Are Housing Prices Mostly Regulatory Costs?

 I've done research on housing costs, inflation, and regulation many times over the last decade or so.  See my previous article for background information that might be useful in the following.  Recently I claimed that over 70% of material costs for housing are due to building cost, and someone challenged this claim, asking for sources.

Now, I may have gotten ahead of myself, and I need to explain a few things.  First, I don't actually think the costs are directly due to building codes.  Rather, building codes require specific types of materials.  Many other viable options exist that are much cheaper, but building codes generally don't allow them to be used.  These include things like compressed wood products that are stronger, more fire resistant, and often even cheaper than the much more heavily regulated 2x4s, plywood, and drywall that are practically mandatory.  (In fact, compressed wood products are even more fire resistant than most steel studs, which will weaken and even melt with heat that would require many hours to get through compressed wood.)  Why aren't modern homes just built with poured concrete?  Because electrical code has requirements that don't make sense and thus cannot even be followed with poured concrete walls.  There's a reason we don't see extremely cheap 3D printed concrete houses flooding the market.  It's because building codes assume houses must all be build with hollow walls where plumbing and electrical can go, and the requirements making those assumptions cannot be satisfied with any other architecture, even if it is far more fire proof, earthquake resistant, water proof, and generally safer and technically superior in every way than "traditional" construction.

If you need evidence of the above, see this source on legal problems with 3D printed construction.  If you need more, you can also look up legal problems with very low cost tiny homes and with cantilever homes.  Building codes also get in the way of underground construction, which can be much cheaper in some areas than traditional construction (and which can significantly reduce heating and cooling costs).

So, the point here is that building codes restrict what construction materials builders are allowed to use.  This is where regulatory costs of these "legal" construction materials becomes a building code cost.  I don't have the time or energy to find sources on every construction material used in modern home construction, but I can give you one very solid one: Wood.  Here is a 2018 article about the impact of tariffs (a form of regulation) on home construction costs.  It is estimated in the article that this increased home construction costs by an average of $9,000 (and apartment construction by $3,000 per apartment).  That's on the low end of regulatory cost increases, likely running around 0.25% to 0.33%.  And keep in mind that this is just one regulation increasing the price of wood.  EPA regulations on logging and on energy (used for milling and kilning the lumber) likely add significantly more than that.  That article also estimates that regulatory costs make up 32% of multifamily developments (mainly apartment complexes).

I also have some personal knowledge of concrete production processes, and one the steps is heating limestone to high temperatures and maintaining those temperatures for several hours.  This causes the calcium carbonate to release its carbon component in the form of carbon dioxide.  EPA regulation over the last ~10 years or so has hit the concrete industry hard both with regulations increasing energy costs and with CO2 emissions regulations, making concrete foundations (also legally required by most building codes) significantly more expensive.

A more recent article explores how lumber price volatility, caused in part by concerns about regulatory changes and the impact of U.S. Treasury interest regulation, has caused significant increases in home construction costs.  This article estimates that regulations on construction materials increases home construction costs by 14.94%.  I don't have data on what percentage of home construction costs goes to materials, but labor is generally the bulk of the costs, so the regulatory costs included in material costs are almost certainly well over 30% and it's certainly conceivable that they are as high as 70%.  (Also, thus far I've not seen a study that takes all regulatory costs into account, including trickle down costs like transportation, EPA energy regulation costs, and such.  So that 14.94% likely only includes direct regulatory costs at the last step before the materials are bought by the construction company, which is only a small portion of total regulatory costs.)

This paper explores the regulatory costs of construction during development and construction (which doesn't even include the regulatory costs that went into the gathering, fabrication, and transportation of materials), and it estimates a total regulatory cost during those stages of 23.8% for single family homes. 

This article discusses the study and includes some nice breakdowns of data from the paper.  It also includes some additional data about regulatory price increases of lumber (mainly tariffs and market volatility caused by unpredictable economic regulatory changes) and lists a number of other materials impacted.  It also mentions delivery delays caused by pandemic regulations, which also contribute to cost increases significantly.

