YESTERDAY the New York Timesran a piece on a brewing rent crisis in America:
For rent and utilities to be considered affordable, they are supposed to take up no more than 30 percent of a household’s income. But that goal is increasingly unattainable for middle-income families as a tightening market pushes up rents ever faster, outrunning modest rises in pay.
The strain is not limited to the usual high-cost cities like New York and San Francisco. An analysis for The New York Times by Zillow, the real estate website, found 90 cities where the median rent — not including utilities — was more than 30 percent of the median gross income.
The piece nods to the idea that rising rents—or housing costs generally, in America and elsewhere—are about more than supply and demand. Housing affordability activists like to point out that most new construction is for luxury housing, meaning that supply of non-luxury units is not growing by very much. Others love to say that price declines have historically gone hand in hand with falling construction.
These arguments are both nonsense. The latter point gets causation the wrong way around; given an unexpected decline in demand due to financial crisis or other shocks prices fall and interest in new construction dries up until existing inventories are cleared. The former point misses the fundamental fungibility of housing. When new construction of luxury units lags, the very rich buy up older housing stock at exorbitant prices and pay to have them redone. You see this in London, for instance, where literally every house in the city is now being rehabilitated, including those that were rehabilitated last year. Residents have to actively shoo away the builders trying to erect scaffolding, on the assumption that the owners will be wanting an extra floor or two on their house. It is a headache. There is a team of wildcat subcontractors digging us a new wine cellar as we speak. The point is that if demand for high-end housing is not satisfied with new construction, that demand will flow to existing supply, putting upward pressure on prices right across the housing stock.
A new piece in TechCrunch makes this point nicely in a very good explainer of the housing crisis in San Francisco. The economy of the Bay Area is booming, but the region is one of the most difficult places to build in the country. Prices are therefore soaring and neighbourhoods are changing, touching off some occasionally nasty social conflicts.
But the author of the TechCrunch piece, Kim-Mai Cutler, puts her finger on the real problem. Yes, supply constraints are the cause of the affordability crisis. The trouble comes in trying to understand why those constraints are there and how to alleviate them.
The issue is not technical limitations. In oil markets you have a cheap source of supply, in the form of oil that more or less bubbles obligingly out of the ground. But as soaring demand reduces the available supply of oil of that sort prices soar. Then we all worry for a bit before technology comes to the rescue. Engineers find new ways to do things using less oil, new ways to dig deeper holes, and new ways to shoot water at rocks until the rocks can't take it any more and weep oily tears. Housing is not really like that. There are cheaper or more expensive ways to build homes, but in the cities facing these crises construction costs constitute a relatively small portion of the expense of housing. The rest is rent.
Economic rent is the cost of non-produced inputs or advantages; the result of natural or contrived exclusivity.
Thank you, Wikipedia. So, San Francisco is a nice place to live. It's a nice place to live for a lot of reasons: the weather isn't bad, the surrounding countryside is gorgeous, the city has all sorts of cool stuff in it, and (perhaps most important) living in San Francisco gives one access to the local labour market, which is a really excellent thing to have access to. If local regulations did not do much to discourage creation of new housing supply, then the market for San Francisco would be pretty competitive; anyone with land in San Francisco could make more San Francisco by building on that land. The price of San Francisco would then fall to the marginal cost, which is the expense of building another unit of housing, which is not very high.
Now because the cost of living in San Francisco would not be very high, the consumer surplus available from living there would be extraordinary, and everyone would want to move there. Inflows of people would stop when the cost of making more San Francisco rose to meet the value derived from San Francisco by the marginal resident. Costs would rise, because the denser the city became the more expensive it would be to build new units (building super-tall towers does cost more, per unit, than building relatively modest apartment buildings). And the value to the marginal resident would fall for two reasons. First, the marginal resident will definitionally be someone who is relatively indifferent between living in San Francisco and living somewhere else. Everyone more eager to live there would already have moved in. And second, as people move in congestion costs within the city rise, reducing the value of San Francisco to everyone in San Francisco.
This, ostenibly, is why we have things like zoning codes. The welfare-maximising population of San Francisco may be higher (and possibly much, much higher) than the population which maximises the welfare of those already living in San Francisco. So the city devises a set of regulations that effectively make current residents monopolists, able to artificially limit supply and raise price. Society as a whole is slightly worse off; San Franciscans are slightly better off.
