Why are many luxury goods made in rich places? Italian leather goods typically are higher quality, and more expensive, than similar items from developing countries. And Brooklyn, New York, turns out a number of upscale items, from fancy pickles to high-end wallpaper and furniture. Could a struggling US city, such as Detroit, compete?
The short answer: not easily. The reason has to do with economic geography—and holds lessons for politicians and policy makers trying to bring economic development to poorer regions.
Chicago Booth’s Jonathan Dingel looks at two leading theories for why high-income locations produce high-quality goods. One credits the factors of production: rich places have more educated workers, or more capital per worker. The other, the home-market effect, says that companies are targeting what their local customers want, and local high-income customers are willing to pay more for high-quality goods.
Dingel finds that while both theories are valid, strong local demand from rich customers is particularly important—especially when it’s supplemented, through trade, by demand from high-income consumers in other markets. “A firm’s demand curve will include both people who live in the same city and people who live in other locations—nearby cities and countries, to the extent that countries don’t erect trade barriers,” says Dingel.
Using US manufacturing data, Dingel compared regions with disparate income levels such as New York City and Wichita, Kansas. There are differences in the experience and education levels of workers in these two cities, but that alone doesn’t explain entirely why goods such as tables made in higher-income New York, say, tend to be higher quality and higher priced than tables made in Wichita. Neither do other factors, such as the cost of doing business in high-income areas and the age of companies that may have evolved into luxury makers when faced with competition from cheaper imports. Rather, the data point to New York’s proximity to other high-income cities on the east coast creating a larger local market for high-quality products, Dingel says.
Ultimately, local policy can do only so much to shape economic outcomes. A mayor or state legislator may have some ability to affect which industries set up within a jurisdiction, but “economic outcomes are determined by an interlinked system of geography,” Dingel says. Even if government policy changed to restrict foreign competition, and even if US manufacturing output increased, “poor cities would be unlikely to be manufacturing high-quality goods—those are likely to be produced in higher-income cities.”