Why do people treat housing as a special form of wealth? How exactly is housing different from other forms of capital, such as equipment, financial, etc? Since the distinction between housing and capital regularly drives policy making, it is important to understand the differences between housing and other forms of capital. As such, this post will address these questions.
Imagine a world in which people cannot always borrow as much as they wish in order to operate their businesses (like the world we live in). As a result, business owners must rely partly on their own wealth to run their operations. But as we know, and as was found in a recent data analysis by Fagereng el al (2017) , some people are better than others at operating a business. The combination of limited credit and the differences between people’s ability to operate a business imply that the amount of output produced with a given amount of capital depends heavily on the entrepreneurial ability of its owner!
Think about it like this: if John is not an astute businessman and Adam is, then capital would be most productive if Adam had access to (or was able to borrow) all the capital (I will expand on the reason for this in a moment). But what if John has all the money and, for some reason or another, cannot lend it to Adam? In that case, John is holding on to capital that is not put to productive use. John is running his businesses to the ground, and thus, shuts down without hiring any workers. Now suppose that John was able to anticipate that he would run his business to the ground, and decided to offer Adam to run his business for him since Adam is better at operating a business. But why would Adam sacrifice his time, effort, and motivation to run someone else’s business without getting the full benefit of his hard work? Since Adam “has no skin in the game”, he does not do a great of a job at running John’s business. But wait, suppose instead, that John and Adam found a way to borrow and lend and Adam was able to use the money his borrowed from John to start his own business. Since Adam is a better entrepreneur than John, he would be more successful and perhaps would be able hire John to help him out in his operation. Ultimately, both of them may be better off in this scenario as Adam is incentivized to put his heart and soul into his business to make it successful, and John is earning a salary and interest on the capital he lent to Adam. The conclusion is that in this situation it is better for both John and Adam if Adam is able to borrow all of John’s capital.
Now, let’s turn to housing. Suppose I were to take Homeowner Adam and Renter John and switch between them: John goes to live in Adam’s house and Adam goes to live in John’s rental unit. From an accounting perspective this would have no affect on output: rent and imputed rent (the amount of rent that would be garnered if an owner-occupied unit was rented out) would be the exact same. Furthermore, suppose that a certain amount of money was invested in a renovation of a house. Whether it was done by Adam or by John, the increase in the house price would be roughly the same, regardless of the fact that Adam is better at operating a business relative to John. Lastly, while it is true that certain types of houses appreciate at different rates, the rate of appreciation is determined mainly by market forces, and not so much by Adam’s or John’s entrepreneurial ability.
This leads me to the the bottom line: the inherit difference between capital and housing is that the allocation of capital across individuals in the economy matters for production and wages, whereas the allocation of housing across individuals does much less so.
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