Despite claims by the Conference of Mayors and the transportation lobby that there is as much as $96 billion in construction “ready to go,” the fact is that it takes a long time before meaningful numbers of workers can be hired for such projects.

As a recent Congressional Budget Office study explains, “Practically speaking … public works involve long start-up lags. … Even those that are ‘on the shelf’ generally cannot be undertaken quickly enough to provide timely stimulus to the economy.”

The prospects for unconventional projects such as alternative energy sources are even worse. The CBO calls them “totally impractical for counter-cyclical policy” because they take even longer to come online…

Finally, the impact of increased public works spending on state and local governments cannot be ignored. Most federal transportation spending goes for projects initiated by them. When they think there is a chance that the federal government will increase its funding, they tend to cut back on their own spending in hopes that the feds will foot the bill. A study by economist Edward Gramlich found that the $2 billion appropriated by the Local Public Works Act of 1976 postponed $22 billion in total spending as state and local governments competed for federal funds and actually reduced GDP by $30 billion ($225 billion today).

Meanwhile, proponents of infrastructure spending claim that Congress should sift through the shelved projects to identify those projects that will be economically beneficial, or in other words, have a “positive net present value”. One particular free-market impostor is bold enough to advocate highway spending, as “new roads can largely pay for themselves through tolls and other user fees.”

For the non-financial types, Net Present Value (NPV) is the amount of wealth created, discounted (per the time value of money) to the present, of a particular endeavor. Or in other words, positive NPV projects are expected to “pay for themselves”, from an investment point of view. As a simple rule, opportunities that have a positive NPV should be pursued, and negative NPV projects should be avoided.

2008 Nobel Prize winner Paul Krugman possibly infers positive NPV when he says “public investment leaves something of value behind when the stimulus is over”, but just because something of value is left behind doesn’t mean it was a good investment or that it had positive NPV. At the same time, if not inferring positive NPV, Krugman’s inference that something of value is left behind by private investment makes me think that he actually believes NY Times readers will be easily deceived by his amateurish sleight of hand.

While we know that something of value will be created by infrastructure spending, how certain can we be that alternative spending ideas won’t create something of greater value.

Those who claim positive NPV public infrastructure projects are plentiful neglect some common features of infrastructure projects. From my first-hand experience and study, ambitious, large-scale projects are vulnerable to huge cost overruns. I don’t feel I’m going out going out on a limb when I say that very large projects that are completed on-budget or under-budget are a rarity.

Having been involved with many extremely large projects, one thing has been consistent – they have grossly cost more than originally conceived. There are long-standing jokes (not so funny for taxpayers) among consultants that when estimating big projects in Chicago (and I imagine everywhere), you have to assume the cost at the end of the day will be a factor of 2-3 times as expensive. (The factor varies depending on whether it’s airport work, highway work, or other boondoggles.)

I typically attribute the under-estimation to “optimism bias” of project proponents. Politicians promise the public benefits of the project to voters, and if lucky have the project named after themselves.  Often, by the time the over-budget project is complete, the politician’s term will have ended. If all goes as planned, the politician will have moved to a higher office by then. Often, voters forget the cost over-runs of a boondoggle project once they start using it. After all, it was only a few dollars out of each of their pockets.

Furthermore, bureaucrats are driven to expand their departments and budgets. Designers and consultants who advise on the feasibility of the project are interested in eventually having the inside track on the full commission They thus have the incentive to low ball cost estimates, and inflate benefits. Contractors initially bid low, knowing huge projects are full of changes that are typically more lucrative than the original scope.  Estimators often neglect potential risks such as unexpected soil conditions.  They may neglect these things out of expediency, incompetence, or willfully in order to further a project that has the potential to bring future fees.

Industry lobbies produce studies that exaggerate the need for certain projects. Furthermore, project feasibility studies often neglect or underestimate the time needed to condemn the land needed for the large projects, as they usually are not careful to properly anticipate resistance from landowners who do not wish to give up their land or live near the blighted construction site.

