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The Review of Economic Studies Ltd.

Social Interactions, Local Spillovers and Unemployment


Author(s): Giorgio Topa
Source: The Review of Economic Studies, Vol. 68, No. 2 (Apr., 2001), pp. 261-295
Published by: The Review of Economic Studies Ltd.
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Review of Economic Studies (2001) 68, 261-295 0034-6527/01/00120261$02.00
? 2001 The Review of Economic Studies Limited

Social Interactions,Local
Spillovers and Unemployment
GIORGIO TOPA
New York University

First version received May 1997;final version accepted July 2000 (Eds.)

I analyse a model that explicitly incorporates local interactions and allows agents to
exchange information about job openings within their social networks. Agents are more likely to
be employed if their social contacts are also employed. The model generates a stationary distri-
bution of unemployment that exhibits positive spatial correlations. I estimate the model via an
indirect inference procedure, using Census Tract data for Chicago. I find a significantly positive
amount of social interactions across neighbouring tracts. The local spillovers are stronger for areas
with less educated workers and higher fractions of minorities. Furthermore, they are shaped by
ethnic dividing lines and neighbourhood boundaries.

1. INTRODUCTION
Over the past decade economists have increasingly recognized the importance of non-
market interactions in a variety of contexts, such as joblessness, crime and other social
pathologies, peer influences in education, social learning and the diffusion of innovations,
localization choices by households and firms, growth and income inequality. One common
feature in these studies is the assumption that agents' choices and payoffs are affected by
other agents' actions not just indirectly through markets, but also directly through imi-
tation, learning, social pressure, information sharing, or other non-market externalities.
It is also assumed that agents interact locally, with a set of neighbours defined by an
economic or social distance metric.
Benabou (1993, 1996) and Durlauf (1996a, b) incorporate local interactions in the
human capital accumulation process into endogenous growth models that exhibit neigh-
bourhood stratification and persistent and widening income inequality. In the field of
economic geography, Audretsch and Feldman (1996) and Rauch (1993) argue that local
knowledge spillovers produce agglomeration economies and hence affect the location
decisions by firms. There exists also a rich theoretical literature that stresses the role
of interactions in models of herds and information cascades (see Banerjee (1992) and
Bikhchandani et al. (1992)), or in models of social learning (Bala and Goyal (1998), Gale
and Rosenthal (1999), Morris (1997)).
On the empirical side, a vast and growing literature has attempted to provide a stat-
istical estimate of the magnitude of local interactions and neighbourhood effects.1 Glaeser
et al. (1996) explain the very high variance of crime rates across U.S. cities through a
model in which agents' propensity to engage in crime is influenced by neighbours' choices:
in so doing, they provide estimates for the range of social interactions. Case and Katz
(1991) explore the impact of neighbourhood effects on several behavioural outcomes, such

1. Jencks and Mayer (1990), loannides and Datcher (1999) and Brock and Durlauf (1999) give excellent
surveys of the empirical literature.
261
262 REVIEW OF ECONOMIC STUDIES

as criminal activity, drug and alcohol use, childbearing out of wedlock, schooling, church
attendance. Ludwig et al. (1999) use the Moving To Opportunity programme as a natural
experiment to evaluate the magnitude of neighbourhood effects. Bertrand et al. (1999) find
that local social networks have a significant impact on individual welfare participation. In
studies concerning education, there is a long tradition starting with the Coleman report
(Coleman et al. (1966)) of studying possible peer influences on educational outcomes:
Hanushek et al. (2000) use very detailed data on Texan schools to estimate peer effects in
student achievement, whereas Zax and Rees (1999) use a Wisconsin Longitudinal Study
to estimate the impact of peer influences during school years on subsequent earnings.
Sociologists have also argued, long before economists, that "one's neighbours mat-
ter" in defining one's opportunities and constraints (see Burt (1992)). Individuals are not
considered as isolated entities but rather as being part of networks of friends, relatives,
neighbours, colleagues, that jointly provide cultural norms, economic opportunities, infor-
mation flows, social sanctions and so on. Wilson (1987) argues that adults in a community
influence young people by providing role models in terms of the value of education, steady
employment and stable families. Coleman (1988) considers social networks as a source of
"social capital" since they provide valuable information, lower transaction costs, allow
monitoring and enforcement of socially optimal outcomes.
The main objective of this paper is to formulate and estimate a model of local interac-
tions in the labour market. In particular, I assume that agents exchange information with
their social contacts about job opportunities and that hiring may occur through informal
channels. The model generates a stationary spatial distribution of unemployment that can
be compared to the empirical unemployment distribution over a set of contiguous
locations in order to estimate the model parameters. I can then test for the existence of
local information spillovers and provide an empirical measure of their magnitude. The
main innovation with respect to the existing empirical literature is to provide a more
structural approach to the estimation of local interaction effects.
The importance of informal channels in finding jobs has been documented, among
others, by Corcoran, Datcher and Duncan (1980) and Granovetter (1995). Both studies
report that more than 50% of all new jobs are found through friends, relatives, neighbours
or occupational contacts rather than through formal means. This is especially true for low-
skill jobs, for less educated workers and for black workers. From a theoretical standpoint,
informal hiring channels may coexist in equilibrium with a formal labour market because
of information asymmetries: Montgomery (1991) analyses a model in which employers
cannot perfectly observe the quality of prospective employees and solve the adverse selec-
tion problem by relying on referrals from their high-ability workers. The basic assumption
is that there exists assortative matching in agents' social networks, so that high-ability
workers are more likely to refer individuals like themselves.
In my model, agents reside in locations that are linked through an explicit network
structure. Each agent, while employed, can transmit information about job openings to
her unemployed contacts; the same agent, while unemployed, can receive useful tips about
jobs from her employed contacts. Risk-averse individuals find it in their best interest to
engage in such information exchanges in order to (partially) insure themselves against
possible future unemployment shocks. These mutual insurance arrangements can be
sustained even in a limited commitment environment.
Unemployment in the model evolves according to a Markov process over the set of
locations. At any point in time, employed individuals may become unemployed with some
exogenous probability, whereas unemployed individuals may find a job with probability
TOPA SOCIAL INTERACTIONS 263

increasingin the number of neighbours currentlyemployed. This process generates


positivespatialcovariancesof unemploymentbetweennearbylocations.
I use data on the spatial distributionof unemploymentin Chicago to estimatethe
structuralparametersof the model. One of the most strikingfeaturesof unemployment
in Chicago in recentyears is its geographicconcentrationin a few areas, mainly in the
South and the West Side: both in 1980 and in 1990, Census tracts with high levels of
unemploymenttendedto be clusteredtogetherin geographicallycontiguousareas,rather
than being spread around in a random fashion (see Figures 1 and 2). The change in
unemploymentratesbetween1980and 1990was also spatiallycorrelated(Figure3). This
geographic"lumping"is consistentwith the presenceof local interactionsand information
spillovers.

- 5-1-7-9 fK-1

rate,1980
Unemployment
0-5:::1_n ]:.:: :'.''1.e:1|9: 2 0 2 4 Miles

7.9-12.1
-12.1-17-7
-17-7-66.7
FIGURE 1
Map of unemployment rate, 1980
264 REVIEW OF ECONOMICSTUDIES

Unemploymentrate 1990
0=5iio-56 2 0 2 4 Miles
-56-9
9 -9
13-9-23-4
23-4-100

FIGURE 2

Map of unemploymentrate, 1990

The unit of observationin the structuralmodel is a Census tract, and the basic
assumptionof the model is that residentsof one tract exchangeinformationlocally with
residentsof the adjacenttracts.This local interactionimpliesthat the employmentrate in
one tract is affectedpositivelyby the employmentrate in the neighbouringtracts. The
transitionsinto and out of unemploymentalso dependon a set of observabletractcharac-
teristics.Allowing for tract heterogeneityis imnportant in order to addressthe issue of
positive sorting of individualsacross locations. In fact, agents may sort into different
neighbourhoodson the basis of their neighbours'characteristicsor because they have
similar preferencesover differentconsumptionbundles (see, for example, Becker and
Murphy(1994)).
Such sorting may induce positive spatial correlationof unemploymenteven in the
absence of any local informationspillovers.I try to distinguishthe social interaction
TOPA SOCIAL INTERACTIONS 265

....,...i.~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~.
...

rate,90-SO
Unemnployment
[I]-66*7--19 2 0 2 4 Miles
-1 9-0.6
0 6-3.2
3.2-7.8
7.8-72.9

FIGURE 3
Map of unemploymentrate, 1990-80

channelfrom other possibleinter-tractinfluencesby using additionalinformationon the


specificdimensionsalong which agents'social networksare constructed,and on the geo-
graphicboundariesof local communitiesidentifiedby residents.For example,since there
exists a strong degreeof ethnic homogeneityin social networks,one would expect social
interactionsto be weakerbetweentractsthat have very differentethniccompositions.
I estimatethe model via the indirectinferencemethodologyof Gourieroux,Monfort
and Renault(1993),sinceit is not possibleto characterizeanalyticallythe invariantdistri-
bution of the contact process describedabove. The structuralparametersare estimated
indirectly,by minimnizing the distance between the actual data and simulationsof the
structuralmodel for differentparametervalues.In particular,one uses the parametersof
an auxiliarystatisticalmodel (more readilyestimnablethan the structuralone) to definea
266 REVIEW OF ECONOMIC STUDIES

chi-square criterion for the indirect estimation.2 In the auxiliary estimation, I also control
for unobserved tract-specific fixed effects that do not vary over time.
The empirical results support the model with built-in local interactions and reject the
hypothesis that the observed spatial patterns in unemployment can be explained by
observed tract characteristics alone. The estimated local spillovers are significantly posi-
tive: on average, an increase in the employment rate of neighbouring tracts by one stan-
dard deviation brings about an increase in expected employment of 0-6 and 1 3 percentage
points in 1980 and 1990, respectively.3 Interestingly, spillovers are stronger in tracts with
lower education levels and with higher fractions of non-whites. This is consistent with
other direct evidence on informal hiring.4
Furthermore, the local interaction channel is found to be weaker across adjacent
tracts that have very different ethnic compositions, as well as across local community
boundaries that have been identified by residents. This result lends support to the hypoth-
esis that the observed spatial patterns in unemployment are indeed generated by social
interactions as opposed to other possible inter-tract linkages. Finally, an important caveat
is represented by the finding that the introduction of spatially correlated shocks, to mimic
the possible presence of correlated unobservables, greatly reduces the size of the infor-
mation spillover. However, the model with correlated shocks does not fit the data as well
as the baseline model.
The theoretical and empirical framework developed in this paper may be applied
more generally, to any of the settings described above in which local interaction effects
may be present. The wider goal of this paper then is to provide some tools to test for the
existence of interaction effects, to estimate their magnitude, and to simulate the effects of
proposed policy experiments in their presence.
The remainder of the paper is organized as follows. Section 2 presents the structural
model and its general properties. Section 3 describes the indirect inference methodology
and the auxiliary model, and discusses important identification issues. The data used in
the estimation and the simulations are described in Section 4. Section 5 reports the empiri-
cal results of the indirect inference estimation of the structural model, and provides some
numerical estimates of the magnitude of the spillover effects. Section 6 concludes.

