Creative Class

One consequence of the economic crisis is that the rate of home ownership has been slipping, as the chart below shows (via Calculated Risk).

A growing number of economists and urbanists question whether the United States has put too much emphasis on homeownership and over-invested in housing. Ever since the Great Depression, America has generously subsidized homeownership through the tax code and by other means. Housing does take up  a significant share of U.S. investment comparatively speaking; and, in some regions, real estate, housing, and construction made up a huge share of the local economy, as high as 25 to 30 percent at the height of the bubble, bigger than education, health-care, government, or manufacturing. I’ve argued elsewhere that the two American dreams - of homeownership and of unfettered economic mobility - may be in conflict, as homeownership, especially in downturns like today, impedes mobility and makes it harder for individuals to move to work and the labor market on the whole to adjust.

The benefits versus costs of homeownership is an important debate. On the pro-side, Joel Kotkin makes the case for homeownership in his recent Forbes column. Stephen Slivinski provides a thorough review (via Tyler Cowen) of the downsides of what he calls America’s homeownership bias.

Simply put, Americans may have overinvested in housing. This has been a worry of economists for a while. It’s a concern based on what they see when they compare the rates of return - profit per dollar invested - for a variety of capital types …  “When you observe that the measurable rates of return are different across the sectors,” said the Dallas Fed study author, Lori Taylor of Texas A&M University, “you either have to conclude that there are substantial unmeasured returns across the sectors or you have to conclude that society would be better off with a reallocation of resources.” These unmeasured benefits would have to be very large - at least $3,600 per homeowner in America - for the investment imbalance to be explained …

Robert Shiller, an economist at Yale University and an expert on national housing markets, has estimated that “from 1890 through 1990, the return on residential real estate was just about zero after inflation.” Throw in the costs of maintenance of the property and it’s easy to see how renting could certainly be cheaper than owning, even if you include the tax advantages. Yet the opportunity cost of those home investments - the foregone investment opportunities elsewhere - go largely unseen …

Being tied down to a house tends to make people less likely to leave an area in which employment prospects are deteriorating …A seminal study by British economist Andrew Oswald of the University of Warwick traced the link between unemployment and homeownership. Oswald looked at the United States, the United Kingdom, France, Italy, and Sweden between 1960 and 1996 and discovered that, on average, a 10 percentage point increase in homeownership tended to correlate with a 2 percentage point increase in the unemployment rate.

Recent studies of European data discover that you don’t see these sorts of correlations in areas with higher concentrations of renters. Renters are simply more able and willing to move away when their community hits the economic skids. In addition, workers who aren’t likely to move from a specific location might create frictions in the markets for labor skills. It’s a cost to the economy when people live in an area in which their skills are no longer valued. But there is a potential personal cost too: The overall welfare of that worker may suffer. Homeownership also tends to contribute to adverse political incentives. Incumbent homeowners have an interest in keeping their property values high and have been shown statistically to have a bias in favor of land-use regulations. These restrictions limit the number of houses that can be built in any geographic area and, consequently, keep housing inventory low and property values artificially inflated.

It appears that the crisis is causing a shift from homeownership to rental, as the graph below (also from Calculated Risk) shows. This trend may end up being a good thing for certain homeowners and for the flexibility of the U.S. economy as a whole.

One thing we know about crises is they frequently bring about significant changes in the system of housing tenure. The Great Depression and New Deal innovations in housing finance and housing policy, plus the post-war boom and infrastructure building, brought a massive shift toward single family homeownership. My hunch is it’s time for new hybrid forms of housing tenure which mix the benefits of ownership with the flexibility of renting.

Were you - like me - ever amazed at how so many people could afford bigger and bigger homes, New England beach houses and Florida condos, expensive cars? The answer, according to a terrific article by Ben Funnell in the Financial Times, is simple: cheap, available credit.