For a more in-depth look, Bent Flyvbjerg has extensively studied cost overruns of large projects and similar topics:
How Optimism Bias and Strategic Misrepresentation Undermine Implementation Concept Report No 17 Chapter 3, Bent Flyvbjerg, January 4, 2007.

Characteristics of Large Infrastructure Projects

Large infrastructure projects, and planning for such projects, generally have the following characteristics (Flyvbjerg and Cowi, 2004):

• Such projects are inherently risky due to long planning horizons and complex interfaces.
• Technology is often not standard.
• Decision making and planning is often multi-actor processes with conflicting interests.
• Often the project scope or ambition level change significantly over time.
• Statistical evidence shows that such unplanned events are often unaccounted for, leaving budget contingencies inadequate.
• As a consequence, misinformation about costs, benefits, and risks is the norm.
• The result is cost overruns and/or benefit shortfalls with a majority of projects.

Projects With Cost Overruns and Benefit Shortfalls

The list of examples of projects with cost overruns and/or benefit shortfalls is seemingly endless (Flyvbjerg, 2005a).

Boston‘s Big Dig, – 275 percent or US$11 billion over budget in constant dollars when it opened, and further overruns are accruing due to faulty construction.

Denver‘s $5 billion International Airport were close to 200 percent higher than estimated costs.

The overrun on the San Francisco-Oakland Bay Bridge retrofit was $2.5 billion, or more than 100 percent, even before construction started.

The Channel tunnel between the UK and France came in 80 percent over budget for construction and 140 percent over for financing. At the initial public offering, Eurotunnel, the private owner of the tunnel, lured investors by telling them that 10 percent “would be a reasonable allowance for the possible impact of unforeseen circumstances on construction costs.”

Policy Implications

The policy implications of the results presented above are as follows:

• Lawmakers, investors, and the public cannot trust information about costs, benefits, and risks of large infrastructure projects produced by promoters and planners of such projects.

• The current way of planning large infrastructure projects is ineffective in conventional economic terms, i.e., it leads to Pareto-inefficient investments.

• There is a strong need for reform in policy and planning for large infrastructure projects.

[hat tip: bound rationality]

Also, the wisdom of Tyler Cowen:

…quick projects are usually wasteful projects. Good new projects need to be thought out and planned. The environmental impact study alone can take years. But Obama has told the state governments they will have to “use it or lose it” when it comes to federal grants. The result will be a lot of poorly conceived projects just to capture the money.

The biggest problem with a fiscal stimulus is this: our economic problems stem from having spent too much in the first place. Now that our homes are no longer rising in value every year and America is aging, more saving is in order, not more spending. Recovery will come only when we discover which new and valuable things the economy should produce as it shifts out of real estate and finance. Simply borrowing and doling out more cash doesn’t solve that problem.

[hat tip: Positive Liberty]

and Harvard’s Linda Bilmes:

A good play to start looking for lessons is by analyzing the three biggest recent examples of heavy government spending on infrastructure: the Iraqi reconstruction effort, Hurricane Katrina reconstruction, and the Big Dig artery construction in Boston. Let me start by pointing out that all of these were plagued by a number of serious problems.

(more from Alex Tabarrok)

And if the government really wanted to, it could easily find positive NPV projects by butting its nose in the business of anti-growth cities that are unreasonably down-zoned by anti-growth policies, as noted at winterspeak:

Infrastructure Spending will be allocated the way Infrastructure Spending is always allocated — it will be based on political expediency, not whether it is a positive net present value or not. If Infrastructure was based on positive net present value, we’d have sky scrape[rs] being built in San Francisco, and 8 story apartment complexes built in Cambridge, MA, and I don’t see a whole lot of either going on.

In my opinion, there is only one true test of a positive net present value, and that is whether private capital is willing to take on a particular project. And, if private enterprise is willing to risk capital to achieve a particular endeavor, why not let them put their own money on the line instead of taxpayer funds.

