Housing Prices

“Supply Constraints Are Not Valid Instrumental Variables for Home Prices because They Are Correlated with Many Demand Factors,” by Thomas Davidoff. February 2014. SSRN #2400833.

During the early and mid 2000s, housing prices increased dramatically in California, Arizona, Nevada, and Florida—but not in Texas. The conventional explanation for this difference is that the right to build housing (i.e., the securing of zoning and other regulatory approvals) is in short supply in the former states, and thus demand increases result in housing price increases rather than increases in the quantity of houses at stable prices. (See “Zoning’s Steep Price,” Fall 2002.) Even though the resulting housing prices are well above the marginal cost of new construction, new supply is not forthcoming because the legal rights to build are difficult to obtain. In contrast, in the absence of zoning restrictions in places like Texas, even if too many resources are allocated to housing through either market forces or misguided policy, the result will be just more housing rather than a bubble in housing prices.

In my first “Working Papers” column (Summer 2010), I described a paper by Thomas Davidoff from the University of British Columbia Business School that dissented from the view that housing price increases were largely the result of supply restrictions. He demonstrated that metropolitan areas with a history of low price and large supply appreciation in the past had a boom-and-bust price pattern in the 2000s that did not differ from metropolitan areas that had a history of large price appreciation with little supply increase. He argued that this lack of difference in pricing behavior cast doubt on the role that supply constraints (natural or regulatory) played in the housing bubble.

In this new paper, Davidoff critiques the methodology that economists use to conclude that the housing bubble was the result of supply constraints. Typically economists regress the change in housing prices over some time period against one of two measures: the Wharton Residential Land Use Regulatory Index (WRLURI) or a Wharton-developed measure of the amount of land that cannot be developed in a metropolitan area because of characteristics like a steep slope, unsuitable soil, or the presence of wetlands and bodies of water. A positive coefficient on such variables is thought to be sufficient evidence of a supply constraint effect on prices.

Davidoff replicates such a regression of price changes (the ratio of the highest subsequent sale price relative to the 2000 price by metro area) on the Wharton measures across metropolitan areas. He finds that those cities with a one-unit-higher value of the index than average (more restrictions or less developable land) had a 20 percent increase in prices during the boom. He then estimates a regression of quantity changes (the ratio of 2009 to 2000 housing units) on the Wharton index and finds no effect.

Why are price increases explained by the index but not housing supply changes? Davidoff argues that the results can be reconciled if demand growth and supply constraints are correlated. That is, increases in the regulation of housing supply are themselves caused by demand growth. He writes that more desirable locations are more developed, inhabited by people more inclined to favor government intervention, and thus more regulated. The market value of environmental amenities, such as lots on hills with an ocean view, has increased as people have become richer. In turn, the people who live there have acted politically to “preserve” those amenities. Thus, the alleged measures of supply constraint are actually contaminated measures of intense demand fueled by large increases in real income as well as scarce developable land and the regulatory constraints that accompany desirable places.

Paid Maternity Leave

“What Is the Case for Paid Maternity Leave?” by Gordon B. Dahl, Katrine V. Loken, Magne Mogstad, and Kari Vea Salvanes. October 2013. NBER #19595.

This paper assesses the effects of extending publicly financed maternity leave. For their test case, the authors examine Norway, which expanded its maternal leave benefit from 18 to 35 weeks in a series of steps in the late 1980s and early 1990s. While on leave, the mother receives 100 percent of her wage through the program. In 1992, when the 35-week benefit was fully implemented, the program cost roughly 0.5 percent of Norway’s gross domestic product. So what did the taxpayers gain for their money?

The study uses a research discontinuity design comparing results for those born just before the eligibility expansion date with those born just after—the equivalent of random assignment. The design of the Norway expansion makes the program an almost ideal test case. The specific timing of each step increase (two weeks in 1987, two weeks in 1988, two weeks in 1989, four weeks in 1990, four weeks in 1991, and three weeks in 1992) was not announced until less than nine months before implementation to prevent strategic conception, and the data offer no evidence of strategic delivery to take advantage of the extended benefit. In addition, there is no possibility of sample selection problems because the take-up rate among those eligible was 100 percent.

The authors conclude that the program had no effect on a wide variety of outcomes: test scores after 9th grade, high school graduation rate, total years of maternal employment, and parental income. In addition, because there was a minimum earnings requirement to receive the benefit, only 74 percent of mothers were eligible and were more affluent than the population of all mothers. The extensions in paid maternal leave raised taxes, had no observable effects on socially important outcomes, and redistributed Norwegian wealth to the affluent.

Occupational Licensure

“Relaxing Occupational Licensing Requirements: Analyzing Wages and Prices for a Medical Service,” by Morris M. Kleiner, Allison Marier, Kyoung Won Park, and Coady Wing. February 2014. NBER #19906.

Morris Kleiner has studied the economics of occupational licensure extensively (see “A License for Protection,” Fall 2006, and “Working Papers,” Fall 2011). In this paper, Kleiner and coauthors examine the effect of variation across states in the supervisory requirements of nurse practitioners. In states that require nurse practitioners to be supervised by doctors and do not allow independent prescription writing, nurse practitioner wages are 14 percent lower, physician wages are 7 percent higher, and fees charged for heath care services are 3 to 16 percent higher. In states that allow nurse practitioners to practice independently and write prescriptions, the fees charged for services are lower while health care quality (as measured by changes in the infant mortality rate and malpractice insurance premiums) is not affected. Regulations that restrict the ability of nurse practitioners to provide lower-cost routine medical services reduce their income and increase the income of their competitors as well as the prices of medical services.

