Wednesday, May 23, 2018

Housing: Part 299 - Construction, health, and education employment. Which is unsustainable?

One of the most popular themes you hear about the bubble/bust is that there was massive over-investment into real estate.  This meant that lost manufacturing jobs were temporarily masked by overemployment in construction.  It also meant that Americans thought we were wealthier than we were because we had built a bunch of homes that weren't worth what they were selling for.  When the inevitable bust came, there was a double whammy.  First, all those unsustainable construction jobs disappeared.  And, second American household net worth dropped back down to reasonable "real" levels.

This is one of countless cases where the premise determines the conclusion.  At the center of all conventional explanations of the bubble and bust, there is the presumption that home prices can be pushed wildly above fair value by generous lending and/or speculation.  The problem is that in an asset class like real estate, prices that rise for any reason will be accompanied by rising debt and riskier borrowing.  And, if prices collapse for any reason, the most leveraged owners will fail first and most often.  The fact that these things correlate with price fluctuations tells us deceptively little about the power of credit to move markets.

But, since housing (the service) is related to housing (the asset) that is frequently funded with debt, those correlations are treated as evidence of causation, and the public discussion about housing markets takes off running with presumptions that are rarely questioned, and can't practically be falsified.

Housing is one of three sectors, together with education and health care, that has tended to suffer from lower than average productivity growth, so that consumers tend to spend more on it over time, with much of that spending simply covering inflated prices.

Here, I compare housing (in green) to education and health care (in orange) in terms of percentage of total labor and percentage of GDP.  (Construction employment isn't a great metric here for labor used for housing, but creating a better metric would be time consuming.)

My point here is to address the "keeping up with the Joneses" meme.  That Americans overspent on housing because they wanted a house as nice as their neighbors', even though they couldn't afford it.  The irony is that housing is the outlier here.  Americans have been doing the opposite of that.  Americans' reaction to low productivity in housing has been to maintain nominal spending on housing as a percentage of total consumption, which means that real consumption of housing has not kept pace with rising real incomes.  This has been the case for more than 30 years.  During the boom, the real expansion of housing was just barely starting to expand at the same rate as spending on other categories.

This is in contrast to education and health care, which, both in terms of labor and spending keep growing to larger and larger portions of the American budget.  Now, that's what a sector looks like when we are engaged in an arms race to "keep up with the Joneses".  Ironically, it is the stability of spending on residential housing that leads to this claim only being applied to housing.  Since residential investment has ranged between 4% and 6% of GDP for decades, then that is taken as normal, and an increase to the top of that range is seen as abnormal.

Why?  Why can't Americans decide that marginal new incomes will be spent on housing?  We spend it on education and health care.  Is that spending on education and healthcare unsustainable?  Are we less rich than we think we are because the country is full of overvalued hospitals and universities?  One might reasonably argue that they are overvalued, for similar reasons why housing is overvalued - limited competition.  But, we rightfully see that as a cost, and nobody suggests that the problem is too many schools and hospitals.

To further the irony, to the extent that status is involved in any of these forms of consumption, the status that is associated with housing is generally associated with not overinvesting in real new stock.  The pricey high status units are the units located where residential investment is very limited.

And, in the end, this whole error comes from the problem of associating the service with an asset that has a closely monitored market value which we over-attribute to credit access.  Because, if we didn't overlay all that baggage onto this form of consumption, we wouldn't have this intuition against it.  If Americans decided that their homes should be twice the size they were, who's to argue?  What does that have to do with unsustainability?  If our cars are twice as good as cars were 30 years ago, or our healthcare is twice as good, or our tech gadgets, etc. does that make them unsustainable?  It's an incoherent question.  We consume what we consume.  The way we approach housing consumption is the anomaly.

Let's say we had built millions of unneeded homes, or that we added improvements to our homes in 2005 that were more extensive than they had been before?  (By the way, we didn't.)  It's not like we had to wake up one morning in 2006 and say, "Oh, man.  We can't afford all this housing." and then all move back into smaller units and leave 10% of the housing stock empty until we could actually afford it.  It doesn't work that way.  We built it.  It was here to use.

