The pandemic is still upending the economy in surprising ways

The pandemic is still upending the economy in surprising ways

Matthew Yglesias — Read time: 9 minutes

The pandemic is still upending the economy in surprising ways

Remote work created a housing boom which has depressed labor force participation

Lane Brown wrote an article for Curbed asking a good question: how can rents be up in a city like New York if the population still hasn’t fully recovered to its pre-pandemic level?

Unfortunately, the answer the piece suggests is that it’s a conspiracy whereby landlords are somehow colluding to keep units off the market in order to drive up rents. There’s no evidence for this, it’s extremely hard to see how landlords could possibly pull it off, and it’s somewhat hard to square with the fact that the same basic trend is visible everywhere.

And it’s too bad, because in macro-political terms, I do think it’s good for leftists to appreciate that one way for property owners to enrich themselves is to collude to restrict the supply of housing. They can’t really do this in the way that Brown suggests, but they of course can directly access the political system to impose zoning and other land use restrictions that curb supply. This doesn’t particularly explain New York City price trends over the past two years. But looking at the past 20 or 50 years, it’s absolutely true that property owners colluding to block supply is central to the story. They just do it by blocking new construction, not by warehousing existing units.

But what explains the short-term trend? How can demand be up even if the quantity of people is down?

I think this actually has a pretty straightforward explanation: population and relative rents are down in places like New York and San Francisco because of remote work. Absolute rents are up everywhere, and that’s also because of remote work. Thanks to remote work, fewer people want to live with roommates, more people want spare rooms to use as home offices, and many people have benefitted from a mix of rising wages and diminished commuting costs, allowing them to afford more square feet per person.

There’s reason to believe that remote work will have significant long-term benefits, but the very sudden shift in commuting patterns has happened much more quickly than the building stock can adjust. And a lot of other phenomena are downstream of that. Homelessness has risen in many places, for example, because your home office has displaced someone poorer than you from a bedroom.

And it’s even impacting the labor market. This increase in housing demand has meant rising costs for renters, but older people with lots of home equity scored a financial windfall as home prices boomed. What do older people do when they reap an unexpected asset price windfall? Well, some of them retire earlier than they otherwise would have. And Jack Favilukis and Gen Li calculate that this accounts for all of the post-pandemic decline in older workers’ labor force participation. It’s not that people have re-evaluated the meaning and purpose of life or that their work ethic has collapsed. It’s not fear of Covid. It’s that remote work boosted white collar workers’ desired level of housing consumption faster than the construction industry could add housing, creating a windfall for incumbent homeowners who then chose to take the windfall in the form of earlier retirement.

The wealth effect

The basic idea is pretty easy to understand. If I found a duffel bag full of money in a forgotten closet, I might splurge on something or save it for a rainy day.

But suppose you’re a 65-year-old regional manager who was planning to retire in 18 months when you become eligible to claim your full Social Security benefits. Well, if you get a cash windfall that’s plenty to live on for those 18 months, you might just say fuck it and retire a bit early. Why not? You’ve worked hard your whole life, your job is not particularly glamorous, and you don’t like dealing with annoying Zoomers at work.

I’m a little annoyed by the Favilukis and Li paper’s title, “The Great Resignation Was Caused by the COVID-19 Housing Boom,” because the Great Resignation was a dumb meme. To the extent that it refers to anything real, I think we should see it as referring to the pandemic-era boom in quitting one job in order to take another. That’s a real thing that happened; it’s the means by which higher labor demand translates into higher wages in an economy when few workers have a labor union that can negotiate raises in a less chaotic way.

What they are looking at instead is the rise in early retirements.

Beyond the title, though, it’s a good paper, and it shows a few different things:

From 2011-2021, higher price growth leads to lower labor force participation for older homeowners.

Higher house price growth has very little impact on the labor supply of younger homeowners.

Higher house price growth has very little impact on the labor supply of older renters.

The conclusion is that, in general, older homeowners use home equity windfalls to enter early retirement or semi-retire.

They then exploit the fact that the house price boom hit different metro areas differently, more muted in New York than in Boise for example, to create a counterfactual scenario of how age-specific labor force participation would have evolved if 2020 and 2021 home price trends had been the same as they were in 2019. The big difference is this thin pink line rather than the thick red one — showing we would have had substantially more old homeowners in the workforce without the home price boom.

Note that the big changes here are among people who are older. But this is important. As Lydia DePillis and others have written, the post-pandemic decline in labor force participation is overwhelmingly a story about older people. I’ve become enough of a cranky old person to be entertained by Adrian Wooldridge’s musings on legal marijuana and work ethic but statistically, the story about seniors retiring thanks to a wealth boost is a much bigger deal.