Banking and Antitrust

“Antitrust and the Financial Sector—with Special Attention to ‘Too Big to Fail,’ ” by Lawrence J. White. April 2014. SSRN #2418954.

Financial analysts from diverse perspectives have argued that the Too Big To Fail (TBTF) banks must be made smaller in order to prevent a recurrence of the financial crisis in the fall of 2008. Lawrence J. White, who directed economic analysis in the Department of Justice’s Antitrust Division in the early 1980s and had a bird’s eye view of the savings and loan crisis in the mid-1980s as a member of the Federal Home Loan Bank Board, has written a paper that asks whether there is an antitrust issue lurking in the lessons from the last financial crisis.

He argues that antitrust should concern itself exclusively with issues of market power and that the characteristics of TBTF financial firms that worry analysts have nothing to do with market power. The firms are opaque, thinly capitalized structures whose creditors can “run”—that is, try to withdraw their money, leaving the banks insolvent and nonfunctioning. But notice that “market power” is nowhere to be found on the list of characteristics that identify TBTF banks; rather, those characteristics focus simply on how integrated the banks are in the broader financial system. Thus, for White, TBTF has nothing to do with antitrust. Instead, TBTF is the result of subsidies and negative externalities that should be dealt with directly rather than through antitrust action.

Electricity Regulation

“When Does Regulation Distort Costs? Lessons from Fuel Procurement in U.S. Electricity Generation,” by Steve Cicala. October 2013. SSRN #2336558.

Electricity regulation and its consequences have faded from public view in recent years. To refresh your memory, federal deregulation of interstate wholesale electricity transactions in the early 1990s and the subsequent increase in cheap natural-gas-fired generation resulted in large differences between wholesale and retail electricity prices in the urbanized coastal areas of the country. Large industrial customers wanted direct access to the cheaper wholesale prices and threatened to invest elsewhere unless they could access the lower spot electricity prices. In response, California and states in the U.S. Northeast “deregulated” the generation of electricity in the late 1990s.

California lowered and froze retail electricity rates from 1996 though 2002 and did not allow any increase for changes in the price of fuel. In the winter of 2000–2001, a draught-induced reduction in hydropower from the Pacific Northwest combined with an increase in natural gas prices to produce wholesale prices that were higher than the frozen retail prices. The resulting shortages and blackouts discredited electricity deregulation in the public’s mind even though they were the result of the retail rate freeze interacting with a deregulated wholesale market. Since then, no state has deregulated its electricity market and many states have reverted to traditional rate regulation.

Even though electricity deregulation is no longer being actively considered anywhere, economists continue to utilize the variation in generator regulatory status across states to study its effects. In this paper, the author employs a difference-in-differences methodology comparing the behavior of generators that were deregulated with the behavior of generators in close geographic proximity but in states that were not deregulated. He finds that deregulated generators reduced the price they paid for coal by 12 percent relative to counterfactual generators in states that continued cost-of-service regulation.

In addition, those coal generators in regulated states installed costly scrubbers to comply with sulfur emissions regulations, while deregulated generators simply switched to burning low-sulfur coal from Wyoming’s Powder River Basin. Cicala argues that outcome supports the Averch-Johnson theory of regulation, which argues that rate-of-return regulation induces more—rather than less—capital-intensive production methods (scrubbers rather than low-sulfur coal) because of the guaranteed rate of return on investment.

In contrast to the findings for coal-fired generators, Cicala finds no difference in the price paid for natural gas between regulated and deregulated states. Coal and natural gas procurement are affected differently by regulation because of differences in the asymmetry of the information available to generators and regulators. Natural gas is a homogenous commodity sold in open, transparent markets, while coal is a heterogeneous commodity whose characteristics must be matched with the capabilities of generators’ boilers and is sold through private bilateral contracts. Regulators are less able to infer whether a coal generator’s expenses are justified.

The savings documented by Cicala are true social welfare gains and not just the result of a transfer of rents from coal mines to utilities. The deregulated generators buy coal from mines that require 25 percent less labor and pay 5 percent higher wages.

Telecommunications Spectrum Allocation

“Next Generation Spectrum Regulation: Price-Guided Radio Policy,” by Kenneth R. Carter. April 2014. SSRN #2422340.

In 1959, Ronald Coase proposed that the creation of property rights and the use of auctions be employed to allocate electromagnetic spectrum. In 1994, the FCC held its first auction for cell phone spectrum. Since then, 87 auctions have been held for various types of spectrum, but administrative rather than market decisions still play a prominent role in spectrum allocation. Bandwidth, signal power, and bandwidth borders are all bureaucratically determined and standardized before auctions are held.

The physics of transmission result in tradeoffs between bandwidth and power for a given level of information transmission capability (bits per second). Because of the standardized choices made by the Federal Communications Commission prior to current auctions, numerous efficiency-enhancing possibilities are eliminated before the current auctions even take place. Carter proposes that bandwidth, power, and level of interference all be variable rather than standard and describes the process by which computer simulation routines could solve the spectrum optimization problem.

ERRATUM

Because of a terminology error, the Spring 2014 article “The Next Banking Crisis,” by Charles W. Calomiris and Stephen H. Haber, incorrectly describes a recently issued final rule on Qualifying Mortgages. The text states that such mortgages have a “total-debt-to-income ratio limit of 43 percent”; in fact, that is the limit of the ratio of debt service to income.