German Housing Market and its Implications on Unemployment

Abstract

It is a main characteristic of the German housing market that the rates of residential mobility in Germany are very low compared to the United States and other European countries. I first want to show in this paper, that low mobility rates could in theory be viewed as outcomes of a tight housing market. Then I would like to go further and try to look at the effects of this inflexibility on unemployment.

Since in Germany the housing market as well as the unemployment has experienced a big change after reunification, it will be interesting to apply these hypotheses in Germany. First, I want to summarize the main characteristics of the German housing market, focusing on vacancy rates. After doing that, I would like to outline a correlation between vacancies and unemployment. On the whole, the main goal of this paper is to test the hypothesis that characteristics of the housing market have visible implications on unemployment in cities and - if this hypothesis holds at all - to ask what city planners and local or state governments can do to improve the situation.

I then ask a second question: Urban Economists have always been interested in housing vacancies. On the one hand, they are not useful to the whole economy because they represent unused, “dead” capital. On the other hand, however, vacancies seem to be important for the national economy because of the increasing residential mobility with increasing vacancy rates. Is there an “ideal” vacancy rate?

Introduction

It is generally agreed that the very high unemployment rate that is experienced in Germany these days can mainly be explained by structural reasons. Today, Germany has an unemployment rate of 9.2% in total, 17.1% in the East and 7.5% in the West of the country. Also within both parts of the country, unemployment differs to a large extent. Being aware of that, the German government tries to induce new industry to settle in areas with high unemployment. However, this is a very difficult task, because especially in the structurally weak areas, where there is a great lack of skilled workers. Therefore, I want to look at this problem from a different perspective: If the industry does not come to the unemployed, why don’t they go to where the jobs are? There can be no doubt about the fact that people living in areas with very high unemployment - especially those who are not so skilled - would be much more likely to get a job in structurally stronger areas with a higher total job fluctuation, since thereisa visible demand for almost all kinds of workers. Of course, very few people would move before finding a new job. But do people actually want to look for jobs that are located far from home? Obviously, there is a great inflexibility among the unemployed people - the rate of residential mobility in Germany is very low anyway. In this paper, I will also try to answer the question, why this is the case.

But why do I focus on Germany? As the Eastern part came from a socialist regime with theoretically little unemployment and housing was generally supplied by the state, East Germany was suddenly confronted with a completely new situation. The change of these variables during reunification was enormous and therefore it could be a great help in the question how housing and unemployment in cities are related to each other.

The Theory

When economists consider housing - especially vacancy rates - they have to be aware of the fact that housing is not at all a homogeneous good. If it were, one could easily draw the standard supply/ demand diagram and visualize the one and only reason for vacancies:

The price sticks to p* for some reason, it

supply does not go down to p[1]. Therefore, there is

too little demand and too much supply.

However, housing is different. Dwellings differ in a lot of things (location, size, …), so they are very heterogeneous and comparison between different alternatives is more difficult. Then, housing is immobile, very durable, and very expensive. Furthermore, the transaction (moving-) costs are very high. So the equilibrium price of a dwelling does not necessarily have to be at p[1] , since an unexpected impact on a housing market cannot be balanced out very fast. The less flexible a housing market is (the less people are willing to move in order to improve their situation), the more likely additional vacancies can occur.

Since housing is heterogeneous, it is worth a look on how vacancies differ among different quality classes of housing. I will point out later, that the vacancy rates in Western Germany are very low in general and also very different from one city to the 4 other (and Eastern Germany is a very special case), so it makes sense to look at the United States for theory reasons.

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We can see, that vacancy rates differ a lot from a low to a high rent range. We can also see, that the vacancy rates are increasing to a large extent in the higher category, staying approximately even from $300 on upwards. The reason for that is the higher profit for investors in higher quality housing, so the supply is relatively bigger. However, this data is very unstable throughout the years. In the year preceding this data presented, the vacancy rate is 11.9% in the highest and 2.1 per cent in the lowest category. This means either that there is some sampling error, or a true, heavy instability in vacancy rates. (So for some reason, the vacancy rate not only seems to be hard to find variable, but also a very strange one.) Applying the filtering model, an upward change in demand would lead to an upward filtering, a change in supply to upper and highest quality housing. An outcome of that is the even tighter housing market in the low-income category, the average price also rising, so that the ability of low-income households is still reduced.

