Urbanisation makes the world more unequal

A recent article, by Kristian Behrens and Frédéric Robert-Nicoud, at VoxEU.org deals with the above issue and argues that large cities are more unequal than the nations that host them. The article contends that this is because large cities disproportionately reward talented superstars and disproportionately 'fail' the least talented. Cities should thus be the primary focus of policies to reduce inequality and its adverse consequences for society. Now the obvious question is Why should there be policies to reduce inequality? Are the authors attacking inequality when their real concern is with poverty?

The basic argument of the article is,

Large cities are more unequal than the nations that host them. For example, income inequality in the New York Metro Area (MSA) is considerably higher than the US average and similar to that of Rwanda or Costa Rica. Large cities are also more unequal than smaller towns. Figure 1 plots the relationship between population size and the Gini index of income inequality for a 2007 cross-section of US MSAs (solid line). The relationship is clearly positive. This holds true even when considering that large cities host more educated people on average (dashed line); income inequality cannot be entirely explained by higher educational attainment in large cities.

How can we then explain the size-inequality nexus? Researchers have proposed two main explanations so far, both of which have to do with city composition.

First, large cities may differ systematically in their industrial structure and the functions they perform. Large cities host, for example, more business services and the higher-order functions of finance and R&D, whereas small and medium-sized cities host larger shares of lower-order services and manufacturing. Consequently, larger cities are more skilled. However, industry composition explains only about one fifth of the observed skill variation across cities (Hendricks 2011). Furthermore, that variation cannot fully account for observed income inequality.

Second, large cities attract a disproportionate fraction of households at the bottom and at the top of the income distribution [ ... ]. Central cities of US MSAs attract, for example, poor households because they offer better access to public transportation [ ... ]. Large cities also attract rich households because they reward their skills more highly than smaller cities – a ‘superstar effect’ in ‘superstar cities’ [ ... ].

This is the second potential source to the positive relationship in Figure 1: returns to skill are increasing in city size [ ... ].

The argument for the second issue is that while larger cities increase the income of everyone, the top 5% benefit substantially more than the bottom quintile. The article continues,

In a recent study we propose a simple theory to explain why this happens [ ... ]. In our theory, large cities are places that disproportionately reward the most talented people (the ‘superstars’) and that disproportionately fail the least talented (‘selection’). In a nutshell, larger cities provide incentives for the most able to self-select into activities that offer high payoffs to the successful. However, the risk of failure associated with those activities also increases because workers in larger cities compete against more numerous and better rivals.

Disproportionate rewards for the most skilled – and failure for the less skilled – then drives income inequality. Both channels are stronger in larger cities, thus establishing the positive link between city size and inequality, even when abstracting from differences in industry composition and educational attainment.

The theory also predicts that increasing globalisation among global cities will translate into larger urban income inequality. Just as large cities provide large local markets to reward skills, larger global markets serve the same function. One novel aspect of our analysis is to emphasise the existence of both a direct effect of increasing globalisation on inequality (the ‘superstar effect’) and an indirect effect that goes through increasing urbanisation and the growth of cities. Cities are more ‘valuable places’ in a globalised world, which may serve to explain increasing urbanisation. The latter is positively linked to inequality, an aspect that has not been much analysed until now.

But perhaps the most interesting bit of the article are the caveats they put at the end.

We conclude with two words of caution. First, nominal income inequality (which is measured) is not equivalent to real income inequality (which is not directly measurable). Insofar as large cities offer a wider range of cheaper goods and services than small cities do, and if this pattern is especially pronounced for the least well off, then actual real urban inequality may be less severe than nominal inequality [ ... ]. Actually, Harvard economist Edward Glaeser claims that the large poverty rates of central cities are a testimony of their success, not their failure: they attract poor households by catering better to their needs [ ... ].

Second, fighting (urban) inequality does not require aggressive local redistributive policies, for such policies attract the poor and repulse the rich, leading to the bankruptcy of local governments, such as the fiscal crisis that hit New York City in the 1970s.

If inequality really is the issue then you may ask, Inequality of what? Is nominal/real income inequality what we should be worried about or is consumption inequality the real issue?