Tuesday, May 26, 2015

Exposing political favouritism in land rezoning

Property development can be a dirty business, particularly when it comes to land-banking, which is the speciality of Australia’s largest developers.

Land-banking involves the speculative buying of large parcels of land that are currently unsuitable for development in the hope of future development potential. But hope alone is not a business strategy. How can land banking be so routinely successful for developers in Australia?

One argument is that successful land-banking comes from political favours in terms of rezoning and public provision of infrastructure. These favours provide substantial value gains to landowners at no cost to themselves. While in certain cases this account appears to have some merit, there has been no systematic evidence that rezoning favours the politically connected.

Until now.

I have a new working paper out with my co-author Professor Paul Frijters, that you can download here, in which we look systematically at land rezoning decisions in Queensland.

The basic result is this: How well-connected you are determines how successful you will be in getting your land rezoned for higher value uses. In Queensland $410million worth of additional development rights were given to mates in just our sample of decisions.

In the study we use sample of planning decisions and landowners involving a total area of 12,676Ha, made by one State authority, the Urban Land Development Authority (ULDA), which took planning powers away from local councils with the intention to increase the scale and speed of development in the rezoned areas. Throughout its time the ULDA was no stranger to accusations of bias, with the Local Government Association of Queensland arguing the government is “playing politics and favouring developers.”

In order to establish how well-connected both rezoned and non-rezoned landowners were, we trawled through a wide range of data on political donations, lobbyists and their clients, industry groups memberships, politicians and their former employers, relationships of ULDA board members, and landowner’s corporate records, in order to construct a relationship network.

We also compiled historical sales data to estimate that this series of rezoning decisions increased the value of the rezoned land by $710 million.

Our main finding however, is that well-connected landowners owned 75% of the rezoned land, but only 12% of comparable land immediately outside the rezoning boundaries, indicating that these decisions were primarily driven by the relationship networks of the landowners, rather than any technical assessment of efficient and appropriate locations for urban expansion.

Political favours in the property industry were found to be much more about being part of the entrenched well-connected political class, whose tight-knit mutual relationships support implicit favouritism, than about visible activities such as making political donations.

These well-connected landowners made $410 million in profit from the rezoning decision, at the expense of the public at large who had the option to instead sell those additional development rights. The data tells the story that connected property developers bought land unsuitable for development land on the urban fringe, then successfully lobbied State politicians and bureaucrats through their relationship networks to rezone areas where they had bought properties, wrong-footing both councils and other property developers. This process of influence took 7 years on average.

Scaling up our results suggests that the ‘back-scratching’ rezoning game has probably cost the general public many billions of dollars in Queensland in the last few decades.

We propose a number of technical solutions to this great game of political favouritism in land rezoning. The size of the gains to rezoning can be diminished by increasing land taxes. Development rights could instead be sold to land owners, perhaps through local auction processes, or the value gains recovered through a betterment tax. Even a local democratic system for voting on new areas for urban expansion would counterbalance vested interests with the interests of the public more broadly.

One unfortunate lesson however, is that the same relationship networks that allow favouritism to thrive in rezoning decisions will obstruct any systematic reform of rezoning processes.

UPDATE [1]: Please read the original study carefully to understand how we controlled for the fact that well-connected developers might be just better at anticipating where urban expansion will occur. Our control group of landowners are in almost identical locations.

UPDATE [2]: Seems that NSW is looking to one-up Queensland in the land development back-scratching game. Former Energy Minister for Chris Hartcher, who is under investigation by the corruption watchdog, is now lobbying on behalf of land developers.

Sunday, May 17, 2015

Environment Minister sabotages environmental groups

Minister for the Environment, the Honourable Greg Hunt MP. What a title. Pity the guy doesn’t deserve it.

Hunt’s latest effort is to conduct a Parliamentary Inquiry into the Register of Environmental Organisations, which maintains records for eligible organisations and carries with it tax deductibility status, and annual reporting obligations. 

The Terms of Reference clearly reflect an intention to amend the qualifying rules to ensure environmental groups that aren’t directly involved in ‘on-ground activities’ like tree planting, will have a hard time staying on the Register. Groups whose primary interest is in political lobbying on behalf of people who value the environment, such as the Environmental Defenders Office, the Wilderness Society and others, may lose support deductibility status, leading to fewer donations and ultimately less political clout. 

What sort of crazy political system would it be if we facilitated and supported organisations that involve themselves in political decisions on behalf of people who care about the environment?

The Honourable Minister for the Environment better do something about that. 

Sarcasm aside, the sad story behind this Inquiry is one of an elite group of vested interests pulling the strings of both major parties in Australian politics. Hunt knows the game is about a trade in favours, and he is doing his utmost to signal to mining and other business interests that he is on their side, and that he is a willing participant in a game of quid pro quo. I have no doubt that our ‘environment minister’ will find himself on the payroll of a major mining interest, or more than one, when he retires from politics. 

While cleaning up our political system will just about require a revolution, there a couple of simple things you can do about this Inquiry if you are interested in having an Australia that has an active organisational sector representing environmental protection. 

Or you can write a submission to the Inquiry yourself.

My submission is here (pdf) if you would like to copy from it in part or in whole.

