Last week I took a look at the economics underlying Demographia’s “International Housing Affordability Survey” and found them severely lacking. As it turns out, Demographia’s data isn’t much good as a measure of the costs of poor planning rules – but it does seem to provide some information about people’s “revealed preference” for urban amenity.

To recap: urban economics suggests that differences in the level of the median house price to median household income ratio between cities can be interpreted as differences in livability. All else equal, people should be willing to pay more to live in cities that offer better quality of life.

But how should we interpret changes to the median multiple from year to year? If a city’s median multiple rises from 5 to 5.5, does that mean that the city suddenly got 10% more livable? Or did something else happen?

Demographia is very certain that higher median multiples are the product of one thing, and one thing only: limits on sprawl into greenfield areas. Here’s Don Brash, former Governor of the Reserve Bank of New Zealand and former head of several right-wing political parties, laying out that view in Demographia’s 2008 report:

Once again, the Demographia survey leads inevitably to one clear conclusion: the affordability of housing is overwhelmingly a function of just one thing, the extent to which governments place artificial restrictions on the supply of residential land.

With that in mind, Demographia’s data seems to indicate that housing in Los Angeles and Las Vegas (as well as many other US cities) suddenly became a lot more affordable in the late 2000s. It’s obvious that they must have removed their Metropolitan Urban Limits – how else to explain such a big drop? Oh, wait…

Demographia Los Angeles Las Vegas median multiple

(It’s slightly disturbing that our Reserve Bank used to be run by a man who doesn’t believe that interest rates and credit conditions can affect house prices. But I digress.)

Here’s a graph of changes in Demographia’s median multiple estimate for Auckland since 2004. We haven’t seen the same drastic swings as in the US, where the housing bubble and bust was pronounced, but house prices have risen relative to incomes. (Although, as Stu found in his analysis of different measures of housing costs, this hasn’t flowed through to rents or mortgage payments, due in part to changes in interest rates.)

Demographia Auckland median multiple

This change has been especially pronounced in the last few years. Since 2012, Auckland’s median multiple has risen roughly 22%. Does this mean that we’ve become 22% more “livable” during that time?

With all due respect to the good work done by Auckland Council and Auckland Transport since their inception, probably not. So we need to look for alternative explanations, of which there are several. I’ll focus on three in particular.

The first potential explanation is that there has been a market failure. Residential construction slumped massively during the Global Financial Crisis, with the most significant reductions occurring in the supply of apartments and attached dwellings. Here’s a graph that John Polkinghorne put together illustrating that trend:

NZ building consents

Incomes and employment have mostly come back from the recession, but construction has been a bit slow to respond. I suspect this reflects technical constraints within the development sector, as it takes a while to organise finance, find sites, and hire the cranes, bulldozers, and blokes/blokesses in hardhats. Until they get into gear, there may be a bit of an undersupply – but one that will tend to sort itself out.

The second potential explanation is that the introduction of Auckland’s Unitary Plan has caused people to expect housing supply to be more constrained in the future. While the Unitary Plan envisages the gradual expansion of the city’s Metropolitan Urban Limit to meet new demand for greenfield suburbs, it maintains extensive controls on the supply of new dwellings in accessible, high amenity areas. Moreover, the plan actually got significantly more restrictive following the consultation process.

Transportblog has highlighted this issue a number of times before. To recap, here’s a map (from Koordinates) that shows where the Unitary Plan got more restrictive as a result of consultation. The areas in red have been down-zoned to restrict development, while areas in green have been up-zoned. The large orange areas show future greenfield land. As you can see, there are not a lot of opportunities to develop new dwellings in the isthmus and lower North Shore, while West Auckland has been happy to facilitate growth:


Unitary Plan changes from draft to proposed version on Koordinates

Timing is important here. Demographia’s figures suggest that there was a jump in house prices relative to incomes between the end of 2012 and the end of 2013. This coincides with the notification of the Unitary Plan in September 2013, which, as described above, will ease greenfield land supply while limiting development opportunities in the inner suburbs.

However, there is also a third potential explanation: that our rising house prices reflect increasing awareness of Auckland’s great quality of life. For most of the last decade, our city has been near the top in Mercer’s Quality of Living Survey. It’s been ranked third for five years running.

So maybe the story is that potential migrants and investors have observed that, by international standards, Auckland offers high quality of life at an affordable price. And they are in the process of arbitraging that away.