Debt, he says, is “capitalism’s dirty little secret.” Cheap mortgages, cheap car leases, and the use of home as veritable ATM’s created fictitious living standards for the middle class and the bulk of the population at a time of low productivity and paltry growth in incomes, and where the bulk of the gains in wealth were scooped up by the top fraction of households.

The economic crisis appears to be causing a slight but noticeable shift from the suburbs to the cities, according to an analysis of recent Census data by Brookings demographer William Frey, reported in the Wall Street Journal.

“The central-city population in U.S. metropolitan areas with more than one million people (excluding New Orleans …) grew at an annual rate of 0.97% between July 2007 and July 2008 …That compared with a growth rate of 0.90% in 2006-2007, and growth rates around 0.5% in the years between 2002 and 2005, when the robust real-estate market led to new jobs and new housing developments outside the cities, where open land is more plentiful … Population growth in the cities has translated to slower growth in the suburbs. U.S. suburbs in metro areas greater than 1 million people grew at a 1.11% annual rate in 2007-2008, the same as a year earlier and down from growth rates between 1.29% and 1.48% between 2002 and 2005.”

The combined effects of the recession, job loss, and the housing crisis have made it more difficult for many to sell their houses, in effect locking them in place and slowing rates of residential and geographic mobility. Frey points out that:

“This shows cities were reviving at the end of this decade, and they are also surviving a recession that has been a lot harsher for other parts of our landscape …Cities are big enough and diverse enough that they are able to survive these ups and downs in the economy a lot better.”

And this is especially true of the biggest and most diverse cities, like New York and Chicago, which are hubs of large mega-regions, as well as magnets like greater D.C. and Silicon Valley which continue to draw in highly skilled and ambitious people from the U.S. and the world. Large Rustbelt cities, like Detroit, continue to lose people, and rates of growth in housing-driven Sunbelt cities have slowed considerably.

The June unemployment numbers do not look very pretty for the United States. After four months of improvements in the number of jobs lost, the numbers again increased to 467,000 up from 322,000 in May. The unemployment rate, now at 9.5 percent, is the highest in 26 years. The recession is entering its 20th month and will soon reach two years with little end in sight.

While the great recession of the 21st century grinds on, explanations for it continue to elude us. Some think that it is a depression and they may be right. I suggest that we have at least four issues on our plate that have emerged as a perfect story. The solutions to all are institutional. First, let’s start with the financial crisis. This financial crisis resulted from market failure. The lack of rules or what some like to call regulatory arbitrage, that is, working the rules led to the financial meltdown. We are still not out of the woods on this one because the rules have not been fixed. Without rules markets cannot work.

Second, we now have a global recession with falling demand and rising unemployment. A classic case of underused resources. The recession was in part caused by the financial crisis, but only in part. It is clear now that at least two interpretations are in order. First, it was a classic case of over-investment in housing. We have about two to three million too many houses. It will take about six years to work this off through population growth and attrition. This “inventory recession,” to use an old phrase, is nothing new, only the sector is - housing. The other interpretation is that it was caused by imbalances in the global economy between rich and poor countries. In either case, as Richard Florida pointed out with housing, or Business Week with global imbalances, new rules are needed.

Third, we have finally realized that we do indeed have a sustainability issue in the environment. It is both about the carbon footprint and about the type and amount of energy used. This is not a cause of our current financial and economic problems but it impacts it directly since it is about investment, and with a huge amount of uncertainty where to invest it is also putting a drag on the economy. Rules would help.

Finally, we are just realizing that globalization that started a few decades ago might be a dead end. It is a dead end not because the world does not want to globalize (most do) but because markets cannot work without rules. And in a global economy we need global rules. Here is the rub. All of the above problems in some way suffer from having a global economy without a set of global rules. When the last era of globalization ended at the dawn of the first world war, the rules that governed up to then also evaporated and it took decades to put them back in place after the second world war.