2. THE STRUCTURAL MODEL


The starting point of the analysis is the idea that agents are embedded in social networks:
in particular, they can exchange information about job opportunities with their social
contacts, who are more likely to transmit useful information if they themselves are
employed. Thus the probability of finding a job is greater, the higher the employment rate
in one's social network.
The information exchange activity among agents can be seen as the result of an
efficient insurance arrangement with limited commitment. Each agent has an incentive to
transmit job information to her contacts when she is employed, in the expectation that
they will reciprocate when bad times hit. With risk averse agents, such implicit contracts
are sustainable even in the absence of formal enforcement mechanisms by means of direct
penalties (e.g. social stigma) or the threat of exclusion from the insurance arrangement if
a violation occurs (such contracts have been analysed by Thomas and Worrall (1988) in

2. A very good introductionto indirectinferencemethodscan be found in Tauchen(1996).


3. See Table4. A one standarddeviationchangein the employmentratecorrespondsto 8 and 12 percent-
age pointsin 1980and 1990,respectively.
4. See Granovetter(1995),Jencksand Mayer(1990),and Corcoran,Datcherand Duncan(1980).
TOPA SOCIAL INTERACTIONS 267

the context of long-term wage contracts, and by Ligon, Thomas and Worrall (1999) in
the context of informal credit in developing economies).
The specific way in which I model the information interaction is through a discrete-
time Markov process on a set of locations, that is similar to a contact process (this was
first studied by Harris (1974) in the context of interacting particle systems). In the first
part of this section I present the model and describe its basic properties. The individual
units in this setup are Census tracts, since the empirical analysis will be conducted at this
level of aggregation. In the second part, I discuss the use of physical distance to determine
who is "close" to whom, and I present some evidence that justifies carrying out the analy-
sis at the tract level. In addition, I discuss possible micro-foundations of the model at the
level of individual agents, and show that this disaggregated framework is observationally
similar to the former one.

2.1. A model of inter-tract local interactions


The building blocs of the model are a set of locations, a state variable and a set of
neighbours for each location, and conditional transition probabilities for the state of each
location that depend on the state of the neighbours in the previous period.
Let S be a finite set of locations. A location in this framework is taken to represent
a Census tract. Each location i is indexed by a vector of characteristics Xi that are constant
over time. These characteristics may affect the probability of gaining or losing jobs in
each location. Time flows discretely from 0 to oo in the model. The state of each tract
every period, Yit, is the employment rate within each area. For computational reasons,
the state variable can only take a finite number of values in the interval [0, 1]. In particular,
yitE-E {el, . ., eKl, where e1 = 0, eK= 1, and ek-ekJ, = 0 1, k = 1, ..., K. Therefore, the
state of the system at any point in time is a configuration of employment rates YtE
<t/=Es.
91_Es
An "adjacent tract" distance metric is defined over the set of locations: tracts i and
j are defined to be at distance 1 if they share an edge on the physical map of the city;
tracts i and k are at distance 2 if k is adjacent to a tract that is at distance 1 from i, and
so on. In general, the distance d between any two tracts i and j is defined as the number
of tract boundaries that one needs to cross to travel from a point inside tract i to a point
inside tractj.5
Using this metric, a finite set of neighbours Ni is defined for each location i, as the
set of tracts located at distance 1 from i.6 Therefore, I assume here that residents of one
tract interact only with residents of the areas physically nearest to them. This definition
could be easily modified to include all neighbours at distance up to d from i, for some
d> 1.
The evolution of the system is governed by the following conditional transition prob-
abilities, that spell out how the state of any one site may change in the next period, given
the present configuration. If tract i is at full employment (i.e. yit = 1), then it may drop to
the next lower employment rate with a probability that depends on its own characteristics

Pd Pr (yi,t+1 = ? 91yit= 1; Xi) = y(Xi), ()

5. In the case of sitesarrangedon a two-dimensionalintegerlatticeand indexedby a pairof integers(i,j),


this is equivalentto defininga distancemetricd s.t. I(il,Il) - (i2,j2)1 |il -1 i2 + |IIl -j2-
6. On average,a Chicagotracthas 4 2 adjacentneighbours.Typically,tractsareroughlyrectangularareas
with four neighbours,one for each edge.
268 REVIEW OF ECONOMIC STUDIES

and will stay at the present state with probability (1 -Pd). On the other hand, the prob-
ability of going from zero employment to the next higher employment rate depends on
the tract's characteristics, but also on the information Iit that residents of tract i may
receive from their employed social contacts in the neighbouring areas

Pu. Pr (yi,t, I = 0 1Yit = 0; yt, Xi) = cx(Xi)+ X(Xi) Iit- (2)


The flow of information received by tract i is in general an increasing function of the
employment rate in the neighbouring tracts

Iit= f(YNt), P- 0)> (3

where yN 1/N Yit.7 Again, tract i may stay at a zero employment rate next period
with probability (1 -Pu). In the estimation that follows f() is simply the identity function,
so the information variable Iit is equal to the average employment rate of the neighbours
yN. As for the functions A(-), a(-), and y( ), they are assumed to be linear in their
arguments: e.g. 2(X) .X0+ = l iXl.
Finally, if the state of tract i at time t is in the interior of the unit interval, then it
switches to either an upward mode or a downward mode with probability 0.5, and in each
case the same transition probability as in equations (1) or (2) applies. Therefore, we can
write:

Pr (yi,t+ 1 = ek-llYit = ek; Xi) = 2 (4)


Pr Yi,t+1=ek+lJYit=ek;Yt,Xi)= (5)
Again, the state of tract i may remain unchanged during the next period with probability
[12(Pd +PU)]-
The transition probabilities (2) and (5) capture the information exchange process.
The employment rate in any one tract may rise through two separate channels: one is a
function of tract characteristics that may reflect labour supply or demand conditions in
the area, and is independent of any interaction. The second factor is the information
about job opportunities received by tract residents from social contacts in the neighbour-
ing tracts. The term X(.) captures the "contagion" effect as in the standard contact pro-
cess. It is worth noting that the strength of the information exchange channel may also be
affected by the tract residents' characteristics. This allows me to estimate local spillovers in
unemployment for different "types" of tracts, in terms for example of the education levels
of its residents or its race composition. Finally, the information exchange process is
assumed to affect the probability of an increase in employment, but not the probability
of a drop in employment in the tract (equations (1) and (4)). In other words, I assume
that information interactions may affect employment opportunities, but do not play a
role in the transitions out of employment.
Allowing for tract heterogeneity with respect to certain observable characteristics is
important in order to be able to discuss the implications of positive sorting across
locations. Agents may sort into different areas on the basis of some characteristics, which
may also be related to employment outcomes. Therefore, one could observe positive spa-
tial correlations of unemployment that are not related to any information spillovers but
are simply due to the spatial correlation patterns of the covariates along which people

7. With a slight abuse of notation, I use Ni to indicate both the set of neighbours of tract i, and the
number of elements in this set.
TOPA SOCIAL INTERACTIONS 269

sort.8 The absence of a time subscript on the X covariates amounts to assuming that the
process through which agents lose and find jobs takes place at a higher frequency than
the process that rules individuals' locational choices and hence the spatial distribution of
these characteristics across tracts.
One final note concerns the nature of the random shocks that are used to simulate
the model. The system is started off at some initial configuration yoe X< Every period, a
vector (o, of shocks is drawn from a uniform distribution on [0, 1]. Then the state of each
location in the model is updated according to the realization of the shock wi, using the
transition probabilities detailed above.9 These exogenous shocks to employment can be
i.i.d. in space over the map of the city, or they can be generated according to some
autocorrelation structure. The latter option is exploited in the estimation to allow for the
possibility of correlated unobservables driving the spatial correlation patterns observed in
the data.

2.1.1. Model properties. In Section 3 the structural model is estimated by comparing


simulated realizations of the cross-sectional distribution of unemployment, drawn by the
stationary distribution of the model, with the empirical cross-sectional distribution of
unemployment at a given point in time. Therefore, I focus on the cross-sectional properties
of the stationary distribution rather than on the dynamic properties of the model.
The model described above generates a first-order Markov process on the map of
locations. The state space 3"contains all possible configurations of employment rates over
the set of locations. Since 3" is finite, I can index each state by w = 1, . . ., W where W is
the total number of possible states for the whole system. Let X be the set of all probability
measures on 3". Then a probability measure A e Y on v is simply a finite vector of
probabilities Aw, w = 1,..., W. In particular, the evolution of the system is governed by
the following rule

At+ = Q It,
where Q is the (Wx W) transition matrix, whose entries qrs denote the transition prob-
abilities from state r to state s. These transition probabilities can in principle be calculated
from the conditional transition probabilities (1)-(5). A stationary distributionof the pro-
cess is a vector v such that v = Q v. It is straightforward to show that a unique stationary
distribution v(X) exists, for any given choice of tract characteristics X.'0
It is very difficult to prove analytical results on the properties of the stationary distri-
bution. However, if one considers the case where locations are homogeneous in terms of
their characteristics, the structural model is very similar to a discrete time contact process
defined over a finite integer lattice. The behaviour of the contact process has been exten-
sively studied in the literature on interacting particle systems." Two results are particu-
larly interesting from my perspective. According to the first, the states of any two sites on

8. One good exampleis education.Highlyeducatedpeoplemay locate in an areabecausethey enjoythe


companyof other educatedpeople, or becausethey attach great importanceto school qualityso they move
to tractswith good schools. On the other hand, agents'educationlevels positivelyaffect their employment
opportunities.
9. For example,supposeYit= 1. The shock Oi is drawnfrom a U[O,1].If oit <Pd, thenYi,t+1 = 0 9; other-
wise,Yi,t+I = 1.
are fixed,the transitionprobabilitiesare givenand definea Markovchain
10. Sincethe X characteristics
withtransitionmatrixQ overthe finitestate-space3".Thischainis irreducibleand aperiodic,so standardresults
on Markovchainsimplythat a stationarydistributionexistsand is unique.
11. Liggett(1985)gives an excellenttreatmentof this and otherinteractingparticleprocesses.
270 REVIEW OF ECONOMIC STUDIES

the map exhibit non-negative spatial correlations. The second result states that this corre-
lation is bounded above by a quantity that decays exponentially with the distance between
locations.
Simulations of the structural model show that indeed as one lets the system evolve
for several periods, high or low employment clusters appear on the map of locations. If
tracts are homogeneous, these clusters are equally likely to take place anywhere on the
map. Tract heterogeneity implies that low-employment clusters are more likely to occur
in certain areas of the map, since tract characteristics affect the transition probabilities
between different employment levels.
In my simulation and estimation exercise I take as given the spatial distribution of the
X covariates (determined by the sorting process), and I run the local interaction process
conditional on that, until it converges to the stationary distribution. The structural param-
eters of the y ( ), a(Q), and X(.) functions are estimated off the stationary distribution.
The case in which all the spatial correlation is driven by sorting rather than by local
interactions corresponds to the case where )L(*) is identically zero for all values of the X
characteristics, so the model delivers a very straightforward way to distinguish the two
effects.

