Last month, Glenn Kelman, CEO of the real estate broker Redfin, posted a viral Twitter thread with anecdotes about the unusual state of the housing market. His stories are familiar to anyone who has been following the news: soaring prices, unprecedented bidding wars, inventory at record lows.
Kelman concludes his thread with a warning:
[An] investor recently said, with an ancient touch of awe but also greed, that one source of America’s miraculous economic recovery was the bounty of “the land itself.” We have more room to grow than we ever imagined. We just have to make sure that benefits everyone.
What is the bounty of the land itself? Do we really have room to grow? Can we really make sure that benefits everyone?
When we think of the bounty of the land, we tend to think of amber waves of grain. But in Triumph of the City, Harvard professor Ed Glaeser argues that the wealth of modern America chiefly derives not from our farms, but from the land beneath our cities.
A cursory glance at the statistics would seem to bear this out. An acre of farmland in Iowa today goes for $7,500. A recent study puts the value of an urban acre of land in Houston at $272,000 as of 2010.
That same study estimates the average value of an acre of land in the New York City area at $5,264,000, and puts the value of an acre of land in central New York City at $123,000,000! Put another way, land in central Manhattan is 16,400 times more expensive than the best farmland this country has to offer.
Why is urban land so expensive? In Glaeser’s telling, it is because in a modern economy, economic productivity derives from physical proximity. We need to be close to each other to collaborate and share ideas and build. To do that, we have to live close to each other and have access to modes of transportation that allow us to quickly meet.
It is the development of ideas that makes cities so important to our standard of living. A small team of talented people can write a song or develop software that can be used simultaneously and repeatedly by billions of people, and teams are simply more effective when they can communicate in person.
One illustration of this is the Covid vaccines, developed by teams from Moderna and BioNTech in labs in Boston and Mainz, with the original mRNA research done by scientists at universities in Philadelphia. Another is the iPhone, developed in Silicon Valley. Our clothes are designed in New York, our software is developed in San Francisco, and our movies are written in Los Angeles.
While communications technology has made it easier for teams to collaborate remotely, high stakes collaboration will likely still mostly happen in person; it is scarcely worth saving a few dollars on rent or airfare when hundreds of millions or billions of dollars are at stake.
The result, then, is that the most productive knowledge workers cluster together to be more effective. Our farms are the land where we grow our food, but our cities are where we grow new technology, and it is technology that makes us wealthy.
It is not just knowledge workers that rely on physical proximity to be productive. Most of what we now think of as our essential workers - teachers, doctors, bus drivers, grocery store clerks - can only be productive by being available in person. This became painfully clear during the pandemic, when they either temporarily lost their jobs or were forced to work and bear the risk of catching the virus.
These service workers have to follow the knowledge workers wherever they go. If there is not enough housing close to the knowledge workers, they will be forced to live in overcrowded conditions or commute a very long way - which is why you hear of “super commutes” in the Bay Area of over two hours each way.
To be close together, as measured in minutes per trip, society has invented new modes of transportation: the bicycle, the electric streetcar, the subway, the automobile, the electric scooter. But the most direct way to be close to one another is to live and work directly on top of one another, as we do in our inner cities.
This is how the most valuable land in Manhattan can be worth 500 times more than the average land in Houston and the resulting buildings can still be somewhat affordable.
In Houston, a 2,000 square foot single family house might be built on an 8,000 square foot plot of land. In Manhattan, apartment towers often have ten square feet of indoor space per square foot of land underneath, so an 800 square foot condo might only use 80 square feet of land!
Good thing, too. At $120 million per acre, or $2,800 per square foot, that 80 square feet of land still costs $224,000, a meaningful contributor to the $1 million+ list price for a unit that size, but completely manageable. This is because our Manhattan apartment is 40 times more land efficient than a typical suburban house! This is perhaps what Kelman means when he says we have more room to grow than we ever imagined.
