The Link between Real Estate and Economic Development:

Real Estate Dept. Chair Stephen Malpezzi sits down for a post-travel interview

At the beginning of Summer 2007, Department Chair Steve Malpezzi hit the global “Urban Development Policy Trail,” with trips to Washington, D.C., Beijing, Seoul, and Bellagio (the real one in Italy). We caught up with Steve on his return to the office.

Question: What have you been up to the past six weeks?
I gave a series of presentations on development issues, including two meetings with the Commission on Growth and Development, headed by Nobel prize-winning economist Michael Spence; some meetings with World Bank colleagues; a presentation on housing affordability to the Development Research Center that advises China’s State Council; meetings with several Korean researchers on urban and real estate issues; and finally I participated in a Rockefeller Foundation conference on urbanization held at their compound at Bellagio on Lake Como.

Lake Como?
Research on urban development around the world takes me to a pretty wide range of places. Over the years I have visited some of the most horrific slums you will ever want to see in Africa, Asia, and Latin America; but I have also seen a bit of the other end of the spectrum. Rockefeller’s conference center at Bellagio is actually rather simple in many ways – we stayed in fairly plain rooms in a renovated monastery – but the setting was spectacular. The key is that Rockefeller, along with organizers from the University of Pennsylvania and Columbia, put together a great group of people. I learned a lot from that week.

Such as?
Well, to give just one example, I spent more time with epidemiologists and medical professionals and than I normally do these days. For example, I learned that some of the slums I’ve visited in the past, such as Mathare Valley in Nairobi, have rates of infant mortality that are more than ten times as high as the average for urban Kenya as a whole. Remarkably, as Kenya urbanizes, health indicators like infant mortality and child death rates drop remarkably on average; but there are pockets in some of the large slums that have some of the worst public health statistics I have ever seen. While Kenya’s urbanization is certainly a plus, it appears that there is a lot to do to target better infrastructure and health care to these slums, and Nairobi is just an example. Worldwide there are an estimated 100 million people living in these kinds of slum settlements.

You’re a Professor of Real Estate in the American Midwest. How did you get involved in these kinds of issues?
I’ve had an interest in international issues since college days, but my most important formative experiences stemmed from the decade I spent as an economist in the Urban Development Department of the World Bank, before I arrived in Madison in 1990. Since then, while I do quite a bit of research on the U.S., I try to keep my hand in, and help out where I can on global issues.

What does it mean to be an “international expert” on urban development?
Make sure you put quotes around “international expert” in the printed version of this interview. (He laughs.)Really, there is a great misconception that the “expert” parachutes into a country that’s completely at sea about some problem, figures out a solution, and lays it out for the local officials. The truth is quite different. I’ve never been to a country on any continent where there weren’t already people who understood the problems quite well, as well as the solutions. Your role as an outsider is to find those people, learn from them, and hopefully bring something to the table from your experience in other countries. You’re basically making a market in information, and helping those who already know the issues frame them better. Sometimes you can say things to people in power that local officials or researchers cannot.

So you’re not as smart as we first thought you were?
Right. My recent trip to China is a good example. I’m not someone who has spent his life studying China, and I frankly have little to tell the fine economists at China’s Development Research Center things they don’t already know about China. What they wanted to hear from me is what the best research and practical experience in countries like Korea and the United States and Malaysia, among other places, can inform them as they grapple with their problems.

Such as what, specifically?
Well, to give just a few examples, there is a lot of concern about rising house prices in a number of Chinese cities. Sound familiar? In a number of countries I’ve worked, we’ve done a lot to sort out how to collect and analyze housing market data to get a better sense of what’s actually happening to prices. To give another example, the Chinese government is very concerned about what they perceive as a development system that is currently skewed to producing a lot of housing at the high end without enough production that is affordable to middle income Chinese citizens. We drew on experience in Malaysia as well as the U.S. and a number of other countries to show how they could undertake some analysis of the incentives that developers face in order to trace through the kinds of things that might be tilting profitability away from the middle of the market.

