Lerbs (2014) estimated the price elasticity of new single-family housing supply for 413 German counties and cities over 2004-2010 using a dynamic panel of building permit rates, finding an average long-run elasticity of roughly 0.33 but a steep gradient across the urban hierarchy: strongly positive supply responses in major cities (long-run about 0.80), weaker responses in urbanized counties, and no statistically detectable price response in rural counties. The mechanisms generating this heterogeneity - land-use regulation, land availability and infrastructure constraints, urban growth dynamics, and asymmetric (kinked) supply responses to price rises versus falls - were left unexplained, as were the reasons for rural price-inelasticity. Later work has estimated aggregate German supply elasticities and provided causal regulation evidence only for neighboring Switzerland, while no study has decomposed the mechanisms of German local supply-elasticity heterogeneity or disentangled the competing explanations for the rural result. The problem of identifying and quantifying these mechanisms therefore remains open.

Background

The price elasticity of housing supply measures how strongly the flow of newly built housing responds to a change in the ratio of house prices to construction cost. When that ratio (sometimes interpreted as a Tobin's-q-type incentive to build) rises, developers should acquire land and obtain permits; the speed and size of this response determines whether local demand shocks translate into more housing or into higher prices. Empirically the response is usually proxied by building permits - administrative approvals that precede construction - because permits are available annually for every local jurisdiction, whereas housing starts and completions are reported with delay and coarser coverage. Lerbs (2014) studied German single-family housing this way: for 413 counties and independent cities over 2004-2010, the dependent variable was the annual permit rate (permits per 100 existing single-family homes), modeled dynamically - with the lagged permit rate capturing the slow adjustment of construction - and estimated by two-step difference GMM (a generalized method-of-moments estimator for dynamic panels that instruments differenced regressors with their own lags). The sample follows the official settlement-structure typology of the BBSR (Bundesinstitut für Bau-, Stadt- und Raumforschung, the Federal Institute for Research on Building, Urban Affairs and Spatial Development, whose county types are the standard German regional classification), which splits these jurisdictions into major cities (independent cities with at least 100,000 inhabitants), urbanized counties (population density of at least 150 inhabitants per square kilometer), and rural counties (density below 150).

His central results were an average short-run price elasticity of 0.215 and long-run elasticity of about 0.33, but with pronounced heterogeneity: short-run elasticities of 0.652 in major cities (long-run about 0.80), 0.315 in urbanized counties, and 0.132 with a standard error of 0.106 (p = 0.213, 95 percent confidence interval roughly -0.08 to 0.34) in the 181 rural counties - that is, no statistically detectable price response in rural areas. To interpret the rural estimate the paper invoked the kinked supply curve hypothesis: because housing is a durable good that is costly to demolish but never rebuilt one-for-one in declining areas, supply responds to price increases but not to price decreases, so markets whose prices have fallen below replacement cost (the cost of constructing an equivalent new dwelling) exhibit flat supply. The durable-housing mechanism was formalized by Glaeser and Gyourko (2005) for declining US cities, and Maennig and Dust (2008) documented asymmetric price reactions in shrinking versus growing German metropolitan areas. For context, the international literature had already established that supply responsiveness differs widely across countries and cities: Caldera and Johansson (2013) estimated an aggregate German long-run price elasticity of new housing supply of 0.428 in an OECD (Organisation for Economic Co-operation and Development) comparison; Fortune and Moohan (2008) concluded from cross-country case studies including Germany that elasticity estimates describe but do not explain supply responses, pointing instead to institutional factors such as local authorities' land-release behavior; and Saiz (2010) showed for US metropolitan areas that geographic constraints (steep terrain, water) and regulation jointly lower supply elasticity. For Germany itself, Schulz and Werwatz (2011) showed for Berlin that house prices are anchored to replacement cost in the long run, which is precisely the anchor that breaks - making supply kinked - where prices fall below it.

Problem Statement

Identify and empirically disentangle the mechanisms that generate the large, documented cross-location differences in the price elasticity of new single-family housing supply across German counties and cities - the elasticity gradient running from strongly positive short- and long-run responses in major cities (short-run 0.652, long-run about 0.80) through intermediate values in urbanized counties (short-run 0.315) down to an estimate statistically indistinguishable from zero in rural counties (0.132, standard error 0.106). Specifically: quantify how much of this heterogeneity is attributable to (i) land-use regulation and the land-release behavior of local planning authorities, (ii) physical and infrastructure constraints on land availability and development, (iii) urban growth dynamics and demand persistence, and (iv) asymmetric, kinked supply responses to price increases versus decreases that the durable-housing hypothesis predicts where prices fall below replacement cost. In particular, determine whether the absence of a measurable price response of new construction in rural counties reflects persistently weak demand, an overhang of vacant or excess housing stock that precludes additional building, or an inherent asymmetry of supply responses to price falls. The analysis is to rest on the German local panel over a span substantially longer than 2004-2010 (covering boom and downturn episodes), with supply indicators beyond building permits where possible (housing starts or completions) and explicit measures of regulatory and geographical constraints, and is to quantify the share of the heterogeneity attributable to each of (i)-(iv) and determine which of the three explanations accounts for the absent rural price response of new construction.

References

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