Asymmetrical Information - Megan McArdle

06.12.13

Will the Young People Go Home Again?

Europe's periphery is losing its best young workers. What happens if they don't come back?

Young workers are fleeing Europe's periphery for the richer countries in the center.  A lot of analysts are worried about what this means for European welfare states, but Karl Smith tells them no to worry; eventually, those young people will be back:  

I am not that worried – at least about the fundamentals. The danger I see is that “deficit hawks” will use the exodus of young workers to push painful but unnecessary benefit cuts. In the short run this is likely to cause some ugly accounting but in the long run chances are better than fair that the young people will be back. Though it may be difficult to envision now, this is setting up a situation where wages and profits will be especially attractive in the periphery in the years to come.

There are a couple of ways to get to this result but I think the following will be the easiest for most folks to swallow. Lots of old Spaniards are going to mean a relatively high demand for things old Spaniards like to buy, like Spanish doctors. This increases the demand for doctors and raises their wages. That, in turn, increases the demand for things that well-to-do Spanish doctors like to buy, like fancy restaurant meals. That increases the demand for Spanish chefs, waiters, busboys etc. The process reverberates through the whole economy, making Spain an especially attractive place to live and work.

I love counterintuitive economics, but I am unconvinced.  And the reason I am unconvinced is that we can actually observe what this looks like right here in the United States, where labor mobility is high, and as a result, you have fairly substantial segments of the country which basically consist of old people, poor people, and a thin middle class of government workers sandwiched between them.  They look like my mother's hometown, Newark, New York.  

If factor price equalization should be enough to lure people anywhere, it's places like Western New York.  These places are chock full of gorgeous old infrastructure.  Hundred and fifty year old houses on acres of land can be purchased for the low six figures.  The most expensive house in town costs less than a condo in my neighborhood of DC.  And let's just say that my neighborhood is not somewhere that you should expect to see on one of those HGTV shows where wealthy jet-setters seek the ultimate in luxury and services.  

The other infrastructure is pretty great too.  Excellent roads.  Convenient airports in Syracuse and Rochester.  A number of good colleges in Western New York, from Cornell to Syracuse. Lovely scenery--low, rolling hills undulating for mile after mile, soft with grass in the summer and frosted with sugar-white snow all winter long.  In the valleys, you find the lakes and rivers carved by the last ice age; you practically can't throw a rock without hitting a pristine water view.

So why is no one living there?

The short answer is that the weather sucks.  But actually, people up there like the weather.  I know it sounds crazy.  Frankly, if you ask me, on the topic of the weather, my relatives are playing a few cards short of a full deck.  But they don't mind the snow as much as I undoubtedly would.  They've got electric starters on their cars and storm windows, and hey, no need for a chest freezer when you can stash the stuff right outside in a cooler.  It'll stay frozen solid until the spring thaw.

The young people leave anyway, for two reasons: it's too expensive, and there aren't any jobs.  All over the South and Southwest, there are people sighing about their air conditioning bills and pining for the cool green hills of Western New York.  Half my cousins talk about going back--maybe not to the small town, but to somewhere around Syracuse or Rochester.  But they're still living in Florida.

Too expensive?  Didn't I just tell you how cheap the houses were?  And yes, they are cheap.  But my aunt pays twice as much in property taxes as we do, on a property that's assessed for less than one third of the value of ours.  Her property taxes are so high because the businesses have all fled, which means that the tax base is very thin.  The biggest employer is probably the various levels of government.  There are a lot of elderly people, and there are a fair number of poor and working poor people who don't have the skills or the money to relocate.  But the middle of the economy--the part that's supposed to pay for all the rest--is missing.  

The businesses go away for a lot of reasons, but all of them boil down to this: it's too expensive to do business in Newark.  They can't compete with companies in lower-tax states, much less with China.  The biggest business left in town is a furniture factory, Halligan's furniture, which I commend to you for its quality and durability.  At least three generations of my family's rear ends have spent decades comfortably ensconced in Halligan chairs and sofas.  But I don't know how they manage to keep it up in the face of Chinese competition.

The taxes--and the electric power, and the water and sewer, and the workman's comp, and basically every other expense you can imagine--are high for two reasons.  First, because Western New York is lashed to downstate New York, which is full of liberals employed in high-skilled industries that throw off an enormous amount of cash per person (tech, finance, consulting, advertising, entertainment, etc).  Those liberals like big expensive regulatory mandates, extremely generous welfare programs (one in three people in New York City was on Medicaid long before Obamacare came along), and very highly-paid government workers protected by ironclad work rules.  Those things require a lot of taxes and expense for both individuals and business. Goldman Sachs, which has high margins and competes only with businesses situated in other similarly inclined urban areas, can afford it.  The old jewelry manufacturer, the flower nurseries, and all the other businesses in Newark that shut down, could not.  

This has locked the local tax system into a death spiral.  Companies move out, taking relatively well-paying jobs with them.  Young skilled workers leave in search of a better job.  The workers who stay behind are older, or retired, or they work for the government.  Most of the high school class leaves for the college and the military and never come back.  The ones who do stay have limited opportunities, which means they don't generate much in tax revenue.  So the taxes have to go up to pay for all the mandatory benefits.  The generous Medicaid eligibility rules (New York State requires local governments to kick in a quarter of the cost).  The school system.  The health system.  All those roads and systems have to be maintained . . .and whoops!  There goes the property tax bill again.  And when the taxes go up, more people leave.  

You see it most acutely in cities like Rochester, and Buffalo, which have had the same experience as Detroit's emergency manager: you can tinker around the edges, but there's no actual way to get these cities on a sustainable fiscal footing.   The amount they are required to pay, for everything from road maintenance to pensions, is larger than any feasible tax regime could sustainably pull out of the tax base, especially since the tax base shrinks every time you try to raise taxes.  

Western New York survives, barely, because it is legally attached to downstate New York, which sends in fiscal transfers whenever the burden of all the downstate mandates actually threatens to send the whole region into mass government bankruptcy.  Detroit, unfortunately, is attached to Michigan, which doesn't have a lucrative financial services industry to subsidize the decaying auto plants.  But at least these places are entitled to transfers from the US federal government.  Who's going to pay Greece's bill for retiree health care?  Where is the money going to come from to pay all those doctors?  

There is, after all, a great deal of demand for doctors in East Africa.  What there aren't is a lot of doctors, because the people who want doctors do not produce enough surplus to afford their services.  A retired civil servant in the suburbs of Athens doesn't produce any surplus at all.  The best case scenario may be that his children go abroad and send remittances.  But while that may pay the bill of a few doctors, for this system to work, most of the children have to stay abroad, don't they?  

Places can die.  When all the young people leave, regions, even large regions, can sink into a poverty trap from which they cannot recover.  It would be nice if this were some sort of self-correcting mechanism, but Western New York has been in decline since 1959, when the St. Lawrence Seaway took the last of the traffic from the Erie Canal.  That seems like a long time to wait for factor price equalization to save you.