2.2. Census tracts, physical distance and aggregation


In the structural model, the set of neighbours for each site is defined by physical distance,
in that the neighbours of tract i are the tracts immediately adjacent to it. Ideally, one
would like to have individual data on social networks for a large but well delimited set of
agents, with information on the sequence of social ties that connect each agent to any
other agent in the set. Then one could cast the model in terms of individual agents and
define neighbours as the set of alters to whom each agent is directly connected. Such a
model would predict the emergence of unemployment clusters in the abstract space gener-
ated by the map of social ties between agents, which could then be matched to the data.
In the absence of such direct data on networks, one has to rely on economic and
sociological considerations to make assumptions about the likely dimensions along which
social networks are constructed. In general, one can think of several distance metrics as
potentially good candidates to trace out the spatial structure of social networks.12 I want
to argue that physical distance is an important determinant of the way networks are
constructed.
The underlying idea is that establishing and maintaining social ties is costly, and
these interaction costs increase with physical distance. For example, transportation costs
have both a monetary and a time component that make it harder to maintain active
contacts with persons living far away or simply reduce the frequency of exchanges with
such persons. In addition, local institutions (such as neighbourhood clubs or associations,
churches, PTAs in local schools, local businesses) play an important role in fostering local
social ties and facilitating information exchanges at the local neighbourhood level.
There has been considerable debate in the sociological literature on whether the notion
of a local community has lost its meaning in an era of increasing mobility and an expanding
array of communication devices. However, there is evidence that an important fraction of
social contacts takes place at the local level. In a study of Toronto residents in the 1980's,
Wellman (1996) finds that about 38% of yearly active contacts in all networks takes place

12. Conley and Topa (2000) define four different metrics, physical distance, travel time, ethnic, and occu-
pational distance, and examine the spatial patterns of unemployment with respect to each metric.
TOPA SOCIAL INTERACTIONS 271

between pairs of agents who live less than 1 mile apart; this percentage rises to 64% for
contacts between agents less than 5 miles apart. In a Detroit study that used a 1975 survey
of about 1,200 residents, Connerly (1985) states that 41% of respondents had at least one
third of their Detroit friends residing within one mile. More relevant to this paper, Hunter
(1974) reports that out of roughly 800 Chicago residents interviewed during 1967-68,
about 49% said that the majority of their friends resided in the same local community.
Therefore, identifying social contacts with agents who live physically nearby seems like a
reasonable approximation for one of the dimensions of social networks.
A second question concerns the appropriate scale of analysis. Perhaps the most
relevant social interactions occur within Census tracts, thus making the assumption that
residents of one tract exchange information with residents of neighbouring tracts not very
meaningful. However, in the city of Chicago, Census tracts represent fairly small units of
analysis. Pairwise distances between adjacent tract centroids are less than one mile for all
but a handful of tracts. Typically, tracts contain five or six street blocks. The average
population (16 years and older) in a Chicago Census tract was 2700 in 1980 and 2500 in
1990.
More importantly, Census tracts are a sub-division of larger units called Community
Areas. There are 75 such areas in Chicago, and each area contains on average 12 tracts.
These areas, such as Hyde Park, Woodlawn, Lincoln Park, Englewood, have names that
Chicago residents readily associate with neighbourhoods. In fact, Community Area
boundaries were drawn in the 1920's by a group of Chicago sociologists, such as Ernest
Burgess and Robert Park, to represent communities with a distinctive identity. The main
criteria used to establish these Areas were: "(1) the settlement, growth, and history of the
area; (2) local identification with the area; (3) the local trade area; (4) distribution of
membership of local institutions; and (5) natural and artificial barriers" such as rivers,
railroad lines, large roads, parks.'3
Even though neighbourhood boundaries change over time, these Community Areas
still represent, in many cases, meaningful and cohesive neighbourhoods. Hunter (1974),
in his survey of Chicago residents, asked respondents to name the boundaries of their
neighbourhoods. He identified roughly 200 neighbourhoods, which in all cases represent
units larger than Census tracts. In many cases, the boundaries of these neighbourhoods
coincide with the original Community Area boundaries.'4 Therefore, it makes sense to
assume that there exist meaningful inter-tract social interactions, and to take Census tracts
as the unit of analysis.
Finally, I would like to focus on the issue of aggregation. The structural model could
be set up at the individual level, where sites represent individual agents, and the set of
neighbours is defined as the set of contacts within a neighbourhood of radius r. The
transition probabilities would then be defined at the single agent's level, determining the
transitions into and out of work. Then the model could be aggregated to the tract level
for estimation purposes.
It is hard to come up with an individual level model that, when aggregated, generates
transition rules as in (1)-(5). However, one can compare the behaviour of such a model,
in terms of its spatial properties, with the structural model presented here. Conley and

13. From the Local CommunityFact Book, Erbeet al. (1984).A certaingeographicarea was considered
a CommunityArea if it had "a historyof its own as a community,a name, an awarenesson the part of its
inhabitantsof common interests,and a set of local businessesand organizationsoriented to the local
community".
14. In the estimationthat follows,I exploittheseboundariesto try to distinguishspilloversdue to social
interactionsfrom otherpossiblesourcesof spatialcorrelation.
272 REVIEW OF ECONOMIC STUDIES

Topa (2001) analyse a model in which artificial agents are placed at the centroid of each
tract, and interact both with agents in their same tract, and with agents in tracts whose
centroids are less than one mile away, on the physical map.15 The transition probabilities
are defined at the agent's level, and are very similar to the ones described here. The
contagion term At() is a declining function of physical distance, so the interaction is
stronger between residents of the same tract than between residents of two separate tracts.
The spatial properties of these two alternative models can be compared by looking
at the Auto-Correlation Functions (ACFs) and the spectral densities generated by the
spatial distribution of employment in model simulations, following a procedure described

0-3 , - l
Tractlevel
- - - Individual level
0-25

0-2 -

0-15

0-1

0-05-

-005
0 2 4 6 8 10 12
Physical distance (adjacenttracts)

FIGURE 4
ACF comparison: tract level vs. individual level model

in Section 3.2. Figures 4 and 5 show that one can find parameter values such that the
ACFs and the spectral densities are quite similar in the two models, thus implying that
the models can be made to deliver similar spatial correlation patterns.16 Therefore, I con-
sider the structural model presented in this section as a viable approximation to a more
disaggregated model in which local interactions are defined at the level of individual
agents.

3. ESTIMATION STRATEGY
The objective of the estimation strategy is to estimate the structural parameters of the
model presented in Section 2.1, in order to test for the existence of spillovers generated

15. The numberof agentsin each tractis proportionalto the actualpopulationin Chicagoin 1980.One
artificialagentcorrespondsto about 20 peoplein real life.
16. However,the parameterestimatesand the spillovermagnitudesmay be differentin the two setups.
Conleyand Topa (2001)examinethis issue in more detail.
TOPA SOCIAL INTERACTIONS 273

0-35 , , I, , ,
Tractlevel
- - - Individuallevel

0-3-

-
t 025

-
d02

0-15 /

(015 ' / ' X * N<aI ,

-4 -3 -2 -1 0 1 2 3 4
Frequency

FIGURE 5
Spectrum comparison: tract level vs. individual level model

by the local interaction process. The cross-sectional data used in the estimation are
assumed to be a realization of the unique stationary distribution of the model. I focus on
the stationary distribution in order to be able to disregard the potential impact of different
initial conditions on the spatial moments used in the estimation.
In principle, one can write the likelihood function for the stationary distribution of
the model starting from the set of conditional probabilities of the state at one location,
given the contemporaneousstate at neighbouring locations (the key result here is the fac-
torization theorem discussed in Cressie (1993, p. 412)). However, it is extremely hard to
write the likelihood in this case, because the construction involves pinning down a nor-
malizing constant (itself a function of the model parameters) which is not available in
closed form.
Therefore, following an indirect inference strategy, I look for an auxiliary statistical
model that can fit the unemployment data well, but is much simpler to estimate than the
structural model. Such a model need not necessarily nest the structural model and may in
fact even be misspecified. In particular I look for a statistical model that best approximates
the spatial properties of the stationary distribution out of the local interaction model.
Choosing an auxiliary model is similar to selecting moments in Simulated Method of
Moments to be matched between the data and simulations of the structural model, in
order to deliver estimates of the structural parameters.
The idea behind indirect inference is quite intuitive. Let 0E Oc93P be a vector of p
parameters that fully characterize the structural model.'7 Let 00 denote the true value,
assuming that the structural model is correctly specified. Likewise, let pe AcC91q be the

17. These are the parameters of the y( ), a(-), and 2(-) functions in the conditional transition probabilities
(1)-(5).
274 REVIEW OF ECONOMICSTUDIES

vector of q parameters of the auxiliary model, with q' p. First, one estimates the auxiliary
model using the actual data. These parameter estimates p depend on the true value 00.
Then one simulates the structural model for different values of 0 in the parameter space
0. For each choice of 0, one can estimate the auxiliary model using the outcome of the
simulations (in this case, a simulated unemployment realization over the map of the city).
This estimation yields parameter estimates P(0) that depend on the specific value of 0
used for that simulation. The parameters of interest 0 are estimated by minimizing the
distance between i(00) and p(O), according to some metric to be specified. In the remain-
der of this section, I first of all present the indirect inference procedure and describe the
auxiliary model; secondly, I discuss identification issues.