The bottom line is that big projects tend to go over-budget. Even the rare big projects that are showboated as being a positive NPV investments for society, rarely are after all is said and done as their actually cost far exceed their original budgets. When private projects (positive NPV or negative) are over-budget, investors who took the risk are on the hook for the losses. When public projects are over-budget, the taxpayers are on the hook for the losses. And when it comes to big, ambitious projects, budget over-runs and sizable losses are frequent.

The post Urban[ism] Legend: Positive NPV Infrastructure appeared first on Market Urbanism.

For whatever reason, we’re not built to naturally internalize negative externalities. When riding on a crowded highway, no one (no non-economist, at any rate) curses the government for not making the road more expensive; they demand more capacity — fewer traffic lights, higher speed limits, more lanes, more roads. And when free parking results in no available parking, no one demands market pricing for spots; they ask why the lot’s so small and the garages so scarce, and they get angry about those two new developments that just went in, bringing new residents who unsurprisingly use the valuable, yet free, parking spots when they’re open.

We see a shortage of a public good, and we think more, not more expensive. And as a result, the failure to price public goods appropriately leads to an inefficient use of existing resources, and an inefficient allocation of new resources. We don’t use existing roads well, and we spend too much valuable capital building new roads. We don’t use existing parking well, and we spend too much valuable capital building new parking OR we allow shortage concerns to undermine good investments.

This type of anti-market bias which seems to be the natural default in humans creates unhealthy positive-feedback loops such as the highway -> development -> congestion -> widen/extend highway, etc. loop. But in that light, we should be glad modern society has been able to overcome so many of its anti-market biases such as making profits, charging interest, and trade between strangers. Hopefully, as society adapts to deal with issues of scacity of land, resources, and time, it will overcome the unhealthy biases it needs to shed to sustain growth.

The Bellows post also refers to a post Matthew Yglesias wrote about the Chicago parking meter privataization, where he said:

In general, the market price of street parking should be very similar to the market price of garage parking. Since a garage is more secure and protected from the elements, that has certain advantages. But a street spot might be more convenient. So you’d be looking at rough similarity. And in parts of the city where there’s no viable market in garage building, that’s a market signal that parking demand is low and therefore street parking should be very cheap. But where garages are charging a lot, street parking should also be expensive. Among other things, that would reduce the need for new construction to be accompanied by expansive parking garages.

Perhaps more important, it would reduce the tendency for conversations about any new development to become immediately dominated by people’s fear of parking shortages. The whole shortage phenomenon is (as shortages tend to be) a symptom of bad pricing policy. Chicago is a big city with a vibrant downtown and tons of economic activity. Space is limited and expensive. Unless you charge more than a quarter for it, you’ll get shortages.

Still, the privatized meter pricing will remain highly regulated (to satisfy the anti-market bias of political constituents), preventing the full “market price” efficiency to be achieved.

The post Irrationality Towards Shortages appeared first on Market Urbanism.

There is a superficial attractiveness to policies that seem to promise an end to falling housing prices, but there are three reasons why these proposals don’t make much sense to me.

First, the government has no business trying to make housing less affordable to ordinary Americans.

There is no reason to hope that middle-class Americans should pay more for any basic commodity, whether that commodity is coffee or oil or housing. Government should be fighting to reduce supply-side barriers and make housing cheaper, not trying to inflate prices artificially.

Second, most of these proposals seem likely to be expensive failures. The government just doesn’t have the tools to rewrite the laws of supply and demand. If the cost of building a home in Las Vegas is $150,000, and there are no restrictions on building, then all the credit policies or bailouts in the world aren’t going to permanently keep prices above $150,000.

Finally, these policies all have the common feature of getting the government further entrenched in the operation of the housing market, and this creates all sorts of long-term market problems. I would have thought that recent events at Fannie Mae and Freddie Mac, for example, would have made Americans recognize the costs of having government-sponsored enterprises play mortgage lender to the nation. I would have hoped that the history of public housing would have made us wary about spending huge amounts of tax dollars to get into the business of public property management. The current crisis may imply a need for more federal regulation of lending, but it does not suggest that the federal government should be subsidizing more borrowing.