I’ve illustrated that process in the following graph, which shows the relationship between Demographia’s median multiple (X axis) and Mercer’s Quality of Living Survey (Y axis). The trend-line is estimated based on 2012 data. I’ve also plotted Auckland’s median multiple and Mercer index in 2015.

The red dot that represents Auckland is moving towards the trend-line, suggest that its prices are catching up with its livability.

Demographia Auckland median multiple change 2012-2015

Previous studies have found that growth in New Zealand house prices is strongly correlated with net migration – i.e. migrants tend to bid up house prices. Net migration to New Zealand did, in fact, start picking up in 2013 – around the time that Demographia’s estimate of the price to income ratio began to rise. Perhaps this is evidence for the “amenity arbitrage” hypothesis?

NZ net migration Feb 2005-2015

So, which explanation is true? Honestly, it’s impossible to say without a lot more detailed analysis. My point in writing this is not to argue that there is a single explanation for changes in Auckland’s house prices, but to point out that there are many possible explanations. Housing markets are affected by a number of factors, and it’s inappropriate to focus on one without controlling for the rest.

This is, essentially, why Demographia’s analysis fails. Rather than articulating a model that encompasses all of the potential explanatory factors, they have settled on a single number and insisted that it must be interpreted in a single way. It’s hard to see the value in that approach. And it’s definitely not good economics.

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71 comments

  1. Nothing new about this but I’ll throw it out there anyway. There is more to affordability than the sale price of the house. A lot of factors affect that alone, but overall affordability – how much it costs to *live* there, not just buy there – is affected by distance from where you want to go, the quality of the housing, its energy efficiency, maintenance requirements, etc. Then there is the desirability factor; that adds to the cost. There is also the consideration of value for money, which is a very individual thing. Some people think they’re getting a great overall deal in Dairy Flat, others think the same in Freeman’s Bay. So many of these things are beyond the reach of policy-makers. Just tacking on more houses to the fringe takes into account none of these.

    1. One thing I quite like about Eric’s post is that it identifies the tension between thinking about housing prices as an “equilibrium” phenomenon (i.e. reflecting long-run tastes, preferences, and costs of supply) and thinking about them as a “disequilibrium” phenomenon (i.e. reflecting the impact of frictions and market imperfections that may or may not be arbitraged away).

      When using “equilibrium” assumptions about markets, it’s always helpful to keep in mind Walras’s description of markets as “groping towards equilibrium” – i.e. not there yet, and not always going in the right direction. But it’s very difficult to formally model this…

  2. People who argue that planning rules and supply restrictions are an important factor in making housing markets unresponsive to demand i.e.inelastic supply. Believe this not only causes house prices to be higher than otherwise because increased demand is translated to higher prices not increased quantity supplied. But it also causes more volatile pricing as supply is slower to respond and because of this delay causes booms and busts.

    You can see this in the graphs of Britain versus Germany housing prices since WW2.
    http://www.macrobusiness.com.au/2011/06/how-germany-achieved-stable-affordable-housing/

    1. The linked article also highlights the role of tenancy law. Renting here kind of means you’re temporary in someone else’s house, so don’t change anything and be ready to move out in 42 days notice. Whereas in Germany and other countries in Europe you can still make the house your own place (paint the walls and decorate, etc.) and evicting tenants is subject to strict laws. If you’re a family here and want to have a stable home, buying is the only real choice.

  3. It appears that on the Mercer – Demographia scale, the three rightmost points are outliers. Vancouver, Sydney, and another? Without them, the x/y gradient and r value are very different.

  4. I have done comparisons on a proposed NZ development under restrict zoning and non-restrictive zoning models. The cost of development in the non-restrictive zoning model was 50% less than the restrictive model, and the amenities were identical.
    By design or accident, this lowering of costs always brings the value-added price of the development close to the medium multiple of 3 to 4 x income. Anything over this multiple, when I have analysed the costs, are almost always due to non-value added costs and highlight a systemic failure in how to supply one of life’s basis needs, housing.
    Non-value added costs in this case are all caused solely by the effects of restrictive zoning policies. These include the cost of land banking, up zoning, extra council levies and development fees, and the multiplier costs that affect the likes of commission and GST etc.

