Housing is productive investment

Here is a great post from the ADP Research Institute about how American population and economic production are being driven by housing supply obstruction and housing expenses. Here are the great closing graphs:

As technology improves, the scope of work that can be geographically shifted will only expand, and the process of domestic offshoring is likely to grow. But if high-paid and high-powered individuals continue to concentrate in command-and-control cities while others are priced out, regional inequality is likely to widen. Inasmuch as opportunities arise from geographic proximity, domestic offshoring may limit the scope of opportunity available to those living in more affordable parts of the country, while locking them out of the more expensive ones. And that, in turn, is bound to fuel social and political polarization.

Halting the technological progress that is expanding the boundaries of work that can be shifted geographically is neither sensible nor feasible. But undoing the policy constraints that stand in the way of curbing housing price appreciation in the nation’s most expensive places is both sensible and feasible. In other words, domestic offshoring is inherently a symptom of the regional divide in housing costs between the nation’s costly and affordable cities. Avoiding its worst implications requires housing policy to effectively address that divide.

I think this relates to a problem I have with a lot of “offshoring” discourse, and points to how large a problem limited housing is.

First Some Thoughts on International Offshoring

Why is there offshoring? Is it because wages for foreign workers are lower than for American workers?

No! It’s not! And it drives me batty that even economists and people who should know better describe it that way. I can understand how a CEO might describe it that way. On a micro-econ scale, that is sort of the decision they are making, but macroeconomists should know better and it should be important to them to describe it correctly.

Why does production move now? Why to one country with low wages instead of a different country with low wages? Why in this industry and not that industry?

The fundamental reason for offshoring is that some places are becoming more productive. And the places that are becoming more productive are generally the places that had previously been less productive, and for whom there is lots of easy catch up growth possible, once they get their local institutions and cultural norms in order (which is really hard to do, don’t mistake me).

Since they are economies that have been unproductive, their relative local improvements increase their capacity to produce, but that production is still relatively low compared to the richer economies. So, their production increases, but it increases specifically in the sorts of low-value-added productive processes that less productive economies can pull off.

Think about it from this perspective. There is a historically poor country. It has previously been dominated by subsistence farms, peddler retailers, domestic production, etc. It pulls some institutional progress together so that it is capable of supporting basic scaled operations - final assembly of consumer goods, more large scale agriculture, etc. What could possibly happen? There really is only one potential outcome. It will be able to specialize in relatively low-value manufacturing and assembly. It will be able to produce more of those types of things. Many of its residents will be able to piece together toys and electronic components rather than sitting on a street corner selling socks and lighters to passersby.

This is a huge win for the country I’m describing. The new toy assemblers will make much less than toy assemblers may have previously made in the rich economies where some toy assembly was still being performed, but they will be making much more than they made sitting at a street corner table selling socks and lighters to passersby.

Offshoring doesn’t move to where wages are low. It moves to where wages are rising!

To the CEO looking at his spreadsheet and deciding to offshore, it looks like the advantage is the low wages. After all, on the spreadsheet, that cell has a lower number! But, the low wages are actually a product of all the cumulative disadvantages of that market. When the offshoring happens, it is the mitigation of all those other disadvantages which has made those markets more competitive. They aren’t so competitive that their workers can earn wages as high as our local workers. But they are competitive enough for their workers to earn higher wages than they used to earn.

But, thinking about the costs as the cause of these transitions is really a distraction. The core change that has happened is that the foreign region is capable of producing more. For the most part, they will be producing things that previously had to be produced elsewhere. That has to lead to offshoring from other places. The details about the relative costs of all the inputs into that production (including wages) are downstream of that fundamental cause.

For instance, imagine a place where wages had been low. Then, because of local progress, something happens that, say, allows for the economical supply of a necessary input into some manufacturing process. Now, that country can become a major supplier of that good. Their wages will still be low, relative to richer counties, but the low wages have nothing to do with the offshoring of that production from other places to their region. There were low wages before they became competitive, and there are slightly less low wages after they become competitive. But, once they become competitive, the CEO looks at her spreadsheet and concludes that they need to offshore production to the “low wage” market, even though they would have never offshored to the same market when wages were even lower.

Offshoring vs. Migration

On the margin, offshoring probably doesn’t create as much value as migration does. In other words, for any individual Mexican worker, emigrating to the United States will raise their wages more than taking a job at a new factory that an American corporation opens in Mexico. That is because the United States has a more functional economic system, so working in America is more productive than working in Mexico.

