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first QUARTER 2019


Opportunity Zones in
Distressed Communities

Initial Coin

Rural Hospital

More Money,
More Problems?

Interview with
Enrico Moretti

Volume 24
Number 1
First QUARTER 2019



Opportunity Zones: More Money, More Problems?
The promise and pitfalls of a new financing model for
distressed communities    

Director of RESEARCH

Kartik Athreya
Editorial Adviser

Aaron Steelman


Corporate Crypto Crowdfunding
The technology behind cryptocurrencies shows
promise for raising capital but has also drawn scrutiny
from regulators                    

Econ Focus is the
economics magazine of the
Federal Reserve Bank of
Richmond. It covers economic
issues affecting the Fifth
Federal Reserve District and
the nation and is published
by the Bank’s Research
Department. The Fifth
District consists of the
District of Columbia,
Maryland, North Carolina,
South Carolina, Virginia,
and most of West Virginia.


David A. Price
Managing Editor/Design Lead

Kathy Constant
Staff WriterS

Jessie Romero
Tim Sablik
Editorial Associate

Lisa Kenney


1		 President’s Message/What’s Lost when Rural Hospitals Close
2		Upfront/Regional News at a Glance
3		 Federal Reserve/Dealing with Monetary Policy Spillovers
6		 Jargon Alert/Money Supply
7		 Research Spotlight/Raising Innovators
8		 Policy Update/No Poaching
9		 At the Richmond Fed/Concentrating on Market Concentration
18		 Interview/Enrico Moretti
24		 Economic History/A Capital Compromise
28		 District Digest/Rural Hospital Closures and the Fifth District
32			Opinion/Whom Will Opportunity Zones Help?

Emily Wavering Corcoran
Mike Finnegan
Sara Ho
Luna Shen
Sonya Ravindranath Waddell

Janin/Cliff Design, Inc.
Published quarterly by
the Federal Reserve Bank
of Richmond
P.O. Box 27622
Richmond, VA 23261
Subscriptions and additional
copies: Available free of
charge through our website at or by calling Research
Publications at (800) 322-0565.
Reprints: Text may be reprinted
with the disclaimer in italics
below. Permission from the editor
is required before reprinting
photos, charts, and tables. Credit
Econ Focus and send the editor a
copy of the publication in which
the reprinted material appears.
The views expressed in Econ Focus
are those of the contributors and not
necessarily those of the Federal Reserve Bank
of Richmond or the Federal Reserve System.
ISSN 2327-0241 (Print)
ISSN 2327-025x (Online)

President’s Message
What’s Lost when Rural Hospitals Close


n addition to monetary policy, the Richmond Fed
works with a number of partners to identify and try
to address economic challenges and opportunities in
underserved communities. That’s why our research staff
and I have spent the past year trying to understand more
deeply the differences in outcomes we see between urban
and rural areas. Residents of smaller towns, for example,
are significantly less likely to be employed than people
who live in larger cities. What’s behind those differences,
and what can policymakers do?
We’re looking at four key themes that could move
the needle in rural communities. The first is education,
or more broadly, preparing people to enter the workforce, as I’ve discussed in this column before. The second is connecting people to good jobs, for example, via
collaborations between community colleges and local
employers. We’re also studying obstacles to labor force
participation, such as disability and addiction. Finally,
we’re researching how to address the consequences of the
social and geographic remoteness of many rural communities. By this, I don’t mean that there aren’t strong social
networks in small towns — the opposite is often true. But
there may be informational and institutional gaps that
don’t exist in larger cities. If you live in a place where
fewer adults have gone to college, for example, you might
not view college as a viable option for yourself.
Research is only part of the equation. We’re also working to share what we’ve learned and to highlight initiatives
that might be replicable in other areas. This fall, for example, we’re hosting a national conference that will bring
together community leaders, employers, researchers, policymakers, foundations, and others to identify practical
strategies that can have the largest benefit for rural areas
and their residents.
Given that context, the closure of many rural hospitals,
which Emily Wavering Corcoran and Sonya Ravindranath
Waddell discuss in this issue’s District Digest, is a trend we
pay attention to. Here in our district, a dozen rural hospitals
have closed since 2010, and 21 are at serious financial risk of
closing. Nationwide, more than 100 hospitals in rural areas
have shut their doors.
As Emily and Sonya explain, a variety of forces have
contributed to these closures. Hospital stays have become
shorter on average, in part because of medical advances
that allow more procedures to be performed on an outpatient basis; this is a benefit for patients, but it means
less revenue for hospitals. The declining population in
many rural areas has also been a challenge for hospitals,
not only from a revenue perspective, but also because

the quality of care tends to
improve when procedures are
performed more frequently.
Rural hospitals find it more
difficult to attract talent. In
addition, many hospitals have
struggled with the costs of
caring for patients who do not
have health insurance, particularly in states that did not
expand Medicaid with the
Affordable Care Act.
The most obvious implication of a hospital closure in a small town is reduced access
to health care, which may be of particular concern in communities that are struggling with high rates of addiction
and disability. In smaller communities, as Emily and Sonya
note, a hospital closing can also mean the loss of many of
its core well-paying jobs.
What is less appreciated is that hospitals also play a vital
role as “anchor institutions” in rural communities. These
institutions provide civic leaders and highly educated workers who can raise the aspirations of those around them.
They invest in their communities and educate residents
about healthy lifestyles. They supply amenities that attract
talent. They signal a community’s vibrancy to potential
business owners and residents. So when a rural hospital
closes, much more than jobs are lost.
This doesn’t necessarily mean a hospital can stay open
if it is no longer financially viable. But it does mean policymakers who are interested in seeing rural communities
thrive must acknowledge that the success of their hospitals
is a compelling public policy objective that includes, but
goes far beyond, health care.

Tom Barkin
Federal Reserve Bank of Richmond

E co n F o c u s | F i r st Q u a rt e r | 2 0 1 9



Regional News at a Glance

By L i s a K e n n e y

MARYLAND — A 131-year-old paper mill in the western Maryland town of
Luke closed in June, eliminating 675 jobs. The mill, owned by Miamisburg,
Ohio-based Verso Corp., was one of the largest employers in Allegany County,
which has an unemployment rate higher than the state average. According to the
Baltimore Sun, the mill was controversial among environmentalists because it was
one of the largest industrial sources of air pollution in the state but generated
energy by burning “black liquor,” a paper-making byproduct, which is considered
a renewable fuel under a state green energy program.
NORTH CAROLINA —Did a craft brewery just open near you in Charlotte?
Good news: Your home may be worth more. A recent report from researchers at
the University of Toledo and the University of North Carolina at Charlotte studied
homes sold in Charlotte between 2002 and 2017 and found that when a brewery
opened within a half-mile, condo prices in city-center neighborhoods jumped an average of nearly 3 percent while single-family home prices increased nearly 10 percent.
It’s been found that breweries spur revitalization when they move into abandoned
industrial spaces by drawing other businesses to the area.
SOUTH CAROLINA —The Carolina Panthers will soon strengthen their ties
to South Carolina. On May 20, South Carolina lawmakers passed a $115 million
tax incentive package for the NFL team to move its headquarters and practice
facilities from Charlotte, N.C., to Rock Hill, S.C. The Panthers plan to purchase
about 200 acres in Rock Hill for a $200 million sports complex that should
be open by 2022. The state’s Commerce Department estimated that the new
complex could have an economic impact of up to $3.8 billion over 15 years. The
Panthers will continue to play games at their existing stadium in Charlotte.
VIRGINIA — Pharmaceutical maker Merck & Co. announced in May that it
will invest $1 billion over the next three years to expand its vaccine manufacturing
plant in Rockingham County. The expansion will add 120,000 square feet and an
estimated 100 new jobs. To support the project, James Madison University and Blue
Ridge Community College will work together to develop biotechnology engineering
and computer science programs aimed at creating a workforce trained for jobs at
Merck and other life-science companies in the area.
WASHINGTON, D.C. —A record number of tourists visited D.C. in 2018,
according to a May report from the nonprofit Destination DC. More than
21 million domestic tourists visited D.C. and spent almost $8 billion. This
was an increase of 1.1 million domestic visitors and a 4.3 percent increase in
spending from 2017. Tourism in the nation’s capital supports almost 80,000
jobs in everything from music venues to museums to sports stadiums. Figures on
international tourists won’t be available until later in 2019.
WEST VIRGINIA — In early May, state business and education leaders
announced they were joining together to form the “West Virginia Ready
Graduate” initiative. After studying hiring, promotion, and college admissions
data, the initiative pinpointed the characteristics, skills, and knowledge that
West Virginia students need to succeed in the workforce. Building on the
initiative, a new internship program will place rising high school juniors and
seniors in four-week paid summer internships at various state businesses. The
internship will result in college credits.


E co n F o c u s | F i r st Q u a rt e r | 2 0 1 9


Dealing with Monetary Policy Spillovers
Fed policy has effects outside U.S. borders, but what can monetary
policymakers here and abroad do about it?
B y T i m S a bl i k

Photography: The Brookings Institution


uring the financial crisis of 2007-2008, the Fed
took extraordinary measures to cushion the fall
of the U.S. economy. This included cutting the
federal funds rate to near zero and purchasing assets on a
massive scale to further increase the supply of money in the
economy — a policy known as quantitative easing, or QE.
The intent of these policies was to alleviate domestic
economic problems such as mounting unemployment.
As the financial crisis turned into the Great Recession,
the Fed embarked on a second and third round of QE.
While these policies may have helped soften the blow
of the recession on the United States, other countries
complained that the Fed’s actions were having disastrous
effects on their economies.
In 2012, Brazilian President Dilma Rousseff referred
to the expansionary policy in the United States and
other advanced economies as a “monetary tsunami” that
was overwhelming emerging economies. In the immediate wake of the crisis, many investors sought safety in
developed markets despite low or even negative interest
rates. When the initial panic subsided but interest rates
remained low, however, investors began to seek higher
returns in emerging markets.
Those investments reversed course in mid-2013 after
then-Chair Ben Bernanke indicated that the Fed might consider slowing QE soon if economic conditions in the United
States improved. His comments triggered a sharp response
in emerging markets such as Brazil and India as investors
who had sought higher yields in those markets suddenly
pulled out. This and other market reactions to Bernanke’s
comments came to be known as the “taper tantrum.”
In a 2014 speech, Raghuram Rajan, then-governor of the
Reserve Bank of India, called on the Fed and central banks
in other advanced economies to be more mindful of the
effects their policy decisions could have on other countries.
“Even if a central bank has a purely domestic mandate,
the country’s international responsibilities do not allow it
to arbitrarily impose costs on the rest of the world,” he said.
But just how much impact does Fed policy have on the
rest of the world? And what, if anything, can it or other
central banks do about such monetary policy spillovers?
The Dollar’s Global Reach
The U.S. economy accounts for nearly a quarter of worldwide GDP, making it the largest economy in the world. It’s
unsurprising, then, that economic shocks in the United

States often have global repercussions. One recent study
found that the last four global recessions all overlapped
with major U.S. recessions. To be sure, spillovers go both
ways. America’s interconnections with the rest of the
world mean that policy changes in other countries affect it
as well. But most economists agree that the United States
is a driving force behind the global business cycle, making
spillovers from Fed policy changes particularly powerful.
One reason for this is the role of the dollar in the
global economy. Nearly a third of non-U.S. trade is priced
in dollars, and according to the Bank for International
Settlements (BIS), non-U.S. banks have about $15 trillion
in U.S. dollar liabilities. The dollar’s outsized involvement
in global trade and finances means that the effects of U.S.
monetary policy are more than just domestic.
“There’s a lot of activity in dollars outside the United
States,” says Stephen Cecchetti of Brandeis University,
who previously served as director of research at the New
York Fed and economic adviser at the BIS. “So when the
Fed changes the safe rate of return on dollar-denominated
assets by changing its monetary policy, everything adjusts.”
Along with Tommaso Mancini-Griffoli, Machiko
Narita, and Ratna Sahay of the International Monetary
Fund, Cecchetti found that changes in U.S. monetary
policy had an even larger effect on the median non-U.S.
financial firm in advanced economies than domestic
monetary policy changes in those countries. Another
recent paper by economists at the Federal Reserve Board

Raghuram Rajan, then-governor of the Reserve Bank of India,
speaks about the costs of monetary policy spillovers at the
Brookings Institution in Washington, D.C., on April 10, 2014.

E co n F o c u s | F i r st Q u a rt e r | 2 0 1 9


of Governors also found that monetary tightening by the
Fed was associated with banking crises in countries whose
economies were linked to the United States via trade or
dollar-denominated bank liabilities.
Still, despite the vocal complaints from leaders of other
countries about Fed policy during the Great Recession, it’s
not clear that unconventional monetary policy such as QE
generated more spillovers than the Fed’s traditional monetary policy. A 2018 paper by researchers at the Fed Board of
Governors found no evidence that QE had larger international spillover effects than conventional monetary policy.
In fact, QE may have had positive effects on other
economies, at least initially. Anusha Chari, Karlye Dilts
Stedman, and Christian Lundblad of the University of
North Carolina at Chapel Hill used high-frequency data
to examine the effects of U.S. monetary policy shocks on
emerging market countries between March 1994 and June
2016. They didn’t find strong evidence of the “monetary
tsunami” that Brazilian President Rousseff spoke of during
the QE period, but they did find that the value of equity in
emerging markets increased significantly during this period.
“In a classic asset pricing framework, rising equity valuations implies that the cost of capital is falling,” says Chari.
“That can have a positive effect on investment and growth.”
But any positive effects turned sharply negative during
the taper tantrum in 2013. Indeed, this was the concern of
central bankers in emerging markets during the QE period:
that positive spillovers from the Fed would increase the
leverage in their financial systems, setting financial firms
up for a fall when Fed policy reversed. And by all accounts,
that fall was hard. Chari and her co-authors found that the
spillovers from the taper tantrum were nearly three times
the size of those from the QE period for debt measures.
Further, the effects on equity were nearly triple the effects
on debt during the taper period.
A Call for Coordination
In his 2014 speech, Rajan called on the Fed and central
banks in other advanced economies to commit to greater
collaboration to reduce the disruption from spillovers.
“The current non-system in international monetary
policy is, in my view, a source of substantial risk,” he said.
There is some evidence that synchronizing monetary policy responses to global economic shocks can be
beneficial. Laura Liu of Indiana University, Christian
Matthes of the Richmond Fed, and Katerina Petrova of
the University of St. Andrews examined monetary policy
spillovers between the United States, United Kingdom,
and the euro area across time in a 2018 paper. They found
evidence that monetary policy in the United Kingdom
and Europe happened to be more in sync with policy
changes in the United States during the early 1980s. While
not the result of explicit coordination, the movement of
policy in the United Kingdom and Europe in response to
unexpected changes in U.S. policy during this period was
associated with more positive spillover effects.

