Understanding Patterns in U.S. Regional Economic Growth

The economic growth rates of U.S. regions have long varied, along with where the fastest-growing areas are found. In recent decades, many Midwestern cities have struggled to retain population and improve economic prospects for their residents, while many cities in the South and West have experienced rapid population and income growth. The places growing the fastest have been described as “superstar cities” because they are home to much of the innovation driving overall U.S. economic growth.See, for example, Gyourko, Mayer and Sinai (2013) and Diamond and Moretti (2021). On the other hand, their high costs of living are crowding out lower-income residents.

So, then, what explains recent differences in U.S. regional economic growth?

In this article, we describe the factors that generate regional differences in incomes and costs of living, identify the major factors driving divergent outcomes over recent decades, and examine what this may imply for the future. An important part of the story is that advancements in technology and globalization have driven faster productivity growth in higher-income coastal areas than they have in lower-income regions in the middle of the country. In addition, increasingly restrictive land use rules have helped to raise housing prices, preventing people—especially lower-skilled workers—from moving to areas with better economic opportunities.

Differences in Amenities and Productivity Generate Differences in Costs of Living and Incomes

In the early 1980s, economists Sherwin Rosen and Jennifer Roback each made early contributions to modeling how differences in amenities and productivity interact to make places more desirable or less desirable in which to live or conduct business.See Rosen (1981) and Roback (1982). While some amenities can be constructed (like an amusement park), others are natural (like good weather). All else equal, households are willing to pay more—or earn less—to live in locations with better amenities.

The second desirable attribute of an area is productivity, which determines how much output workers can create. Natural regional characteristics—such as a port or a long growing season—raise productivity, but other characteristics—such as the skill level of workers, the presence of entrepreneurs, the size of the labor market and the existing industry mix—also matter. Again all else equal, regions with greater productivity have higher incomes and employ larger shares of their populations.

Differences in amenities and productivity across locations result in differences in costs of living (or rent). Households and firms prefer to be in high-wage, high-amenity places, which leads to higher rents in those areas.

For example, rents are higher in places like New York City, with its high wages, and Hawaii, with its good weather. Not all people move to such places, though, because the high costs of living offset the benefits of higher wages and better amenities.

Differences in Productivity Growth and Willingness to Pay for Amenities Explain Differences in Regional Growth Rates

When productivity grows faster in one place than in others, people will move to take advantage of higher wages, which tends to push up the cost of living. Similarly, if people’s willingness to pay for amenities increases, places with a lot of amenities will attract new residents, who typically will raise the cost of living while accepting no improvement in wages. Different rates of productivity growth and shifting preferences for amenities are the historical norms in the U.S., and they have been primarily the result of changes in technology and rising incomes, respectively.

Major Economic Changes Have Led Some Places to Grow Faster than Others

For much of the 20th century, productivity growth was faster in places with lower initial levels of productivity and wages. The transition of workers from lower-productivity agriculture jobs to higher-productivity manufacturing and service sector jobs was the primary reason that lower-wage places began catching up to higher-wage places. This transition was particularly beneficial for Southern states, which were concentrated in agriculture.See Caselli and Coleman (2001).

The rate at which lower-wage regions closed the gap with higher-wage ones started to slow in the 1960s, and in the 1990s, higher-wage places began to see faster income growth. Economists examining the post-1960 period have identified a couple of reasons for the trend’s slowdown and then reversal.

First, starting around 1960, the importance of manufacturing in the economy began declining as rising incomes led households to shift more of their purchases toward services. In addition, the globalization of manufacturing production, which peaked in the 1990s and 2000s, further weakened demand for U.S.-made manufactured goods. As the center of U.S. manufacturing, the Midwest bore the brunt of the falling demand for manufacturing workers, and wage and population growth there stagnated.

A second reason that faster income growth moved to higher-income places was the information technology boom and advancements in semiconductors that started in the 1990s. Innovation and productivity growth in these industries were especially strong in coastal areas like San Francisco, Seattle and Boston, which already had high concentrations of technology workers who were well positioned to create new technology firms in these and nearby locations. Consequently, the rapid expansion of the information technology sector spurred faster growth in many U.S. coastal areas, while many inland regions languished.

A final important development that shifted the relative desirability of U.S. regions has been the rising willingness of households to pay for sunshine, beaches and mountains; increasing incomes have allowed households to spend a greater share of their budgets on amenities.See Rappaport (2007). This development has strongly favored coastal parts of California, but also places like Florida and Texas, where the adoption of residential air conditioning in the mid-20th century made hot summers more tolerable. As predicted by the model, places with good weather have shown growth in both population and costs of living, with relatively slower wage growth.

