Are cities humanity’s greatest invention or does the economics of land supply inevitably lead to an ever widening divide between the haves and have-nots?

“A City upon a Hill” is a phrase from the parable of Salt and Light in Jesus’s Sermon on the Mount. In Matthew 5:14, he tells his listeners, “You are the light of the world. A city that is set on a hill cannot be hidden.” Image source: churchsermonseriesideas.com/city-on-a-hill/.

Are cities on a course to create a class divide reminiscent of Dickens’s time -or even worse, some sort of neo-feudal state?

Should we be optimistic or pessimistic about cities?

Many cities around the world, including in my country New Zealand, are struggling with the issues of housing affordability and congestion. Social ills related to housing affordability are becoming more pronounced. There are concerns about a growing underclass of homeless and the inadequately housed. While the middle class is fractioning because housing security is not being achieved like it was for previous generations.

Housing affordability and congestion -the ability of cities to inclusively allow more people to affordably live and interact in urban environments is the modern equivalent of past crises where cities were incubators for fatal diseases.

Some people and many politicians deny the seriousness of what is happening in the housing market. For example, despite rising public outrage, New Zealand’s last government refused to utter the words ‘housing crisis’. This despite the facts on the ground indicating its housing policy settings had failed to work, especially in New Zealand’s biggest city -Auckland.

Worldwide there is a growing movement focusing on urban issues, in particular, housing affordability and congestion. Generation Rent is a phrase that has entered mainstream talk. There are multiple ‘Yes in my backyard’ groups -centred in unaffordable cities like San Francisco, Seattle and London. There are activists, academics and politicians dedicating themselves to finding the right policy tools to rectify the problems cities face in housing affordability and congestion.

Within this wider housing affordability movement it is possible to discern housing optimists and pessimists, the issue which seems to divide them is whether cities have reached peak space or not. In economic speak -whether land for new housing supply is inelastic (fixed) or elastic (flexible). Housing optimists believe space in a city hasn’t peaked -there is flexibility to supply more if needed, while pessimists conflate urban space with land and believe it is fixed. Because of this belief in the inflexible nature of urban land supply housing pessimists believe policies should be focused on equity -capital gains taxes, betterment taxes, banking and finance reforms etc.

Housing optimists

Edward Glaeser

One of the best housing optimists is Edward Glaeser. He believes cities are a triumph of human inventiveness. On the issue of housing affordability Glaeser’s extensive studies indicates it is the particular infrastructures, rules and regulations regarding how urban space is utilised, specific to each particular city which are the biggest factors.

Wikipedia has done a good job summarising Glaeser’s economic research on housing.

During the 2000s, Glaeser’s empirical research has offered a distinctive explanation for the increase in housing prices in many parts of the United States over the past several decades. Unlike many pundits and commentators, who attribute skyrocketing housing prices to a housing bubble created by Alan Greenspan’s monetary policies, Glaeser pointed out that the increase in housing prices was not uniform throughout the country (Glaeser and Gyourko 2002). Glaeser and Gyourko (2002) argued that while the price of housing was significantly higher than construction costs in Boston, Massachusetts and San Francisco and California, in most of the United States, the price of housing remained “close to the marginal, physical costs of new construction.” They argued that dramatic differences in price of housing versus construction costs occurred in places where permits for new buildings had become difficult to obtain (since the 1970s). Compounded with strict zoning laws the supply of new housing in these cities was seriously disrupted. Real estate markets were thus unable to accommodate increases in demand, and housing prices skyrocketed. Glaeser also points to the experience of states such as Arizona and Texas, which experienced tremendous growth in demand for real estate during the same period but, because of looser regulations and the comparative ease of obtaining new building permits, did not witness abnormal increases in housing prices.

Edward Glaeser’s approach is beginning to influence New Zealand policy makers. Steven Joyce, the former Minister of Finance commissioned a report, called “Quantifying the impact of land use regulation: Evidence from New Zealand” published in July 2017. This report almost exclusively used Edward Glaeser’s techniques to show that the cost of new housing in many urban areas of New Zealand, had deviated above its marginal cost due to land use restrictions.

Note, land use restrictions are not just zoning which prevents the outward expansion of a city, it is also restrictions, such as, height, setback, shade planes, heritage, view shafts, minimum car parking requirements etc, which limit the upward expansion of a city.

Auckland’s house building restrictions were assessed as being the worst of any urban centre in New Zealand -56% of the final cost of an average home being estimated to be the result of overly restrictive land use regulations.

In 2016, Edward Glaeser was interviewed by a Australian news channel about his book “Triumph of the City” and how that applied to Australian cities.

Edward Glaeser takes a constructive approach to the problems cities face. Believing that housing affordability and congestion can be fixed by better infrastructure combined with rules and regulations which allow urban space to be more efficiently used. Glaeser’s message is that by taking this approach, cities can continue their successful role as providing the contacts and connections which drive human inventiveness.

Note Glaeser in his interview mentions tax policy -advocating for land value taxes. In New Zealand we would call this unimproved value rates -a type of local government tax. He prefers this tax because it does not add to the marginal cost of building more houses on an urban site. Glaeser also argues that taxing road congestion is an exciting idea, along with Bus Rapid Transit and allowing commercial land owners around train/subway stations to benefit, by being able to develop commercial and residential space and in return to fund, in part, the commuter rail systems. Glaeser stating the closer these transit systems are to being fully commercial operations the better. With regard to automobile dependence Glaeser discusses in some detail that if highways are free, they encourage too much sprawl, causing cities to be somewhat dysfunctional.

