Broken market or Broken policy? The unintended Consequences of restrictive planning

Is the title of an article by Paul Cheshire in the National Institute Economic Review, Volume 245, No. 1, August 2018.

The abstract reads:

This paper summarises the evidence from recent research relating to the British Planning system’s impact on the supply of development. Planning serves important economic and social purposes but it is essential to distinguish between restricting development relative to demand in particular places to provide public goods and mitigate market failure in other ways, including ensuring the future ability of cities to expand and maintain a supply of public goods and infrastructure; and an absolute restriction on supply, raising prices of housing and other urban development generally. Evidence is presented that there are at least four separate mechanisms, inbuilt into the British system, which result in a systematic undersupply of land and space for both residential and commercial purposes and that these have had important effects on both our housing market and the wider economy and on welfare more widely defined.

The article's conclusion reads,

The evidence shows, then, that our planning system is restrictive in terms of the overall supply of land and housing space in the aggregate. It is not just locally restrictive in order to preserve land of significant environmental quality which in its unbuilt state generates amenity or has recreational value. Such purely local restrictions are likely to have positive welfare effects although the costs they impose also need to be taken into account. Overall restrictiveness of supply relative to demand, in the absence of such environmental gains, does not increase welfare but does increase the price of housing relative to incomes, so reduces welfare, and has, as we have seen, unintended adverse consequences; for example on the length of commuting.

Our planning system imposes this overall restrictiveness by means of at least four separate mechanisms. Its decision making is systemically restrictive because results of applications and conditions imposed for ‘affordable’ housing are unpredictable, so development risk is increased; it imposes quantitative restrictions on the supply of space (where it is most valued) by its imposition of Green Belts and height controls; its mechanism for deciding how much land to allocate for housing ignores the most important determinant of demand, so systematically undersupplies land; and there is substantial variation in local restrictiveness measuredby the proportion of applications refused.

Since all have the effect of reducing the supply of housing and other development relative to demand this drives up prices in real terms. Not only has this made housing increasingly unaffordable but it has had very regressive distributional effects, especially redistributing assets to older home owners. There are other unintended effectsof more restrictive planning. A more restrictive pattern of local decisions on housing proposals causes a substantial increase over time in the proportion of local homes that are empty. Not only that but greater local restrictivenesssignificantly increases the average length of commutes for those working locally. There is also evidence consistent with Green Belts increasing commuting distances as workers leap frog out to buy less expensive housing space. This increases the spatial extent of cities even if it reduces the footprint of urbanisation.

The extent of the price distortions induced by restrictions on the supply of land and housing mean that there is a misallocation of resources. Even in the US, where overall restrictiveness has historically been considerably less than in Britain, it has been estimated (Hseih and Moretti, 2017) that GDP would have been some 13.5 per cent higher had not restrictions on building slowed the flowof labour to the highest productivity locations over the period 1964 and 2009. No similar estimates have been done for other countries. Cheshire et al. (2015), however, did estimate that the loss of total factor productivity in the supermarket sector in England, as a result of forcing them to locate on particular sites in ‘town centres’, was 32 per cent just between 1996 and 2008. Cheshire and Hilber (2008) estimated that the restriction on the supply of office space in British cities reached the equivalent of a tax on construction costs of 800 per cent in London’s West End and even in less prosperous cities, such as Birmingham, averaged 250 per cent: there is certainly evidence that the economic effects of planning which is generically restrictive, can be large.

To sum up, there seem to be many reasons for concluding that our policies determining housing supply are broken but no obvious reason to conclude that the housing crisis results from a ‘broken housing market’.

So the answer to the question in the title seems to be broken policy. This raises the interesting and important question of, if you did a similar study for New Zealand would you get similar results? I'm very afraid you would. But just how broken are New Zealand's housing policies? And how costly are these blunders?

Housing and the economy

Two minutes on the topic of "Housing and the Economy" from Jagjit Chadha, Director of the National Institute of Economic and Social Research in the UK. The sorts of issues he talks about apply in New Zealand as well as in the UK.

Here's how we solve Britain's housing crisis

The Institute of Economic Affairs’s Kristian Niemietz and former Head of Research at the Adam Smith Institute Ben Southwood discuss the housing shortage, its supply-side nature and the politics which underpin it.

Interviewed by the IEA's Kate Andrews, the pair examine the historical origins of the housing crisis, which date back to legislation introduced under Clement Attlee’s government in the 1940s.

They also look at the well-organised NIMBY movement (short for “Not In My Back Yard”), and its influence on government policy.