    All of these non-value added costs, when removed, do not affect the utility or the amenity value of the development, or that of the city, at all. To the buyer, these costs can also be called ‘waste’, but to the beneficiary is called ‘how I make my money,’ revenue, or super profit and thus these beneficiaries are keen to protect the status quo.
    Of all the variables that indicate ‘what’ the price of housing should be, then the price of land is the most important, and the biggest determinant of that base price is whether or not it is restricted relative to demand.
    As simplistic as the Demographia measure is, it red flags issues with non-value added costs.
    Also the Mercer Index is a livability measure that is used for international relocation’s (normally short term) and how to set their remuneration package. Other than for international relocation’s any livability index that does not ask its permanent residents on how they rate their cities livability, including cost of housing, does not have any meaning.

      1. Hard to tell without knowing what is actually proposed. National has certainly kept their changes cloaked in secrecy to this point. My personal view (based on a fair amount of experience in the field) is that the RMA itself isn’t necessarily an issue. Because it’s an effects-based, rather than proscriptive, planning framework, developers almost always have the option to apply for resource consent to go beyond the rules. The catch is that in order to get consent they have to show that their development doesn’t have excessive negative effects.

        However, district planning provisions, which are applied under the RMA but which are not actually _part_ of the RMA, may be more problematic. District plans are where the action all happens in urban planning – they set out where people can build and how intensely they can develop sites. Changes to the RMA won’t necessarily affect the contents of district plans and so could in principle have no effect whatsoever.

        As an aside, thanks for the links to articles – interesting perspectives.

        1. Speaking as both a resident and former Residents Group co ordinator- the RMA is not working and it’s entirely because it’s effects based.

          I’ve heard multiple developers wishing there were “rules”- then everyone knows where they stand. Under the Effects based version developers just cheekily go way beyond the rules and rely on $500hr “experts” to swear black and blue that there won’t be any negative effects. Whether it’s “Independent” Commissioners in Council or at court levels the developer wins and the community gets screwed.

          The RMA is a rotting zombie. Take out its brain and finish it off!

          In related news- “Walking Dead” final tonight…

          1. That’s a pretty sensible point. It speaks to the underlying irony behind right-wing parties’ critiques of the RMA, which is that the RMA had its intellectual origins in the post-1984 reforms. It embodies the massive over-optimism about transaction costs that characterised many policy reforms of that time. However, it turns out that in reality you can’t assume away transaction costs and imperfect information.

  5. Apologies if you covered this (dont have time to read it all today) but clearly a huge factor in affordability is the average wage. For years governments have sought to reduce real wages in NZ. Every time a small sector of the economy sees pressure on real wages the Government adds that to the list of required trades and imports more people. The result is some sectors decline and see a lower real wage, some grow and see no increase in wages as we bring in more people. So much for market forces! In nominal terms the house prices increase but wages stagnate.

    1. I agree with you for once here. The construction industry in particular are expected to tolerate ludicrously low wages for a job that you are lucky to last three decades in before your body completely packs in. Yet it is on the critical skills list permanently to try and pay them $30 an hour.

  6. Surely the biggest influence on price is credit/loans?

    Something happened in 2003 and that was a massive expansion in the supply of credit/loans for housing. That is why around 50% of Aucklands housing stock is now owned by investors and why housing prices have sky rocketed. I would assume its a massive bubble with rental returns failing to meet interest payments in any real way and the whole system reliant on ever increasing house prices justifying the original loans.

    Shame for the generation that missed the boat and are now forced to rent…

    1. Classical economists (and neos) would argue it is not a major factor as they believe money is neutral. We didnt have capital rationing at the beginning of these graphs so it isn’t the main driver. The rest of us think it does matter but it should drive short term prices not long term. The long term trend has to be due to real economy factors like land supply, housing material costs and fees and demand due to demographics like migration and the birth rate 25 years earlier etc. And yes a better city should lead to higher demand you would think. Interest rate changes should be short run as it affects your budget until you are able to squeeze a pay rise or cut your other non-essential spending. Let’s face it house prices were high in real terms when interest rates were 15%.