Homebuilding Restrictions Play a Role in Relocation to Fast-Growth and High-Amenity Places

In recent years, home prices across the country have increased faster than inflation, particularly in areas experiencing greater productivity growth and that have attractive amenities. Economists have found that restrictions on homebuilding, particularly in high-income places, have contributed to outsized home price growth and slower population growth. Homebuilding restrictions also have held back U.S. real gross domestic product (GDP) growth, because they raise home prices and discourage people from moving to places with higher productivity and wages.See Herkenhoff, Ohanian and Prescott (2018).

In addition, homebuilding restrictions have affected the type of workers who move to places with faster productivity growth.

Economists Peter Ganong and Daniel Shoag showed that the migration rates of lower-skilled workers declined after 1980, while the migration rates of higher-skilled workers increased.See Ganong and Shoag (2017). This skill-based shift in migration patterns has exacerbated income differences across regions.

To understand why, imagine that Boston experiences faster-than-average productivity growth. Wages go up, but few new homes are built, so Bostonians spend most of their higher wages on higher rent. In St. Louis, both a lower-skilled worker and a higher-skilled worker learn about jobs that would pay them more in Boston. But because rent is so high in Boston, only the higher-skilled worker decides that the move is economically beneficial.The different decisions occur because higher-income households spend smaller shares of their incomes on housing, making them less sensitive to changes in housing prices. Moreover, higher-income households are more willing to consume less housing (i.e., smaller units) in the face of higher prices. As a result, the difference in average incomes between St. Louis and Boston grows more than it would have if both the higher- and lower-skilled workers had decided to relocate. Restrictive land use policies can make it difficult for lower-income residents to move to places with better opportunities, contributing to the concentration of joblessness and poverty in some places.For more, see Chetty, Hendren and Katz (2016) and Amior and Manning (2018).

What Are the Future Implications for Regional Economic Growth?

What can we say about future differences in regional economic growth? First, the negative effects of homebuilding restrictions on cost of living will continue to be important. Places that reduce land use restrictions typically will grow faster. Second, manufacturing will continue to be important to the Midwest’s economy, and manufacturing’s share of GDP will probably continue to shrink. This suggests that the Midwest will grow more slowly than other parts of the country. And third, demand for good weather and natural beauty is likely to continue to grow as incomes rise, but climate change may shift the location of some natural amenities.

Notes

1. See, for example, Gyourko, Mayer and Sinai (2013) and Diamond and Moretti (2021).
2. See Rosen (1981) and Roback (1982).
3. See Caselli and Coleman (2001).
4. See Rappaport (2007).
5. See Herkenhoff, Ohanian and Prescott (2018).
6. See Ganong and Shoag (2017).
7. The different decisions occur because higher-income households spend smaller shares of their incomes on housing, making them less sensitive to changes in housing prices. Moreover, higher-income households are more willing to consume less housing (i.e., smaller units) in the face of higher prices.
8. For more, see Chetty, Hendren and Katz (2016) and Amior and Manning (2018).

References

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Barro, Robert J.; and Sala-i-Martin, Xavier. “Convergence.” Journal of Political Economy, April 1992, 100(2), pp. 223–51.

Caselli, Francesco; and Coleman II, Wilbur J. “The U.S. Structural Transformation and Regional Convergence: A Reinterpretation.” Journal of Political Economy, June 2001, 109(3), pp. 584–616.

Chetty, Raj; Hendren, Nathaniel; and Katz, Lawrence F. “The Effects of Exposure to Better Neighborhoods on Children: New Evidence from the Moving to Opportunity Experiment.” American Economic Review, April 2016, 106(4), pp. 855-902.

Diamond, Rebecca; and Moretti, Enrico. “Where Is Standard of Living the Highest? Local Prices and the Geography of Consumption.” Stanford Business School Working Paper 3997, December 2021.

Herkenhoff, Kyle F.; Ohanian, Lee E.; and Prescott, Edward C. “Tarnishing the Golden and Empire States: Land-Use Restrictions and the U.S. Economic Slowdown.” Journal of Monetary Economics, January 2018, 93, pp. 89-109.

Ganong, Peter; and Shoag, Daniel. “Why Has Regional Income Convergence in the U.S. Declined?” Journal of Urban Economics, November 2017, 102, pp. 76-90.

Gyourko, Joseph; Mayer, Christopher; and Sinai, Todd. “Superstar Cities.” American Economic Journal: Economic Policy, November 2013, 5(4), pp. 167-99.

Rappaport, Jordan. “Moving to Nice Weather.” Regional Science and Urban Economics, May 2007, 37(3), pp. 375-98.

Roback, Jennifer. “Wages, Rents, and the Quality of Life.” Journal of Political Economy, December 1982, 90(6), pp. 1257-78.

Rosen, Sherwin. “The Economics of Superstars.” American Economic Review, December 1981, 71(5), pp. 845-58.