole host of other places. If we want to grow our exports in a smarter way, we need to encourage this sort of thing rather than deny that it’s happening.

As a result of the urban productivity premium, policies that stifle the growth of Auckland are likely to put a drag on New Zealand’s economy. In the US, a reluctance to let productive cities grow caused people to move to lower-wage cities like Phoenix, Houston, and Atlanta. Down here, the results are likely to be even worse, as New Zealanders are much more internationally mobile than Americans. If we put a lid on Auckland’s growth, some people will go to Hamilton or Tauranga instead, but many others will head to Australia or the UK.

Fortunately, we’ve got a much better option: Improve New Zealand’s cities rather than trying to smother them. Moreover, we’ve got some great opportunities to do just that. In Auckland, that means:

• Making cost-effective investments in more transport choices, including better walking and cycling
• Building the City Rail Link to unlock access to the city centre and allow firms to grow and benefit from the knowledge spillovers floating around
• Preserving and improving our parks and public spaces – Waterfront Auckland is a truly world-class waterfront development agency and we should build on its success
• And, as Krugman and Glaeser point out, it’s absolutely vital that we allow dwellings to be built in the places where people want to live – which increasingly means building more in places like Ponsonby and Mount Eden that are close to jobs and amenities.

We shouldn’t limit our vision to Auckland, either. While Auckland’s larger and faster-growing than Christchurch or Wellington, those cities also support agglomeration economies and interesting urban lifestyles. Investments in better cities will pay off there as well. Some of the same policies can also make small cities more liveable – although Hamilton will probably never need a CRL, look at the difference that NZTA’s Model Cycling Communities programme has made to Hastings and New Plymouth.

Why don’t we get on with it then?

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