We are now into the second decade of the second globalization of the world economy. Until we are able to put the “rules of the game” in place markets, I am afraid the economy, and the financial sector, cannot be expected to lead to growth. The environmental rules are even more onerous. We just might need to start working on the rules of the game sooner rather than later. This seems like a task for the creative class. What is needed is talent and honesty in order to put a global structure in place where all can prosper. This is no small task.

Writing in The Atlantic, I argued that the economic crisis was reshaping America’s economic geography, with big city centers and mega-region hubs like New York City, talent-rich regions like greater D.C., and college towns weathering the storm relatively well, while Rustbelt cities and shallow-rooted Sunbelt economies being much harder hit.

Take a look at the graph below from the newly released SP/Case-Shiller Home Price Index for April.

Phoenix and Las Vegas have taken the biggest hits: Housing prices there have declined more than 50 percent in the past year. Miami is next, then Detroit where housing prices have sunk to mid-90s levels. San Francisco is the only significant talent region to be pummeled. Part of this is to be expected given the tremendous run-up in housing prices there, but still prices remain higher than 2000 levels. San Diego, L.A., and Tampa have all seen declines in excess of 40 percent.

Housing prices have declined less significantly in greater D.C., Chicago (hub of the great Chi-Pitts mega-region and a magnet for regional talent), Seattle (a high-tech, high human capital center), Atlanta (a talent hub for the southeast), New York, Portland, Boston, Denver - (talent hub for the Rockies), Dallas (a mega-region hub), and Charlotte (which along with Atlanta hubs the great Char-lanta mega-region). Cleveland breaks the pattern, but like Detroit its absolute housing values have fallen. Prices in greater D.C., along with Denver, Dallas, and Cleveland, were actually up in April.

The Index also tracks prices in terms of their 2000 baseline. Nationally, it’s at 140, meaning housing prices remain 40 percent higher than in 2000, more or less in line with 2003 prices. Looked at it this way, the geographic pattern could not be more striking.

Rustbelt cities have seen, by far, the biggest declines relative to 2000 prices. Detroit and Cleveland are the only two cities where housing values have slipped below 2000 values - Detroit at 69 percent and Cleveland at 98 percent.

Prices have just about fallen back to 2000 levels in Sunbelt cities like Phoenix (105), Atlanta (105), Las Vegas (112), Dallas (115) and Charlotte (118). Miami (145) and Tampa (140) break the pattern; their prices remain significantly above 2000 levels. My guess is that prices will continue to fall and sharply in these two markets in the coming months.

But prices in prices in Boston (146), L.A. (149), greater D.C. (167), and New York (170) remain significantly above - 50 to 70 percent above - 2000 levels. While these prices may dip some, my hunch is these markets will not be devastated and will remain substantially above 2000 levels.

The SP/Case-Shiller Index suggests that housing prices are still falling and have another 30 or more to go before they hit bottom. One thing you can be sure of, it will continue to be felt unequally across regions.

Here’s the abstract from a new paper by Ed Glaeser and Matthew G. Resseger (thanks to David Ptak for the pointer).

There is a strong connection between per worker productivity and metropolitan area population, which is commonly interpreted as evidence for the existence of agglomeration economies. This correlation is particularly strong in cities with higher levels of skill and virtually non-existent in less skilled metropolitan areas. This fact is particularly compatible with the view that urban density is important because proximity spreads knowledge, which either makes workers more skilled or entrepreneurs more productive. Bigger cities certainly attract more skilled workers, and there is some evidence suggesting that human capital accumulates more quickly in urban areas.

Full text is here.

“The bicycle is the means of transport used most often in Amsterdam,” reports Bike Europe. “Between 2005 and 2007 people in the city used their bikes on average 0.87 times a day, compared to 0.84 for their cars. This is the first time that bicycle use exceeds car use.”

When I started cycling in the Boston area a decade or so, I recall there was a competition between bike, car, and train commuters on designated routes. The bike commuters cleaned up.

It’s getting better in cities from New York to Portland, but American and Canadian cities have a long way to go to catch up - in car too many, commuting by bike remains fraught with risk.