Sudden change is hard on the economy

The economics of the Covid era keep surprising us.

The initial negative blow to the economy from the pandemic was obviously a supply-side issue. But there was a lot of concern, including from me, that lost income due to the supply shock would create a lingering demand shortfall and a long, slow recessionary slog. That didn’t happen. Policymakers did such a good job of stimulating the economy that in broad GDP terms, it’s almost like the pandemic didn’t happen. We finally achieved a full employment economy in the winter of 2019-2020, so it would’ve been natural for growth to slow down a bit and we would have arrived basically just where we are.

But of course the pandemic did happen (you probably remember it), so the specific way this played out was kind of weird. People got lots of financial assistance from the American Rescue Plan and especially from the CARES Act, and most households spent less money pre-vaccine than they normally do. That led people to build up a big savings buffer that we’ve been collectively spending down since the fall of 2021.

When everyone tries to spend an unusually large amount relative to what they earn, you get what Jason Furman points out — an economy where real wages have fallen despite workers’ enhanced bargaining power from low unemployment.

This comes down to timing. People spent 2022 trying to make up for consumption they deferred back in 2020. But restaurants don’t have a time machine that can get people who were furloughed back in 2020 to work extra shifts in 2022. It will work out in the long term — the actual white-knuckle, scary stuff already happened — but the temporal mismatch is very awkward.

The same is true on the housing front.

Even if the pandemic had never happened, remote work would’ve clearly become more popular over time. But if that had happened gradually, we would have seen a collapse in new office construction, but not necessarily soaring vacancies. And rather than a sudden surge, we’d have seen a gentle increase in housing demand, an increase that would have re-employed the disemployed office builders doing residential construction instead.

But because it all happened at once, we ended up in an awkward situation. White-collar workers are consuming more square feet per capita of housing, which has left other people sleeping in the streets of downtown office districts that are full of half-empty buildings. Meanwhile, older homeowners reaped an unexpected windfall and retired early, increasing inflationary pressure on the labor market. A lot of the stuff that’s happening now seems distant from the pandemic in a way that “restaurants are closing because of a virus” wasn’t. But the shock keeps rattling around, with tertiary consequences all over the place.

Excess savings have diminished a lot now, and asset prices have been depressed by rising interest rates, so I expect the particulars of this early retirement surge to start fading soon. But the impact on the housing market itself will linger.

The built environment needs to change

To go back to where we started, with Brown’s piece, one straightforward implication of the rise in housing demand is that unless cities allow for new construction, their populations will fall.

We’ve seen this as a long-term trend in a lot of cities anyway. Both Washington, D.C. and Boston saw their populations crash for several decades after peaking in 1950 due to broad suburbanization trends. But over the past generation, they’ve rebounded — albeit not all the way up to 1950 levels. So how do these cities manage to be expensive when they accommodated more people 70 years ago?

Well, the average household size has fallen. A two-bedroom apartment that once accommodated mom, dad, and two kids is now likely a DINK couple and a home office or maybe a pair of roommates. A four-bedroom family house that used to accommodate two parents and five kids now might have two children, each with their own bedroom plus a playroom.

There’s nothing wrong with that; society is becoming more affluent and people are enjoying the fruits of material abundance. On the exurban fringes of our metro area, newly built homes are bigger than the newly built homes of 20 or 30 or 40 years ago. And there’s no reason in principle that expensive central cities couldn’t be adding square footage to keep pace. But it would require significant regulatory changes. Big towers full of one-bedroom apartments could get the young professionals out of group houses and open older dwellings up for families. Changes to the rules about staircase requirements in apartment buildings could make it easier to build spacious three-bedroom floor plans in high rises. Changes to rules barring windowless bedrooms would make it cheaper to convert offices to apartments, creating some economical (albeit awkward) dwelling opportunities for people.

But if not, they’re going to be stuck with a very awkward combination where the residential population falls, rents are rising somewhat anyway, downtowns stay perpetually half-empty, and office landlords stop putting money into keeping up their properties.

As far as I can tell, municipal officials everywhere are vaguely aware that there’s a problem here, and they’re all tinkering around the margins with tax abatements for residential conversions and such. But at the same time, there’s a lot of magical thinking around these dynamics, as reflected in that Curbed piece that fails to acknowledge the reality of a world where demand for residential square footage is up and office square footage is down. The speed of that change is awkward for any city, but it’s made much more awkward by bad, inflexible policies that, to the best of my knowledge, no place has actually fixed.

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