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Simon's avatar

Great article Cameron. I have been thinking about a more intuitive explanation for why up-zoning does not lead to the short term increase in development that people might expect. I think the issue is that the idea of up-zoning is based on a set of assumptions about competitive markets that do not apply to a natural resource like land.

The thinking behind up-zoning goes something like this: it starts with the infamous Econ 101 example: Given a market for a product, say left handed screwdrivers, producers would like to sell at the most profitable price known as the Monopoly Price. However if everyone in the market is selling at the Monopoly Price, any individual producer could make more money by lowering their price and selling more screw drivers. This creates a prisoner’s dilemma where every individual producer could make more money by lowering their price, but would lose money if everyone else lowers their prices. In this scenario producers will either find a way of coordinating (ie form a cartel) or they will have to lower their prices to the competitive market price. So far so good, nothing new here - this is the basic example we all know and love. In this theory, if the total number of “allow units” increases through up-zoning, then the increased supply should lead to a decrease in prices.

The thing that makes this example work is the fact that producers in a commodity market have a way to make more money from lower prices. So why doesn’t this supply-demand prisoners dilemma apply to housing? If I own 10 acres of land, I can only sell up to 10 acres of land. Land owners have no incentive to “defect” and lower price, because they cannot make up the difference by increasing the volume of land sold, because the supply is fixed. I can sell the 10 acres that I have at higher prices and make more money, or sell the 10 acres that I have at a lower price and make less money. There is no dilemma, there is not really even a choice, there is no scenario where I make more money by selling land at a discount. Based purely on the incentives of each individual owner to hold rather than sell at a discount, the market will move towards the Monopoly Price without requiring any kind of collusion.

In order to build more housing, the developer must first acquire the land on which to build. Whether the land is zoned for high or low density, the sale of land and construction will be constricted by the sellers to maintain their desired prices, preventing a construction boom. Up-zoning does not create more supply of land, it does not increase the number of land owners and it does not add any incentive to sell land at a discount. Owners will continue to follow the same incentives to get the price they want, in exactly the same way they did before rezoning. The result is that the lot will become more valuable rather than the units becoming cheaper. In effect up-zoning provides a free handout to existing owners whether they choose to build or not.

In short, the idea that up-zoning will increase construction does not account for the pricing power of sellers in a market with fixed supply, because this is not included in the supply-demand model for a competitive market that is implicitly being referenced. I think the core of the confusion comes from combining the building which behaves like a commodity, with the lot which behaves like a natural resource. In many respects, these two things operate in the complete opposite way, which makes it very hard to reason about “housing” without separating it into the two components. I have basically just restated the same points you have made, but I hope that makes intuitive sense.

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Revere's avatar

Pure gold:

> Taxes that increase development costs, and regulations that reduce development profit by restricting site density, are not passed forward into higher house prices, but back into lower land values. This is one of the oldest findings in the economics of land.

A great and thorough article!

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