While we all want to live near “the best,” financial constraints caused by a sudden negative shock to wealth or income force many to downgrade to a city that offers fewer long-term benefits. A new paper by Adrien Bilal and Esteban Rossi-Hansberg elaborates on how viewing location itself as an asset informs why people move from better to worse locations when faced with such a negative shock.
The location of individuals determines their job opportunities, living amenities, and housing costs. We argue that it is useful to conceptualize the location choice of individuals as a decision to invest in a ‘location asset.’ This asset has a cost equal to the location’s rent, and a payoff through better job opportunities and, potentially, more human capital for the individual and her children. As with any asset, savers in the location asset transfer resources into the future by going to expensive locations with good future opportunities. In contrast, borrowers transfer resources to the present by going to cheap locations that offer few other advantages. As in a standard portfolio problem, holdings of this asset depend on the comparison of its rate of return with that of other assets. Differently from other assets, the location asset is not subject to borrowing constraints, so it is used by individuals with little or no wealth that want to borrow. We provide an analytical model to make this idea precise and to derive a number of related implications, including an agent’s mobility choices after experiencing negative income shocks. The model can rationalize why low wealth individuals locate in low income regions with low opportunities even in the absence of mobility costs. We document the investment dimension of location, and confirm the core predictions of our theory with French individual panel data from tax returns.
The results are relatively intuitive (if someone is hit with a negative income or wealth shock and has limited ability to borrow money, downsizing makes sense), but Bilal and Rossi-Hansberg’s conceptualization is novel. By moving to an environment where the “location asset” is of lower value than their previous one, relocators are foregoing future gains for immediate returns (the definition of borrowing).
The results of their findings are significant, particularly for those experiencing negative shocks at the lower rungs of the economic ladder.
[W]e estimate that after an unemployment spell individuals at the bottom of the local asset distribution downgrade 8 percentile points relative to agents at the top. As expected, when we allow this effect to vary by a location ranks decile, we find that individuals use the location asset more in poorer places. These facts are, as far we know, unknown to the literature and can be estimated precisely given the large number of observations in our data…
[Borrowing c]onstrained individuals locate in cities with lower land rents and lower returns to skill than unconstrained individuals with the same skills. The reason is that they use the location asset rather than the financial asset to adjust their intertemporal consumption path. More specifically, they borrow using the location asset to transfer resources to the present, something financial markets do not allow them to do.
The authors also find that “place-based” policies that attempt to improve the environments of otherwise undesirable locations are “naturally costly, and impl[y] taxing other locations.” These place-based policies are particularly harmful to low-skilled workers because,
In the equilibrium with place-based policies rents are positive and identical in all cities, but for the lowest skilled individuals the benefits of locating in the improved cities are still zero. Hence, anyone with [the lowest skills] loses from the policy. By continuity, there is a range of individuals with [low, but not the lowest skills] that are also worse off after the policy. If they have some skills, they benefit in terms of future income, but the increase in rents still dominates. Or, in other words, the policy prevents them from borrowing with the location asset. Something they would like to do.
Much like how it should be the prerogative of the individual to borrow money to finance their consumption habits now in exchange for forgoing future income to pay it back, it’s also perfectly reasonable for them to choose to forgo future economic opportunities by moving to lower-opportunity places. Despite the temptation for policymakers in these low-opportunity areas to “revitalize” their cities, they should first recognize the potential for these policies to exclude financially constrained potential residents.