We do need action to fix our banking system, but we don’t need quixotic policies aimed at pushing up housing prices. I suspect these policies have some appeal because they seem to help homeowners (like myself) as well as financiers. Still, the government can’t repeal the laws of supply and demand in the housing market. The price decline should remind homeowners, and home buyers, that housing should never be seen as a short-term speculation, but rather as a place to live, and hopefully to enjoy, for the long run.

Many politicians love high housing prices because it allows them a chance to offer “solutions” to the high prices. Unfortunately, those “solutions”, have brought us rent control, public housing, and a whole affordable housing bureaucracy, which have done little to systemically solve the problem. Nonetheless, we don’t hear any of the politicians who champion affordability cheering because of the lower housing prices.

Let’s give a little credit to the housing market for correcting itself, enabling new people to afford homes they couldn’t afford three years ago, and let’s avoid creating more problems (and “solutions”) by artificially re-inflating housing prices. And hey, what about the renters?

The post Glaeser: Let Housing Prices Fall appeared first on Market Urbanism.

Housing markets without the benefit of hindsight

Fannie reaches its goals–sort of

Zero Down!

Fannie and Freddie’s other mission

Section 8

Bill cared too

Affordable equals “subprime”

Calm down

And don’t forget Andrew Cuomo

Shiller and fundamentals

The role of the CRA

It’s not the CRA

No money down, revisited

Bear Stearns, the CRA, and Freddie Mac

Stiglitz on the crisis

The post Russell Roberts on Government Intervention in Housing appeared first on Market Urbanism.

I came across the snagfilms website from a recent Wall Street Journal article. Most of the documentary videos lean towards “progressive” tastes, but hopefully they’ll add some free-market content such as Friedman’s “Free To Choose” videos.

Through quick browsing, this video seemed to be the only one that had relevance to Market Urbanism. I think it does a decent job dispelling the Urbanism Legend that high density is bad for the environment. However, some of the commenters seem to fall for the myth that further government intervention will somehow solve the problem. They all seem to forget that progressive government meddling in transportation and land use has done much to cause the problems of sprawl and auto-dependency that modern progressives are now trying to fight with more intervention.

[Watching it a second time, I wanted to point something out. One commenter stated that European and Japanese developers plan for a 50 year life-cycle of buildings, while in the US only 12 months. This is absolutely false. Developers usually use a 10-year discounted cash flow model, but still incorporate a sale value of the property based on projected incomes in the 11th year. That sale value could be calculated on the cash flow of the next 10 years and so, on, but they usually use a more simple calculation for the 10th year sale. They could use 50 year models, but they wouldn’t give much better information than the standard 10-year model. European developers use the same methods as the US. Anyone who says otherwise is trying to decieve you.]

The post Urban[ism] Legend: Density is Bad for the Environment appeared first on Market Urbanism.

If you haven’t read the entire series, you can catch up with these links:
Rent Control Part One: Microeconomics Lesson and Hording
Rent Control Part Two: Black Market, Deterioration, and Discrimination
Rent Control Part Three: Mobility, Regional Growth, Development, and Class Conflict

Conclusion

Rent control is not just a simple price control setting the price at which willing renters and landlords are permitted to do business, it is much worse.  It is a coercive act that gives landlords no legal option, but to rent to a tenant against his will, often at a financial loss.  Rent control adds a non-voluntary burden to landlords which deepens over time because landlords do not have the option to rent to a tenant at below market rates. 

Not only does rent control cause huge distortions in the housing market, but the burdens fall disproportionately on the poor and underprivileged people it was intended to benefit. Although particular people are able to live with the comfort of low rent payments, even those renters will see their living conditions deteriorate as landlords neglect repairs and maintenance. As the situation gets worse, middle class residents are able to move away, leaving behind the poorest residents who have become reliant on the reduced rent.