If we think of America, Inc. as a factory, it is a factory that maximizes output when the workers cluster together as much as possible into a few islands. It is no surprise that the land in the center of those islands is so valuable - living at the center of a knowledge hub raises your productivity and your wages.
This is intuitively true for the people that work directly in a knowledge industry. The BLS says that the median web developer or designer in Seattle makes $144,760 a year, while in Albuquerque, the median web developer or designer makes only $58,940. Wall Street has the high paying finance jobs, Hollywood the good jobs in entertainment, and Washington, DC the top jobs in government.
This is perhaps less intuitively but equally true for the essential service workers in those knowledge hubs. The median cashier makes nearly $34,000 in the Bay Area, but only $23,000 in Albuquerque. The median waiter makes $34,000 in the Bay Area and only $20,000 in Albuquerque. It is true that some of this reflects higher local rent, but it also reflects the fact that higher productivity and wealth in knowledge industries drives up wages for all workers in a region. Put another way, being forced to work in a low-wage region is simply a tax that benefits no one and vanishes into thin air.
It is no surprise that if you introduce something that enforces physical distancing, such as a restrictive land use policy, it wreaks havoc with economic output. The country as a whole loses out, but the biggest losers are the young workers who for example would have liked to have moved to the Bay Area to enjoy higher wages and to learn additional skills at world-class Bay Area firms, but are forced to stay in Albuquerque. It is thus odd that we allow municipalities a totally free hand to determine their own land use policies - they are effectively currently setting economic policy for young people in other cities!
We have discussed before the awesome power of agglomeration effects, the network effects that kick when an industry starts gaining critical mass in a certain region. Skilled workers want to work where there are a lot of firms to choose from and a lot of other skilled workers to learn from, firms want to locate where the skilled workers are and where the specialized suppliers are (such as venture capitalists), and specialized suppliers want to locate where the firms are. This keeps anyone from moving to a less expensive city even when rents are very high, and helps explain why our richest cities are so expensive.
The Economist recently published a story observing that American companies are starting to dominate the global landscape - of the top 100 global companies by market cap, 60% are American, even though America makes up only 4% of the global population. This is of course mostly the result of recent American dominance in tech.
It is true to say that big American companies are globally dominant, but this obscures a significant detail. Of the 100 most valuable companies in America, 50% of those companies (as measured by value) are located in just two tiny regions, Seattle and the San Francisco Bay Area, which combined are home to only 3% of the US population!
These two metropolitan areas have a disproportionate share of the highest paying jobs and opportunity in our country’s leading industries. Even looking at a measure that ignores the impact of the highest paying jobs, the median household income in Seattle and San Francisco is nearly $100,000, far above the $69,000 national median, and even farther above the $51,000 median income in a city like Albuquerque. Keeping our most productive innovation hubs open to newcomers is crucial for our competitiveness as a country.
We have determined that urban land under major productive innovation hubs is very valuable, but this doesn’t tell us how a productive innovation hub comes to be. Glaeser walks us through the history of our leading cities to help us understand this.
In the 19th and early 20th century, transportation costs were so high that the placement of major cities was almost entirely determined by geography. Before we had trucks or even railroads, everything had to move by water. In 1816, it cost as much to ship goods thirty miles overland as it did to ship them across the entire Atlantic Ocean. Most of the earliest American cities were ports along the Atlantic.
The next step was the construction of the canals that connected the agriculturally fertile Midwest to the rest of the country; the Erie Canal connected the Great Lakes to the Atlantic and the Illinois and Michigan Canal connected the Great Lakes to the Mississippi. The cities along the rivers where agricultural goods were processed and transshipped became the biggest cities in America: Buffalo, St. Louis, Chicago, and Cincinnati were all among the top ten most populous cities by 1860.
However, no city was a bigger winner than New York City, which had a deep enough port to handle the big ships now coming from Europe, and was now suddenly connected to the interior of the country via the Hudson River and the Erie Canal. It became a logistics hub, where shipments were repackaged for delivery on smaller ships to the rest of the country.