3.1. Indirect inference methodology


The data (y,, xn) used in the estimation are cross-sectional data on unemployment and
tract characteristics over the city of Chicago. The outcome variable y, is the (n x 1) vector
of unemployment rates for all tracts i = 1,.. , n. The covariates x, are a (n x M) matrix
of exogenous variables.
The auxiliary model is a statistical approximation to the structural model. Let
Jn(yn xn p) be the GMM criterion used in the auxiliary estimation; when performed on
the actual data, this yields the following parameter estimates
pn = arg min Jny(Yn,
xn, p). (6)
pE-

The auxiliary model is possibly misspecified, since I assume that the structural model is
a,s
the true model. One can show that p, -4 p as n -* oo, where p r(0O). The function
r: e - is defined as follows:
r(0) = arg min Joo(G,0, p). (7)
pEM

where Joo(G,0, p) = lim,OO J(Yn 9Xn Ip), and G is the distribution of the random shocks
that determine the stochastic process of y. The limit criterion Joo(G,0o, p), evaluated at
the true value 00, is assumed to have a unique minimum at p.
Turning now to the simulations, for each value of Oe 0EI draw H simulated realiza-
tions of y out of the stationary distribution of the structural model, PYh(X, 0), h
1,.. , H. I then perform the auxiliary estimation on the simulated outcomes, for each
value of 0 and for given x,: this yields
pn~(0)= arg minJn (Yn 0),xn,p)- (8)
peS

Again, for the simulated estimator of p, one has pn(0)


n 4 r(0), VOe 0; in particular for
the truevalue 0 n,j^(0O) -4 p.
The indirect inference method simply evaluates mn(0) -n- P(0) over the parameter
space e, and picks the value 0* that minimizes this distance mnh(0). The indirect inference
estimator nH is then the solution to the following minimum chi-square problem

on = argmmi[n
L _ H 1h =1 p(o)] -
Qn[Pn HI
Hh= lPI(0) 9
Oee

As is the case for a standard GMM procedure, the optimal weighting matrix Qn in the
quadratic criterion (9) is Q = V-1, where V, is the covariance matrix of the auxiliary
TOPA SOCIAL INTERACTIONS 275

parameters p. The indirect inference estimator is consistent and asymptotically normal. A


standard chi-square specification test for the structural model is also available: the statistic
icKis equal to the minimized value of (9), scaled by a function of H, and is distributed as
a 2(q -p), where q = dim p and p = dim 0.
Finally, Gourieroux, Monfort and Renault (1993) provide a test of hypotheses on
the structural parameters 0. Let 0 be partitioned into 0= [ ] , and consider the null
hypothesis Ho: 01 = 0. Define the constrained indirect estimator OH,o as the estimate that
results from minimizing (9), subject to the constraint 01 = 0. The test statistic Kc is defined
as the difference between the constrained and the unconstrained optimal value of (9), and
is distributed as a x2(dim 01).

3.2. The auxiliary model


Since I am particularly interested in the spatial properties of the stationary distribution
generated by the structural model, I need to consider an auxiliary statistical model that
mimics these spatial characteristics well.'8 An obvious choice is a Spatially Auto-Regress-
ive model (SAR), since theoretical results and simulations on the contact process suggest
that the stationary distribution exhibits positive spatial correlations, decreasing in the
distance between locations. A SAR of order D can be defined as follows

Yi>d= idYi +?i (10)

where the superscript Nd refers to the average level of unemployment in the tracts at
distance d from tract i.19
I use a criterion, based on spectral decompositions, to compare the spatial properties
of a contact process and of a SAR model, and to choose the order of the SAR that best
fits the contact process. Let the contact process be the "true" model, and let the SAR be
an approximating model to the truth. For a given order D of the Spatial Auto-Regression,
I estimate via maximum likelihood the parameters of the SAR that best fit the true
model.20 I can then compare the fit across different possible approximating models (i.e.
SAR models of different orders). The result is that the goodness of fit improves as one
adds higher order terms to the SAR: Figure 6 reports the spectral density of a typical
cross-sectional distribution generated by the contact process and compares it to that of
several SARs. In most cases, a SAR of order 6 or higher fits the spectra generated by a
contact process remarkably well: therefore, I use a SAR(6) as the basis of my auxiliary
model.
The statistical model in (10) needs to incorporate a set of M covariates xi in order to
control for tract characteristics that may both affect the probability of finding and losing
jobs, and be dimensions along which agents sort into locations. The structural model of
Section 2.1 also lets the local interaction term 24() be itself a function of local character-
istics. To capture this feature in the auxiliary model, I add interaction terms between y_1

18. Consistencyof the indirectinferenceestimatordoes not dependon the specificchoiceof the auxiliary
model. However,the closenessof fit betweenthe structuraland the auxiliarymodels affects efficiency:see
Tauchen(1996).
19. This is definedas yNd= Wi(d) y, where Wi(d) is the i-th row of a weightingmatrix W(d) constructed
as follows. Wi(d)givespositiveequalweightsto all tractsthat are at distanced from i. If a tractsharesan edge
with i on the physicalmap, d= 1; if a tract is adjacentto one of these immediateneighboursof i (but is not
adjacentto i), d = 2, and so on. The weightsadd up to unity.
20. See Hansenand Sargent(1993).The detailsof the constructionare availablefrom the authorupon
request.
276 REVIEW OF ECONOMIC STUDIES

CP vs. SAR(1) CP vs. SAR(5)


