A demographic depression

When I read the newspapers from the 1930s I’d occasionally see hopeful articles about how consumer spending would have to pick up soon, because of all the “pent-up” demand.  If people hadn’t been buying cars for a while then presumably their cars would wear out, and this would trigger new demand for replacements.  Of course I knew that there actually was no light at the end of the tunnel, which made these articles seem slightly pathetic—as if they were grasping for straws.  They overlooked the fact that the depression made America much poorer, and that low consumer demand reflected that poverty.  For similar reasons, there isn’t much “pent up demand” for cars in Somalia, despite low sales in recent years.

Sometimes I see this argument applied to the housing slump.  Housing construction is down 70%, to levels far lower than at any time in post-war history (relative to population.)  And this slump has been going on for a number of years.  Surely we’ll soon need to build more houses, to meet our growing population.  If only that were true.  Unfortunately, as sharply as housing construction has fallen, household formation has fallen even faster.

Jim Glass sent me some very interesting data on household formation, which casts a very different light on the recent housing crash.

By my simple measure recent housing starts peaked with an inventory of 40% of an average year’s worth of starts above the trend line in 2007. That’s a cyclical high but a typical one. About the same or a little higher was reached in three other cycles since 1960.

But the plunge in starts since 2007 is unprecedented “” by the end of 2010 cumulative starts were 72% of an average year’s worth of starts below trend. The next-lowest figure was 46% below trend back in 1970. If things were “normal” this would predict a huge boom in housing starts soon.

But housing starts are *following* household formation, which is plunging even faster, like an ICBM heading straight to its target.

In 2007 household formation was 1627k (average 1998-2007: 1499k) and housing starts were 1355k (average 1998-2007: 1716k). In 2010 household formation was all of 357k, down 78% from 2007 and down 76% from the prior ten year average. Housing starts were 587k, down 57% from 2007 and down 66% from the prior ten years. That’s a big fall, but it is still *well behind* the fall in household formation.

If I still had my blog I’d post the graphs “” the line for household formation is heading straight down like to the bottom of the sea, it’s three times the fastest-deepest decline of the last 40 years. The line for housing starts looks like it is just striving to not fall too far behind.

I hate to be the bearer of bad news, but that light at the end of the tunnel is an onrushing train called falling household formation.  It’s caused by three factors:

1.  Less immigration due to the post-2006 crackdown.

2.  Less immigration due to the severe recession and high unemployment

3.  20-somethings who can’t get jobs are living with their parents.

The problem is not that we built too many houses and need to work off the excess.  Yes, we did, but we worked off that excess long ago.  No the current problem is crashing demand for homes due to an unprecedented plunge in household formation.  Call it a demographic depression.  And the root cause?  I know I’m going to sound like a broken record, but the biggest cause in low NGDP (although obviously other factors are also at work here–including immigration crackdown, minimum wage increase, extended unemployment insurance, etc.)

PS.  I can’t wait for some smart alec commenter to write in and tell me the minimum wage increase can’t possible affect household formation, as no one can afford to live by themselves on the minimum wage.  I already look forward to slapping you down.  So go ahead and make my day.

PPS.  This website shows that the Census had forecast household growth of about 1.1% per year.  In this website you can find the data Jim used; only a 0.3% growth in household formation last year.  And it’s possible the Census is a bit behind the curve, as for instance they didn’t catch up to the 1990s immigration surge until the 2000 census.  Thus it might be even worse than Jim’s figures show.

A good exam question for EC101

Soon after I began blogging in 2009 I did a post suggesting that a slowdown in immigration might have been a contributing factor in the housing crash.  But at the time I lacked data on migration, which is surprisingly hard to find–especially for illegal immigration.

Here’s some data from the NYT:

Douglas S. Massey, co-director of the Mexican Migration Project at Princeton, an extensive, long-term survey in Mexican emigration hubs, said his research showed that interest in heading to the United States for the first time had fallen to its lowest level since at least the 1950s. “No one wants to hear it, but the flow has already stopped,” Mr. Massey said, referring to illegal traffic. “For the first time in 60 years, the net traffic has gone to zero and is probably a little bit negative.”

