Neighborhood Dynamics and the Distribution of Opportunity

This paper uses an overlapping-generations dynamic general equilibrium model of residential sorting and intergenerational human capital accumulation to investigate the effects of neighborhood externalities. In the model, households choose where to live and how much to invest toward the production of their child's human capital. The return on parents' investment is determined in part by the child's ability and in part by an externality from the average human capital in their neighborhood. We use the model to test a prominent hypothesis about the concentration of poverty within racially-segregated neighborhoods (Wilson 1987). We first impose segregation on a model with two neighborhoods and match the model steady state to income and housing data from Chicago in 1960. Next, we lift the restriction on moving and compute the new steady state and corresponding transition path. The transition implied by the model qualitatively supports Wilson’s hypothesis: high-income residents of the low average human capital neighborhood move out, reducing the returns to investment in their old neighborhood. Sorting decreases citywide human capital and produces congestion in the high-income neighborhood, increasing the average cost of housing. On net, average welfare decreases by 3.0 percent of presorting steady state consumption, and 0.01 percent of households starting in the low-income neighborhood receive positive welfare.