EXOGENOUS SHOCKS AND THE DYNAMICS OF CITY GROWTH: EVIDENCE FROM NEW YORK

Economic Policy Review - Federal Reserve Bank of New York, Dec 2005 by Haughwout, Andrew F, Rabin, Bess

1. INTRODUCTION

The response of cities and regions to shocks plays a central role in our understanding of the spatial organization of firms and households, which has been shown to have important implications for economic outcomes ranging from air pollution to productivity growth. Yet because exogenous, unanticipated shocks are rarely observed, efforts to identify their effects are often hampered.

This paper empirically examines the spatial and temporal responses of the New York City economy to a large, but spatially concentrated, exogenous shock to its capital stock: the terrorist attacks of September 11, 2001. Our focus on the city's response allows us to draw inferences about how city economies work, rather than to explore the effects of terrorism on New York or other cities. We utilize data before and after 9/11 to study the response because we believe that the size, location, and timing of the shock were unanticipated, and because the shock was large enough to create substantial dislocations in the city's economy. While the actual financial losses produced by the attacks were not large relative to the size of the city's economy, a major element of the shock was the perception that the city would be in danger of future attacks.

Our analysis reveals that New York City's economy was surprisingly resilient to the 9/11 attacks and the damage they caused, but the shock was associated with significant changes, particularly in the spatial distribution of activities. Furthermore, the particular character of the city's economy and the shock it sustained played an important role in the pattern of the city's recovery. We argue that several explanations could account for this economic resilience. One is that based on previous events, private actors had already reacted to the threat of terrorism, and that the events of 9/11 were, in a meaningful sense, anticipated. A second possibility is that a repeat of the 9/11 attacks was regarded as very unlikely. A third possibility is that the destruction of the World Trade Center, while unanticipated, came amid a disequilibrium in the city's real estate markets and, by chance, happened to reinforce preexisting trends. Finally, it is possible that public pronouncements, regulation, and planning played a substantial role in the economic recovery. Perhaps most surprising is this fourth possible conclusion-that government could have a positive effect in such a setting. Yet recent work on New York City's real estate markets concludes that regulation plays an important role in economic development more generally (Glaeser, Gyourko, and Saks 2004). Such signals are perhaps particularly effective when an economy is out of equilibrium, as New York City's may have been in early 2001.

2. THE EFFECT OF 9/11 ON NEW YORK CITY'S ECONOMY

In the late 1990s, New York City was experiencing extraordinarily strong growth for such a mature economy. Between 1996 and 2000, private sector employment in the city grew at a 2.6 percent annual rate, the strongest four-year run in more than four decades. In each of those years, the rate of city job growth exceeded that of the nation. Private sector wage and salary growth also exceeded the national average over this period, rising 7 percent per year in real terms (Bram 2003). This economic strength was reflected in broader measures of activity as well. In January 2000, the New York City index of coincident economic indicators (CEI), a measure of the shortrun dynamics of economic activity, reached its highest level since the series began in 1965. ' City housing values were also at very high levels in both absolute terms and relative to the nation (Bram, Haughwout, and Orr 2002). Real revenues from the city's four largest taxes reached an all-time high, despite rate reductions, in fiscal year 2000-01 (Edgerton, Haughwout, and Rosen 2004).

In the subsequent two years, the city experienced a sharp economic downturn. Private sector jobs reversed their strong growth and, for the 2001-03 period, fell at a 2.1 percent annual rate. By November 2003, the CEI had retreated nearly 10 percent from its peak value. Revenues from the city's four major taxes declined sharply in real terms during fiscal year 2002. and they had yet to recover their 1999 level by fiscal year 2003.

The sources of this reversal in the city's fortunes are not controversial: the 9/11 attacks on the World Trade Center, the decline in the stock market, and the national recession all clearly played important roles in the slowing of aggregate city economic activity.

2.1 Isolating the City-Specific Component of the Shock

The destruction of the World Trade Center had several potential effects on the economy of New York. First, and most horrific, the attacks took nearly 2,800 lives. In economic terms, this means that the human capital stock for the entire metropolitan region was reduced, at least in the short run. Despite the tragic consequences for the individuals and their families, the direct impact on the supply of human capital in New York City-an open economy with more than 3.5 million jobs and 8 million residents-was small.