      1. So, let’s feed some numbers into a mortgage calculator:

        what is the amount you can borrow for every $100 per forthnight you can pay off?

        at the moment rates seem to be around 6.5%

        6.5%, 30 years: $34,000
        6.5%, 20 years: $29,000

        So, houses used to be cheaper, but also the interest rates used to be higher. http://www.rbnz.govt.nz/statistics/key_graphs/mortgage_rates/ suggests rates around 14% around 1990. So you could borrow

        14%, 20 years: $17,000
        14%, 30 years: $18,000

        So you can borrow about 70% more thanks to the low rate. How does that compare with the house price increase vs. the index increase?

        But there is also the required deposit. Suppose a house costs 6 times your income, and this price increases by 10% during this year, and the required deposit is 20% of the price. Then just the increase in required deposit alone is 12% of your income. You’d have to save significantly more than that to eventually be able to get a loan. How do people get around that?

      2. mfwic, give me a quick econ 101- money might be neutral, but surely the supply of credit isn’t? Take a micro self-contained market with 2 buyers and 2 houses, one better than the other and no bank. Assuming they both want the better house, the one with the fatter wallet bids $1 higher than the “poorer” person has in their wallet, and gets the nicer house.

        Now bring a bank into the equation that’s lending them unlimited amounts at 5% per year- the new price would relate to willingness/ability to service the debt for decades, and might send the price through the roof.
        Surely the availability of easy credit is a massive factor?

        1. Ok first many and probably most economists now don’t buy the money is neutral thing. That was the classical dicotomy but if it was true then why do we have business cycles and why do downturns appear to have lasting permanent effects? But I can give you their view on your question. Money is neutral in your example because although the existence of credit (or money created) allowed them to bid up the price of houses in nominal terms then stayed constant in real terms. The credit increased the money supply so the value of money actually decreased. That means there was inflation in that economy and everything you could buy went up in nominal price. But in real terms because the price of everything went up, the real things you trade also went up in price. You would still work the same number of hours to buy a house or swap the same number of sheep carcasses or whatever you trade to make your living.

          Jumping beyond theory the problem with that school of thought is in a real economy not everyone is aware that the money supply has increased. They see a rise in prices and think it is a supply and demand issue rather than a decline in the value of money so they make inefficient investment and consumption decisions. So in reality the monetary economy does impact on the real economy which is why we have the obsession with inflation. That and the fact that western governments used inflation as a cheating way to get out of their debts, for example the US and the Vietnam war costs. It kind of suited them to dump fixed exchange rates to screw foreign creditors and run high inflation to screw domestic creditors. But they were not alone our government did it too. Had they been net creditors there is no way in hell they would have allowed double digit inflation.

          They teach other costs of inflation like so called shoe leather costs and menu costs but technology has reduced these right down for most businesses and people. The big one is how it distorts investment and spending and as Lenin claimed foments discontent as a few people win big while most lose value. He saw undermining the currency as a way to revolution.

    2. Yes – lower interest rates would seem to do a fair chunk of the explaining.

      Shows the incompleteness of Demographia’s indicator of ‘housing affordability’. Median multiples ignore interest rate changes – a pretty major omission when any bank’s definition of affordability largely relies on ability to service a loan – not on nominal prices.

      With mortgage interest rates now about 35% lower than the most recent peak (9.6% April 2008 down to 6.1% Jan 2015 for 2-year fixed mortgage – http://www.rbnz.govt.nz/statistics/key_graphs/mortgage_rates/ ), that obviously means a lot of extra houseprice a buyer can afford – given a stable budget for mortgage repayments.

      Also interesting to explain with regard to Auckland’s prices is why they’re rocketing so far ahead of other NZ cities (see good comparisons of affordability here: http://www.interest.co.nz/property/home-loan-affordability) . Perhaps this is where international perceptions of amenity and livability may come in – especially in fuelling foreign investment. But I’d also suspect its to do with some broad-scale economic restructuring going on that’s supporting centralisation. The same dynamic of big, livable cities’ real estate markets diverging from national averages seems also at work in the UK (London vs the rest), USA, and to some extent Australia (Sydney/ Melbourne vs the rest). Perhaps a combination of highly visible cities attracting investment capital + economic restructuring favouring the big, globally-connected centres? Plenty of work needed to prove that one!

      1. Perfect storm – banks loosening up lending criteria on housing, combined with low interest rates = high demand for loans, much more “money” than supply.