On top of all of this, I did construction work off and on in my late teens and early 20s, and I learned about additional impacts of regulations that don't typically get counted in estimates.  On one construction site I worked on, a team of plumbers spent their entire work shift sitting around doing nothing, because the electrical union had convinced the state government to add to building code a restriction on who can even touch electrical equipment.  Some electrical equipment, I forget what but something like a breaker box or some such, had been left too close to a sewer line or water line, such that the plumbers couldn't do the work they were supposed to do, and they couldn't legally move it.  The electrical workers weren't scheduled to come in until the next day, but the plumbers couldn't just take the day off, because they had families to feed, so the construction company paid for a day worth of labor from some 3 or 4 plumbers for nothing.  And it actually ended up costing a bit more than that, because the plumbers weren't scheduled for the next day, and they had to get their job done before insulating (what I did) and drywalling could be completed.  Delays caused by regulations don't just cost time, they also cost the wages of people scheduled to work who can't because of the delay, because people still need to make a living, whether everything is ready for them to work or not.

Anyhow, I don't have the time or energy to go step-by-step through the supply line working out the exact percent of the cost that comes from regulations.  I've provided plenty of sources showing that individual steps can end up costing at least 30% each in regulatory costs for the end product of those steps, and there are many more steps than just one for any kind of construction material.  Just 30% per step hits 69% in a mere two steps.  (This is a compounding increase, not an additive one, so the math is 1.30^2, which gives 1.69 or an increase of 69%.)  The truth is, I was really hedging when I said 70%.  It's probably closer to 80% or 90%, and that's just material costs.  When you include labor regulations, direct costs of build codes, licensing, and all of the other stuff, the total cost of a home is probably no less than 60% to 70% regulation, likely at least 80%, and if the math on regulatory compounding in my last article is right, it may be as high as 90% or possibly even higher.

The fact is, a significant majority of the cost of houses today is regulatory costs.  Even before loan costs and bank fees, you are mostly paying for the regulation.  You are paying for contractors to use more expensive, inferior materials.  You are paying for vehicle safety regulations that provide only marginal safety benefits.  You are paying for emissions and energy restrictions intended to solve problems that haven't even been proven to be real problems.  You are paying for plumbers to sit on their butts all day, so that the electricians can feel more secure demanding excessive pay for their labor.  And after all of that, the little bit of money remaining is what is actually paying for your house and the legitimate labor that went into its construction.

How Regulatory Costs Can Compound to Suffocate an Economy

 Around a decade ago, I wrote a college English paper on the topic of inflation.  I went into my research with the assumption that inflation is primarily caused by greedy businesses raising prices faster than wages, and at the time I though my research supported this assumption.  I was wrong, but I did not realize this until several years later, when I was discussing my research with a friend over email, and he asked me some questions I had not considered.  When I did the math, it proved my original assumption wrong.

For the paper, I looked at inflation over the 50 year period from 1960 to 2010.  Now I don't recall all of the exact details, and I don't have the time or energy to search my archives for the original paper, but a few figures were hard to forget.  Average inflation from 1960 to 2010 was 659%.  That means that prices increased by 6.59 times over those 50 years.  Housing prices increased by somewhere in the neighborhood of 1,000% (a little more, I think), and car prices increased by somewhere in the neighborhood of 800% to 900%.  That's 10 times and 8-9 times.

I did some math on these figures, and they seemed to match up with some claims by others that greed driven inflation caused prices to increase, and businesses just deliberately lagged on wages, so that they would come out ahead.  I don't recall the exact value, but wages during that time period increased by significantly less.  A smoking gun?  I thought so.  Now, I did find some evidence that some of the inflation was caused by government regulation, so in the paper I accused businesses of taking advantage of regulation to justify bigger price increases than the actual cost of the regulation.  Again, the numbers seemed to support my claims.  I'm pretty sure I got an A on the paper.  It was a little controversial, but the professor graded based on my English writing skills and not the subject matter or opinions.

As mentioned above, several years later I was discussing this with a friend over email.  He wondered exactly how much role the government regulation played.  We both agreed that government regulation couldn't have contributed much, probably not more than a few percent.  At the same time, he wanted to know why houses and cars had inflation so much more than the average, and the obvious answer was regulatory costs.  During that time period, building codes grew quite substantially, and regulations around selling and buying homes grew a lot as well.  Similarly, this was the time period where all of the safety and emissions regulations for cars were put in place.  But could regulation alone really explain such a huge difference?

So I did the math.  Say regulatory costs increase prices for something by an average of 2% per year.  Over the course of 50 years, that's a 269% cost increase for producing that thing!  2% doesn't seem like much, but when you compound it over time, it adds up fast.  Of course, we don't have new building codes or car manufacturing regulations coming out every year, so this surely can't explain all of the difference.  This is true, but the 2% is an average.  Emissions requirements for new vehicles increased prices by far more than a measly 2%.  Each new safety regulation added significantly more than 2% to the price of new cars.  Periodic large regulatory cost increases can increase prices at least as fast as constant small ones.  A 15% increase each decade adds up to a 201% increase over 50 years.  When you intersperse that with multiple 2% to 5% increases every 3 to 5 years, that can easily add up to enough to explain the difference, and building codes are even worse, because they typically have a bigger impact.