0.6 0.6

0-4 0.4

0.2 O. D= [~I | 0.2

-4
G
-2 0 2 4
~~~~~~~~~~~0
-4 -2 0 2 4

CP vs. SAR(6) CP vs. SAR(8)


0.6 0.6

0.4 - 0.4

0.2 0.2

-4 -2 0 2 4 -2 0 2 4

FIGURE 6

Spectrum comparison: Contact Process (solid) vs. SARs

and a subset of the covariates. Let xi be a Jx 1 vector of regressors, with J< M. Let
-= [y,..., y6 ] Equation (10) can be rewritten as
yi = (.i) + (xi) ,B+ -i, i= 1... ,n. (1

The following assumptions are made concerning the covariance structure of the error
terms: E(8i) = 0, E(,c2) = ui, E(8cie) = 0, Vi?j.. In other words, I assume no cross-corre-
lation between different units, but I allow for heteroskedasticity. Another observation
concerning the error terms is in order. The data used in the estimation are taken from
two Census years, 1980 and 1990, thus creating a short panel. Therefore, all the variables
in (11) should be indexed by a time subscript. However, the short panel feature allows me
to incorporate an unobserved, time-invariant component into the error term:
Eit= pi + uit. The term rpiattempts to capture features of a specific location (unobservable
to the econometrician), that may attract or turn away agents with certain characteristics
that may be in turn correlated with the ability to find jobs. Insofar as these unobserved
characteristics are really time-invariant over the decade under consideration, I can elimin-
ate them by first-differencing the data. I follow this approach in the estimation, so the
auxiliary model (11) is to be taken in its first-difference specification from now on, unless
otherwise noted.21 Hence, all time subscripts are suppressed.
In equation (11), the yN covariates are correlated with the error term E?, since they
are endogenous. Therefore, I use instruments for these variables: one obvious choice is to
use the exogenous variables in the neighbouring tracts to i. In particular, I use obser-
vations in neighbours up to a distance 3 from tract i: so the instruments are

21. Therefore, y' really denotes Yit- Yit-1; xi denotes xit - xit; and the error term actually denotes the
difference in the time-varying part of the original error term, uit- uit -1 .
TOPA SOCIAL INTERACTIONS 277

Xi[N ... .N3] The complete set of instruments can then be defined as
Zi[ [ N] . These variables are assumed to be uncorrelated with the error terms

E(zjEj)= 0. (12)
Equation (12) provides moment conditions that I can use to estimate the auxiliary model
of equation (11) via a GMM procedure.
The use of IV is not strictly necessary here. The auxiliary model is only a statistical
model that summarizes certain properties of interest of the structural model, and can be
misspecified. Thus, an equally valid procedure would be to estimate (11) via ordinary least
squares. This procedure would yield biased estimates for 4 and ,B,but it would not affect
the consistency of Vn'. However, using IV can be interpreted as adding several spatial
cross-correlations of y and x to the auxiliary model (as it is, the model only includes
autocovariances of y). This is roughly equivalent, in a time-series context, to adding cross-
moments involving leads and lags of y and x.
Finally, I augment the auxiliary model bv a certain number of raw spatial moments
of the unemployment variable. The rationale for doing so is to add flexibility to the
auxiliary model, in order to be better able to detect signs of misspecification of the struc-
tural model. As Tauchen (1996) shows, the X2 test of the over-identifying restrictions is
more likely to fail to detect misspecification if the auxiliary model is not flexible enough.
In addition to the mean and variance, I consider the spatial covariances up to distance
D, since the structural model delivers implications in terms of the spatial distribution of
unemployment: these are the pairwise autocovariances for pairs of tracts at given distance
d, whereas the 4 parameters in the SAR measure the autocovariance between unemploy-
ment in tract i and the average unemployment in the neighbouring tracts. These additional
auxiliary parameters can be estimated together with those of the SAR using the same
GMM framework. Let v, be the vector of moments to be estimated

yr= [A, a 2, C15 ..* CD] 5

where Cd = Cov (yi yY), d= 1, ... , D. Here yd indicates the unemployment rate in tracts
that are at distance d from tract i. So the complete vector of auxiliary parameters is p
[? yr] . I also need to define

Zi - Ei(0, 0)

Yi -
2 _ 2 2

g(4s,p)-YiY'12C (13)

I yD
_2-C

where [Y jiN i2
i ... yf xN . The GMM estimator pn6MM is obtainedvia minim-
ization of a quadratic criterion Jn(p) based on g(41, p), with the standard properties, and
the optimal choice of a weighting matrix is SA?', where S is the covariance matrix of the
limitingdistributionof 1/ S In?= I g(4i5 p).22

22. Conley (1999) providesa robust estimatorfor the covariancematrix S that does not rely on any
specificassumptionson the structureof the error terms, but only uses informationon economic distances
betweenlocations.Use of this robustestimatordoes not leadto significantlydifferentresultsthanmorestandard
estimators. Therefore, in what follows, I use Sn = 1/n n= g(4i, pn) *g(4, pn)
278 REVIEW OF ECONOMIC STUDIES

3.3. Identification
Identification issues are crucial in this empirical exercise. This paper argues that local
spillovers, generated by local social interactions, may explain part of the spatial patterns
of urban unemployment observed in the data. The estimation methodology basically
works by matching empirical spatial moments with simulated moments out of the local
interaction model, to estimate the structural parameters of the model and thus give a
measure of the magnitude, if any, of the local spillovers. However, there may be other
factors that give rise to the same patterns of positive spatial correlation in unemployment,
but may be indistinguishable from the social interaction channel that I focus on.
Formally, this discussion can be cast in terms of Manski (1993)'s analysis of identifi-
cation issues in the context of endogenous social effects, such as peer influences, neigh-
bourhood effects, social interactions, contagion, and the like. Restricting oneself for
simplicity to linear models, one can posit the following population relationship

y=a ?4+E(yIA)+E(xIA)y?+x1 +, (14)

where y is a scalar outcome variable, x and ? are attributes that directly affect the unit's
outcome (observed and unobserved,respectively), and A are attributes that define the indi-
vidual unit's "reference group". In the present context, y is unemployment, x are tract
characteristics, and A is the distance metric that specifies which tracts are neighbours of
each tract i. Each term in (14) represents a separate effect: in addition to the direct effect
,Bof observable characteristics on outcome, 4 expresses an "endogenous social effect" that
the mean outcome in the reference group has on the individual unit's outcome, whereas y
represents an "exogenous or contextual effect" of the mean observable attributes in the
neighbouring tracts on tract i's unemployment rate. Furthermore, the error term E may
depend in part on unobservable characteristics that are themselves spatially correlated.
In the context of the linear model (14), Manski (1993) shows that the endogenous
social effects 4 can be identified if one assumes that there are neither exogenous effects
(y = 0) nor correlated effects (Eei?j = 0). I make these assumptions both in the structural
and in the auxiliary model. Specifically, in the structural model the conditional transition
probabilities (1)-(5) only depend on tract i's own characteristics and on the neighbours'
employment rate in the previous period, while the neighbours'characteristics do not play
a role. In addition, the evolution of the system is ruled by random draws a) from a vector
of uniform distributions that are i.i.d. in time and in space by construction.
In the special case where exogenous and correlated effects are absent, 4 and ,B are
identified if the conditional expectation E(x IA) varies non-linearly with A, and
Var (xIA)> 0 (Proposition 2 in Manski (1993)). In my model, x are tract characteristics,
whereas A is the physical distance metric. Therefore, Manski's identification conditions
are satisfied. In practice, I estimate E(x IA1) non-parametrically as a local average
I /Ni xj1 1, where Ni is the set of neighbours at distance 1 from i.
Furthermore, it is worth noting that even if neighbours' characteristics did play a
role in the evolution of the system, identification would still be ensured by the non-linearit-
ies implied by the stationary distribution of the structural model, as well as by the asym-
metric way in which tract characteristics and information enter those conditional
transition probabilities (this point has been made by Brock and Durlauf (1999, p. 31-33)).
Identification conditions for the structural parameters in ( ), ac( ), and y( ) can also
be expressed in terms of the indirect inference methodology. Intuitively, one wants to rule
out the possibility that the chi-square criterion (9) may be minimized by more than one
set of parameter values. Formally, this requirement amounts to assuming that the limit
TOPA SOCIAL INTERACTIONS 279

criterion JCO(G, 9o, p) has a unique minimum at p, that the binding function r( ) in (7) is
one-to-one and that ar/aO is of full column rank. The rank condition can be locally
tested and is in fact satisfied at the point estimates reported in Section 5.23
Finally, with regard to the identification of the auxiliary model, I assume that the
error terms are uncorrelated in the cross-section, E(Ei?j) = 0, Vi ?j, and are uncorrelated
with the neighbouring tracts' characteristics: E(x7E?) = 0. The latter condition concerns
the validity of the instruments used in the auxiliary estimation. Both conditions can be
easily tested.
The assumptions made here, regarding the absence of exogenous or correlated effects,
may be considered too strong. For example, suppose criminal activity in one location
spills over to neighbouring locations, because of physical contiguity. An increase in crime
may induce certain types of residents to move out, who are more likely to be employed
than people who stay. Alternatively, the rise in crime may have an adverse effect on local
businesses and employers, forcing them to leave. Thus the crime level in the neighbouring
tracts would impact unemployment within those tracts, and have a contextual effect on
the unemployment rate in tract i (y? 0), generating positive spatial correlation in unem-
ployment that is not due to social interactions. Another example is the location of schools.
Suppose high school quality in tract j induces agents with high ability or motivation to
locate in tract j as well as in neighbouring tract i. This may affect attributes such as
graduation rates or school drop-out rates in both tracts, while at the same time reducing
unemployment in both tracts. Again one would observe a non-zero exogenous effect (y? 0)
in that attributes of neighbour j would be associated with outcomes of tract i . Finally, as
an example of correlated effects, one can think of positive sorting inducing positive corre-
lation of certain unobserved attributes across neighbouring areas, that may directly affect
employment outcomes.
These are potentially serious violations of the identification assumptions. Therefore,
I follow three alternative strategies in the estimation of the structural model, to try to
distinguish spillovers that are due to social interactions across neighbouring tracts from
other possible inter-tract influences. The first two approaches exploit indirect information
that may be available on the dimensions along which social networks are constructed,
while the third addresses the issue of generic correlated effects across tracts.
There is considerable evidence in sociology on the extent of assortative matching in
agents' social networks. In particular Marsden (1987,1988), using data from the 1985
General Social Survey, shows that network homogeneity with respect to race and ethnicity
is very high.24Quite simply put, individuals are more likely to interact with people of the
same race or ethnicity than with members of different groups. The idea then is to divide
the set Ni of tracts physically adjacent to i into two subsets: those that are ethnically
"close" to tract i, and those that have a very different ethnic composition. Let me call the
latter subset EDNi.25 If social networks follow racial and ethnic lines, then one can expect

23. This is done by running a very long simulation of the structural model at the estimated value 0 H, and
numerically evaluating the matrix of partial derivatives ap/IO at the optimum OH. I can then test whether this
matrix has full rank.
24. For example, the likelihood of observing a social contact between two black persons is 4 2 times higher
than that generated by pure random matching, given the relative proportions of the different ethnic and racial
categories in the population.
25. Operationally, I use the same procedure as in Conley and Topa (2000) to calculate pairwise ethnic
distances between tracts. I consider nine different racial and ethnic groups to construct this metric. I then define
a set EDNi of "Ethnically Distant Neighbours" of i as those tracts in Ni whose ethnic distance from i is above
