Posted by on January 6, 2016

In his New Year message, David Cameron, the Prime Minister of the United Kingdom, promised to tackle the “moral outrage” of the UK’s housing crisis which is pricing “hard-working young people” out of the market.  Hopefully, this will be the beginning of an elevation of this issue on the political agenda in the UK.  And in the United States.

It is amazing that zoning, planning, development and construction legislation (altogether, “land use policy”) does not occupy more political bandwidth.  For most families, housing costs are by far their biggest expenditure.  If they own a home, it is their biggest investment.  For most companies, occupation costs are their second biggest expense, after personnel.  Still, when was the last time you saw land use policy discussed in a presidential debate?

A potential reason for this is that, until about the 1980s, it looked like land was going to disappear as a major factor in developed economies.  Agricultural land had long ceased to be important.  Cities were undergoing a slow bleeding of population to the suburbs.  With the improvements in communication and information technology, many thought that there would be a “death of distance” that would also be the death of big cities.

But then something happened.  For reasons that economists are still debating [1], people and businesses started to move back to the centers.  In London and New York City, the number of people living in the heart of the cities has never been higher.  But the supply of property did not keep up with the additional demand and the consequence has been soaring prices.  In turn, these prices have produced rising inequality, falling productivity, falling labor mobility, less integration and greater pollution.  And, oh yes, the Japanese even think that they are a major factor behind the low birth rates seen in advanced countries.

But it didn’t have to be this way.  As is so often the case, the major culprit is bad government policy.

Mark Twain famously advised people to buy land since they aren’t making any more of it.  Although this is largely true[2], the productivity of the land is heavily affected by government policy.  And government policy has, in a classic case of crony capitalism[3], artificially restricted supply and driven up prices.

In Los Angeles, where a study by UCLA found that tenants spend on average 47% of their salaries on rent (way above the 30% rate that is normally considered affordable), 78% of the residential land is zoned for low-density, single-family homes, versus approximately 25% in San Francisco and New York City.  San Francisco, with some of the highest property prices in the USA, could double its housing density and still be only half as crowded as New York City.  In the town of Mountain View, dead in the heart of Silicon Valley and home to some of the leading technology companies, housing is only one-third as dense as San Francisco.  A recent attempt by Google to build housing on its corporate campus in this city is being resisted by neighbors on the grounds that the new homes would mean more pets, apparently posing a grave threat to the local owl population.  When it comes to denying others their California dreaming, the Silicon Valley hypocrites are not without creativity.

I could go on, including through my own experiences in the crazily restrictive city of London, but I am sure that my readers have their own examples.  In any event, David Cameron gets the joke and he knows whom to blame: “If [local governments] can’t get their act together and build the homes their areas need, we will intervene directly.”

We know that the problem is land use policy, and not an absolute scarcity of centrally located land, because economists have come up with clever ways to distinguish between the two[4].  Studies have produced estimates of the costs of these artificial limits to supply that were, as a percentage of the total cost of the building, about 20% in Washington DC and Boston and about 50% in New York City and San Francisco in 1998; they have certainly increased since then.  When the analysis was repeated in Europe in the early 2000s, the results were even more staggering.  Economists estimated that regulation increased the market value of land by roughly 300% in Paris and Milan, 450% in the financial district of London and 800% in the tonier West End of London.  When you consider the total value of real estate in these cities, you can imagine the magnitude of the distortion.  And the wealth transfer.

All of this boils down to a large and growing divergence between the cost of construction and the market value of properties.  In a recent speech entitled “Barriers to Shared Growth: The Case of Land use Regulation and Economic Rents,” the Chairman of the Council of Economic Advisers in the Obama administration, Jason Furman, pointed out that the gap between the inflation-adjusted cost of construction and the inflation-adjusted price of homes in America has increased by about two-thirds since the 1990s.  The gap was much larger before the financial crisis and with the recovery in property prices, it is widening again.  Various studies cited in the speech attributed this growing divergence to restrictive land use policy.

What are the consequences of all this?

One of the major drivers of productivity growth is workers moving to areas offering higher paying, and more productive, jobs.  But to do this, they have to live somewhere.  Although pitching a tent in someone’s back yard is an alternative, but not a costless one, this means that an employee has to be able to afford to live within commuting distance of the new job.