But in fact, the structure of local politics tends to magnify rent-seeking, generating enormous social costs. The benefits and costs of population growth occur in a way that practically guarantees highly restrictive building rules. The (large) potential benefits to would-be San Franciscans accrue to people who have no political power within San Francisco. The gains to San Franciscans from population growth are distributed very broadly; when a new building project allows more people to live in San Francisco, everyone in the city derives a small benefit from that growth—from the larger market size, greater opportunities for professional networking and knowledge spillovers, and so on. But the congestion costs associated with that new project are highly concentrated on the people living in the immediate vicinity of the new construction. There is a population level at which new growth entails net costs for all San Franciscans. But residents of San Francisco will limit new growth long before it reaches that level, because there will always be a strong constituency to block projects.
We therefore get highly restrictive building regulations. Tight supply limits mean that the gap between the marginal cost of a unit of San Francisco and the value to the marginal resident of San Francisco (and the market price of the unit) is enormous. That difference is pocketed by the rent-seeking NIMBYs of San Francisco. However altruistic they perceive their mission to be, the result is similar to what you'd get if fat cat industrialists lobbied the government to drive their competition out of business.
Tyler Cowen, a professor of economics at George Mason University, argues that the very definitions of labor and capital are arbitrary. Instead, he looks around the world to find the relatively scarce factors of production and finds two: natural resources, which are dwindling, and good ideas, which can reach larger markets than ever before.
If you possess one of those, then you will reap most of the rewards of growth. If you don’t, you will not.
Ideas and natural resources are scarce relative to unskilled labour and salt water, but they're not that scarce. We have machines to produce more ideas, and we call them things like "San Francisco". And the ideas, conveniently, allow us to extend the apparently limited life of natural resource reserves seemingly indefinitely. If you had vast oil reserves, you may have thought you had it made, since they weren't making any more of the stuff. Then fracking came along, and suddenly your ability to reap the rewards of economic growth was greatly reduced. And if you were the sort of smarty who worked for companies that came up with brilliant ideas like fracking, you might have thought you had it made, since coming up with ideas is hard and therefore valuable. Then you went to pay your rent.
It's useful to think about things like this within the context of Thomas Piketty's "Capital". Consider this chart:
The ratio of wealth to national income is rising in America, and a meaningful part of that rise is associated with housing. (In Britain and France, housing is even more important.) Now it might be that increased housing supply growth would reduce housing values and housing wealth, but would not reduce total wealth. The very rich now forking over a huge share of their salary for housing might instead save that money and invest it elsewhere, leading to corresponding increases in other domestic capital or net foreign capital. But I suspect that would not be the whole story. In her piece, Ms Cutler makes a point I have also emphasised in the past:
UC Berkeley economist Enrico Moretti calculated that a single tech job typically produces five additional local-services jobs.
But in San Francisco, that spillover effect is much smaller. This is in no small part because so much of our incomes end up going toward housing costs. The city’s economist Ted Egan estimates that each San Francisco tech job likely creates somewhere slightly north of two extra jobs, not five.
The housing dynamic in San Francisco raises the capital intensity of consumption. That contributes to an increase in the capital share of income and to the stock of wealth in the economy. Zoning restrictions are a tool of the oligarchy, effectively. I'm only one-fourth kidding. But they are; they are a means by which owners of capital extract an outsized share of the surplus generated by job creation.
So, what is to be done? Well, one option is simply to use the levers of government to seize back the surplus for redistribution to the masses. That's not an ideal solution, in this case at least, as it piles nasty incentive effects onto the distortions already created by zoning restrictions. Better to fix the initial distortion, which takes us to the second option.
You could reform local institutions to generate better zoning outcomes. There are lots of good ideas for how to do this floating around. What is less clear is how one builds support for institutional reform. One shouldn't say that it can't be done, but first such ideas need to win intellectual battles, and then they need to win political battles, and so it is safe to conclude that such reforms represent part of a long-term strategy for improvement.
Maybe the market will fix itself? That's not entirely impossible. Assume that there is persistence to zoning regimes, such that relatively liberal-building cities tend to stay that way even after population growth begins ramping up. And assume that as San Francisco deflects away would-be migrants to other cities, critical masses of people begin to pile up, leading to the growth of new tech hubs, at least some of which will occur in liberal-building places. Then maybe one eventually generates a flip in technological leadership to a city that likes building more than San Francisco. On the other hand, if San Francisco zoning mostly deflects away non-techies who add to San Francisco congestion without adding much to its tech-centre synergies, then San Francisco's regulations may be reinforcing its status as technological leader.
That leaves technology as the saving grace. Maybe we invent really good holodecks, which make it much less critical to actually be in San Francisco. Maybe we invent teleportation, laws of physics be damned. Maybe we simply come up with better ways to build and design cities, which minimise the real or perceived downsides to residents of new building.
Or maybe we do nothing, and simply sit back and observe as housing remains an instrument of oligarchy. Who knows. But however one imagines this playing out, we should be clear about what is happening, and what its effects have been.