E co n F o c u s | F i r st Q u a rt e r | 2 0 1 9

Fortuitous alignment of monetary policy across countries is one thing, but explicit central bank policy coordination has proven to be a more complicated issue. During
the period between the two world wars, New York Fed
Governor (the title for Reserve Bank presidents at the
time) Benjamin Strong worked with the heads of the Bank
of England, the German Reichsbank, and the Banque de
France to support the international gold standard. The
BIS was established during this period in part to facilitate
central bank cooperation, according to economic historians Michael Bordo of Rutgers University and Catherine
Schenk of the University of Oxford.
The post-World War II international monetary system,
developed in Bretton Woods, N.H., also involved plenty of
central bank cooperation. Throughout the 1960s and into
the early 1970s, the Fed and other central banks intervened
in currency markets in order to maintain the fixed exchange
rates that underpinned the Bretton Woods system. (See
“The Fed’s Foray Into Forex,” Econ Focus, Second Quarter
2017.) But in the cases of both the interwar gold standard
and Bretton Woods, policy coordination alone was ultimately not enough to keep the systems in place.
Throughout the 1970s and 1980s, the Fed periodically
coordinated with central banks in other advanced economies to stabilize the value of the dollar. In the “Plaza
Accord” of 1985, for example, the United States pledged to
pursue expansionary monetary policy while Japan agreed
to pursue contractionary policy. But as the 1980s came to
an end, policymakers and economists grew more skeptical
of the value of this sort of explicit coordination.
“Policymakers became increasingly convinced that the
best way of maintaining economic stability was to keep
‘one’s own house in order,’” wrote Claudio Borio of the BIS
and Gianni Toniolo of Duke University and the University
of Rome Tor Vergata in a 2006 history of central bank
cooperation. While central bankers today acknowledge
that their policy decisions can have effects on other countries, they have little appetite for subordinating domestic
monetary policy to international concerns.
In 2013, finance officials and central bankers from
Canada, France, Germany, Italy, Japan, the United
Kingdom, and the United States issued a statement in
which they agreed to “cooperate as appropriate” but reaffirmed that “fiscal and monetary policies …will remain
oriented toward meeting … domestic objectives using
domestic instruments.”
“The central bank’s mandate in any country is a domestic one,” says Cecchetti. “That’s not to say that central
bank officials don’t care about what happens elsewhere in
the world, but they focus on domestic conditions because
that’s their job.”
Indeed, coordinating policies to minimize international
spillovers could even make it more difficult for the Fed or
other central banks to meet their domestic objectives. In a
recent paper, Fed Vice Chair Richard Clarida argued that
formal policy coordination could threaten the credibility

for containing inflation that the Fed fought so hard to build
in the 1980s and 1990s by making domestic policy concerns
secondary to international considerations. To the extent that
this causes domestic inflation expectations to become unanchored, this could ultimately lead to worse spillover effects
as the Fed grappled with reasserting control over inflation.
“The all-in cost to a regime of policy cooperation could
swamp the theoretical benefits,” Clarida wrote.
Resilience and Transparency
Short of policy coordination, then, what can countries do
to defend against monetary policy spillovers?
After Bretton Woods, many economists thought flexible exchange rates would provide some defense, allowing
countries to pursue their own monetary policies in the face
of international capital flows. A country that is open to
international capital and has a fixed exchange rate pegged to
the dollar, for example, cannot deviate its monetary policy
from the Fed’s. The discrepancy in interest rates between
the two countries would trigger capital inflows or outflows,
putting pressure on the currency to adjust. The only way
for a country to be open to international capital and retain
independent monetary policy is to have flexible exchange
rates. (This is known as the Mundell-Fleming trilemma.)
But Hélène Rey of the London Business School
found that countries with floating exchange rates face
similar spillovers from Fed policy as countries with fixed
exchange rates. That means central banks in countries
with flexible exchange rates may still be obliged to
respond to spillovers from other central banks, constraining their independence.
Additionally, monetary policy responses to another
country’s spillovers may be counterproductive. In their
2019 paper, Cecchetti, Mancini-Griffoli, Narita, and
Sahay note that if easing by the Fed increases leverage
in the financial systems of other countries by increasing
capital flows, central banks in those countries would likely
respond by tightening their monetary policy. This would
have the effect of raising interest rates in that country further, potentially attracting even more foreign capital and
magnifying the spillover effects.
“All the natural domestic monetary policy responses to
spillovers are probably going to make things worse,” says
An alternative option is macroprudential policies —
requirements such as capital and liquidity rules imposed
on financial firms to prevent system-wide problems. Such

policies may offer a better defense against spillovers by
making countries’ financial systems more resilient. A 2019
article by Elöd Takáts of the BIS and Judit Temesvary
of the Fed Board of Governors suggested that there are
advantages to keeping one’s financial house in order. They
examined the fallout from the 2013 taper tantrum and found
that countries that had implemented macroprudential regulations prior to the event were significantly less affected.
Financial regulation is also an area where cooperation
among central banks is less controversial. Through groups
like the Basel Committee on Banking Supervision, policymakers routinely discuss best regulatory practices and
formulate minimum standards for financial firms. These
global standards can help prevent weaknesses in one country’s financial system that can lead to negative spillovers for
the rest of the world. This type of regulatory collaboration
does not keep central bankers from independently pursuing
the monetary policy best suited to their domestic economic
conditions. Unsurprisingly, then, central banks in advanced
economies have largely favored this type of cooperation.
Another way that the Fed might be able to help moderate the effects of its spillovers is by clearly communicating
its policy moves in advance.
“During the taper tantrum, the shock that had the
greatest impact was the most unexpected one,” says Chari.
“When Chair Bernanke first mentioned tapering during
congressional testimony in May 2013, the market really
When the Fed actually started to raise interest rates
and taper QE, it proceeded very gradually, using forward
guidance in its policy statements to signal when changes
would occur. “With a gradual rollout, the cumulative spillover effect might be the same, but you won’t get these big
shocks,” says Chari.
The Fed seems to favor these latter two approaches
to mitigating policy spillovers — cooperation in financial
regulation and open communication about monetary policy
moves — over the sort of explicit policy coordination proposed by Rajan. At a May 2018 conference in Zurich on the
international monetary system, Fed Chair Jerome Powell
expressed the Fed’s commitment to communicate policy
decisions “as clearly and transparently as possible to…avoid
market disruptions” and pledged to “help build resilience
in the financial system and support global efforts to do the
same.” While such measures may not prevent monetary
policy spillovers that arise from America’s economic dominance, they could at least lessen their impact.

Cecchetti, Stephen G., Tommaso Mancini-Griffoli, Machiko Narita,
and Ratna Sahay. “U.S. or Domestic Monetary Policy: Which
Matters More for Financial Stability?” Manuscript, January 2019.
Chari, Anusha, Karlye Dilts Stedman, and Christian Lundblad.
“Taper Tantrums: QE, its Aftermath, and Emerging Market Capital
Flows.” National Bureau of Economic Research Working Paper
No. 23474, June 2017.

Powell, Jerome H. “Monetary Policy Influences on Global Financial
Conditions and International Capital Flows.” Speech at the Eighth
High-Level Conference on the International Monetary System sponsored by the International Monetary Fund and the Swiss National
Bank, Zurich, Switzerland, May 8, 2018.

E co n F o c u s | F i r st Q u a rt e r | 2 0 1 9



Money Supply


hen the economist Milton Friedman said
that “inflation is always and everywhere a
monetary phenomenon,” he was highlighting the relationship between inflation and the supply of
money in the economy. To see this relationship in action,
we can look at famous cases of hyperinflation, such as the
Weimar Republic of pre-World War II Germany. To pay
reparations from World War I, the German government
began rapidly printing money, thereby increasing the
amount of money in the economy. The large increase in
the supply of money caused the value
of a single bill to become less than
it was the day before. Storeowners
raised their prices in response and so
consumers needed more currency to
buy the same quantity of goods; this
process continued until eventually
people would bring wheelbarrows
of cash to buy simple household
items. Even today, there are occasional cases of hyperinflation ­­— such
as in Venezuela, where the supply
of money has recently increased by
double digits in percentage terms on
a weekly basis.
But what, exactly, is the money
supply? Economists have used four
main measures, known as M0, M1,
M2, and M3. The four measures are
nested: M3 includes M1 and M2; M2
includes M0 and M1.
The main feature distinguishing
the four measures is the liquidity of their components
(how easily one can exchange the asset for cash). The
smallest and most liquid measure, M0, is strictly currency
in circulation and money being kept by banks in reserves;
hence, M0 is often referred to as the “monetary base.”
M1 is defined as all of M0 plus the remaining demand
deposits not in reserves as well as traveler’s checks; it is
often referred to as “narrow money.” M2 is everything
included in M1 plus savings accounts, time deposits (under
$100,000), and retail money market funds. M3 is everything in M2 plus larger time deposits and institutional
money market funds. (Because the cost of estimating M3
was thought to outweigh its value, the Fed stopped reporting it in 2006.)
Additionally, as pointed out by the monetarist economist Anna Schwartz, there is a relationship between the


E co n F o c u s | F i r st Q u a rt e r | 2 0 1 9

components of these measures of money supply and how
they are primarily used as a medium of exchange or a store
of value. The components of the most liquid measures
of the money supply, M0 and M1, all act as a medium of
exchange in the economy, while the components of M2
are used primarily as a store of value; M3, in turn, can be
thought of as a close substitute for money. Thus, the general idea is that there is a positive relationship between the
medium of exchange property and liquidity.
The role of the money supply in the way that many
economists think about inflation
has evolved in the past decade as
a result of changes in how the Fed
conducts monetary policy. Before
2008, an increase in the monetary
base was generally agreed to stimulate the economy in the short run
and increase the price level in the
long run. Today, monetary policy
remains central in the determination
of inflation, but the role of the monetary base is much reduced.
What changed is that the Fed
received authority from Congress
to pay interest on reserves (IOR)
to banks for the reserves they hold
at the Fed. The Fed responded to
the 2007-2009 recession in part by
engaging in massive purchases of
Treasuries and mortgage-backed
securities, adding greatly to the monetary base. By adjusting the interest
rate on reserves appropriately, inducing banks to maintain high levels of reserves at the Fed, the Fed avoided
the situation in which this infusion into the monetary
base would lead to inflationary increases in bank deposits
and lending and, therefore, in the money supply.
In short, in the post-2008 world, the Fed controls inflation by controlling the interest rate on excess reserves.
Thus, an increase in the monetary base no longer necessarily leads to an increase in the money supply or, therefore, to
an increase in the price level. Put differently, the familiar
textbook relationship between central bank money creation and inflation has become less useful for understanding
M1 and IOR might not be the best cocktail party conversation starters, but knowing about the money supply and
its evolving role is important for monetary policy.

Illustration: Timothy Cook

By M i k e F i n n e g a n

Research Spotlight
Raising Innovators


By S a r a H o

chose to pursue. Inventions are classified into very narrow
nnovation is a major driver of economic growth. Thus,
technology classes; for example, there are separate classes
it’s no wonder that many economists are researching
for synthetic versus natural resins. They found that having
how to increase the supply of innovation.
a father who is an inventor in a given technology class
In a recent article in the Quarterly Journal of Economics,
increased a child’s probability of inventing in that same
a group of economists characterized the factors that shape
class by at least a factor of five. Similarly, children were
who becomes an inventor in the United States. Their findmore likely to invent in the technological class related
ings were twofold. First, children’s chances of becoming
to the industry in which their fathers worked, even if the
inventors vary sharply with their characteristics at birth:
father himself did not have a patent.
race, gender, and parents’ income. Second, exposure to
The researchers looked at geographical effects on rates
innovation during childhood affects not only who becomes
of innovation. Moving a child from an area of relatively
an inventor, but what type of innovation he or she pursues.
low innovation, such as New Orleans, to a place of high
In their analysis, the researchers defined inventors as
innovation, such as Austin,
people who have filed for patincreased his or her probabilents, been granted patents, or
“Who Becomes an Inventor in America?
ity of becoming an inventor by
both. They linked patent data to
The Importance of Exposure to
37 percent. Furthermore, chilfederal income tax returns and
Innovation.” Alex Bell, Raj Chetty, Xavier
dren were influenced by the
to school test records. Using this
technological class they grew up
data, they were able to track indiaround. Children who grew up
viduals’ characteristics at birth,
Reenen. Quarterly Journal of Economics,
in Silicon Valley were especially
their math test scores (a proxy
May 2019, vol. 134, no. 2, pp. 647–713.
likely to patent in computers,
for ability), whether they evenwhile children who grew up in
tually became inventors, and if
medical device manufacturso, what they invented. The information was anonymized.
in medical devices. The
Several characteristics appeared highly predictive of
an inventor in a
children’s propensity to become inventors: being white
grew up.
or Asian, being male, and having high-earning parents.
To account for the possibility that families of different
motivasocioeconomic backgrounds could afford better education of having role models around. Regarding the latter, the
tional resources and opportunities for their children, the
researchers studied the effects of growing up in areas with
researchers separated the effects by breaking up their
higher shares of female inventors. They found that women
sample of children by race, gender, and parental income.
are significantly more likely to innovate if there were more
Even among children with the same high math scores,
women innovating in the area where they grew up; they also
those with high parental incomes were still more likely to
found similar significant causal effects when they broke the
become inventors than those with lower parental incomes;
samples down by technological class.
Asians and whites were still more likely to become invenHow much do these factors affect the goal of increasing
tors than Hispanics and blacks; and men were still more
innovation? The researchers considered a scenario in which
likely to become inventors than women.
women, minorities, and children from low-income families
In addition, the authors showed that exposure to innoinvent at the same rate as white men from high-income
vation during childhood had causal effects on who became
families; they estimated that there would be 4.04 times
an inventor and what type of innovation they pursued. In
as many inventors in America as there are today. In additheir sample, children whose fathers were inventors were
tion, the researchers looked for — and failed to find —
nine times more likely to become inventors themselves.
evidence that inventors from underrepresented groups
(See “Following in the Family Footsteps,” Econ Focus,
had inventions with more citations or higher monetary
Fourth Quarter 2017.) The authors found similar results
return. In their view, this means that not only are there
even when accounting for the fact that inventors generally
fewer inventors from these groups overall, there are fewer
had higher incomes than noninventors.
highly consequential inventors, whom the authors call
The researchers addressed the question of nature vs.
“lost Einsteins.” Thus, policies that give children from
nurture — that is, whether these children might have
underrepresented groups more exposure to invention could
inherited their propensity to invent. To assess this, the
significantly increase innovation in the future.
researchers looked at the types of innovations the children
E co n F o c u s | F i r st Q u a rt e r | 2 0 1 9


No Poaching
B y L u n a She n


n March 2019, four fast-food chains — Dunkin Donuts,
Arby’s, Five Guys, and Little Caesars — agreed to stop
requiring “no-poach agreements” of their franchise
owners. The agreements allegedly restricted a franchisee’s
ability to recruit or hire employees from within the same
chain, curbing the workers’ job mobility. The settlement
followed a yearlong investigation by 14 state attorneys
This settlement is another blow to no-poach agreements
following an announcement by the Justice Department’s
Antitrust Division in October 2016 that it would treat
naked no-poach agreements as criminal offenses. (Justice
defined a “naked” no-poach agreement as one “not reasonably necessary to any separate, legitimate business collaboration between the employers.”) The Justice Department
views such agreements as in violation of the Sherman Act
because they restrain competition in the labor market.
They also hurt employees by limiting the information available to them, their bargaining power, and their job opportunities. At the same time as the Justice Department’s
announcement, Justice and the Federal Trade Commission
(FTC) jointly released guidance on antitrust policy for
human resources professionals.
In September 2017, Alan Krueger and Orley Ashenfelter
of Princeton University published a paper revealing that
among 156 of the largest franchise chains in the United
States, 58 percent had no-poach agreements; among
40 of the largest fast-food chains, 80 percent had no-poach
agreements. Spurred by this revelation and the Justice
Department’s new attitude, state attorneys and private
plaintiffs launched investigations and filed class-action
lawsuits against no-poach agreements. Washington state
Attorney General Bob Ferguson reached settlements
with more than 50 companies to end the agreements and
sued Jersey Mike’s Subs when they did not comply. The
lawsuits initially focused on fast-food franchises but have
since expanded to other franchises, including tax preparation services and hotels. For example, while Ferguson’s
first three waves of settlements targeted fast-food chains,
he announced a fourth wave in October 2018 that included
gyms and a car repair service.
There have also been no-poach agreements to restrict
skilled employees. In September 2010, the Justice
Department filed a civil antitrust complaint against Adobe
Systems, Apple, Google, Intel, Intuit, and Pixar alleging
they had made agreements among themselves to place
their employees on “no call” lists so they would not recruit
employees from one another. In the settlement, the companies agreed to stop these agreements for at least five
years. Later, Apple, Google, Intel, and Adobe’s employees

E co n F o c u s | F i r st Q u a rt e r | 2 0 1 9

won $415 million in a class-action lawsuit against them
for their no-poaching practices. Noncompete clauses are
illegal in California, so tech companies allegedly resorted
to such agreements to try to keep their talent.
More recently, Duke University paid $54.5 million
in a class-action suit over an alleged agreement with the
University of North Carolina not to hire each other’s faculty. The Justice Department participated in support of
the plaintiffs.
The matter of the franchise no-poach agreements in
particular is slightly more complicated because there
are subtleties to what could be illegal versus legal agreements. For example, if two firms have some sort of joint
venture and poaching would get in the way of that, a
no-poach agreement might be lawful. Naked no-poach
agreements would be treated as per se illegal — that is,
inherently illegal, with factors such as intent not taken
into account — while cases where a no-poach agreement
could actually help competition would be reviewed under
the “rule of reason,” in which harms are weighed against
In several recent fast-food franchise cases, the Justice
Department weighed in by filing a memorandum with the
court stating its position that in the context of franchises,
no-poach agreements should be judged under the rule
of reason. According to an article by Nicole Castle and
Matt Evola of the law firm McDermott Will & Emery,
the Justice Department seemed to reason that no-poach
agreements between parent companies and franchisees
might help competition because they help promote brands
and maintain brand quality, thus improving competition
between brands even if they reduce competition within
On the other hand, FTC Chairman Joseph Simons
does not see the competitive benefits of such agreements. In a December 2018 interview with GCR USA,
he stated, “The FTC doesn’t see what the benefits of
a non-compete agreement are when there is no highly
skilled labour involved.... There doesn’t seem to be any efficiency benefit, so outlawing that would seem not to have
a cost to it; actually it might have a benefit.” He did not,
however, think it likely that such agreements violate antitrust laws, because the franchises do not have enough market power to limit competition; an employee could always
quit and start working for another franchise.
The cost of a violation could be high. In a criminal
Sherman Act case, a company can face criminal penalties
of up to $100 million, while individuals can face penalties
of up to $1 million and up to 10 years in prison — and
that’s before any civil actions.