After focusing on vacancies, I also want to consider regulation in housing and subsidizes to housing and their effects on the market, because we will see, that this is a very striking characteristic of the German housing market.

Malpezzi and Green (1996) point out, that supply -side constraints clearly affect the price of housing. They run a cross-section data regression among 59 American Metropolitan Areas. It turns out, that the price of housing is significantly higher in areas with a higher percentage of land unavailable for development. This is per se not very striking, but the effect is even much higher if you look at the change of the price in sub-standard housing: Their final regression equation revealing this difference in the change of prices with greater constraints is the following:

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This is relevant regarding unemployment, because less skilled workers, that cannot afford standard housing, are more likely to be unemployed, as I will indicate later. In this paper, they also found a (not as significant) negative correlation between vacancy rates and supply-side constraints. Again only focusing on substandard housing, their final regression is:

Vacancy rate = 0.146 - 0.0024 * (% land unavailable) R[2] = 0.06

In the literature, the effects of subsidized housing units are controversial (Malpezzi and Green, 1996): On the one hand, subsidized units are low-quality and therefore supplying low-income people with affordable housing, since we have seen above, that especially in low-quality housing the market is tighter and this would be a relief. On the other hand however, it is argued that subsidized units will inevitably crowd out low-cost rental units. I think, on the longer run, the latter argument will dominate, because the market will inevitably take these subsidized units into account.

The next questions are, how do low vacancy rates and highly regulated, tight housing markets affect mobility rates.

The answer is obvious: More vacancies lead to more possibilities to move and so the mobility rate should increase and more flexibility in the housing market should be the result. Regulations also negatively affect mobility rates, since people deciding if they should move or not have fewer possibilities to choose from in their target area. Finally, I want to look at the effects of inflexibility in the housing market on unemployment. The labor market is as heterogeneous as the housing market. There are very heterogeneous jobs and there is also a heterogeneous supply of labor force. Therefore a major matching problem exists in the labor market and a lot more time is used (wasted) on searching. This searching will take a longer time, if you have difficulties with not only finding the proper job but also the right dwelling in a tight housing market. Thus a “natural” vacancy rate exists as well as a “natural” unemployment rate. And this unemployment rate will increase with problems in finding new homes as well.

In the literature there seems to be evidence, that under some circumstances there can actually be a large effect of inflexibility on the unemployment rate: In a recent paper, Oswald (1999) compares the increase of home ownership (as a sign of inflexibility) in Europe to the increase of unemployment since the 1950s using several regression analyses. His results are strikingly significant as shown, for example, in Figure 1. Here, he compares home ownership rates and unemployment rates in both European and North American countries.

Figure 1. Home-ownership and unemployment rates forty years ago: The Countries of North America and Europe in 1960

Case study of Germany

Historical and Legislative Background of German Housing

In Germany, housing always has been highly regulated. In order to reduce the housing shortage after the Second World War, there were rigid state controls on housing until the mid 1950s. These were lowered subsequently, but housing permit procedures still are very complicated and restrictive. The loss of 5.5 Million dwellings during the World War was also the main reason for the huge rental sector that can be observed in Germany still today: Directly after 1945, West Germany engaged in a massive new construction program. Generous tax incentives for landlords and a stable rental market with rent control “created and sustained a large private rental sector in (Western) Germany.” (W.A.V. Clark etAl., 1997). In 1995, the home-ownership rate is approximately 40 % in the former West Germany.

The former German Democratic Republic faced similar difficulties. In fact, the overall situation there was even worse. Some 10 per cent of housing had been destroyed during the war; the division of the country cut the eastern part off from its previous coal, steel and cement supplies. “680 large enterprises and 7500 km of railway were dismantled and shipped as reparations to the Soviet Union.” (Dienemann, 1993) In 1949, most dwellings were privately owned, which changed under very rapidly under the socialist regime.

Although the construction of new housing in the GDR rose after the war since the socialist party (SED) decided to give an always-greater priority to housing in its five-year plans, the system still experienced a huge shortage in housing and a lack in housing quality. “The construction of new housing rose sharply, from an average of 34000 p.a.

between 1950 and 1956 to around 85000 p.a. in the 1960s. […] In the period from 1976 to 1990, 2.8 to 3 million dwellings were to be constructed or modernized. ” (Dienemann, 1993) However, the economic system did not manage to succeed in these plans although there was at least some success: In the 1980s there was a real production of dwellings of 120,000 p. a. and the quality of housing could (at least in the bigger cities) almost be compared to western standards.

