Ryan Avent on How Big Cities Might Account for America’s Economic Edge Relative to Europe

Ryan Avent offers an arresting thesis, drawing on a Free Exchange column that I assume he wrote:

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.

The great advantage of big cities is that they greatly facilitate the diffusion of useful knowledge:

Technology innovators and entrepreneurs congregate in Silicon Valley, for instance, rather than in smaller places where they have less to offer to, or get from, would-be partners. And knowledge-sharing among such people tends to make cities more productive as they get bigger. In a 2009 paper Mr Glaeser and Matthew Resseger of Harvard University find that in highly skilled areas, city size explains 45% of the variation in worker productivity (it has almost no effect in underskilled cities). This connection between size, skills and productivity is not simply due to brainier workers choosing to live in more populous places. The cities themselves seem to promote learning. Mr Glaeser and Mr Resseger note that new arrivals to big cities do not receive the city’s wage premium all at once, but rather enjoy faster wage growth over time.

So what accounts for Europe’s relative deficiency when it comes to generating and sustaining big cities?

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.  

The column also cites incomplete European integration as a barrier. I would add that generous social insurance programs might effectively lower the cost of remaining in a low-productivity city or region.

This Free Exchange analysis struck me as very interesting, as it offers an alternative, or perhaps a complement, to the Prescott thesis regarding the productivity gap between the U.S. and Western Europe. It also suggests that the U.S. should “double down” on its urbanization advantage to increase national wealth.