Slums are “economically rational”

May 11, 2005 | Economics, Markets, Primer posts, Slums

… and bad.  Because they are economically rational, they come into being any time the conditions are right. 

 

Slum_Philadelphia_mid_20th

Philadelphia, mid-twentieth century

 

Because they are bad, we need government-incentivized affordable housing.

 

The ‘law of economic gravity’

 

            Simply put, uneconomic endeavors cannot survive.  In the long run, the economics must work – that is, recurring income must exceed recurring expense.  Otherwise the venture fails, and keeps failing until sustainable income-expense (link in .pdf) equilibrium is created.

 

            The private sector has a straightforward and economically rational solution to the problem of unsustainable renters, consisting of the following steps:

 

  1. Compress rentable space each unsustainable renter occupies.  This has the effect of increasing the revenue per unit.

 

Slum_tenement_1880

Tenement, 1880

 

  1. Reduce operating expenses to a bare minimum.  This results in an accelerating cycle:

 

·         Inadequate operating expenses — > deferred maintenance and a decline in property physical condition.

·         Declining property condition –> lower curb appeal, difficulty attracting good tenants –> acceptance of marginal tenants.

Slum_Thailand

Thailand, present day

 

·         Accepting marginal tenants –> higher collection/ bad debt losses, higher maintenance, secondary problems (e.g. vandalism) –> higher-income tenants move out.

·         Loss of market tenants –> lack of rentability –> stigmatization of the property.

 

  1. Adverse-select the worst location because these have the lowest acquisitions/ operating costs and the tenancy residing in them has the fewest alternatives and the least economic imperative for (as an example) transportation and public services.

 

Slum_Camden_NJ_1938

Camden, New Jersey, 1938

 

The long-term end result, of course, is a slum, and it is economically significant that exactly the same slum-creation economics recur in cities going back two thousand years. 

 

Slums are ‘economically rational’

 

            From the standpoint of a diversified housing financial ecosystem, slums are ‘economically rational’ – that is, they will inevitably emerge when certain conditions are present, namely:

 

·         Demand: a large supply of very poor households.

·         Supply: existing stock of housing that can be acquired cheaply and not maintained.

·         Market economics: An economy in which owners can sell to buyers.

 

Slums will inevitably come into being unless government intervenes in otherwise ‘normal’ market practices.

 

Slum_Manila

Manila, present day

 

They are bad because they breed disease, malnutrition, unemployment, and crime.

 

Slum_South_Bronx_3

South Bronx, New York, 1985

 

Slums are normally temporally dynamic — they come and they go, and their location thus shifts in cycles of decades or quarter-centuries.  The nation’s urban cores are replete with formerly affluent neighborhoods become slums, and former slums …

 

Boston_North_End_early

Boston‘s North End, 1901

 

… become gentrifying upscale neighborhoods.

Boston_North_End_Today