Many of the issues discussed here apply not just to the UK but also to many other countries, like New Zealand.

Why is rent do damn high?

Many of the arguments here apply to New Zealand.

You’ve no doubt heard it before: the rent is too damn high!

In major cities across the United States, rent prices have been skyrocketing for some time. As a percentage of median income, rent is much higher for those that choose city life over suburbia.

But why are rental prices in these cities so expensive, and what can we do about it?

It’s a classic case of supply and demand: lots of people want to move to big cities because of the opportunities they afford. Naturally, they demand housing. But the supply is often short due to many factors, from geography to regulations. What does economics tell us happens when there’s a lot of demand, but not so much supply? Prices rise. As a consequence, many people are priced out of pursuing the lucrative opportunities available in major cities.

Coastal cities, like San Francisco and New York, have obvious geographical restrictions on building “out.” One way to deal with this problem is to build upwards with more skyscraper housing. This often isn’t feasible due to regulations on building heights, density, parking requirements, etc. But these regulations could be lessened or removed, allowing big cities to become denser and lowering rent prices. Lifelong city-dweller Matt Yglesias discusses this approach in this Duel.

On the other side, Tyler Cowen, who has always lived in the suburbs, argues that allowing cities to become denser may only provide a short-term solution. As more people move in, the cities become more productive with higher incomes for their inhabitants. And the rents rise again.

The Maori Party needs to do Econ 101

Thanks to Mark Hubbard on twitter

Perhaps Maori Party might like to read econ 101. The unintended consequences of rent controls are basic knowledge. https://t.co/YmNZYrzea3

— Mark Hubbard (@MarkHubbard33) September 5, 2016

I was alerted to this NewsHub article: Maori Party calls for immediate rent freeze.

The Maori Party is calling for a rent freeze to stop struggling families being forced onto the streets.

Co-leader Marama Fox has spent the past couple of weeks at the cross-party inquiry into homelessness, listening to hundreds of "absolutely heartbreaking" tales of how Kiwi families ended up without a roof above their heads.

"These are not people who are just desperate dropkicks. They are just struggling to meet the rent," Ms Fox told Paul Henry on Tuesday morning.

While the idea may make for a great headline, it sounds all very nice, Econ 101 tells us it would help. In fact it would make things worse.

Rent controls are just a big amount of stupid. As Swedish economist Assar Lindbeck once quipped

"next to bombing, rent control seems in many cases to be the most efficient technique so far known for destroying cities"

Increasing rents are just a sign that there is a problem on the supply side of the market. The question to ask is Why? And the people to ask the question of are, usually, the local (and national) government. The problem here is that the market can not adjust, largely due to local and central government interventions in the market. Prices are raising and thus we would expect the quantity supplied to increase. An increase in supply would over time reduce the excess demand in the market and thus reduce price increases.

Except this isn't happening since it's too difficult for the supply to expand in face of the constraints on land supply and building controls.

Putting rent controls in place will only make this problem worse. It will mean there is even less incentive for people to expand the housing supply. If you force the price of housing below the market equilibrium - and there is no point in rent controls if they aren't below equilibrium -  then the quantity demanded goes up and the quantity supplied goes down, relative to equilibrium, and thus the excess demand gets even larger. An excess demand that there is no incentive for people to remove because prices can not adjust.

If the Maori Party really is interested in helping the disadvantaged, rather than just producing nice sounding PR, then it should call for these people to be simply given money. Increasing their "income" so they can pay market rents and letting the market mechanism work for them is way better to deal with the problem than preventing the market from working at all.

In addition the Maori Party should be working to remove the constraints that prevent the supply of houses from growing enough to satisfy demand.

But this doesn't simply involve creating nice headlines and 60 second sound bytes so there isn't much chance of any politician being interested in doing it.

Why are big cities becoming expensive places to live?

Arnold Kling argues that the reason may be upward sloping demand curves:

But one possibility I want to throw out there is that people want affluent neighbors. If I want an affluent neighbor, and an affluent neighbor is going to live in a neighborhood with high prices, then in some sense I want to live in a neighborhood with high prices. In the extreme, this makes my demand for neighborhoods upward-sloping. Higher prices make me want to live there.

and

Back to cities. Suppose that an important “urban amenity” is having a lot of affluent people around. Young singles may wish to meet potential marriage partners who are affluent. People who have acquired affluent tastes (sushi, yoga, wine) may want to be around people with similar tastes.

