Does America’s Housing Crisis Need Supply-Side Or Demand-Side Solutions?

The latter strategy will be useless, even counter-productive, if not mixed with the former strategy.

High housing costs are an urban American problem, and there is boundless debate on how to address it. Should developers be allowed to build unfettered, or be restricted on the prices they charge and number of units they erect? Should individual buyers compete in open markets, or get government subsidies? Should public officials be YIMBY or NIMBY? Fundamental to these questions is an economic one—should cities seek supply-side or demand-side solutions for housing?

This question taps into an age-old debate about which economic theories achieve the best outcomes. The supply-side argument, popular among conservatives, posits that lower taxes and open markets do, by incentivizing producers to make more of their product, thereby increasing supply and lowering prices. The demand-side position, popularized by the progressive economist John Maynard Keynes, posits that central planning and wealth redistribution increases people’s spending power.

Although originating in academia, this debate has practical applications for housing. Many of America’s most job-intensive metros—such as San Francisco, New York City and Washington, DC—have median home prices double or more the national median. High rents, meanwhile, are common even in lower-cost cities. According to data, 26 of America’s 50 major cities have average one-bedroom rents above $1,000, and seven of them exceed $2,000, with San Francisco topping out by far at $3,600.

The supply-side solution is to deregulate land use laws to allow more construction, something that seems obvious given the huge mismatch in many metros between job and housing growth. The Bay Area, as an extreme example, has, since 2010, added one housing unit for every ten jobs created.

The merits of the different demand-side solutions, however, are more complex. Many officials, having concluded that some demographics won’t be able to find decent housing in an open market, think that these solutions are necessary. Here’s a breakdown of their various ideas.

Reducing Demand

Although this isn’t Keynesian, it fits the demand-side category, and in respect to the housing issue, boils down to one idea: keeping newcomers out. One way to discourage inward migration is by passing restrictive taxes, such as when British Columbia taxed foreign speculation on real estate in Greater Vancouver. Such policies may have the effect of cooling prices, but aren’t exactly socially just. Along with having potential racial undertones—the Vancouver measure was thought to discourage Asian immigrants from buying second homes—these measures defy the historical role of cities, which have long been opportunity zones for outsiders seeking a better life, not gated communities for the natives.

Price Controls

So rents are skyrocketing in your city? Okay, try this: get your elected officials to mandate that owners of existing buildings charge lower rents, and that developers of new ones sell their units at lower prices. After this magic wand has been waved, celebrate the newfound affordable housing…right?

The problem with these mandates is that they ignore how price signals can dictate a market economy, irrespective of government policy. Cities can force landlords not to raise rents, but if that means their revenue streams can’t keep up with inflation or maintenance costs, then landlords will either neglect or abandon those units. This has been the consequence in America’s rent-controlled cities, such as San Francisco, where, despite the housing shortage, between 10,000 and 30,000 units have been abandoned.

Price controls on newly-constructed units, such as Inclusionary Zoning, can discourage construction altogether. Again, that’s because developers must pay certain upfront costs to build projects; forcing them to charge lower prices will make such projects uneconomical.

Subsidizing Individuals

Giving money directly to individuals—the true Keynesianism—is done today via Section 8 rental vouchers. This model is preferred by some conservatives, too, since it funnels money directly to recipients, rather than through the bureaucracy. The problem with vouchers is that they have little usefulness—and may even worsen the problem—in areas where housing supply is artificially limited.

“Given these supply constraints,” writes Ed Pinto, an American Enterprise Institute fellow, “efforts to increase demand are self-defeating—the result is to make home prices less, not more, affordable.”

How so? If a given metro area has numerous voucher recipients, but isn’t increasing housing supply, it means that much more capital is being used on the same set housing stock. That is a recipe for price inflation in housing, or anything else.

Subsidizing Producers

Subsidizing producers—i.e. housing developers—is a strategy that has both supply-side and demand-side elements. For example, Low-Income Housing Tax Credits, a government subsidy granted to developers, enables them to attain financing, which they then use to build low-income housing projects. LIHTC is thus arguably the best option, since it achieves the main goal: producing more affordable units.

The program’s flaw may be in poor execution. According to a May NPR report, LIHTCs fund less housing than they once did. This is due in part to higher approval and construction costs; but also because the program suffers from pricey middlemen called “syndicators,” and some cases of developer fraud. The key, said Iowa Senator Chuck Grassley, was to have increased oversight of the program.

So which is it?

As long as there are disadvantaged people who can’t access housing themselves, there will need to be both demand-side and supply-side solutions. But for the broader affordable housing debate, the emphasis should be much more on the latter. San Francisco is a case study city where every last demand-side strategy—rent control, inclusionary zoning, public housing, an affordability trust fund—has been tried. It remains unaffordable because it hasn’t combined these solutions with a valid agenda to have supply keep pace with population growth.

And that gets to the heart of the answer: even the most dogged demand-side analysts must agree that if more supply, and a broader climate of deregulation, does not exist, it will diminish the effectiveness even of their pet programs. Ones like Section 8, LIHTC and Inclusionary Zoning will become inflicted with red tape, higher costs, and less ways to be used. The loser in that situation will be the person trying to pay their rent.

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