The decline in illegal immigration, from a country responsible for roughly 6 of every 10 illegal immigrants in the United States, is stark. The Mexican census recently discovered four million more people in Mexico than had been projected, which officials attributed to a sharp decline in emigration.

American census figures analyzed by the nonpartisan Pew Hispanic Center also show that the illegal Mexican population in the United States has shrunk and that fewer than 100,000 illegal border-crossers and visa-violators from Mexico settled in the United States in 2010, down from about 525,000 annually from 2000 to 2004.

And when did this slowdown begin?

How did this happen?

Partly, emigrants say, illegal life in the United States became harder. Laws restricting illegal immigrants’ rights or making it tougher for employers to hire them have passed in more than a dozen states since 2006. The same word-of-mouth networks that used to draw people north are now advising against the journey. “Without papers all you’re thinking about is, when are the police going to stop you or what other risks are you going to face,” said Andrés Orozco.

And now for the exam question:

How would rapid hispanic immigration to the sunbelt combined with increasingly restrictive zoning laws be expected to impact housing prices in California, Nevada, Arizona and Florida?  Suppose Texas lacked those restrictive zoning laws, how would immigration affect their housing prices?  Now suppose there was a sharp slowdown in immigration after 2006, which dramatically reduced forecasts for future population growth in the sunbelt.  How would this impact housing prices?  Now suppose that NGDP fell dramatically below trend in late 2008, how would this affect housing prices in Texas and the other sunbelt states?

And the answers:

1.  Housing prices should surge in California, Nevada, Arizona, and Florida–but not Texas, where supply is elastic.

2.  After 2006 housing prices should plummet in the four high-flying states, but remain stable in Texas.

3.  After mid-2008 housing prices should fall in all 5 states, indeed almost all 50 states (excluding only those few that avoided the recession.)

HT:  Tyler Cowen

PS.  After completing this post I noticed an interesting Karl Smith post (Oops, Actually Adam Ozimek) on how the flight of illegals is impacting the low end of the labor market:

The obvious question to ask is whether there be others who step in to take the jobs these immigrants would have taken at the wage that will be offered. This question, which I go into detail on here, does ignore one crucial aspect of the problem. The cost to employers is not simply higher wages per hour, but higher unit labor costs. That is, for a given unit of value-added output, what happens to the total cost of labor? Wages may only need to go up by 10% in order to find workers willing to replace illegal immigrants, but if the quality of work goes down -if the workers are slower, sloppier, etc.- then unit labor costs may double or more.

You can see this implied in the Bloomsberg article where a contractor says “It’s not the pay rate. It’s the fact that they work harder than anyone. It’s the work ethic.”

Update:  It was Adam Ozimek, not Kark Smith.  My apologies to both.

Karl Adam then quotes from a AP story on farm work in Alabama:

For more than a week, the state’s probation officers have encouraged their unemployed offenders to consider taking field jobs. While most offenders are required to work while on probation, statistics show they have a hard time finding jobs. Georgia’s unemployment rate is nearly 10 percent, but correction officials say among the state’s 103,000 probationers, it’s about 15 percent. Still, offenders can turn down jobs they consider unsuitable, and harvesting is physically demanding.

The first batch of probationers started work last week at a farm owned by Dick Minor, president of the Georgia Fruit and Vegetable Growers Association. In the coming days, more farmers could join the program.

So far, the experiment at Minor’s farm is yielding mixed results. On the first two days, all the probationers quit by mid-afternoon, said Mendez, one of two crew leaders at Minor’s farm.

“Those guys out here weren’t out there 30 minutes and they got the bucket and just threw them in the air and say, ‘Bonk this, I ain’t with this, I can’t do this,'” said Jermond Powell, a 33-year-old probationer. “They just left, took off across the field walking.”

Mendez put the probationers to the test last Wednesday, assigning them to fill one truck and a Latino crew to a second truck. The Latinos picked six truckloads of cucumbers compared to one truckload and four bins for the probationers.