Concentrating on Market Concentration
B y T i m S a bl i k

Highlighted Research

“Diverging Trends in National and Local
Concentration.” Esteban Rossi-Hansberg, Pierre-Daniel
G. Sarte, and Nicholas Trachter. Federal Reserve Bank
of Richmond Working Paper No. 18-15R, September
2018 (revised February 2019).


he market concentration of large U.S. firms is increasingly a topic of public debate. Politicians have called
for using antitrust laws to break up large tech firms such as
Google, Facebook, and Amazon. The economics profession
has contributed to this debate through a number of recent
papers that show that market concentration in the United
States has gone up across industries in recent decades.
Policymakers and economists worry about concentration
because it could be a sign of weakening competition. Firms
that control a large share of their market have fewer large
competitors to contend with. As a result, they may have
more power to raise prices and reduce wages and production, all of which would have a negative impact on the economy. In 2017, Jan de Loecker of Katholieke Universiteit
Leuven and Jan Eeckhout of Universitat Pompeu Fabra
Barcelona published an influential paper showing that average markups — what firms charge for goods and services
above their marginal costs — were going up across the U.S.
economy and that this increase was being driven by the largest firms within industries. It was another sign that market
concentration and market power were on the rise.
“De Loecker and Eeckhout and other papers were arguing
that market power was going up,” says Nicholas Trachter, a
senior economist at the Richmond Fed. “But on the other
hand, many prices didn’t seem to be getting higher, and
firms were claiming that it was very hard for them to raise
their prices because of competition. So I began trying to
understand how to connect these two stories.”
Along with his colleague at the Richmond Fed, PierreDaniel Sarte, and Esteban Rossi-Hansberg of Princeton
University, Trachter began thinking about how large
national firms expand into local markets. In many sectors
of the economy, such as retail and services, firms compete
locally rather than nationally. For example, a coffee shop
in Richmond doesn’t compete with a coffee shop in Seattle
for customers. Likewise, restaurants in Manhattan don’t
compete with restaurants in San Francisco.
Using the National Establishment Time Series, they
were able to study the concentration of industries at the
national and local levels. They found that for many sectors of the U.S. economy, concentration was rising at the
national level but was actually falling locally.

“At first we thought we might have made a mistake,” says
Sarte. But through a series of tests, they confirmed that the
results were accurate. “Once we saw that, we thought, how
can we reconcile these two trends of rising national concentration and falling local concentration?”
In a paper published in the Richmond Fed’s working
paper series as well as in the National Bureau of Economic
Research’s working paper series, they explained how both
trends were being driven by large national companies. When
a national chain such as Walmart or Starbucks opens a new
store, the chain increases its share of the national market,
which, in turn, increases national concentration. But they
typically don’t open new stores where one already exists.
Instead, they expand into new locations, where other firms
are already operating. Rather than drive those firms out of
the local market, Rossi-Hansberg, Sarte, and Trachter found
that large firms decreased local concentration when they
opened a new store.
“So large firms grow at the national level by expanding
geographically, but at the local level there is more competition because there are now more firms in the local market,”
explains Trachter.
To the extent that consumer markets are local, then,
these findings suggest that competition may be increasing rather than decreasing. To be sure, not all industries
are local. The manufacturing sector, for example, benefits from economies of scale and easy transportation
of its products that make it more of a national sector
than a local one. But industries that do exhibit diverging
trends of national and local concentration employ roughly
three-quarters of U.S. workers and account for two-thirds
of all sales, making local competition important for a large
segment of the economy.
“What we found is that the world is a lot more subtle
than one might have been led to believe just based on the
aggregate concentration data,” says Sarte. “Even before we
did this study, some people had a feeling that we shouldn’t
conclude that the U.S. economy has become less competitive just because of what we see at the national level. And I
think we showed that’s right.”
Of course, concentration is just one possible sign of market power, and economists have been exploring other ways
to measure whether the economy has become less competitive. But Trachter and Sarte view their findings as a word of
caution for advocates of breaking up large firms.
“Our paper shows that market concentration is not
market power,” says Sarte. “There’s more work to be done,
but there’s enough evidence here to suggest that we should
at least pause and do that work before making major policy
E co n F o c u s | F i r st Q u a rt e r | 2 0 1 9


Opportunit y Zones

More Money,
More Problems?

The promise and pitfalls of a new financing
model for distressed communities
By Jessie Romero


usinesses and jobs are few and far between in the St.
Paul’s neighborhood of Norfolk, Va., a 200-acre area
north of the Elizabeth River. Most of the residents live
in three public housing complexes that were built in the 1950s,
and the poverty rate is as high as 72 percent in some areas. In
January 2018, after 13 years of planning and debate, the city council approved a resolution to demolish Tidewater Gardens, Young
Terrace, and Calvert Square and replace them with mixed-use,
mixed-income developments. In the resolution, the council noted
that the residents’ current housing left them “isolated, economically
challenged and vulnerable to recurrent flooding.”
The project won’t be cheap. Merely tearing down the 618-unit
Tidewater Gardens community will cost more than $7 million, and over
the next decade the total redevelopment could top $1 billion. Norfolk
and the Norfolk Redevelopment and Housing Authority have been
awarded a $30 million grant from the Department of Housing and Urban
Development, but it remains an open question how the remainder of the
development will be financed. So city officials are excited about a provision in
the Tax Cuts and Jobs Act of 2017 that is designed to draw long-term investment to struggling communities by offering tax advantages to investors who
finance projects in “opportunity zones.”
All of St. Paul’s has been designated an opportunity zone, and the city is in
serious talks with a number of potential investors. “Opportunity zones could
really be the answer to help move the needle in the areas of the project where
the city may not be able to leverage some of its traditional financing mechanisms” says Sean Washington, senior business development manager for the City
of Norfolk and the city’s designated opportunity zone lead.
Norfolk isn’t the only city that’s excited about the potential influx of opportunity zone investment; the program has generated enthusiasm nationwide and enjoys
broad bipartisan support. But economics and past experience suggest it might be
necessary to temper that enthusiasm with caution and patience.
Planning for Opportunity
The concept grew out of a 2015 white paper by Jared Bernstein, a senior fellow at the
Center on Budget and Policy Priorities who also served as an adviser to Vice President Joe
Biden, and Kevin Hassett, the current chair of the Council of Economic Advisers and a former scholar at the American Enterprise Institute. At the time, both Bernstein and Hassett
were serving as advisers to the Economic Innovation Group (EIG), a bipartisan policy group
that had just been founded to study entrepreneurship and innovative investment strategies.
10 E c o n F o c u s | F i r s t Q u a r t e r | 2 0 1 9

“We wanted to think about policy solutions that could
address the geographic divides that have come to define
outcomes in the U.S. economy,” says Kenan Fikri, director for research and policy development at EIG. “How
could we move capital at a scale commensurate with the
Bernstein and Hassett’s paper was short on details, but
EIG sought out congressional partners who could flesh
out the idea and develop legislation. Sen. Tim Scott, a
Republican from South Carolina, was especially interested,
and in 2017 he introduced the “Investing in Opportunity
Act” with 14 co-sponsors from both sides of the aisle. The
bill stalled in the Senate Finance Committee, but Scott
continued to advocate for opportunity zones and eventually secured their inclusion in the 2017 tax bill.
Once the law was passed, states had until April 2018
to designate their opportunity zones from among a pool
of eligible low-income census tracts, subject to certification by the Treasury Department. A census tract is
a statistical area of between 1,200 and 8,000 residents.
More than 8,700 opportunity zones, covering about
11 percent of the country, have now been designated
across all 50 states, Washington, D.C., and five U.S.
territories. About 10 percent of them are in the Fifth
District. (See map on next page.) In Norfolk, 13 census
tracts in addition to the three tracts in the St. Paul’s area
are opportunity zones. On average, according to an analysis by EIG, the poverty rate in census tracts that received
the designation is around 30 percent, compared with just
over 12 percent across the United States as a whole. More
than one-fifth of adults in opportunity zones lack a high
school diploma, and median family income in the zones
is about $25,000 below the U.S. median.

Even before the law passed, community development
professionals throughout the Federal Reserve System
began meeting to discuss what role the Fed could and
should play, says Jeanne Milliken Bonds, community
development regional manager at the Richmond Fed.
One key role the Fed has taken on is to convene local
leaders, potential investors, and community members.
“We want to bring people together to be educated, so that
the people who live and own businesses in opportunity
zones won’t be at a disadvantage — so that the investment
happens with them, instead of to them,” says Bonds. To
date, the Richmond Fed has convened several meetings
throughout the district and participated in Norfolk’s
finance planning session. Most recently, the Richmond
Fed helped lead a three-day educational tour of West
Virginia for investors, legislators, and developers, among
others; the tour was in partnership with West Virginia
Forward, the West Virginia Department of Commerce,
the Benedum Foundation, and the office of Sen. Shelley
Moore Capito, R-W.Va.
Investing in an Opportunity Zone
What’s in it for investors? The chief benefit is the opportunity to defer, and potentially reduce or even eliminate, capital gains taxes. (See sidebar.) Investors pay these taxes when
they earn a profit from selling assets such as stocks, bonds,
or property. But under the opportunity zone program, an
individual or firm can roll those profits into an opportunity
zone investment and defer paying the taxes until they sell or
exchange the investment (or until 2026, whichever comes
first). Depending on how long they hold the opportunity
zone investment, they can also reduce the taxable portion of the deferred gain by up to 15 percent. In addition,

Opportunity Zones: The Nitty Gritty
Governors designated their state or territory’s opportunity zones last year from among a pool of low-income
high-poverty census tracts, with input from other state
and local leaders. To be eligible, a census tract had to
have either a poverty rate above 20 percent or a median
household income no greater than 80 percent of the
median for the state or broader metropolitan area. Up
to 25 percent of the eligible tracts could be designated,
using whatever criteria officials deemed appropriate. In
Norfolk, for example, in addition to need, the mayor
considered criteria such as proximity to institutions and
access to transportation. Governors could also designate a small number of ineligible tracts that were contiguous with low-income tracts, provided the median
household income wasn’t more than 125 percent of the
median in the adjacent qualifying tract. All designations
were subject to certification by the Treasury secretary.
Investors can defer the tax on any prior gains they
invest in a qualified opportunity fund (QOF) until the

investment is sold or exchanged, or until Dec. 31, 2026,
whichever comes first. If the QOF investment is held
for longer than five years, the investor can exclude 10
percent of the deferred gain from taxation. If the investment is held for more than seven years, the investor can
exclude 15 percent -- which means those who want to
exclude the maximum amount need to get started by the
end of 2019. Also, investors who hold their QOF investment for at least 10 years do not have to pay taxes on any
gains on the amount they invested in the QOF, although
they would still have to pay taxes on the original deferred
amount, less any exclusion, by Dec. 31, 2026.
In addition to investing in real estate, QOFs may also
purchase stock or take a partnership interest in new or
existing businesses in opportunity zones. But not all
businesses are eligible; the rules specifically exclude golf
courses, tanning salons, massage parlors, race tracks,
and liquor stores, among others.
— Jessie Romero

E co n F o c u s | F i r st Q u a rt e r | 2 0 1 9


Opportunity Zones in the Fifth District
About 10 percent of the country’s
8,764 qualified opportunity zones
are in the Richmond Fed’s district






haven’t done much actual investing yet — largely
because they’ve been waiting for the Treasury
and the Internal Revenue Service to clarify the
rules of the game. With the release of a second
set of proposed regulations in April 2019, many
observers are hopeful that the money is about to
start flowing. “We’ve gotten a lot more phone
calls since the second tranche of regulations was
released,” says Washington. “Investors feel a lot
more comfortable now.”


Will This Time Be Different?
Since the early 1990s, the federal government had
made a variety of attempts to stimulate investment in economically distressed areas. These programs, including empowerment zones, renewal
communities, enterprise communities, and the
New Market Tax Credit (NMTC), varied in their
particulars, but in general they offered tax deductions or credits to businesses that open or expand
in a designated area or that employ the area’s
District of
of Columbia
residents. (Empowerment zone and enterprise
and renewal community incentives have expired.
The NMTC is slated to expire at the end of 2019,
but legislation has been introduced to make it
Designated Qualifed Opportunity Zone
permanent.) One economic rationale is the need
to solve the “first-mover” problem, in which the
total of 8,764
reflect the final
QOZ designations
all are in
been designated
of whichfor828
first person to invest in a new area has to do a lot
States as of June 14, 2018. A total of 8,762
the Fifth census
District.tracts were designated nationally
of initial research and vetting that later investors
of which 828 were within Fifth District states and the
U.S. Department
of the2018-48,
of Columbia.
See IRS Notice
can capitalize on — not to mention take on higher
Bulletin 9, Institutions
July 9, 2018, Fund,
for the https://
list of all population census tracts designated as QOZs
risk. As a result, there’s less incentive for anyone
for purposes of ßß 1400Z-1 and 1400Z-2 of the Code.
to go first, even if there are profitable opportunities on the table. Empowerment zones and their
ilk are intended to provide that incentive, with the
investors may become eligible to pay zero capital gains
hope of kick-starting investment and economic activity.
taxes on any profits from the new investment. The EIG
The evidence on the effectiveness of these programs is
estimates that U.S. households and corporations have about
quite mixed. According to a 2013 article in the American
$6.1 trillion in unrealized capital gains that could potenEconomic Review by Matias Busso of the Inter-American
tially be invested in opportunity zones.
Development Bank, Jesse Gregory of the University of
“The opportunity zone program doesn’t turn a
Wisconsin-Madison, and Patrick Kline of the University
bad deal into a good deal,” says Clark Spencer, senior
of California, Berkeley, the first round of federal empowvice president for investments at Grubb Properties, a
erment zones in 1993 substantially increased employment
Charlotte-based real estate developer. “But to the extent
and wages without increasing the cost of living. But other
you have a good deal, in my view this is one of the most
research has found insignificant effects or has found that
significant tax advantages the federal government has
positive effects are accompanied by rising rents and housever given individual investors.”
ing prices that displace current residents. There’s also
An opportunity zone investment has to be made
research suggesting that empowerment zones and similar
through a special fund known as a qualified opportupolicies simply shift economic activity from one place to
nity fund (QOF). QOFs are required to hold at least
another without any net gain.
90 percent of their assets in opportunity zone properties
In their white paper, Bernstein and Hassett described
or businesses. Grubb Properties started a QOF in early
some factors that could limit the impact of previous
2019; it has raised about $25 million to date and has two
tax-based policies. First, they concluded that the poliactive projects in North Carolina. Nationwide, around 134
cies were overly complex, which both made it costly for
opportunity funds have been created, representing more
businesses to comply and curtailed the activities they
than $29 billion in capacity, according to data gathered
could undertake. They also argued that the incentives
by the professional services firm Novogradac. But they
were generally too small to make a meaningful difference



E co n F o c u s | F i r st Q u a rt e r | 2 0 1 9

in firms’ decisions and that they were poorly targeted to
communities’ needs. Perhaps most important, according
to Bernstein and Hassett, was that the programs didn’t
facilitate any involvement by financial intermediaries such
as banks or hedge funds.
So what’s different about opportunity zones? Proponents
point to several features that might make them more effective than past policies. One is that the zones were designated by state governors with considerable input from
local leaders, who presumably know more about the needs
and growth potential of their communities than do federal
authorities. In addition, the opportunity zone program
pools the resources of multiple individual and institutional
investors, increasing the potential funds available and
limiting the risk to any one person or firm. And depending on the size and profitability of the opportunity zone
investment, the tax benefits are potentially quite large.
“Rather than reward specific projects,” says Fikri, “the
goal of opportunity zones is to change investor behavior,
to change the risk profile, and encourage investors who
aren’t the usual suspects in these communities. It’s trying
to change how the market itself behaves.”
The Feature Is a Bug
These features of opportunity zones could also prove to be
bugs, however. For example, the size of the potential tax
break is what could lure new investment, but it depends
on how profitable the investment is — which depends in
part on rising property values and rents. So some observers
fear that in many places, the opportunity zone designation will create or hasten a process of gentrification to
the detriment of lower-income residents who don’t own
their homes and instead are forced out by rising rents.
Lending weight to this concern, researchers at the Urban
Institute found that since 2000, the designated tracts had
experienced greater increases in median family income,
housing costs, and the share of residents with at least a
bachelor’s degree — all proxies for gentrification — than
eligible tracts that were not designated. An analysis by
Zillow found that after the final opportunity zones were
announced, real estate sale prices increased 25 percent year
over year in designated zones versus 8 percent in tracts
that were eligible but not designated. Before the final
zones were announced, prices in all the eligible areas had
increased at about the same pace.
“Gentrification is a legitimate concern, and it will probably happen in some places,” says Bonds. “But there are
controls that can be put in place, for example, through a
city’s zoning and permitting process. If cities are planning
ahead and sharing information with the community, it
lowers the odds it will happen.”