At that point, any questions about whether we could afford it or not were purely nominal questions - how many dollars would we need to arbitrarily print in order for borrower collateral and ability to pay to remain functional.  Eventually, the public mania about housing became dysfunctional enough that there were widespread calls for making sure we didn't support the functional value of collateral and the ability to repay.  The strong intuition of people to take that position is mindboggling when you step away from it and question the presumptions behind it.  The routine and explicit calls for ruin, even today in hindsight, are a dark lens into the human psyche.

But, before the mania reached that level, the Federal Reserve was explicitly pulling back on nominal growth in order to reduce real residential investment.  And, this goes back to my earlier point.  Can you imagine treating any other form of consumption this way?  Would we slow the economy down to reduce real consumption of education or healthcare?

Housing is pure capital, so we are actually very limited in how much we can do that, because we have to sort of pre-pay for future consumption.  We have to build a unit that will provide housing for years into the future.  It would be like when the tech revolution happened in the late 1990s, if we would have had to pre-pay for all of our future smartphones when we bought our first one.  This makes it difficult to increase our housing consumption.  Yet, because that future consumption is capitalized and because we worry about how that affects our perception of wealth, this is the consumption category we get all tied up in knots about.


  1. I really don't see a difference between housing and smartphones. In the case of phones, corporations made the upfront investment, knowing that future cash flows from the "service" would generate an adequate ROI. There is nothing stopping private capital from building an unlimited supply of homes knowing that future rental streams will deliver an adequate ROI (except zoning regulations perhaps). Yet they choose not to. Perhaps the private market simply isn't excited about future rental streams.

    1. Are you joking?

      "There is nothing stopping private capital from building an unlimited supply of homes knowing that future rental streams will deliver an adequate ROI (except zoning regulations perhaps). Yet they choose not to. Perhaps the private market simply isn't excited about future rental streams."

      Yes, nothing except you cannot build anywhere along the West Coast, in Boston of NYC, or many other places where property zoning restricts supply.

      Give me the right to build whatever I want on two acres in West Los Angeles, and you have made me rich for life.

    2. Well, I did say zoning. But my bigger point was all this talk of the Fed, monetary policy, false-narratives is missing the point. The private market would solve the problem, if it could. 100% of our time should be spent on zoning.

  2. Not on topic but something I thought you'd find interesting. They are retiring Ataturk airport in the middle of Istanbul (as space-constrained a city as there is). So there will be a huge piece of empty land in the city. Seems like a good place to put some houses, but nope: it will be a Monumental People's Garden:

    I wonder at what point the conventional wisdom changed from assuming that bigger cities were better to assuming that cities should be suburban wherever possible.

    1. At least here in the US, i think we should "give up" on big cities. Entrenched interests are too strong, it's a nightmare to build infrastructure, etc. I'd rather see the government make large investments in "tier 3" cities to try to build new competitors to the existing "tier 1" cities. Many people would happily move from the big cities but the momentum can't get going without a kickstart.

  3. Just a quick observation for consideration by Kevin,Benjamin and "Anonymous" ...

    Much has been made here (by all, especially Kevin), as to the restrictive nature of local Zoning regulations. And if I understand Kevin correctly, his "Closed Access City [Area]" construct is the direct (and detrimental) effect specifically of local Zoning restrictions. Actually, I agree (conceptually) with all of that.

    But the implication seems to be that, if "we" (as Kevin is so fond of saying) were to merely "roll back" or eliminate these "government imposed/inflicted" local Zoning ordinances - especially in these "Closed Access" areas - that there would somehow be a surge in home construction, and in particular, low income affordable housing. I'll state flatly that that implication is patently and demonstrably false.

    Any "rollback" of local zoning laws - anywhere - would be immediately supplanted with local "Homeowner's Associations" - with generally/probably more restrictive terms than the governmental zoning restrictions they replace. In fact, if you check various "Closed Access" areas such as the California Bay area (I lived there for 10-12 years), you will find that even highly restrictive, governmental "zoned" areas have "homeowner's associations" in addition, that are substantially more restrictive - AND more legally enforceable - than the "government" zoning.

