The IMF 40 Years Interview Part II: Demand and Supply Across Countries

This post is a continuation of the long version of my interview with Hites Ahir...

 3.      In your research, you have found that demand patterns are consistent across countries, but supply patterns are not. What explains this?

Housing demand is determined by, inter alia, income, prices, demographics, mortgage markets, and of course tastes or preferences.  Let’s focus on incomes today, using Exhibit 1, taken from Malpezzi and Mayo (1987).  These are called Engel curves, after the German economist who began the study of such budget shares in 1857. The horizontal line represents monthly household income in dollars. The vertical line represents the rent-to-income ratio, or budget share, at each income level. Based on analysis of household surveys, we can trace out the average rent-to-income ratio within each city at different levels of household income. Negative sloping lines indicate that rents rise more slowly than incomes (housing expenditure is income inelastic, in economist’s jargon).  A flat line would indicate a constant rent-to-income ratio for rich and poor alike; and a rising line indicates elastic demand. 

Exhibit 1

Demand for housing within a market has been found to be “normal” which means that as incomes rise people consume more housing. No surprise there. But while expenditure on rents rises with income, these expenditures don’t generally rise as fast as incomes rise. Housing is inelastic with respect to income, or in other words a necessity.

Exhibit 1 is based on a classic study Steve Mayo and I carried out years ago in 14 cities from a range of developing countries.  For clarity the dotted lines show only 4 of the 14 city results, although the other 10 were qualitatively similar.  Within markets (cities), housing consumption increases with income, but less slowly than income.  That’s not a surprise. We see this behavior with a number of goods and services. Food is the obvious example – because goods like food and housing are necessities.  

The solid line is different.  The 14 cities all had different average incomes, of course, and so we also plotted the 14 rent-to-income ratios at each city’s average income.  The solid line is the regression line through these 14 points; this shows how the city curves shift up slowly as the entire city’s income level rises.  In other words, over the very long run, as cities develop, elasticities (responsiveness) will tend to be higher than within a single city’s cross section, which is just a snapshot of a particular period.  Housing markets take significant time to adjust, and single cross section snapshots do not reveal truly long run behavior.  

Owner results are qualitatively similar, although the budget shares tend to be a little higher for owners in a given city at a given income level.  

Price elasticities (not shown on the Exhibit) are less well studied, but usually similar in absolute value, i.e. often range from -0.4 to -0.8.  As housing prices rise, the quantity of housing consumed falls; but a bit less rapidly than the prices rise.  Taking these two effects together, if housing’s price elasticity is negative but less than one, as housing prices rise, expenditure (price times quantity) rises, holding income and other things equal.

One immediate consequence of this (and a plethora of other confirmatory research) is that the common practice of adopting a single expenditure ratio as a threshold for so-called housing affordability is very much at odds with actual household behavior. Households around the world treat housing as a necessity; the fraction of income devoted to it systematically falls as incomes rise within a city.

Future demand research will not only upgrade and update these demand estimates, but will expand our focus from developing countries alone to a broader range of emerging markets and developing countries. How these Engel curves behave throughout the entire range of incomes found at different levels of development, and how they change over time, is ripe for further study.

The bottom line about demand is not that it’s identical in all cities.  Other things matter, some readily measured like incomes, prices, and demographics; some are harder to measure including cultural effects on preferences. Nevertheless housing demand appears to be remarkably systematic and predictable, given a few key variables.  Supply is more complicated.

Exhibit 2, from a review I’ve just begun with Lingxiao Li, presents stylized supply curves for housing generated from the elasticities estimated by 6 studies of 15 different countries.  There are many caveats about the strict comparability of these different studies, so think of Exhibit 2 as suggestive, not precise. Housing supply elasticities (responsiveness) appear to be all over the map.  In cities like Bangkok and Atlanta, during the periods studied, small increases in housing prices begin to quickly call forth new supply. That supply can be from new construction; but also from upgrading and modification of the existing stock, through what is often called “filtering.” With these sources of supply working well, supply curves in these markets are flat.

At the other extreme, cities like Seoul and San Francisco have low estimated price elasticities of supply.  In these cities real estate developers and managers of existing real estate assets are constrained in some fashion, and slow to respond to initial price signals. Thus their supply curves are relatively steep.

The estimations behind Exhibit 2 vary in their econometric technique and type and duration of data, so, as already noted, precise numerical comparisons should be taken with grains of salt. But qualitatively, nobody familiar with those cities would be surprised that Atlanta’s real estate supply is much more responsive than San Francisco’s; or that Bangkok’s is more responsive than Seoul’s. Especially in the 1980s when the first studies of these elasticities were completed.

In fact, Bangkok’s real estate supply system was later disrupted by the excesses of the hot money-driven real estate bubble that was the trigger for the 1997 Asian Financial Crisis (see Mera and Renaud). Seoul’s  supply system, while still problematic in some respects, is somewhat more responsive since 1990s era reforms (see Kim and Park). So there’s probably been some convergence in these supply elasticities although we’d certainly benefit from some careful research on this question. A lot of research remains to be done on the supply side, including understanding the time varying nature of changing responsiveness. Mayo and Shepard provide a template for research on this question, and some evidence from Malaysia.

On the other hand many observers argue that the difference between supply conditions in U.S. metropolitan areas has increased over time (Ganong and Shoag).  Certainly the volatility in U.S. housing prices has increased, and also the correlations across markets has also increased, making it increasingly difficult to diversify across regional housing markets (Malpezzi forthcoming).

Malpezzi and Wachter make another salient point about supply. As Samuelson’s famous paper on the Le Chatelier principle reminds us that as we take longer and longer run perspectives, elasticities necessarily increase in absolute value. The central insight is a simple one: the longer the time period under consideration, the more ability we have to adjust either demand or supply or both. As Malpezzi and Wachter showed with simple simulations, and Wheaton demonstrated with a more sophisticated model some years earlier, this implies that markets with an initially more inelastic market much more readily generate large boom and bust cycles. In elastic markets, like Atlanta, and Bangkok, booms are harder (though not impossible) to start. As I have told my students for years, every real estate boom ends with something else that starts with the letter B.

So far we discussed differences in supply elasticities, but not how or why they arise. When we examine these elasticities in terms of deeper determinants, it turns out they are not correlated with income or city size; but neither are they truly random.  Research across countries and across cities demonstrates that much of the variation is explained by supply side constraints, both natural (physical geography) and man-made (land use and development regulations). We have to live with geography, but we can change regulations.  This leads to another central theme of housing research: Regulations have costs and benefits.  Review both carefully.  I see questions below give me a chance to discuss the latter a little further.

References

Chai, Andreas, and Alessio Moneta. "Retrospectives: Engel Curves." Journal of Economic Perspectives 24, no. 1 (2010): 225-240.

Ganong, Peter, and Daniel Shoag. "Why Has Regional Income Convergence in the Us Declined?",  (2013).

Kim, Kyung Hwan, Sock-Yong Phang, and Susan Wachter. "Supply Elasticity of Housing." 66-74: International Encyclopaedia of Housing and Home, 2012.

Kim, Kyung-Hwan, and Miseon Park. "Housing Policies in the Republic of Korea." THE HOUSING CHALLENGE IN EMERGING ASIA,  (2016): 92.

Malpezzi, Stephen. "Economic Analysis of Housing Markets in Developing and Transition Economies." In Handbook of Regional and Urban Economics. Volume 3. Applied Urban Economics, edited by Paul Cheshire and Edwin S. Mills, 1791-1864. New York and Oxford: Elsevier Science North-Holland, 1999.

________. "Residential Real Estate in the U.S. Financial Crisis, the Great Recession, and Their Aftermath." Taiwan Economic Review,  (Forthcoming).

Malpezzi, Stephen, and Stephen K. Mayo. "The Demand for Housing in Developing Countries: Empirical Estimates from Household Data." Economic Development and Cultural Change 35, no. 4 (1987): 687-721.