This is obviously difficult if the supply of property is kept artificially low.  For example, economists estimate that the hyper-productive Bay Area in California would have about five times the number of employees if land use policy were relaxed.  One researcher concluded that, across America, these artificial constraints on labor mobility have reduced the size of America’s economy by an estimated 9.5% in 2009.  This was equivalent to a total of $1.4 trillion or almost $5,000 per person.

These restrictions make America poorer, but the effect is far from evenly spread.  Since property is very disproportionately owned by the wealthy, a policy that restricts supply and inflates prices greatly benefits the “haves” to the detriment of the “have nots.”  It is estimated that 40% of the wealth in the UK, a total of £3 trillion, is the consequence of restrictions on land use.  For the US, the estimate is 12.5%, for a fast growing total of $10 trillion.  As an editorial in the Financial Times (entitled “Target the planning laws not the one per cent”) puts it:

It is wealth created not by improving our living standards but by making them worse; by building too few houses in London and San Francisco, not too many.  It is not earned by skill or effort.  It is taken directly from the pockets of some – the young, especially those who were born poor – and transferred to others via political regulations on building.  This is not wealth, this is plunder.

The effect is so huge that one researcher, Mathew Rognlie from the Massachusetts Institute of Technology, has claimed that surging house prices account for the lion’s share of the growing inequality identified by Thomas Piketty in his book Capital in the Twenty-First CenturyThe Economist article that discusses Rognlie’s research sums it up nicely in its sub-title: “Rising house prices may be chiefly responsible for rising inequality.”

And this is only the direct effect on inequality.  Artificially inflated prices also hurt the poor indirectly.  One way has already been mentioned: workers are unable to move to higher paying jobs if they can’t afford to live nearby.  They keep a worse job in an area with more affordable housing – and inequality increases.   And consider the impact of housing costs on access to quality education.   It is a well-known fact that higher quality public schools drive up the prices of homes in the surrounding areas, an effect that would be reduced with less restrictive land use policy.  This is especially detrimental to minority groups that cannot afford to live in the areas where their children can attend good quality public schools.

Put all of this together and it is easy to see that much of the inequality in America today is a direct or indirect result of land use policy.  But you won’t find this point being made in Piketty’s 700-page book.

But the evils of government restrictions don’t end there.  As Edward Glaeser, an economist who focusses on land use, frequently points out, dense cities are much more environmentally friendly than sprawling ones.  California’s Environmental Quality Act (CEQA) allows almost anyone to sue to block development, making it a favorite tool of the “not in my back yard” (NIMBY) crowd.  As a researcher from the University of Southern California note : “The irony is that CEQA is now preventing us from building high-rises near public transit, which would improve the environmental quality by allowing people to walk more and not use their cars.”

I don’t think that you will hear Bernie Sanders make this point the next time he is talking about how capitalism is destroying the environment and causing climate change.

And let’s not forget corruption.  In Spain, the head of the planning office in Marbella, a glitzy seaside area, was jailed for 11 years and fined EUR 240 million for issuing construction permits in return for bribes.  If this is the scale of the bribes, it’s guaranteed that the bogus deals ran into the multiple billions.  In 2014, the Times of India reported that the bribes needed to secure permits in Mumbai equalled up to one-third of construction costs.   Corruption surrounding real estate is endemic in almost all developing countries and in many developed ones.  The explanation is simple.  Only in real estate does a low-level politician or bureaucrat control decisions that have such huge economic effects.

What can be done about these problems?  This posting is already overlong, but here are some suggestions:

Land use restrictions must be drastically reduced or eliminated.  Politicians like David Cameron are finally beginning to learn the lessons of Economics 101 that the best way to deal with high prices is to eliminate restrictions on supply.  And, as Cameron indicated, this will almost certainly require a push from central government.

Local officials, and local voters, have completely perverse incentives when it comes to allowing further development.   Homeowners have no incentive to allow an increase in the competing supply of properties[5].  Local authorities bear much of the increased infrastructure costs associated with growth, while the benefits are typically disbursed over the entire region.  Allowing local control over development is a recipe for NIMBYism run wild, which is precisely what we have.