Given the cost of housing, you would have to have very strong preferences for the "urban amenity". I can't help thinking there must be cheaper way to take advantage of the amenity.

Worstall on Davies on Coase on housing

In a previous post I commented on the idea of Steve Davies to apply Coaseian thinking to solving the British (and other countries) housing problem. In part Davies wrote

For Coase the solution was to assign a property right to one of the two sides and then allow a process of bargaining to take place. If the first group have the right then those who do not want development would have to pay them not to do it. If the second, then the developers (and ultimately the buyers) have to pay for the right to develop. Crucially it does not matter which of these two we go for: in either case we will end up with the outcome that maximises total welfare so long as the bargaining process itself is not too costly.

Now at the Adam Smith Institutes's blog Tim Worstall comments on this idea. He writes

We have no doubt this would work and that should be good enough as a solution. However, while it would work we’re really not convinced that it is the correct solution. For what it is saying is that those who wish to prevent building upon land that they do not own have some form of right to say or insist so. That’s why they might be due some compensation from those who do build. And we rather reject that basic contention.

Property ownership does mean that one should be able to dispose of the property as one wishes. Consistent with this is that other people do not have the right to impose their views upon you of how you should dispose of that property. Thus we’re uncomfortable with the idea of creating a right which can then be subject to such Coasean bargaining.

Tim has a point, sorting out who has what rights to object to a housing development could raise the transaction costs of Coaseian type bargaining to such a degree that it would become impractical. And if multiple people or groups claim said rights negotiating with each of them could be expensive and time consuming. However if it is clear who the parties involved are and there are only a few of them, ie transactions costs really are low, then the Coaseian solution could be an improvement over the current situation.

Davies on Coase on housing

At the LSE's British Politics and Policy blog Steve Dacies writes that low house-building levels and the unaffordability of existing homes are problems that have been plaguing Britain for decades. And this is true not just in the UK but most other countries, like New Zealand, as well.

Davies writes,

There is now something of a consensus among academics and commentators that the shortage of housing (and buildings of all kinds) is one of our most pressing problems. Many others such as welfare costs and low productivity are at least partly caused by the lack of house building and the consequent high price of housing. However, this has not as yet led to any political action. The problem of course is the conflict of interest between people who want to build, buy or rent new houses on the one hand, and people who do not want new development on greenfield sites on the other. The second group have so far been able to block any action and this does not seem likely to change.

But the work of Coase shows that this deadlock is quite simply unnecessary and avoidable if we only think about it in the right way, as Mark Pennington explains. Current policy on development is shaped by conventional welfare economics, where two people engaging in a transaction can impose costs on bystanders. So a developer and a house buyer can impose costs on existing home owners and people who wish to preserve the rural environment. This is dealt with by regulations through planning laws.

As Pennington explains, Coase rejects this model. For him the costs are reciprocal – there are two sides each of whom is potentially imposing costs on the other. One wants to build houses, the other to preserve space. To the extent that one side gets its way the other suffers a loss. What we actually have is not an externality or pollution but a conflict over how to use land.

For Coase the solution was to assign a property right to one of the two sides and then allow a process of bargaining to take place. If the first group have the right then those who do not want development would have to pay them not to do it. If the second, then the developers (and ultimately the buyers) have to pay for the right to develop. Crucially it does not matter which of these two we go for: in either case we will end up with the outcome that maximises total welfare so long as the bargaining process itself is not too costly.

Fortunately, in the case of land use the cost of negotiation is low. If we applied this model instead of a complex and costly planning procedure we would simply have a default right, either to build or not, which would have to be bought out. We could make one default apply in some parts of the country and the other in the rest (although this should not matter, it might be politically astute). There would then be a process of bargaining and through this we would actually find out how much people really valued one alternative or the other (as opposed to their asserting it – words are cheap).

The result would be development in some areas but not in others and this would reflect the actual value that people collectively placed on the two competing uses and the associated moral values. This would be different in different places (unlike the inflexible present system). As Pennington points out this would also be an ethically superior outcome because it would reflect ethical and value pluralism rather than having one group’s values imposed on the rest through the political process which is what we have now.

For Coase the world of positive transaction costs is the world we should consider when thinking about policy. High transactions costs can prevent otherwise efficient trades from taking place. But if we can structure things so that transaction costs are low then bargaining between parties will lead us to efficient outcomes. Thus as Davies notes if we assign property rights to either developers or to those who wish to prevent new development and let them bargain the two groups can work the problem out for themselves. Bureaucrats not needed.