        Its not a surprise that the Reserve Bank is now looking at lending restrictions for the banks. Just a shame its 12 years too late. Thanks Alan Bollard! (Governor 2002 – 2012)

  7. Plenty of reasons for Auckland’s out of control house pricing but surely selling property to overseas based foreign investors is a really stupid idea! Even if they somehow magically don’t boost prices by much (extremely unlikely!) for every single house that is sold overseas that is one less house that is available for people living here (a lot of foreign investors don’t even rent them out).
    At this stage in Auckland’s development (after years of low intensity urban sprawl) what foreign investors could possibly be useful for is the apartment market. Apartments require lots of good quality workers as they are more complex to build. Allowing investing in apartments would kill 2 birds with 1 stone… e.g. increase the density of inner suburbs (to make the city more liveable), provide young people with good rental options in the city (then when they are older with kids move out to the burbs), allows the foreign investors a place to invest (while helping the economy out rather than draining it as they currently do).

  8. Peter the beauty of the Demographia measure is its simplicity. It points to potential problems, but the problem will not necessarily be the same in all cases. Your graphs of Los Angeles and Las Vegas, do not show that the UGL was removed, but they do well illustrate the fact that artificially high prices (which are a common consequence of UGLs) are susceptible to booms and busts. So it is not unreasonable to ascribe the changes you observed to the presence of the limit. As for amenity value and migration, if city A has a higher amenity value than city B, and the cost for building is the same in A and B, then all that will happen is that more people will live in A. It would have only a minimal effect on prices. It is only if the supply of land (or the number of places with high amenity) is restricted in A that the price of land will increase significantly. So your graph of price vs amenity value demonstrates that land supply restrictions are driving up prices. The same applies to migration (or selling to foreign investors). It is only a problem if the supply of land is restricted.

  9. (ctd) Your point about market failure is rather more interesting. In a previous post you highlighted that it was the price of land that was driving high property prices. In a ‘normal’ housing market, if house prices increase in response to increasing demand, it becomes cheaper to build a new house than to buy an old one. House construction booms and the increase in supply restrains the price increases. But if the increased prices are capitalised in the price of the land, building a new house is no longer going to be cheaper than buying an existing house. In fact it is going to cost more because of all the fees and charges now levied on new construction. So the market no longer responds to the price signals (well it does, but not the way we expected). What is more, if the price of land is increasing rapidly (as it is in Auckland) it becomes more profitable to hold onto land than to develop it, further reducing the possibility of people building their way out of the crisis.

        1. Really? That is the opposite of what I have found in terms of any kind of complex system. Maybe some becomes simpler but there is always the ocean of unknowns ahead of us.

          I agree with Socrates that the more we learn the more we realise we don’t know.

          1. I agree with Socrates as well, and that is simple to understand, but for some it is paralysis by over analysis.

            We don ‘t have to reinvent the wheel here, just look at where and why housing is affordable and do that, and look at where and why housing is not affordable and don’t do that.

            Capital gains tax, high or low interest rates, higher or low LVR’s, physical constraints, ‘amenity’, immigration, etc. does affect prices but only as a multiplier based on whether the land is restrictively zoned or not. Restrictive zoning allows non-valued added costs to easily be added to the cost of development (and therefore increases the price) without any further amenity being added.

            So now you know more, and have realize you still have more to learn, according to Socrates.

          2. OK so houses are really cheap in Detroit. So, all we have to do is engineer a collapse of our industries, drive our tax base out of the city and go bankrupt! Problem solved.

            Houston or Atlanta houses are cheap outside the centre. So, let the city spill out onto the massive plain that surrounds the city in all directions and drive a huge boom through thriving petrochemical industry. Then build massive highways that are congested pretty much all the time and force everyone to drive everywhere and long distances. Any problems with that?

            Or German housing which has consistently fallen over time. So, have a constitutional right to build (we don’t have a constitution in NZ by the way), have most of the population becomes renters with a pretty much lifetime right to occupy (plus rent restrictions) and create great rail based PT systems that link satellite cities to main centres.

            I think it is a little more complicated than that.

          3. “(we don’t have a constitution in NZ by the way)” Not having a constitution is one of the strengths of New Zealand IMO. A written constitution puts limits good governments but bad governments just ignore it or even tear it up. In the USA they swapped the tyranny of HM King George III for the tyranny of a bunch of long dead slave owners aka ‘the framers’. A written constitution in the USA permitted slavery, allowed the Supreme Court to issue the Dred Scott decision, permitted people to be incarcerated without trial in WWII and still prevents sensible gun control laws. Thank goodness we live in a country where Parliament is sovereign.

