Charter Cities and Human Capital in Poor Nations

Paul Romer: One of the goals of this blog is to encourage the kind of exchange between economists and other experts that we expect from an academic seminar. Matt Kahn, fromUCLA has offered this first outside contribution in the E-Seminar series.

Charter cities that don’t tax away as much of the income gains from higher skill may also offer higher real returns to skill compared to many a worker’s country of origin. The promise of better rules may also attract foreign direct investment to charter cities, generating economic opportunities for skilled workers from less-developed areas. A paper by Heckman and Scheinkman (1987) shows that equilibrium returns to skill can differ across sectors so higher returns in a modern sector based in the Charter City need not lead to correspondingly higher returns in traditional sectors that operate in surrounding countries. Could the differences in spatial returns to skill created by a charter city cause a Brain Drain from nearby poor countries that harms those left behind?

Empirical work by Rauch (1993) and Moretti (2004) documents the local social returns to education. Using data from the United States, Moretti (2004) finds that a 1 point increase in the percent of the local population that is college educated leads to a 1.4 percent increase in the real wages of non-college educated locals, and a 0.3 percent increase in the real wages of local college graduates. As the skilled move to the charter city, those who remain in neighboring poor areas will experience a short-run wage reduction.

Beyond this negative short run effect, there is reason for optimism. In the long run, the presence of charter cities will likely increase human capital stocks in neighboring poor countries.

Suppose a charter city’s administrators only admit new residents scoring higher than a given threshold on cognitive and non-cognitive tests. In a lottery system for “passports” into the city, a person receives a higher probability of admission the higher he scores on the tests. A young person living outside of the charter city but aspiring to live there will have the right incentives to invest his time and effort in raising his test scores.

Some individuals will succeed and gain access to the charter city but some will fail. Among the subset of people who just miss admission to the charter city, some will migrate to other nations. The remainder will choose to stay in the areas neighboring the charter city. Their collective skills will contribute to the stock of human capital, unleashing the local human capital spillover effect. Through this dynamic process, the introduction of the charter city improves skill levels in surrounding areas.

The logic is identical to the claim that the international brain drain actually increases domestic investment in education in less-developed countries. The opportunity for young, skilled workers to move to higher returns sectors will raise the returns to education and skill formation at home.

References

Heckman, James and Jose Scheinkman, The Importance of Bundling in a Gorman-Lancaster Model of Earnings,” Review of Economic Studies, (1987) LIV, 243-255.

Moretti, Enrico 2004, Human Capital Externalities in Cities. Chapter in the Handbook of Urban Economics Volume IV) edited by Vernon Henderson and J. Thisse. Volume 4. North Holland Press

Moretti, Enrico. 2004. Estimating the Social Return to Higher Education: Evidence from

Longitudinal and Repeated Cross-Sectional Data. Journal of Econometrics 121, no. 1–2:
175–212.

Rauch, James E, 1993. Productivity Gains from Geographic Concentration of Human Capital: Evidence from the Cities Journal of Urban Economics, vol. 34, no. 3, November , pp. 380-400