Malpezzi, Stephen, Stephen K Mayo, and David J) (with Gross. Housing Demand in Developing Countries. Washington, D.C.: World Bank, 1985.

Malpezzi, Stephen, and Susan M. Wachter. "The Role of Speculation in Real Estate Cycles." Journal of Real Estate Literature 13, no. 2 (2005): 143-64.

Mayo, Stephen, and Stephen Sheppard. "Housing Supply and the Effects of Stochastic Development Control." Journal of Housing Economics 10, no. 2 (2001): 109-128.

Mera, Koichi, and Bertrand Renaud. Asia's Financial Crisis and the Role of Real Estate: ME Sharpe Inc, 2000.

Samuelson, Paul A. "The Le Chatelier Principle in Linear Programming." Rand Corporation, memorandum, 1949.

Wheaton, William C. "Real Estate" Cycles": Some Fundamentals." Real Estate Economics 27, no. 2 (1999): 209-211.


Next Post: Progress and Challenges in Developing Country Housing Markets

Forty Years of Studying Housing and Urban Development -- The IMF's Hites Ahir Interviews Malpezzi

The IMF's Hites Ahir and Prakash Loungani have created a tremendous online resource, Global Housing Watch.  It's become one of my go-to sources for information about housing prices around the world.

Prakash, with some help from Hites, also has a terrific blog, The Unassuming Economist, that I've cited in my sidebar list of recommendations since we re-started REUD Viewpoint.

One of the nice features of their blog is that Prakash and Hites often interview economists and others of interest to readers of REUD Viewpoint.  One of my favorite recent interviews is one they did of Kecia Rust of the Centre for Affordable Housing Finance in Africa.  It's got some really interesting data on housing costs in Africa, that will inform my own current research with my friends Moussa Diop and Jay Sa-Aadu.

So I was pleased when they invited me to be interviewed.  Hites sent me a dozen or so questions, and asked me to respond via email.

Which I did, recently.  But those who know me are already chuckling.  I've long the famous aphorism "I have written a long letter, since I didn't have time to write a short one."  (In fact until today I sloppily attributed this quote to George Bernard Shaw, although the Internet reminds us the source is much in dispute.)

So Hites and I have edited the first version down.  But on the theory that if you take each question as a separate post, and the further theory that some of the things I've edited out, including references, are of some use, we decided I would publish the long version here, in sections.

So, here we go.  This first REUD Viewpoint version incorporates Hite's original working title, which I found amusing.

(And in case you can't read my intentions well in print, my umbrage is feigned!)

An Economist’s Lifelong Study of Housing MarketsHites Ahir interview of Steve Malpezzi, March 3, 2017 (via email)

One initial comment at your proposed title for this interview – “lifelong” sounds like I’m nearing my end.  I’ve only been doing this for 40 years (started in 1977!)  Remember, to Boomers, “64 is the new 44.”  Even in an earlier era, after age 60 one of my great heroes, Benjamin Franklin: served as ambassador to England and to France; created the first reliable chart of the Gulf Stream; invented the Franklin Stove and the glass harmonium; contributed to and signed the Declaration of Independence; became the first Postmaster General; became President of the Pennsylvania Abolition Society; served at the Constitutional Convention; and wrote his Autobiography.

I don’t expect any of my work to approach the smallest of these accomplishments, but I hope to at least make some additional contributions to the study of cities and real estate markets over the next few decades.

1.      What got you interested in housing markets?

Serendipity. In the 1970s I was studying politics and economics while majoring in international affairs at The George Washington University. I needed a part-time job, and one of my roommates who worked for the Urban Institute’s Ray Struyk helped me get an interview, and I started working as a research assistant on housing market behavior, initially for Ray and later for Jim Follain. I had an empirical bent, and I enjoyed our work on the measurement and interpretation of house prices. The Institute was filled with other great colleagues, so I learned a lot.  I also met GWU’s Tony Yezer, who became my PhD advisor when I switched over to economics.

Later I was able to follow my international interests when I was hired to study housing markets at the World Bank, working with another great group of people including my collaborator Steve Mayo. I found housing and other urban development issues fascinating, something I was happy to study both in my home country and, when the opportunity presented itself, around the world. 

Eventually I found my way to the University of Wisconsin, where I found more excellent colleagues, including my coauthor Richard Green, and did more research on housing markets but also learned a lot about other kinds of real estate.

In 2016 I "retired" from Wisconsin -- as I've said many times over the past year or two, I retired but I didn't quit.  I'm still active on the research front, still attending conferences held by the American Real Estate and Urban Economics Association and other groups.  I serve as Dean of the faculty of the School for Advanced Studies of the Homer Hoyt Institute.  Morris Davis, a colleague at Wisconsin, is now in charge of the Rutgers Real Estate Center, and along with Morris, Julia Coronado and Kevin Riordan I regularly blog there as well.

2.      In a nutshell, how do housing markets work?

Exhibit 1

Let’s start with a schematic diagram (Exhibit 1) of the housing market. Inputs, such as land, labor, finance, materials, and infrastructure, are combined by supply-side agents, such as landlords and developers, to produce housing services. Homeowners, and to a lesser extent, renters, are also producers, because they maintain and upgrade their houses. Relative prices provide producers of housing services with information that helps to determine whether to provide more or less housing, and whether input suppliers should provide more or fewer inputs.

In many (not all!) countries, the market for housing services per se can be approximated as a competitive market.  Housing production activities (the middle box in Exhibit 1) have few natural barriers to entry, or large economies of scale. In those competitive countries, few landlords or developers are large enough to exert significant market power.

The market for many inputs may be less competitive. The ownership of land is often more concentrated. Large economies of scale may make the production of some inputs a natural monopoly, as with some types of infrastructure. Elements of the housing finance system may have economies of scale, imperfect information, and other barriers to entry and exit.  Poorly designed government regulations could also, wittingly or not, restrict the competitive allocation of inputs, especially developable land.

Many housing problems can be traced to low incomes, and need to be addressed by raising those incomes. Other problems in housing markets can be caused by problems in the input markets, especially land, finance, and in the regulatory and property rights framework of the market.

To economists, the role of government in any market is to set the “rules of the game,” including property rights, and the legal framework, and to take actions – taxes or subsidies or regulation or occasionally direct provision – that attack so-called “market failures.”  Besides the previously mentioned economies of scale and monopoly power, and poor (“asymmetric”) information, market failures can be due to what are termed externalities or spillovers. Externalities are costs or benefits that are real, but aren’t priced into the market transaction.  Housing related examples include increased traffic congestion, or water runoff associated with new developments.  Extreme poverty can be analyzed as a market failure as well.

We also have to be aware of the possibility of government failures. Just because we can cite an externality or other market failure in support doesn’t mean we’ve adopted a government intervention that improves the situation. Getting the regulatory environment right requires serious work to understand the size and nature of the market failures, and the effectiveness of the interventions proposed to mitigate them.  The same can be said of any intervention – taxes, subsidies, setting the property rights/legal framework, or direct public provision.

References

Datta-Chaudhuri, Mrinal. "Market Failure and Government Failure." The Journal of Economic Perspectives 4, no. 3 (1990): 25-39.

Franklin, Benjamin. The Autobiography of Benjamin Franklin: PF Collier, 1817.

Haveman, Robert H. The Economics of the Public Sector: John Wiley & Sons, 1976.

Isaacson, Walter. Benjamin Franklin: An American Life, 2004.

Malpezzi, Stephen. "Housing Prices, Externalities, and Regulation in U.S. Metropolitan Areas." Journal of Housing Research 7, no. 2 (1996): 209-41.

________. "Economic Analysis of Housing Markets in Developing and Transition Economies." In Handbook of Regional and Urban Economics. Volume 3. Applied Urban Economics, edited by Paul Cheshire and Edwin S. Mills, 1791-1864. New York and Oxford: Elsevier Science North-Holland, 1999.

Mayo, Stephen K., Stephen Malpezzi, and David J. Gross. "Shelter Strategies for the Urban Poor in Developing Countries." World Bank Research Observer 1, no. 2 (1986): 183-203.

