Economics of Contempt

Ed Glaeser -- the Harvard economics professor and preeminent urban economist -- has a new paper with Joshua Gottlieb, called "The Economics of Place-Making Policies," which was released today as part of the Spring 2008 Brookings Papers on Economic Activity. The bulk of the paper addresses whether the federal government should undertake policies aimed at strengthening specific places -- for instance, whether the government should try to resuscitate a dying city like Detroit. This is not a new topic for Glaeser, and he again expresses a preference for policies that focus on people rather than places. But the final section of Glaeser and Gottlieb's paper addresses the impact of land use regulations on housing prices, and since I've taken it upon myself to make the case that restrictive land use regulations probably contributed to the housing bubble, I thought I'd highlight what Glaeser and Gottlieb have to say about land use regulations. They present a couple interesting graphs, which I will discuss, but first, here is the crux of their argument with respect to land use regulations:

"If we believe that the most productive areas of the country have restricted construction through extensive land use controls and that these controls are not justified on the basis of other externalities, then it may be welfare-enhancing for the federal government to consider policies that could reduce the barriers to building in highly productive areas."

In other words, the most productive cities (i.e., those with agglomeration economies and lots of skilled workers) are using land use regulations to restrict the supply of new housing, thereby blocking other people from moving in. The most interesting graph (in my opinion) that Glaeser and Gottlieb present is also the simplest. This graph examines the relationship between housing prices and the Wharton Land Use Index (which measures the restrictiveness of a metropolitan area's land use regulations): This shows that restrictive land use regulations are correlated with high housing prices. This is nothing new, and obviously individual housing markets vary widely, but it's interesting to see on a graph at least. It also rebuts the argument that restrictive land use regulations have no effect on housing prices. They do; this is fact. If they don't, then 30+ years of economic studies on land use regulations are wrong. Anyway, to support the argument that productive cities are using land use regulations to restrict the supply of new housing, Glaeser and Gottlieb examine the link between housing prices and the growth in each metropolitan area's housing stock between 2000 and 2005: This graph shows that "the most expensive places have little building and the places with the most building are not particularly expensive." In previous posts, I argued that in the face of a demand shock, restrictive land use regulations cause higher and longer housing price appreciation, which contributes to the psychology that drives speculative housing bubbles (i.e., "housing prices always go up!"). Glaeser and Gottlieb provide one possible source for such a demand shock: the rapid rise in demand for housing in the most productive cities. So it's worth seeing whether the most prominent bubble cities are also among the most productive. If we measure productivity by Gross Metropolitan Product (admittedly a crude measure), here's how the bubble cities rank:

Los Angeles: #2 Miami: #11 Phoenix: #14 San Diego: #16 Inland Empire: #17 Denver: #19 San Jose: #23 Las Vegas: #29

So productivity as the source of demand shocks isn't a panacea, but you could certainly make the case that high productivity contributed to bubble formation in the most prominent bubble cities. The fact that the major bubble cities all ranked in the top 30 for GMP out of 316 metropolitan areas is certainly suggestive, though I'm not sure of what just yet.