Of course this relates to an old and tiresome debate on immigration that I’d just as soon skip.  Instead, think about how this might be reducing downward wage and price flexibility in the current recession, a pattern that surprised even Paul Krugman.

The art of the possible

One of my favorite Adam Smith sayings is that “There’s a great deal of ruin in a nation.”  When reading others, I often think that people get too pessimistic about this or that country, based on a few highly visible problems.

But another way of thinking about this idea is that maybe even very well run countries fall far short of their “potential.”  I use quotation marks, as potential seems like a very slippery and unscientific concept.  After all, there may be deep-seated reasons why countries struggle to come up with good governance.  Still, you never get anywhere without setting goals.

Bryan Caplan and Will Wilkinson have been discussing the possibility of a regime of open immigration, and whether it could co-exist with a modern welfare state.  I can’t answer that question, but I will argue that we are very far from the “policy possibilities frontier” for liberaltarianism.  Imagine a country:

1.  Which accepts more immigrants per capita than almost any other nation on earth, despite being the most densely populated country with more than 5 million inhabitants.  So densely populated that they need to reclaim land from the sea in order to find places to put people.

2.  Has very high taxes on activities that produce environmental externalities, yet remains the most free market country according to several indices of economic freedom.

3.  Has a very comprehensive welfare state including national health care and pensions for all, yet still maintains a highly efficient tax system at rates far below that of other developed countries.  And if that’s not enough, runs gigantic budget surpluses year after year, despite the ultra-low tax rates and very generous welfare state.

You think that’s utopia?  No place like that could exist?  Think again.

This example tells me that while there may be some political limits to how many immigrants we can absorb, and we may not be able to provide the same welfare benefits to immigrants as to native-born Americans, we aren’t even close to the policy frontier.  We can have much lower taxes, a much more complete welfare state, and much higher rates of immigration.  And while we’re at it, let’s also run a gigantic budget surplus.  We just need to try harder.

And here’s a nice side effect.  Success get emulated.  As others see how well you are doing with the liberaltarian model, they’ll want to copy the policies.  That speeds up the day when the entire world can become a giant Schengen area.

PS.  I cheated a bit in point #2 above.  As my wife keeps reminding me, Hong Kong is not a “country.”

The real problem is multiple problems

This is a meta-analysis of my blogging.

Adverse economic shocks seem to be distributed somewhat randomly.  A priori, you’d expect them to occasionally occur in close proximity, especially if one problem might help trigger another.  When we have the bad luck of seeing two or three big adverse shocks back to back, we can get a major economic disaster.

My research on the Great Depression convinced me that it was two depressions, occurring one right after the other.  A demand-side recession that began around September 1929, and a supply-side depression that began in July 21, 1933 (with another demand shock in late 1937.)  Because they occurred back-to-back, most saw them as one “Great” Depression, and looked for explanations of what caused “the” Great Depression.  No mono-causal theory has proved plausible.

I thought of this recently because of my posts arguing the housing vacancy “problem” is actually two problems, or maybe three.  First, we built too many houses in 2002-06, perhaps due to bad regulation, or maybe bad private sector decisions.  Two other factors increased house prices; low interest rates caused by the tech crash (not easy money), and rapid immigration.  Those two reasons are “good” reasons for a housing boom.  So the housing boom was not good or bad, but partly good and partly bad.

The vacancy problem is also multifaceted.  Partly it was the bursting of the housing bubble.  Partly it was the slowdown in immigration.  And a big part was the huge drop in NGDP relative to trend, which drove unemployment much higher for young first-time home buyers.

And then I realized that my other blogging has a similar pattern.  The financial crisis was really two crises.  The first was caused by lots of foolish sub-prime lending, and led to a bailout of Bear Stearns.  The second was caused by a sharp fall in NGDP after June 2009 [Update: I meant 2008], and led to the failure of Lehman.

