Again: Housing Demand Curves Do Slope Downwards

I wanted to follow up my previous post in defense of the standard view of housing demand curves, because I saw an interesting conversation on Twitter.

This thread is ridiculous. As far as I followed it, I couldn’t actually find anyone who would argue that the sudden magical destruction of half of New York’s housing supply would raise the price of the remainder.

And that’s just bonkers.

First, We Need Some Ground Rules

First of all, a very infuriating sidenote: Nick Rowe is explicit in his piece that his model could only unambiguously apply to a small change in supply. I pointed out in my original piece that Nick’s actual graph and verbiage doesn’t necessarily suggest a small change, but certainly the formal model is about a small change in supply. Yet here we are, casually acting like his (hypothetical) model can be applied to a 50% reduction in the housing stock. For the record, the housing stock very rarely changes by more than a few percentage points per year, if that.

With that frustrating willingness of the casual advocates of the model to abandon their own formal model addressed, let’s get to the meat of the question.

If the housing supply of NYC magically fell by half tomorrow, would prices for the remaining stock rise or fall?

Let’s set a few ground rules. First of all, let’s assume that the method of housing destruction has no impact on residents’ assessments of future housing viability. In other words, this critique is ignored:

When we’re talking about 50% overnight swings in the housing supply of a whole city, we’re clearly talking about one of two things: (1) nuclear attacks and Day-After-Tomorrow-Style-Tsunamais, (2) Magic.

Nuclear attacks and disasters could lead to the remaining housing stock being less valuable because such disasters radically alter the economic benefits to a specific location, or, for nukes, to any population clustering. Plus, those events aren’t relevant because they also destroy non-residential assets and infrastructure. They destroy houses, but also roads, stadiums, and office buildings. And they create damage that takes years to clean up.

So if we want to know the pure effect of a 50% reduction in housing supply, we must, of necessity, be talking about a magical reduction in housing supply. And since it’s magic, we can add in simplifying rules like (1) no policies were changed from current law and (2) nobody’s expectations about the viability of future housing were changed and (3) no non-residential assets were damaged or lost.

Okay, we have our assumptions then. We have those 3 above, plus “Housing stock falls by 50%.”

Next, We Need a Better Theory of Cities

I didn’t make my opinion clear enough in my last article. Let me restate.

Cities do not have strong complementarity; even weak complementarity is handicapped by major problems of congestion and negative strategic complementarity, such as crimes of opportunity. People do not live in cities because “they wanna be where the people are.” They live in cities (talking population clusters here, not urban downtowns) because they wanna be where the jobs, schools, harbors, roads, power plants, sewage, parks, sidewalks, police, and hospitals are.

If only the residential housing stock is destroyed, then the all the real reasons people live in a city will still be there the next day. Roads will suddenly have half the traffic. There will be empty lots right around Subway stops, so the fewer houses near those stops will be prized possessions. All the people who work in New York presumably aren’t just going to be laid off the next day (again, this was a magical reduction in housing supply: no employers were directly disrupted). They have to live somewhere. They’ll pack into existing spaces, bid up the remaining houses, etc.

Some people, finding themselves homeless, will leave. And all those landlords who lost rental units will have a serious negative income shock.

But construction company employment would almost certainly offset these losses in the short- and medium-term. I mean imagine how many construction workers who would suddenly have jobs if the available land for construction in NYC doubled overnight. And imagine the crowds of people who’d be bidding up those new apartments and houses, knowing that, for a few years at least, they’d get a low-congestion NYC.

The long-run price effect is unclear. NYC’s current zoning laws would not allow all destroyed housing to be fully replaced, as much of it predates current laws. As such, it is possible that some housing could never be rebuilt. The size of this effect is unclear. And it’s possible that, with a massive reduction in local population, many local businesses would fold. On the other hand, local construction businesses would grow explosively. Furthermore, we know empirically that land values have tended to be much higher after urban fires and floods than before, as large destruction incidents enable cities to reconfigure to better meet the needs of contemporary production processes. The reality is that reduced housing supply isn’t the only cost to zoning: poorly configured cities are another key cost. The classic examples come from Boston and Chicago, but this result is not atypical.

