The Lump of Buildings Fallacy

Ryan Avent on the economics of new buildings in a growing metropolitan area:

But you can see the problem. If you limit building supply, then you limit the number of firms that can locate in an area. But firms don’t work in isolation. They create demand for other businesses (accountants, consultants, lawyers, ad firms, or design firms, for instance). Additional supply, by making it affordable for more businesses to operate in an area, attracts additional ancillary uses, which will occupy still more space.

Now, if there is falling demand for an area in the first place — if some structural trend, like suburbanization associated with rapid increases in car ownership, or like the collapse of Midwestern industry, is undermining the very purpose behind an economic node — then adding a lot of new supply might accelerate decline. When rents are falling and vacancy rates are rising, local leaders often think that a bold new project may turn an area around. But this is mistaken; it will add to supply and accelerate price declines, potentially pushing rents below building maintenance costs and generating pressure to tear down existing structures.

But this is precisely the opposite of what we observe in the economically dynamic, skill-driven cities in which supply limits are so enormously costly.

Exactly. If you make it cheaper for a company to get the office space it needs to expand, you increase demand for secondary business services. And the increased employment in those secondary business service fields also increases demand for lower skilled support staff (janitors, security guards) as well as for general retail and entertainment services. There’s a huge multiplier associated with an increase in business activity that’s mostly limited by the high cost of space and the hassles of congestion (not just traffic jams, but general crowding and unpleasantness). If you manage congestion better and reduce restrictions on the availability of space, you can reap big benefits.