Not Quite As Simple As One Would Like It To Be

Simple economic analysis can take you a very long way.

Not only do I hold this statement to be true, but it is one of the cornerstones of this blog. The idea that at its heart, economics is about a few important principles, and that the judicious application of these principles can take you a very long way – this idea has motivated nearly all of my writing on this blog.

But as with everything else in life, so also with this alluring, tempting idea. Every now and then, simple economic analysis can only take you so far, and you must wheel out the heavy artillery to make further progress.

In yesterday’s video, we heard John Cochrane talk about how if there is a problem, look first for the regulation that caused it. And there is more than an inconvenient iota of truth in that assertion. But between too much regulation and too little regulation lies that slippery little point of the optimum amount of regulation. Nobody knows exactly where that point lies, and it moves once you get close to it, but it is very much there. Finding it is all but impossible. Keeping it in sight once you find it is impossible.

But it’s there all right.

Consider housing.

The conventional wisdom has been that if restrictive zoning regulations are removed, ease of getting building and other permissions simplified, and taxes on construction lowered, it will increase the stock of housing of all kinds including affordable housing. This, in turn, will lead to lowering of house prices – “richer renters trade up into new luxe units, starting a chain of move-ins and move-outs that lower prices for modest homes”. This can be called the “trickle-down” theory of housing affordability. Instead, I’m inclined to believe that a meaningful dent in the housing affordability issue in the medium-term has to involve an increased supply of large volumes of public (or heavily subsidised) housing.

You’ll meet economists who tell you that housing can only be solved by removing as much regulation as possible. You’ll meet other economists who tell you that public housing is the only solution to the problem. And you’ll get bloggers like me, who will tell you that the truth lies somewhere in the middle. But by referring to Gulzar Natarajan’s (GN) excellent blogpost, let me explain to you why I think so:

  1. People in India think like much of the rest of the world, and are inclined to view housing as both a place to stay, but also as an investment asset. These are GN’s words, not mine, taken more or less directly from his blogpost, but they are worth repeating here. Yes the demand for housing is more than the supply, in many cities the world over, but that demand itself rather complicated to think about.
  2. For example, some people buy a house to stay in it. Others buy a house in order to sell it at a high price later, without ever having stayed in it. A Knight-Frank report form 2019 tells us, for example, that 25% of all residential houses in Gurugram are vacant. That number is almost 22% for Pune, 15% for Mumbai and about 10% or so for Ahmedabad, Bengaluru and Delhi.
  3. Who is likely to be able to afford to buy a house as an investment?
  4. Which types of houses will have higher margins?
  5. So the supply of what type of houses will go up?
  6. The answers most likely to be correct for the three questions above are “More affluent folks | luxury housing as opposed to affordable housing | Luxury housing”.
  7. By the way, Noah Smith has an excellent post (referenced by GN in his blogpost) that goes against the case I’m building here. It is, hopefully, free to read, and the link is here. Here’s an excerpt: “…you could probably get them to admit that if we built 10 market-rate (“luxury”) apartments for every resident of Austin, most of them wouldn’t get filled, and landlords would be forced to slash prices, and regular folks would have cheap apartments to live in”
  8. That is, Noah is saying that an increase in supply will get prices down eventually. And with reference to the excerpt, it’s not just “them” – I will also agree that prices will come down eventually. How long will the “eventually” take is one good question to ask in response. That is, how long before the price of those unoccupied apartments will come down? Will the rate of reduction be the same for all cities in all countries? Will class distinctions matter, for example? What about religion, what about caste and what about availability and affordability of public transport?
  9. Or as GN puts it: “We need to step back here a little bit. The starting conditions of the cities under consideration matter. For example, how segmented is the housing market, how do the prices in the different segments compare, what’s the likely profit differential between higher-end and marginal housing, what’s the marginal demand for higher end housing, how does it compare with the supply, how do the starting prices for each housing segment compare with the annual incomes of different population groups etc. Differences in each can generate entirely different outcomes.”
  10. There are many points to make over here, related to pricing, regulations, urbanization, public transport, urban sociology, and much else besides. But for the purposes of this blog post, I’ll leave you with just this one thought: economic models need to be rooted in the lived reality of whichever specific region you are modeling for. Noah isn’t wrong in his post, and neither is GN. But the “correctness” of their argument is very much dependent on whether they’re talking about Bombay or Austin.
  11. Context matters, in other words, and a good first pass answer as an economist always is “Well, that depends.”