High Housing Costs And High Wages Often Go Together, But They Don’t Cause Each Other

I completely agree with Elisabeth Ericson that it would be desirable to create additional tax brackets so that someone earning $250,000 and someone earning $2.5 million aren’t facing the same marginal rate. But her subsidiary point about “grow[ing] up in cities where cost of living is high and salaries commensurately so” reflects a common but interesting error.

Earnings are higher in metro areas like San Francisco and Boston than in metro areas like Jacksonville and Phoenix. And housing costs are also higher in metro areas like San Francisco and Boston than in metro areas like Jacksonville and Phoenix. Consequently, the gap in real living standards between a guy who delivers pizzas in Boston and a guy who delivers pizza in Jacksonville is smaller than a naive look at wages would indicate. This sometimes leads people to conclude that the gap in wages is a kind of illusion almost as if Boston and Jacksonville have different currencies and we need to adjust for that fact when comparing income.

In reality, though, housing costs don’t repeal the basic rules of economics. What you get paid for delivering pizzas is approximately equal to the productivity of your labor. So if the pizza guy gets paid more in Boston than in Jacksonville, that’s because he’s more productive. Sometimes that’s because there are quality differences. If you’re the best hairstylist on the planet, it doesn’t make sense to live in Jacksonville—you should move someplace where there are lots of rich people. But sometimes it just reflects a difference in circumstances. The same pizza delivery guy with the same pizza delivery skill will be more productive (and thus earn a higher wage) in a richer city rather than a poorer one. People from Mexico can improve their productivity (and thus wages) by migrating to the richer United States and for all the same reasons people from Jacksonville can improve their productivity (and thus wages) by migrated to the richer San Francisco Bay Area.

So why doesn’t everyone move to Boston? Well there are lots of reasons (weather, family, friends, obnoxious Red Sox fans, etc.) but this is where housing costs play a big role. The extra productivity is very real, as are the higher wages, but if you move you’d need to “give back” a lot of your wage gains in the form of higher housing costs or longer commutes. That works like a tax that discourages people from improving their productivity through migration. But unlike with a tax, the revenue doesn’t fund public services. It merely accumulates as rents for people who bought real estate at the right time.

Ryan Avent gave a presentation about this at the Kauffman Foundation a few weeks ago, though I’m not certain he persuaded the audience that this is as important as I think it is.