Thursday, January 28, 2010

UPDATE - How not to climb the property ladder

I really appreciated the discussion on my last post, and wanted to clarify some of the issues raised.

My two key points were:
1. The capital gain made from buying a cheap home and upgrading later does not always improve your ability to buy a larger place in the future, and
2. That forgoing life's little luxuries to start a savings plan directed at owning your own home is not always effective.  The 'work hard and save' mantra does not work if prices increase faster than your ability to save.

The issues flagged by readers were that
1. I ignored increased wages
2. I ignored the paying down of principle, and
3. I ignored the fact that rents increase in line with CPI while loan repayments do not.

My response is under the fold.

Tuesday, January 26, 2010

How not to climb the property ladder

Baby boomers and older generations often cite high expectations, and the inability to save, as the main hindrance to the younger generations’ ability to buy their own home. They go into great detail about how much it has always been a struggle to buy a home, and that if young people decreased their expectations and bought something small they could work their way up the property ladder.

I am one of those generation Ys looking to buy my own home, and from this perspective, it is not quite that simple.

The mythical property ladder
The argument that if younger generations decreased their expectations, and maybe bought a small apartment now, so that they could somehow work their way up the ‘property ladder’, is entirely misleading.

For example, a young couple buys an apartment for $200,000 in lieu of a $400,000 house they really want based on the contemptuous advice of older generations. They imagine that in 10 years they might be able to sell for $350,000, netting a profit of around $100,000 to spend on a larger home (after transfer costs). The problem is that larger homes have also increased in price by 75%, so that the $400,000 house is now $700,000. Buying that dream home has gone from a $400,000 prospect to a $600,000 prospect even with the apparent advantage of being on the property ladder.

The way to benefit from increasing property prices is to buy multiple investment properties, so that you leverage the benefits beyond your single dwelling needs.

No more avocados
Next, we can look into the arguments about spending a little less on luxuries to get a person into a home-buying financial position. Dining out, gadgets, and holidays all seem to get mentioned. But if we look into it, these relatively small expenses are not the main factor – the main factor is income.

A hypothetical future home buyer might spend $200 per week on dining out, ‘gadgets’ (mobile phones etc), and travel. That’s $10,400 per year – maybe $3,000 on a trip to SE Asia, $2,000 on gadgets, $2,000 on dining out, and the balance for other luxury items. Let’s see what that money could have done if it were funnelled into a property-buying strategy.

Assuming a starting point with no savings, this hypothetical person (or couple, or family) can save about $58,000 in 5 years assuming they receive 6% on their savings. If they thought they might one day want to live in a home that currently costs $300,000, by the time they save their $58,000 the home is worth $400,000 (at a 6% price growth rate). They now need $80,000 for their deposit. They continue saving instead of splurging and in another 5 years they have $137,000 saved. The home is now worth $535,000. They have enough for a deposit, but the repayments on their home and associated ownership costs are now around $900/week.

So after ten years of saving, living life without those luxuries that make it so much more enjoyable, they are in no better a position than before.

I’ll leave you with a question. If you bought a home for $100,000 in 1990, and the market his risen so that it is now worth $600,000, how much better off are you?

Sunday, January 24, 2010

How randomness rules our lives and why statistics need discipline

I have been reading Leonard Mlodino’s terrific book The Drunkard’s Walk, which is essentially an historical narrative on the development of thought around randomness and probability intertwined with modern statistical anecdotes. I would highly recommend this book to you all (especially if the inner nerd in you enjoys a little mathematical philosophy like mine does).

I feel the need to share some of the most interesting insights, and highlight some of my remaining concerns about the nature of randomness and probability. My main reason for caution is because the normally practical and insightful discussion occasionally crosses the boundary between mathematical and statistical insight and plain old common sense. These instances reiterate my stance that statistics need discipline. For now I will put these to one side – topics for future posts.  Today I want to share one of the more interesting insights into differentiating luck from skill with some basic probability theory.

Tuesday, January 19, 2010

Helmet law rebound effects and the success of terrorism

I write regularly about rebound effects - those unintended consequences that occur due to behavioural adjustments.   I wrote my Master’s thesis on the rebound effects from energy efficient technologies and household energy conservation behaviour (a good summary is here, my thesis is here, a draft paper on household conservation is here, and a draft paper on the effect of government environmental subsidies is here)

I have written about rebound effects from using photovoltaic panels.  The rebound effect from recycling, which enables us to use even more of the raw material we are trying to conserve. Recently, I wrote about the potential rebound effect from sunscreens – because we don’t have the immediate signal of sunburn to tell us that we have had enough sun exposure, we tend to spend more time in the sun.