Much of your international work is connected to the World Bank and other official development agencies. There have been a lot of criticisms of these organizations recently. Any comments?
Putting aside all the news items about some of the personalities involved, let me highlight a few systemic issues. All those official development agencies suffer from two problems I call the paradox of lending, and the paradox of projects. The paradox of lending is familiar to any banker – if you are in a financial institution whose business is to lend, there is always tremendous pressure to make loans. It’s hard to really be viewed as a hero within the organization when you stop a bad loan. Of course, in the long run, the people who keep the organization focused on good loans are the real heroes, but that doesn’t make it easy to do, and the World Bank and other financial organizations need to do more to put the right incentives in place in their lending operations. The paradox of projects is that sometimes what’s good for an individual lending operation can be bad for the economy. For example, in past World Bank loans for low cost housing developments (called “sites and services” in the jargon) have taken place in markets where broader policy reforms would actually lower the measured rate of return to the Bank’s project. My view, and those of most of the Bank staff I know, is that the focus should be more on the market and less on the project. Nevertheless, with all their faults, on balance I would argue that these organizations make their biggest contribution through the market they make in information, not from the lending per se. A third paradox is that if these institutions didn’t lend real dollars, they wouldn’t get much of a hearing on the information and policy fronts, the things that really matter most. The last time I checked, the World Bank would only rank about 50th among commercial banks worldwide by assets, so it’s not the money that matters, at least in a global sense; it’s the ideas.

We hear a lot about U.S. “competitiveness,” rising China, and so on. How does the U.S. fit in with other countries today?
U.S. GDP per capita is currently around $40,000. That’s an impressive number when you consider that in the early 70s, GDP per capita in today’s dollars was about half that. Put another way, if there are something like 10,000 or 12,000 years of settlement in North America, it took us over 10,000 years to get from somewhere near zero to $20,000 per capita, and less than 40 years later, well within most of our lifetimes, to double it. But the comparisons with other countries are even more amazing. Other rich countries in Western Europe and Japan have GDPs per capita like ours, but the poorest countries such as Laos or Myanmar in Asia, or Mozambique or Chad in Africa have GDPs per capita of well under $1,000, even after you’ve controlled for differences in the cost of living across countries. Even China and India are well under $3,000 per capita, again after adjusting for price differences. Why we live in a world with such huge differentials is not only an intellectually fascinating question, but it’s hard to think of any questions that have greater practical import for the welfare of people around the world. And even in a narrower sense, I think there are many arguments that suggest that the American economy is better off in the long run as China and India’s economies strengthen, and would be even better off if some of the laggards like Chad and Myanmar could come up to speed.

Is that because a richer third world is a safer third world?
That’s a tough question with a complicated answer, but I think on balance the answer is yes, even though I don’t subscribe to simple economic determinism. A lot of the problems we have in the Mideast and other hot spots transcend economics, but better functioning economies can certainly be part of the solution. I would argue, for example, that tackling economic development issues in the West Bank, Gaza, and much of the rest of the Middle East is a necessary, but no means sufficient, condition for improving the political and security situation there. The “failed states” that shelter our greatest security risks generally have failed economies as well.

So how do you encourage development in poor countries?
There is no silver bullet or “key” to development. It’s a complicated, messy, multidimensional process. But there are a number of elements that we know contribute to development. Getting property rights and the public policy environment right is a big part of the solution, and getting an education system working that delivers quality education to a wide fraction of the population – boys and girls – are big pieces of the puzzle.

Boys and girls?
That’s right. Increasingly, evidence tells us that countries that have big gaps in education between boys and girls are among the worst laggards. There are a number of mechanisms through which that disparity can retard development, not least of which is turning infrastructure investments in water and sanitation into better public health and development outcomes seems to hinge on having a threshold level of education among women. For example, whether you have a fancy piped water supply or not, in most societies it’s women, not the men, who make sure the children wash their hands after they defecate.

These issues seem a little far afield from real estate. What role does real estate play in economic development?
I thought you’d never ask. Real estate is typically about 2/3 or more of the tangible capital stock in developing and developed countries. We typically see acceleration in real estate investment in countries that start to transition into a higher level of development, as incomes rise, people demand more housing, and markets require more sophisticated stocks of commercial real estate. This is also tied to an increasing investment in public real estate, including infrastructure.

