Does where you live really matter?

UChicago economists explore how housing dynamics impact U.S. inequality

Housing costs increasingly determine where and how lower-income households live, as well as their future prospects. As the 2020 election approaches, policymakers and politicians who hope to confront these problems might be helped by economic research from the University of Chicago.

Persistent questions about wealth disparities, the influence of neighborhoods and the effects of gentrification underscore the urgency of recent work done by three UChicago economists: Profs. Veronica Guerrieri and Erik Hurst at the Booth School of Business, and Asst. Prof. Peter Ganong at the Harris School of Public Policy.

All three scholars have studied housing in the United States, writing papers that point to the increasing equality gap between high- and low-income households. In short, where people live directly impacts their quality of life and that of their children—whether that means access to jobs, better education or urban amenities.

New Becker Friedman Institute working papers by Guerrieri and Hurst touch on related themes, discovering specific ways in which wealth shapes the development of neighborhoods, often to the detriment of lower-income families.

Partnering with Alessandra Fogli of the Federal Reserve Bank of Minneapolis, Guerrieri’s paper builds on research that reveals the impact of neighborhoods on a child’s future earnings, and describes the macroeconomic implications of this effect.

The bottom line: As the education premium increases and people are priced out of neighborhoods with better schools, those children suffer long-term negative effects. Residential segregation, her work shows, significantly amplifies the increase in equality in an economy where technological progress increases the skill premium.

“When the difference among neighborhoods is something that affects differentially the income prospects of children who grow up there, such as the school quality, social norms, networks and so forth, not only higher inequality translates into higher segregation, but also higher segregation feeds back into even higher inequality,” said Guerrieri, the Ronald E. Tarrson Professor of Economics at Chicago Booth. “Policymakers should pay particular attention to these spatial considerations in order to reduce the gap in opportunities that American kids are offered to reach their potential.”

The quality of schools isn’t that only factor determining where high-income people choose to live. According to research co-authored by Hurst, those groups are also drawn by the quality of amenities in a neighborhood, such as restaurants, retail shops and entertainment venues.

Hurst and collaborators—Victor Couture and Cecile Gaubert of the University of California, Berkeley and Jessie Handbury of the University of Pennsylvania Wharton School—found that larger numbers of wealthy people are living in U.S. cities than there were three decades ago, and that those people are choosing to live downtown. This movement has fueled a growth in amenity-rich downtown neighborhoods that are increasingly unaffordable to lower-income households.

These powerful market forces—wealthy households demanding more amenities, which attract more wealthy households—are driving increased gentrification within downtowns in many American cities.

“The increasing demand for high amenity neighborhoods in downtown areas by the rich results in increasing rents throughout all downtown neighborhoods,” said Hurst, the V. Duane Rath Professor of Economics at Chicago Booth and a leading expert on housing and labor markets. “The increase in rents unambiguously hurts lower-income renters residing there. As the incomes of the rich continue to increase, more and more downtown neighborhoods of major cities will gentrify in the coming decades. It is hard for city planners to stop these gentrification forces.”

Ganong’s paper was published in 2017 in the Journal of Urban Economics, but its insights into the divergence of income equality within regions across the United States has generated renewed interest—cited recently in congressional testimony and in national publications like The New York Times.

For much of the past century, per-capita incomes across U.S. states strongly converged and population flowed from low-income to high-income areas. Ganong and co-author Daniel Shoag of Harvard University reveal that these two phenomena are related. Although those moves often came with higher housing costs, those increases were more than covered by higher incomes. By increasing the available labor in a region, migration drove down wages and induced convergence in human capital levels.

However, over the past 30 years, both the flow of population to high-income areas and income convergence have slowed considerably. This is explained, in part, by a change in the relationship between income and housing prices. Although housing prices have always been higher in higher-income states, housing prices now capitalize a far greater proportion of the income differences across states.

Policymakers looking to regulation should take note: Tighter regulations impede population flows to high-income areas, and weaken convergence in human capital and per capital income.

“Over the past 40 years, NIMBY (‘not in my backyard’) regulations against new housing construction proliferated, undermining housing affordability in many cities with good jobs,” Ganong said. “However, I’m hopeful about the prospects for reform because there is new bipartisan interest in this issue. Housing and Urban Development Secretary Ben Carson is chairing a new ‘White House Council on Eliminating Regulatory Barriers’ and several Democratic candidates have proposed plans along similar lines.”