The nation undoubtedly faces an affordable housing problem, one that can be understood through the economic lens of housing supply-and-demand. Since the Great Recession, mortgage rates have remained low but at the expense of overall housing costs, with prices of the average American home soaring to $316,000 in June of 2019. A study by Freddie Mac attributes the rise in housing prices and rental rates to a growing housing demand and a diminishing supply. Alarmingly, the U.S. economy is 2.5 million housing units short of its long-run demand.
Today, there are ongoing policy proposals to make housing more affordable. Yet many of the proposals come with unintended, and oftentimes adverse, consequences. An analysis, then, should be done on the supply-and-demand dynamics of housing. Such an analysis will naturally lend itself to clearer solutions for housing affordability.
A Diminished Housing Supply
As noted before, the U.S. economy is 2.5 million housing units short of its demand. This housing shortage is driven by two factors: 1) a depleted construction industry, and 2) land-use controls limiting housing in areas with robust employment growth.
A study by the National Association of Home Builders shows that 2018 marked a post-crisis high of unfilled construction jobs. Further, the current construction labor force is 1.2 million workers short of the 2006 construction boom, despite the 2.5 million housing units demanded today.
In part, the shortage stems from the curtailing of immigration, a population that makes up 25 percent of the construction industry. The shortages in both labor and housing have driven up costs for construction firms, cutting into profits on the margin. With marginally less profit per additional project, firms have incentive to focus on luxury property rather than affordable housing, further driving up prices on an increasingly scarce supply of low-income housing.
In urban cities, housing is inelastically supplied—meaning, on the margin, the cost is high to supply one additional housing unit. For the large part land-use controls are to blame.
Defined as zoning regulations, permit requirements, and building codes, land-use controls are essential to a healthy and comfortable living environment. Yet when taken too far they quickly become exclusionary. Restrictions on lot size, building height, or placement often result in inefficient uses of urban space; meanwhile, costly permit requirements and building codes disincentivize new construction. In fact, new research suggests that zoning and land-use controls resulted in an 8.9% decline in aggregate economic output and a 50% decline in aggregate U.S. economic growth over a span of 45 years. Given studies like these, cost-benefit analyses for rigid land-use controls (namely environmentalism and protecting community life) have become unfavorable; protections advocated by municipalities, established businesses, and neighborhoods should not come at such a cost to economic growth.
Thus, fixing the supply-side of the affordable housing problem has garnered bipartisan attention. Democratic presidential hopefuls have labelled housing affordability a crisis, proposing plans to roll back irrational land-use regulations. And on June 25, President Trump signed an executive order that established a White House council to investigate affordable housing regulation. Both plans target impediments to urban growth, namely zoning restrictions on lot size, height, building placement, and excessive permit requirements. With more space to build and less cost for permits, the price to build should lessen.
An Excess in Housing Demand
Policymakers appear to have less of a grasp on the demand-side dynamics of housing affordability. On the supply-side, solutions are relatively simpler: if the construction industry is waning, create policy for its revival; if land-use controls are hindering growth, deregulate them. In both cases, policymakers increase supply due to its shortage. Applying the same intuitive logic, should policymakers decrease housing demand due to its excess? In reality, this appears impractical.
The increase in housing demand has been driven by less controllable variables than the supply-side including shifts in demographics as people live longer, greater credit availability, and historically low interest rates since the financial crisis. Policymakers cannot mold policy to alter such trends. Thus, instead of analyzing the origins of housing demand—as was done above with housing supply—a more worthwhile analysis should be directed at the two proposed solutions for housing affordability that impact consumer housing demand: subsidization and privatization of the housing industry.
Housing subsidies are meant to lessen the financial burden of low-income Americans. Most housing subsidies function as a tax credit for low-income renters. If, for instance, a renter spends more than a certain percentage of income on housing, then he or she is awarded a proportionate tax credit for housing costs.
A recent article detailed the 2020 Democratic presidential contenders’ plans to subsidize the industry. One plan costs $93 billion, another $134 million, and another over $200 billion. Such varying cost estimates illustrate the novelty and complexity of the problem, yet it is not the aim of this piece to detail the cost-effectiveness of individual proposals, their sponsors, nor their merits or pitfalls. Indeed, without a thorough cost-benefit analysis, these numbers are not useful as one cannot factually determine their effectiveness.
Instead, an examination of the effect of large subsidies on the housing market would be instructive. In the short-run, more money would be redirected toward low-income Americans, lessening their financial burden. Yet the tools of economics offer further nuance about housing demand. As the article noted, “There is surface logic to giving money to people who can’t afford to pay the rent.” In a housing market where demand exceeds supply by 2.5 million housing units, a large boost in housing subsidies would, in the long-run, only further spike housing demand for those previously unable to pay rent. As housing demand ramps upward, these policies could inadvertently increase rental prices. Therefore, by heavily targeting housing demand (and notheavily targeting supply), large subsides run the risk of eventually making rent less affordable. Though well-intentioned, the subsidies could result in the opposite outcome than was originally intended.
What then is the opposing case on how to solve the affordable housing problem via demand? Reduce residents’ dependence on public housing. According to Howard Huscok of City Journal, the zoning of public housing shuts out the potential for cities to generate new wealth and opportunity for high- and low-income residents, as it restricts private building and entrepreneurship.
The Trump Administration’s requested FY20 budget seems to reflect this sentiment: Department of Housing and Urban Development’s (HUD) funding is set to decrease by $8.7 billion, or 16.4 percent, from the 2019 estimate; the budget proposes to replace portions of public housing with housing vouchers (wherein landlords in the private market are given subsidies to reduce prices for low-income families). Further, current subsidy plans would be eliminated if deemed “inefficient,” an ambiguous term that is not further defined. Both options aim to reduce dependence on public housing by redirecting housing demand to the private market.
Theoretically, the free market would have its way: since low-income housing is highly demanded, producers (construction firms) in the private market would seek to satisfy that demand. The market would thus spur low-income housing construction, increasing its supply for potential buyers. Although there could be promise in pseudo-privatizing the public housing industry, it appears to be a political pipe dream due to its short-run consequences.
In this hypothetical, unforeseen tradeoffs would result in disproportionately negative outcomes for the most vulnerable citizens. If left mostly to the private market, short-run prices would almost surely increase; and as housing construction is a slow process, market prices would not lower until more units are supplied down the road.Therefore, low-income Americans run the risk of losing their publicly-funded homes to the private market in the short-run.
A Path Forward
Clearly, there are a shortage of housing units in the U.S. economy; the long-run solution, then, should be to increase housing supply by either 1) deregulating land-use controls or 2) reviving the construction industry, or perhaps doing both.
The demand-side is trickier. Subsidizing provides short-run benefits and long-run costs to the people it purports to help; privatization is just the opposite. Policymakers must consider the unintended consequences of their actions (while subsidizing), and also the most vulnerable in society (while privatizing). A healthy combination of the two will lead to positive short- and long-term solutions to the housing affordability problem.