On the whole, you can say that due to the socialist legacy in the east, the new construction of housing was not as efficient as in the west and a shortage of well inhabitable dwellings could be seenfrom 1949 until 1990. In 1995, the home-ownership rate was still much lower there than in the west and reached only 25 %.

Compared to the US, West German environmental protection regulations such as zoning laws are much more restrictive, building permits are much more difficult to get, the bureaucratic regulations differ between different communities, all building plans must conform with several standards (German industry norm, local standards and Federal German standards). Hence, land zoned for construction is scarce and thus extremely expensive. Land and city planners have a much greater power than, for example, in the United States. Overall, you can say that building new houses in Germany is much more difficult and expensive, so the total number of available housing units cannot be changed as fast as in the US when there is an additional demand and hence supply is inelastic and adjusts only slowly to shocks.

Changes in the German Housing Market the last 15 years

In fact, there was an over-supply of housing in West Germany in 1986 and a shortage again even before and also after reunification. In East Germany, there was also still a clearly visible shortage. Immediately before reunification, there was a housing waiting list of 800,000 in the GDR, of which about one-third were socially urgent cases, and “out of around 7 million dwellings, 860,000 were without a bath and a shower, 1.3 million were without an inside toilet, and over 3.2 million were without modern heating.” (Dienemann, 1993).

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We can see from table 2 that the reaction of the German housing market was not immediate. It took Germany some years to react on changes to the big oversupply in 1986 as well as the exogenous shock of reunification to the opposite direction in 1989/90. Shortly after reunification, there was a great demand for new dwellings not only in the Western part, where the existing supply of housing could not satisfy migrants from Eastern Germany. But also in the former GDR, where rehabilitation and renewal of the existing stock took place, there was a housing shortage.

When the communist state left an administrative vacuum and the political system of the Federal Republic was suddenly transferred onto the GDR, a chaotic situation arose with vacancies on the one hand and an over-supply on the other hand.

To illustrate this, I would like to use the squatting riot in Berlin in November 1990, which also was an outcome of this phenomenon.

In the final days of the old GDR, many run-down dwellings were abandoned, since there were “extremely low rents, the lack of legal means to enforce the payment of these low rents [and] ineffective maintenance and management systems”, so many dwellings became “hard to let [and] suffered detoriation” (Dienemann, 1993). In East Berlin in 1990, a total of 25,000 dwellings were empty. So in Berlin- Friedrichshain, some riots took place when 400 mostly young people (out of 4,000 people in total, who were seeking housing in this area) simply took over empty run-down dwellings. 80 per cent of dwellings were in need of renovation in this area. This explains, how chaotic the East German Housing Market was during reunification and what the local authorities had to deal with. Finally, for about 100 occupiers agreements have been reached to enter into tenancy agreements.

An additional exogenous shock on the German Housing market predominantly on bigger cities in the West was the civil war in the former Yugoslavia, which brought several waves of refugees to Germany in the 1990s.

[An econometrical, cross-sectional data analysis of the supply and the demand in the German housing market would be very interesting at this point, but it would exceed the scope (and also the complexity) of this paper by far. Interested readers should consider reading Axel Börsch-Supan’s book “Econometric analysis of discrete choice: With applications on demand for housing in the U.S. and West-Germany”, 1987.]

According to Börsch-Supan (1993), the vacancy rates are relatively fifteen times (!) higher in the US than in Germany. This difference seems to be “too” high to be true, but taking into account, that the rental sector in Germany is very well developed and smoothly functioning (W.A.V. Clark etAl,1996), the German housing market still works somehow, in spite of the fact that it isverytight. Nonetheless, due to its heavy regulations, it is lacking in flexibility and thus malfunctioning.

From reunification to the year 1995, the number of new dwellings per year has doubled. In total, we have an over -supply of mostly lowest income housing units in East Germany (however, a lot of new dwellings are built - mostly uppe r quality housing), whereas in West Germany there generally is no over-supply.

