Wednesday, July 24, 2019

Is the increasing cost of housing about productivity?

Construction productivity has long lagged productivity in other sectors.  For example, a McKinsey report has manufacturing productivity in several OECD countries increasing by 70 percent, while construction productivity has been flat.

Microeconomic theory holds that in a competitive economy, in equilibrium, the Marginal Rate of Physical Transformation between goods must equal the Marginal Rate of Substitution (that is, the tradeoff on the production side must equal the trade-off on the consumption side).  Prices equilibrate both.  So let's say in the case above, one could in 1994 trade one house for one bundle of manufactured products. By 2012, one could trade one house for 1.7 bundles.  For this to equilibrate, this means that the price of housing must rise to 1.7X the price of manufactured goods.  This might, in the end, lead people to consumer more housing (because increasing productivity in the manufacturing sector could raise incomes), or less housing (because its relative cost is housing).

The world is more complicated than this--for example, we have not seen overall productivity spill over anything like completely into wages.  But if you wonder why the rent is to damn high, the productivity story could well be a large part of the reason. 

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