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The Economic Theory of Zoning: A Critical Review
Municipal zoning regulations are the most important way in which local governments affect housing markets. Numerous studies have been undertaken to analyze the impact of zoning on housing and land prices, on population density, and on welfare. However, despite the volume of previous research, there is little agreement on the effects of zoning or how to properly analyze those effects.
Several papers have reviewed the empirical literature on zoning.(1) This review focuses on the theory of zoning, specifically on how zoning is modeled, especially whether zoning is embedded in an urban model, and the implications derived from these models for the impact of zoning on welfare and housing prices.
We divide the effects of zoning on economic agents into six broad categories: supply-side effects, demand-side effects, Tiebout effects, externality effects, endogenous zoning, and rent-seeking behavior. Supply-side effects concern how zoning affects the suppliers of housing services and the land market. Demand-side effects concern how zoning affects consumers' choice of the optimal consumption bundle, especially the choice of housing characteristics. Tiebout effects result from consumer mobility in response to zoning. Externality effects discussed in the zoning literature include production externalities, economies of agglomeration, externalities associated with non-conforming uses, public-goods and congestion externalities. Endogenous zoning studies attempt to explain why particular zoning regulations arise, rather than treating zoning, as does much of the literature, as "parametric." Rent-seeking behavior involves the expenditure of resources by individuals to maintain zoning ordinances in pursuit of their self-interest. Complete analysis of zoning involves consideration of all these effects. However, the extant literature, taken as a whole, does not provide a comprehensive theory of all the effects.
We selected the papers for review because they represent interesting and original contributions to the particular category under discussion. Several of the papers cover more than one category, so our categorization is based on our judgment of the main interest of the modeling effort.
II. ZONING MODELS: OVERVIEW AND
In studying the welfare implications of zoning, it is important to appreciate that zoning has several effects, e.g., zoning affects both demand for, and supply of, housing. Most studies do not consider all the effects of zoning. Welfare implications in the zoning models we review frequently depend on restricting the range of possible effects. The welfare implications of zoning also differ for different economic agents. We discuss welfare effects with reference to the following classes: existing homeowners, post-zoning homeowners, owners of undeveloped land, and those excluded by zoning.
Zoning is welfare-improving if it reduces the level of negative externalities to which consumers and firms are exposed by an amount greater than costs associated with implementing and enforcing zoning. While welfare effects are unobservable, implications about the effects of various kinds of zoning on housing or land prices can be observed. Some studies attempt to derive welfare conclusions from the observable implications of zoning on prices. These connections are suspect for reasons explained below.
The theoretical literature presents many contradictory conclusions about the implications of zoning for welfare and land and housing prices. These conclusions differ partly because of different assumptions and different model structures. The main structural difference is whether one or several jurisdictions(2) are modeled and whether the model is spatial. Zoning models also differ by the variables which are endogenous and exogenous, and by the main assumptions on producers and consumers. Table 1 summarizes the main features of the zoning models under review. [Tabular Data Omitted]
Three features of the studies summarized in Table 1 stand out for the welfare evaluation of zoning. First, the majority of studies assume that consumers are identical (in preferences and endowments). These contributions, thus, do not distinguish the differential impact of zoning on different classes, e.g., existing homeowners versus new arrivals. Second, the majority of studies assume that production (usually housing production) is in long-run perfectly competitive equilibrium. Thus, dispersal of profits, either as income to residents or as "municipal extractions" is not addressed. Third, about half of the models do not explicitly incorporate any kind of externality, which drives many of the conclusions that zoning decreases welfare.
Many zoning issues can be addressed in terms of simple static model of the housing market in some local jurisdiction, as illustrated in Figure 1. Figure 1 assumes that there is a well-defined good called "housing." Since, in fact, housing consists of a bundle of characteristics (discussed below), quite restrictive assumptions are required to assure the existence of a "composite commodity" called "housing."(3) Assume initially that there are no externalities. S and D denote, respectively, the initial supply curve and demand curve in the absence of zoning or other land-use restrictions. Zoning can affect the price of housing by shifting either supply or demand or both. As an example of the supply-side effects of zoning, some authors argue that minimum lot-size zoning increases producers' marginal costs for housing, thus shifting the supply curve to S'. If this is the only effect, then the new equilibrium will occur at b. Welfare of potential entrants as measured by consumers' surplus will decline. If existing homes are "grandfathered," i.e., exempted from the new regulation, the owners will be better-off as a result of the price increase.