What’s different about opportunity zones?
Proponents point to several features that might
make them more effective than past policies.
But these features could also prove to be bugs.
That planning is part of Sean
Washington’s job. “We’re working on the
guardrails,” he says. “What can we do to
ensure that the purpose of opportunity zones
— to help people — is actually accomplished?”
Local leaders know their communities, but
they also face local political considerations. So
zones might have been chosen not based on how
many people would be helped but rather on satisfying particular constituents. Leaders also might have
wanted to choose areas that they knew would attract
a lot of investment to their cities, which means it’s
likely the investment would have occurred without the benefit of government involvement. Skeptics
view the designation of areas like Long Island City in
Queens (already home to JetBlue and Ralph Lauren);
essentially all of Portland, Ore. (seen by many as ground
zero for hipster culture); and North Miami (where a
$4 billion luxury condo development is already underway) as evidence that many opportunity zones are likely
to benefit investors more than low-income Americans.
These areas aren’t representative of all opportunity zones;
the Urban Institute also found that designated tracts did
have higher poverty and unemployment rates than eligible
tracts that weren’t designated. At the same time, they
did not have less access to capital as measured by existing
commercial and residential lending.
Finally, it’s possible that a lot of QOF money could flow
to cities that already have “shovel-ready” projects (and
might have attracted investors anyway). “That’s certainly
a hazard in this first year,” says Fikri. “When something
is totally new, it’s easier if something is already in the
pipeline and can be repurposed to fit the program. But
we’re optimistic that as the second wave of investments
comes, the incentive will be meaningful on the margin
at unlocking new capital.” Fikri also notes, however, that
opportunity zone projects will be most likely to help
the zones’ residents when they’re paired with workforce
development and educational programs. “More adults in
opportunity zones don’t have high school diplomas than
do have college degrees,” he says. “There’s a lot more work
to be done to ensure that the most disadvantaged people
can take advantage of the opportunities.”

Bernstein, Jared, and Kevin A. Hassett. “Unlocking Private Capital
to Facilitate Growth in Economically Distressed Areas.” Economic
Innovation Group, April 2015.

Busso, Matias, Jesse Gregory, and Patrick Kline. “Assessing the
Incidence and Efficiency of a Prominent Place Based Policy.”
American Economic Review, April 2013, vol. 103, no. 2, pp. 897-947.
E co n F o c u s | F i r st Q u a rt e r | 2 0 1 9


The technology behind
cryptocurrencies shows promise for
raising capital but has also drawn
scrutiny from regulators


By Tim Sablik
offering, or ICO. In an ICO,
ransferring computer files
sell bitcoin-like digused to require loading them
capital for their
onto a flash drive, burning them
companies have
to a CD, or (if you are old enough to remember)
in an initial
writing them to a floppy disk. Today, everything is in the
cloud. Services like Dropbox, Google Drive, and Apple’s
iCloud allow users to upload files to remote computer
servers and retrieve them later from any device. Cloud storoften
age systems tend to be owned by large corporations. But
developed by the issuer. In 2017 and 2018, ICOs raised
American computer scientist Juan Benet thought he had
more than $27 billion worldwide — nearly half as much as
a better idea: What if, instead of relying on companies to
traditional IPOs in the second quarter of 2018 alone.
build and maintain servers for cloud storage, it was possible
ICOs have attracted the attention of more than
to share excess storage capacity on personal computers?
digital startups like Protocol Labs. The venerable
That’s what Protocol Labs, the company Benet
Kodak Company got in on the action by selling
founded, set out to do in 2014. Drawing inspiration
that could be used to purchase rights to
from Bitcoin, the decentralized payment system that had
on an online platform. Early propolaunched in 2009, Protocol Labs’ Filecoin would be a new
to both enable new decentralized
digital currency used exclusively on a decentralized cloud
funding by avoiding tradistorage network. Users could earn filecoins by offering
and going directly to the
storage on their computers for use on the network.
What’s more, the sale of filecoins could fund the creation
“The idea was that ICOs would be transparent, secure,
of the network itself.
and self-regulating, operating outside of national borders
Protocol Labs’ $257 million sale of filecoins was an
and regulatory frameworks,” says Nick Morgan, a partner
example of what has come to be known as an initial coin


E co n F o c u s | F i r st Q u a rt e r | 2 0 1 9

Funding Phenomenon
Cryptocurrencies such as Bitcoin proved that it was
possible to assign and track ownership of digital objects
without a central authority. The technology that enabled
this was actually a variant on an old idea: the simple ledger. Bitcoin’s ledger, known as the blockchain, contains a
record of every transaction ever made using the cryptocurrency. The blockchain’s new twist on the ledger was to distribute a copy to all Bitcoin users, making all transactions
public knowledge and also making it impossible for any
one user to alter the ledger and fake a transaction without
the consent of a majority of the network. This allowed
Bitcoin to serve as a decentralized payment method that
was virtually impervious to fraud.
At first, the blockchain was simply a tool for Bitcoin
transactions. But users soon began to explore other functions, such as embedding contracts into the blockchain.
These “smart contracts” are similar to computer programs:
They specify actions that occur automatically when certain conditions are met. In 2012, a software engineer and
Bitcoin enthusiast named J.R.Willett suggested that such
contracts could be used to raise funding for new projects
or even entire companies. In a white paper, he explained
how someone could write a smart contract that laid out a
business proposal and allowed anyone to purchase a stake
in that business in exchange for bitcoins. Those bitcoins
would provide the funding to create the new venture, fulfilling the same role as traditional venture capital.
No one jumped on Willett’s idea immediately, so he
took it upon himself to launch Mastercoin in 2013 as
a proof of concept. He raised half a million dollars in
bitcoin, and the first ICO was born. It took a few more
years for ICOs to catch on, but by 2017, the market took
off. (See chart.) Some advocates speculated that it might
replace traditional corporate funding entirely, but economists have generally been more skeptical of its prospects.
“In a normal financial setting, there doesn’t seem to
be any advantage to using an ICO instead of traditional
equity funding,” says Joshua Gans, an economist at the

A Flash in the Pan?

Total Funds Raised in ICOs Worldwide



with the law firm Paul Hastings who focuses on securities
regulation. “That turned out to be incorrect.”
Through a series of actions starting in mid-2017, the
U.S. Securities and Exchange Commission (SEC) made it
clear that most tokens sold in ICOs met the definition of
a security and were therefore subject to the same requirements as traditional stock offerings. Perhaps because of
this increased attention from regulators, ICO activity
has slowed dramatically of late, inviting speculation that
the ICO boom had mostly been about evading regulatory
scrutiny. In the first quarter of 2019, ICOs raised about
$600 million compared with more than $8 billion over
the same period the year before. Nevertheless, ICOs’
rapid rise captured the attention of economists who are
exploring whether the technology behind cryptocurrencies might improve how corporations raise money.

Q1’16 Q2’16 Q3’16 Q4’16 Q1’17 Q2’17 Q3’17 Q4’17 Q1’18 Q2’18 Q3’18 Q4’18 Q1’19

Source: CoinSchedule

University of Toronto who studies technological innovations and industrial organization.
In a paper with Christian Catalini of the Massachusetts
Institute of Technology, Gans examined where the value
of tokens sold in ICOs comes from. Unlike traditional
securities, the value of which is tied to the profitability
of the firm over its lifetime, tokens are only worth what
someone would be willing to pay for the underlying good
or service they represent. To be sure, investors may inflate
that value by overestimating how much the good or service will ultimately be worth. Token issuers face a tension
between raising more money upfront by making the
tokens an attractive store of value for investors and keeping the price stable so the tokens can actually function as a
medium of exchange on the platform for customers.
“That limits how much money an ICO can really raise,”
says Gans. “That suggests that if we are seeing ICOs, it
may be because there are constraints on the ability of
entrepreneurs to access traditional equity markets.”
Expanding the Market
Open access to funding is one of the benefits often
attributed to ICOs. Startups typically have a harder time
obtaining funding than established firms. Their ideas are
untested, making them a risky bet for banks and investors
alike. Angel investors and venture capital firms specialize
in taking on greater risks to give entrepreneurs a chance,
but research indicates that such investors are geographically concentrated in places like the San Francisco Bay
area or New York, and most venture capital investments
are made locally. This could limit the startups that are able
to obtain such funding. In concept, ICOs expand the venture finance market to the entire world, allowing anyone
with an internet connection to invest in a new idea.
Another advantage of ICOs is that they allow developers to presell their ideas to gauge market interest before
actually investing in their product or service. ICOs are
similar to crowdfunding in this respect. For example, Eric
Migicovsky initially tried to raise money for his Pebble
E co n F o c u s | F i r st Q u a rt e r | 2 0 1 9


smartwatch from angel investors. When he fell short of
his goal, he turned to crowdfunding platform Kickstarter
to sell the idea directly to consumers. His crowdfunding
campaign raised more than $10 million — more than
100 times the amount he needed. Like crowdfunding,
ICOs could help bring ideas to market that institutional
investors might pass on. And for firms attempting to
build an online platform, the ability to gauge demand and
establish a network of users before doing any work may
be even more valuable than the money they raise.
“One of the benefits of an ICO is that you can see how
many people take up the offer and that gives you an idea
of how aggressively to build out your product or service,”
says David Yermack, a business economist at New York
Cost is another factor that may limit entrepreneurs’
access to traditional financing.
“The cost of raising money in an IPO is severe,” says
Yermack. “You typically pay a 7 percent underwriting
spread and then usually have your shares discounted by
10 percent or more by the underwriter before they sell
them on the market. So right there you are at a 17 percent
discount, and that is not counting the overhead cost of
regulatory compliance, delays, and the legal liability you
expose yourself to.”
Proponents of ICOs have argued that they are an easier
source of startup funding, which could enable more entrepreneurs to bring their ideas to market. But critics allege
that the savings touted by ICO champions, particularly
during the market’s high point, stemmed largely from
avoidance of important regulatory safeguards, making the
ICO market ripe for fraud.
Wild, Wild West?
Whether entrepreneurs are trying to raise money via traditional channels or ICOs, the process suffers from the
same problem: asymmetric information. Simply put, the
sellers know more about the project, and its likely chances
of success, than the investors.
One response to this problem is to require sellers of
corporate securities to disclose information to investors,
as the SEC does in the United States. Firms looking to go
public through an IPO must disclose information similar
to what public companies are required to include in their
annual reports to the SEC, such as financial statements
and a description of the business. To determine whether
something a company is selling to the public is a security,
the SEC uses criteria established in a 1946 U.S. Supreme
Court case involving the sale of Florida orange groves.
According to this so-called Howey test, sale of a security
involves “an investment of money in a common enterprise
with profits to come solely from the efforts of others.”
In arguing that ICO tokens were not securities, many
issuers focused on the last part of the test. They have
argued that ICO tokens are just a way of preselling goods
or services to customers, not investment vehicles. Some

E co n F o c u s | F i r st Q u a rt e r | 2 0 1 9

have also maintained that the decentralized nature of
blockchain companies means that their success, and the
ultimate value of the tokens, is not dependent on the
efforts of organizers.
But in a series of reports, enforcement actions, and
the detailed framework it released in April, the SEC has
made it clear that virtually any involvement by an “active
participant” (such as a promoter or organizer) in the
ICO process that contributes to the value of the tokens
would be enough to qualify those tokens as securities. For
example, the Decentralized Autonomous Organization
(DAO), which launched its ICO in 2016, claimed to be
a decentralized corporate finance network that would
allow token holders to vote on future projects to fund
using the money raised in the ICO. In 2017, the SEC published a report on the DAO and argued that it was not as
decentralized as it claimed. The parent group that created
the DAO remained heavily involved in its governance by
appointing “curators” to select the proposals that DAO
token holders could vote on. This and other factors led
the SEC to conclude that the DAO’s tokens should have
been registered as securities.
Regulation is not the only solution to reduce asymmetric information in security markets, however. ICO
organizers also have market incentives to be transparent
with investors. In a paper with Sabrina Howell of New
York University and Marina Niessner of AQR Capital
Management, Yermack found that groups that published
white papers describing their proposal or the underlying
code of their platform were more likely to have a successful ICO. Previous venture capital investment in the
project was also highly correlated with ICO success.
To be sure, market incentives were not enough to prevent widespread ICO fraud. According to a 2018 study by
the Satis Group, a token advisory firm, nearly 80 percent
of ICOs were determined to be scams, meaning there was
evidence that the project leaders had no intention of actually developing their project with the proceeds from the
token sales. But those scams accounted for just 11 percent
(roughly $1.3 billion) of funds raised in the ICO market. In
contrast, the 15 percent of ICOs that succeeded and issued
tokens that went on to trade on exchanges accounted for
about 70 percent of the total funds raised.
Looking closer, Satis Group found that just three
projects accounted for most of the money raised by ICO
scams, which suggests that while there was no shortage
of frauds in the market, investors largely avoided them.
In fact, two researchers have argued that investors may
have even been too conservative. Hugo Benedetti and
Leonard Kostovetsky of Boston College studied more
than 4,000 ICOs and found that, if anything, they
seemed underpriced given the average performance of
tokens, even after accounting for the presence of frauds
and failures.
It remains to be seen whether evading regulations or
exuberance over cryptocurrencies in general were the main

drivers of ICO growth or if entrepreneurs will still be drawn
to ICOs over traditional fundraising for other reasons.
“There is definitely some regulatory arbitrage and quite
a bit of fraud that has happened,” says Howell. “But I think
ICOs also open the possibility for some exciting new business models.”
New Possibilities
Through the blockchain and smart contracts, ICOs could
be used to fund the development of decentralized platforms. Examples of such platforms include Wikipedia and
Linux. Both are maintained by volunteers rather than an
owner or group of owners.
“That is appealing to some people because you can
avoid a single point of failure, and you can potentially have
a more democratic form of governance for the platform,”
says Howell.
The challenge is that it can be hard to motivate people to work for free. Relying on volunteers may result
in few decentralized platforms being built. Through an
ICO, however, it is possible to raise money to pay for the
development of a platform without necessarily giving the
developers control over it.
“You could remunerate the people who actually create
a platform’s value rather than the person or people who
built it,” explains Howell. “For example, you could imagine
a decentralized version of Uber where the drivers actually
have control over the platform and are earning a larger
share of the rents from that service.”
Still, it isn’t clear how easy it would be to create such a
platform in practice, even with an ICO. As the SEC found,
one such attempt — the DAO — was not as decentralized
as it claimed.
Smart contracts present other interesting possibilities beyond decentralization, however. For example, they
could potentially solve long-standing problems with corporate governance and share management.
“It’s surprising, but most companies today don’t know
who their shareholders are,” says Yermack. The existing
share registration system makes it challenging to conduct
accurate shareholder votes, hampering the effectiveness of
shareholder oversight over public companies. The blockchain could make it easier to see who owns shares and

