Try listing every problem the Western world has at the moment. Along with Covid, you might include slow growth, climate change, poor health, financial instability, economic inequality, and falling fertility. These longer-term trends contribute to a sense of malaise that many of us feel about our societies. They may seem loosely related, but there is one big thing that makes them all worse. That thing is a shortage of housing: too few homes being built where people want to live. And if we fix those shortages, we will help to solve many of the other, seemingly unrelated problems that we face as well.

The obvious effects of expensive housing

Where you live affects nearly everything about your life – where you work, how you spend time off, who your friends and neighbours are, how many kids you can have and when, and even how often you get sick. Most people’s most valuable asset is, by far, their own home. And housing is so important for the overall economy because it determines the location and supply of the most important ‘resource’ of all: people.

There’s a growing consensus that housing is too expensive in most Western countries. In many places, the prices of new homes far exceed the cost of building more of them. Higher incomes in cities draw people to those places, who use some of their increased wages to bid up rents and house prices there. Easier credit and falling interest rates, which reflect a lower cost of borrowing and lower returns from other investments, have helped people bid up the price of housing as well. For most goods, including very expensive and durable goods like ships and airplanes, higher incomes and falling interest rates would cause supply to increase, instead of keeping the price permanently high. But for housing in and around many in-demand cities, supply has not been able to keep up with demand.

This is true across the developed world: Dublin, Singapore, Auckland, Paris, Vancouver, Rome, Hong Kong, Barcelona, Moscow, Cape Town, Zurich and many other cities have wildly expensive housing compared to the cost of building more of it. Costs are especially high in places whose economies are built on intangible capital, like software or financial services. In these kinds of industries, there are especially large benefits to people being near one another, because it makes them both more productive and more innovative. This is why the San Francisco Bay Area – probably the most productive place in the Western world – is also one of the most in-demand places to live. And that demand, plus restrictions on building more houses, is why it is one of the most expensive places to live as well.

This housing affordability problem has become much worse over the past four decades – coinciding with, and partly driven by, the growth of the intangible economy — the move towards production based on software and intellectual property, instead of machinery and other physical capital. In the 1960s, it was commonplace that a middle class single-earner American or British family would be able to afford a comfortable home.

When more people want to live in an area, we either build more homes to accommodate them or squeeze them in to the existing housing stock, with those people bidding up the price of living there. We can see all of these mechanisms in play in the Western world’s most in-demand cities. In London, for example, empty homes now make up only a few percent of the total, as it becomes more and more costly to leave something empty.

The most dramatic evidence of housing scarcity can be seen in price rises over the past forty years. Average New York City metropolitan area house prices are up 706% since 1980 (or 376% more than US consumer prices, and 326% more than US wages). For San Francisco the rise is 932%. London house prices are up over 2,100% in that period (or around 1,500% more than wages). Prices in Sydney, Australia, have risen by 1,450% (compared to hourly wage increases of 480%). In Ireland, prices have risen by about 800% in that period, driven by rises in Dublin in particular. Rents show similar, but less extreme, trends, because they are not directly affected by interest rates.

These prices range from about twice to four times the cost of building new homes of equivalent specification. This wedge, between build costs and house prices, is a rough proxy for how much extra cost is being driven by restrictions on new building.

By contrast, almost every other household product has become better and less expensive since then. Compared to 1975, the number of hours a median American worker would have to work to buy a television fell from 60 hours in 1975 to 7 hours in 2013; to buy a fridge-freezer, it fell from 65 hours in 1975 to 20 hours in 2013; to buy a manual exercise treadmill, from 18 hours in 1975 to 6 hours in 2013; and to buy a washer-dryer, from 67 to 30 hours. Even cars are three times ‘cheaper’ in terms of hours worked on an average hourly wage now than they were in 1964. And none of these estimates accounts for how much better most of these products are now than they were in 1975.

So while other durable goods have become cheaper over time, housing has become more expensive. Even though incomes have risen, both parents in a family now typically have to work to afford a decent family house in a major city, and people have had to move farther and farther outside city centres to find somewhere they can afford to live, spending more time and money on commuting to and from work.

So the obvious effect of expensive housing is that people often spend a lot of their money on renting or buying their home, leaving them with less money to spend on other things, especially if they live in and around the Western world’s most wealthy cities. And the problem is getting worse.

Productivity

The obvious effect of expensive housing – people having less money to spend on other things – is the one most people focus on. But it is only part of the story, because expensive housing makes people change their behaviour too – it affects where you live, what your job is, how big your family is and what your day-to-day life looks like too. And it’s these hidden effects that are the most important.

As we’ve described above, better jobs drive up the price of housing when it’s difficult to build more. But that works both ways: when housing is scarce in high-productivity areas, some people are priced out of the area altogether, so they can’t move within range of better jobs.

This means that many people are working in less productive jobs than they could if it was easier for them to move to more productive places. Their wages and productivity are lower and it’s harder for highly productive businesses to hire them. That means people who do get to live in these high-productivity places are less productive than they could be, because they are less able to combine their skills with the complementary skills of the people who have been priced out.

As a result, many businesses end up leaving highly skilled staff without assistance, spending their time on work that could be done by others, lowering the time they can spend on the tasks they’re best at. This happens in people’s private lives too: people often spend hours trying to fix their leaky pipes instead of just calling in a plumber, because the prices of plumbers near them have risen to cover the costs for plumbers to live there.

On average, workers in larger cities tend to be more productive than workers with similar skills and education in smaller cities. Sheer size is not all that matters, because complementarity between workers matters even more – a skilled software engineer will likely increase her income more by moving to Berlin (population: 4.4 million) than to Mexico City (population: 21 million). But there is strong empirical evidence that, other things being equal, bigger is better. This helps workers directly: people who moved from small to large cities in a study in Spain gained a wage premium when they did so, and accumulated better experience as time went by – and their experience persisted even if they moved away later, in the form of higher wages.

In the United States, productivity per worker tends to rise by 2% or more with each doubling of city size. The link between size and productivity is only apparent when the city includes skilled, educated workers, which suggests the effect is mostly driven by the transfer of knowledge and division of labour among high-skilled workers. Metropolitan areas that are largely made up of unskilled workers do not become more productive as they get bigger.

By historical and global standards, today’s most successful cities in America and other Western countries are astonishingly sparsely populated and sprawling. Haussmann’s Paris, Gaudi’s Barcelona, and the Georgian and Victorian areas of London are much more densely populated than nearly every square mile of the Bay Area and even most of the NYC metro area, other than Manhattan.

The main cause of this is regulations that ban buildings that make better use of the land. Economists Gilles Duranton and Diego Puga judge that if New York allowed more of the sorts of densities that were more common historically, rents and house prices would fall towards construction costs, and the city would at least double in population, to over 40 million people. Similar things would happen to the Bay Area, Boston, Los Angeles, and other US ‘