It was also the logical place for processing and manufacturing the raw materials that came in through the port, to minimize transportation costs. The leading industry in New York for over a century was the garment industry, where incoming textiles from around the world would be turned into ready-to-wear clothes. At the time, sugar refining and publishing were also important manufacturing industries oriented around the port.
The population of New York City grew from 30,000 in 1790 to 800,000 by 1860 to nearly 8 million by 1950. At its peak in 1910, 3% of the entire population of the US lived in Manhattan.
What technology giveth, technology taketh away. The advent of the truck removed the transportation-derived advantages of New York and the other major cities along the rivers and Great Lakes. Factories were already moving to the South before they started moving overseas. The automobile allowed people to move to the suburbs and still be within a convenient trip to the city. New York recovered better than its peers because of its status as the American capital of finance, which boomed as its other industries shrank.
In The New Geography of Jobs, Berkeley economist Enrico Moretti looks at how modern innovation hubs like Silicon Valley came to be. The popular belief is that they tend to spring up close to top universities like Stanford, as basic scientific research done at universities is commercialized. This would explain why Boston, with its huge concentration of top colleges, is so successful.
Moretti actually does not find much support for this hypothesis. There are top universities in almost every major metropolitan area in America, and most of them have not spun off any meaningful industry. Instead, he finds that most research points to the biggest innovation hubs in America being largely the product of random chance.
The biggest innovation hub in America, Silicon Valley, is usually traced back to when William Shockley moved back home to Palo Alto from Bell Labs in New York - this spawned Fairchild, Intel, and the rest of the modern tech industry. Seattle became a tech hub when Bill Gates and Paul Allen moved Microsoft back from Albuquerque to their hometown.
Moretti cites a study by UCLA professors Lynne Zucker and Michael Darby showing that biotech hubs like San Diego and Boston are mostly the result of where star scientists happened to be located when they made their big discoveries. Hollywood can be traced back to D.W. Griffith, and Wall Street to New York’s history as a shipping hub.
We have to be careful not to overstate the case here. It is likely that all of these people who founded innovation hubs went home or chose where they lived in part based on quality of life; it is probably not a coincidence that most modern innovation hubs have popped up in places with temperate climates and room to build.
It is also likely that there is some correlation between higher education and innovation - the sheer number of top universities in Boston gave them more shots on goal and made it more likely that high tech industries would develop in their backyard.
Finally, Moretti says there is some evidence that governments have been able to incentivize niche innovation hubs to develop in smaller cities, and in other countries there have been some limited instances of industrial policy being successful.
However, the conclusion is clear. We flatter ourselves that we can shape the cities we live in to attract wealth and innovation, when the evidence is so strong that people mostly follow natural resources. In another century it was ports and navigable rivers and lumber and ore, today it is warm winters and top research universities and international airports and agglomerations.
We act as if innovation is a product of the cities we build, when in fact it is just often the case that innovators arrive and we grow cities around them after the fact. Historically, getting an innovation hub is more like striking oil than building a factory. This goes some way to explaining the behavior of cities like San Francisco - when you strike oil, you want to try to hoard it, and you get “resource curse” type behavior where everyone directs their energy toward maximizing their slice of the pie, rather than baking more pies. How else to explain the situation in California where instead of building, landowners and construction trade unions and residents negotiate to limit new construction and divvy up the spoils?
We should expect and want our superstar cities to get even bigger. Glaeser observes that we no longer have the same problems with crime, water, and sanitation that limited the growth of cities in the past. The biggest and densest cities are now highly desirable places to live, particularly for young people, so much so that some people pay incredibly high rents and “reverse commute” to their jobs in the suburbs.
The demand to live in big cities is not simply a function of agglomeration effects. The biggest cities have enough scale to offer unique cultural amenities, such as live theater and niche restaurants. They also offer a large market for young people to find mates. Big cities with multiple innovation hubs are much more likely to have specialized, high paying jobs for “power couples”. Finally, different industries in the same city can accelerate innovation by learning from each other. All of these different advantages of scale interact and build on each other.