Vatn, Arild, and Daniel W Bromley. "Externalities-a Market Model Failure." Environmental and Resource Economics 9, no. 2 (1997): 135-151.

Wolf, Charles Jr. Markets or Governments: Choosing between Imperfect Alternatives: MIT Press, 1993.

Next Post: Supply and Demand Patterns Across Countries

Values of the Wisconsin Real Estate Program

From Merriam Webster: Values: a person's principles or standards of behavior; one's judgment of what is important in life.

It’s not hard to make decisions when you know what your values are. Roy Disney

Why a blog entry on values? From an economist, no less?

Real estate is about land and bricks and mortar to be sure. And of course it's also about dollars and cents; or euros or pesos or renminbi, if you prefer.  But ultimately it's also about values.

Three decades into my career, with about half that time at Wisconsin, I found myself in a room with about a dozen UW Real Estate faculty, senior alums, and friends of the program. We were taking a day to reflect on where we were in the evolution of the UWRE program. Lots of topics came under scrutiny: how to do better at developing skills like ARGUS and Excel, greater integration between research and teaching, improving student writing and presentation skills, how to utilize key research findings to improve industry practice, and so on.

All was going well, a surprisingly productive meeting was underway, when somebody – I don’t remember who, exactly – made the point that all the matters we had discussed so far were important, but that what really drives a successful program, a successful business, is a shared set of the right values.

That simple observation kicked us into another gear. How to address such complex and often slippery questions as those about our values? Especially since we were a dozen who were trained and practiced in real estate and economics, not philosophy or ethics.

Fortune favors the brave, or perhaps the foolhardy. We agreed that the subject was central to our program, too important to gloss over just because nobody in the room had a degree in “values.” After all, our illustrious forbears, from Richard Ely to James Graaskamp, had constantly addressed values in their writing, teaching, and business practice.

We decided a good starting point was to make a list of the related aspirations we thought we could observe in the best of our alumni and other real estate professionals. Within half an hour, we had our list, with a dozen elements that we thought characterized the values to which the students, faculty, and professionals who comprise the UW real estate program aspire.

Here's the list:

• Ethical dealing
• Seek profits, but see the broader social perspective
• Empathy: examine investments from alternative points of view
• Holistic decision-making
• Multidisciplinary approach to education and analysis
• Keep finance and development connected
• Prudent, informed risk taking
• Outward and forward-looking orientation
• Lifelong learning
• Sifting and winnowing
• Giving back
• Passion

It's important to note that our intention, realized or not, was to report what we thought we observed in others, rather than try to put forward our own personal favorites. I could never have comfortably contributed to such an effort in my first few years at UW; but a decade and a half in, I had the advantage of many conversations with alums, Center Board members, and others; and of course the conversations were supplemented with observations of actual behavior.

The list above is discussed in more detail below. Each element is worthy of its own post. Each element has, in fact, been the subject of voluminous books, research and debates. By merely presenting the list and a few comments here, our aim is simply to jog thinking, to start the conversation, to invite comment and criticism.

For Badgers Only... Or for Everybody?

Ernest Hemingway's famous advice: "First you have to know the subject; then you have to know how to write."  Well, I still have a lot to learn about both values and writing.  As discussed above, the focus of this blog post is what I think I've learned, so far, about values at Wisconsin's real estate program.  Perhaps if you are engaged with a different program, or not into real estate at all, you might think this post is one to skip.

Please don't.  Read on.  Whether you are a died-in-the-fur Badger, or not; whether you are focused on real estate, or some other line of work or study; I hope you find some nuggets, some stories that interest you.  Wherever you are from, or going, you'll have your own set of stories about these matters; no doubt some of your stories will be similar to ours.  Some will be different.  What have I got right, or wrong?  What's important that I've left out?  Badger or not; real estate or not; comments on and criticisms of this blog post will be especially welcome.

Now let's dig in,

Deal Ethically 

The first, and perhaps the most important of the values identified by our little group, is ethical dealing. Of course, this raises the immediate question, what is ethical? Philosophers, theologians and ordinary people have wrestled with this question for millennia. One starting point for a Wisconsin approach is based on a “Golden Rule,” treating other market participants as we ourselves would wish to and expect to be treated. Nearly every philosophical and religious tradition refers to some version of a Golden Rule as a starting point for ethical behavior:

May I do to others as I would that they should do unto me.  Plato

What is hateful to you, do not to your fellow man. This is the law: all the rest is commentary. Talmud, Shabbat 31a

None of you [truly] believes until he wishes for his brother what he wishes for himself. Number 13 of Imam Al-Nawawi's Forty Hadiths

Do not do to others what you do not want them to do to you Analects 15:23

And as ye would that men should do to you, do ye also to them likewise. Luke 6:31

This is the sum of duty: do not do to others what would cause pain if done to you. Mahabharata 5:1517

The Golden Rule finds no limit of application in business. James Cash (J.C.) Penney

A Golden Rule is an overarching principle that requires elaboration, and hard thinking about its application to specific cases.  For example, honest dealing and personal integrity are generally required by a Golden Rule.  Economists have long understood that it is impossible to write complete contracts; thus a well-functioning market requires some level of trust, which honesty and ethical behavior engenders.

Seek Profit, but Remember the Broader Social Perspective

Real estate is a social enterprise as well as a private business. Good real estate developments and decisions generate external as well as private benefits. Bad decisions can adversely affect our broader society as well as those who took the original risks.  What account should be taken of neighbors?  Of future generations?  How should gains and losses to different agents be properly weighed?

Measuring full costs and benefits, the external as well as those priced by the market, is hard enough. Once measured, we still need to grapple with the fact that different costs and benefits accrue to different people.  Exactly how to weigh different private costs and benefits, e.g. returns to investors, and external costs and benefits, is not a simple question.

One starting point for thinking about these issues is to read Milton Friedman's classic essay, "The Social Responsibility of Business is to Increase its Profits."  Friedman argues that a firm should "use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud."

Often misinterpreted, if the essay is read carefully, one realizes that Friedman does not actually argue for a pure laissez faire world; in such a world many firms would strive mightily to avoid Friedman's "open and free competition" (as Adam Smith himself clearly worried); and some would not hew to Friedman's stringent injunction to operate "without deception or fraud." Sadly, every day's newspaper brings stories of businesses seeking and abusing market power, skating close to the edge of deceptive practices, and, more often than we'd like, fraud.  Of course the news fails to report the day's tally of competitive businesses behaving honorably.  Nevertheless only an economic naif would believe that governments have no role to play in setting up and regulating the "rules of the game."  The problem is, for a variety of reasons to be explored in later posts, we sometimes do a lousy job at setting up and enforcing the rules.

"Sustainability" is another lens through which many students and an increasing number of real estate professionals try to examine our social goals.  By itself the term sustainability is vague and ill-defined, as UW's Dan Bromley among others has emphasized.  But I would argue that sustainability has been useful to motivate analysis and conversation about important market failures as well as government failures.  If carefully and properly defined, sustainability could be an important criterion for real estate decisions, along with traditional measures of profitability.  Jim Graaskamp put it well:

Man is the only animal that builds his terrarium about him as he goes, and real estate is the business of building that terrarium. So we have a tremendous ethical content, tremendous social purpose. The student is looking for a field in which entrepreneurship and a way of life can be integrated into social purpose. We like to argue that the entrepreneur of tomorrow is going to be the individual who can inventively implement social policy.

Be Empathetic

The best real estate professionals learn to naturally examine investments from alternative points of view.  This is related to taking the social perspective mentioned above, but at least some minimal empathy is required for private success.    Orison Swett Marden, the nineteenth century precursor of today's legion of self-actualization gurus (but with better advice and minus the psychobabble) put it simply:  "The golden rule for every business man is this: 'Put yourself in your customer's place.'"

Who among us in the real estate world can't point to a failed project where a developer built their personal dream, when that dream was in deep conflict with what customers wanted?  How does a professional design an appropriate project, and get the necessary approvals, if they don't have an understanding of how the customers for their products think?  Professionals need to understand how their lenders and investors will view the project, what objections neighbors might have, how to meet the requirements of various planners and utilities and other necessary partners.  In other words, we need empathy.