make it easier to conduct votes, potentially bringing along
some other benefits as well.
“You could have much more transparency into things
like shareholder activist purchases, executive compensation, and managers’ trading of shares for compensation or
investment purposes,” says Yermack.
Of course, it is possible to use smart contracts and reap
these benefits without ICOs, but the fact that token sales
already utilize the blockchain may make them a natural
candidate for testing these theories.
A Flash in the Pan?
With the recent slowdown in ICO activity, some observers think that the market may disappear as quickly as it
came. At the same time, the SEC has made it clear that
it doesn’t intend to treat all ICOs as security offerings.
It recently ruled that tokens issued by TurnKey Jet Inc.,
which would allow holders to charter a jet, did not need to
be registered as securities because they were only tradeable
among members of the program. Some countries, such as
China and South Korea, have taken a stronger stance and
chosen to ban ICOs entirely. Others, such as Singapore
and Switzerland, have been more permissive. Worldwide,
this suggests that the ICO experiment could continue, at
least for now. But it may take more time to fully determine
the benefits of ICOs, if any.
“The people who are interested in token offerings now
tend not to view them as a way to reduce the regulatory
cost of raising money,” says Morgan. “Rather, they believe
the technology offers them some benefits for the business
enterprise they are trying to get off the ground.”
The benefit of raising money in advance for a project
while establishing a base of eager customers has proven
useful throughout history. The Royal Albert Hall in the
19th century and the Centre Court of Wimbledon in the
early 20th century were both funded in part by preselling
seats. Digital tokens open up the opportunity to conduct
such presales for many more types of goods or services, but
it remains to be seen whether firms engaging in ICOs can
deliver on their promises.
“We’ve seen a lot of ICOs, but very few products actually come to market,” says Gans. “So it’s very much a question whether they’ll be around in the long term.”

Benedetti, Hugo, and Leonard Kostovetsky. “Digital Tulips?
Returns to Investors in Initial Coin Offerings.” Manuscript, May
20, 2018.
Catalini, Christian, and Joshua S. Gans. “Initial Coin Offerings
and the Value of Crypto Tokens.” National Bureau of Economic
Research Working Paper No. 24418, March 2019.
Howell, Sabrina T., Marina Niessner, and David Yermack. “Initial
Coin Offerings: Financing Growth with Cryptocurrency Token
Sales.” Manuscript, April 5, 2019.

Li, Jiasun, and William Mann. “Initial Coin Offerings and Platform
Building.” Manuscript, Oct. 1, 2018.
“Report of Investigation Pursuant to Section 21(a) of the Securities
Exchange Act of 1934: The DAO.” Securities and Exchange
Commission, July 25, 2017.
Yermack, David. “Corporate Governance and Blockchains.” Review
of Finance, March 2017, vol. 21, no. 1, pp. 7-31.

E co n F o c u s | F i r st Q u a rt e r | 2 0 1 9



Enrico Moretti


E co n F o c u s | F i r st Q u a rt e r | 2 0 1 9

EF: During perhaps the first decade or so of the World
Wide Web, there were numerous predictions that geography would disappear or almost disappear as an issue in
knowledge work. It seemed as if white-collar workers, if
one believed the predictions, would be able to work from
Moretti: Yes.
EF: What happened?
Moretti: It’s one of the main paradoxes of our times. The
explosion of the internet, email, and cellphones democratizes
the access to information. In the 1990s, people thought it
would also make the place where the company is located or
where workers live much less important.
The idea of The World Is Flat by [Thomas] Friedman was
indeed that location would lose its importance. Because I can
sit in front of a laptop in rural Tibet and have access to the
same information that I have if I am in the center of Silicon
Valley in downtown Palo Alto, location was expected to matter
less for workers and firms.
But what we have seen over the past 25 years is that the
opposite is true: Location has become more important than
ever before, especially for highly educated workers. The types
of jobs and careers that are available in some American cities
are increasingly different from the ones available in other
American cities.

Photography: Brittany Hosea-Small

Geographic differences in economic well-being, it
seems, have become increasingly salient in American
policy and political conversation. These differences
are a longtime concern of University of California,
Berkeley economist Enrico Moretti. In his research, he
has found that the sorting of highly educated Americans
— and high-paying jobs requiring a lot of education —
into certain communities has led to other communities
falling behind. Moreover, they’ve been falling behind
faster economically as time goes on. This pattern, in
turn, has been reflected in other socioeconomic differences, including divorce rates and life expectancies.
Moretti’s interest in American geographical sorting
began during his days as a Ph.D. student at Berkeley,
where he arrived after his undergraduate education in
his native Milan. At first, he just wanted to fill in some
blanks in his knowledge of America. “I started looking
at data from the U.S. census,” he says. “Just out of
curiosity, wanting to know more about this country,
I started looking at the different city averages of
whatever the census could measure — earnings, level
of education of the workforce, the type of industry.
I suspected there were big differences, but I didn’t
know how large the differences were.” He went on to
write his Ph.D. dissertation on the benefits in terms
of higher earnings that less-educated workers obtain
from being in a city with a large share of workers with
college degrees.
Along with a long list of articles on these matters
in top economics journals in the time since, Moretti’s
2012 book for general audiences, The New Geography
of Jobs, has received widespread attention (and was
on former President Barack Obama’s short list of
recommended nonfiction books in a Facebook post
last summer).
Moretti has some experience as a self-described
unskilled worker himself, spending a year working
with special-needs children as part of the staff of the
social welfare department of a town outside Milan.
“I was a low-level aide, just being there with the kids,
mostly. But it has stayed with me in many ways. It’s
hard to think of a more consequential type of activity.
As much as I think that academic work is important
and socially relevant, it is not even close to this.”
In addition to his current position at Berkeley,
Moretti has been on the faculty of UCLA and has
been a visiting scholar at Columbia, Stanford, and
Yale. He is editor-in-chief of the Journal of Economic
David A. Price interviewed Moretti in his office at
Berkeley in March 2019.

There’s nothing new in the fact
The presence of agglomeration economies it is advantageous for firms because
it results in higher productivity.
that some areas are economically
and the advantages of geographical
The third channel is the thickmore dynamic than others and
agglomeration don’t necessarily imply that ness of the market for specialized
offer better labor market opportuthe same process applies forever. When
services. Again, if you are in an area
nities; that’s always been the case.
where there are many other firms
What is different today is how large
there are shocks large enough, we see
like yours and they all need a very
the difference between the most
entry and we see exit.
specialized type of vendor, you are
successful labor markets and the
more likely to find it in an area
least successful labor markets has
where there’s a big agglomeration of firms in the same sector.
become and how fast they are growing apart. It’s a paradox
All three factors exist in manufacturing, of course. But
because it is true that we can have access to a lot of information
they are much stronger for firms and workers that engage in
and communicate easily from everywhere in the world, but at
the same time, location remains crucial for worker productivity
That is why we see some agglomeration of traditional manand for economic success.
In the first three decades after World War II, manufacturufacturing firms, but when we compare it to agglomeration of
firms in the innovation sector, the latter is much stronger. I
ing was the most important source of high-paying jobs in the
have just finished a new project where I study how locating in
United States. Manufacturing was geographically clustered, but
a high-tech cluster improves the productivity and creativity of
the amount of clustering was limited. Over the past 30 years,
inventors. If you look at the major fields — computer science,
manufacturing employment has declined, and the innovation
semiconductor, biology, and chemistry — you see a concentrasector has become a key source of good jobs. The innovation
sector tends to be much more geographically clustered. Thus,
tion of inventors that is staggering. In computer science, the
in the past, having access to good jobs was not tied to a specific
top 10 cities account for 70 percent of all the innovation, as
location as much as it is today. I expect the difference in wages,
measured by patents. For semiconductors, it’s 79 percent. For
earnings, and household incomes across cities to continue
biology and chemistry, it’s 59 percent.
growing at least for the foreseeable future.
This means that the top 10 cities generate the vast majority
of innovation in each field. Importantly, the share of the top
EF: Alfred Marshall, as you know, wrote about so-called
10 cities has been increasing since 1971, indicating increased
agglomeration economies as long ago as 1890. Presumably,
he was thinking about manufacturing when he wrote
In a world where all the information is available online, you
about that. Why are the trends you’re describing becomwould expect the opposite to happen, and yet we see more
concentration of inventors today, as measured by my data, coming so much more important now? What is different about
these “innovation sector” industries?
pared with the early ’70s. I think it’s because the three channels
are particularly strong for these types of workers and firms.
Moretti: The microeconomic foundations of agglomeration
economies represent an area of active research right now. We
EF: When you talk about innovators and innovative indushave a general sense of the magnitude of the economic benefits
tries, you mention semiconductors and life sciences. Are
of agglomeration. We are still trying to empirically assess the
there other industries that for you fit in this category?
relative importance of the microeconomic channels that may
generate those benefits. There are three that have been idenMoretti: The innovation sector is broad and diverse, and it’s
not just information technology or semiconductors. Life scitified in the literature and are likely to play a significant role in
practice. The first one is the existence of knowledge spillovers,
ences is a huge part of it, obviously. But there are other parts
also known as human capital spillovers: the fact that our human
of the economy that are innovative, from entertainment to
capital depends not only on where we go to school and how
finance to marketing.
much schooling we get, but also on the people who surround
What they have in common are two things. One is that
us and from whom we learn.
they make intensive use of human capital. The other one is
The second one is the matching advantage offered by thick
that they make products, whether goods or services, that are
labor markets. In the case of specialized workers, who often
new and unique and hard to outsource, at least in the short run.
have idiosyncratic skills, thick labor markets allow for a better
match with firms. For example, if you are a biotech engineer
EF: In looking at these phenomena, you’ve written about
specialized in, say, biofuel and you work in Silicon Valley,
what you call the Great Divergence among cities. What is
where at any moment in time there are a thousand biotech
diverging? And should we be worried about it?
firms looking for biotech engineers, you are more likely to find
the one that studies biofuels than if you are the same biotech
Moretti: What is diverging is, on a simple level, where good
engineer located, say, in Chicago, where at any moment in time
jobs locate.
there are fewer biotech firms looking for engineers. A better
The data tell us that since the 1980s, average salaries, espematch means a better career for the workers. At the same time,
cially for skilled workers, have been diverging. The average
E co n F o c u s | F i r st Q u a rt e r | 2 0 1 9


Enrico Moretti
➤ Current Position
salaries of workers with a college degree
More generally, I don’t think we
Michael Peevey and Donald Vial
or a master’s degree in places like San
should think of this as a process that
Professor of Economics, University of
Francisco, New York, Seattle, Boston,
does not allow any entry into or exit
California, Berkeley
Raleigh, Austin, or D.C. have been
from the group of successful cities. Let
growing at a much more rapid pace
me give you some examples. On the
➤ Education
than the salaries for college graduates or
entry side, two of the most striking
Ph.D. (2000), University of California,
workers with a master’s degree in other
examples of local economic success
Berkeley; Laurea (1993), Bocconi
cities. These cities started with higher
over the past 40 years in the United
salaries to begin with but have gained
States are Austin, Texas, and Raleigh➤ Selected Publications
more relative to other cities.
Durham, N.C. Austin in the ’80s was
“Housing Constraints and Spatial
The share of workers with a colnot a very thriving economy, certainly
Misallocation,” American Economic
not a global center of innovation that
lege degree in the labor force is also
Journal: Macroeconomics, 2019 (with
it has become today. It was a sleepy
diverging, with the most successful citChang-Tai Hsieh); “Who Benefits
provincial labor market that started
ies growing significantly faster. These
From Productivity Growth? Direct and
attracting tech jobs — probably after
cities started with a higher share of
Indirect Effects of Local TFP Growth
[Michael] Dell started his company,
college graduates, and they have been
on Wages, Rents, and Inequality,”
possibly because of other reasons —
attracting even more.
NBER Working Paper, 2018 (with
Richard Hornbeck); “The Effect of State
and became one of the most dynamic
Companies in industries that are
Taxes on the Geographical Location
labor market in the United States over
very advanced and very specialized find
of Top Earners: Evidence from Star
the past 30 years.
it difficult to locate in areas where they
Scientists,” American Economic Review,
Raleigh-Durham, just like Austin,
would be isolated. Nobody wants to
2017 (with Daniel Wilson); “Local
wasn’t much of a global innovabe the first to move to a city because
Economic Development, Agglomeration
they’re going to have a hard time in
tion center in the ’60s and ’70s. The
Economies and the Big Push: 100
finding the right type of specialized
employment boom associated with the
Years of Evidence from the Tennessee
workers. And it’s hard for workers with
Research Triangle took place over the
Valley Authority,” Quarterly Journal of
specialized skills to be first because
past 30 years.
Economics, 2014 (with Patrick Kline);
they’re going to have a hard time findSeattle in the ’70s didn’t have much
“Real Wage Inequality,” American
a software industry. In fact, outing the right job. It’s an equilibrium in
Economic Journal: Applied Economics, 2013;
which areas that have a large share of
side of Boeing, there was nothing in
The New Geography of Jobs, Houghton
innovative employers and highly speSeattle that would predict it becomMifflin Harcourt, 2012; “Social Learning
cialized workers tend to attract more of
ing a global center of innovation. It
Evidence from Movie Sales,” Review of
both. It is difficult for areas that don’t
was Bill Gates moving Microsoft from
Economic Studies, 2011
have a large share of innovative employAlbuquerque, N.M., to his hometown
that jump-started the Seattle software
ers and highly specialized workers to
cluster. Through its success, Microsoft became the anchor for
jump-start that process. Ultimately, that is what generates the
the Seattle innovation sector, a sector that now includes not
divergence across cities.
just software, but also internet, life sciences, and many other
To be clear: When I’m talking about cities, I’m referring
parts of the tech world.
really to what the census defines as metropolitan statistical
These are three examples of cities that entered the group of
areas. The definition includes not one municipality but the
successful innovation-driven local economies. By contrast, conentire local labor market. For example, here it would be not
just the municipality of San Francisco or Berkeley, it would be
sider Rochester, N.Y. It used to be a major innovation cluster;
the whole Bay Area.
it accounted for a significant share of U.S. patents in the ’80s
and early 1990s. Kodak and Xerox were major innovators in the
EF: One can imagine a dystopian conclusion to this story
local economy. Then Kodak’s main product went out of busiwhere parts of the country continually grow rich without
ness because people started taking digital pictures and stopped
limit while others become poor without limit. Is there a
buying film. Xerox had its own problems and laid off a lot of
natural stopping point to the process, or is this a future
engineers. As a consequence, Rochester experienced a major
that we can look forward to?
collapse in its local high-tech sector and exited the group.
The point I’m making is that the presence of agglomeration
Moretti: There are two factors to consider. First, in many
economies and the advantages of geographical agglomeration
successful cities, housing and commercial real estate tend to
don’t necessarily imply that the same process applies forever.
become scarcer and therefore more expensive. This effect
When there are shocks large enough, we see entry and we see
reflects both geographical limits and local housing policies that
exit. Agglomeration economies do offer a strong advantage to
constrain the supply of new housing in many cities. This is an
certain cities, for some periods of time, but they don’t imply
important limiting factor, as firms need to pay workers more
that this process is deterministically bringing the United
just to compensate them for the cost of living.
States toward complete concentration of economic activity.