Other housing optimists highlight that a number of different cities have solved the issue of affordable housing and there is in fact a variety of successful city development models that could be adopted. I particularly like the following article for the way it describes how different cities using a variety of different urban development models have been successful in building their way to affordable housing.

Housing Pessimists

There is a side of housing affordability movement which is more pessimistic and focuses on the negative outcomes resulting from the housing crisis. For this reason I have called them housing pessimists. They see the property market as unfixable, which will cause an inevitable slide into an increasing class divided society. In their minds political intervention on equity grounds is imperative.

Land supply is seen by housing pessimists, as the root of the problem for a growing divide between the haves and have-nots. This is the contention of the authors of “Rethinking the economics of land and housing”.

Their argument is that land is not being made, that it is just there, fixed in quantity. It is the ultimate monopoly. They argue that fixed land supply and all that follows from that -in particular economic rent and the division of the factors of production into labour, capital and land -was acknowledged in the past but in recent times has been downplayed if not forgotten by the economics profession. They believe this is the driver of an increasingly unequal housing market and a loss of productivity in the economy.

I find housing pessimists good at explaining what is happening in highly supply restricted markets and the implications for those missing out on affordable housing. But their explanation for why a housing crisis exists in the first place I find flawed. It is dependent on the theory that the supply of new residential space is fixed, which as I will explain in the next section is not necessarily the case.

Housing pessimists believe in the importance of reforms to finance and taxation to mitigate the intractable problem of fixed land supply. Below is half-hour interview of the authors of “Rethinking the economics of land and housing”, where they explain their argument -it is certainly worth watching. As I have said, I have serious doubts about the starting premise that a fixed land supply really is the main issue. But otherwise they make an interesting and intelligent argument and it is always good to acknowledge the best differing viewpoints, rather than arguing against strawmen.

In New Zealand’s political economy there are people who advocate for variations of the housing pessimistic view. Gareth Morgan, for example, a rich philanthropist who attempted to start a new political party called The Opportunity Party, has long advocated tax reform to fix the housing bubble and lack of productive investment in New Zealand’s economy. In all his writings and speeches he concentrates on how demand for speculating on the housing market is encouraged through the finance and taxation system at the expense of other productive investments. Gareth thinks that tax reform -a comprehensive capital gains tax is needed to fix this problem This is a quite common argument taken up by a wide group of people. In my opinion Gareth type arguments lacks balance because they do not consider the effects of supply on the housing market.

I doubt that tax reform alone will lead to more affordable housing and I think it is unlikely this sort of demand side consideration is in the long run as important as sorting out the land use considerations which underpins housing supply.

Does it matter that land is not being made anymore?

If any part of the world had reached its limit of ‘production’ with respect to land for housing it would have been Tokyo in the decades since 1963. In that year Tokyo’s inner municipal precinct reached a population of 10 million. But in fact in the decades since, the city has found the land to nearly triple its residential space.

Tokyo Precinct is the central municipality of the world’s largest metropolitan district. Tokyo-Yokohama has a population of 38 million. The metropolitan area extends into four prefectures -Tokyo, as well as the largely suburban Kanagawa, Saitama and Chiba municipalities. In 1963 the Tokyo Precinct had 10 million people and now there is 13.29 million. In 1963 the Precinct’s residents had, on average, 15sqm of residential space per person and now they have about 32sqm. This means the residential built environment has grown from 150m sqm to 425m sqm -an increase of 284% over the last 55 years.

If Tokyo can find the space to nearly triple the built environment across the middle of the biggest city in the world, then I think it is hard to claim that land supply for cities really is fixed.

Cities can grow out too, I am sure that Tokyo’s outer municipalities grew significantly in the last 55 years too. In New Zealand less than 1% of the country’s land area is taken up by towns and cities -so there is space for the expansion of cities if they are allowed to used it.

The political economy in places like London, Auckland and San Francisco might be such that new housing space is inelastically supplied, because it is hard to remove overly restrictive land use rules, provide the necessary infrastructure and change the culture that makes it acceptable for more people to live closer together. Practically in these cities it is true that land supply is fixed. But lacking the political will to make housing supply elastic is a separate issue to claiming a fixed land supply is a fundamental unchangeable economic state for cities.

It is the fixed versus flexible land supply issue which pushes me cautiously towards being a housing optimist. But it is not something I am absolute on. Because of factors like the difficulty purchasing the desired shape and number of urban land parcels for some types of intensification, urban land markets will always, depending on prevailing planning rules, have a greater or lesser amount of supply monopolistic pricing power.

An Auckland economist is studying the pricing power of intensifiable urban land given Auckland’s prevailing planning system -the Unitary Plan -his empirical work and economic literature review indicates there is pricing power.

For New Zealand as a whole, it is a small country, with limited access to bigger construction supply chains for housing and infrastructure. It is possible that demand for housing from a high immigration rate or foreign capital chasing property speculation capital gains or even a safe haven for storing capital could be so great that elastic new residential space is overwhelmed.

This seems to be the experience of Ireland’s property booms and busts. Being free to build in the countryside (often in places with poor access to cities) was not the silver bullet for Ireland achieving affordable housing. During the height of the Celtic Tiger more houses were built than at any other time in the history of Ireland. Yet house prices, housing need and rent supplement dependence kept rising.

Overall I believe that people can be optimistic about cities. In the long run the true nature of cities being a force for good will prevail.