A few days ago, I visited downtown Long Beach. The city of Long Beach is located in LA County, right on the Pacific. It has a population is 456,000 and is fairly expensive. The city should be booming, but instead it seemed sort of depressed. What went wrong?
I saw one fairly new high-rise residential building, but mostly it was just block after block of older low rise commercial and residential buildings, with very little construction underway. There are a few homeless people walking around, although not so many as in LA. Given the high rents and housing prices in coastal California, why isn’t Long Beach experiencing a boom in redevelopment?
I suspect the problem is regulations. California has such strict regulations that it is now extremely expensive to build in California. Thus the state no longer sees the dynamic economic growth it experienced during the second half of the 20th century. And these regulations are not protecting beautiful old historic neighborhoods; downtown Long Beach is rather bland and unattractive. A hundred new high-rise residential buildings in DTLB would attract new restaurants and shops, making the city far more attractive. A few of the poorer residents would have to move a few miles inland, but there would be many more good service jobs to pay their bus fare.
One of the most important economic identities is that saving equals investment (at least at the global level.) So if California stops building housing, what happens to all of the saving that used to go into property development?
With less investment in real estate, savers have trouble finding people that wish to use their funds. Thus puts downward pressure on the equilibrium interest rate. Some might argue that the actual interest rate differs from the equilibrium interest rate due to Fed policy. But if the Fed is committed to a 2% inflation target, then it must cut its interest rate target when the equilibrium rate declines. Over time, the two rates are generally quite close.
The fall in interest rates does not, by itself, bring saving into equilibrium with investment. You need potential investors to respond to lower rates by creating more non-residential investment. Projects that were not profitable at a 5% interest rates become highly profitable at a 1% interest rate.
Most people don’t understand this process. When they see it play out, they misdiagnose what is actually going on. I see article after article claiming that the Fed “artificially” lowered interest rates, and that this created “malinvestment” into unproductive projects. They claim the problem can be fixed by raising interest rates to a level that imposes discipline on investors, a rate that doesn’t allow for low quality investments to be profitable. That’s wrong.
The US does have a malinvestment problem, but it’s not at all what many pundits assume. The cause of the malinvestment is zoning and other regulations that make it difficult to build housing. And housing is not just another sector; it’s a key part of investment. These bad regulations push saving into areas that are less productive than housing construction, including marginally productive government and corporate investment.
The problem of malinvestment cannot be fixed by having the Fed tweak interest rates; it requires much more fundamental solution. The only way to fix malinvestment is to remove regulations that prevent developers from building what people really want, which is high quality housing. The Upper East Side of New York was wonderfully transformed in the 1920s, when low-rise buildings were replaced with high-rise residential buildings. Downtown Long Beach can and should do the same. But America has lost its ambition, and settled into stagnation.
If you ask most people what stands in the way of them having the sort of lifestyle they wish to have, not many will mention a lack of food or clothing. Most have adequate cars and TV sets. Most have a school to send their kid to and some form of health care. Instead, housing is the one area where lots of people are dissatisfied, where dramatic improvements in living standards are still possible. But that requires building new housing in locations close to good jobs. Bandaids such as rent control do not result in a single extra person having housing, and indeed reduce the housing stock in the long run. More housing is the low hanging fruit to raising living standards. Fix housing regulation and you go along way toward fixing malinvestment.
PS. While downtown Long Beach is unattractive, the oceanfront is nice:
READER COMMENTS
Jim Glass
Jan 22 2023 at 9:29pm
The Upper East Side of New York was wonderfully transformed in the 1920s, when low-rise buildings were replaced with high-rise residential buildings.
Back in that era the Empire State Building was built in, IIRC, 11 months from first shovel of dirt to open with “for rent” signs out. After 9/11 it was more like 11 years just to clear away the wreckage of the buildings around the WTC site. (I’m not sure of the exact number of years without checking my files. Might’ve been more or less, but it was years and years and years … I was there.) You know why.
Jim Glass
Jan 22 2023 at 9:40pm
Just took a quick look in my files. 10/9/2009, more than eight years after:
“Cleanup work finishes. Demolition to begin. Officials announce new, slower work plan.”
Mark Brophy
Jan 22 2023 at 10:37pm
The biggest malinvestments were in government spending, trillions of dollars worth of debt financed at absurdly low interest rates dictated by the Federal Reserve. Long Beach real estate is an example of bad regulatory policies. Investors rationally stayed away, the opposite of malinvestment.
Kenneth Duda
Jan 23 2023 at 2:20am
You are right that investors should stay away from investing into a badly regulated area, but you are wrong that that avoidance is “the opposite of malinvestment.” When the government spoils good investing opportunities with bad regulatory policies, investors have t direct their capital has to something less productive. That less productive use of capital *is* malinvestment, not its opposite.
-Ken
Knut P. Heen
Jan 23 2023 at 8:58am
I think it is more precise to use under/over investment compared to the optimal level. There will often be cases in which there are overinvestment in X and underinvestment in Y. Malinvestment covers both, but it is a less precise term.
Scott Sumner
Jan 23 2023 at 12:46pm
“Investors rationally stayed away, the opposite of malinvestment.”
You are mixing up decisions that are privately beneficial from those that are socially beneficial. Society would benefit from more investment shifting into California housing.
MarkW
Jan 23 2023 at 7:05am
But that requires building new housing in locations close to good jobs
Or maybe it requires good jobs migrating to (or developing in) places with lighter regulation where it’s easy to build new housing. Isn’t that easier to achieve? And isn’t that what’s been happening in recent decades? Why would ‘good jobs’ (other than at the port) remain anchored to Long Beach even while housing for workers remains scarce and expensive? And even the port has been losing marketshare — apparently those jobs can move too.