Such an approach to housing really would be RMA change!

But what affect are the Chinese actually having on house prices?

With all the xenophobic rubbish we are getting from Labour and bizarre calls for bans on foreign ownership of housing by the likes of the BNZ's Tony Alexander I find myself asking, But what is the actual effect of foreign buyers on the prices of homes?

I mean if I go to a house auction and bid $X for the house then all a foreign buyer has to do to get the house instead of me is bid $X+1. So the actual effect on the sale price of the house of having a foreign buyer in the market could be very small. But everyone seems to be assuming that the effect of foreign buyers is huge, But is it? What do we actually know about the effect of foreign buyers on house prices? What studies have looked at this?

I'm guessing the answer to the question is we know nothing and thus we get the sort of mindless, ill-informed scaremongering we see from Labour.

From what studies I have seen about housing problems, in particular Auckland's housing problems, its the lack of supply that is the issue not demand. The likes of Labour and Alexander seem to want to fix a supply-side problem by affecting the demand-side. Well, that just won't work. To lower house prices we simply need more homes. No amount of demand-side tinkering will  increase the supply of housing.

Bad housing policy is not just a New Zealand thing

Regulation of the housing market here is New Zealand causes all sort of problems but may be we should be grateful on one has, yet, put forward a policy like this one in the U.K.

Philip Booth writing at the IEA blog notes,

Last week, the Royal Institute of Chartered Surveyors (RICS) argued that there should be a limit on house price rises of 5 per cent per annum. If rises went beyond this limit, RICS suggested, the authorities should put restrictions on the mortgages banks could offer.

There would be several objections to this policy if it were to be followed in isolation. Sometimes house prices rise for good reason, and limiting price rises will make the market even less able to respond by building new houses and by turning commercial property into residential property. Secondly, if house prices are rising because incomes are rising strongly, or because of a previous recession, the only consequence of limiting rises to 5 per cent per year will be that people refuse to sell, as they will expect catch-up growth over the coming years. The UK is also not a single housing market: supply and demand conditions differ in different parts of the country. For the last 30 years, house prices have risen strongly in London and the South East, but less strongly elsewhere.

And if people are blocked from obtaining mortgages, even though banks are happy to lend, it will make it even more difficult for the young to get on the housing ladder. Further, people who are prevented from taking out mortgages may well take out more expensive and completely unsuitable forms of credit instead.

Surely the whole point of having a housing market is to signal changes in scarcity via changes in prices. It is these price changes that give incentives for the contraction or expansion of housing supply and demand. A rapid increase in prices would suggest the need for an expansion of supply, i.e. the building of more houses. If you limit price increases you limit the incentive to increase supply just when it is needed most.

But the main message here, a message with more general application, is to do with the danger that one set of bad regulations drives another set of bad regulations which ........ Booth explains,

The main problem with this proposal, however, is that its designers are looking down the wrong end of the telescope. We have the Bank of England making it more difficult for banks to lend money due to onerous capital requirements. It then responds to the problems this creates by unconventional monetary policy, inflating asset prices – including for houses.

Concerned about the extension of mortgage credit, the government then brings in the statutory regulation of mortgages – with a whopping consultation document of 500 pages. Then, worried about the difficulty people have getting mortgages, the government – seemingly oblivious to the policies in the US that caused the 2008 crash – provides mortgage guarantees (through schemes like Help to Buy) to people who can’t obtain mortgages on commercial terms. To cap it all, we have one of the most restrictive land-use planning policies in Europe. Even after a decade of stagnation of real incomes, house prices are still rising from levels far higher than in nearly all comparable countries.

In a vicious circle of regulation begetting regulation, we have a proposal to cap the house price increases caused by all the other regulations

May be a better approach would be to look at the regulatory mess we already have and pick it apart and reduce it down to those controls that are really necessary, thereby reducing the need to create new regulations to deal with the unintended consequences of the last set of regulations. Sometimes less really is more.

And Econ 101 dies (updated)

The Stuff website is reporting that Labour's housing spokesperson Phil Twyford said,

"It is based on the notion that increasing supply of houses at any price will somehow bring down prices. This is trickle-down economics at its most dubious."

WTF?!

Yes Phil increasing supply does lower price. Assuming that demand is not totally elastic, just draw a supply and demand diagram and move the supply curve out to the right, price goes down. Its Econ 101 stuff.

And these people want us to vote for them!!

Update: Matt Nolan at TVHE got to this one first. Sorry, what? he rightly asks.