    Benjamin offers a thought-provoking "challenge":
    "Give me the right to build whatever I want on two acres in West Los Angeles, and you have made me rich for life."

    Well, me too. Except I wouldn't exercise my hypothetical "right" to construct high-density, low-income housing. I'd probably use it to house a small nuclear reactor to supply electricity to all those southern California folks driving Teslas.

    My point here being, no "granted right to build whatever you want on two acres..." - ANYWHERE - extends a "right" to degrade adjacent property.
    See Ronald Coase.

    1. Shayne, there is certainly something to what you say. The problem is widespread enough to be arguably intractable. There are some places where it isn't so bad - Japan, South Korea, Germany, Switzerland. Part of the difference is political. But those differences are deep and not easily changed. And I agree that simply changing a law or two won't be enough. Zoning is really just one tool that is part of a broader framework that, in practical terms, has given too much control to local instructors in an era where urbanization and densification happen to bring tremendous value.
      The sort of state-level restrictions on local rules that Scott Weiner is pushing seem like a step in a functional direction. But I'm no expert on those governance issues. I see my main input as pointing out the damages this is causing. Most notably that it caused a housing bubble that was disastrously blamed on other things. If the urban problem is never solved, I would be very happy if, at least, my work stopped this terrible policy of denying homeownership to a custodian in Omaha trying to buy a $90,000 cottage because restricted housing supply in California created a dislocation.

  4. Hi Kevin:

    If I understand you correctly - and I'm NOT at all certain I do - you are defining "The problem ..." as being a lack of, or at least a sub-optimal level of, low-income affordable housing - particularly in certain areas you've deemed "Closed Access". Furthermore, that the "Closed" aspect of "Access" in this context is due explicitly to local government imposed/inflicted zoning restrictions.

    First, let me say that I am in complete agreement with you regards the second statement above - specifically that local zoning restrictions DO "Close Access" to alternative land uses. That is by design and quite intentional, by the way. I'm also in basic agreement that there exists a very low level of what you or I would consider "low-income affordable housing" in these "Closed Access" areas. As I indicated above, I lived there all through the 80's and into the early 90's, and I can personally attest to the lack of low-income affordable housing. And I visit there often (close friends and relatives), and the "problem" is even more severe now than it was then.

    Where I suspect we disagree - and again, I'm NOT at all certain I'm understanding you correctly - is that "Closing Access" in specifically these areas, has anything at all to do with intentionally denying affordable housing access to low-income folks or driving low-income folks out of these areas. MY assertion is: THAT is decidedly and demonstrably NOT the case.

    Applying the foundational economics principle of "Opportunity Cost", you should quickly realize that the (potentially) residential real estate prices prevalent in places like the SF Bay area have almost nothing to do with either interest rates OR lending availability. They have everything to do with the value of alternative uses for the land - mostly, Industrial uses. As a refresher, the economics principle of "Opportunity Cost" is defined as: "The value of the most highly valued FORESAKEN alternative."

    That is the point I was trying to make with Benjamin's hypothetical "two acres" example above. In the absence of a "zoning restriction" designating explicitly that "two acres" be designated "residential" or even "high density residential", no one would build "residential". They would build "industrial" - because it is more lucrative to do so.

    Or, as I stipulated above, I may well be completely missing your point.

    1. Industrial is not more lucrative. If it was, the land would already be being used for industry and residential zoning/ property rights would already be curtailed, and housing would be a commodity built based on rent.

      However, I don't think its valuable to consider that wishing that rules that prevent new housing being built would all be removed such that housing/cesspool/heavy industry on any site is what is being requested.

      In your specific example, CA electricity costs would mean your power plant starts out as a loser, jokes about Teslas aside. The only value you could add vs cheap empty land in BFE east CA is slightly lower distribution costs, but the distribution network is already built.