E co n F o c u s | F i r st Q u a rt e r | 2 0 1 9

EF: How important are universities like Berkeley and
Stanford to the rise of an industry cluster?
Moretti: I think universities do play an important role, but
it’s more nuanced than a lot of people seem to think. Many
observers note that Stanford is in the middle of Silicon
Valley and infer that Silicon Valley is located there because
of Stanford. Yet there are 330 metropolitan statistical areas
in the United States. Most of them have colleges or universities, many have very good colleges and universities, but only a
handful of these metropolitan areas have sizable private-sector
innovation clusters.
St. Louis has Washington University, an excellent research
university, but it doesn’t have much innovation outside
the border of the university. Ithaca has Cornell, another
excellent research university, but there aren’t that many
private-sector jobs in innovation outside the university. New
Haven has Yale, one of the most prestigious universities in
the world, and Santa Barbara has UC Santa Barbara, which
has several Nobel Prizes and terrific engineering and physics
departments, but those cities aren’t important centers of
private-sector innovation.
As for Stanford: When [William] Shockley decided to relocate from the East Coast and founded the first semiconductor
firm in Silicon Valley, Stanford was not a powerhouse in engineering. Stanford was a good university, but there were much
better engineering departments on the East Coast. Arguably,
the Stanford engineering department became one of the leading
engineering departments, thanks in part to the rise of Silicon
Valley. The growth of Stanford as a research university was as
much an effect as a cause of the growth of Silicon Valley.
I do think universities play an important role once a cluster
starts developing. It is difficult for cutting-edge high-tech firms
to be far from academic research. It’s a symbiotic role where
universities foster private-sector research and, at the same
time, are strengthened by the presence of an innovation cluster.
EF: Much has been written about “coolness,” of appealing
to a bohemian creative class, as a development strategy for
cities. The idea is attracting educated workers and their
companies by trying to foster a certain cultural feeling.
How effective is that?
Moretti: Much has been written about it. There are scholars
who have suggested that coolness is a recipe for local economic
development. I tend to be a little bit skeptical of that simplistic recipe. If you look at the history of U.S. cities, coolness
often follows economic prosperity. In other words, the types
of amenities that college graduates and other workers with
high-level schooling tend to appreciate are often the effect of
having a lot of them around and of having a lot of disposable
income to be spent in an area rather than the ultimate cause of
economic growth.
I’m not saying cultural amenities don’t play a role, but I think
it’s hard to see examples of cities where the mayor decides to
increase the coolness of the city and as a consequence the city

becomes a thriving local economy with thousands of good jobs.
I think it is more typical to see areas where economic growth
is followed by improvements in local amenities — whether it’s
restaurants, museums, entertainment, or quality of life. It’s an
equilibrium. Empirically, improvements in cultural amenities
tend to be as much an effect of economic growth as a cause.
EF: Do you think the rise of two-career couples and especially assortative mating among the highly educated has
contributed to the divergence among cities’ paths?
Moretti: It plays an important role. There is good research
that shows that larger labor markets have an advantage over
medium-sized and smaller labor markets because larger labor
markets offer more job opportunities for both members of a
couple — and this is increasingly valuable as assortative mating
In a world in which only one member of a couple works,
a larger city offers some advantages, but in a world in which
both members of the couple work and both members are looking for professional jobs, a larger labor market is particularly
The more specialized the skills of the two members of the
couple, the more city size matters. If they are not very specialized, size matters but not as much; if they are both very
specialized, the empirical evidence suggests that larger cities
are significantly better for their careers. It’s not impossible for
such couples to locate in small- or middle-sized cities, but it
may be costly in terms of wages and earnings.
EF: A lot of your work looking at the divergence of cities
has been looking at the U.S. context. Is this a global phenomenon? Have you seen the same thing in your native
Italy, for example?
Moretti: It’s a global phenomenon. It emerges most clearly in
the United States given the size of the country, its geographical
differences, and the fact that U.S. cities are more spatially separated than ones in Europe. But the same economic forces are
also at play in European countries. Notably, we also see similar
political dynamics.
Take the United Kingdom, for example. The same political
polarization that we observe in the United States, with the
deep divide in voting patterns between heartland states and
coastal states, is clearly present in the United Kingdom. The
polarization of the Brexit vote tightly follows the economic
divide between the most advanced local labor markets in
London and other parts of southern England on one side and
the declining communities of the U.K. rust belt on the other
side. We see a similar economic and political divide in France,
where there are growing differences in labor market opportunities between the largest cities, especially Paris, and smalland medium-sized communities. Just like in the United States
and the United Kingdom, the economic divide in France
results in a growing political divide, with the yellow vests being
the most recent and visible manifestation.
E co n F o c u s | F i r st Q u a rt e r | 2 0 1 9


We see a large economic divide in Italy as well. The difference between cities like Milan, Bologna, and the industrial
areas of the northeast, on the one hand, and southern regions,
on the other, has been growing. Unlike in the United States
and the United Kingdom, in Italy and France geographical
differences manifest themselves mostly as differences in local
unemployment rates rather than differences in average wages.
That’s because of the labor market institutions: In Italy and
France, wages are largely set by collective bargaining and therefore can’t vary much across cities. But unemployment rates do.
Geographical divergence is also taking place in developing
countries. Consider, for example, the way that China or India
have developed in the last 20 years. Shanghai and Beijing essentially look like western cities in terms of productivity, salaries,
and standard of living. By contrast, the western part of China
has grown but by much less than coastal cities. The same is
true when you look at India. Bangalore is India’s Silicon Valley,
and in many respects its labor market is not very different. At
the same time, the state of Bihar has grown but much less,
and it has an economy that looks a century behind Bangalore.
Overall, I think the economic forces we see in action in the
United States are also in action in many countries, including
those at different stages of development.
EF: In America, statistics indicate that we have become
less willing over time to relocate in pursuit of economic
opportunity. Why do you think that is?
Moretti: Geographical mobility in the United States has been
declining. Americans remain more mobile than Europeans, but
they are less geographically mobile than they were 30 years ago.
Propensity to move collapsed during the Great Recession.
Since then, it has recovered slightly, but the long-run trend has
been clearly downward. College graduates remain more mobile
than high school graduates and high school dropouts by a vast
margin. But in general, all groups in this country have become
less mobile. I don’t think we have determined the exact reasons
yet. It’s an important open question.
On the one hand, lower mobility could in principle be a
positive development if it reflects stronger attachments to
communities or better information about job opportunities
elsewhere. In the past, there were probably a lot of errors in
mobility decisions. Since one had to move to a city to find out
what jobs were there, some workers probably had to move
repeatedly before finding the right job. Today, internet job
sites provide much more information on job openings in other
cities and probably lower the amount of misdirected mobility.
On the other hand, lower mobility could be a negative
development if it reflects outside constraints, such as credit
or housing constraints. If you think about the places that
in the ’50s and the ’60s were thriving in the United States
— Detroit, for example — they were places where the average family could move and quickly find affordable housing.
Today’s boom towns, whether San Francisco or Boston or
D.C. or Seattle, are quite different in this respect: Housing is
much more constrained and expensive. This makes it harder

E co n F o c u s | F i r st Q u a rt e r | 2 0 1 9

for the average family to relocate there. I’m not saying this is
the only factor or the main factor, but I suspect housing may
be an important factor.
EF: In February, as you know, Amazon stated that it will
not build a headquarters in New York City as it had originally announced in November 2018. Was this a bad outcome for New York? Or can there be too much of a good
thing for a city that’s already prospering?
Moretti: Forgoing Amazon had a cost for New York in terms
of missed diversification. The tradable sector of New York
City — the type of jobs that engage in producing services sold
outside New York City — is historically heavily dependent on
finance. Diversification of the New York labor market is a good
thing for the city because it is too dependent on one sector.
The cost to New York is represented not only by the
25,000 forgone Amazon jobs, but more importantly, also by
the forgone agglomeration effects Amazon could have brought
to New York. By having Amazon in New York, the city could
have attracted more internet and software companies. My
work suggests that the indirect agglomeration benefits would
probably have been even more important than the direct effect
of adding 25,000 new jobs inside Amazon. Overall, the city has
forgone a large number of good jobs, not just within Amazon
but from an entire ecosystem that could have formed around
Amazon. Keep in mind that while finance still offers excellent
average salaries, over the past 10 years, salaries in tech have
grown more than salaries in finance.
The New York economy, of course, will survive. Without
Amazon, it might grow less and might be less diversified. But it
remains a thriving regional economy with strong fundamentals.
An important related question is what does this mean for
the national economy as a whole. Those 25,000 Amazon jobs
are going to locate somewhere else in the United States, so from
the national point of view, those jobs are not lost. However,
from the national point of view, there are aggregate advantages
stemming from the concentration of high-tech employment.
In a new paper I just finished, I find that by concentrating geographically, high-tech firms and workers become more productive and more innovative, which has aggregate benefits for the
national economy. In particular, if you take the current location
of inventors in the United States, which is now very concentrated in a handful of locations, and you spread it across all
cities, to the point where you equalize the number of inventors
in each city, the U.S. aggregate production of innovation in the
United States would decline by about 11 percent as measured by
number of new patents. Thus, the concentration we observe in
tech employment has drawbacks in the sense that it increases
inequality across cities, but at the same time, it is good from
the point of view of the overall production of innovation in the
country. I see this as an equity-efficiency trade-off.
EF: As you know, within regional economics, there are
long-running disagreements about the roles of so-called
place-based and people-based policies. What do those

terms mean to you, and where would you put yourself on
that continuum?
Moretti: Traditional government aid is people based, in the
sense that the government targets some individuals or families
for transfers: welfare payments, food stamp, housing assistance, or other forms of aid. The growing divergence in economic fortunes of U.S. communities has increased the political
demand for place-based policies, where entire communities are
targeted for aid, not just specific individuals.
There’s a debate among economists on whether government aid should focus on individuals and families or whether
it should extend to entire communities, over and above what
specific individuals in those communities may already receive.
In economic terms, one key question is whether there are
regional externalities in the process of local economic development that are important enough that we should target entire
communities. I don’t think we have a full answer yet.
Pat Kline and I have studied the largest place-based policy ever attempted in the history of the United States: the
Tennessee Valley Authority. The TVA is an example of a “big
push” policy designed to lift the economy of an entire region,
a region that at the time was one of the poorest and least-developed in the country. The TVA started under FDR in the
1930s and continued through the 1950s. It used federal funds
to bring roads, electricity, and public investment to an area
that didn’t have any. We find a good economic return on that
investment. We conclude that FDR’s idea of jump-starting
economic development in such an underdeveloped region with
a coordinated big push was a success.
However, I would not expect that adopting the same policy in the economically distressed areas of today — the Rust
Belt, for example — would have the same effect because we’re
starting from a much different level of economic development.
Building new roads or new power plants might have worked
for the Tennessee Valley in the 1930s since it did not have any,
but it will not necessarily help the economically weak regions
of the country today.
Today, the question of how to jump-start economic development in regions that are struggling has a much less obvious answer than it did when FDR was thinking about the
Tennessee Valley in 1930. It is not easy for the federal or state
governments to engineer successful industry clusters in areas
that don’t have one.
EF: In research with Chang-Tai Hsieh at the University of
Chicago, you found that regulations of the housing supply
in high-productivity cities reduced U.S. economic growth
by more than a third from 1964 to 2009. How could local
regulations in a small number of cities have such an enormous effect on the economy?
Moretti: The reason relates to what we were discussing
earlier. Labor productivity is vastly different across U.S.
cities: Some cities have very high productivity, while others
have very low productivity. The same worker can be more

productive or less productive depending on her location.
What has been happening in the United States over the
past 30 years is that the cities that have high labor productivity
have also adopted increasingly restrictive land-use regulations
that limit the amount of new housing that can be built. One
extreme example is the Bay Area, where labor productivity
and wages are among the highest in the nation. Many workers
would like to move here to access those high wages generated
by the high labor productivity. But most cities in the Bay Area
have decided to severely constrain the amount of new housing
that gets built.
I’m not talking about limits to developing parks, hills, or
green fields, which should be preserved. I’m talking about limits to housing that could be built on empty parking lots near
downtown San Francisco, near train stations in Silicon Valley,
or in underutilized industrial space in the urban core of the
region. It is a political decision that local voters have adopted.
Its ultimate effect is to severely constrain the number of outside workers who can have access to high-paying jobs in the
region. These cities have essentially built a wall around their
borders that makes it very hard for outside workers to access
the region’s high productivity.
In the paper, we estimate that the costs that these land-use
restrictions have imposed on the rest of the nation in terms of
forgone GDP, employment, and earnings are high. We find
that more flexible housing policies in high-productivity areas
would have large benefits for the U.S. economy as a whole.
EF: You’ve analyzed the importance of word of mouth in
driving the success of movies. What drew you to that question and what did you find out?
Moretti: Part of my research agenda has to do with social
interaction and the role that social interaction plays in economic outcomes. We have been discussing forms of social
interaction that determine the economic success of local
Another form is represented by social interactions that
determine the success of specific products. What drew me to
that specific research question was the fact that a movie is a
type of product known as an experience good: You don’t know
its quality in advance. You have some expectation about its
quality, but its true quality is revealed only after you have consumed it. Thus, social interactions are potentially important.
Experience goods are quite common.
In my research, I looked at surprise successes — movies
that the public liked more than the market expected. I tracked
the effect of those positive and negative surprises on future
sales. And I found that for this type of experience good, social
interaction can play a major role in determining which product
succeeds or fails.
Movies that are ex ante almost identical but differ slightly
in terms of how much the public ends up liking them can have
vastly different sales thanks to social interaction, which magnify the small initial difference. It’s not unlike the story about
the divergence of cities, if you think about it.
E co n F o c u s | F i r st Q u a rt e r | 2 0 1 9



A Capital Compromise
How war debts, states’ rights, and a dinner table bargain
created Washington, D.C.
By J e s s i e Ro m e ro


y the summer of 1783, soldiers in the Continental
Army were fed up. The British army had surrendered at Yorktown, Va., two years earlier, effectively
ending the Revolutionary War, but soldiers remained on
duty while treaty negotiations dragged on in Paris. They
hadn’t been paid in full for their service in years, and
when the Continental Congress passed legislation furloughing them, they suspected they never would be. On
June 21, around 400 angry members of the Pennsylvania
militia surrounded the building in Philadelphia where the
Congress met, scaring off so many delegates that legislators failed to achieve a quorum. Alexander Hamilton and
other congressional leaders urged Pennsylvania’s government to send in friendlier troops for protection, but the
state refused. The next day, the Congress announced it
was abandoning Philadelphia in favor of Princeton, N.J.
Over the next few years, legislators would meet in
Annapolis, Md., Trenton, N.J., and New York City. In
1788, the Constitution gave Congress the power to establish a permanent home for the federal government, but
there was considerable disagreement among the states’
delegates about where that home should be. Eventually,
the debate would become entangled with arguments about
the nation’s finances, reflecting deep philosophical divides
between the country’s founders. The compromise that
was eventually reached in 1790, which created a new district on the banks of the Potomac River, had long-lasting
political and economic repercussions for the region and
for the country.
“Not Worth a Continental”
When the Revolutionary War began in 1775, the American
rebels weren’t lacking in courage, but they were lacking in
currency. The Second Continental Congress didn’t have
any authority to raise revenue to fund the army. “Not then
organised as a nation, or known as a people upon the earth
— we had no preparation — Money, the nerve of War,
was wanting,” George Washington wrote in an early (and
eventually discarded) draft of his first inaugural address.
The Congress formalized its own existence with the
Articles of Confederation in 1777, but its power was limited
to requesting supplies and money from the states — requests
the states failed to fulfill. “The individual States, knowing there existed no power of coertion [sic], treated with
neglect, whenever it suited their convenience or caprice, the
most salutary measures of the most indispensable requisitions of Congress,” according to Washington.