Wednesday, May 13, 2015

Back-scratching: Do what's best for your mates and screw the rest

tl;dr I have a new experiment demonstrating the sheer power of back-scratching, even when it imposes huge costs on others. 

These days it seems that just about every political decision is about doing favours for the connected few at the expense of the many. It is part of an implicit quid pro quo; trading of favours now for favours in the future. 

I call it back-scratching, and it is a topic I have been researching for three years.

While trading favours can lead to amazing levels of productive human cooperation, it can also generate a considerable amount of unproductive cooperation when the trades benefit the few at a cost to the many. More than that, back-scratching can come with substantial efficiency losses; the costs to outsiders can far outweigh the gains to favoured insiders.

The revolving door between regulators and the regulated is one clear mechanism sustaining back-scratching. Ben Bernanke is just the latest long list of powerful regulators swinging through this door.

But studying back-scratching in the wild faces a major problem. Favours are almost impossible to objectively observe. Not only is there a powerful incentive to conceal favours, determining the ‘no favour’ counterfactual is almost impossible. Was the government contract given to the most efficient firm? Or was it a favour to the winner because an alternative bidder could have delivered a better outcome for the price? More often than not we just don’t know.

I have a new working paper out reporting an experiment on the economics of back-scratching. Studying back-scratching in a controlled experiment, while sacrificing realism, allows a close examination of the fundamental cooperative processes at play. The ‘big new thing’ I was able to do, in light of the long history of cooperation games in social psychology and economics, was to measure costs of back-scratching against an efficient counterfactual, and test which institutional designs encourage or curtail back-scratching.

To be brief, the basic experiment has 4 players in a group (the minimal number for an in-group and out-group to form), with one player able to choose which of the others to receive a prize of $25 in a round (in experimental currency). The payer who receives the prize allocates a fresh $25 the next round to one of the other three.

Obviously the best thing to do is form a back-scratching alliance with one other player and trade the $25 favour back and forth. Over 25 rounds an alliance pair would make $625, while the other two would make nothing.  

What makes back-scratching costly is that each of the potential recipients is given a randomly shuffled ‘productivity number’ each round, either 1, 2 or 3, which determines a payoff for everyone in the group. Each player gets an amount equal to the receivers productivity number in a round. Give the prize to the player who is 1, the group gets $1 each. Give the prize to the player with 3, the group gets $3 each. Think of this productivity number as reflecting the efficiency firms competing for a government contract. 

To sustain a back-scratching alliance means not choosing the most productive player for the prize in two-thirds of the rounds. It earns the alliance $725, the outside group $100, and comes with an efficiency loss of $100 from the repeated non-productive choices.

It turns out that most players repeatedly formed alliances, even though they were young honest university students who didn’t know each other. In real money terms (rather than experimental currency) alliance pairs ‘stole’ $30 from the outsiders to increase their alliance earnings by $20.

Surprisingly alliance players were happy about their actions. They thought they had been very cooperative by doing their mate a favour, and didn’t feel guilty about the costs they imposed on others. They also rationalised their behaviour, saying that forming an alliance is a justifiable strategy, while also concealing it by lying when explicitly asked in a later survey if they had formed an alliance.

I tested two institutional changes in the experiment. Staff rotation, a common anti-collusion policy, and a low-rent policy mimicking bureaucratic procedures to limit the size of prize able to be allocated with discretion. Neither was particularly effective at stopping back-scratching. I also manipulated the strength of relationships between players.

For me the take-home lessons are:
  • Loyalty is strong. Rotation policies are good, unless those people being rotated in have existing loyalties. This means there is a trade-off for regulators; staff with more industry experience are also likely to come with stronger prior alliances and hence be more prone to back-scratching. In politics it means voting in a different political party brings with it the alliances of that party.
  • Bureaucracy can work. The array of procedures emerging in our large organisations could simply be the result of seeking internal fairness over favouritism. But back-scratching can still arise even with minimal amounts of discretion.
  • Social norms are strong. In organisations or groups where some people are observed ‘doing the right thing for the group’, this quickly becomes the norm. Whereas where favouritism is observed, the group descends into counterproductive back-scratching.
  • Be loyal, but not too loyal. If your alliance partner fails to come through with favours when expected it pays to look for someone else whose back needs scratching.
None of this is really rocket science. If this sounds obvious to you then you’ve probably learnt a lot about human behaviour through life experience. It also means the experiment is capturing some elements of real phenomena.

After spending three years researching this topic, of which this experiment is a small part, I have come to the conclusion that group formation through favouritism is probably the primary determinant of political outcomes. Countries themselves can even be seen as a loose alliance of insiders looking to do what’s best for themselves even when it comes at a cost to other countries.

And if you look deep enough there is an evolutionary foundation for this behaviour. As Joshua Green explains:
Morality evolved to enable cooperation, but this conclusion comes with an important caveat. Biologically speaking, humans were designed for cooperation, but only with some people. Our moral brains evolved for cooperation within groups, and perhaps only within the context of personal relationships. Out moral brains did not evolve for cooperation between groups (at least not all groups). How do we know this? Because universal cooperation is inconsistent with the principles of natural selection. I wish it were otherwise, but there's no escaping this conclusion
This. Fundamentally. Is why corrupt back-scratching is so hard to eradicate, and why it will continue to be the main game in politics.