Check out this video of Amsterdam bike commuters:

I recently read The Wikipedia Revolution by Andrew Lih. The story of Wikipedia is a microcosm for looking at at least three things:

1. How the Internet and Web are changing almost everything, destroying old models but with inherent weaknesses of their own.
2. How collaborative group efforts can be greater than the sum of their parts.
3. The human desire to have all knowledge.

1. Wikipedia is a perfect symbol of the Internet. It exists in a virtual reality, with a mass of contributors who don’t know each other. It has almost totally undercut older encyclopedias like Britannica and World Book, but depends entirely on the goodwill of its contributors. It has no stable means of support, and at the end of the book (published this year) Wikipedia was moving its headquarters to San Francisco, expanding staff and becoming much more expensive to operate in a leap of faith.

2. Wikipedia’s model of using a large number of contributors isn’t new, although the lack of professional editing is. The Oxford English Dictionary was originally built the same way, using file cards in cubbyholes in the 1800s, a fascinating story told in The Professor and the Madman. Wikipedia’s strength is its self-correcting and self-regulating nature. Its weakness is that unless someone knowledgeable about a field contributes, the articles will be weak.

In 2005, Nature magazine famously did a comparison of Wikipedia and Britannica’s science articles and found their accuracy comparable. However, when I first saw Wikipedia a couple of years ago I looked up two things I knew something about: grantwriting, which is my field, and BKS Iyengar, who is my wife’s teacher. Both were weak - not inaccurate, but sorely lacking. I checked recently and the Iyengar articles are much improved, but grants articles are still marginal (I’ve resolved to fix them when I get some time). If these two quick checks are representative, there are probably many other weak areas (in fairness, Britannica Online doesn’t have seem to have articles on either topic.)

3. People have been trying to capture the world’s knowledge for millennia. The first modern encyclopedia was probably Diderot’s French Encyclopédie, although Lih’s book says the first major attempt may have been by Pliny the Elder in the first century. But since knowledge is incomplete and constantly expanding and changing, the print versions were outdated within years. Wikipedia corrects this, but at the expense of a central editor or editors.

The larger question is about knowledge itself, which is famously growing faster than anyone can keep up. It has also been destroyed or lost in massive amounts, like the burning of the great library of Alexandria, the book burning in China’s Quin dynasty, or the medieval witch burnings which eliminated knowledge of folk medicine. In Asimov’s Foundation Trilogy, the Encyclopedists are trying to preserve human knowledge in advance of a total breakdown of civilization (apparently the books are going to be made into a movie next year). (Funny thing about old science fiction. Spaceships leap across the universe, but computers are still the size of houses and books are still published on paper.)

Obviously, things are changing very fast. Wikipedia could drive print encyclopedias out of business then fail itself. The wiki model is very democratic, but like many very open systems subject to error and manipulation. Stay tuned.

Two of my favorite management thinkers, John Hagel and John Seely Brown, have just released an important new study, The Big Shift. I’ve read the research, which expands on some of my own constructs, and had a chance to talk with Hagel about it at length last week. One of the most important findings is that return on assets for American companies has been declining for decades. Here’s a short-form version that appeared over at Harvard Business Review online.

The 2009 Shift Index reveals a disquieting performance paradox in the US corporate sector. On the one hand, labor productivity has nearly doubled since 1965. During those same years, however, US companies’ Return on Assets (ROA) progressively dropped 75 percent from their 1965 level.

How can firms be getting lower returns even as they’re becoming more efficient? The answer resides in the heightened competition among firms. Competitive intensity nearly doubled between 1965 and 2008, forcing firms to compete away the benefits of productivity gains, which were instead captured by creative talent in the form of higher compensation and numbers of consumers through increasing performance/price ratios and wider choice.

It’s little surprise to find also that the highest-performing companies are struggling to maintain their ROA rates and are increasingly losing market leadership positions. Taken as a whole, the findings portray a U.S. corporate sector in which long-term forces of change are undercutting normal sources of economic value. “Normal” may in fact be a thing of the past: even after the economy resumes growing, companies’ returns will remain under pressure.