Nothing better illustrates the entrenched advantages of superstar cities than the recent Amazon HQ2 process, where Amazon solicited tax incentives from every major city in America only to eventually conclude that they instead wanted to expand in New York and Washington DC, the most expensive cities on the list, because talented workers frequently want to live in superstar cities and that single consideration trumped everything else.
It does happen from time to time that a group of capitalists are able to corner a valuable resource that they did little to create.
At the dawn of passenger air travel, in 1938, the government established what would eventually become the Civil Aeronautics Board (CAB) to regulate the aviation industry as a public utility. The CAB had the power to approve new airlines, decide which airlines flew on which routes, and establish airfares.
In practice, the CAB operated on behalf of the airlines. This meant that the existing major “trunk” (non-commuter) carriers were immune from new competition - the CAB never approved a new trunk carrier as long as it existed. Even existing carriers needed to obtain a route certificate from the CAB to fly a new route, which was nearly impossible.
Regulated airfares were calculated on the basis that planes should only be half full, which meant that flights would be more comfortable - airlines today average closer to 80% of capacity - but also meant that airfares would be very, very high, in part to pay for all of that extra empty space. The minimum round-trip airfare from Los Angeles to New York in 1974 was over $1,500 in present-day dollars, a trip you can easily find for less than $300 today.
This meant that airlines were profitable and stable and airline employees and executives were comfortable and well paid, but it also meant that air travel was not within reach of the masses. After, to fly, you effectively had to buy an entire extra empty seat!
The regulatory regime did not cover charter flights, and it did not cover intrastate travel - meaning airlines like Southwest, which flew entirely within Texas at the time, could offer a different model with much more efficient aircraft use and much lower airfares. This offered a model for what deregulated air travel might look like.
When airline deregulation was first proposed in the mid-1970s, the airlines and unions opposed it, claiming that it would deteriorate the quality of American air travel. They of course foresaw that deregulation would render their route certificates worthless, and competition would reduce their collective profits and destabilize their industry.
Deregulation came to pass in 1978,1 and in a way, many of the warnings from the airlines proved accurate. Air travel today is far more crowded and uncomfortable today for those of us who fly economy. Subsidized airfares to some smaller cities went away. Wages for airline employees stagnated. Airlines went bankrupt, reorganized, and then went bankrupt again.
On the other hand, as airfares plummeted, air travel was democratized. Since deregulation, the share of Americans that fly in a given year has more than doubled, and total passenger traffic has more than quintupled.
When you read about that era today, you get the sense that airline executives and employees truly thought of it as their industry. We looked at how after deregulation, then-American Airlines CEO Bob Crandall paid the employees from before deregulation double for doing the same job as new employees, and justified it by saying “they helped build American into the great company that it is”. They saw themselves as the guardians of American air travel, and a stable share of monopoly profits their just reward.
An ownership mentality is healthy up to a point, but looking back, it seems crazy that airline executives saw themselves as the proper gatekeepers of who in America should get access to the miracle of flight! They certainly did not invent the airplane, nor did they design the jet engine. A monopoly on aviation seems like something that properly belongs to society, not the shareholders and executives of whatever airlines happen to exist at the time.
If we accept that airline shareholders (or the executives acting on their behalf) should not be the final word on who in America gets to fly, why should California landowners be the ones who collectively determine who in America gets to live in California? Does California belong to Californians, or to American society as a whole? After all, most of the Californians of today would not be there if there were land use restrictions at the time they moved there; by establishing restrictions beginning in the 1970s, they simply pulled up the ladder after they got to the top.
We are taught that private property exists in part to align incentives. If you build something great that benefits society, you should be able to keep a piece of that for yourself. You can exclude people from using what you build unless they are willing to pay.
