Thinking at the European Central Bank: House Prices and Small Business Creation

The Center for European Policy Research organized a labor market workshop at the European Central Bank recently. The conference happened in the ECB’s new building, on the banks of the river Main, a deconstructivist structure designed by the architectural firm Coop Himmelb(l)au. The firm has designed buildings in Lyon (Musée des Confluences), in South Korea (the Busan Cinema Center). The ECB building has quickly become a Frankfurt landmark.

The focus of the conference was not urban economics — although one can argue that unemployment has major implications for mayors. I discussed a paper that aims at showing the impact of the housing market on job creation, in a way similar toAdelino, Schoar, and Severino (2015). The purported causality runs as follows: a change in house prices affects the value of small entrepreneurs’ houses; this affects the value of their equity, and thus the value of the collateral in case entrepreneurs use this equity to borrow and fund their ventures. The authors argue that an increase in house prices will lead to more job creation by small and medium entreprises, and symmetrically a decline in house prices will lead to fewer job destructions. This is the collateral channel.

Small businesses in areas with greater increases in house prices experienced stronger growth in employment than large firms in the same areas and industries. Adelino, Schoar, and Severino (2015)

Why small and medium enterprises? Well some authors have argued that small and medium-sized firms are the main drivers of job creations. But that remains debated (see Davis, Haltiwanger, Schuh 1996, and here): yes, small businesses create more jobs, but they also exit at a much higher rate. In gross flows, small businesses indeed create most jobs. In net though (accounting for the exit rate), their contribution is substantially smaller than larger firms.

Of course, arguing that house prices affect job creation through the collateral channel is hard to demonstrate: it is no surprise that house prices and job creation correlate strongly; for instance, jobs in construction and real estate services vary in an easy-to-understand way with house prices. That is the real estate sector channel. House prices partly reflect demand for construction and real estate services, and that’s a much simpler Econ 101 explanation of the correlation than the collateral channel.

Another reason why it’s hard to make the point that house prices cause job creation through the collateral channel is because local banks suffer heavy losses when house prices decline. And thus extend less credit in tough housing market times. Houses are a big share of banks’ balance sheet… and thus the decline in house prices doesn’t cause a limited ability to borrow because of the entrepreneur’s own house value, but because the bank holds mortgages that default with a higher probability. This is themortgage channel.

I love papers that show that the housing market “causes” the labor market. But it’s really tough to make a bullet-proof case for the collateral channel.

Adelino, Manuel, Antoinette Schoar, and Felipe Severino. “House prices, collateral, and self-employment.Journal of Financial Economics (2015).

Davis, Steven J., John Haltiwanger, and Scott Schuh. “Small business and job creation: Dissecting the myth and reassessing the facts.” Small business economics 8.4 (1996): 297-315.

Federal Reserve of St Louis “Are Small Businesses the Biggest Producers of Jobs?” by Kliesen and Maues.