Rents in Megacities Can't Go Up Forever
As rents and home prices in the most productive megacities continue to climb, the obvious question is whether this is sustainable. Will New York, San Francisco and London become unstoppable juggernauts, soaking up more talent and becoming more expensive each year? Maybe not. I can see several reasons this growth in megacities will prove bounded rather than spiraling out of control.
We live in a special time where clustered activities are unusually important for economic growth. Some activities, such as dentistry and cement production, don’t cluster geographically very much, for obvious reasons. In contrast, finance (New York and London), information technology (the Bay Area), and entertainment (Hollywood and New York) are the most clustered. For whatever reasons, it makes sense to have many of the top decision-makers in one place.
Leading cities have become so expensive in large part because two of these clustering sectors -- finance and information technology -- have been ascendant. There is no particular reason to expect those trends to continue forever, and that will bind rents in affected cities.
Many more economic sectors tend to be spread out geographically -- such as higher education, caring for the elderly, installation of smart-home equipment, fracking, restaurants -- and if more economic activity takes these forms, to some extent rents will equalize across different cities.
The rise in the size and value of the financial sector clearly is checked by the total amount of portfolio wealth. But what about information technology? Might it not outpace the productivity gains in other sectors of the economy, year after year? Maybe, but even if it does that doesn’t have to all show up in Bay Area real estate prices.
If you think of a typical technology project, some of the gains go to the venture capitalists and the intellectual property holders, and some of the gains go to broader society, including consumers. Insofar as the gains are disproportionately reaped by the early project initiators, then yes real estate values in the Bay Area (and other tech clusters) will rise. But the most likely future for information technology is that it will spread its benefits more and more broadly into more and sectors of the economy. That scenario suggests a partial convergence of urban futures.
Another way to put the point is that intellectual property returns erode over time. In the early years of smartphones, a big part of the gain goes to Apple. As cheap imitators enter the market, prices fall and more of the gains go to consumers, or business users of the product, who are scattered across the country.
There is yet another reason the growth of very high productivity cities will reach a limit, namely that the wealthiest people are not always the most creative. Often wealthy people were very creative; that is how they earned their money. But looking forward, the supercreators of the next generation just aren’t that rich yet, and they may prefer to experiment with their new ideas in lower-rent environments, if only because that will make it easier to hire other people.
If you were to pick a city or city-state that is just full of wealthy people, Monaco would be an obvious candidate. Yet it is hardly a favorable environment for future creativity, if only because it costs a lot to live there and that scares away many of the young. The fact that it is full of the creative spirits of the past is scant reason to revisit that assessment. Part of the vitality of the current megacities is that they have had cheaper areas on their fringes, such as Brooklyn in New York or Oakland or East Palo Alto in California, but increasingly those areas are cheap no more.
Finally, megacities have a problem making it affordable to raise large or even medium-size families. How many of us could live in San Francisco, London or New York City and bring up three children in a decent neighborhood with good schools? Only the already well-to-do can manage such a feat. The result is that cities do not replenish themselves, and rely on continual injections of outside talent, most of all through immigration.
My personal stance is pro-immigration, but the politics of both the U.S. and the U.K. are showing that only so much immigration will be allowed. That too will check the growth of the megacities, and thus the magnitude of their rents. Reliance on immigrants also insulates megacities from the core political trends of their nations and thus limits their political influence, again a reality already in the U.S. and U.K.
The importance of the megacities is hardly going away. But neither do we face a future where the expense of living in these cities simply will rise without limit.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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