If New York and San Francisco are rich because the current residents of those cities worked harder or made sacrifices and investments that the residents of Detroit or Cleveland failed to do, then there is a case that they should have a free hand to limit construction and block outsiders from coming in.
It is hard to square this with the evidence, however. Certainly coastal landowners had little to do with the technological innovation that suddenly made their land so valuable;2 they had nothing to do with the advances in transportation that allowed people to move away from navigable rivers, or the innovation hubs that sprung up when William Shockley moved back home to Palo Alto or when Bill Gates moved back home to Seattle.
It is only natural to want to hoard and restrict access to a scarce and valuable asset to maximize personal profits. It is a basic Econ 101 exercise to show that you will make a lot of money if you collude with your competitors to cause a shortage that allows everyone to raise prices. California homeowners today are behaving no differently than the members of OPEC did in the past.
The modern cartel involves more steps and misdirection than OPEC did, of course. The NFL will highlight their charitable giving, but they always ensure there is a shortage of franchises so teams can credibly threaten to leave to a new city to extract taxpayer-funded stadiums from municipal governments. The airlines of the 1970s made a big deal of the subsidized service to smaller cities enabled by the regulated system of the time while charging massively inflated airfares on popular routes.
Elite colleges publicly tout how they offer scholarships to a small number of underprivileged students so they can remain mostly an exclusive club for the children of alumni and the extremely wealthy, while receiving public funds and tax-exempt status. California homeowners do precisely the same thing - they tout the production of small amounts of affordable housing that is distributed by lottery and limited rent control on older buildings, but they maintain California as an exclusive club for longtime residents and their children and the extremely wealthy who can afford to pay inflated market prices, while receiving massive amounts of public funds via Prop 13 and federal tax breaks.
If California homeowners were really serious in their insistence that blocking development was about ensuring affordable housing, it would be simple to pass a law where future home sales could only take place at a price that reflected a fair return on the initial price paid, thus keeping housing affordable for the next generation. Such a law will surely never be tabled.
Of course, the fight over housing is not only about profit. Another factor is stability. Everyone desires stability, but the unique strength of capitalism is what Schumpeter called “creative destruction” - we are willing to tear what has been built and build bigger and better. This is wonderful for the consumer but destabilizing to the capitalist that is being destroyed.
The airline industry of the 1970s was not even that profitable, but as it was protected from new entrants, it was highly stable, something executives from that time were fought to preserve. While the industry as a whole was less profitable after deregulation, some airlines, like Southwest, were big winners. Many other airlines went out of business.
The status quo is, above all else, stable. New development would bring change. No doubt some homeowners would be big economic winners, as they could now perhaps build 20 units on a plot of land where before they could only build one. Others would be losers, as a new supply of housing brings in more residents and lower prices and more problems. It is perfectly understandable that even homeowners that suspect that they might stand to gain from new development would be willing to fight for the status quo, if they are perfectly happy with their lives as they are.
Finally, at some level, it is all about ego. Airline executives of the 1970s were proud of what they had built, and were offended that there would be Congressional hearings about how bloated and corrupt it was. Even today, over forty years later, they defend the pre-deregulation system.
The residents of any city are proud of what they have built. They believe that it is their wise decisions that have brought prosperity to their region, not outside forces. A developer that wants to tear down what they have built to build bigger and better is delivering both an insult and a threat.
Just as the airlines of the 1970s wanted to dictate that planes should be half full and tickets should be very expensive, so too do homeowners want to dictate that cities should be, well, half full and very expensive. In both cases, it is very clear from market prices that the average consumer would rather pay less and brave the crowds.
In American capitalism, the choice usually falls to the consumer. Participants in a given industry can work together to a limited extent - for example, airlines can establish alliances and standards so you can smoothly transfer from one airline to the next - but they are not typically permitted to collude to block new entrants or coordinate production or prices.
Should we treat homeowners like American Airlines? One counterargument is that we do not typically subject small businesses to the exact same rules as major companies; Grandma’s Friendly Pie Shop is not treated the same as Amazon.