The recession itself is complex.  The initial part of the recession (after December 2007) was caused by both a drop in housing construction, and a drop in auto output as a result of soaring gas prices.  It caused RGDP to be flat in the first half of 2009.  Then a completely different problem occurred in late 2008, when tight money drove NGDP and RGDP much lower.  Even the recovery is complex, with the slow recovery being mostly attributable to weak NGDP growth, but also to unusually pronounced wage rigidity triggered by 99 week UI and a 40% minimum wage rise.

So that’s my shtick.

When I read others I often see what looks to me like overly simplistic views of these problems; “the” Great Depression, “the” financial crisis, “the” housing glut, “the” Great Recession, etc., etc.  But here’s the great irony.  I think others see me as the guy with the one-size-fits-all mono-causal explanation for everything.  Mr. NGDP.  Here’s Tyler Cowen, expressing what I think is the prevailing view of my blog:

I believe that the prominence and persistence of “demand-only” theorists in the blogosphere (DeLong, Krugman, Sumner, and others) give blog readers quite a skewed picture of the actual debate.

I see supply-side labor market problems as being a bit more important in this recession than Krugman and DeLong.  But on the other hand my view of the cause of the drop in NGDP is probably much more focused on monetary policy, whereas they’d give more weight to financial distress, fiscal policy, etc.  That’s what makes me seem so mono-causal, I view monetary policy as being “the” determinant of NGDP growth, more so than almost anyone else.

BTW, when I said that I often see others as offering mono-causal explanations for big problems, I’m excluding most of the best bloggers—especially Tyler Cowen, who is quite open to multiple perspectives.

Part 2:   Immigration

Speaking of multiple problems, Adam Ozimek sent me a post and an article where he discusses how immigration could improve the job market, and indicated Matt Yglesias had done similar posts.  Last year I argued that the immigration crackdown in 2007 might have contributed to the housing slump, but didn’t have much to say about policy implications.

I don’t think it’s realistic to have housing needs drive our immigration policy, but I agree with Ozimek and Yglesias that more immigration would help.  My general view of immigration is that it’s a good thing; indeed I agree with Will Wilkinson that it’s the best anti-poverty program out there.  (It’s ironic that the 1965 immigration bill isn’t usually considered part of LBJ’s “War on Poverty,” given that it was just about the only part of the war that was highly effective, maybe more so than all the rest combined.)

FWIW, I’d recommend increasing immigration enough to raise our population growth rate to Australian levels (2% per year), and I’d diversify to match the world’s population distribution.  That means more Africans and especially Asians, and fewer Mexicans.  I have nothing against Mexicans, and indeed personally I’d benefit more from half of our immigrants coming from Mexico, than a huge upsurge from Asia.  I’ll retire in LA where low-cost Mexican labor raises living standards for upper-middle class people like me.  In contrast, at the recent AEA meetings most of the job candidates we interviewed were Asians.  So they compete with US-born econ professors.

I see two advantages to diversifying immigration:

a.  There will be more political support as it will be seen as fairer–less focused on groups that directly compete with America’s unskilled workers.

b.  It will create more cultural diversity.  Many conservatives worry about a dual culture (Anglo/Latino) creating friction, and eroding America’s traditional culture.  Many Asians (and some Africans) get well-paying professional jobs, and blend into American culture pretty well.  I’m not saying Latinos don’t eventually do so, but the large concentration of Mexican immigrants in certain areas frightens cultural conservatives.

If we are to have a big increase in immigration we’ll have to deal with the opposition of low wage workers and cultural conservatives, and this is one way.

Immigration and housing prices

This Wikipedia entry suggests that illegal immigration is about 700,000 per year, in net terms (1,500,000 gross).   I presume this refers to the trend rate before the recession.  I also found an article in Yahoo that makes the following estimates:

The study released Wednesday estimates that 11.1 million illegal immigrants lived in the U.S. in 2009. That represents a decrease of roughly 1 million, or 8 percent, from a peak of 12 million in 2007.

The study puts the number of illegal immigrants down to about where it was in 2005. They still make up roughly 4 percent of the U.S. population.

