Housing: Part 309 - The Closed Access Cities Should Double Or Triple Their Minimum Wages

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by: Kevin A. Erdmann

Here is a story about rising minimum wages leading restaurants in San Francisco to automate or use self-service features. (HT: MR) Recently, I argued that a rule requiring solar panels on homes in California, which would normally be inefficient, might actually be somewhat useful in the upside- down world that develops when your economy is characterized by obstacles to capital allocation. I think this might be a better example.

Now, the best solution to the problem of high-cost cities is to find ways to expand housing in those cities until costs decline to roughly the unobstructed cost of building. When reading this post, please don't lose sight of that fact and that, given the choice, that is the policy I would clearly support. And it is the policy that would clearly lead to more equitable economic outcomes.

Since that solution hasn't been achieved yet, we are faced with the problem of having a handful of cities, with a population that is basically capped at around 50 million, who have a geographical monopoly on certain kinds of productive labor markets. In order for those labor markets to grow or for more Americans to tap into those cooperative networks, we have to engage in a bidding war on the local housing stock. This leads to rising rents and prices until some marginal household who isn't in a position to leverage those cooperative labor networks can't pay the bills anymore and they move away to a less-expensive city to make room for the more productive worker.

This leads to all sorts of conflict, complaints about gentrification, etc. But for the country as a whole - again, if we have to accept that the optimal solution is unavailable - this conflict is a necessary adjustment that will inevitably happen with any economic growth. In fact, accelerating this adjustment and this conflict will help strengthen economic growth because it will match workers better with the locations where they can be most productive.

But whether we encourage this transition or not, it will happen. This is clear today, after we have spent a decade putting the federal thumb on the mortgage market in an attempt to prevent households from bidding up the price of housing. Yet, the conflict and the pressure continue. Rents continue to rise. Local populations are forced to move away.

Before we imposed regulatory brakes on the segregation process, loose lending in 2004 and 2005 was helping to accelerate it. The economy was strong. But accelerating the process that way created a major side-effect. There are two types of Closed Access residents who don't belong there and who need to move away in order to allow productive workers to move in. First are workers who are earning lower wages and who are usually renters. Second, are long-time residents - frequently older households - who are shielded from the high costs because they bought their homes years ago and they are living in homes that would fetch thousands of dollars a month in rent. This is a level of rent that these households would never entertain if they had to pay it in cash each month. But they are insulated from it because they own their homes and they are sitting on unrealized capital gains from years of appreciation. When young, aspirational borrowers bid up the prices of homes in Closed Access cities, it triggered a massive out-migration of these households, who now took advantage of the hot market to realize those capital gains. When flexible lending markets allowed young households to bid those homes up to prices that truly reflected the value of their future rents, the owners were more likely to sell and reap their profits. Hundreds of thousands did.

This had a positive effect of accelerating the segregation process, allowing more productive workers into the Closed Access cities. But this came at a tremendous cost. Because in order to induce that segregation, we had to create trillions of dollars' worth of transfers to those real estate owners. They made space by leaving town, but they took a huge chunk of change with them. In fact, to the extent that workers are willing to pay the entry fee to get into those cities and earn higher incomes, the productivity of those workers went to the former homeowners. The country as a whole was more productive and richer, but the riches were mostly claimed by rentiers.

Long ago, I spent many posts looking at minimum wage laws and concluded that at the national level there seems to be a systematic loss of employment that is associated with rising minimum wages. Normally, that would be a reason to oppose it. But in the upside-down world that is created when we oppose the allocation of capital to its highest use, bad becomes good.

In this case - again, if we are resigned to the fact that these cities will not simply allow more homebuilding - raising the minimum wage is the best alternative to that option. These cities should triple their minimum wage levels. A commenter at the Marginal Revolution link to the original story noted that workers making $50/hour would qualify for housing subsidies in San Francisco. Unless San Francisco can commit to expanding its housing stock, if you need housing subsidies, then you should live somewhere else. You are blocking the process of segregation. The unemployment that would be triggered by a $50 minimum wage would accelerate the process without triggering the trillions of dollars in transfers to real estate owners. Unemployed workers would move away. Maybe some would be able to earn the higher wage level locally, which minimum wage proponents would naturally support. This would be a positive development for the workers that remained.

Maybe, if it was successful enough at triggering unemployment, it would actually lead to lower local rent levels and prices, reducing the transfer of economic rents to existing real estate owners. This might just be an effective way to moderate the housing market again. Just keep raising the local minimum wage until home prices in LA or San Francisco are, say, within 50% of prices in other cities. In the upside-down world of Closed Access, the minimum wage would be a boon to productivity and equality. Let's see how high it can go.

In the upside-down world of Closed Access, marginal increases in the minimum wage that don't lead to significant employment loss would be bad, because the extra income would simply have to be deployed in the never-ending bidding war for housing. So, marginal increases in the minimum wage would probably increase the transfer of economic rents to real estate owners.

In the upside-down world of Closed Access, the minimum wage would only be useful if it was high enough to trigger significant unemployment and reduced the demand for local housing. Let's say that a minimum wage of $50/hour was enough to price out a few million workers who would leave those cities to find work elsewhere, driving rents down so that decent apartments were available for $1,000 per month. Surely, there would be some wage level that would induce such an outcome. The Closed Access cities would be utopian. Everyone there would be comfortable, from the custodian to the CEO. It would be a clear improvement from today's condition. And it would be basically a free lunch. Sure, several million residents will need to move to find gainful employment. But this would arguably be less painful than the process of several million residences gradually moving away as their cost of living slowly grinds higher.

So, I will carve out an exception for minimum wage policy. In most places, minimum wages are questionable. But in the Closed Access cities, the minimum wage should be high enough to bring down home prices.