          4. mfwic – 100% agree. The only two other countries without a written constitution are the UK (ranked as having the best legal system in the world – we are close behind) and Israel (which has built a stable democracy in the Middle East – no mean feat).

            As you say, allows us to be much more flexible and pragmatic in our approach to issues. You look at how twisted in knots Australia has got at times dealing with the constitution in the context of state rights. And the US is a perfect illustration of why written constitutions can be dangerous if allowed to become archaic.

            And yes, thanks be for parliamentary sovereignty!

    1. So how do you address land banking other than through govt. intervention?

      All these neo liberals and their glorious “free market” seem to forget people with market power (e.g. Land bankers) will abuse that power just as monopoly businesses abuse their market power. Its in their interests to constrain land development irrespective of what RMA legislation allows.

      1. Realist the best way to counter land bankers is to get rid of urban boundaries, up zone and allow infrastructure development to respond to development. This will increase competition, increase the incentive to develop and crest uncertainty as to the return from land banking. The current system of staged expansion creates a one way bet situation for landowners.

        1. I agree Matthew. Land banking would also be discouraged by returning to rating based on ‘unimproved value’. This used to be the preferred basis for local authorities throughout New Zealand. It has the advantage that, as well as discouraging land banking (by significantly increasing the cost of holding empty land), it more closely matches council charges to costs (the cost of provision of local roads, public transport and the three waters is largely dependent on the area served not the degree of development). Rating on unimproved value would also encourage compact development, which this blog favours. It has been abandoned in favour of capital value rates mainly on ‘ability to pay’ arguments but unfortunately with unintended consequences.

        2. The problem is the Govt. is the largest land banker. They received approx. $1.4 million a ha for their land at Hobsonville Point which is about as far as fringe Auckland you can get. I think it is by no accident that Govt. are trying to off load some of their surplus land at these inflated prices while the going is good.

  10. Housing prices are high because people can fund big loans. One way to fix that would be higher income taxes and / or higher rates.

    Soak up the liquidity. People won’t be able to afford to borrow as much. Prices come down. I suspect this would only work if owning a home here was limited to citizens and people actually resident here so their incomes were within the taxation catchment.

    I also suspect the removal of high taxes in the mid-80s actually began the housing price explosion…. Which then truly went off when money became cheap everywhere, even here. My first mirage in 1985 was 20.5%. My current one is less then 6%.

    For my own part, I’d rather pay higher tax or rates – and fund infrastructure and services – than just shovel into the Black Hole that is a bank mortgage.

    My sister in Ottawa pays double my Auckland rates for a (comparable) house that’s worth half as much. The $3500/year she posts in tests for her $350,000/home is why her home if only with $350,000. Mortgage loans there only cost 2.6%/annum. Without the high rates, her home would be worth far more.

    1. Auto-corrected “mortgage” to “mirage”? – I like that. Maybe a few more people need to contemplate the “mirage-ness” of the current debt-pile disguised as a housing boom.

    2. Without surplus liquidity, where is the possibility to invest in innovation and job creation that leads to a bigger total pie?

      I believe that additional taxes are punitive measures that reduce willingness to take risks, reducing competitiveness and stifling investment/innovation. Providing an appropriate policy response to encourage investment is difficult.

      I think that the concentration of investment in residential property by both residents and external investors is the issue, reducing the effectiveness of capital markets and reducing the overall level of savings within society. Finding a solution to this issue has the potential to unlock the potential within the economy.

      Fixing this is not easy and increasing tax provides an alluring but doubtful solution, in all likelihood the costs will just be passed on, making those least likely to be able to afford a cost increase the ones that bear the cost.

      All I know is that I’m glad I’m not responsible for trying to fix the issue.

      1. “additional taxes are punitive measures that reduce willingness to take risks, reducing competitiveness and stifling investment/innovation”

        And yet in the US of the 1950s under Eisenhower (that notorious Socialist) the top tax rate in the US was 93% and it was a period of tremendous innovation and risk taking.

        In fact, a lot of research has shown that people will take more risks when they have less to lose, for example when there is a good social safety net that will ensure they don’t drop too far. That is why Northern Europe is an incredible source of innovation and research.

