This article reviews the urban density debate and argues the relaxation of local zoning restrictions on city center density will create jobs and stabilize housing prices in California’s urban core.

NIMBY barriers to recovery

In the midst of this jobless Lesser Depression, zoning restrictions imposed by local governments must be reviewed, reassessed and changed with political will.

While the Federal Reserve, the White House Administration, Congress and private enterprise have all been struggling to revive the flat-line economy for the past several years, little attention has been given to the shot-callers behind the scenes and the great influence they wield: city planning departments and local zoning boards.

Much attention has been paid to the macro issues facing the real estate market and the general economy during the Lesser Depression — nationwide home sales volume, general pricing trends, foreclosure rates and so on — but we must keep in mind that real estate is always local, with national and global trends extrapolated from micro level market realities. [For more information on all of these factors affecting the California real estate market, see the first tuesday Market Charts.]

While the effect zoning boards have on local real estate markets is self-evident to some extent, it has become clear that the protectionist leanings of Not In My Back Yard (NIMBY) zoning boards have attenuated the economic recovery on the whole, restricting access to the young and talented workforce we have in Generation Y. [For more information on local zoning boards and the economic recovery, see the January 2012 Social Science Research Network (SSRN) study, City Unplanning.]

The protectionist leanings of NIMBY zoning boards have attenuated the economic recovery on the whole.

first tuesday has long advocated a paradigm shift in the California real estate market toward increased urban density. A denser urban core facilitates more robust economic growth and undergirds a sustainable real estate market recovery, thus avoiding runaway pricing brought on by shortages of new construction. With research, scholarship and good sense on our side, it seems clear that zoning restrictions have only become more stringent, further stifling industry and real estate development, and thus job creation.

Some 40 years ago, as the ramifications of zoning restrictions first became apparent in the U.S., there were only three metropolitan areas in which restrictions on land use had a direct effect on pricing, according to the recent study “City Unplanning” by David Schleicher. This effect is determined by disparities between housing prices and the cost of building. As supply is restricted in regions where job opportunities abound, like California, housing prices increase above the mean price, outpacing the equilibrium level controlled long-term by the rate of consumer inflation. [For more information on this fundamental real estate pricing concept, see the October 2011 first tuesday article, The equilibrium trendline: the mean price anchor.]

Today, real estate prices in nearly every major metropolitan region on both coasts of the U.S., as well as some denser inland areas, suffer from this disparity. NIMBY attitudes, adopted by upper echelon enclaves in California’s urban centers, quickly translate into zoning restrictions which keep new development at bay, elbowing the young and talented workforce into the suburban fringes — a location that recent studies have shown the up and coming Gen Y wants nothing to do with. [For more information on the real estate preferences of Gen Y, see the February 2011 first tuesday article, The generations have spoken, who will listen.]

New economic models in the Lesser Depression

In response to of the use of strict zoning regulations to limit nuisances introduced by urban development and increased density, economists have developed a model that demonstrates the benefits of density, not just for local productivity gains and prosperity, but on a macroeconomic scale.

Agglomeration economies are thickly populated urban areas that stand as monuments to the economic gains made possible through the magic of density. Economists studying the effects of urban density on productivity gains and prosperity have articulated the benefits of agglomeration in three basic categories:

  • reduced logistics costs between business owners in cooperative industries;
  • the increased size of labor markets allowing businesses to match with workers best suited to their needs, resulting in greater productivity and efficiency for the employer and higher wages and fuller employment for the labor force; and
  • the existence of information spillovers between businesses, allowing for innovation and more robust competition, as well as information spillovers for individuals among the labor force, who benefit from the added cultural and educational benefits of living in close proximity with other educated and upwardly mobile individuals.

A doubling of density in a metropolitan area’s stock of human capital increases productivity 10 to 20 percent, according to a study by economists at the Federal Reserve Bank of New York. That is to say, all other aspects of a worker’s skills being equal, the density of the region in which a worker is employed exponentially increases his productivity. As a result, the earnings of the inhabitants of higher density areas are greatly increased.  [For the full report from the Federal Reserve Bank of New York, see the March 2010 study, Productivity and the density of human capital.]

The same study shows that 90 percent of U.S. GDP is produced in dense, major metropolitan areas. Couple this with the findings from the SSRN study showing that zoning restrictions are exponentially tighter in these same urban areas, and one becomes acutely aware of the stifling nature of myopic, self-destructive NIMBY attitudes toward urban density.