Empathy is a desirable characteristic within the business enterprise as well as in our external dealings.  Research by psychologists and scholars of management, such as Daniel Goleman, repeatedly shows that empathetic managers and team members are more productive.

Empathy works. Buyers need to learn to put themselves in investors’ shoes, and vice versa.  Whether equity partners or lenders, all need to learn to see a project from the perspective of neighbors, planners, and others with an interest in the built environment.  Empathetic managers are more effective leaders.

Take a Holistic Approach to Decisions

Real estate decisions are complex, and so good decisions will necessarily be holistic. We are serious about the technical side of our business, but analytics are not mechanical. Avoid the “fallacy of misplaced concreteness,” or “I know the answer’s right, it came from a spreadsheet.”

I state this despite the fact, well known to my former students, that I am a spreadsheet freak. True spreadsheet freaks never forget that the spreadsheet itself is merely a tool, an organizing framework for information. Remember three things: (1) Spreadsheets do not make decisions, people do. (2) There’s no such thing as “the” rate of return or “the” value of a property. All interesting real-world problems are answered with ranges, not a single number, and their associated probabilities. (3) Garbage in, garbage out.

And not everything that's important in real estate (or life) can be quantified.  The need for the holistic approach was well articulated by Jim Graaskamp:

I think the fun of real estate is that one can be so eclectic.  You can be going into one discipline or another almost constantly: the chemistry of floor cleaning -- which is a fairly elaborate chemistry -- at one moment and behavioral analysis of a survey research study the next.  Moments later you may be smashing some architectural scheme flat because the energy conservation systems are inadequate or the style incompatible with community architectural history.  In essence the producer of that artistic enterprise called the real estate project has to be conversant in all related specialties if he is going to have the attention and the respect of a multitude of technicians and specialists.  He must be able to recognize when he is being hornswoggled because of the professional enthusiasm of one of his specialists.  

Real Estate Training and Education Requires a Multidisciplinary Approach

If real estate decisions and execution requires a holistic approach, then perforce real estate education requires a multidisciplinary approach. The depth and breadth of the Wisconsin curriculum is one of our major comparative advantages, mirroring the complexity of the decisions.

As an economist, naturally I begin with the tools of "the queen of the social sciences."  But I've learned to pollute my thinking with insights from political science (my first degree), psychology, legal studies, urban history, sociology, and so on.

Both undergraduate and graduate education in real estate at Wisconsin cover a range of subjects and approaches.  Required courses include the real estate process, real estate law, urban economics, finance, valuation, and residential and commercial development.  Additional courses are available on capital markets case studies (including participation in national competitions); and (when resources permit) electives in international real estate, and housing economics.

Enrichment activities include domestic and international real estate field trips; undergraduate participation in ExpoREAL, Munich; and MBA participation in MIPIM, Cannes.  Students serve as rapporteurs for RE-Invest Summit, faculty moderate the wrap-up panel. MBAs conduct and analyze AFIRE annual investment survey.  Every fall Wisconsin holds a Global Real Estate Markets Conference, New York Stock Exchange (joint with Toll Brothers).  MBA and GREM students participate in Graaskamp Center Board meetings.  Both undergraduates and graduate students participate in Real Estate Club and Wisconsin Real Estate Alumni Association activities, including mentor programs.  These include the Innovator Award series, the WREAA Reunion held every other year, and WREAA Trends Conference held in the off years.

It's sometimes useful to make a distinction between education and training. 

Training is about developing practical day-to-day skills:  learning the models, learning Excel, learning Argus, learning different parts of the capital stack; those are all skills you need, things you need to know.

Deeper concepts, more abstract learning, I file under the rubric education. You need both. 

If you come out of a university program with a lot of high concepts, but don't know how to read a lease or how to calculate a rate of return, you're not going to last very long. 

On the other hand, if you don't have any sense of the big picture beyond your spreadsheet, you're also going to struggle. Furthermore as you progress in your career the mix of training and education that you will need will vary.  Generally over time the education part, the concepts and big picture will loom ever larger.  The day-to-day stuff I file under training will never go away and will always be important, too. But over time the mix will change.

The chart above represents a very stylized view of how different classes and activities fit in the education-skills continuum.  Also note that there's lots of other learning opportunities in the mix.  Classes you take with us are an important part of your training-education portfolio, but they are only  a part.

The mix varies within courses as well as across them of course. Classes like valuation and development are especially important as parts of training, although they also have important elements of education and high concepts. The urban class has more conceptual material than say the development course; but you'll also learn some very practical skills regarding data analysis and presentation.

The learning portfolio is not static, of course.  The stuff we need to learn is always evolving.

Remember that Development and Finance are Connected

Real estate development and finance are intimately connected.  We aim to turn out developers who understand finance, and don’t view real estate finance as merely financial engineering, but also have a deep understanding of the the underlying assets. Apparently much of Wall Street forgot this latter requirement circa 2000-2008, but the Wisconsin-trained should never do so.

It’s a surprisingly common misconception among some older alums that previous luminaries, notably Jim Graaskamp, were in some way antagonistic to modern finance. What’s accurate is that previous luminaries and those of us who’ve attempted to follow them have been deeply antagonistic to bad financial practice and policies.

In fact Graaskamp’s dissertation was famously one of the first careful empirical studies of mortgage prepayment and default. He didn’t just rail against bad underwriting, he sought to improve it through then state-of-the-art analytics grounded in careful empirical research. Graaskamp’s findings in his dissertation still underlie the PSA approach to prepayment modeling.

In another area he was scathing as well as prescient in his denunciation of bad underwriting and conflicts of interest during the 1980s Savings and Loan crisis. More recently research by Erwan Quintin, Andra Ghent, Tim Riddiough and other faculty have examined these issues in the context of the 2007-9 financial crisis and its aftermath.

Manage Risks with Prudent and Informed Strategies

The best real estate practice is characterized by prudent, informed risk-taking.  There’s no reward without risk, but risks need to be analyzed, quantified where possible, and appropriately managed.

Real estate’s forward-looking nature, the need to focus on expected values of variables we can only imperfectly forecast, the effects of occasional “black swans” and far more common crises and complications of every type, requires us to think constantly about risk, and it’s even nastier cousin, uncertainty. In the early 1970s Graaskamp criticized the then-popular real estate texts for neglecting modern risk analytics:  “Somehow educators as well as real estate professionals have forgotten that risk and financial management requires explicit measures of phenomena and not banal, conventional wisdom, a shrug of the shoulders, a simple perception that hotels are always riskier than apartments to everybody concerned.”

Graaskamp was very specific about the tactics of risk management for real estate professionals. First and foremost is to know when to walk away from a potential investment or activity when the risks are unacceptable. He provides specific examples, such as avoiding multifamily housing investment where rent controls and other poorly thought-out regulations create unacceptable risks (see Turner and Malpezzi).   Graaskamp also emphasizes improved information flow as risk mitigation techniques. These could be economic and financial but also sometimes very nuts and bolts such as a better soil study.

History matters, learn from the past is another Graaskampian injunction.  For example loan servicing practices can be improved, based on studies of previous borrower behavior such as Graaskamp’s own PhD dissertation research.  Again these risk mitigation tools are not just about the financials and cash flows, but all sorts of measures like studying flood plains and fire risks. Another way to mitigate risks is to rethink how contracts are written: net versus gross leases, fixed rate versus adjustable-rate mortgages, the use of recourse or not. Sometimes it’s necessary to pay to hedge an investment even though some hedges are extremely costly. Be ready to rethink leverage; higher leverage magnifies losses as well as gains. What’s the correct vehicle for real estate investment? Is a tenant-in-common structure really a good idea, even if it looks advantageous under pro forma assumptions? Since Graaskamp’s time the Limited Liability Corporation has become a common and effective tool for risk mitigation in the real estate industry. Think hard about the right incentives for partners, lenders, your own staff, as well as your suppliers and your clients.