a certain threshold: 85 for 1980, 91 for 1990 (the maximum possible ethnic distance is 100v i). These thresholds
roughly correspond to the 55-th percentile of the distribution of pairwise ethnic distances.
280 REVIEW OF ECONOMIC STUDIES

very little social contact and informationexchangebetweentract i and tractsin EDN, 26


In practice,I modify the conditionaltransitionprobability(2) in the followingway

= a2(X,) + X(X,3 -
PU N Yjt + XEDN(Xi) ED =
SYk-l
- kt- (15)
N1 EDN,
The otherupwardtransitionprobability(5) is modifiedaccordingly.If local spilloversare
mostly generatedby social exchanges,one would expect the local interactionchannelto
be weakerwith tract i's ethnicallydistant neighboursthan with its other neighboursin
Ni. On the otherhand, otherinter-tractinfluencessuch as crimeshouldnot be so affected
by racialand ethnicdistance:in the data, the spatialcorrelationof crimeacrossadjacent
tractsis 0-75 for areas that are ethnicallyclose, and 0-79 for ethnicallydistant tracts. In
termsof equation(15), this hypothesistranslatesinto XEDN(') < 0, and can be testedusing
the KCtest statistic.
The second approach relies on Hunter (1974)'s study of local communities in
Chicago. As I mentioned earlier,he identifiesneighbourhoodboundarieson the map
of Chicago that in many cases correspondto CommunityArea boundaries.Since local
neighbourhoodsare loci of social exchange,one would again expectsocial interactionsto
be weaker between tracts that are separatedby one of these boundaries.The way to
implementthis in the modelis similarto the ethnicdistancecase. For each tract i, I define
a subset NCAi of its adjacentneighboursas those tracts that are not in the same Com-
munityArea as i and belong to a differentneighbourhoodaccordingto Hunter'sbound-
aries. The transitionprobability(2) is modified in a manner similar to (15), with an
additionalinteractionterm XNCA (-). The hypothesisis then 2NCA( () < 0.
As for the possibilityof correlatedeffects,I experimentwith the assumptionthat the
random shocks 0it are uncorrelatedin space, to see whether it affects the estimation
resultsin any way. In particular,I simulatethe structuralmodel introducinga certain
amount of spatial autocorrelationin the random draws woit, and look at whether the
introductionof this alternativesourceof spatialcorrelationin the model affectsthe par-
ameterestimates,especiallythose of the social interactionterm 2( ).

4. DATA AND SIMULATIONS


The data for this papercome from two sources.The main sourceis the SummaryTape
Files 3A of the 1980 and 1990 Census.These are summarystatisticsat the Censustract
level for a wide set of variables,based on the 100%count data. There are 863 tracts in
the City of Chicago,groupedinto 75 CommunityAreas. The second sourceis the Block
and Block dataset on homicidesin Chicago, 1965-1995, that is used here to construct
crimerate variablesat the Censustractlevel.27
I concentrateon the City, ratherthan on the whole SMSA, becausethe City has a
higherpopulationdensity,so using spatialproximityto representsocial distancemay be
more appropriate.Some tractswere droppedfrom the samplebecause of their zero (or
near zero) populationand labour force. Even so, the samplecontains 841 observations.
The outcomevariableis definedas the percentageof unemployedpersonsover the civilian
labourforce(16 yearsand older)in each tract.The observabletractcharacteristicsXi that
I control for in the estimationcan be roughly groupedinto the following three sets of
26. A similarstrategyhas beenfollowedby Munshiand Myaux(1998),to helpidentifyendogenoussocial
effectsin the adoptionof new contraceptivemethods,in a sampleof ruralvillagesin Bangladesh.
27. Block, C. R., Block, R. L. and the Illinois CriminalJusticeInformationAuthority:Homicidesin
Chicago, 1965-1995; 4th ICPSR version, 1998.
TOPA SOCIAL INTERACTIONS 281

TABLE 1
Summary statistics of all variables
1980 1990 1990-80
Variables Mean Std. Dev. Mean Std. Dev. Mean Std. Dev.
Unemployment rate 11 71 8 16 14-93 12 06 3 22 8 95
Segregation index 87 20 13 03 91-82 11 52 4 62 14-32
Non-white persons (%/o) 50 55 39-63 57 91 37 14 7.36 14-59
Hispanic persons (%l) 7 19 1292 19 53 26 36 12-34 17 24
High-school grad. or more (%) 53 65 1694 62 53 17 20 8 88 1023
College grad. or more (%l) 10-86 12 91 15-62 17 37 4 77 8 62
Crime index 22 59 15-51 19 39 13 50 -3 20 8 04
Females (%) 52 91 6 63 51 81 5 29 -1 10 5 68
Persons 18-24 y.o. (%) 1935 670 1594 706 -341 6 19
Persons 0-24 y.o. (%) 41 74 12-03 38-01 11 97 -3 73 7 74
Persons per household (average) 2 77 0 62 2 82 0 67 005 040
Vacant housing units (%) 736 5 99 1048 8 18 3 12 8 14
Median gross rent 227 42 55 22 252 07 73 22 24 65 51 77
Average housing value 10 05 13 52 26 18 22-30 16 13 19 60
Employed in prfs/mngr jobs (%) 9.59 891 1277 1155 318 712
Out of labour force-males (%) 30 29 13 22 3048 1403 0.19 1208
Out of labour force-females(%) 51 01 12-56 45 82 13 73 -5 19 11-87
Same county workers (%) 83 89 12 02 94 60 5 46 10-71 12-41
Median travel time to work 27-26 6 38 27 99 6 52 0-73 5 96

See the Appendix for a definition of all the variables and units.

covariates. Summary statistics for all variables are presented in Table 1 and precise defi-
nitions are given in the Appendix.
First of all, I consider a set of sorting variables, i.e., variables that may affect the
decisions by different types of individuals to locate in a given area. These include average
housing values in the Census tract, median gross rents, the fraction of vacant housing
units in the area, a crime index, the fraction of persons with managerial or professional
jobs, the percentage of non-white persons, the percentage of Hispanic persons, a segre-
gation index, and the number of persons per household.
Secondly, I consider variables that may be linked more directly to the probability of
being employed. These include the percentage of persons with at least a high school dip-
loma, the fraction of persons with at least a college degree, the age composition in the
tract (to proxy for potential experience), the fraction of females 16 years and older, and
the percentage of males and females out of the labour force in the tract.
Finally, there is a relatively large literature in urban and labour economics that dis-
cusses the spatial mismatch hypothesis. This literature aims at explaining the high unem-
ployment levels in mostly black, inner city neighbourhoods by local labour market
conditions. The basic idea is that during the 1970's and 1980's many jobs (especially low-
skill ones in the service industry) have moved from central city areas to the suburbs. In
addition, the contention is that there is low residential mobility and a certain degree of
housing segregation for inner-city blacks. For example, it may be very costly for a black
household to relocate to the suburbs in a mostly white neighbourhood, where the social
capital provided by a black community would be missing. Several authors, such as Holzer
(1991) and Ihlanfeldt and Sjoquist (1990,1991) have analysed this issue empirically. By
now, there is a certain consensus that physical proximity to jobs explains a portion of
black/white unemployment differences, for instance. Therefore, I include the median com-
muting time to work for workers who live in each tract, and the fraction of residents who
go to work in the same county.
282 REVIEW OF ECONOMIC STUDIES

Numerical simulations of the structural model were performed in order to deliver


realizations yh(xn, 0) to be used in the estimation of 0. The simulations use the conditional
transition probabilities (1)-(5), where 2(.), ac(), y( ) are linear functions of tract covari-
ates X. The outcome variable y takes values in the discretized [0, 1] interval E, and stands
for the employmentrate. Therefore, in order to make the simulated yn(xn, 0) comparable
with Ynfrom the data, I operate the transformation yn(xn, 9) = 100 (1 -Jy) on the outcome
y of each simulation.
For a given value of the parameters 0, the system is simulated starting at full employ-
ment: i.e. the initial configuration of employment rates over the map of locations is y_1-28
The X covariates that enter the conditional transition probabilities are taken from the
data and stay fixed at either their 1980 or 1990 level throughout the simulation. I let the
simulated process run for 1300 iterations. This seems a large enough number to let the
process converge to its stationary distribution. I then draw H "snapshots" out of this
distribution: these deliver the sample of H simulated realizations yn(xn, 9) used in the
indirect inference procedure. It is essential, of course, to use the same sequence of shocks
{t = 1 for all the different simulations involving different values of 029
Computational limitations imply that the dimensionality of the parameter space 0
has to be rather small. Therefore, instead of letting the transition probabilities of the
structural model depend on the full set of M covariates described above, I use a subset of
L characteristics, with L < M. In particular, I choose the three covariates that contribute
the most to reducing the spatial correlation in raw unemployment rates. In practice, I run
the auxiliary regression (11) without interaction terms, both in levels and in first differ-
ences, and compute fitted residuals Cj=_ y ,B. I estimate non-parametrically the Auto-
Correlation Function (ACF) of these residuals, as a function of distance, following a
methodology developed in Conley and Topa (2000). Then, I repeat this estimation exclud-
ing from the set of covariates one variable at a time, to see how the ACF changes follow-
ing the exclusion of each variable. It seems that the three variables that bring about the
largest reductions in spatial correlation of unemployment are the percentage of non-white
persons in the tract (NW), the fraction of high school (for 1980) and college (for 1990)
graduates (HI and CL, respectively), and the crime variable (CR).
Therefore, in the simulations, I specify the X(-) functions for 1980 and 1990 as follows
X(Xi)80O + Xnw NW80 +ed HII80+ Xcr ' CR8,
X(Xi)90-Xo + Xnw NW70+ Xed CL9i0+ Xcr CR70; (16)
the a(-) and y( ) functions are defined exactly in the same way. Finally, to further reduce
the number of structural parameters to be estimated, I impose symmetry and pro-
portionality restrictions on a(.) and y(*)
Yo= &Xo,

ynw= -8anw

Yed= i50ed,

Ycr = _3ac X

28. The initial condition does not really matter, since there exists a unique stationary distribution.
29. The auxiliary estimation actually uses first-differenced data. To make the simulations y consistent with
this, I use the following strategy. For each value of 0, I first run the simulation fixing the X characteristics at
their 1980 levels. This yields a simulated unemployment realization for 1980, Y(0)80. I then repeat the simulation
for the same 0 (and the same sequence of shocks) using the 1990 values of X. This delivers Y(0)go. I then
compute Y(0)go-80-Y(0)go -Y(0)80. This is the simulated counterpart to the dependent variable of the auxiliary
regression on the data.
TOPA SOCIAL INTERACTIONS 283

where 3 > 0. All these manipulations imply that the actual vector of structural parameters
to be estimatedis 0 =_Ronw Xed Xcr a0 anw aed acr 3] . This vector is augmentedby
EFDN or XNCA in the model specifications that allow the intercept of the local interaction
term to differ for ethnically distant neighbours or for neighbours in different Community
Areas and different "Hunter neighbourhoods".
I use a simulated annealing algorithm to minimize the indirect inference criterion (9)
with respect to the parameters 0. This algorithm is explicitly designed to find a global
minimum of functions that may present multiple optima and discontinuities. Therefore,
it is particularly well suited for the problem at hand. Very briefly, simulated annealing
performs a random search over the parameter space, and accepts not only downhill moves
but also uphill moves. The probability of accepting an upward move depends positively
on a "temperature" parameter that decreases as the search progresses. At the beginning
of the search, the algorithm is allowed to make large upward moves, and thus searches
over the whole parameter space. As the temperature drops, the algorithm concentrates on
more promising regions, but the random nature of the search still allows it to escape local
minima. Simulated annealing has proven to be very effective in this particular problem.30

5. EMPIRICAL RESULTS
As a preliminary step, I report in Table 2 the results of the estimation of the auxiliary
model, performed on the actual unemployment data in first differences. It is worth noting
that, even after controlling for tract characteristics as well as time-invariant tract-specific
fixed effects, the unemployment rate of neighbouring tracts has a positive and significant
parameter estimate, at least for tracts up to a distance 2 from tract i. Even though the
auxiliary parameters are not the actual parameters of interest, they still give an indication
that unemployment is characterized by positive spatial correlations: this in turn is consist-
ent with the model of local interactions.
Figure 7 also reports the non-parametric ACF estimates for the dependent variable
and the fitted residuals of the auxiliary regression. The solid line refers to the actual