But, really, this is an apple vs. oranges comparison. A growing local production potential (which includes new facilities that come about from offshoring) is an effect, not a cause. An economy capable of producing more will…. well, it will produce more, and it will create higher local wages. Offshoring is the result of that improvement. Offshoring raises local wages, but it is really just part of the process of wages reaching their new higher potential. When a worker migrates, their personal wages rise, but that change has affected one person rather than an entire economy. Offshoring is the result of improvements across a whole economy.

Of course, the offshoring presents challenges to the regions where the production had previously taken place, which is a localized downside to a global improvement.

What does this have to do with American Housing?

ADP does a good job of parsing these differences. New cultural norms and technologies that make it possible for work to be more decentralized are a sort of technological improvement that can help boost the economic potential of American cities where housing is more affordable. It’s sort of like containerization in global trade. When countries developed the capability to produce more, locally, containerization reduced shipping costs so that they were better able to realize their new local potential by tapping into global markets.

But, we have created a weird situation in American cities. In global production, growth potential is highest where incomes have been lower because they can catch up with the developed world. In the US, we have imposed housing restrictions on ourselves that bind the most in productive cities. So, the potential for growth in the US is positively correlated with current incomes.*

So, building more houses in coastal California and the northeast is like increasing productive potential. That is actually the equivalent of what offshoring normally is, except that, in the US, it can happen in the richest places, and it would involve migration from poor to rich places.

Moving production to other, cheaper cities is sort of like if offshoring meant that American corporations moved production to developing countries and then had American workers move to those less productive countries to perform the work. The local wages in those places would rise, but would it really be a global improvement? It would be a mixed bag.

Housing is productive

A common mistake is to consider housing unproductive. I think, in the colloquial form, this mistake comes from the way that the value of homeownership is linked, inappropriately, to unusual capital gains. The basic value of homeownership is, or should be, the service of shelter, which is measured as rental value. Homeownership can add to that value by aligning the interests of the landlord and the tenant. Because homeowners don’t pay themselves rent, the rental value of owned homes can be forgotten. Because our broken system has produced excess capital gains for some homeowners, this inappropriate benefit of homeownership has been normalized. This sometimes gets twisted into a perverse model of housing that completely discounts the legitimate value of housing and centers the illegitimate value. That is basically what someone is doing whenever they say “Housing can be affordable, or a good investment, but it can’t be both.” That is a confused perspective.

Even in a functional, affordable market, new housing is productive, because it provides shelter, and shelter is useful! As obvious as this is, it runs counter to many colloquial and even professional mental models of housing’s value.

Housing is ultra-productive in the housing deprived cities. In those areas, it doesn’t just provide shelter. Each additional unit lowers the pressure on the marketplace and lowers the excess rental values of the existing homes, returning the national income to productive earners rather than rentiers. New housing in the expensive cities provides shelter to its residents like a normal house does, increases access to productive locations, and lowers the rent transfers from workers to real estate owners across the region. There are probably few sectors that offer more value per dollar invested.

The ultimate reshoring

Building new homes in the expensive cities combines the benefits of improved third world institutions and migrating to high productivity regions (actually by reorienting migration flows back from low productivity to high productivity destinations).

The net migration within the US is from the high cost places to other places. In the case of urban housing, building more will increase global potential while decreasing the localized downsides of these transitions. Currently, households are being forced to migrate away from the cities they would choose to live in. The net result of more housing would be to reduce that displacement. It would be a win-win.

So, I think the developments that are leading firms to relocate some workers to cheaper locations is sort of like an internal offshoring, but as the ADP report notes, this is a pale success compared to providing more opportunities within the cities that are currently expensive and hemorrhaging residents.

*It so happens that the limit to growth is in population, so local total income growth in, say, San Francisco, would be mostly related to rising population, and, in fact, would lower per capita income in San Francisco. The decline in local incomes would be related to fewer economic rents going to residential real estate, so real, earned incomes would end up higher and more equitable. We basically hand over $1 trillion or so a year to American residential real estate owners in unearned rents, which is a very pre-capitalist, third world type of thing to do. We happen to do it where our richest, most productive citizens live. As I complain about frequently, this leads to the confused identification of cities that are in the grips of unproductive rentiers as “superstar” cities.

But, this is a whole can of worms that I shouldn’t have even taken this much space to get distracted with here.