Perhaps the solution is to draw a line between Big Coastal Homeowner and Little Midwest Homeowner. Zillow says that the median home in Albuquerque is worth about $250,000, while the median home in Seattle is $800,000 and the median home in San Francisco is now $1.5 million. The vast majority of America is similar to Albuquerque; the national median home price is $350,000.
In a past essay, we saw that a major flaw of the current system is that we direct massive amounts of public money each year to the richest homeowners, which gets capitalized into the resale value of expensive homes. Homeowners are exempt from tax on imputed rent income, which is relatively worthless to middle class households with inexpensive houses and low income tax rates (that is, the vast majority of homeowners), and a windfall to upper class households with expensive homes and high tax rates. This is worth tens of thousands of dollars a year to wealthy homeowners; the federal government estimates that this exemption alone currently deprives the Treasury of $130 billion a year! That would pay for a lot of affordable housing.
This is compounded by lots of other tax breaks: the deduction of mortgage interest and taxes, the subsidization of the 30-year mortgage, and in California, Prop 13, which mostly exempts longtime homeowners from property taxes and creates a massive budget shortfall that has to be made up through high income taxes on workers - who naturally are more likely to be young newcomers who rent.
We can treat Little Midwest Homeowner like Grandma’s Friendly Pie Shop, and continue to exempt them from taxes and federal oversight. We need only treat Big Coastal Homeowner like American Airlines. This could include the phase-out of tax breaks for expensive homes, the establishment of minimum national property tax rates that would supercede Prop 13, and most importantly, the transfer of planning authority in our most expensive municipalities to the federal government, so we get more development.
Despite the housing crisis, we spend only $70 billion a year on multifamily housing in the entire country. To put that into perspective, as a country we spend $169 billion a year on real estate commissions and transfer costs. Yes, we spend more than twice as much trading existing houses with each other than we do actually building new apartments and condos for people to live in. (No wonder the CEO of Redfin is so interested!)
As Kelman suggests, we do indeed have more room to grow than we ever imagined, and we can do so in a way that benefits everyone. We routinely construct multifamily housing in this country for $200,000 per unit in labor and materials; even with the cost of land, it should be no problem to do so profitably in cities where condos currently sell for over a million dollars. In New York, developers even routinely purchase “air rights” from neighboring buildings for over $300 a square foot so they can build higher and still manage to make money. There is no question that if we permitted more development, we would get more affordable housing.
There is no denying that new development would run counter to the interests of many existing landowners, but competition always runs counter to the interest of existing business owners. In another country, this might be a reason to ban development in our most valuable cities, but this is America!
It is as Woody Guthrie sang: “This land is your land, this land is my land, from California, to the New York island”. Are we going to make sure that California and the New York island are open to everyone?
Ed Glaeser’s Triumph of the City was published a decade ago and is packed with insights about cities that are even more relevant today.
Enrico Moretti’s The New Geography of Jobs from 2013 is a great look at why some cities are richer than others.
Golden Gates, published last year by former WSJ and current NYT economics reporter (and Bay Area native) Conor Dougherty, is a deeply reported look at every angle of the unfolding Bay Area housing crisis, from the politicians to the YIMBY movement to the families being forced out of their homes. Highly recommended.
The story of how deregulation came to pass is an interesting one. There was no outcry over high fares yet at the time. Stephen Breyer, who at the time was a lawyer on the team investigating Watergate, found illegal contributions from American Airlines and realized it was tied to the CAB. Breyer brought it to Senator Ted Kennedy, who was running for President. Kennedy decided that holding hearings on ending the CAB would be a good way to score political points. He lost the nomination to Jimmy Carter, but Carter also thought passing deregulation would be a good win for his administration. In the meantime, the airline industry and the airline unions bungled their efforts to block the legislation. As a result, deregulation was passed far earlier than anyone expected.
If this sounds familiar, this is similar to what Henry George argued in the 19th century to advocate for a land tax.