November 20, 2024 By Layla Law-Gisiko, President. The City Club of New York
“Buy land; they're not making it anymore”
Mark Twain.
The conventional supply-and-demand approach, which presumes that increasing the housing supply will lead to greater affordability, fails to address the root causes of the housing affordability crisis. This approach, while seemingly primal and basic, is actually specious. Drawing on the theories of Adam Smith, David Ricardo, Thomas Piketty, Joseph Stiglitz, and Ryan-Collins, Lloyd, and Macfarlane in Rethinking the Economics of Land and Housing, critics argue that the conventional approach fails to account for the unique characteristics of land and housing as commodities. They highlight how financialization, speculation, and wealth concentration distort housing markets and exacerbate inequality. The housing crisis cannot be resolved simply by increasing supply without additional interventions that address the influence of land values, speculative investments, and inequality in the housing market and that in certain circumstances, increasing supply will actually exacerbate the housing crisis.
In modern housing policy, increasing the supply of housing is often cited as the primary solution to the affordability crisis. According to a basic supply-and-demand framework, a larger housing stock should reduce prices by creating competition and addressing housing scarcity. However, housing and land are not commodities like others in the market. Land is fixed in supply, derives its value largely from its location and external factors, and is influenced heavily by speculative and financial practices. This analysis reveals that, contrary to the assumptions of traditional economics, increasing the housing supply is unlikely to resolve the crisis unless additional policies address the complex dynamics of land values, speculation, and market concentration.
1. The Distinct Economic Characteristics of Land
Adam Smith, in The Wealth of Nations, identifies that land is economically unique due to its immobility and finite supply. In his example of the Shetland Islands, he notes that the value of land depends not only on the potential productivity of the land itself but also on the resources available in the surrounding environment (Smith, 1776). Smith explains that in Shetland, the high rent was determined not by what could be produced on the land alone but by the fish resources in the adjacent sea that residents relied upon. This example reflects the way land values are often tied to external factors that drive up prices independently of actual housing demand or productivity on the land itself. In urban housing markets, this idea manifests in the form of location premiums—factors like proximity to employment, schools, and amenities—which increase land values beyond what housing construction alone would justify.
David Ricardo builds on this by developing the concept of economic rent in Principles of Political Economy and Taxation. He argues that the increase in land value does not necessarily correlate with improvements or investment in the land. Instead, as demand increases, the price of land rises even when its productive potential remains constant, a phenomenon that primarily benefits landowners without contributing to the general welfare (Ricardo, 1817). This effect is most pronounced in high-demand urban centers, where scarcity of land intensifies competition for available housing and drives up prices. Ricardo’s insights show that demand-driven policies, like increasing housing supply, do not directly address the escalating land prices that underlie much of the housing affordability problem. Without interventions to moderate land prices, even substantial increases in housing supply will fail to bring about affordable housing options.
2. Wealth Inequality and Housing Speculation: Piketty’s Perspective
Thomas Piketty, in Capital in the Twenty-First Century, emphasizes how wealth concentration leads to distortions in housing markets. Piketty’s fundamental inequality, r > g (where the return on capital exceeds the growth rate of the economy), highlights how individuals with access to capital—such as the wealthy, venture capital, hedge funds—can acquire assets, including housing, at a rate that far outpaces the general economic growth (Piketty, 2014). This imbalance allows wealthy individuals and entities to invest in property as a speculative asset rather than a necessity, leading to increased prices that are often untethered from the local economy or the needs of residents.
Piketty’s analysis illustrates that when the wealthy can accumulate multiple properties, invest in high-end housing, or when corporate landlords acquire housing portfolios, the supply of homes for the general population does not increase in a way that supports affordability. Instead, housing becomes a repository for wealth and a hedge against inflation, leading to a form of wealth concentration that exacerbates inequality. For instance, investment in luxury developments intended for high-net-worth individuals contributes little to the affordable housing supply, yet it drives up the average price level and decreases the accessibility of housing for lower-income households. As a result, increasing the housing supply without controlling speculative behavior and wealth concentration fails to address the root causes of unaffordable housing. (Piketty, Thomas. Capital and Ideology. Harvard University Press, 2020.)
3. Financialization of Housing and Market Distortions
Ryan-Collins, Lloyd, and Macfarlane, in Rethinking the Economics of Land and Housing, argue that housing has become heavily financialized in recent decades, meaning it is increasingly treated as a financial asset rather than a basic need. Financialization encourages speculative investment in property, decoupling property values from local income levels and skewing affordability. The authors state that “the financialization of land and housing has encouraged banks to prioritize mortgage lending over other forms of productive lending,” which inflates housing prices due to increased credit availability rather than genuine demand (Ryan-Collins et al., 2017). This speculative demand, driven by banks and financial institutions, promotes the accumulation of housing assets as investment tools, reinforcing rising land values and reducing the stock of affordable housing.
