Place-Based Policies: Lessons from Theory

We revisit the rationale for place-based policies using a canonical urban framework with agglomeration spillovers. We derive six main lessons. First, the spatial allocation is inefficient even when spillover elasticities are constant across regions. Second, under constant and positive spillover elasticities, the optimal policy is a national wage subsidy funded by a lump sum tax, reallocating activity towards higher wage locations. Third, more generally, a region’s optimal labor subsidy rate equals its spillover elasticity. Fourth, place-based policies that favor low-wage locations on efficiency grounds are justified when density has negative spillover effects, spillover elasticities are higher in low-wage locations, or across-skill spillovers favor more mixing in low-wage locations. Fifth, government spending on infrastructure, investment incentives, or housing policies cannot fully correct externalities from labor density. Sixth, housing supply elasticities do not affect the design of first-best place-based policies targeting agglomeration spillovers.