One elementary but sorely neglected aspect of real estate risk management is appropriate sensitivity analysis of expected cash flows. Whether it’s a simple single-period cash-on-cash calculation, or cap rate valuation; or a full-blown multi-period model in Argus or Excel; there’s a strong tendency to focus too much on "the" single number: "the" rate of return, "the" value of a project. Of course the only thing we know for certain about these numbers is that they are wrong. How wrong? And what do we do about it?

Some problems are institutional, driven by for example the problematic aspects of FIREAA or USPAP or other regulatory frameworks. But many problems are baked into the analysis by our own cognitive shortcomings. How often have we seen sensitivity analysis consist of testing out rent falling a dollar or two a foot, when we have seen historical variation five times that or more? How often have we seen proformas forecasting 5% vacancy, testing a worst-case of 10%, in markets with 15 to 25% vacancy; in which once A-rated tenants like Enron or Kmart or Circuit City or May or Federated have gone belly up?

Let’s be clear: the project does not exist that makes money when a realistic worst-case scenario becomes reality. The Wisconsin approach to risk management is to first model using realistic assumptions that can be defended with data and experience; then to stress test using the similarly realistic, often hair-raising, blood-curdling characteristics of bad times. The goal is not to only invest in projects that make money under worst-case scenarios.  Nothing would ever be built, no deal ever done. Rather, the goal is to use the insights from realistic modeling to help structure our affairs so that if the worst case becomes a reality, we only lose money, not our entire company and livelihood.

Keep an Outward- and Forward-looking Orientation

Real estate is in many respects a local endeavor – no one buys a property in the U.S., you buy a building in Madison, Chicago, London, or some other market.  But local markets do not operate in a vacuum. Today’s real estate professional has to understand not only the local and the national, but also the world beyond the boundaries of her metro area.  She must be thinking about the market’s needs and constraints next year, next decade, and beyond.

When I came to Wisconsin in 1990, only a minority of real estate professionals were much concerned with global markets.   Fortunately, with the help of several alums and especially senior lecturer Rod Matthews, we were able to get ahead of the curve on international real estate issues.

In the early 1990s, Rod, with support from Kerry Vandell and other faculty, taught our first regular seminar on international real estate. He soon followed this up with a series of superbly organized international field trips to Europe, Asia, and Latin America.  Later, faculty including myself, Francois Ortalo-Magne, Erwan Quintin, Joe Walsh and others extended our student's international participation to MIPIM, ExpoREAL, AFIRE and so on.

Our global educational initiatives were innovative, but if we go back far enough we are reminded that indeed there's nothing new under the sun.  Imagine my surprise when I recently found that our founding father Richard Ely was ahead of us in this as well, helping faculty at China's Nanking University to start their own real estate program about a century ago.

Our Global Real Estate Master (GREM) program is a joint initiative between Wisconsin School of Business and several partner business schools:  HEC, Paris; Hong Kong University of Science and Technology; INCAE, San Jose, Costa Rica; and Shanghai Jiao Tong University.   Each fall, students from our partner schools converge for a truly global learning experience,an intensive semester of advanced real estate courses,  some bespoke for GREM students and some sharing the classroom with our own MBAs.  GREM students join  our MBAs for our annual Global Real Estate Markets conference in New York, cosponsored with Toll Brothers.

Practice Lifelong Learning

Curiosity is almost always a hallmark of those who achieve long run success, in real estate as in other endeavors. The B.A. or MBA in Real Estate and Urban Land Economics is the beginning, not the end, of your education in the field. Read. Think. Discuss.  As John Dewey put it back in 1916:

One of the most important, perhaps the most important, goal of the University education – undergraduate or graduate – is to go beyond imparting knowledge, to develop the students, later the professionals, ability to teach themselves.

In some respects lifelong learning has become more challenging over time, as the nature and pace of innovation in real estate has accelerated, as have the basic economic and demographic processes that underlie our industry. At the same time opportunities for lifelong learning have become more widely available and easier to use, with improvements in communication, data availability, etc.  There’s been an information explosion. Traditional forms such as books, journals both specialized and general are easier to obtain than ever before.  And now many new forms are available.  After all you are reading this blog!

Excellent lectures and presentations are available, many for free, on YouTube and similar services. If I have a question about real estate markets in, say, San Francisco, or even Seoul or Cairo, a few minutes work at my keyboard can turn up dozens of articles and, if needed, contacts that put me in touch with local experts via email or Skype. Of course WREAA members have always had the ability to contact members of our alumni network; but now this too is expanded and easy to tap, with advances in social media.

Perhaps one of the larger challenges in this environment is to quickly and reliably evaluate the quality of the information available. Search on “the economy” in, say YouTube, and many of the responses will be dicey at best. For example when I recently made such a search, the first hit was titled (so ironically) “YouTube is Hiding this Video! The Economy is Collapsing – Martial Law and FEMA camps and the New World Order.” All in, 9 of the first 10 hits on the economy were this sort of apocalyptic nonsense.

The real problem, of course, is not filtering out obvious nonsense, but in filtering out the not-so-obvious nonsense.  There are techniques for evaluating the quality of sources, worthy of a future detailed post. For today here are just a few tips.  Is the source linked to, and/or cited, as serious work by other sites and sources you deem reliable? Such as the Graaskamp center or other academic real estate programs, the WREAA, ULI, and so on?  Has it been vetted by the quality press such as the New York Times, the Wall Street Journal, the Financial Times, or The Economist?

Straight Google searches are very useful, but material that comes up in Google Scholar has passed at least some academic filtering is serious material. (Admittedly Google Scholar searches will pick up denser, sometimes outright tedious material!)

Are the primary sources of the data/information clearly laid out and generally reliable?  Are data presented appropriately?  For example, are time series of dollar amounts appropriately adjusted for inflation?

Of course none of these techniques is foolproof; and there is always a danger of over-filtering and ending up in an information bubble. I have to admit I occasionally check in on videos from Peter Schiff, Harry Dent, James Rickards, and the like, just to check out what the fringes are up to, and to take a look at their latest screeds. Even a blind pig occasionally finds an acorn.

But don't spend too much time on the fringes.  Do escape your bubble and make a point of reading quality people with perspectives different from your own.  Do you view yourself as a small-c conservative, very concerned about the shortcomings of government interventions in real estate markets and the economy?  Then read your peeps, but be sure to occasionally check out Brad DeLong, Paul Krugman or Noah Smith.  Did you Feel the Bern, are you suspicious of over-reliance on free markets?  Fine, but in addition to your usual suspects, read Ed Glaeser, Tyler Cowen or Greg Mankiw.  Test your thinking by reading throughtful, serious people who have a different point of view.

One of my favorite rubrics for lifelong learning is “Reading for Life” (RFL).  Take a little time out from tweeting, unplug your iPod, close up Facebook, shut down your blog, and … read a book!
In my previous blogging life, I had several entries on RFL, and a fairly long list in pdf form.  They were mostly books, but I also recommended periodicals, journal articles, and even blogs (see the list to the right of this post).  Of course just because I include a book or other reading in an RFL entry, even if it's one of my special favorites, doesn't imply I agree with the author.  Whether you, or I, agree with an author or not, always read with our class motto in mind:  Don’t be a sap!

Another handy lifelong learning rubric is Database for Life (DBFL).  The idea here is a simple one: Turn data collection from a variable cost to a fixed cost.  Too many people work as follows.  Every time Ethel takes on a new project, she collects the data from scratch, redoes all the analyses, charts, presentations, etc.  Everything she does is a “variable cost.”

In contrast, every time Lucy takes on a project, she “warehouses” the data in one of her Databases for Life.  When she needs the data for another project, she already has much of it on hand; she only has to update it. Original data collection is a fixed cost that is then spread out over many projects.  Micro quiz:  whose cost per project is lower?

Start your database for life today.   Think about the kind of data you’ll be working with over the next decade or more.  What are the recurrent units of observation?  Then create an Excel database in which you warehouse all the data you collect, over time, with those units of observation.