Real estate is not something that’s traded across countries; it’s pretty rare to move a building across a national boundary. How relevant is your international work for day-to-day concerns of Wisconsin’s Real Estate Program?
It’s very relevant. Our alums have been active internationally for quite some time. In fact, I believe the first call I got from an alum when I joined the faculty in 1990 was from Mark Behling, to talk about some of the real estate investment he was undertaking in Mexico. We now have dozens of alums active in international real estate all over the world, on every continent, but even those who are not primarily working globally day-to-day find that there are spillover benefits from knowing about the world outside our borders.

Such as?
Well, there’s nothing like seeing how things are done in other places to get a deeper understanding of how your own market works. Occasionally we find ideas overseas that translate well here. For example, Canadian experience with rollover mortgages taught us a lot as we began to move into a world of a menu of mortgage products including adjustable rate mortgages in the 70s. (Recent experience tells us what can happen when we forget some of those lessons!) The Danes were among the early leaders in tapping capital markets instead of bank lending for real estate finance, and of course many countries have benefited from lessons of U.S. markets in thinking about their own real estate problems. Most of those lessons are positive ones. For example, many countries have benefited from our recent development of public vehicles including REITs, and we have also been leaders in applying information technology to real estate markets. Sometimes the lessons are negative ones; I have certainly gotten a lot of mileage from the 1980’s S&L crisis in helping colleagues around the world think about the pitfalls of badly designed incentives in real estate finance systems.

In the end I don’t see a bright line between domestic and international real estate any more. In the classroom, in an urban class, I might just as well mix lessons from my regulatory work on U.S. housing markets along with studies of Malaysia and Korea. And much of the work I’ve done on local economic development for the state of Wisconsin, including my service on the Kettl Commission and work with Competitive Wisconsin, draws heavily on my international experience. Local economic development issues in Kumasi and Kenosha have some huge differences, but also some remarkable similarities. Property rights and incentives matter for households, firms, and government agencies. Education is critical in both places.

You’re not the first or only faculty member to bring international perspectives to the program.
By no means. While there are some precursors in work earlier colleagues did in Canada and other countries, Rod Matthews was certainly our pioneer, and I learn a huge amount about other countries since I’m lucky enough to have an office next to Francois Ortalo-Magne. Our senior lecturer Sharon McCabe is increasingly involved in our international activities as well, and we have tremendous support on these from Center Director Tim Riddiough, who by the way is currently in Asia, and the rest of the faculty and staff.

How does this fit in with what the rest of the School is doing?
Both at the MBA and undergraduate levels, the School of Business is increasingly working to globalize the curriculum and research agendas, and I think it’s fair to say we’re seen as among the leaders in these activities by the rest of the School. To date we’ve probably made the most progress on the MBA front with the trips to MIPIM and China that Rod and Francois and Sharon have worked so hard to make a reality. Francois’ active participation in AFIRE is another window into the rest of the world. Over the next few years we’re going to continue to push to maintain our international curricula within the MBA, but we want to also do more on the undergraduate. This is consistent with the School of Business, which recently voted a goal of having every undergraduate student have some significant international experience, whether a semester abroad, a substantive field trip, or some other broadening experience. With roughly 1,000 undergraduates in the School, this is a goal we’re just starting to push towards as a business school. For the next few years we’ll focus on learning by doing, putting together trips and activities like the undergraduate trip to Expo Real that Sharon McCabe is leading this fall, and also developing the resource space. This is something where we will be pushing very hard in the years ahead.

So it sounds like the future for Wisconsin’s Real Estate Program is increasingly global.
I think it’s fair to say that, but let’s keep it in perspective. Global markets have much to teach all of us, but U.S. markets remain the largest and most liquid in the world, and will continue to be our bread and butter. I guess I’d come back to the point I made earlier, that in terms of thinking about real estate markets, finance, and development ideas, and all the rest of it, we no longer draw bright lines at the borders. Our program aims to be the best in the world, and that certainly implies we aim to be the best in the United States.