As we can see from table 3, there was a big movement in the German Housing Market still in the Mid-90s. Germany experienced a big increase in private investments in housing in both of its parts.

Table 3 German Housing 1995 to 1997

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Source: Statistisches Bundesamt, 1998

Many private investors (such as my father) were attracted by the income tax advantages for owners supplied by the government, when investing in new housing after reunification, but they are now mostly disappointed because of the development of the value of housing these days.

Mentality

Although in Germany by far less people own their own house compared to the United States or even other European countries, the residential mobility is much lower. Generally, Germans don’t buy houses unless they want to live in them forever. When they want to live somewhere for a limited period of time, they usually rent an apartment. Owning a house is something for a lifetime there. You can easily see the effect of this when you look at the quality of housing. In Germany there are usually very elaborate houses, whereas in the US people are mostly satisfied with less expensive and less durable housing units. (A good indicator is the thickness of the walls.) This has two major outcomes: The relative expenditure of income on housing is in generally much higher in Germany and the size of one household is mostly smaller. Perhaps it is also the Germans’ perpetual discontentment with the ir situation. Replacement and upgrading of dwellings by their owner who upgrade in place instead of moving can be observed to a much greater extent than in the USA.

So imagine you have just bought a very expensive house and then you lose your job. It is evident that Germans will then have much more problems to abandon their new home in order to look for something new. I even think that the reasons of different mentalities are much more important than anything else trying to explain differences in residential mobility.

On the whole, you can say that (a) housing is seen as a much more valuable good and (b) German workers’ regional commitment and ties are much stronger than those of US households.

Conclusion

On the whole, you can say that Germany’s Housing Market has gone (and is still going) through unique experiences the last 15 years. Because of hard restrictions by local, Länder-” and state governments and because of very low vacancy rates in the West, the market cannot react to exogenous impacts very fast. This is a major disadvantage for the whole economy. The very high unemployment rate in Germany is mainly due to structural reasons and this paper argues that housing is a highly underestimated variable influencing mobility in the labor market.

The vacancy rate, however, is not a good estimate of the flexibility in a housing market. Not only do vacancy rates differ a lot over time, their effects are also very dependent from other variables such as the size of the rental sector: In Germany, the rental sector is a main part of the housing market and thus this market is still functioning in spite of the very tight hosing market. Therefore,oneideal vacancy rate does not exist, as the ideal rate would differ from one country to the other. In Germany, for example, a vacancy rate as high as in the USA would not be necessary in order to obtain a smoothly functioning housing market.

However, you could in theory think of an ideal vacancy rate in a single country considering special other characteristics at the same time.

So what can be changed in the German urban planning and legislation in order to improve the flexibility of the housing market?

First of all, the high rental sector in Germany is not a bad thing, since increasing home- ownership would even increase the inflexibility in mobility, which is a big problem in Germany anyway. Secondly, institutions or legislation can of course not change the German mentality, which is the main problem considering inflexibility. One of Dienemann’s (1993) conclusions for the East is, that the German policy should even try to encourage people to stay in the East of Germany rather than move to the West. He argues, that the “’five new Laender’ otherwise loses qualified young people, which leads to even worse structural problems in the German economy. However, I think this is not helpful in this very moment, since therearejobs for qualified people in the West and these people are suffering from the very high unemployment in the East. I do not think that anyone should evendiscouragethe East Germans to move in order to grant their own employment employment.

However, the strong regulation and the confusing legislationcanbe changed: In my opinion, the regulations causing inflexibility in the German housing market and its implications on unemployment are highly underestimated. In the future, German governments have to try to find a uniform and standardized, simpler legislation for new housing construction. This will not be easy, since there are many different groups of interests that try to keep strong regulations. One has to take into account, that in Germany ecological concerns are high much more highly estimated than in the USA and urban planning has a higher importance, simply due to the fact that there is less space in Germany and a much higher population density. In my opinion, all these concerns are well justified, but the country has experienced a very high structural unemployment for quite some time now and some changes in the direction of more flexibility would definitely be helpful. As I said before, the process of change in the direction of a more liberal legislation will always be difficult and slow.

But in the also very difficult and long lasting European unification process, there is the chance for Germany to change this legislation, since the housing legislation in France and Spain is not as strict.

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