My own main DBFLs include: U.S. annual data, U.S. quarterly data, U.S. monthly data, U.S. states, U.S. metro areas, U.S. counties; a cross-country database, and a world city database.  Many others are possible, e.g. units within your favorite city (by zip code, Census tract etc.); or within your favorite non-U.S. country.

Sift and Winnow

"Sifting and winnowing, by which alone the truth shall be found." This UW adage stems from UW Real Estate “founding father” Richard Ely’s famous “trial,” about which more in another post.

The Wisconsin Idea tells us that the University needs to be connected to real problems and issues faced by Wisconsinites as well as those beyond our physical borders, in the rest of the nation and indeed around the globe. It is our basic job description.

The touchstone of "sifting and winnowing" is part of our inheritance from our intellectual and institutional forbearers, beginning with Richard Ely. Many readers will have heard the phrase, and anyone who’s been to campus has seen the plaque atop Bascom Hill, from a century ago:

Whatever may be the limitations which trammel inquiry elsewhere, we believe that the Great State University of Wisconsin should ever encourage that continual and fearless sifting and winnowing by which alone the truth can be found. Taken from a report of the Board of Regents. 1894

This quotation, famous on campus and off, came out of a fierce debate about unionization in 1894. In brief, Ely supported unionization, and some of the Regents did not. They never, to my knowledge, reached agreement on the specific issue, but they did, in the end, establish a firm principle that at Wisconsin, people had a right to speak on different sides of important issues; a right to be heard; and that we owe those with whom we disagree, as well as those with whom we agree, a duty to listen.

To be clear, "sifting and winnowing," doesn't mean that every idea is equal; but rather that ideas should be heard, and examined on their merits, rigorously, rather than reflexively. Corollary: at Wisconsin we scrutinize, we argue, even passionately at times; but we do not shout down or demonize those with whom we differ.As Daniel Patrick Moynihan famously put it some years ago, everyone is entitled to their own opinion, but not their own facts. Sifting and winnowing helps us establish the facts, and helps us form opinions that are grounded in those facts as well as our values.

Unfortunately we live in a world where simple solutions get the headlines. All too often, we talk past each other, cherry picking research and arguments that support our preconceived notions, and ignoring research that challenges our preconceptions. Psychologists call this confirmation bias, and it's a very powerful part of human nature. We're all subject to it. We have to fight it, every day. The best way to fight confirmation bias is to hold to rigorous standards of evidence, and hold your own opinions to the same standard to which you hold others.

Give Back

Giving back is another central Wisconsin value. Public service as well as private value creation is a defining characteristic of the Wisconsin graduate.

Giving back is not just a financial consideration. It’s also about helping students find productive internships, making oneself available for interactions with the real estate club speakers and field trips, and providing our classes with up-to-date and complex case study material. It’s also about identifying good candidates for our educational programs and mentoring current students; and being inclusive, helping not just our children and friends, but others on whose life and career we can have a positive impact.

Of course dollars matter too; for both general support and specific purposes. Glazer and Konrad 1996 report that anonymous donations to charities are less than 1% of the total. Social prestige is apparently a strong motivation for at least many donors. So it's interesting that examples of giving back at UW include the Wisconsin Naming Partnership, in which 13 donors gave an $85 million bequest under condition we not name the Wisconsin School of Business for any individual donor, but keep its Wisconsin identity. This was foreshadowed by the 2007 campaign in which over 700 individuals donated money, from a few hundred dollars into seven figures, to name our real estate center, not for the donors themselves, but for our master teacher James A Graaskamp.

What’s true of bequests to children is also true of bequests to one’s University or to the education project generally.  As Andrew Carnegie put it:

...when the man who dies leaving behind him millions of available wealth, which was free for him to administer during life, will pass away "unwept, unhonored, and unsung," no matter to what uses he leaves the dross which he cannot take with him. Of such as these the public verdict will then be: "The man who dies thus rich dies disgraced."

Carnegie had his own views about the specifics of philanthropy, which he laid out in his famous article Wealth (later renamed "The Gospel of Wealth").  He was not a big fan of “alms,” concerned by incentive effects; but rather focused on what today we’d call “building human capital.”

In a follow-on to Wealth, Carnegie suggested his personal ranking of the best ways to deploy one’s philanthropic capital, and started off thus:  “Standing apart by itself there is the founding of a university…” said the founder of Carnegie Tech (where my Uncle Mario, the first Malpezzi to attend college, attended for a year circa 1930; now Carnegie Mellon University).  In  "The Best Fields for Philanthropy" he focused on examples like Stanford and the Lick Observatory, noting that research as well as teaching are important activities worthy of support.

Other Carnegie suggestions included libraries (there were 2,509 Carnegie libraries built, including a fine example in Baraboo where I’ve spent some happy hours reading), hospitals and medical research (focusing in prevention as well as cure), parks, public halls and concert venues (see Madison’s Overture Center!) and swimming pools.  Regarding the last suggestion, I'm a bit more of a fan of paying for public basketball courts than pools, but to each their own.

Passion

Real estate is not merely a job, it’s a passion. In real estate we have the privilege of working in an industry that offers many kinds of jobs for people with very different skill sets and different predilections. Whether you tend towards analytics, or are a "people person," or some convex combination, there is a job for you in real estate.  Find what you want to do within real estate and embrace it. Enthusiasm is a hallmark of the Wisconsin tradition.

I've been extremely fortunate in both my personal and professional life.  Focusing on the latter, for 40 years I've gotten up every day excited to go to work.  Why?  Because I'm privileged to have a job where I spend most of my time trying to find answers to questions about cities and economies and real estate that I think are important, that have a bearing on people's lives.

Now that I've "retired," after four decades at the Urban Institute, the World Bank, and the University of Wisconsin, I still wake up charged to hit the books, to hit the computer, to email and call and hang out with similarly obsessed friends and colleagues, to learn something new about our field.  I invite you to join me.

Reading for Life

Ambrose, Brent W, Anthony B Sanders, and Abdullah Yavas. "Servicers and Mortgage‐Backed Securities Default: Theory and Evidence." Real Estate Economics,  (2015).

Baum, Andrew, and David Hartzell. Global Property Investment: Strategies, Structures, Decisions: John Wiley and Sons, 2012.

Bénabou, Roland, and Jean Tirole. "Individual and Corporate Social Responsibility." Economica 77, no. 305 (2010): 1-19.

Berkman, Robert I. The Skeptical Business Searcher: The Information Advisor's Guide to Evaluating Web Data, Sites, and Sources: Information Today, Inc., 2004.

Bottazzi, Jean-Marc, Jaime Luque, and Mário R Páscoa. "Securities Market Theory: Possession, Repo and Rehypothecation." Journal of Economic Theory 147, no. 2 (2012): 477-500.

Bromley, Daniel W. "The Poverty of Sustainability: Rescuing Economics from Platitudes." Agricultural Economics 32, no. s1 (2005): 201-210.

Carnegie, Andrew. "The Best Fields for Philanthropy." The North American Review 149, no. 397 (1889): 682-698.

________. "Wealth." The North American Review 148, no. 391 (1889): 653-664.

Cole, Jonathan R. The Great American University: Its Rise to Preeminence, Its Indispensable National Role, Why It Must Be Protected: PublicAffairs, 2009.

Corbae, Dean, and Erwan Quintin. "Leverage and the Foreclosure Crisis." Journal of Political Economy 123, no. 1 (2015): 1-65.

Dewey, John. Democracy and Education: An Introduction to Philosophy of Education: Macmillan, 1916.

Diop, Moussa, Steven Lanza, Thomas Miceli, and CF Sirmans. "The Use of Eminent Domain for Economic Development in the Era of Kelo." Economic Development Quarterly 27, no. 4 (2013): 352-62.

Downs, Donald A. Restoring Free Speech and Liberty on Campus: Cambridge Univ Press, 2006.

Economist, The. "Special Report: Corporate Responsibility -- Just Good Business." 2008.

