Nov 20, 2018

Amazon HQ2 Decision Shines Light on Urban Housing Issues

Kevin Erdmann Visiting Fellow

As American cities continue to grapple with rising rents, the Amazon “HQ2” decision is bound to lead to concerns about its effect on local housing costs. It is likely that a development the size of a new Amazon headquarters (even when split in half between the New York and Virginia locations) will cause local housing costs to rise, but it is useful to think carefully about why that’s the case.

In a world without constraints and tradeoffs, rents would not rise. The Amazon headquarters would create new local opportunities and workers would move into the area to take advantage of those opportunities.

In the real world, there are tradeoffs, and even in the best of circumstances, increased demand for living in an area will increase the cost of living and create stresses. Infrastructure will need to be upgraded.  New, denser residential units will cost more to build. New residents will move in, which will change the character of the local neighborhoods. Some current residents will be displaced by in-fill developments. Others will be driven away by rising rents. Others may simply not appreciate the change in character.

Sometimes, new building, itself, is blamed for rising rents. The addition of new, better units attracts more affluent tenants, causing local rents, services, and amenities to change in a way that drives existing tenants away. But, in this case, it is clear that it is the local economic opportunities brought by the new headquarters which will make these locations more valuable, draw more families to the area, and increase the need for, and value of, local housing. In other words, the addition of more expensive housing won’t be attracting affluent new tenants; more affluence will call for the addition of more expensive housing.

Yet, the temptation is often to counter these stresses and changes by limiting housing supply. Stresses on infrastructure, displaced residents, the influx of families that change local demographics and culture can all, in a direct sense, correctly be blamed on an increased supply of housing.

But the fundamental force that will cause those problems is the influx of people and opportunities. Nothing that happens with supply is going to shift the demand for things like housing and infrastructure back to where it was. At the end of the day, the quantity demanded will be rationed, at the margin, by rents.

So, the attempt to stop all of those stresses from growth by limiting growth through housing supply, perversely, can only make them worse. Limited supply reduces the stresses of growth, but it leads to much more pricing pressure, which ends up creating more displacement and more changes to local demographics. A major element in recent American migration patterns has been a relentless flow of households with low incomes out of prosperous cities that permit new homes at very low rates. The two cities that Amazon has named as their choices for new headquarters already suffer from housing supply that restrains growth. At the metro area level, Washington, DC does a better job of permitting new homes than New York City does. But both metro areas are at the sorry end of the spectrum with regard to domestic migration. They both have an unusual amount of outmigration, and the households that move away tend to have much lower incomes than those who stay.

The increase in demand is clearly a good development. While the competition among cities to create individualized subsidies to attract firms like Amazon is not an ideal demonstration of good governance, it does suggest that cities recognize the clear value that the Amazon headquarters brings to them, even after accounting for the stresses. The stresses of a city that is growing because it attracts aspirational households are good stresses, and to an extent they are unavoidable. Even a discovery as purely good as a tonic that prevents cancer would put some oncologists and their staffs out of work.  Progress is always good. That doesn’t mean it ever comes without some costs.

If the rise in demand is met with new supply, that progress comes, mostly, for free. Rents will not increase by much, even though, as is clear in prosperous cities where housing supply has been limited, households are willing to pay much higher rents to gain access to those opportunities where they are forced to.

That is what economists are trying to measure when they report real economic growth—the stuff we get that we don’t have to pay for. Restricting local supply seems to resolve some of the stresses that come along with that free stuff, but in the process, it ceases to be free. Restricted supply comes with a large transfer of rents to homeowners and landlords who now collect extra income for acting like monopolies. It also comes with a large transfer of people who must move out to make way for new families who are willing to outbid them for a spot in the new, more prosperous city.  Now, instead of simply adding something new to the city, something new must be traded out for something else that must be closed down or moved away.

The decision about how to manage local housing markets when growth comes is a decision about managing stress from new abundance or from power and deprivation. The expression of power is a tempting siren’s call, but America’s calling and its strength is to restrain power in order to defend shared abundance. Many urban Americans are operating under a cartel that limits the supply of an important resource, and so America’s most prosperous cities are becoming untethered from that calling.

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