E co n F o c u s | F i r st Q u a rt e r | 2 0 1 9

So the Congress financed the war by printing money:
up to $240 million in face value, the equivalent of nearly
$6 billion today. The fledgling government also took
loans from France, Spain, and private Dutch investors and
issued scores of “loan office certificates,” which were basically IOUs to merchants and citizens who provided goods
to the army. The individual states also printed their own
currency — Pennsylvania had 250 different forms of notes
— and issued various bills of credit and bonds. These were
specified in a confusing array of currencies and commodities. One Massachusetts debt issue promised to repay
bondholders “according as five bushels of corn, sixty-eight
pounds and four-seventh parts of a pound of beef, ten
pounds of sheeps wool, and sixteen pounds of sole leather
shall then cost.”
Within a few years, Continental notes were worth
pennies on the dollar. Store owners used them as wallpaper and the phrase “not worth a Continental” entered the
American idiom. Eventually, the Congress couldn’t pay
its soldiers or the interest on the national debt. When
the war ended, the Congress didn’t even have enough
specie to buy paper on which it could print certificates
promising to pay soldiers in the future.
The Federalist Plan
In the late 1780s, the new country’s finances were in disarray. Without a functioning currency, the government of
Virginia started accepting deer skins — “well dressed for
the purposes of making breeches” — as payment for debts.
A former general in the Revolution wrote that “money is
now no more a currency than the ragged remains of a kite.”
One of the framers’ goals in drafting the Constitution,
which was ratified by a majority of the states in 1788, was
to address many financial woes by creating a stronger
federal government with the authority to tax and regulate
commerce. But the matter of the Revolutionary War debt
remained; in 1790, the outstanding state and federal debt
totaled at least $70 million, or nearly $2 billion in today’s
dollars. One proposal to deal with the debt was to pay out
the face value to the original debtholders who had held
onto their notes but pay only the depreciated market
value to those who bought on the resale market. Initially,
the debt was owned largely by soldiers, store owners, and
farmers. But in later years, it was bought up by speculators,
primarily from the North, for far less than the original
value. According to research by historian Cathy Matson of
the University of Delaware, just 47 Northerners, primarily

Image: Library of Congress, Geography and Map Division

from New York and New Jersey, owned 40
percent of South Carolina’s, North Carolina’s,
and Virginia’s combined debts. These new
debtholders stood to gain a substantial windfall
if the debts were repaid in full.
The new treasury secretary, Alexander
Hamilton, later of Broadway fame, disagreed
with this proposal. In January 1790, he submitted the “First Report on Public Credit” to
Congress, in which he described the nation’s
debt as “the price of liberty.” The arguments
for repaying it in full, without discriminating among debtholders, “rest[ed] on the
immutable principles of moral obligation.”
Hamilton made a more practical argument
for repayment as well. In countries where the
national debt was properly funded and “an
object of established confidence,” transfers of
public debt could function as money and create a larger stock of capital to fund trade, agriculture, and commerce. Repaying the debt
and establishing sound public credit would
also, in Hamilton’s view, solidify the union
of the states and increase America’s standing
with the rest of the world.
To establish this credit, Hamilton, a
staunch Federalist, recommended that the federal government assume and consolidate all the outstanding
debt and then pass an excise tax to generate the revenues to pay it off. To many people, including fellow Founding Father James Madison, Hamilton’s plan
seemed like a ploy to increase the central government’s
power. “Madison was a leading Federalist in creating the
Constitution. But he never envisioned a system as centralized as the one Hamilton began trying to create,” says
Denver Brunsman, a historian at George Washington
University. “Hamilton seemed to be proposing a system
that matched the one America had just fought against.”
Madison and other supporters of stronger states’ rights
also objected to Hamilton’s plan because some states,
including Maryland and Madison’s home state of Virginia,
had already paid off substantial portions of their war
debts. Subjecting them to a federal tax would mean they
were subsidizing other states’ debts. Finally, they hated
the idea of Northern speculators profiting at the expense
of Southern farmers and merchants. The House rejected
Hamilton’s plan in April of 1790.
The Compromise
At the same time Congress was debating debt assumption,
it was also trying to decide where to establish the nation’s
capital. Article I of the Constitution gave Congress the
authority to establish a district as the seat of the U.S.
government. This district would not be part of a state;
instead, Congress would have the power to “exercise
exclusive Legislation in all Cases whatsoever.” The lack of

Topographical map of the original borders
of the District of Columbia.

statehood was an “indispensable necessity,” according to
the framers, in order to prevent state officials from being
able to interrupt or influence the federal government’s
At least 16 different locations had been proposed,
the majority of them in the North. Many Southerners
feared that a Northern capital would diminish the South’s
influence, and Madison and other Southern representatives advocated locating the capital in Virginia, on the
banks of the Potomac River. But by the spring of 1790, it
appeared likely that a geographically central location such
as Philadelphia would win the day.
Writing in 1792, Thomas Jefferson, then the secretary
of state, recalled running into Hamilton in New York in
June of 1790, just a few months after the House rejected
his plan. To Jefferson, Hamilton appeared “somber,
haggard, and dejected beyond description,” so Jefferson
invited him and Madison to his home the next day for
a “friendly discussion” of their differences. Over dinner
on June 20, Madison agreed to stop opposing the debt
assumption plan, and even to round up votes in favor
of it, if Hamilton would help him deliver the capital to
Virginia. “It was observed … that as the pill [of debt
assumption] would be a bitter one to the Southern states,
something should be done to soothe them,” Jefferson
wrote. “The removal of the seat of government to the
Potomac was a just measure, and would probably be a
E co n F o c u s | F i r st Q u a rt e r | 2 0 1 9


popular one with them.” On July 16, Congress passed the
Residence Act, which created “a district of territory, not
exceeding ten miles square, to be located as hereafter
directed on the river Potomac.” A few weeks after that,
Congress approved Hamilton’s Funding Act.
Jefferson would come to oppose debt assumption — and
Hamilton himself. When the compromise was reached, he
had recently returned from several years in France and was
unfamiliar with the domestic debates. “Jefferson wanted
to play the role of diplomat and mediator and thought that
helping resolve Hamilton’s and Madison’s dispute would
bring the country together,” says Brunsman. “But he would
come to believe that he had been duped by Hamilton and
that the compromise was his greatest political mistake.”
Jefferson concluded his recollection of the dinner with
the following observation: “[Debt assumption] was unjust,
in itself oppressive to the states, and was acquiesced in
merely from a fear of disunion, while our government was
still in its most infant state. It enabled Hamilton so to
strengthen himself by corrupt services to many that he
could afterwards carry his bank scheme and every measure
he proposed in defiance of all opposition.”
Cutting the Diamond
The selection of the new capital’s precise location was left
to President Washington, who selected a site centered on
the Maryland shore of the Potomac, extending in a diamond shape nearly to Mount Vernon. (See map.) The first
boundary stone was laid in 1791, and Congress convened in
the District of Columbia for the first time in November
1800. (Philadelphia served as the temporary capital while
D.C. was being built.) Washington remained intimately
involved in the district’s planning and construction, but he
never had the opportunity to govern from the new capital;
he left office in 1797 and died two years later. The first
president to take the oath of office in Washington, D.C.,
was Jefferson.
Controversy continued even after the seat of government was officially established. Within just a few
years, the residents of Alexandria, Va., began trying to
reverse their inclusion in the capital district because they
were angry about losing their Virginia state citizenship
and their right to vote in congressional and presidential
elections. In addition, an amendment to the Residence

Act stated that public buildings could be built only on
the Maryland side, which meant few of the commercial
benefits of having the capital would accrue to Virginia.
Abolitionists took up the cause of removing Alexandria
from the capital because it was a hub for the slave trade.
In 1846, President James Polk signed legislation retroceding — returning — the area to Virginia, lopping off the
southwest corner of the diamond.
George Washington envisioned Washington, D.C.,
as a cultural and financial center, but “it was basically a
backwater for decades,” says Brunsman. “I think of it as
Jefferson’s revenge. He took office in 1801, and he ensured
that the city would be the seat of government and not
much else.” It didn’t help that much of the city was burned
to the ground during the War of 1812.
D.C. is far from a backwater today. Fueled by
post-World War II increases in federal spending, the
broader metropolitan area, which includes suburban
Maryland and Virginia, has grown into the sixth most
populous in the country. Median household income in
the city is more than $82,000, compared with about
$60,000 for the nation as a whole, according to the
Census Bureau’s most recent estimates. In the surrounding counties, household incomes are well above
$100,000. The wealth isn’t equally distributed, however. Median income for black households in the city
is about $42,000; for whites, it’s more than $134,000.
And between 2000 and 2013, more than 20,000 black
residents were displaced from formerly low-income
neighborhoods, according to a study by the National
Community Reinvestment Coalition.
While D.C. has prospered, its residents have advocated to undo the conditions of its founding. Since 1801,
dozens of constitutional amendments and other bills
have been proposed to give the city official representation. The 23rd amendment in 1961 gave D.C. presidential electors in the Electoral College. In 2000, the city
started stamping “taxation without representation” on
its license plates to protest its lack of full representation
in Congress, and in 2016, nearly 80 percent of D.C. residents voted in favor of a referendum for statehood. The
House voted in favor of D.C. statehood in March 2019,
but there’s little chance of a dinner table compromise to
bring the bill to the Senate.

Ferguson, E. James. The Power of the Purse: A History of American
Public Finance, 1776-1790. Chapel Hill, N.C.: University of North
Carolina Press, 1961.


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Matson, Cathy. “The Revolution, the Constitution, and the New
Nation.” In Stanley L. Engerman and Robert E. Gallman (eds), The
Cambridge Economic History of the United States, Vol. 1: The Colonial
Era. Cambridge: Cambridge University Press, 1996.


Richmond Fed Researc

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The Persistence of
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By Kartik Athreya,
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Richmond Fed Research

Digest 2019
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Economic Quarterly is published
by the Research Department of the
Federal Reserve Bank of Richmond.
The journal contains articles written
by our staff economists and visiting
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pertinent to Federal Reserve monetary
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Second Quarter 2019
Time-Varying Skewness and
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Lance Kent and Toan Phan
CDS Auctions: An Overview
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Economic Trends Across the Region

Rural Hospital Closures and the Fifth District
B y E m i l y W a v e r i n g C o r c o r a n a n d S o n y a R a v i n d r a n a t h W a d d ell


ince 2010, some 106 hospitals in American rural areas
closed their doors. The closures took place at a time
when population and employment growth is more
skewed than ever toward our biggest cities, when finding
access to health care in more isolated areas is as difficult
as it has ever been, and when the loss of an anchor institution, such as a hospital, can have devastating effects on the
community and economic development of rural households. Why do we see hospitals in rural areas closing at a
higher rate than at any time since the mid-1980s? What
are the economics that hospitals in rural areas are facing?
And what may be the consequences of the loss of these
anchor institutions for communities?
The share of rural hospitals that have closed exceeds
that of hospitals in urban areas, and rural hospital closures have accelerated. (See chart.) Of the 106 hospitals
that closed, two-thirds were in the South — as defined
by the census regions West South Central, East South
Central, and South Atlantic — and of these, 12 were in
the Fifth Federal Reserve District. (“Closing” here means
ceasing to provide general, short-term, acute inpatient
care.) According to a Government Accountability Office
(GAO) report, rural hospitals in the southern United
States represented 38 percent of rural hospitals in 2013 but
77 percent of the closures from 2013 through 2017. In the
Fifth District, although North Carolina, South Carolina,
and Virginia had the highest number of hospital closures,
an analysis by David Mosley and Daniel DeBehnke of
Navigant used variables such as total operating margin,
days of cash on hand, and debt-to-capitalization ratio to
determine that West Virginia had the highest number

Number of Hospitals

Rural Hospital Closures









Fifth District

NOTE: No rural hospitals in the Fifth District closed in 2010 or 2011.
Source: Cecil G. Sheps Center for Health Services Research and authors’ analysis


E co n F o c u s | F i r st Q u a rt e r | 2 0 1 9


and share of rural hospitals at high financial risk of closure.
Of course, hospital mergers and acquisitions can also
affect local options for medical care. These, too, have
been more prevalent in rural areas than in urban areas.
Approximately 12 percent of rural hospitals nationwide
(326 hospitals) merged from 2005 through 2016. Some of
the dynamics, primarily financial pressures, that lead to
rural hospital closures are the same as those that lead to
mergers or acquisitions.
Why Are Rural Hospitals Closing?
The primary drivers of rural hospital closures are, in fact,
economic. The length of hospital stays has decreased
across the country; in rural areas, that loss of inpatient services is only compounded by the rural population loss over
time. (See chart.) According to a congressional report in
2018, the occupancy rate of urban hospitals was 66 percent
compared with 40 percent for all rural hospitals and 31
percent for rural hospitals with fewer than 50 beds. Rural
hospitals also have tighter profit margins than urban hospitals. For example, while urban hospitals had a median
profit margin of 5.5 percent in 2016, rural Critical Access
Hospitals (CAHs) and other rural hospitals had median
profit margins of 2.6 percent and 2.0 percent, respectively.
The reduced inpatient services result from not only an
effort to reduce health care costs, but also from medical
advances that allow for more procedures to be performed
as outpatient services, which reduces or eliminates the
need for patients to receive hospital care.
Another part of the story lies in both long-standing
and more recent economic developments. In the past
few decades, as local mining, manufacturing, and agricultural employers have left rural areas, the loss of employer
health coverage has contributed to the financial challenges of rural hospitals. Some demographic trends, such
as an increasingly older population in rural areas, have
made inpatient services more in demand, but others,
such as a declining population overall, have made it more
challenging for rural hospitals to operate profitably. The
GAO found that rural hospitals have also faced increased
competition from federally qualified rural health centers
and urban hospitals. These competitors provide services
that rural residents had previously sought at their local
hospital, such as emergency care and behavioral health
care. Sometimes, rural patients will bypass their local
rural hospital for larger rural or urban facilities even
when services are available locally. One study found
no effect of hospital closures for Medicare patients
and found that hospital closings were associated with


reduced readmission rates, which is regarded as a sign of
What’s “Rural”?
increased quality.
Health care policy matters, too. The last string of rural
In this article, except where otherwise noted, “rural” is
hospital closures occurred in the 1980s after Congress
defined using the Federal Office of Rural Health Policy’s
mandated the use of fixed, predetermined reimbursement
(FORHP) definition, which includes any of three areas:
rates for hospitals through the prospective payment system
(1) a county outside of a metropolitan area; (2) a county
(PPS). In response, then, to growing concerns over rural
in a metropolitan area but with a rural-urban commuthealth care access, the Centers for Medicare & Medicaid
ing area code of 4 or higher; or (3) one of the 132 large
Services implemented the Rural Hospital Flexibility
and sparsely populated census tracts with a rural-urban
Program of 1997 (commonly called the “Flex Program”),
commuting area code of 2 or 3 — these tracts are at
which authorized payment of inpatient and outpatient serleast 400 square miles in an area with a population denvices on a “reasonable cost basis” for hospitals designated
sity of no more than 35 people per square mile. In this
as CAHs. According to an issue brief from the Kaiser
way, FORHP attempts to classify “rural” in a way that
Family Foundation in 2016, more than half of rural hospiaccounts for distance to services and sparse population.
tals were CAHs, about 13 percent were designated as Sole
(For more information on ways to classify urban and
Community Hospitals (SCHs), 8 percent were Medicarerural areas, see “Definitions Matter: The Rural-Urban
Dependent Hospitals (MDHs), and another 11 percent
Dichotomy,” Econ Focus, Third Quarter 2018.)
were Rural Referral Centers. All of these designations
provide enhanced or supplemental reimbursement under
populations. No doubt delayed and forgone Medicaid
Federal law requires that hospitals treat patients regardexpansion — and higher rates of Medicare coverage due
less of their ability to pay, which means all hospitals have
to an aging population — exacerbated the financial strain
some amount of uncompensated care. In 2017, hospitals
facing rural hospitals that were already struggling with
nationwide provided approximately $38.4 billion in uncomdeclining population, higher poverty, and relatively more
pensated care. Hospitals with high levels of uncompensated
care, formally known as Disproportionate-Share Hospitals
Marc Malloy, a senior vice president with the hospital
(DSHs), receive federal financial assistance, although it only
and medical facilities chain HCA Healthcare, notes that
covers approximately 65 percent of total uncompensated
these economic disadvantages of rural hospitals can lead
costs. The 2010 Patient Protection and Affordable Care
to a negative spiral. “Smaller hospitals are significantly
Act (ACA) was intended to reduce the federal government’s
disadvantaged when competing for resources, negotiating
financial assistance to DSHs on the assumption that more
with commercial payers, and attracting top talent — both
uninsured patients would have their services covered by
clinical and managerial,” he says. “As finances get tighter,
it becomes difficult to attract doctors in high-margin
Medicaid soon after the passage of the ACA. But as of
businesses like orthopedics, vascular surgery, pediatrics,
mid-2019, 14 states have not expanded Medicaid (including
or maternal care. The tough finances leave the board of
North and South Carolina in the Fifth District). States that
directors with the dire choices to sell a failing hospital or
expanded Medicaid to low-income adults under the ACA
reduce services until the organization has atrophied to
saw both larger coverage gains and larger drops in uncomthe point of closure.”
pensated care — a 47 percent drop in uncompensated care
costs on average compared to an 11 percent decrease
Urban vs. Rural Population Growth
in states that did not expand Medicaid. A 2018 article in the journal Health Affairs found, in fact, that
the ACA’s Medicaid expansion was associated with
better hospital financial performance and notably
lower likelihoods of closing, especially in rural mar0.8
kets and counties that had large numbers of unin0.6
sured adults before Medicaid expansion. Almost
75 percent of the rural hospitals that closed from
2010 through mid-2019 were in states that did not
expand Medicaid.
A Negative Spiral
The CAHs that closed from 2010 through 2014
generally had lower levels of profitability, liquidity, equity, patient volume, and staffing. Other
rural hospitals that closed had smaller market
shares and operated in markets with smaller




Fifth District Urban



U.S. Urban

U.S. Rural



Fifth District Rural

Source: Population statistics are from Census Bureau. Urban/rural definitions are from the USDA
RUCC codes, where urban is defined as codes 1-3 and rural as codes 4-9. For more information, see
“Definitions Matter: The Rural-Urban Dichotomy,” Econ Focus, Third Quarter 2018.

