New economic geography: fewer centers, more edges

from a plane

There’s obviously no room to build anything, anywhere.

October’s Economist Survey on the global economy by Ryan Avent included a shout-out to his Piketty-informed thoughts on housing prices. In short, the productivity gains from current technology have increased inequality between people and places. The returns on specialized skills are worth more in an era of cheap communication and transportation, great cities aggregate many people with such specialized skills –and furthermore, agglomeration effects appear to be growing even as communications costs decline. Even virtual reality won’t be able to replicate the everyday, subtle reinforcement of ambition that great cities provide; as Paul Graham writes:

The physical world is very high bandwidth, and some of the ways cities send you messages are quite subtle… A city speaks to you mostly by accident—in things you see through windows, in conversations you overhear. It’s not something you have to seek out, but something you can’t turn off.

Ideas have become so complex that those with specialized skills need to gather around others with complementary skills just to understand topics, much less to achieve the discovery or innovation stage. And, well, interesting people like one another; not for nothing has “assortative mating” taken off, spawning study of managing “the two-body problem” in fields like academia and medicine. (Hint: bigger cities, with bigger labor markets, are more likely to solve the problem. This has become a boon to universities recruiting in large metro areas, while those in small college towns struggle.)

In short, there are fewer centers and more edges. Scarcity being what it is, the centers (and only the centers) are winning more capital, and the edges are losing.

The result has been a highly uneven reallocation of wealth, whereby some places are winning in the form of skyrocketing property prices. These high prices create a substantial drag on the economy: increasingly high rents in the most productive locations steal from the most productive. This steers:

  1. Capital towards landlords, enlarging a rentier class (as Piketty notes) and starving more productive sectors.* This creates a vicious circle, as the NIMBY cartel further tightens its regulatory capture over the land use regime, and extracts ever-higher rents.
  2. Labor towards less costly, and less productive, places, creating economic losses. One recent study quantified that economic loss to the United States in 2009 at 13% of GDP — equivalent to sawing off the entire state of California.

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This might be worth unpacking further at a later date: Just reforming land-use regulations, or even entirely repealing the “shadow tax” of zoning, still won’t do enough to produce more affordable housing. Even if zoning is reformed to “make more land,” that land’s still subject to construction’s “hard costs,” which are just too high nowadays.

Construction costs have risen faster than inflation, and far faster than stagnant workforce incomes. Slides 5-6 of this presentation [PDF] by Thomas Hoffman from Enterprise points out that even with free land, even the cheapest construction now costs 50% more than the affordable rent for a low-income family.

Sure, embedded within construction costs are other perhaps-useless regulations, but housing affordability in gateway cities is a problem with many root causes, and with many solutions as well.

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* Rent or mortgage principal paid, aka “housing service expenditure,” does not have a multiplier effect on GDP because it’s not factored into GDP. However, it’s worth noting that in 2000, HSE amounted to nearly $1 trillion, which supported only some of the 1.1 million jobs in real estate (NAICS 531). Reducing rental prices would take investment income from landlords and give them back to consumers, who would probably spend in other sectors that generate more jobs per dollar.

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