Yes, supply does matter for housing affordability (Op-Ed)
The Globe & Mail recently published an op-ed by Dr. Josh Gordon, in which he argues that only “cheap credit, foreign ownership, speculation and high rental demand” can explain the significant housing price increases observed in Toronto and Vancouver since 2010. Dr. Gordon and I agree about one thing: demand for housing impacts its price. That is where our agreement ends, as he argues that demand is the only factor that impacts housing prices. The article goes to great lengths to disabuse the reader of the “supply narrative [which] has been endlessly repeated.” Many of the arguments, however, don’t stand up to scrutiny, and the article dismisses the vast and high-quality empirical research which demonstrates the importance of supply-side factors in housing markets.
Let me preface my concerns by acknowledging that the op-ed gets several things right. First, short-run price changes are almost always demand-driven in housing markets. Housing policies that only target supply will lack effectiveness. Second, a narrative which encourages increasing housing supply does financially benefit developers, and can benefit some politicians. The op-ed points to the fact that since 2010, neither Toronto nor Vancouver have seen changes in regulation, and that “rates of housing construction have remained very strong.” This, Gordon argues, means that increasing housing supply cannot stop prices from rising because building rates are already robust. However, a recent report from the Canada Mortgage and Housing Corporation (CMHC) suggests otherwise. It looked at five Canadian cities and examined how housing supply changed relative to price increases, a concept that economists call “supply elasticity.” Unsurprisingly, Calgary, Montreal, and Edmonton each had a supply elasticity two to four times higher than that of Toronto and Vancouver. A constant or modestly-increasing rate of supply in the face of skyrocketing prices is a sign of an unhealthy or “inelastic” housing market. The report also showed the importance of demand factors. This is to be expected: both supply and demand impact market prices.
Regulations which restrict the quantity and composition of housing construction are problematic because they make the supply of housing less elastic. Contrary to the suggestion of the op-ed, constraints to housing supply caused by regulations are problematic even if those regulations are not getting stricter. The same CMHC report showed that Toronto and Vancouver have the most stringent land-use regulations which includes longer approval times, development fees, and rezoning requirements.
The article is right to state that supply constraints are often blamed for the sustained price increases seen in many major North American cities, but the article is wrong to dismiss the research which supports this claim. There are dozens of peer-reviewed papers published in top economics journals that have demonstrated that housing elasticities and regulatory constraints are a significant factor in determining the long-run price level of housing, as well as relative prices between cities. For classic studies see here, here, here, or here. Regional studies also abound (see here or here). Even studies which emphasize geographical rather than regulatory constraints come the same conclusion: supply elasticities matter for housing prices.
Despite the mountain of empirical evidence, the op-ed bizarrely states that the supply narrative is “evidence-averse,” the “emperor has no clothes,” and that “I have yet to encounter a single academic peer-reviewed article which documents a substantial causal link between supply-side factors and housing unaffordability in Canada.” Though most research on this topic is centred on the United States, due to the quality of the datasets available (the Wharton Residential Land Use Regulatory Index is an example), there are enough fundamental similarities between housing markets in Canada and the United States to be confident that supply factors impact prices in this country. Additionally, numerous Canadian policy papers have discussed the impact of supply-side factors on housing prices, including reports from Ryerson, The Fraser Institute, and the aforementioned CMHC report.
Avoiding supply-side issues leaves out a significant number of policy options that could bolster housing affordability. It is reasonable to argue whether policies should emphasise the demand-side or the supply-side of the housing market. It is unreasonable to argue that policies should only target one or the other completely. The right balance in policy surely depends on the city and the point in time. Arguing that the quantity of housing units is unimportant for the price level belies the empirical literature, economic theory, and common sense.