Greater central control over these decisions would also reduce the scope for local corruption.  Finally, this change would elevate the issue and give it the political prominence that its economic weight merits.

In addition to reducing the extent of land use restrictions, the goal should be to increase certainty, including over timing.  In the current system, a huge impediment to development is uncertainty over what construction rights will be granted and when they will be issued.  By increasing the risk of investment, this has a chilling effect on new supply.   A particular cause of this is the right, embedded in many land use regimes, for neighbors to object to development for nebulous or inappropriate reasons.  These laws are an open invitation to NIMBYism and are frequently abused to suppress competing supply.

Serious consideration should be given to instituting or increasing land taxes.  This is an old idea, going back to the proto-economist Henry George in the 19th century, which is gaining new adherents.  For example, Peter Orszag, the former head of the Congressional Budget Office and the Office of Management and Budget, has recently become a very public proponent of it.  I don’t often find myself in agreement with Orszag, but even a blind pig occasionally finds an acorn.

The beauty of a land tax is that it has a minimal impact on the supply of the taxed good; in fact, by raising the cost of holding idle land, it would likely increase its supply.  As Orszag points out, given the role of property in the recent expansion of inequality, this type of tax is also an effective way to help address this issue.

A land tax would also automatically capture some of the windfall benefits of public infrastructure improvements.  Property Week reports, for example, that the enormous Crossrail infrastructure project in London has caused house prices to increase by up to 73% along its route, beating the London average by over 50%.  Finally, although it can be a little difficult to administer, since it requires estimates of the market value of both unused land and the land beneath buildings, at least it cannot be easily avoided.  It is difficult to hide land in a Swiss bank account.

Although it is tough to love any tax, we have to tax something and I can think of a lot worse things than land.  Cutting other taxes and making up the shortfall with a new or increased land tax makes a lot of sense.

As part of a massive overhaul of K12 education in the US, we need to break the absolute link between schools and their surrounding districts.  This would be easy to achieve with a voucher system or a much broader charter school movement, and is yet another benefit of moving to these systems.

Proximity is an unavoidable issue, but the current system denies access to higher quality schools to families that cannot afford to buy a home in a pricey neighborhood, even though they would be willing to endure the cost and inconvenience of commuting for the sake of their children’s education.

Rising inequality.  Low productivity growth.  Unaffordable housing and low real earnings.  Corruption.  Racial segregation and poor education.  These are some of the biggest problems that we currently face.  Land use policy contributes substantially to all of them, yet it is barely discussed.  This issue needs to be elevated in the political debate, particularly by small-government candidates who can use it to demonstrate how intervention is so often a false friend to the poor in society.  Republican Party candidates, are you listening?  Do you care?

Roger Barris

Weybridge, United Kingdom

[1] The leading theory for this renewed interest in city centers comes from Edward Glaeser, a University of Chicago trained economist who has embraced the dark side and now teaches are Harvard.  Glaeser, in books such as Triumph of the City, argues that advances in technology have increased “network effects,” which is economist-speak for the benefits of being able to hang around with a bunch of other smart, motivated and entrepreneurial people and bullshit about new business ideas.  And then to make these real using the local ecosystems of venture capital firms, supplier companies, and suitable employees.

[2] Although don’t tell this to, for example, the Dutch or the residents of Tokyo, Hong Kong, New Year City or Monte Carlo, all of whom have been manufacturing more land for centuries.

[3] “Crony capitalism,” for those of my readers unfamiliar with the term, refers to the ability of powerful economic interest groups (in this case existing property owners) to use the government for their benefit (in this case by restricting competing supply).

[4] Some of the pioneer work in this field has been done by Glaeser, who used statistics to disentangle the market price of a built home from the market price of the land attached to it.  If the problem is absolute scarcity, then the market value of a built square foot should not be much greater than the market value of a square foot of yard.  In fact, the differences are huge: the built square foot is often worth ten times the unimproved land.

[5] There are entire books dedicated to this particular form of crony capitalism, with titles such as The Homevoter Hypothesis by William Fischel and Scarcity by Design by Peter Salins.

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Posted in: Economics, Policy

Comments

  1. Svetlana
    January 7, 2016

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    Glaeser also said that “ideas are the ultimate creator of wealth”, so not everything is lost..Triumph of the City” is a great reading

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