One theme that I see frequently addressed in the literature is the idea that expansion in the financial sector is a causal factor in subsequent stagnation. I think this is a specious correlation. I have argued that low real long term interest rates are predictive of subsequent stagnation and that they are a causal factor in an expanding financial sector.
Further, I have argued that the constraint on homebuilding in our most productive labor markets could actually be a causal factor in the decline of real long term interest rates. And, even without the effect on interest rates, since in a supply-constrained environment, housing demand becomes inelastic, then constraining housing supply leads to an expansion of nominal real estate values. So, there is a direct effect of local supply constraints pushing up local real estate values and potentially an indirect effect of lower real long term interest rates resulting from that local effect leading to higher real estate values everywhere.
So, instead of a series of trends that goes: financial expansion -> housing expansion -> overdevelopment -> contraction
I think, in the recent series of events we have something more like: local supply constraints -> nominal housing expansion -> declining interest rates and declining non-real estate investment -> contraction
|Income = MSA Median Income as % of US Median|
The Closed Access context created by the local housing supply constraints allows firms and workers there to both earn higher incomes. Closed access means less competition for their services. The median income in just 5 cities representing about 15% of US population has now jumped to 125% of the national median income. This is a recent phenomenon. As housing has taken center stage as the binding constraint, costs in these cities have skyrocketed. Even as incomes rise, families in these cities struggle - economic growth doesn't even help, because it just leads to higher rents. All those high incomes go to rent.
So, we see this recent cadre of very high income households, we see rising costs which lower measured real incomes, and we see these families that face economic stress in good times and bad times.
And, just like with all the other conceptual errors we make with this housing issue, we take all these statistics, and we throw them all in the aggregation blender, and it spits out numbers that completely lose the salient part of the information - that this is a localized problem. And, we see a statistical story that looks like:
income inequality -> desperation borrowing -> unsustainable financial expansion -> contraction
And we fill in the details with a story about how middle class consumption is the key to economic growth, and that income inequality leads to stagnation. But, this gets it wrong. First, the borrowing has practically all gone to high income households. But that borrowing is to buy access to the high income cities. They bought access by paying the previous residents of those cities a hefty sum for their homes. And many of those former residents took the cash and retired to Boulder. The high costs that are pulling down real incomes are just an annuity payment on the sunk cost of Closed Access housing. These Closed Access cities have imposed a significant cost on the US economy, and to the extent that capital gains on that real estate have been realized and utilized in household economic decisions, those costs have been internalized. We can fix the future impact of continuing these policies, but the costs that have already been imposed are reflected in the cash transfers to those former owners. We can't get that back.
That story about inequality and desperation borrowing always struck me as a bit odd, anyway. How does an economy characterized by desperate middle class borrowing manifest itself in a housing bubble? In that narrative, the power of predatory lending is carrying a lot of water, and, frankly, even without fully unpacking the counter-narrative I developed about localized housing, it should have struck all of us as comically implausible.
I think the more accurate series of issues here is: local supply constraints -> limited competition among local highly skilled labor in frontier innovative industries -> localized higher profits, wages, and costs -> borrowing to fund access (through local real estate) to those high incomes instead of funding productive investments -> contraction
So, rising inequality is associated with stagnation, but in an upside-down sort of way. The stagnation comes from the higher incomes, because those higher incomes are only serving as a conduits for economic rents. This is also probably associated with reduced growth from investment, both because firms in these cities are protected from competition and also because capital is attracted to rent-seeking in these real estate markets instead of to productive endeavors. I think this explains why practically all the income inequality has come from wage inequality; why wage inequality has practically all come from between firms, not within firms; and why the recent decline in labor share of national income has been paired with rising rental incomes, not rising corporate operating income. All of this is due to limited access to lucrative labor markets. The high incomes are a misdirect.
This all seems very complicated, but it actually boils down to a simple and obvious basic truth. Growth comes from the application of new capital to its highest use. Price signals clearly point to housing in these cities as a valuable asset, and local policies prevent capital from being deployed there. This is basic North, Wallis, and Weingast limited access order stuff. We now have limited access cities with limited access outcomes. (To think that this is what has become of the entry ports for countless immigrants - New York and San Francisco were the urban archetypes of Open Access, the pride of accessible American opportunity. Now residents in the Closed Access cities fight immigration because it drives up rents and complain that only the ultra-rich are moving there.)
This leads to immediate gains for those with access to the constrained assets and losses for everyone else. In the long run it leads to losses for everyone.
The misdiagnosis of this problem: seeing high cost as a product of excessive monetary expansion or as a more generalized problem of corporate power, leads to proposals to cut monetary expansion or to exact generalized punitive or redistributive policies on corporations. But, this problem is already leading to generalized deprivation, so heaping more generalized deprivation on either workers or firms only makes matters worse.