The Homeland Security Department’s own estimate of illegal immigrants is slightly lower, at 10.8 million. The government uses a different census survey that makes some year-to-year comparisons difficult.

Of course these are rough estimates, but let’s say a ballpark estimate is that since 2007 we have been losing about 300,000 illegals per year, instead of gaining 700,000 per year.   If so, then it appears population growth in the US might have slowed by about 1 million per year.  Births and deaths don’t change much year to year, and I was also unable to find any indication that legal immigration had changed much in the last three years.  It turns out the data is collected in a very confusing way, and I wasn’t able to find a reliable Census bureau estimate of the components of population growth.  The Census doesn’t show much change in US annual population growth rates, but given they were embarrassed to find 6 million more in the 2000 census than expected, I think it’s fair to say they don’t have a good handle on illegal immigration.

So let’s suppose US population growth fell by one million after 2007, as a result of both the immigration crackdown and the recession.  Could this have caused the housing crash?  Just to get a rough idea of the magnitudes here, let’s assume a very simple model:

1.  Three people per family.

2.  Normal population growth 3 million per year.

3.  300,000,000 US residents

4.  100,000,000 US housing units

5.  Houses depreciate at 1% per year.

In this model we need a million new houses a year for new population, and another million replacement houses for depreciation.  Total construction should be 2,000,000/year, which was roughly the level of the mid-2000s.  Now assume population growth falls by 1,000,000.  This should reduce steady-state housing construction by 1/6th.  Not enough for a housing crash.

If the slowdown was concentrated in illegal immigrant-rich areas with fast population growth (California’s Inland Empire, Arizona, Nevada, etc) it could have had a significant effect on local markets—perhaps two or three times as large as the nationwide effect.  That could have triggered a significant housing slump in the sub-prime markets.  On the other hand, some immigrants left for reasons other than the immigration crackdown and the resulting drop in housing construction jobs.  So there is the issue of disentangling the various shocks.  If the immigration crackdown contributed to the decline in housing construction, there would be some sort of multiplier effect, as other immigrants would leave because of the resulting drop in economic activity.  But I don’t want to oversell that multiplier, as most of the recession was in non-housing areas.

Let me also emphasize that I am not trying to explain away bubble-like behavior at the micro level.  None of this explains banks giving mortgages to low income farm workers so they could buy $500,000 homes, rather I am trying to better understand how at the macro level otherwise intelligent investors might have gotten caught off guard by the nationwide housing slump and fall in real estate prices.  One factor propping up prices (rapid immigration) was pulled away unexpectedly.   In other parts of the country, the early stages of the housing slump were much less severe.

Now let’s suppose that some combination of less immigration and ordinary post-bubble problems led to severe banking problems for institutions that held lots of MBSs.  The Fed mishandles this problem and lets NGDP fall 8% below trend.  Now falling NGDP causes housing prices in non-sub-prime areas to begin falling.  Ditto for commercial real estate.  We saw in an earlier post that it was commercial real estate, not subprime housing, which was the main cause of bank failures.

I actually think immigration was much less than 50% of the initial problem.  But even if it was only 20%, because of the various ripple effects that I just described it is not inconceivable that the ultimate effect of the immigration crackdown could have been quite significant.  In 2008 there may have been a “knife edge” equilibrium, where if the economy had been a bit stronger we might have avoided the zero rate bound.  And if we had avoided that problem, monetary policy might have been able to prevent a steep fall in NGDP.  Maybe immigration is one reason Australia avoided the zero bound and steep recession.  Still, this is all speculation.  Even though I favor a high rate of immigration, the preceding story seems far too speculative to inform our immigration policy.  We are better off learning from other countries that do it better than us (yes, I mean Australia and Canada.)

PS:  There are lots of guesstimates in this post.  My hunch is that immigration slowed, but by less than 1,000,000 per year.  But births have also slowed by a few hundred thousand, which I excluded from the estimates.  Again, I am not looking for a monocausal explanation of the housing crash.  I think it likely that almost all giant economic disasters have multiple causes, whether it be the Great Depression, or the Great Recession.