In effect, rent control grants property rights to renters, that originally belonged to the original property owners. Rent control becomes a redistribution of wealth to rent control tenants away from apartment owners, market apartment renters, and newcomers to the area. Nonetheless, over time the quality of life decreases for all residents of a city where rent control is imposed.

Solutions

So, it wouldn’t be very productive for me to rant about the problems rent control creates, if I didn’t discuss solutions to the problems. Cities can flat out abolish rent control, like California’s Proposition 98, phase it out through vacancy decontrol, or use other methods to end rent control. However, ending rent control, without ending other burdensome policies, doesn’t solve the problems of limited housing options, particularly for low income people.

Abolition

Abolishing rent control overnight would bring many market rate units onto the market at once, and would greatly reduce prices for market units. However, it would force many poor residents to move all at once and would cause a shock to the overall rental market. This would correct itself over time if proper action were taken by municipalities to allow additional supply to the market.

Most importantly, developers need to be allow to bring housing supply to market. Many of the places that have the strictest rent controls are also cities that have very restrictive zoning. As new development comes to market, prices will ease on the previously regulated apartments. In fact, I would argue that development restrictions should be eliminated several years before rent control is fully abolished, in order to give developers time to bring sufficient supply to the market in preparation of full decontrol.

Vacancy Decontrol

Vacancy decontrol is a more moderate method that has been used by many cities to phase out rent control or lessen the scope of rent control. Vacancy decontrol usually means that rent controls are enforced in apartments only until the tenant leaves. At the time a tenant leaves, the landlord is permitted to return the unit to market rates. California’s Proposition 98 is, in effect, vacancy decontrol where current tenants will not be effected as long as they stay in their current apartment.

Vacancy decontrol is typically a compromise between advocates of rent control and apartment owners. While it is preferable over fully-regulated rent control, there are serious drawbacks. The biggest drawback is that it increases the incentive to hoard. When a tenant knows that a unit will be deregulated when he moves out, he will try to stay as long as he can to maintain the benefits. Tenants may have family members stay there or maintain a second residence to ensure he will not loose the benefits of rent control. As a result, controlled units are likely to stay occupied by current residents for a long time, before being let back into the market.

Unfortunately, vacancy decontrol also incentivizes landlords to try to evict tenants in order to deregulate their apartments. There have been many horror stories of landlords harassing tenants, allowing horrible living conditions to prevail, and invading the privacy of tenants as ways of encouraging tenants to move out.

Rent Control and Property Rights

What if we look at rent control as an appropriation of property rights from the landlord to the tenant? A landlord has certain limited rights, while the tenant has extensive rights to the apartment granted through rent control. Since this appropriation typically happened many years ago, one could argue the apartment is more the property of the tenant than the landlord under rent-control policy.

If one accepts this point-of-view, one way to end rent control is to force a sale of the complete property rights either from the owner to the tenant or from the tenant to the owner. The tenant would be forced to offer a price to the landlord to purchase the remaining property rights of the apartment. If the landlord accepts the offer price the unit will be sold to the tenant at that price and become a condominium.

If the landlord rejects the offer price, he will have two choices. Either buy out the renter’s contract at the same price as renter’s offer or sign a contract extending certain rent controls indefinitely for the duration of tenancy. Such a mechanism would ensure the tenant would offer a reasonable amount. In effect, this forced sales will return all apartments to the market immediately, whether they now be owned by the original tenant, original landlord, or controlled only by contractual agreement.

If the tenant could not afford the purchase price, which would likely be below market, he would be permitted to resell the condo unit at any price or forfeit all rights to the property upon failure to execute.
There would be complications if a landlord suddenly lost control of an entire building, creating a fractured ownership of the building. Allowing the landlord the option to extend the lease or buy out the tenant would enable the landlord to maintain ownership of entire buildings at his discretion.

Of course, if one believes rent control was a theft of the original property rights from the landlord, you would be hesitant to reward the tenant for years of hoarding another person’s property. However, if one believes it is theft, should the government be forced to pay reparations to landlords for lost earnings? Perhaps, with a forced sale, the government would be required to remunerate to the landlord, a certain percentage of the transaction as a form of reparations.