        I recommend the book “23 Things They Don’t Tell You About Capitalism” – i have yet to find a comprehensive neo-lib response to the points made there. And I have looked all over the internet for it.
        http://www.huffingtonpost.com/ian-fletcher/a-review-of-ha-joon-chang_b_840417.html?

        NZ has swallowed the neo-lib line hook and sinker. But to actually find real life evidence that low taxes and small government leads to more prosperity for most people is pretty difficult. It seems to lead to more debt for the middle class and a growing underclass.

        It’s great for those who already have the resources and are at the top, but it stifles social mobility and is creating an entrenched economic aristocracy.

  11. “The first potential explanation is that there has been a market failure”

    Just wondering if you could explain what market failure you are referring to? If there’s a market failure, then the government can potentially step in to create a more efficient situation. Is the market failure negative externalities? Positive? A public good?

    1. I suppose that there are a range of views as to whether recessions are a market failure or not 😉

      I’d observe two phenomena that could lead to market failure in the short term:
      1. Investment decisions reflect forward-looking expectations and thus investment levels (e.g. new housing construction) can be volatile. This is because expectations can be affected by murky psychological factors (“animal spirits”) – meaning that market agents don’t always (or even usually) approximate the forward-looking rational maximiser beloved of neoclassical economics.
      2. There are frictions in the development/construction market that may mean that builders are slow to respond to rising demand following a recession. These frictions certainly include policy factors (e.g. planning policies and regulatory processes) but may also include fixed costs of production and transaction costs associated with bringing development on-stream.

      Hard to pick policy implications. One option, I suppose, would be for the government to build state housing in a “counter-cyclical” way – i.e. to ramp up building when labour is unemployed and capital is cheap. Developer Graeme Birkhead raised this prospect in this article: http://architecturenow.co.nz/articles/the-new-auckland-a-radical-rethink/. Andrew Coleman at the Treasury is also quite sharp on this issue.

      1. That’s quite funny.

        He says “With the sophistication of modern, computer-designed manufacturing processes, prefabricated houses don’t all need to look like uniform grey boxes.”

        In the photo he’s standing proudly in front of… Lol

        1. Man you’re precious. Most young families would be stampeding over each other to get into housing like that in a decent area.

          We can’t all afford individually architecturally designed masterpieces. I bet those houses are great inside.

    2. Some would argue the buyers and sellers on a particular day determine market conditions and there isn’t market failure just a fluctuation in price. And I would discount interest rates as having anything other than a short term influence. The interest rates are set to be counter-cyclical to the inflation and they predict inflation in a really complicated model based on really simplistic assumptions which largely results in growth over an arbitrary value being seen as inflationary. Long term increases in price have to be caused by supply not increasing as fast as demand. Part of that must be land restrictions and part building cost increases. Both sap profit and without profit the private sector doesn’t build. Why would they? Part of the cost issue is due the Councils asking for higher standards. We now have to build 1.8m footpaths when 1.4m always worked well in suburbs. The reason is that AT staff figured it would cost them anything to demand it. But it costs someone. It costs the person who buys the house and it costs the person who cant buy a house because a subdivision is no longer profitable so gets delayed. Same goes for stormwater treatment which now costs a fortune in the suburbs but isnt done at all in older areas. Or when it is the ratepayer does it. Can anyone remember a public debate or crisis that required rain water to be treated? There used to be cheap sections now they just dont exist.

    1. It might be part of the puzzle but it didn’t stop rampant property increases in Australia or the UK. It isn’t the silver bullet a lot of people think it is.

    1. I haven’t thought much about land taxes, and I guess I don’t have a strong position either way. I can see both sides of the debate over whether we should tax land value only or whether we should tax improved property value.

      Potential pros of land taxes:
      * They may create incentives to avoid land banking and to use land more efficiently/intensively. (But then again, we already have strong incentives to do so, in the form of developer profits.)
      * Taxing “immobile” activities/assets may provide better incentives for investment than taxing “mobile” activities/assets. (A similar argument is raised in the debate over whether we should tax consumption or incomes.)

      Potential cons:
      * Taxing different activities/assets in different ways may distort investment decisions by encouraging people to invest in lower-value assets that have preferential tax treatment. (A similar argument is raised in the debate over capital gains taxes.)
      * Taxing land values rather than improved values may be worse from a “user pays” perspective, if intensively-developed properties require more infrastructure and municipal services.

