Housing: Part 161 - Q: Why hasn't the productivity crisis caused a bear market? A: Housing

Gavyn Davies asks the question in the Financial Times.  (HT: TC)  The answer is mine.

The reason that lower productivity hasn't caused a bear market is because the lower productivity is due to our limited access housing regime.  There is a cap on the output of our economic centers.  This limits entry into markets that utilize highly skilled and highly networked labor markets.  This creates higher wages for the high skilled workers that use those markets and high rental income for real estate owners in those markets, since those two groups own the valuable resources (land and human capital) that serve as gatekeepers.  Firms in those markets also benefit from the limited access, and also collect economic rents from excess profits internationally.  They probably gain less than the workers and landowners from the domestic economic rents of limited access, but excess profit from foreign operations adds to their gain.

It looks like US corporate profit has increased its share of domestic income.  This is mostly due to low leverage.  This is deceptive, because leverage doesn't look low in relation to book value.  But, the competitive moat for these firms doesn't exist in capital that is on their balance sheets.  It exists in the limited housing stock that prevents competition in the labor markets where they are established.  So, they effectively have off-balance sheet, non-recourse assets, which show up in national accounts as real estate.  This is one reason why corporate equity values are higher than book values.

For corporate capital management, it is equity value that matters, because that is the market price of equity vs. debt.  On that basis, leverage is quite low.  Operating profits are divided between equity holders and debt holders.  It just happens that now equity holds have a higher portion of the ownership, so profits are higher relative to interest income.  Total corporate income is not high as a portion of national income.  As Matt Rognlie has shown, it is income to housing that has increased as a proportion of national income.

There is no inevitable bear market that results from this, except for the eventual development of some foreign competition that is able to break the Western urban claim on economic rents from valuable labor.  The bear market will come when computer science graduates from Stanford are moving to Seoul.  Until then, all of these groups will continue to earn economic profits and a large nominally valued housing stock, a normally priced stock market, high economic stress, low productivity growth, and low interest rates will probably continue to be the norm.