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The Agenda

NRO’s domestic-policy blog, by Reihan Salam.

Thoughts on Trickle-Down and Cities



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In light of the previous post, I’d like to make a tentative case for “trickle-down economics.”

Even if high-income rate reductions yield a larger economy, there is considerable anxiety regarding the relative impact of the resulting wealth gain across U.S. households. If a small number of affluent households capture all of the benefit of increased work hours or intensified work effort or success in tournament-like economic activities that yield bigger prizes, GDP might expand all the same while households further down the income scale might not subjectively experience any palpable welfare gain, particularly if they are locked in positional competition with more affluent households. This contributes to the broadly held sense that the tax code should help mitigate pre-tax inequality.

Another view, however, is that we should tackle the problems associated with positional competition more directly, e.g., we should make a systematic effort to reduce capacity constraints in housing markets in high-productivity metropolitan areas and to increase the diversity and quality of instructional providers through a series of regulatory reforms. This strategy would tend to increase wages at the bottom and middle of the labor force as more people sort into relatively lucrative service work. Yet it also entails some level of geographical dislocation, and it is quite explicitly a brand of “trickle-down economics.” 

How so? Consider the following passage from Greg David, a columnist for Crain’s New York and author of Modern New York:

The true genius of Wall Street in modern New York was figuring out how to make itself rich. Whatever Wall Street created between the late 1980s and the last boom could not justify Goldman’s Lloyd Blankfein being paid nine times more than Salomon’s John Gutfreund. Nor could it justify the billions of dollars Steve Schwarzman took from creating Blackstone or Paul Tudor Jones II’s wealth amassed from his hedge fund. The irony, of course, is that it was this innovation that made New York so rich.

Wall Street’s ability to pay so much for office space and investment bankers’ ability to spend unlimited sums on apartments made real estate developers and landlords wealthy. Its bonuses supported luxury retail. Its philanthropy made New York the home of so many nonprofits. The taxes it paid allowed city government to grow so large and to pay its own workers so well.

Wall Street’s ability to continue to support the city remains in doubt. Its rescue from the financial crisis may have been only a temporary reprieve. The Dodd-Frank law passed by Congress to ensure that there is never another financial crisis ordered a sweeping change in the structure of Wall Street. For example, firms like Goldman Sachs and JPMorgan must sell off or shut down their proprietary trading units on which they came to rely for a large percentage of their profits. Regulators are insisting that financial institutions build up their capital in the belief that the bigger cushion will make them better able to survive financial shocks.

But it is the opposite approach—borrowing more instead of amassing capital—that made the firms so profitable. Even if the political pressures to reduce compensation ebb—and they have had only a modest impact—lower profits will mean that the firms themselves will cut their pay and bonuses.

Economists and politicians believe that the solution is to diversify the economy so New York is not so dependent on Wall Street. The last recession shows that goal has already been achieved. But it won’t save New York. If Wall Street is permanently restructured, New York will be much less wealthy. No industry will pay its people so well that they will be able to generate two other jobs in the city. No industry will pay so many billions of dollars in taxes.

The effects will be wrenching. If financial firms can no longer pay $80 a square foot for office space, building values will decline. No new construction will take place until land prices drop. Both will mean big losses for real estate people. The same will be true for workers. Construction unions will have to accept a sharp decline in their wages and benefits to make new building possible.

The financial squeeze will radiate throughout the city. Without young investment bankers to support the market, apartment prices will decline. The ranks of luxury retailers will thin. Nonprofits will find fundraising much more difficult, and many will close their doors. The public sector will feel the most pain. Wall Street still accounts for 9% of all city tax revenue and 15% of state revenue, which allows Albany to send so much money to the city. 

I imagine David’s view is not universally held. Yet I think he makes a strong case that the extraordinary success of New York city’s financial sector has in various ways “trickled-down” to benefit less-affluent New Yorkers, particularly less-skilled recent immigrants. It is often observed that New York city has an unusually high level of income inequality; one reason is that poor workers are drawn to New York because (a) the fixed costs of transportation are quite low due to the city’s extensive mass transit system (i.e., one needn’t own an automobile to get to work) and (b) the presence of a large number of skilled, well-remunerated workers creates opportunities for less-skilled workers to whom household production or family work can be outsourced. As poor workers climb the economic ladder, the fixed cost of owning an automobile grows less prohibitive while high costs associated with higher-quality housing, education, and the tax burden become more salient. This contributes to residential churn, in which upwardly-mobile workers migrate to lower-cost, and lower-productivity, regions.  At the same time, new migrants arrive to replace these workers at the low end of the labor market. Over time, the result is a more polarized labor market. As Ryan Avent has argued, this is a less-than-ideal outcome for economy-wide productivity. We’d be better off if high-productivity regions were more populous. 

The force pushing mid-skilled workers out of high-productivity cities isn’t the presence of large numbers of high-earners, however. It is capacity constraints. So rather than attack the trickle-down notion as such, we might be better served by attacking capacity constraints. (Apologies for a slightly circular post.)



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