      1. I see a couple of other benefits, assuming they’re used as a means to cut other taxes, not increase total revenue. They should allow lower income tax rates, which should increase the aggregate supply curve. They should reduce the tax benefits of negative gearing, reducing the amount of financial risk in the economy. They should also reduce the wealth of land owners (a demographically concentrated group) relative to workers, which should increase utility through egalitarian effects. And they should reduce overall waste in the economy (assuming more equal taxation of the factors of production leads to greater efficiency).

  12. I think you are missing the point about missing supply… prices have been going up in Auckland, but the number of houses for sale has been flat to falling… so where are the people looking to sell their properties to take advantage of the higher prices? They ain’t there… I think this is a far more useful place to look for explanations that trying to rationalise away the demand. Maybe housing is Auckland is a supply side problem.

    Don’t forget that the construction sector in Auckland is constrained by the Chch earthquake rebuild, which has diverted a lot of resources south.

    1. Supply has actually gone down if you consider how the leaky homes were built and people considered them ok to buy. Then once the problem became known most people ruled them out completely. Many of us would still never buy a house built in that period on the basis that even the fixes will probably turn out to be rubbish.

      1. Very good point. When I was hunting for a house, we looked at a few medium density options. One of the first questions we asked was when it was built. If it was 1996 to 2005 we just didn’t even bother.

        A real trap for immigrant buyers who aren’t aware of the issue and then get lumped with a property that no-one will buy. We saw a few like that.

        1. It really is just shameful. Who would expect that a house they bought almost new could be not only rotten but a health hazard. But supply terms I think it has pushed up the price of everything else.

      2. There’s also the non trivial amount of resource going into fixing them. On my 300m walk to work I pass 2 substantial rebuilds. While this is happening the inhabitants have to find somewhere else to go (for around 18 months), driving demand for accomodation while absorbing resource that could otherwise be building new dwellings.

  13. The fact migration is strongly correlated with rapidly rising house prices in New Zealand supports Demographia’s argument. If the land supply was not so restricted and the consenting process so slow, the rise in immigration would be swiftly met by a housing supply response that would keep prices in check. This is exactly what happens in cities without growth boundaries such as Houston, Atlanta and Dallas which have stayed affordable despite massive immigration and domestic in-migration.

    In contrast, building activity in Auckland has remained subdued despite a rapidly growing population and strong overall economic growth. This blog should stop bashing Demographia and take a more critical look at how the “Smart Growth” policies its authors support are contributing to the housing crisis.

    1. An RBNZ study of net migration and house price movements (http://www.rbnz.govt.nz/research_and_publications/discussion_papers/2007/dp07_12.pdf) observes a correlation between the two variables that goes back to the early 1960s. By comparison, rapid increases to Auckland house prices are a more recent phenomenon – dating back to the early 2000s.

      Let me put it this way: If your response to _all_ new information is to say “my model already explains this phenomenon of which I was previously unaware!”, you might not actually have a valid model.

      1. Surely the supply response of our cities is a factor in our housing crisis situation. Auckland is only building about the same number of houses as Canterbury but it is two and half times bigger! http://www.interest.co.nz/charts/real-estate/building-consents-residential Both cities have had demand shocks -one from earthquakes and now immigration the other from a high natural birth rate and a very high immigration rate.

        What is that about?

        Peter do you have estimate what the elasticity of supply is for Auckland and in your opinion could elasticity in supply be improved?

        http://en.wikipedia.org/wiki/Price_elasticity_of_supply

        1. Good question! I agree that elasticity of supply is a key metric to focus on. The Productivity Commission took a look at this in their 2012 inquiry. http://productivity.govt.nz/inquiry-content/1509?stage=4

          Here’s the key chart: http://greaterakl.wpengine.com/wp-content/uploads/2015/04/Productivity-Commission-elasticity-of-housing-supply-chart.jpg

          New Zealand’s actually got a relatively responsive development sector when compared with Australia or much of Europe, but it underperforms some Scandinavian countries, Japan, the US, and Canada. I’m not sure there is any single policy implication we could take away from the comparison.

  14. Are at the moment rates different if it’s for the first or second house? Maybe by increasing local rates for investment properties we could get more rates and lower house prices? Am I to naive in thinking that it sounds too easy?

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