So really, the long-run effect on home values is ambiguous. If the lost business dynamism from a severe decline in businesses serving locals outweighs the gains from new construction, that would seem to suggest prices should fall. If the lost benefits from reduced complementarity in the short- and maybe long-run outweigh the gains from a better-configured and designed city, then prices should fall. But both of these are empirically unclear questions.

Both questions also depend on NYC zoning laws. If NYC permits huge amounts of new construction, and allows developers flexibility in redesigning whole neighborhoods and re-envisioning the economic life of major sections of the city, then we can expect that post-disaster prices would rise. But if NYC decides that, actually, a lot of these green spaces should stay green, and where we do rebuild, developers should really just rebuild the structures that previously existed, well then, we probably would see prices fall.

However, a caveat: even adding green space could raise prices. If post-disaster NYC develops these green spaces into powerful tourist attractions like the High Line, or into other amenities that greatly improve the quality of life, then even the tight-zoning scenario could see prices rise.

This Seems So Obvious, Lyman. Why Do People Disagree?

They Have Drunk the Milk of Magic.

I assessed a magical loss of housing supply. But that’s not the most magical part of this post.

Complementarity is the most magical part of this post. What is it? I know it’s fun to talk about highly abstracted effects, but we do actually at some point need to get down to brass tacks and talk about what this alleged utility benefit from dense living is.

In the pre-modern period, it was a benefit from security externalities (crowds make you safe, cities had walls, urban clusters were political/military centers), religious amenities (cathedrals and temples), and the extremely tight transportation constraints imposed by (1) unsafe countrysides and (2) poor technology. But this kind of city never included more than 5–15% of the human population.

In the modern period, complementarity relates to basically either total living cost or productivity. Let’s start with total living cost. Dense living puts a very large number of amenities in walking distance. That is, it reduces expenditure on transportation in time and money terms. A person can therefore afford to pay more for their hamburger at the restaurant, because they paid less to get there.

This in turn yields a productivity boost: the urban hamburger-flipper flips more dollars with every spatula. He’s more productive.

Now, the money cost of this is a wash. Money you save on gas you spend on the burger, and there’s no net gain for society. But time you save is a real gain. You pay more for the burger because it’s close to home, and so you work a little more or do higher-value work. The natural, geographic amenities of cities historically helped them achieve clusters of high-value services, and legacy industries are hard to dislodge because they develop agglomerations of peripheral services.

These agglomerations are not, in fact, a product of density, but of history.

Nowadays, when incomes are much higher and our economy produces a vastly large cornucopia of delights and amusements, the value of locating high-income workers in places those workers like (amenity-rich places) is quite high for a firm. But again, this isn’t a gain from density of residence, but density of businesses. Amenities are usually businesses, like stadiums or restaurants. Some are non-business, like parks. Others are more nebulous, like the absence of crime or smog. But crucially, all of these amenities have indirect links to population or density, and those indirect links take years or decades to fully manifest themselves. And in those years or decades, other economic shifts and shocks often occur, which sometimes counteract shifts and shocks in local amenity values.

All of that to say: a 50% housing stock loss would absolutely cause a dramatic short-run price spike. In the long-run, the story is more ambiguous, but a long-run price increase seems quite plausible.

The benefit to living in a city is the density of amenities and businesses. The cost to living in a city is the density of people.

Check out my Podcast about the history of American migration.

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I’m a graduate of the George Washington University’s Elliott School with an MA in International Trade and Investment Policy, and an economist at USDA’s Foreign Agricultural Service. I like to learn about migration, the cotton industry, airplanes, trade policy, space, Africa, and faith. I’m married to a kickass Kentucky woman named Ruth.

My posts are not endorsed by and do not in any way represent the opinions of the United States government or any branch, department, agency, or division of it. My writing represents exclusively my own opinions. I did not receive any financial support or remuneration from any party for this research. More’s the pity.