How NOT to Solve a Housing Crisis (India Version)

This bit in the Washington Post from January is a nice illustration of how the law of unintended consequences is often the result of attempts to subvert the law of supply and demand. It deals with - largely unsuccessful - attempts by local governments in India to eliminate slums. It's why these well-meaning endeavors fail that's interesting.

In short, it goes something like this. Parts of India are crowded. HUGELY crowded. On the order of 16million people to a city crowded. Crowded. So naturally real estate prices tend to soar. If you have a situation where the population of an already people-saturated place is exploding, real estate prices are going to go up (think Tokyo in the 80s, for a more familiar example). So what to do about the slums? If real estate prices are out of control, then it would seem like the government is priced out of being able to afford housing projects for slum dwellers. Ah - but what if we use the housing bubble to our advantage?

The scheme works as follows. The government loosens zoning restrictions (oh yeah, because this was in the Washington Post, it didn't occur to anyone that zoning restrictions might have something to do with the prohibitive price of housing. Someone must really leave an economics textbook lying around at a major American newsdaily one of these days, just to see what happens.) in exchange for a promise from highrise builders that they will also erect some subsidized-rent buildings. Because housing prices are so high and the profit margin on new tennemants so huge, there is more than enough intake from the highrise to pay for the subsidized buildings and still go home with a healthy take. So - simple, right? Problem solved?

Well, not exactly. 'Cause, see, when you go and flood the market with new houses, some of which are artificially cheap, guess what happens to real estate values in general? Yup - they bottom out. And so, suddenly, the profit margin on the new tennemants isn't so huge anymore, and almost overnight there are no takers for these subsidized building projects. The money just isn't there anymore.

That's all economics 101 - but here's the really interesting bit.

If you build at the rate that the housing crisis -- or an election promise -- demands, the market crashes, making a cross-subsidy unworkable. Therefore, you build slowly, so that housing prices remain high. But when prices remain high, some of the former slum-dwellers will sell their flats and move back to the slum. Sometimes that was their plan all along.

Interesting, eh? When slums are available - some people actually see them as "affordable housing." They take advantage of the government scheme, buy a subsidized place, wait for the market to (inevitably) crash, followed by a general drying-up of bids on contracts to build the subsidized houses, at which point prices go back up, they sell their apartment and move back to the slum.

I dunno - the solution to all this seems simple enough to me. If the government wants to help solve the slum problem, then why not just have a general moratorium on zoning laws, at least for a decade? Take a section of the city, throw out the zoning laws, let developers build as high as they want. If the market gets flooded with houses, then some slum dwellers are suddenly able to afford. If a housing crunch follows, then those slum-dwellers that bought in can resell at a profit. In any case, the new buildings aren't going away. This cycle will happen a couple of times, but each time through new buildings get built, and so with each succession the prices can't go quite as high as they did the last time. Over time, the effect is that prices stabilize. The turnovers get less dramatic, and the housing market becomes more predictable. You might not completely eliminate the slums, but with time you build enough houses at low enough prices that most of the slums go away on their own.

Put simply - we build our way out of a housing problem. Gee, who woulda thought? And we can do that because ... (drumroll) ... there are no zoning laws telling us we can't. True, to some extent the current approach with the zoning laws in place is not much different; it follows similar cycles. That is because, as chronic Soviet (and now Venezuelan) shortages effectively demonstrated over most of the last century, government wishful thinking is not immune to economic realities. You can say nice things like "every worker gets beets," but that only works if you produce enough beets for every worker. And you only produce enough beets for every worker if you make it worth the beet-growers' while to grow that many beets. Here's a clue: people respond better to "if you grow this many beets, you'll live comfortably" than they do to "it is your patriotic duty to grow this many beets, regardless of what we pay you."

Something similar is almost certainly going on in India with regard to housing. To get rid of the slums, the government needs someone to build a lot of hosues quickly. That can easily be achieved by simply removing the zoning laws. If it's suddenly legal to build tall buildings on a lot in a hugely crowded city, people will do it. And indeed, the high price of land (resulting from overcrowding) is, in fact, a market signal that such a thing needs to be done. Land is hugely expensive because it is scarce, and in a rational economic system that means that there are rewards for people who figure out ways to stretch it further - say, by housing thousands in a highrise rather than merely hundreds in a four-story getup.

I don't want to say that homelessness and slum-dwelling in India are entirely the government's fault. Obviously it's a lot more complicated than that. And eventually India will build its way out of its housing crisis one way or the other, whether or not the government is fiddling with things. The contours of the process are the same with or without government intervention, but there are nevertheless two advantages to getting the government out: (1) the process happens a lot faster and (2) there are no incentives to stay poor (think about it: you've lived all your life in a slum, so you don't really mind 'cause you're used to it, and suddenly someone hands you a free flat that you can live in for a bit and eventually pocket a bunch of free cash by moving out of. Do you (a) work for a living and buy your own house or (b) take the offer and pocket the free money? Hmmmm....). So yeah, it's a question of time. A sincere interest in seeing the poor housed means you look reality squarely in the face, realize that it can't be done overnight, accept the gradualness of the process but trust your Economics 101 that tells you that if there's a 4million-person demand for housing in a city of 16million, the market will provide. Of course, I guess the politicians don't see it quite that way. They would rather keep their finger on the zoning law trigger, and are content to see things happen just a little bit slower to that end. Nice folks, these politicians.