Friedman, Milton. "The Social Responsibility of Business Is to Increase Its Profits." New York Times Magazine 13, no. 1970 (1970): 32-33.

Ghent, Andra C, Rubén Hernández-Murillo, and Michael Owyang. "Did Affordable Housing Legislation Contribute to the Subprime Securities Boom?" Real Estate Economics 43, no. 4 (2015): 820-54.

Glazer, Amihai, and Kai A Konrad. "A Signaling Explanation for Charity." The American Economic Review 86, no. 4 (1996): 1019-1028.

Goleman, Daniel. "What Makes a Leader?" Harvard Business Review 82, no. 1 (2004): 82-91.

Graaskamp, James A. "Pension Termination Due to Business Failure, Liquidation, or Migration." PhD Dissertation, Department of Commerce, University of Wisconsin-Madison, 1964.

________. "Redefining the Role of University Education in Real Estate and Urban Land Economics." Real Estate Appraiser 42, no. 2 (1976): 23-28.

________. "An Approach to Real Estate Finance Education by Analogy to Risk Management Principles." Real Estate Issues 2, no. 1 (1977): 53-70.

________. "Fundamentals of Real Estate Development." Journal of Property Valuation and Investment 10, no. 3 (1992): 619-639.

Hansen, W. Lee, ed. Academic Freedom on Trial: 100 Years of Sifting and Winnowing at the University of Wisconsin-Madison: University of Chicago Press, 1998.

Howarth, Richard B., ed. Special Issue of Land Economics on Sustainability. Vol. 73(4), 1997.

Kahneman, Daniel. Thinking, Fast and Slow: Farrar, Straus and Giroux, 2011.

Lublin, Joann S. "Companies Try a New Strategy: Empathy Training." Wall Street Journal, June 21, 2016 2016.

Malik, Kenan. The Quest for a Moral Compass: A Global History of Ethics: Atlantic Books Ltd, 2014.

Malpezzi, Stephen. The Wisconsin Program in Real Estate and Urban Land Economics: A Century of Tradition and Innovation. Fall 2015 Edition ed. Madison, WI: James A. Graaskamp Center for Real Estate, 2015.

________. "Residential Real Estate in the U.S. Financial Crisis, the Great Recession, and Their Aftermath." Taiwan Economic Review,  (Forthcoming).

McCarthy, Charles. The Wisconsin Idea. Vol. 3: The Macmillan Company, 1912.

McCoy, Bowen H. "Real Estate Ethics." Real Estate Review 4,  (2000): 27, 31.

Mulligan, Thomas. "A Critique of Milton Friedman's Essay ‘the Social Responsibility of Business Is to Increase Its Profits’." Journal of Business Ethics 5, no. 4 (1986): 265-269.

Patrick, Brian C, Jennifer Hisley, and Toni Kempler. "“What's Everybody So Excited About?”: The Effects of Teacher Enthusiasm on Student Intrinsic Motivation and Vitality." The Journal of Experimental Education 68, no. 3 (2000): 217-236.

Peter, Sandra, and Lesley Farrell. "From Learning in Coffee Houses to Learning with Open Educational Resources." E-Learning and Digital Media 10, no. 2 (2013): 174-189.

Riddiough, Timothy J, and Jonathan A Wiley. "Private Equity for the Common Man."  (2014).

Smith, Adam. The Theory of Moral Sentiments: Reprinted, Penguin Classic, 2010, 1759.

Vandell, Kerry D. "Preparing the Next Generation." Real Estate Issues 28, no. 3 (2003): 26-34.

Velasquez, Manuel G. Business Ethics: Concepts and Cases. Seventh ed. ed.: Pearson, 2011.

Introduction to the City

If you would be known, and not know, vegetate in a village; if you would know, and not be known, live in a city. Charles Caleb Colton

What is a city? Why do cities exist? Why do urban economists call them (with some exaggeration!) our greatest invention?  Those are some basic questions we will tackle from time to time in this blog.

The simplest definition of a city: a place with above average density. Think of a world without cities as a world in which our population (and other things, like capital goods) are randomly scattered across the land. That would be a very strange world, indeed. Much better is the world we live in, where most people cluster together in some form of urban settlement; and where most of those who remain in areas we call "rural" actually live in smaller clusters (think villages) that are actually functionally urban, albeit at a small scale.

There are many other definitions of "city" out there.  My venerable second edition Merriam Webster's says a city is "from the Latin, civitas, citizenship.  Vaguely, any large, important or noted town or unlabeld place, so called by way of distinction.  The collective body of citizens, or inhabitants of a city."

More colorfully, Robert Bevan, writing in The Guardian, libels the U.S. Midwest, where he claims "... the word ‘city’ has been appended with abandon to any one-brothel main street that once offered relief to travelers across the prairies.”  Waxing a little more poetic, polite, and concise, Richard Sennett offers "a place where strangers meet."  Gideon Sjoberg defines a city as “a community of substantial size and population density that shelters a variety of non-agricultural specialists, including a literate elite.”

Getting back to a more analytical focus, in a classic 1938 paper Louis Wirth defines a city as a place with: (1) a ‘large’ population; (2) in a ‘dense’ settlement; (3) more or less permanent; (4) with some social heterogeneity.  Of course this brings up a set of hard to answer questions, namely what’s "large?"  What’s "dense?"  What do we mean by "social heterogeneity?"

In my urban economics class, I suggest a quadrapite model of a city: (1) a city is a land and real estate market; (2) a city is a labor market and a collection of people; (3) a city is a collection of capital, both tangible and financial; and finally, (4) a city is also comprised of a selection of governments and institutions. 

"Above average density" and "where strangers meet" and the like get us started, but for some purposes are a little vague and abstract. For many purposes – data collection, legal matters, governance – we need very specific, to some extent arbitrary, definitions of the city.

When we speak of cities, then, we have to be clear whether we are discussing "the" city in a functional sense -- the way an urban economist things of "the city" -- or "a" city in a legal/political sense -- the way governments define cities with specific boundaries and governance structures.  Let us now focus on the latter.

Cities in the United States

In the U.S., cities are legally “creatures of states.”  The U.S. Constitution discusses the national government, and the states, extensively; cities and other local jurisdictions are never mentioned!
So each state defines its cities, towns, villages, etc.; and every state is different.

In some of its data collection, the Census Bureau works with these definitions;  among many other units of observation, Census tracks data on “places,” which can be incorporated, usually cities and villages.  Practices vary by state, but incorporated places can also be labeled boroughs or towns or municipalities; these can vary by size, and by the specific kinds of functions states delegate to them.  Places can also be unincorporated places; the Census refers to these as Census Designated Places, or CDPs.

A U.S. city or other incorporated place has received a charter from the state government, and will have elected officials.  Unincorporated places exist by tradition.  Nationally, there are about 19,000 incorporated places, and about 4,000 CDPs.

To recap, different states have different rules for designating cities.  These rules often include, but are not limited to, minimum population sizes in most states.  In the event, U.S. cities (as defined by the political-legal Census "place") range in size greatly from 8 million (New York) down to as few as single digit population in a few odd cases.

For more details, see Census web sites here and here.

Urban Areas

Closely related to the idea of a city is the idea of an urban area, of urbanization.  Merriam Webster, 2nd ed., defines urban as "of, or pertaining to cities."

Census defines "urban" a little differently than a "city;" urban areas are densely settled areas that are more fine grained, built up of densely settled census tracts and census blocks.  In a city like Madison, where some areas are still rural in character even though they are contained within the incorporated boundary, we can have a Census tract that is within the city but not counted as urban by Census.

Thus, in many respects, Census' definition of "urban areas" comes closer to a functional definition than does the legal definition of many U.S. cities.

I don't have a chart handy for Madison, but a demographic services firm called ProximityOne has posted a map for Lawrence, Kansas, using 2000 Census data and definitions:

The Lawrence city boundary in green; the urban urban area in yellow.  Obviously there is a lot of overlap, but clearly some parts of the incorporated city are outside the urban area; and some of the urban area is outside the city.