unemployment rate in first differences. The dashed line refers to the fitted residuals,
ii- (Yi) 'GMM-(x1) GMM. Finally,the intermediateline showsthe ACF of a differ-
ent set of fitted residuals, calculated excluding from the covariates the direct effect of
unemployment in the neighbouring tracts: ij=yi - (xi) GMM. The circles, diamonds and
asterisks highlight the portions of the ACFs where one can reject the null hypothesis of
spatial independence, at the 5% significance level.31
It is interesting to note that both the raw unemployment variable and the fitted
residuals 'i display a positive and statistically significant amount of spatial correlation,
that declines monotonically with distance. On the other hand, the fitted residuals Ei do
not exhibit any positive spatial correlation and are close to being white noise (in space),
except for a small amount of negative autocorrelation at distances 1 and 2. Therefore, it
seems that the assumption of no cross-correlation of the residuals across individual units
is a reasonable one.
Tables 3 and 4 present the results of the indirect inference estimation of the structural
parameters. The model is estimated under four different specifications. The first is the
baseline model, with conditional transition probabilities as in equations (1)-(5). The

30. For a moredetaileddescriptionof the algorithm,see Goffe (1996)and Goffe et al. (1994).I am very
gratefulto Bill Goffe for sharinghis MATLABsimulatedannealingroutineswith me.
31. See Conleyand Topa (2000)for the detailsof the ACF estimationand the bootstraptest of spatial
independence.
284 REVIEW OF ECONOMIC STUDIES

TABLE 2
Auxiliary regression on the data
Dependent variable:
Unemployment rate, 1990-80
Variable name rho-gmm S.E. Included?
Unemployment rate (nbs-1) 0 6959 0.1637 Yes
Unemployment rate (nbs-2) 04351 0.1444 Yes
Unemployment rate (nbs-3) -0.3236 0 1760 Yes
Unemployment rate (nbs-4) -0 0891 0 2634 Yes
Unemployment rate (nbs-5) 0 3877 0 3880 Yes
Unemployment rate (nbs-6) -0 2317 0 3160 Yes
Unemployment rate (nbs-1) x
Non-white persons (%o) 0 0013 0 0133 Yes
Unemployment rate (nbs-1) x
College grad. or more (%) -0 0462 0 0166 Yes
Unemployment rate (nbs-1) x
Crime index 0 0136 0 0139 Yes
Constant 0-5943 0 8129 No
Segregation index 0 0151 0 0240 No
Non-white persons (%) 0.0111 0 0538 Yes
Hispanic persons (%) -00524 00258 No
High-school grad. or more (%/6) -0 0336 0 0377 No
College grad. or more (%/6) -0 0269 0 0671 Yes
Crime index -0 0420 0 0681 Yes
Females (%) -0 1780 0.0798 No
Persons 18-24 y.o. (%) -0 1732 0-0749 No
Persons 0-24 y.o. (%) 0 1073 0 0927 No
Persons per household (average) -0 2168 0-1313 No
Vacant housing units (%o) 0.0758 0 0497 No
Median gross rent 0 0022 00078 No
Average housing value 0 0100 0 0141 No
Employed in prfs/mngr jobs (/o) -0-2467 0 0967 No
Out of labour force-males (%) -0-0628 0.0340 No
Out of labour force-females (%o) -0 0610 0.0443 No
Same county workers (%o) 0 0235 0 0307 No
Median travel time to work 0 1615 0 0738 No
Estimated moments of the
Dependent variable
rho-gmm S.E. Included?
Mean 3 0466 02577 Yes
Variance 48 0445 8 0315 Yes
Spatial Cov(l) 170045 3 5405 Yes
Spatial Cov(2) 11-8436 2 3545 Yes
Spatial Cov(3) 8.4629 1 8718 Yes
Spatial Cov(4) 6 3632 1 4791 Yes
Spatial Cov(5) 5 7835 1 3146 Yes
Spatial Cov(6) 3 9162 1.2448 Yes

J test (chi-square, 45 d.f.): 40 1099 (p-value = 0.6788).


Adjusted R2. 02468.
The last column indicates the parameters that are used in the indirect
inference criterion.

second takes into account the possibility that local interactions may be weaker across
tracts that are ethnically very distant, as in equation (15): in practice, only the intercept
of the 2(4) term is allowed to vary, but the additional parameter )ODN is estimated separ-
ately for 1980 and 1990. The third model specification is similar to the previous one, but
considers tracts that belong to different Community Areas and different neighbourhoods
TOPA SOCIAL INTERACTIONS 285

-- -- Resid GMM
05 0 5% signif.
- - - Resid (X only)
0 5% signif.
0-4 Raw unempl.
* 5% signif.
0-3-

Q002

0.1

0~~~~~~~~~0

10
-0-1 ~C or

-0 21
0 2 4 6 8 10
Physical distance (adjacenttracts)

FIGURE 7

ACF for unemployment rate, 1990-80

according to Hunter (1974). Here a single additional intercept parameter XN CA is


estimated.
These three model specifications are simulated using a sequence of shocks {a}T=l
that are i.i.d. over time and, more importantly, across space. The final specification
imposes a certain spatial correlation structure on these shocks, to try to mimic the pres-
ence of correlated unobservables and see how it may affect the results. In particular, the
shocks now follow a SAR(l) structure, with autocorrelation parameter set equal to 0 5.
The structural estimates of the baseline model are reported in the first column of
Table 3,32 The i, test of the over-identifying restrictions indicates that one cannot reject
the null hypothesis of correct specification of the structural model, even at high signifi-
cance levels (the p-value is 0.36). More importantly, a joint test of the null that all the A
parameters are equal to zero can be rejected at the 10% level (using the test statistic 4c
described in Section 3.1). So the estimation of the structural model supports the hypothesis
that an important portion of the spatial autocorrelation of unemployment observed in the
data can be attributed to local interactions that take place across neighbouring tracts.
Tract characteristics alone (operating through the a and y parameters) are not sufficient
to fit the observed spatial distribution of unemployment.
The signs of the a parameter estimates are quite intuitive. The probability of an
upward transition in the employment rate depends positively on the education level in the
tract, and negatively on the fraction of non-whites and on the crime rate in the tract.

32. The auxiliary parameters p based on simulations performed at the optimal value nHare very close to
the auxiliary parameters p from the data. These comparisons are reported in a table available from the author
upon request.
286 REVIEW OF ECONOMIC STUDIES

TABLE 3
Structuralparameter estimates
Parameter Baseline Ethnicities Comm. areas lambda 0 Corr. shocks lambda 0
lambda_0 0-2495 0.2057 0 1966 0 3001
(0-0104) (0.0103) (0.0211) (0.0254)
lambda_EDN(80) 0-0024
(0.0017)
lambda_EDN(90) -0 2094
(0.0226)
lambda_NCA -0 0159
(0 0046)
lambda_ed -01049 -0 1558 -0 0922 -0 1691
(0 0109) (0 0175) (0 0182) (0 0312)
lambda_nw 0 0910 0 1101 0 2718 -0-1657
(0 0107) (0 0090) (0 0328) (0 0157)
lambda_cr -0 2592 -0 3262 -0 3583 -0 3510
(0 0257) (0 0175) (0 0165) (0 0470)
alpha_0 0 3919 0 3724 0 3719 0 6505 0 7528 0 2313
(0 0170) (0 0139) (0 0225) (0 0158) (0 0352) (0 0064)
alpha_ed 0 0778 0-0814 0-0926 0 0737 0 1662 0 1319
(0 0046) (0-0068) (0-0095) (0 0054) (0 0274) (0 0174)
alpha_nw -0-1248 -0 1017 -0 1234 -0 1109 0-0600 -0 0614
(0-0040) (0-0052) (0 0064) (0-0049) (0-0054) (0 0031)
alpha_cr -0 0401 -0 0289 -0 0392 -0-2473 -0 2009 -0-0866
(0 0048) (0 0016) (0 0029) (0-0096) (0-0238) (0 0063)
delta 0 6483 0 6687 0 6784 0 4169 0 5754 0 3128
(0 0171) (0 0113) (0 0118) (0 0066) (0 0274) (0-0045)
K-test 12 0666 6 0698 10 3123 20 0642 18 4197 18 7334
p-value (0 3586) (0 7329) (0 4135) (0 1695) (0 0723) (0 2261)
Kc-test
(Ho: lambda =0) 7 9976 13 9944 9 7519 0 3137
p-value (0 0917) (0 0297) (0.0826) (0 9889)
Kc-test
(Ho: lambda_EDN= 0) 5 9967
p-value (0 0499)
Kc-test
(Ho: lambda_NCA = 0) 1 7542
p-value (0 1853)

Standard errors in parentheses.

Furthermore, I can characterize how the information spillovers vary with tract character-
istics: the interaction term X( ) has a positive intercept, is decreasing in the education
level and in the crime rate, and is increasing in the percentage of minorities in the tract.
Thus the spillover effects are stronger for areas with lower education levels and with
a higher percentage of non-white residents. This is consistent with empirical findings
reported by Corcoran, Datcher and Duncan (1980) and by Granovetter (1995). This litera-
ture focuses on the nature of informal hiring channels and is based on detailed data on
employees' work history (in particular, how they were hired). The authors find that infor-
mal contacts used to acquire jobs are more important for younger workers, low-skilled
jobs, less educated workers and minorities. An alternative explanation for the reported
signs of X,A, and Xed could be related to the choice of physical distance as a proxy for
social distance, in the structural model. Since social networks of poorer, less educated
agents tend to be more geographically concentrated (see Fischer (1982)), it is quite intuit-
ive that the local interaction effect is stronger for tracts with these characteristics, since I
TOPA SOCIAL INTERACTIONS 287

am focusing on the geographic component of social networks. Finally, the sign of X,, may
indicate that local networks and institutional loci of social interactions such as neighbour-
hood organizations tend to break down in the presence of high crime rates in the neigh-
bourhood, perhaps because crime raises the cost of maintaining local social ties.
Columns 2 and 3 in Table 3 report the parameter estimates for the model specifica-
tions that take into account ethnic distance and neighbourhood boundaries. Again, the
overall ic, specification test does not reject the structural model in either case, with very
high p-values. The ethnic distance version fits the data particularly well. As for the joint
test of the null hypothesis that the X parameters are all equal to zero, one can reject the
null even more strongly than in the baseline model (the p-values are now 0 03 and 0.08).
The estimates of the X and a parameters are similar to the baseline model.
The interesting result is that the signs of the additional parameters )EDN and 2?NCA
go in the direction expected according to the theory: the local interaction channel is indeed
weaker across tracts with very different ethnic compositions (at least for 1990), and for
tracts that are separated by neighbourhood boundaries. The first result is especially strong,
since one can rejectthe null hypothesisthat XODN = 0 at the 5%level.
Therefore, there is some evidence that inter-tract influences follow ethnic lines and
neighbourhood boundaries that were identified by local residents. Since social networks
exhibit strong assortative matching with regard to ethnicity and are thought to be stronger
within, rather than across neighbourhoods, this evidence lends support to the idea that
the local spillovers detected here are indeed caused by social interactions rather than by
other factors that may generate positive spatial correlations.
The last two columns of Table 3 introduce a note of caution. Although the point
estimate of the 2(4) intercept is quite positive and significant, one can no longer reject the
null hypothesis that the )( ) term is identically equal to zero. However, the model with
correlated shocks fails to pass the overall Kc,specification test, and in general provides a
worse fit of the data than the model specifications with i.i.d. shocks. Figures 8 and 9
contain the simulated maps of unemployment in the ethnic distance specification with
i.i.d. shocks and in the correlated shock specification, respectively: these can be compared
to the actual data, in Figure 3. The signs of the parameter estimates remain unchanged,
with the notable exception of )L, which reverses sign: thus the interaction effect would
be weaker for tracts with higher fractions of minorities. It may be that the degree of
autocorrelation introduced in the shocks used to simulate the model is too high and simply
washes out everything else. This issue certainly warrants further examination.
In Table 4, I use the parameter estimates of the structural model to perform several
thought experiments, aimed at evaluating the magnitude of the spillovers generated by
local interactions. I consider different types of tracts: the first is an artificial average tract,
in the sense that it has the city-wide averages of unemployment, education, presence of
non-whites, and crime. The other four tracts are real ones, taken from four different
neighbourhoods:33 Woodlawn and Grand Boulevard are characterized by high unemploy-
ment, high poverty rates, relatively low education levels and relatively high crime rates,
and are mostly non-white. On the other hand, Brighton Park and Lake View have low
unemployment, low poverty rates, low crime, high education levels, and are mostly white.
The contrast between Grand Boulevard and Lake View is especially strong, whereas the
differences between Woodlawn and Brighton Park are not as marked.34

33. Table 5 presentssome summarystatisticsfor the four tractsused in the experiments.


34. The latterpair of locationswas chosenbecausethey have non-emptysets of ethnicallydistantneigh-
bours(EDNi),and neighboursnot in the same CA/Hunterneighbourhood(NCAi).
288 REVIEW OF ECONOMIC STUDIES

rate,90-80:SIM(EDN)
Unemnployment 2 0 2 4 Miles
Lii-66.7--1.9

3.2-7.8
7.8-72.9
FIGURE 8
Map of simulatedunempl.rate, 1990-80 (EDN)

The firstthoughtexperimentis to raisethe informationflow I,t availableto residents


of tract i by one standarddeviation,and calculateits expectedimpacton the unemploy-
mentratein the tract.For the two pairsof actualtracts,I also calculatethe effectof giving
