Regional variation in the elasticity of supply of housing, and its determinants : the case of a small sparsely populated country

The long-term price elasticity of supply of housing is a key factor determining the growth rates of housing prices and housing supply as the city grows. Therefore, the housing supply elasticity has considerable influence on the competitiveness of the region and on the growth potentials of the area. Previous empirical investigations provide evidence of substantial regional variation in the supply elasticity of housing within the U.S. The literature further shows that the supply elasticity and its variation across cities are significantly influenced not only by regulatory supply constraints, but also by the city level population, population density, and geographic constraints. This paper studies empirically if these findings apply to a country that is notably different from the U.S. with respect to its size, population density, typical city size, geographic and cultural coherence, and regulatory constraints, i.e., Finland. Apparently, this is the first study to estimate the supply elasticities directly based on the level of housing stock and the Johansen Maximum Likelihood methodology. Our findings are largely in line with those reported for the U.S. Based on quarterly data for the period 1987-2011, the analysis shows substantial regional variation in the long-term supply elasticity across Finnish cities. To examine the factors behind the observed regional differences, we construct an index that aims to measure the city level regulatory and geographic constraints for housing supply. The city size, zoning policies, and geographic constraints are found to be the most significant factors causing regional elasticity diversity. Together, these factors account for 80% of the regional elasticity variations. While more flexible regulation can increase the supply elasticity - and a general policy recommendation is therefore that regional administrations should strive to decrease the regulatory constraints on housing supply to increase the growth potentials of the area - the results imply that the opportunities of regulatory policies to affect the elasticity are limited even in a sparsely populated country with small cities and abundant reserve of vacant developable land.