In essence, dense urban areas have proven to be the industrial and cultural heartbeat of local markets.  Think the massive complexes of high-rise housing in Sao Paulo, Santiago, Bogotá: dynamic western hemisphere cities. When considered in the aggregate, agglomeration economies are worth more than the sum of their parts — other than agriculture and mining industries, the forward motion and overall dynamism of the U.S. economy as a whole happens in these urban areas. While at the same time, access to affordable housing is by far the most limited in the very same regions of frothing economic growth. Result: rising prices for lack of new construction cut off growth just as the local economy is ready to get on a roll.

Suburbia’s death rattle

Unfortunately, as the centripetal forces of job opportunities and rich cultural resources draw people into urban centers, the centrifugal force of NIMBY-dominated zoning boards has kept businesses and workers out. This leads to the suburban sprawl and valuable time wasted on interminable commutes that has created diffuse fringe economies, such as the East Bay in Northern California and the Inland Empire in Southern California.

This trend towards suburbanism was well tolerated, even warmly embraced, through the late 1970s. The confluence of robust government homeownership policies, a glut of inexpensive housing and the strong-arm of affluent NIMBYs eager to protect their neighborhoods from supposed urban decay all colluded to keep prices unreasonably high in city centers.

Gen Y and the Millennials will no longer tolerate the death-march commutes and cultural wastelands that their Baby Boomer forbearers suffered in order to be employed and make their mortgage payments. Thus, the sound of the housing bubble bursting in 2007 could well be considered the death rattle of the suburbs. [For more information on the state of the suburbs, see the July 2011 first tuesday article, The fate of suburbia.]

In order to fuel the bubble, developers followed Wall Street’s lead and the outlying regions of California’s urban communities saw the greatest proliferation of single-family residences (SFRs) it had seen since the post-war period. Of course, this occurred nationwide and the breakneck speed at which SFRs were built, greatly outpacing population and employment growth (read: organic demand), has become the current crippling weight of housing over-supply in the suburbs. Just ask Stockton residents what they think about all this, as its 300,000 residents prepare for the city’s upcoming bankruptcy.

Yet, prices in the city centers are strong, rents even stronger! And employment is held down due to a shortage of housing for all price ranges in urban city centers. Thus we have a glut of homes selling for next to nothing in the suburbs, where there are now no jobs to be had in the Lesser Depression, and a burgeoning boom in the tech industry with no affordable housing to sustain, let alone grow it — a lamentable tale of supply and demand in the labor and housing markets gone horribly wrong.

Lesser Depression requires new zoning paradigm

The realities of the jobless Lesser Depression demand a new paradigm in zoning restrictions and a refreshed attitude toward urban density. A nod to the benefits of increased density and raised height limitations in California’s metropolitan areas and outlying communities equals an embrace of economic growth and prosperity, which inevitably brings a sustainable housing market in its wake.

The disproportionately high housing prices in the population dense regions of California, such as San Diego, Los Angeles, San Francisco and San Jose, only work to stifle economic opportunity, acting as an emergency brake applied to a car that has already crashed.

What California’s housing market needs now is stability. Data compiled and analyzed by first tuesday has shown that prices have yet to return to historical equilibrium following the bursting of the recent housing bubble. Real estate pricing often suffers from a crisis of perspective — prices were so grossly inflated during the boom years that homeowners and real estate professionals watched in stunned disbelief as housing values depreciated by 50 percent or more. In fundamental economic reality however, price depreciation thus far has only driven average home prices in California toward their historical mean, still bumping roughly 15 percent above the long-term average.

By allowing greater density in our urban cores, California can provide greater economic opportunity and the elixir that the housing market needs — price appreciation based on a growing economic base consisting of near-full employment and stable consumer inflation.

Of course, debates over land use and zoning restrictions in California have a built-in end date — the inevitable end of the Baby Boomer influence and the replacement thereof with the urban-oriented, efficiency-driven Gen Y. But the question we must ask is: can California’s economy wait that long?

Editor’s note: This article seeks to contribute to the growing interest in issues of urban density and its effect on the economic recovery. Recent work on agglomeration economies done by economist Paul Krugman, among others, seeks to diagnose and treat issues of income inequality and the increasing regression of the American middle class by identifying the ability of agglomeration economies to stimulate sustainable job growth and create an environment that fosters social, cultural and ultimately financial prosperity for a greater number of Americans. You can read one of Krugman’s seminal essays on agglomeration economies here.