each tract the level of informationthat it would receiveif it had the same neighboursas
the other tract in the pair. The other three experimentsconsist of raisingthe education
level in the tract, decreasingthe proportionof non-whites,and decreasingthe crimerate
by one standarddeviation.
For the baselinemodel, raisingthe informationavailableto an averagetractby one
standarddeviation (about 8 percentagepoints in 1980, about 12 points in 1990)brings
about a decreasein expectedunemploymentof 0.63 and 1 26 percentagepoints,,respect-
ively. This is a rathersmalleffect,but it is roughlyof the samemagnitudeas the effectof
TOPA SOCIAL INTERACTIONS 289

rate,90-80:SIM(COR)
Unemnployment 2 0 2 4 Miles

-3-2-7-8
7-8-72-9
FiGuRE 9
Map of simulatedunempl.rate, 1990-80 (COR)

raisingeducationin the tractby one standarddeviation.The largestchangesin unemploy-


ment ratesare those impliedby a 1 s.d. changein the percentageof non-whitesand in the
crimerate. The impactof crimein particularis very stableacrossall model specifications.
The information spillover grows larger as one looks at the two poorer tracts,
especiallythe one in Grand Boulevard.Here, the decreasein expectedunemploymentis
roughlyone percentagepoint in 1980 and one and a half percentagepoints in 1990.The
spilloveris strongerin GrandBoulevardbecausethis tract is characterizedby lower edu-
cation levels and a higher fractionof non-whitesthan the averagetract.3 Te fact that
the local interactiontermX(~)dependson these characteristicsalso impliesan asymmetry
in the spillovereffects betweenGrand Boulevardand Lake View: for a given change in
35. Althoughthe higherthanaveragecrimeratein the tracttendsto reducethe magnitudeof the spiHlover.
290 REVIEW OF ECONOMIC STUDIES

TABLE 4
Magnitude of spillovers
Baseline Ethnicities Comm. areas Corr. shocks
Experiment 1980 1990 1980 1990 1980 1990 1980 1990

Average tract:
Raise Info. by 1 s.d. 0 63 1 26 045 1-14 0 68 1 38 0 11 0 39
Raise Educ. by 1 s.d. 0 81 0 80 048 047 1 30 1 27 1 28 1 29
Lower nw by 1 s.d. 469 422 361 317 121 100 385 360
Lower Crime by 1 s.d. 2 74 2 33 3 65 3 00 3 34 2 85 407 3 54
GrandBoulevard:
Raise Info. by 1 s.d. 0.91 1.53 0 66 1 27 1.11 1 84 -0 24 -0 05
Same Info. as Lake View 2 86 4 77 2.10 3 99 3 68 5 81 -0 79 -0 17
Raise Educ. by 1 s.d. 0 86 0 89 049 0 62 1 28 1 28 1.50 1 44
Lower nw by 1 s.d. 5 05 444 3 74 3 29 1 14 1 40 4.68 3 58
Lower Crime by 1 s.d. 3 08 227 3 86 2 68 3 34 2 55 493 3 55
Lake View:
Lower Info. by 1 s.d. -0 57 -0 77 -0 36 -0 56 -0 57 -0 69 -0 15 -0 41
Same Info. as Grand Blvd. -1 89 -2 68 -1 17 -1 91 -2 17 -2 58 -0 48 -1 39
Raise Educ. by 1 s.d. 0 85 0 84 0 50 0 56 1.39 1.39 1 29 1 18
Lower nw by 1 s.d. 4 85 4 15 3 81 3 30 1 30 1.39 3 83 295
Lower Crime by 1 s.d. 2 78 205 3 86 2-82 3 54 2 85 406 293
Woodlawn:
Raise Info. by 1 s.d. 078 1 27 0.59 1 37 091 1.42 -0 11 024
Same Info. as Brghtn. Pk. 0 61 1.19 0 45 2 55 0 61 1 29 -0 08 0 22
Raise Educ. by 1 s.d. 072 067 035 041 111 098 128 110
Lower nw by 1 s.d. 442 348 324 276 085 099 430 288
Lower Crime by 1 s.d. 2 85 1 88 3 64 2 62 3 01 2 03 4 50 2 85
Brighton Park:
Lower Info. by 1 s.d. -0 51 -1 21 -0 30 -1 22 -0 42 -1 27 -0 25 -0 64
Same Info. as Woodlawn -0 39 -1 13 -0 22 -2 70 -0 21 -1 11 -0 19 -0 60
Raise Educ. by 1 s.d. 0 89 0 83 0.59 0.51 1.51 1 37 1 26 1.24
Lower nw by 1 s.d. 485 423 389 331 1 52 1.09 3 51 333
Lower Crime by 1 s.d. 2 58 221 3 58 3 06 3.76 3 06 3 74 3 28

Each cell reports the expected change in employment, in percentage points, following each experiment.

information, the size of the spillover effect for Lake View is roughly half the size of the
effect for Grand Boulevard (in absolute value). Thus a tract in Lake View would not
suffer from a decrease in information levels as much as a tract in Grand Boulevard would
gain from an increase in information of the same size.
Finally, giving the tract in Grand Boulevard the same information as the tract in
Lake View has a large effect on unemployment: the expected unemployment rate would
decrease by almost three percentage points in 1980, and by more than four points in 1990.
Again, the reverse experiment on Lake View would raise unemployment by a smaller
amount, because of the different tract characteristics that affect the strength of the local
interactions.
The magnitudes of these effects remain roughly unchanged across the different
model specifications with i.i.d. shocks: the size of the local interaction spillover is
largest under the specification with neighbourhood boundaries (except for the Wood-
lawn/Brighton Park exchange). With correlated shocks, the spillover effect is greatly
reduced for the average tract, and reverses sign in some cases, especially those regarding
Grand Boulevard. This counter-intuitive result may be due to the sign of 2,. under this
specification.
TOPA SOCIAL INTERACTIONS 291

See
Poor
the CrimeCollege Median
Non-white
Households
High-school
indexgrad.
or on households
Unemployment
Appendix grad.
persons household
for or (%o) rate
more
a (%) welfare
(%) (%) income
more
(%)
definition
of
all
the
99 2 30 54 4 25 Tract Grand
44-2
61 83 44 19-43
09 41 82
variables 3801
Blvd.
and

units.18
3
34 65 0 15 17 3 Tract Lake
23 2706
58 76 23 27 42
612View
Summary
1980
31 91 46 14 5 23 Tract
67 statistics
52 68 08 48-11
51 13
4202 for
Woodlawn
TABLE
5
selected
19 52 12 17 Tract
6 11.8 7 8 5-1 Brighton
7-36
53 0-72
5801 Census
Pk.

tracts

40 99 41 15 68 2 Tract
Grand
5
3-27
46 88 88 87 35-46
3801
Blvd.

10 58 0 8 22 Lake
Tract
7-209
12 88-46
05 39 04 5-69
612View

1990

12 87 17 55 7 43 7 33 Tract
9
89 83 03 93 06 52 18
4202
Woodlawn

29 5 14 17 9 Tract
13-1
21 49 51-8529 05 31
0-23 Brighton
5801
Pk.
292 REVIEW OF ECONOMIC STUDIES

6. CONCLUSION
This paper analyses a model of local social interactions in the context of urban unemploy-
ment, and provides empirical estimates of the size of the spillovers generated by local
interactions. The underlying idea is that agents exchange information within their social
networks about job opportunities. There exists a local positive feedback in that agents are
more likely to transmit useful information about jobs if they themselves are employed.
This feedback generates positive spatial correlations of unemployment.
Insofar as the dimensions along which social networks are constructed are at least
partially observed by the econometrician, the information exchange process generates
observable implications that can be used to detect the existence of local interactions. In
this paper, I argue that physical distance is an important determinant of social ties, and
use the observed spatial patterns in unemployment according to this metric to estimate
the structural model. I also argue that Census tracts constitute a meaningful unit of analy-
sis, since they still provide a fine enough grid to look at interactions within
neighbourhoods.
The results of the estimation support the hypothesis that there exist local social inter-
actions across tracts. At least in the case of i.i.d. shocks, one can reject the hypothesis
that the interaction term is identically equal to zero, and the shape of the interaction term
is consistent with independent evidence on informal hiring channels: in particular, the
spillovers are stronger for tracts with lower education levels, higher fractions of minorities,
and lower crime rates. A thought experiment also reveals an interesting asymmetry: if one
raises the level of information available to a disadvantaged tract by one standard deviation
and lowers the information flow to a well-off tract by the same amount, the decrease in
expected unemployment in the former area is twice as large as the increase in unemploy-
ment in the latter. This is due to the different "initial conditions" in the two areas, in
terms of education levels, racial composition and crime rates.
In addition, the local spillover effect is weaker between tracts with very different
ethnic compositions, and between tracts that belong to different neighbourhoods. Since
one expects social ties to be stronger between ethnically homogeneous groups and within
neighbourhoods, this result seems to be consistent with a social interaction interpretation
of the observed spatial patterns in unemployment, rather than with other possible inter-
tract linkages.36
Further research should be done to clarify certain remaining issues. The model speci-
fication with correlated shocks cannot reject the null hypothesis that the interaction term
is zero and generates a very small local spillover, but fits the data more poorly than the
other model specifications. It would be worthwhile to experiment further with different
forms and degrees of autocorrelation. One may also try to think of alternative ways to
distinguish social interactions from other effects (e.g. crime spillovers or school spillovers)
by using police precinct or school district boundaries. Finally, the structural model has
implications for the evolution of the system over time that could be tested using panel
data with several time periods. These time-series properties would provide an additional
set of moments to be matched, and may help clarify some of the forces that determine
the rise and fall of neighbourhoods.

36. As for the exact mechanismsthroughwhich social interactionsoperate,the data are not suitableto
determinewhethertheyworkthroughdirectreferralsto employers,pureinformationexchangesaboutjob open-
ings, or role model effectsand peerinfluencesexertedby one's employedsocial contacts.Individuallevel data
may be more appropriatefor this kind of analysis.
TOPA SOCIAL INTERACTIONS 293

APPENDIX
The following are the definitions of the variables used in the paper:
Unemploymentrate: the percentage of unemployed persons over the civilian labour force (16 years and
older). Unemployed persons are individuals who were neither "at work" nor "with a job but not at
work" during the Census reference week, and who were actively looking for work during the last four
weeks prior to the reference week;
Segregation index: the Euclidean distance of a specific tract from the city-wide mix of ethnicities: if
(a, b, h, g,1,v) are the city-wide proportions of Asian and Pacific islanders, Blacks, Hispanics, Others,
and Whites (respectively) over the whole population, then the index for tract i is defined as:

segri_-
1(ai _
# +(bi _b)2+ (hi-fi)2 + (oi _ o)2 + (Wi _
w)2;

Non-white persons: the percentage of non-white persons in the tract;


Hispanic persons: the percentage of Hispanic persons in the tract;
High school graduate or more: the percentage of persons 16 years and older with a high school diploma
or more;
College graduate or more: the percentage of persons 16 years and older with a college degree or more;
Crime index: a weighted sum of homicides during the calendar years 1978-79 (for 1980) and 1988-89 (for
1990), in tract i and in the neighbouring tracts. The weights used are 1 for tract i, 0 8 for tracts at
distance 1, 0 5 for tracts at distance 2, 0.2 for tracts at distance 3.
Females: the percentage of persons who are females;
Persons 18-24 y.o.: the percentage of persons between the ages of 18 and 24;
Persons 0-24 y.o.: the percentage of persons between the ages of 0 and 24;
Persons per household: the average number of persons per household;
Vacant housing units: the percentage of all housing units that are vacant;
Median gross rent: median gross rent, in 1979 US$, of renter-occupied housing units in the tract;
Average housing value: average housing value, in 1979 US$ (thousands of $), of owner occupied non-
condominium housing units in the tract;
Employed in prfs/mngrjobs: the percentage of employed persons 16 years and older with professional or
managerial jobs;
Out of labourforce-males: the percentage of males 16 years and older who are out of the labour force;
Out of labourforce-females: the percentage of females 16 years and older who are out of the labour
force;
Same county workers: the percentage of workers 16 years and older who work in the county of residence;
Median travel time to work: the median travel time to work, in minutes, of workers 16 years and older
who do not work at home;
Median household income: in 1979 US$ (thousands of $), includes wage or salary income, self-employment
income, interest, dividend or net rental income, social security, public assistance, retirement income,
and other;
Poverty: the percentage of families with income below the poverty line;
Welfare income: the percentage of aggregate income in the tract that is due to public assistance.

Acknowledgements. I would especially like to thank Jose Scheinkman, Lars Hansen and Gary Becker for
their encouragement and guidance. Comments and suggestions from Roland Benabou, Tim Conley, Steven
Durlauf, Chris Flinn, Jim Heckman, Mike Keane, Pat Kehoe, Steve Levitt, Charles Manski, Derek Neal, Tano
Santos, Wilbert van der Klaauw, Ken Wolpin, the editor, two anonymous referees and participants at workshops
at Chicago, NYU, Boston University, Duke, U.Penn., NBER, SITE, and Toulouse were very helpful. The
simulated annealing Matlab codes were kindly provided by Bill Goffe. Thanks to the ICPSR for providing the
294 REVIEW OF ECONOMIC STUDIES

Bloch and Bloch Chicago homicide data. Financial support from the C.V. Starr Center at NYU is gratefully
acknowledged. All remaining errors are of course mine.

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