To respond to this performance challenge, U.S. companies will need to let go of industrial- era organizational structures (and the reporting relationships, incentive systems, and managerial processes that go with them) and operational practices in favor of the new institutional architectures and business practices needed to create and capture economic value in the era of the Big Shift.

Companies must move beyond their fixation on getting bigger and more cost-effective to make the institutional innovations necessary to accelerate performance improvement as they add participants to their ecosystems, expanding learning and innovation in collaboration curves and creation spaces. Companies must move, in other words, from scalable efficiency to scalable learning and performance. Only then will they make the most of our new era’s fast-moving digital infrastructure.

The full report is here. The section on creative cities begins on p. 60. It shows strong relationships between cities with high scores on the Creativity Index and economic output (measured as GDP), returns to talent and economic freedom, as well as a large performance gap between high and low scoring cities on that index.

Chris Anderson’s new book Free argues that with the rise of digital marketplace business can profit more from giving information and content away than by charging for it.

Malcolm Gladwell, reviewing the book for the New Yorker, says not so fast.

There are four strands of argument here: a technological claim (digital infrastructure is effectively Free), a psychological claim (consumers love Free), a procedural claim (Free means never having to make a judgment), and a commercial claim (the market created by the technological Free and the psychological Free can make you a lot of money). The only problem is that in the middle of laying out what he sees as the new business model of the digital age Anderson is forced to admit that one of his main case studies, YouTube, “has so far failed to make any money for Google.”

Why is that? Because of the very principles of Free that Anderson so energetically celebrates. When you let people upload and download as many videos as they want, lots of them will take you up on the offer. That’s the magic of Free psychology: an estimated seventy-five billion videos will be served up by YouTube this year. Although the magic of Free technology means that the cost of serving up each video is “close enough to free to round down,” “close enough to free” multiplied by seventy-five billion is still a very large number. A recent report by Credit Suisse estimates that YouTube’s bandwidth costs in 2009 will be three hundred and sixty million dollars. In the case of YouTube, the effects of technological Free and psychological Free work against each other.

So how does YouTube bring in revenue? Well, it tries to sell advertisements alongside its videos. The problem is that the videos attracted by psychological Free—pirated material, cat videos, and other forms of user-generated content—are not the sort of thing that advertisers want to be associated with. In order to sell advertising, YouTube has had to buy the rights to professionally produced content, such as television shows and movies. Credit Suisse put the cost of those licenses in 2009 at roughly two hundred and sixty million dollars. For Anderson, YouTube illustrates the principle that Free removes the necessity of aesthetic judgment. (As he puts it, YouTube proves that “crap is in the eye of the beholder.”) But, in order to make money, YouTube has been obliged to pay for programs that aren’t crap. To recap: YouTube is a great example of Free, except that Free technology ends up not being Free because of the way consumers respond to Free, fatally compromising YouTube’s ability to make money around Free, and forcing it to retreat from the “abundance thinking” that lies at the heart of Free. Credit Suisse estimates that YouTube will lose close to half a billion dollars this year. If it were a bank, it would be eligible for TARP funds …

And there’s plenty of other information out there that has chosen to run in the opposite direction from Free. The Times gives away its content on its Web site. But the Wall Street Journal has found that more than a million subscribers are quite happy to pay for the privilege of reading online. Broadcast television—the original practitioner of Free—is struggling. But premium cable, with its stiff monthly charges for specialty content, is doing just fine. Apple may soon make more money selling iPhone downloads (ideas) than it does from the iPhone itself (stuff). The company could one day give away the iPhone to boost downloads; it could give away the downloads to boost iPhone sales; or it could continue to do what it does now, and charge for both. Who knows? The only iron law here is the one too obvious to write a book about, which is that the digital age has so transformed the ways in which things are made and sold that there are no iron laws.