I’m convinced that tight regulation is bad for California, but I’m not so sure it’s bad for the rest of us. In particular, it seems not to have been obviously bad for other western states like Arizona, Nevada, Texas, Oregon, Washington State, and Colorado — they all seem to have blossomed as California stagnated (arguably in large part because California has stagnated).
Michael Rulle
Jan 23 2023 at 7:36am
Only bad for California but not the “rest of us”? I do not understand that point. You say those states have blossomed “because” of tight regulation——and even an arbitrage of sorts with California’s own tight regulation which caused stagnation. Don’t get that at all.
I don’t know about those states——except perhaps Houston Texas—-which could not be less tightly regulated.
MarkW
Jan 23 2023 at 11:54am
I’m sorry if I wasn’t clear. I meant that neighboring states likely have benefitted from tight regulation in California which has pushed people and businesses toward their states which are more lightly regulated and where build is much less restricted.
Michael Rulle
Jan 23 2023 at 1:02pm
Yes, agree—-I read it the opposite. Thanks for the clarification.
Scott Sumner
Jan 23 2023 at 12:42pm
“Or maybe it requires good jobs migrating to (or developing in) places with lighter regulation where it’s easy to build new housing.”
But California housing is more expensive despite those bad regulations, so at the margin we’d be better off if more jobs moved into California. I know that’s counterintuitive, but the market has spoken.
MarkW
Jan 23 2023 at 1:25pm
All things being equal, we should expect coastal California to be more expensive just due to climate. But yes, the high cost tells us there’s an imbalance between the number of people who want to live there and the amount of housing. Some of that is generational hangover. There are millions of people who want to stay in California because they grew up there and their family and friends live there, etc even though these same people would not choose California otherwise (I have friends with kids in this situation — they really don’t have the income to live well, but they don’t want to leave either). In this way, non-employment driven demand takes a long time to dissipate.
But I think my perspective is more useful to someone such as yourself trying to sell fellow Californians on YIMBY policies. One way of looking at it is, “We should eventually get around to doing something about restrictive policies because although the jobs and high-demand for housing will always be here in California no matter how much we screw up, still it’d be better to do something sooner than later”. Regardless of whether or not that’s true, it doesn’t promote much of a sense of urgency. An alternate message would be something like — There’s nothing cast in stone about California’s economic strength and housing demand. The world has had plenty of examples of places with mild, Mediterranean climates with chronically poor economies — Greece, Sicily, and Portugal, for example. Right now, ambitious people are pulling up roots and leaving (or not coming to California in the first place). For the first time, California has lost population (and a House seat). If we don’t fix our housing problems by increasing supply, they’ll eventually be solved by declining demand as California continues to stagnate and other states (including Texas and Florida — yuck!) eat our lunch. If current trends continue, Texas could pass California to become the largest state by 2040!
Michael Rulle
Jan 23 2023 at 7:24am
You summarize a well known problem quite clearly, which every time I contemplate I wonder why our governments are so committed (not everywhere of course——but to some degree perhaps almost everywhere)to this way of thinking.
So I ask myself literally “why?”. I believe it is the late ABC sports executive Roone Arledge who once said something like “the answer to almost any problem in media is money”.
He meant bad decisions were made all the time because it benefited many who had the power to carry them out (yes, media was highly regulated during His era).
I did not know Long Beach was part of LA County—-but some groups are or have benefited by this.Either elsewhere (like an inverse opportunity cost) or there. I have seen the same thing play out in an old, yet now fast growing town in northern New Jersey.
It is amazing how fast towns/cities can grow beneficially when they deregulate. They now call this town a “college town”—-my daughter told me that. There are 4-5 Universities within 5-8 miles ——-and it never occurred to me to link that thought to this town.
Andrew_FL
Jan 23 2023 at 9:11am
That is not what malinvestment means. Malinvestment is not a normative term nor is it any redirection of investment funds from where they might been in anarchotopia. This is rather akin to saying there is malinvestment in security because, if there were no crime the optimal level of security would be much lower.
One could perhaps say that insecure or diminished property rights (and that is what zoning really is, infringement on property rights) leads to underinvestment, but it does not lead to malinvestment.
Spencer
Jan 23 2023 at 9:21am
re: “One of the most important economic identities is that saving equals investment”
You’ve been on a roll, but I couldn’t let that one by. Savings is not synonymous with the money supply. All bank-held savings are lost to both consumption and investment, indeed to any type of payment or expenditure.
Philo
Jan 25 2023 at 12:32am
A conceptual question about *malinvestment*: This can’t be just an investment that, as it turns out, is less profitable than some other investment would have been; for then almost every investment would be mal-. Is it, perhaps, an investment that, on the evidence available at the time, *should have been expected* to be less profitable than at least one other investment, with the added requirement that it actually turn out to be relatively unprofitable? Is the concept like that of a *bubble*, which (I take it) is a rise in price that is unjustified by the available evidence, followed by a decline back to the original price, or below? (A difference between these is that an investment is an individual decision, which might very well be irrational, while an asset price is a market phenomenon, which, by the EMH, is not likely to be irrational.)
Jeff
Feb 1 2023 at 7:06pm
Seemd to me the expansion in the money supply paired with nominally chained property tax rates killed California development. People who have held property for more than a couple decades now have an inflation hedge whose annual expense ratio (ie property tax) is lower than even the cheapest investment funds. So it doesn’t make sense to sell or do any kind of redevelopment. Until so many people make that same decision that at some point in the future the entire state becomes an underdeveloped, depopulated wasteland.
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