The End of the American Dream? Inequality and Segregation in US Cities

Abstract

Over the last 40 years, the US has experienced a large increase in inequality. At the same time there has been a substantial increase in residential segregation by income and education. What is the link between inequality and residential and educational choice? We first document a strong correlation between inequality and residential segregation at the MSA level, especially in MSA with higher percentage of families with children. Then we develop a general equilibrium overlapping generations model where parents choose the neighborhood where they live with their children. The key ingredient of the model is that there is a spillover effect: children's future wage is expected to be higher if they live in richer neighborhoods. We model such a spillover effect as a black box that can be explained by different quality of public schools, peer effect, learning from neighbors' experience and so forth. This generates a general equilibrium effect through which the residential choice amplifies future inequality: the higher is inequality, the higher is residential segregation which, due to the spillover effect, generates higher inequality. Is this the end of the American dream? We then calibrate the model, using the elasticities found in Chetty and Hendren (2016) and quantify how much residential segregation has contributed to increase inequality. (We attach slides of a preliminary version of the paper, as the current version is still on progress).