Housing and Inequality

One curious consequence of runaway income inequality in the United States is that it’s produced a bumper crop of research (not sure I’m remembering it right, but I think Marx talks about this in The German Ideology) aimed at explaining away runaway income inequality. At any rate, Reihan Salam tweeted out this paper from Enrico Moretti the other day:

A large literature has documented a significant increase in the return to college over the past 30 years. This increase is typically measured using nominal wages. I show that from 1980 to 2000, college graduates have increasingly concentrated in metropolitan areas that are characterized by a high cost of housing. This implies that college graduates are increasingly exposed to a high cost of living and that the relative increase in their real wage may be smaller than the relative increase in their nominal wage. To measure the college premium in real terms, I deflate nominal wages using a new CPI that allows for changes in the cost of housing to vary across metropolitan areas and education groups. I find that half of the documented increase in the return to college between 1980 and 2000 disappears when I use real wages. This finding does not appear to be driven by differences in housing quality and is robust to a number of alternative specifications. The implications of this finding for changes in well-being inequality depend on why college graduates sort into expensive cities. Using a simple general equilibrium model, I consider two alternative explanations. First, it is possible that the relative supply of college graduates increases in expensive cities because college graduates are increasingly attracted by amenities located in those cities. In this case, higher cost of housing reflects consumption of desirable local amenities, and there may still be a significant increase in well-being inequality even if the increase in real wage inequality is limited. Alternatively, it is possible that the relative demand of college graduates increases in expensive cities due to shifts in the relative productivity of skilled labor. In this case, the relative increase in skilled workers’ standard of living is offset by higher cost of living. The empirical evidence indicates that relative demand shifts are more important than relative supply shifts, suggesting that the increase in well-being inequality between 1980 and 2000 is smaller than the increase in nominal wage inequality.

You can think of the baseline dispute about inequality as being that on the left we think it would be a good idea to try to redistribute some wealth and income away from folks at the top and either give more money or more services to the rest of the population. On the other side are folks who think the reverse. And this housing issue, like the case of the expensive refrigerator, strikes me as something purporting to debunk concern about inequality that in fact is just offering an example of why the right is correct to think that redistribution would be a good idea.

The way I read this research result, if we take a bunch of money away from rich people it will cost them relatively little in welfare since almost half of the excess income of the rich is going to bidding up the price of housing in the kinds of places where rich people can find jobs. If they all had less money, they’d all live in equally good houses; the houses would just be cheaper. But the money acquired through taxation could be used to provide services — better transportation infrastructure, better teachers, healthier food, more medicine — that have real value to the middle class and the poor.