Wednesday, May 15, 2013

More on housing and startups

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People are starting to notice the epic collapse of startup activity of recent years. Via Arnold Kling, see this great note by Glenn Reynolds and a reader suggesting that the decline in housing collateral could be a large factor.

I think so too, as I've discussed before. I'm working on a paper that I hope will shed some light on this question. A few things to keep in mind:

1. Part of the decline is secular; I noted this here. This has coincided with a more general secular decline in business dynamism, and we still don't know what's driving it. The startup problem seems to matter for the broader dynamism decline, though. It's difficult to disentangle the secular component from the Great Recession component.

2. I note here that (a) national house price indices and home equity peak about the same time as startup activity (2006, before the "recession" started) and (b) residential investment peaks about that time as well despite other investment series peaking at least a year later. That's far from a smoking gun, but it is suggestive.

3. More formal empirical evidence for this link is emerging. I discussed one paper here (this one exploits the famous Saiz housing supply elasticity instrument). Another paper, this one exploiting time series and regional variation, obtains similar results. Both of these papers cast doubt on the notion that the Mian and Sufi channel (the household balance sheet channel) is sufficient for understanding the full consequences of house prices (in part because the two papers I mentioned find effects in tradeables in addition to nontradeables).

4. The full details of a housing collateral/startup channel require some unpacking. For example: you could build a really simple model with frictionless housing markets and housing collateral that would not give you a clear house price/startup relationship. To see this, suppose housing and nondurable consumption enter into utility as Cobb-Douglas, so expenditure shares are fixed. Then a house price decline just causes people to buy more houses. You need something more; lots of housing market frictions (which is reasonable) or a simultaneous decline in loan-to-value ratios will probably do it.

5. It would be nice to be able to quantitatively compare the consequences of the main channels through which housing collapse smashed the economy. These include this housing startup channel; the Mian and Sufi consumption channel; the standard residential investment/construction industry channel; and the bank balance sheet channel. Someone should write a paper about this... (working on it).

6. Figuring out the cause of the startup collapse is important since startups account for almost all net job creation.

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