E co n F o c u s | F i r st Q u a rt e r | 2 0 1 9


The challenges of staffing rural hospitals are found
across states. Glenn Wilson, chairman and CEO of
Chesapeake Bank and Trust in Maryland, who is also
on the University of Maryland Medical System Shore
Regional Health Board, says it is challenging to attract
physicians who might see half the number of patients in a
rural area than they would in an urban area and to retain
nurses whose hours will vary unexpectedly from day to day
based on the number of patients on any given day. “State
health care regulators are not adequately recognizing that
in a more rural setting, the costs of providing health care
will be higher. We can’t scale down but so far.”
What Happens to Access to Health Care?
The most common immediate effect of any rural hospital closure is lost access to health care. According to the
Cecil G. Sheps Center for Health Services Research at
the University of North Carolina, the 106 rural hospitals
that closed from January 2010 through January 2019 represented a loss of 3,984 hospital beds in rural areas. For
the closures that occurred from 2013-2017, over half were
at least 20 miles from the nearest hospital, indicating
that hospital closures might even hurt access to emergency services. Although hospitals’ inpatient volumes
continue to decline, the use of emergency services, especially at the CAHs, has not declined, corroborating that
rural communities need local emergency access.
There are other services that go away when the local
hospital closes. Closure of obstetrics units or reduction
of maternity services in rural areas prolongs travel time
for rural women, which is associated with higher costs,
greater risk of complications, longer lengths of stays, and
psychological stress for patients. Research has indicated
that the loss of hospital-based obstetric care in rural
counties not adjacent to urban areas was significantly
associated with increases in births in hospitals lacking
obstetrics units and increases in preterm births. Access
to mental health care and treatment for substance abuse
disorders is also more likely to be in short supply once
rural hospitals are closed.
Cutbacks in services in rural facilities may be driven in

Critical Access Hospitals
“Critical Access Hospital” is a designation given to
certain rural hospitals by the Centers for Medicare
and Medicaid Services with the intention of reducing the financial vulnerability of those hospitals and
keeping essential medical services (and thus access to
health care) in rural communities. There are conditions that a hospital has to meet to obtain CAH status
(for example, it has to be more than 35 miles from
another hospital and provide 24/7 emergency services)
and the benefits of CAH status (for example, costbased reimbursement for Medicare services).


E co n F o c u s | F i r st Q u a rt e r | 2 0 1 9

part by potential quality issues arising from low volume.
“Research indicates that volume and quality outcomes
are positively correlated,” says Malloy. Speaking of his
experience at Mission Health in Asheville, N.C., sold to
HCA in February 2019, he recalls, “At Mission, we closed
labor and delivery services at two of our outlying hospitals
because the volumes were so low. We felt that to ensure
the highest quality and best outcomes, it was better to
move those services to a facility that had the volume to
ensure sufficient staffing, skills, and experience.”
What About Jobs?
In many rural communities, a hospital can be a primary
source of jobs — often skilled, higher-paying jobs. When
a hospital goes away, then, so do those jobs (although in
many cases, hospitals do convert to other facilities, providing more limited, or just different, services). According
to a 2017 article by Anne Mandich and Jeffrey Dorfman
of the University of Georgia, a short-term general hospital is associated, on average, with 559 jobs in its county,
60 of which are hospital based and 499 of which are not
health care related. In addition, hospital employees with
an associate’s degree have a 21.4 percent wage premium
when compared to other opportunities, and those with
a bachelor’s degree can earn 12.2 percent more. A 2006
article in the journal Health Services Research reported
that the closure of a community’s only hospital reduces
per capita income by 4 percent and increases the unemployment rate by 1.6 percentage points. They also found
that there was no long-term economic impact from closures in communities with alternative sources of hospital
care, although overall income in the area decreased for
two years after the closure.
An article published in 2015 tried to estimate the
economic impact of a hospital closure on a rural area
and used as a case study Bamberg County Memorial
Hospital in South Carolina, which closed in 2012. When
it closed, the hospital employed 102 people and created
over $3 million in direct labor income. (Ten of the displaced workers were rehired when the medical center in
adjoining Orangeburg County opened a new urgent care
center.) The case study found that, not surprisingly, in
the two years after the closure, Bamberg County had a
larger decrease in population and employment than contiguous counties.
The Anchor Institution
The case study on Bamberg County documented not
only changes in access to care and transport times to
health care, but also social effects of the closure. According to the article, Bamberg County Memorial, as an
anchor institution in the area, had been a social hub for
the community and gave many young people their first
work experience (and many older residents, their last).
In addition to lost employment for an area, a hospital
closing leads to the exodus of medical professionals, such

as doctors and nurses. Not only does this reduce overall
employment and shrink the pool of higher wage earners,
thus reducing the purchasing power of a community, but
the departure of the medical professionals also means the
loss of individuals who may act as role models, mentors,
volunteers, and patrons within the community. This loss,
while difficult to quantify, should not be discounted.
Moreover, communities that wish to attract businesses must have a compelling portfolio of value that
includes high-quality health care. This could apply to
retirement communities that might locate within a certain number of miles of a hospital or even to colleges if
parents are concerned about proximity to health care in
the event of an emergency. Some employers have mentioned taking a region’s health care facilities into account
when considering where to locate a plant or an office, and
all employers mention the presence of a qualified, healthy
workforce as key to site location decisions.

rural residents with emergency care. For example, some
communities might be able to cease providing inpatient
services but still generate enough outpatient revenue to
maintain an emergency department. One report found
that although half of hospitals that closed from 2010
through 2014 ceased providing health services altogether,
the rest have since converted to an alternative health
care delivery model. Some options include independent
clinics, hospital-owned primary care practices, provider-based and independent rural health clinics, urgent
care clinics, off-campus emergency departments, clinic
and ambulance services, rural emergency hospitals, and
12-hour primary health centers.
The way forward will inevitably vary by state. Maryland,
for example, is the only state in the country that is exempt
from the Medicare hospital reimbursement rules and
thus any federal pressure to focus on rural health will not
affect Maryland. Virginia has seen far fewer rural hospital
closures in part because the state has many multi-hospital
health systems; according to Sean Connaughton, president and CEO of the Virginia Hospital and Healthcare
Association, “It is the small, stand-alone hospitals that
are the hardest to keep open.” Given the negative operating margins of most small rural hospitals, it seems likely
that the mergers, acquisitions, or closures of rural hospitals are likely to continue. But Connaughton also sees
partnership opportunities across rural health care that
could enable a hub-and-spoke network of providers that
sustainably provide training and health care. One example from Virginia is in the Roanoke Valley region, where
Carilion Clinic is working with partners like Virginia
Tech on medical education and Radford University on
nursing education while engaging its network of rural
hospitals to refer patients needing specialty care to larger
hospitals such as Roanoke Memorial Hospital.

What’s Next?
The high rate of rural hospital closures is not expected to
slow anytime soon — instead, some analysis suggests that
they may close at an even higher rate in coming years. Some
430 hospitals across 43 states are at a high financial risk of
closing based on an assessment of their current financial
viability. Together, these hospitals are major economic
contributors to their communities, representing 21,547
staffed beds, 150,000 jobs, and $21.2 billion total patient
revenue. And almost two-thirds of these hospitals are
essential to the surrounding community, meaning they
provide critical trauma care, serve vulnerable populations,
are located in geographically isolated areas, or have a substantial economic impact on the local community.
Within the Fifth District, 21 rural hospitals in North
Carolina, South Carolina, Virginia, and West Virginia face
a high financial risk of closing. This represents nearly one in
five rural hospitals in those states. Of additional concern is
the fact that 14 of the rural hospitals at high risk of closing
in North Carolina, South Carolina, and West Virginia are
considered essential to their communities. West Virginia
has the highest number of essential rural hospitals at high
financial risk of closing, as eight of the state’s 10 at-risk hospitals are considered essential to their communities.
Every now and again, a hospital will reopen, such
as Crockett Medical Center in Texas. Through a tax
increase and reduced services (for example, it is operating
a primary care clinic and an emergency room but not an
obstetrics unit), the hospital managed to resume some
operations and provide its resident access to at least some
care. There might be other models that could provide

Sometimes, an acquisition can provide a health care system
with its best hope of survival. Says Malloy of the sale of
Mission Health to HCA in 2019, “The arrangement with
HCA paints a far brighter future than we would have had
otherwise.” This is less likely to be true of a hospital closing,
however, even if a closure is unavoidable and even if there
are viable alternatives to health care within a short distance.
Closing any anchor institution has the potential to affect a
community heavily in terms of care, jobs, and the presence
of potential role models and pillars of the community. It is
important, then, for policymakers and leaders at all levels of
government to help consider the best ways to help that community move forward.


E co n F o c u s | F i r st Q u a rt e r | 2 0 1 9



Whom Will Opportunity Zones Help?
By K a rt i k At h r e ya


any people don’t know that Federal Reserve
Banks have programs to aid the development
of low-income areas, a responsibility we have
had in one form or another for close to 40 years. Here
at the Richmond Fed, our Community Development
group became part of the Research Department last
year. This transition has greatly increased my own
exposure, and that of my economist colleagues, to community development issues — and at the same time, I’ve
been excited about bringing the best economic thinking
into helping these areas.
Probably the largest-scale community development
program in recent years is one buried within the 2017
tax reform law: opportunity zones. As detailed in Jessie
Romero’s story in this issue, the program authorized state
governors to select areas where investments would receive
major tax advantages, thus attracting capital to those areas.
(See “Opportunity Zones: More Money, More Problems?”
p. 10.) It’s an example of what economists call “place-based”
programs — that is, programs aimed at helping improve
places as opposed to directly helping individuals or families. The idea, of course, is that helping poor places will
ultimately benefit individuals, perhaps by jump-starting
local job growth, even if some of the beneficiaries aren’t the
intended ones.
The justification for place-based policies is at its
strongest when there are high barriers to geographic
mobility — when it is difficult, in other words, for people to move from distressed areas to ones with more job
opportunities. Such barriers could arise from declining
opportunities for low-skilled workers, or for workers
with specific skills, across a region or across the country.
Other potential barriers to mobility include local policies that tightly restrict the housing supply and drive up
rents and house prices in areas where jobs are plentiful
— especially in our largest cities. Moreover, places are
often more than just places: They are communities with
relationships and other “connective tissue” that bind us
to one another.
For these reasons, helping the places where people
already are is intuitively appealing. Yet it is hard to draw
conclusions about how well place-based policies work
in terms of job creation. The effects of a program that
targets individuals with training, cash transfers, or some
other benefit is, comparatively speaking, easier to assess.
When the “treatment,” in the terminology of the social
sciences, is applied indirectly to a census tract, a city, or
a region, making inferences about the effects of the program becomes a truly fraught exercise.
With regard to opportunity zones in particular, the

E co n F o c u s | F i r st Q u a rt e r | 2 0 1 9

work ahead is to more precisely understand how much
they are likely to improve the lives of the least advantaged.
The program’s critical decisionmaking stage, the selection
of the zones, was not required to be based on objective
measures of economic distress, such as unemployment
or poverty rates. Some 57 percent of neighborhoods in
the United States were eligible, and it was left to the
subjective judgments of state officials to choose among
them. No doubt these decisions were made with good and
sincere intentions, but public officials are human and it
would be only natural for them to be influenced by considerations relevant to their constituencies.
Indeed, research by Hilary Gelfond and Adam Looney
of the Brookings Institution found that states varied
greatly in the extent to which they zeroed in on the most
distressed areas. Nationally, about one-quarter of the
areas selected had poverty rates below 20 percent. In a
half-dozen states, they noted, areas chosen as opportunity
zones “were actually better off, on average, than eligible
communities that were not selected.” They pointed to
a county in Nevada designated as an opportunity zone
despite a median household income of over $65,000 and
a family poverty rate of 2.6 percent. The county is home
to a number of major industrial facilities, leading the
researchers to surmise that the designation was meant
not to improve the fortunes of poor people, but simply to
confer a tax benefit on investors.
Even in a zone that is truly distressed, moreover, there’s
the question of how much the poor people in that zone
will benefit. Much of the gains may well flow to people
who are already in good shape: to property owners or to
skilled workers from outside the zone who receive jobs
there. That the investments may create jobs for people
from outside the zone is of course a positive effect, and
may indirectly create service jobs for locals, but just how
much the locals will benefit is highly uncertain.
To be sure, there is potential for significant favorable
effects from the opportunity zone program. And experimentation in community development programs, within
reason, is a good thing. So I hope that as we continue
to engage in the development of opportunity zones,
extremely diligent and detailed data collection will take
place. We need to know “before and after” for a wide
range of stakeholders and potential beneficiaries. Such
efforts would help us think harder about how to structure
place-based programs in a way that efficiently benefits the
people who are intended to be helped.
Kartik Athreya is executive vice president and director
of research at the Federal Reserve Bank of Richmond.

Rural Entrepreneurship

While the transformation of the Santa Clara Valley from
agricultural countryside to Silicon Valley is unlikely to be repeated,
evidence in the literature indicates that local entrepreneurship
can contribute to growth in rural communities — even in remote,
distressed communities.

Labor’s Declining Share

There is wide agreement that labor’s share of U.S. national
income has gone down substantially over the past 20 years.
But there is much less agreement about why. Economists have
advanced a wide variety of explanations, including trends in
automation, outsourcing, industrial concentration, and labor’s
bargaining power.

Federal Reserve

It’s traditionally assumed that only the Fed has the power
to maintain a stable price level. But some economists have
theorized that, in certain circumstances, inflation may actually
be driven by fiscal policy. Would fiscal control of inflation mean
that governments could issue debt to pay for new programs
without worrying about inflation? Some proponents of a new
idea known as Modern Monetary Theory say yes.

Economic History
From 1908 to 1940, the Sears catalog sold
houses — kits that Sears would ship and that
a builder or the homeowners themselves
would assemble locally. Hundreds of the
kits, affordable housing for the middle
class, were built in the Fifth District alone. A
relic of an earlier time or a source of lessons
for affordable housing policy?

At the Richmond Fed
The U.S. shadow banking sector — so-called
because it operates largely outside the
purview of federal banking regulation
— holds as much as $15 trillion in assets.
Richmond Fed economist Borys Grochulski
has looked at how regulators can design rules
that take into account the ability of banks
to shift activity between the regulated and
shadow sectors.

Glenn Loury of Brown University discusses
“poverty traps,” the economics of antidiscrimination policies, optimal criminal
sentencing, economics as a social science,
and the importance of being willing to
change one’s mind.

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The 2018 essay explores the question of whether
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