To sum up, and extend a bit, here is a summary of how Census defines "urban."   An urban area comprises (1) a densely settled core of census tracts and/or census blocks that meet minimum population density requirements (at least 500 people per square mile), along with:
(2) adjacent territory containing non-residential urban land uses, and (3) territory with low population density that links outlying densely settled territory with the densely settled core.

Furthermore, an urban area must encompass at least 2,500 people, at least 1,500 of which reside outside institutional group quarters.

Just to keep us on our toes, the Census Bureau identifies two types of urban areas: (1) Urbanized Areas (UAs) of 50,000 or more people; and (2) Urban Clusters (UCs) of at least 2,500 and less than 50,000 people.

“Rural” encompasses all population, housing, and territory not included within an urban area.

The figure shows the evolution of U.S. urban and rural population over time, since the first Census in 1790.  Two caveats attach to the figure.  First, the definition of "urban" and "rural" have changed over time, but the data are not revised to fit a single definition.  That accounts for some of the apparent blips in the data.

Second, the stacked area chart above gives us a look at the evolution of the levels of urban and rural population over time, but is very misleading with regard to growth rates.  To the untutored eye, it looks like U.S. population growth (especially urban growth) is accelerating, because the line is moving up at an increasing rate.  But growth rates are changes over levels, and as we move forward in time, both the change and the level are going up.  Eyeball the chart.  If you think it's showing faster growth in recent years, then you are a prime candidate for a future post on data transformations that will convince you that U.S. population growth is slowing down, in both the city and the countryside.

In the 2010 Census, about 250 million, or 81 percent, of the U.S. population resided in urban areas. About 60 million, or 19 percent, of the U.S. population resided in rural areas.

Because urban areas are denser, the fraction of U.S. land that's urbanized will be less than the fraction of population.  But it surprises many how little U.S. land is urbanized.  Separately, the U.S. Department of Agriculture estimates how much land area is urbanized.  In 2007, the last detailed accounting, about 25 million hectares (61 million acres), or about 3 percent of our 0.9 billion hectares (2.3 billion acres), was urbanized.  About another 2 percent comprised rural built up areas (e.g. farm buildings, rural housing and other real estate, and highways).

World Urbanization: A First Look

The figure above shows the urban population of the world, by decade.  Data come from the United Nations World Urbanization Prospects.

Today there are roughly 7.5 billion people spread over about 13 billion hectares (32 billion acres) of land. Of course much of this land is arid or otherwise inhospitable to settlement, but more on that another day.  Of those 7.5 billion people, about 4 billion live in cities/urban settlements, and 3.5 billion live in urban areas.

In 1950, just before I was added to the red bars, the world's urban population was only about 3/4 billion; that was only 30 percent of our total 2.5 billion population.

It's an auspicious time to study urbanization! Human history, at least that of homo sapiens, is currently thought to extend about 150,000 years, and some of us have lived in urban settlements for about ten millennia.  According to the best estimates – and these are rough numbers – in 2007 the red bar became bigger than the blue bar, and we very recently crossed over, for the first time, to a world where the majority of human population lives in cities.

Obviously we are unable to actually date the transition to majority urban as precisely as a given year, much less the date “May 23, 2007” announced, I presume tongue-in-cheek, by several U.S. sociologists a few years back.

Obviously the bar charts for 2020 through 2050 above are forecasts, subject to error. If these forecasts are correct -- and the one thing we know for sure about every numerical forecast is: it's wrong! -- by the time today's students are nearing career maturity, around 2050, about 2/3 of our 9 to 10 billion global population will live in cities.

The actual data up through 2010 are themselves subject to error, as they are built up from country estimates.  In addition to sampling errors, the UN's demographers use each country's own definition of "urban." Roughly, for the U.S, as noted above, our threshold for urban is a place of 2,500 or more.  As it happens, 2500 happens to be a common but not ubiquitous threshold for urban place in other countries. Country thresholds range from 1,000 to 10,000 and higher, although 2500 is the most common.   See the "Data Sources" page of World Urbanization Prospects for list of definitions by country as well as additional detail.

So far our brief discussion has focused on the levels of global urban and rural population.  The chart also shows annual growth rates for each decade.  In the 1950s, urban population was growing a bit over 3 percent per year, while urban population was growing about 1 percent; overall population growth was a little under 2 percent.  Today, urban population is growing about 2 percent, while rural population is flat, for a total global growth rate of about 1 percent. In several decades, the UN's forecast is that urban population growth will slow down to about 1 percent while rural population will start to decline.

Until recently, the UN and a number of other global projections suggested that population growth would level off and begin to decline sometime during this century.  More recent projections (see chart above, from Kunzig) suggest that population growth may continue, albeit at a declining rate, through the rest of this century.  

The forecast growth is concentrated in a relatively small group of the world's 200+ countries, mainly those that are large, with especially high fertility rates.  The UN World Population Prospects projects that half the world’s population growth will come from just nine countries; in order: India, Nigeria,Pakistan, Democratic Republic of the Congo, Ethiopia, United Republic of Tanzania, the U.S., Indonesia and Uganda.  

Note that the U.S. is the only "developed" country in the list; the U.S. has a much higher growth rate than most other developed countries, partly because of immigration, and partly because of higher fertility rates. (Interestingly, the higher U.S. fertility rate is in turn due in large part to immigration, since it's recent immigrants and their children who have the highest fertility rates within our borders).  U.S. population grows about 1 percent per year, close to the current global average; many other rich countries like France, Germany or Japan, are flat or declining.  Note also the absence of China in the short list; China is large, but has a modest rate of population growth, around 0.5 percent.

More to Come: Metropolitan Definitions

Another basic set of city-related definitions revolve around metropolitan areas.  These are collections of counties, that are economically connected to cities.  Metropolitan areas -- and related concepts, like micropolitan areas, "combined statistical areas," and the like -- are a big topic, so we will undertake a separate post to examine them.

If you can't wait -- and there's no reason why you should wait! -- see Frey et al. (2004) for a detailed discussion.

Reading for Life

Bevan, Robert. "What Makes a City a City - and Does It Really Matter Anyway?" The Guardian, May 8, 2014 2014.

Colton, Charles Caleb. Lacon: Or, Many Things in Few Words: Addressed to Those Who Think: Longman, Orme, Brown, Green, & Longmans, 1837.

Frey, William H, Jill H Wilson, Alan Berube, and Audrey Singer. "Tracking Metropolitan America into the 21st Century: A Field Guide to the New Metropolitan and Micropolitan Definitions." The Brookings Institution, 2004.

Frug, Gerald E. "The City as a Legal Concept." Harvard Law Review 93,  (1980): 1057-1154.

Glaeser, Edward L. Triumph of the City: How Our Greatest Invention Makes Us Richer, Smarter, Greener, Healthier, and Happier: Penguin, 2011.

Kunzig, Robert. "A World with 11 Billion People?  New Population Projections Shatter Earlier Estimates." National Geographic,  (2014).

Malpezzi, Stephen. "Urban Growth and Development at Six Scales: An Economist's View." In Global Urbanization, edited by Eugenie L. Birch and Susan M. Wachter. Philadelphia: University of Pennsylvania Press, 2011.

________. "Population Density: Some Facts and Some Predictions." Cityscape 15, no. 3 (2013): 183-201.

Nickerson, Cynthia, Robert Ebel, Allison Borchers, and Fernando Carriazo. Major Uses of Land in the United States, 2007: United States Department of Agriculture, Economic Research Service, 2011.

Sjoberg, Gideon. "The Origin and Evolution of Cities." Scientific American 213, no. 3 (1965): 55-63.

United Nations. World Urbanization Prospects: The 2014 Revision: UN Department of Economic Social Affairs. Population Division, 2014.

________. World Population Prospects: The 2015 Revision: UN Department of Economic Social Affairs. Population Division, 2015.

Wirth, Louis. "Urbanism as a Way of Life." American Journal of Sociology,  (1938): 1-24.