The process of financialization also introduces greater volatility into housing markets, as housing prices become more sensitive to interest rate changes and global financial trends than to local housing needs. Financial institutions have a vested interest in maintaining high property values because it supports mortgage lending as a lucrative revenue stream. This alignment between the banking sector and rising land values perpetuates high prices, particularly in areas with strong investment interest, making affordability elusive for average households. In this context, simply increasing the supply of housing without addressing financial speculation and land valuation practices will not make housing accessible to the general population.
4. The Adverse Effects of YIMBY (Yes In My Backyard) Movements
The YIMBY (Yes In My Backyard) movement, which advocates for increasing housing supply in urban areas, has gained significant momentum in recent years as a response to growing housing shortages. While the movement’s goal of promoting denser housing development is well-intentioned, it often neglects the underlying economic forces that drive housing unaffordability. The assumption that building more housing will automatically lead to lower prices is, in many cases, overly simplistic and flawed. By prioritizing unrestricted development without addressing factors like land speculation, financialization, and wealth concentration, YIMBY policies can inadvertently exacerbate the problem (Ryan-Collins, Lloyd, & Macfarlane, 2017).
In cities where speculative investment is widespread, increasing the housing supply can actually lead to higher land values, as developers focus on constructing luxury units that cater to wealthier individuals and investors, rather than meeting the needs of middle- and low-income households. This phenomenon is particularly evident in areas where financialization has decoupled housing from local income levels, creating a housing market that benefits investors rather than residents (Piketty, 2014). Moreover, YIMBY initiatives that focus exclusively on expanding housing stock may fail to address critical drivers of unaffordability, such as the displacement of existing communities through gentrification. This narrow focus risks exacerbating inequality and driving market-based displacement, ultimately deepening the housing crisis rather than solving it (Wyly, 2021)
5. Policy Implications: Addressing the Roots of Housing Affordability Issues
The insights of Smith, Ricardo, Piketty, and Ryan-Collins and colleagues illustrate that housing markets require a more nuanced approach than simply increasing supply. Smith and Ricardo’s discussions of land’s unique characteristics underscore the need for policies that specifically address the scarcity and value of land in urban areas. Ricardo’s theory of economic rent suggests that mechanisms such as land value taxes could help capture some of the unearned increases in land value, directing it toward public benefit rather than pure profit for landowners. By reducing the potential for speculative gain, land value taxes could moderate price escalation in high-demand areas.
Piketty’s findings highlight the necessity of wealth redistribution measures to curb the effects of speculative investment in housing. Policies that restrict or tax multiple property ownership, as well as taxes on luxury developments, could mitigate the influence of wealth concentration in housing markets and make more housing available for those who need it for shelter rather than investment.
Ryan-Collins et al. suggest regulatory interventions to limit the financial sector’s influence on housing, such as prioritizing lending for first-time homebuyers or restricting lending practices that encourage speculative investment. Addressing the financialization of housing could help shift the focus of housing markets from wealth accumulation toward meeting residents’ needs.
The simplistic supply-and-demand framework is inadequate to solve the housing affordability crisis. As insights from Adam Smith, David Ricardo, Thomas Piketty, and the authors of Rethinking the Economics of Land and Housing demonstrate, housing and land markets operate under unique economic pressures that are distinct from other goods in the market. The scarcity and fixed nature of land, speculative investment behavior, and financialization of housing markets all contribute to a system that drives up prices even when housing supply increases. To address affordability, policies must go beyond supply expansion and tackle these underlying dynamics. Through a combination of land value taxation, anti-speculative regulations, limits on the financialization of housing, and support for public housing, policymakers can develop a comprehensive approach that promotes genuine affordability and ensures that housing serves its intended purpose: providing secure, affordable shelter for all.
References:
Piketty, T. (2014). Capital in the twenty-first century. Harvard University Press.
Piketty, T. (2020). Capital and ideology. Harvard University Press.
Ricardo, D. (1817). Principles of political economy and taxation. John Murray.
Ryan-Collins, J., Lloyd, T., & Macfarlane, L. (2017). Rethinking the economics of land and housing. Zed Books.
Smith, A. (1776). The wealth of nations. W. Strahan and T. Cadell.
Wyly, E. (2022), YIMBY: The Latest Frontier of Gentrification. Int. J. Urban Reg. Res., 46: 319-330. https://doi.org/10.1111/1468-2427.13067