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Land-use Regulations and the U.S. Economic Slowdown

October 16, 2017
Since 1990, population growth in California and New York has stalled. Why? The relative price of moving to those states has soared – partly the result of land use regulations that make other locales more attractive, according to the latest research by economists Kyle Herkenhoff, University of Minnesota, Edward C. Prescott, Arizona State University, and Lee E. Ohanian, UCLA. Rolling back land-use restrictions to where they were in 1980 not only would be a boon for the California and New York economies, but for the national as a whole. In an interview, Herkenhoff discusses why.

Q: What is the cost to the nation’s economy of having stricter land use regulations in places like California and New York than in rival economies in Texas or elsewhere in the South and Southwest?

A: If you deregulated all U.S. states back to what their regulation levels were back in the 1980s, we would see labor productivity increase by 10 percentage points nationwide and consumption increase by about 9 percentage points.

Add gains from putting more qualified people in proximity to one another and that would raise labor productivity by 16 percent points and consumption by 11 percentage points.

Q: How big a deal would that be?

If you compare that to, say, Bob Lucas’ classic paper on what is the cost to the U.S. economy of business cycles, he would have said one-tenth of one percent of lifetime consumption is what you’d give up to get rid of business cycles.

Here you’re willing to give up 9 to 11 percentage points of consumption to drop these land regulations.

Q: Technology is supposed to have freed production from the bounds of location. Why does it still matter where workers are located?
 
A: This project started with Silicon Valley in mind.

In the “idea-producing sector,” something like half or two-thirds the world’s venture capital is funneled through that one small region.  That region is constrained. Everywhere around it, you can’t expand. Our paper takes that kind of region as something that can’t necessarily move easily and is bound around all four sides by geography and regulation in terms of how large it can be.

Certainly, going forward, the ability to, let’s say Skype into meetings, will change the nature of cities, I think. What we’ve done here is largely a historical exercise. Taking the path of urban land and regulations, as given, back to the ‘50s and then saying, “What would happen if we change that path?”

Q: Your research concludes that two of the nation’s most populous states – New York and California – would benefit from more people. That will be a surprise to people living on top of one another in NYC and stuck in California traffic jams.

A: We’re talking about entire states – New York and California. The whole experiment here is taking existing stock of land and making it freer from restriction. Let’s say some of it would have been designated for commercial use only and instead we could turn it into use for apartments. That’s the type of regulation we’re looking at.

Some side effects of that could be that you build taller in San Francisco. I grew up in the Bay area, where we always were worried about earthquakes. But if you’ve been to Tokyo – also under seismic threat – you see that we have the technology to build high.

Q: In places with strict zoning laws, like San Francisco, the people who already own property have a distinct advantage over newcomers, looking to buy housing.

A: The incumbent always has an incentive to ask for more regulations. But have they thought about it in the long run? Have they thought about it in terms of their wages? If their kids are going to have to buy a house around there, you think that would change their minds. We would see greater productivity. We would see large consumption gains for society as a whole. Money not sunk into expensive housing would be spent elsewhere or put into more productive investments.

Society, as whole, would benefit, even if we take into account the congestion and other negative effects of deregulating. If you put more people in a region, many people have argued that they’re more productive.

Some theories put that on lower communication costs, lower commuting costs, more interaction – a bunch of things that are hard to measure but somehow in the data come up showing high density regions typically are very productive. It’s non-trivial.

Q: Can you sort winners from losers if land use policies across the nation became more equal?

A: Across regions, we can tell you that the South and the Rust Belt would lose from reduced zoning restrictions in competing states, even though society gains. A lot of regions benefit from New York and California being highly regulated.

The Rustbelt and the South would lose a lot from deregulation of competing states such as New York or California.

Q: How do jobs and population shift in relation to relative land prices? How responsive are they?

A: I think it’s relatively rapid. This is what got us going. California’s share of the US population goes from six or seven percent in the 1950s to something like 12% in the 1990s. And then it just stops. And then around 1980, California’s house price premium jumps from 30 percent prior to that to about 230 percent after that. To us, it looked really clear that something must have changed in those decades of the 1970s and 1980s, something that restricted how many people could afford to move to California. In the 1990s and around the year 2000, even though there’s a huge “dot.com boom,” California’s population share just stays constant. It doesn’t move.

Q: You wouldn’t predict that?

A: You would not. You would say, “If productivity goes up – where you have Silicon Valley and this radical innovation – that’s where people should be.” People move to economic opportunity. For California to have a 22 percent productivity premium over the rest of the United States – and not be sucking in people – something’s going wrong.

Q: What was your strategy for assessing the role of land prices in fostering productivity and economic growth?

A: Our insight was to use Department of Agriculture surveys that actually measured urban land, across all states, going back to the 1950s. Once you have the quantity of land, and you know how much is being produced on the land, and you have some proxy for the price (census house price data) you can, basically, in standard theory, infer how regulate land use must be.
It’s like being a detective. We have pieces of the puzzle. We know how they’re related. We have a good theory.

Q: You find the future of productivity is reflected in house prices. How?

A: There’s two components to a land prices. One has to do with the regulatory component that reflects how easy it is to switch the use of the land. Then there is this productivity component. Is this economy booming or not? And do people want to live in this region because they have to work? They want to work here and earn the high wages that they see coming in the future.

Those two components of land price are exactly what we’re using to measure regulation.

We see the house price –  from that and from observed productivity, we can tell you what fraction of the house price is reflecting growth or growth in productivity in the region and what fraction of the house price is coming from regulation.

If I’m a city council member and I say, house prices go up and that’s a good signal. When did that change? It sounds like the 1990s.

Q: What would be the consequences of Silicon Valley, lower Manhattan or even Albany, N.Y, reducing land regulation?

A: If you deregulate and that also reduces house prices, you also will, unambiguously, get a rise in labor productivity.

Q: What about consumption and investment?

A: Where we differ from a lot of the existing papers, from the research agenda throughout the 1980s and 1990s, was developing general equilibrium economies, economies where everything adds up.  If you don’t eat it, you can invest it. But if you invest it, you can’t eat it.

What we see in this model is that productivity gains from deregulating are so large that you see both an increase in investment and an increase in consumption. The pie just becomes a whole lot larger.

The Heller-Hurwicz Q&A series shares exciting preliminary research findings from University of Minnesota economists. The text has been edited for clarity and length.