The Skyscraper Curse: And How Austrian Economists Predicted Every Major Economic Crisis of the Last Century

If I go there will be trouble
And if I stay there will be double.
So you gotta let me know
Should I stay or should I go?
 — The Clash, Should I Stay or Should I Go

The decision of where to locate your residence is difficult to make. Most of the factors that play a role in your decision-making are basically economic factors. So might this kind of decision-making process be somehow involved in the skyscraper curse? Economist Lucas Engelhardt thought so and wrote an insightful paper about it.

I have reiterated throughout this book that record-breaking skyscrapers and the skyscraper curse are merely symptomatic of what is going on throughout the economy when it is influenced by artificially low interest rates for a long period of time. We have already seen that it causes such things as local-record-breaking building heights in places such as Auburn, Alabama, advanced construction technologies, and advanced architectural innovations.

Many factors come into play with respect to the choice of the location of your residence. A big factor is that the cost of your house or apartment is one of your biggest expenses. Rent or mortgage payments are typically the largest single payments in your monthly budget. Once you have paid off your mortgage your standard of living can increase significantly.

Another big factor is that the decision is a long-term choice. If you plan to buy a house or condominium, then there are transaction costs such as moving expenses, realtor commissions, and attorney fees. You can reduce some of these expenses by placing a greater work burden and risk burden on yourself, but you cannot make them go away. Such costs occur every time you move.

These cost considerations also impact decision-making on the choice of apartments. If you sign a lease, then you are obligated to pay rent over the length of the lease. You also have moving costs, whether you pay a moving company or do the moving yourself. The upshot is that people typically spend time and effort acquiring information to make such decisions and typically do not make thoughtless and abrupt choices. So when you ask yourself, “Should I stay or should I go?” remember that there is a significant cost of moving.

Some of the factors that people consider when contemplating moving are housing prices and the amount of the monthly payment; the amount of property, income, and sales taxes; local amenities; the quality of local schools and shopping opportunities; crime rates; and commute time. The location of churches will also affect some people’s choices. There are trade-offs among all these factors. For example, people with young children will tend to put up with higher taxes if the local schools are good and crime rates are low. Another example is that some people would be willing to put up with long commute times if housing prices and taxes are low, local amenities and schools are good, and crime is low.

Lucas Engelhardt1 made a contribution to our understanding of the Skyscraper Index by providing a fuller theoretical explanation of why we should expect an uneven increase in land prices, rather than a general, even increase in land prices. By using location theory, Engelhardt shows theoretically why we should focus on very high skyscrapers rather than just tall buildings in general. In other words, he does not reject the notion that lower interest rates increase land prices and the height of buildings, but he provides theoretical support for the idea that land prices will increase relatively more in central business districts.

Of the three Cantillon effects, his focus is on the first effect, where artificially low interest rates change land prices, which leads to taller buildings. In my 2005 paper2 the justification for taller buildings in this first effect was not really based on economic theory, but on real estate economics. However, I did provide some theoretical support for the uneven increase in land prices in the second Cantillon effect, where low interest rates caused an increase in company size, which in turn caused an increased demand for office space in central business districts.

Engelhardt uses William Alonso’s3 bid-rent model with a purely residential city where all employment opportunities are in the central business district. While not realistic, these assumptions are reasonable. In the model, each household budgets part of its income to pay rent and commuting expenses, and part of its time to cover the commute. The further you get from the central business district, the higher the commuting costs, which diminishes the amount you are willing to pay for rent. As you get closer to the central business district, your commuting time and expense decreases and your willingness to pay higher rent increases.

This trade-off is pretty familiar to many people: do you live near your job and pay higher rent, or do you live in the suburbs and endure substantial commuting cost and time? It is a trade-off between housing costs and commuting costs.

If commuting costs are very high, rents will be very high near the central business district (i.e., a steep trade-off), but if transportation costs are very low (e.g., free, ubiquitous high-speed trains), then rents will be similar near the center to what they are on the periphery (i.e., a shallow trade-off). But what determines the steepness of the trade-off? The quality of transportation services is obviously important, but also very costly to manipulate. For example, Dana Rubinstein4 reports that government transportation projects are notorious for being long delayed and over budget, with some projects exceeding $2 billion per mile. Engelhardt chose to focus on wage rates and interest rates, which pertain more generally across cities.

Here he employs Murray Rothbard’s5 concept of the discounted marginal revenue product of labor. Normally the difference between this and the mainstream concept of marginal revenue product is negligible, but Rothbard’s concept does introduce the interest rate and time preference into our theorizing about  decision-making by adding time discounting to the mainstream concept.

When interest rates are very low you are less concerned with when you are paid because you lose very little interest. If interest rates are very high, then you want to receive your wages very quickly. Likewise, people who are paid daily are unconcerned about the interest rate, but people who are paid monthly or annually could be very concerned about changes in interest rates.

With respect to the skyscraper curse, when interest rates become artificially low, the discount rate on future sales of products decreases and thereby creates an increased demand for products; and this creates an increased demand for labor and higher wages rates. For example, if the interest rate on inventory paid by an automobile dealership falls from 10 percent to 1 percent, the dealer will want to carry a much larger inventory to better approach maximal profits. This increased inventory, reflected across the economy, will cause higher levels of production, employment, and wages.

What impact will these higher wages have on choice of location? Higher wages will have two distinct effects. First, higher wage rates will result in larger household budgets and a larger budget to pay for rent and commuting costs. Second, the higher wage rate makes a person’s commute time more expensive in terms of opportunity costs. For example, a lawyer who makes $500 per hour serving clients would have to consider a move from a 60-minute commute per day to a 120-minute commute per day as increasing their opportunity cost by $125,000 per year! Likewise, a lawyer who moved and reduced commute time from 60 minutes per day to living in his office and having no commute time would potentially increase their revenue by $125,000 per year.

Engelhardt finds that falling interest rates have an unambiguous impact on higher-wage individuals and the land closest to the central business district, although with lower-wage individuals and land near the periphery the effect is ambiguous. This means that artificially low interest rates induce people to want to move closer to the central business district. This in turn tends to increase land prices and causes taller buildings to be built. So during an artificial boom we would expect things like very tall condominium buildings to be built in central business districts.

If you relax the model and allow for office buildings the results are even stronger because businesses want to minimize travel costs for their employees, customers, and input suppliers. Therefore, they want to locate in the central business district, thereby driving land prices even higher. Engelhardt’s findings provide additional evidence for the Skyscraper Index and the skyscraper curse and his research highlights how artificial interest rates can influence our lives on a very personal level.

• 1Lucas Engelhardt, “Why Skyscrapers? A Spatial Economic Approach.” Unpublished manuscript, 2015.
• 2Mark Thornton, “Skyscrapers and Business Cycles,” Quarterly Journal of Austrian Economics 8, no. 1 (2005): 51–74.
• 3William Alonzo, Location and Land Use: Toward a General Theory of Land Rent (Cambridge, MA: Harvard University Press, 1964).
• 4Dana Rubinstein, “Where the Transit-Build Costs Are Unbelievable,” Politico, March 31, 2015.
• 5Murray N. Rothbard, Man, Economy, and State (Auburn, AL: Mises Institute, 1962).