Vouchers

For those who believe we need to "do something" for housing affordability, there are solution which are much better than rent control.

Federal housing assistance programs began during the Great Depression. In the ’70s, Congress passed the Housing and Community Development Act of 1974. This act shifted the focus from the quality of housing to the affordability by creating the Section 8 program. Learn more about the Section 8 program here. Many state and local authorities have implemented voucher programs as well.

Low Income Housing Tax Credits

Federal programs offer tax credits to developers of low income housing (LIHTC). These tax credits are more valuable than tax deduction and are often purchased by corporations who pay high tax rates. (learn more here)

Of course, there are consequences to subsidizing housing, (which is another topic altogether) but most would agree that a system of subsidizing housing for lower income people with vouchers or tax credits are certainly less less-bad solutions than forcing the burden on the providers of housing and rental apartment market through rent control.

Zoning and Regulation

The difficulties of phasing out rent control could be lessened by the market more quickly and effectively if zoning and other regulations are loosened at the same time. The private market needs to be allowed to meet the demands of market renters, so that lower quality, and smaller apartments remain affordable to people with lower incomes.

Most importantly, municipalities need to end exclusionary regulations that forbid affordable housing that would be used by low income residents. The most widespread example is that of many suburban communities that regulate the number of housing units per acre. Such regulations prevent developers from creating multi-family housing that is typically more affordable to lower income families. Often times, these regulations are aimed at keeping certain people out in order to maintain an upscale community.

Most cities also have provisions in their zoning codes that prevent development of affordable housing. Chicago, for example, has strict restrictions on dwelling units per acre that in many instances are more restrictive than density restrictions. These restrictions are supposedly implemented to encourage more housing for families, but forces developers to build less units, thus larger units. This discourages development of smaller, more affordable units, such as studios and single room occupancy units; and instead encourages development of larger, luxury units.

Almost all municipalities have restrictions on density, usually through FAR (floor area ratio) and height restrictions that inhibit the amount of development that can happen in a certain area. These restrictions directly burden development of market rentals, which in turn, causes shortages in lower quality housing as middle class renters are forced to choose lower quality units that would otherwise be rented by low income families. Thus, destroying affordability for all demographics.

In order to "protect jobs", many cities have implemented zoning restrictions that prohibit residential development on under-utilized industrial land. These prohibitions are very short-sighted, and in effect, keep land prices low in industrial areas since alternative use of the land is prohibited. These days, industries tend to be location insensitive since transport costs have come down significantly over the last century.   Industries typically choose to locate where land is cheap, so in order to attract manufacturing jobs, a municipality must put a huge burden on the housing market.  Forcing land prices down in urban areas to attract industries does more harm than good by preventing redevelopment of the land as housing, driving housing costs higher, elsewhere.

All things considered, most currently affordable units will remain relatively affordable if the market is allowed to satisfy the needs of the wealthy and middle class renters, preventing prices from rising across the board and preventing gentrification of lower housing stock by more wealthy persons.

Property Taxes

Many municipalities tax rental housing at a much higher rate than they tax home owners. This is mostly due to political pandering to homeowners who tend to be a reliable block. Nonetheless, much of the additional tax burden gets pushed on the renter as the landlord shares the burden by raising rents. Removing this redistribution of wealth would ease the burden on rents, as would lowering real estate taxes by cutting spending.

Tax deductions for home ownership also create a misallocations of housing resources away from affordable rentals.

A Free Market for Housing

In conclusion, supply controls do as much damage to affordability as price controls. Eliminating rent control needs to go hand-in-hand with loosening exclusionary zoning and density restrictions in order to allow the market to perform as it should. A truly free-market incentivizes investment in quality affordable housing for all residents by allowing individual decisions to determine living patterns and location preferences based on quality, availability and affordability.

For more reading, see the section on Rent Control on the Links to Articles and Academic Papers page.

The post Rent Control Part 4: Conclusion and Solutions appeared first on Market Urbanism.