In contrast, suppose that zoning has only demand-side effects. These effects can be of two kinds: direct effects and effects via mobility. Assume for the moment that consumers are immobile and that the effect of the zoning regulation is to force the consumption of a more-than-optimal amount of housing (for example, by requiring a minimum consumption of housing, [Q.sub.min]. Then if the zoning constraint is binding the demand curve shifts rightward, as illustrated by D' in Figure 1, say to an equilibrium at c.(4) The demand curve D' is perfectly inelastic in the range of prices [p.sub.o] to [p.sub.d]; over this range of prices the zoning requirement is binding. For prices above [p.sub.o] consumers' alternatives outside the jurisdiction imply that no housing will be demanded within the jurisdiction. For prices below [p.sub.d] the minimum consumption requirement is not binding, so the demand curve D' coincides with the original demand curve D. Compared to the initial equilibrium a, the equilibrium price has increased. In this case, zoning also reduces the welfare of potential entrants, since the increase in demand is a result of consumers being forced to increase their consumption of housing above the otherwise optimal level. Existing homeowners again realize a gain.
However, an increase in price is not, of itself, an indication that zoning is welfare-decreasing. Suppose now that externalities (e.g., a "non-conforming" use like highrise apartments in proximity to detached single-family dwellings) are present. Without zoning (or some other, perhaps more efficient, means) to assure others' conforming activity, a consumer might choose to consume less housing at each price than if he/she were assured others' activity would conform.(5) Then zoning could result in consumers increasing their optimal consumption, resulting in a shift in demand, say from D to D". The increase in price then reflects the increased value consumers perceive in the "conforming use" guaranteed by zoning. Existing residents benefit more than post-zoning arrivals since the existing residents realize an increase in the value of their houses.
Zoning may, on the other hand, either increase or decrease demand for housing when consumer mobility is accounted for. Assume that the jurisdiction is one of several local jurisdiction in a metropolitan area, which may have various zoning regulations. At the initial equilibrium a, all residents of the jurisdiction must be at least as well off in it as in any alternative jurisdiction (the "utility equilization" condition). A local zoning ordinance which reduces the impact of an externality better than other zoning regulations in competing communities may increase demand for housing from persons who resides outside the jurisdiction.
Suppose, on the other hand, that a zoning regulation which bans tennis courts is exogenously imposed in a jurisdiction, and that wealthy consumers strongly prefer tennis courts. The wealthy current residents of the jurisdiction face the prospect of lower utility. The jurisdiction may now compare unfavorably with another jurisdiction to which they may escape. They displace poor consumers who now migrate to the jurisdiction without tennis courts, but the poor consumers' bid functions for housing determine a lower price of housing, i.e., demand declines, as illustrated by the equilibrium d.
While the simple supply-demand analysis can illustrate the effects of zoning regulations under the restrictive assumptions required to define a "housing" market, the analysis of housing inputs and amenities is more complicated. If the effects of zoning on input markets are to be distinguished we must view housing as a bundle of characteristics, and zoning regulations as constraints on the components of the admissible bundle.(6) The imposition of a constraint which, if binding, forces an increase in consumption of one characteristic may also increase or decrease demand for other characteristics, depending on whether they are substitutes or complements to the characteristic which is subject to regulation. A lot-size regulation affects individual demand for acreage in a straightforward way (if consumers are immobile), but may also affect the demand for floorspace or rooms (which may not even be subject to zoning regulation) if lot-size is a substitute or complement to floorspace or rooms. For example, a family with children may, when faced with a minimum-lot requirement, "trade-off" a rec room for a (very) large lot. In this circumstance, in the absence of externalities, zoning is welfare decreasing for potential entrants, but the effect of zoning on the demand for characteristics is indeterminate. (If …