Ok, so regulation can explain the difference between average inflation and the much higher inflation for houses and cars.  Those are only two products though.  Surely it doesn't play a big role in average inflation?  Unfortunately, this is also wrong.  It's easy to miss the impact of multi-stage supply lines, which are hit by regulatory costs at every stage.

Consider this: A car dealership gets hit with a new regulation requiring them to record some additional data about each sale or repair.  That data takes extra time to collect and extra space (physical or digital) to store.  Maybe that increases operating costs by a couple of percent per transaction.  So they must pass that cost onto customers (businesses can't take loses, therefore it is necessary that every cost be passed on to customers or be recovered by paying less for labor).  But also the manufacturer gets hit with a new safety regulation that costs an additional 2% (pretty low end for safety regulations).  That cost gets passed to the dealership, which passes it to the customer.  So now we've got a 4.04% total increase.  (Cost increases like this tend to compound, rather than adding.)  But wait, the steel mill supplying the manufacturer also gets a 2% increase, because of some additional regulation, and so that regulatory cost "trickles down" to the customer, compounding for a total of 6.12% inflation.  The steel mill isn't where the raw material originates though.  They are getting scrap steel from garbage dumps, recycling collectors, and scrap yards, who also got hit by a 2% regulatory cost increase requiring them to pay more for their electricity to meet new EPA requirements, and if they are smelting raw ore, the mining companies were probably impacted by the same regulation.  Now we are up to 8.24%.  There can also be cycles in here that cause additional compounding steps, for example, the mining company, the scrap companies, and the steel mills are also all using steel products, so their cost of operation increases a bit more than the 2%, any time they have to repair or replace steel equipment.

Now, this is a contrived example.  Odds of all of these getting hit all in the same year are pretty low.  At the same time, 2% is a really low estimate for cost of new regulations for any of these.  Not only would most of these regulations increase prices by more like 5% to 15%, government regulations rarely affect only one element of a business's operations.  One safety regulation might only cost 5%, but the bill with that regulation is going to have another two or three, each also adding 5% or more, because "Well, now that we are thinking about auto manufacturing, we might as well look at everything about it."  Additionally though, some regulations affect all industries.  For example, any new vehicle regulation is going to impact over-land shipping costs, and practically everything depends on transportation infrastructure in the developed world.  Fuel regulations also impact transportation costs heavily.  And there are tons of cycles in here as well.  If gas prices go up by 10%, prices for everything at the supermarket are going to increase by at least 5% to cover that, and now I'm paying more, so I have to ask for a raise to cover the increase in cost-of-living, and that will eventually trickle back to the supermarket prices adding an additional fraction of a percent to prices.  Anything that impacts electricity prices (basically and EPA regulation) will raise costs for every company that uses electricity, and businesses can't take losses, so that means prices increases across the board.

Between 1960 and 2010, we had a lot of significant increases in regulatory costs in industries that impact all other industries.  Gasoline and diesel fuel were significantly more heavily regulated.  Vehicle manufacturing was more heavily regulated.  Electrical power generation was more heavily regulated.  Even communications (from post office to every kind of electronic communication) saw heavy regulatory increases.  And housing costs do broadly affect the economy, so the very heavy regulatory increases in housing costs did contribute significantly to all of the other inflation.

When you put this all together, most industries saw significant cost increases due to regulation between 1960 and 2010, every single year, even when the new regulations didn't target them specifically.  The average annual regulatory cost increase to produce average inflation of 659% over 50 years is a mere 3.84%.  (You can calculate this including the compounding effect with 1.0384^50.  The 1.0384 is equal to 100% (the original cost) plus 3.84% (the average increase), and the 50 is the number of years.)

The truth is, it's actually surprising that average inflation was so low, despite the constant barrage of regulatory cost increases.  It's not just easily believable that most of the inflation was directly caused by regulatory cost increases, it's actually feasible that almost all of it was caused by rampantly growing regulation.  (Only "almost" because increasing government debt also causes inflation very directly.  That's a topic for another article though.)  And cars and houses increased in price faster because they were more frequent direct targets of the additional regulation.

Sadly, it really is that simple.  I was wrong.  Inflation wasn't and isn't driven by greedy businesses.  It's mainly driven by constantly growing government regulation, slowly suffocating the economy.