One area I am particularly adamant that unexplored rebound effects exist is in preventative health care costs – by preventing one disease, we enable people to succumb to other diseases, which have potentially greater treatment costs.

But these sly rebound effects do not end there.

Sunday, January 17, 2010

Population growth and the residential property market

I have been asked to develop further my ideas on population growth and residential property.  I hope to make it clear that arguments using population growth as a cause of future house price growth are probably misleading.

The first chart (above) shows the rate of population growth (RHS) and the the growth in the ABS capital city price index (LHS).  There are two important things to take away from this chart.
1. The rate of population growth can change very rapidly, and extrapolating past trends will always miss changes to this rate.
2. There is no significant relationship between these two figures over the period.

Wednesday, January 13, 2010

The land tax remedy

I have made  my point about the social benefits of land taxes clearly in the past.  I want to now direct the interested reader elsewhere for some informative discussion.

Here is an excellent article discussing land taxes and land price bubbles in an Australian context.  More from the same author here, and a plug for his personal blog here (take note of the CPI discussion - I want to discuss that in more detail in the future).

For those who want to digest some of the classic writings on the issue, see Progress and Poverty by Henry George (written in 1879).

Unfortunately there is a powerful political lobby working against such beneficial tax reform.  The Property Council of Australia has been pushing for reductions in land taxes, citing any increase in tax revenue from this source as a national embarrassment.  Of course, the large increase observed in Queensland (below) is partly due to the extremely low land tax base in 2007/08.  Not mention of the scale of the tax, just the increase.  Queensland's land tax revenue was just a third of the land tax revenue of NSW in 2007/08.

A little off topic now, but over drinks on the weekend I was talking to a Dutch friend of mine who also happens to be an economist.  He is thinking of moving to Australia but is very hesitant due to the exorbitant cost of living here compared to incomes.  He recently bought a new apartment in a the 'happening' part of town, and his total costs per month (including loan repayments, body corporate, rates, and his insurance for the home, car and motorbike which are a package) are 800Euro ($1300AUD). That's only $300AUD per week for all those expenses combined! That is below the median rental rate for a 2 bedroom apartment in Brisbane (including new and old stock).

There are a number of reasons for this.  In Holland, interest on loans for owner occupied dwellings is tax deductible.  The interest rate itself is just 4%.

So if the Dutch average household income is slightly higher than Australia's, and the Dutch have generally less land available, why is owning a home so affordable there?  And why is the rate of Dutch home ownership (54%) much lower than Australia's (70%)?

The sunscreen rebound effect

I’ve just returned from a few days at the beach with my family. One thing that stands out as a key function of a parent in the summer beach environment is making sure your child avoids getting sunburnt.

This got me thinking about a world without sunscreen. This cheap little cream enables us to withstand sun exposure like super-humans, avoid painful sunburn, and partake in activities that would be out of the question in a 'no sunscreen' world.

Since sunscreen allows us to tolerate so much more exposure to the sun, is it actually contributing in some way to increased incidence of skin cancer? Are the net health benefits of sunscreen actually much lower because of our change in behaviour?

 How big is the sunscreen rebound effect?

There seems to be some acceptance of the sunscreen rebound. This article states that “Sunburn may even protect against melanoma - by keeping people out of the sun.

Again here:
The Australian experience provides the first clue. The rise in melanoma has been exceptionally high in Queensland where the medical establishment has long and vigorously promoted the use of sunscreens. Queensland now has more incidences of melanoma per capita than any other place. Worldwide, the greatest rise in melanoma has been experienced in countries where chemical sunscreens have been heavily promoted.
And here:
...sunscreen use tends to prolong the amount of time people spend in the sun while they are on vacation—and that only sunburn modifies the behavior of sun-seekers
And here:
Sunscreens suppress natural warnings of overexposure to the sun and allow excessive exposure to wavelengths ofsunlight which they do not block. Because sunscreens create a false sense of security, more effective measures to reduce sunlight exposure, such as limiting time spent in the sun or use of hats and clothing, may be ignored.
My experience suggests that all of these statements are true to some degree.

If everything was held constant - time in the sun, covered clothing, etc (notice the decline in hat wearing in the past few decades?) - then sunscreen may be quite effective at preventing skin cancer. But humans have a tendency to adjust their behaviour to take maximum advantage of such innovations.

The question that remains is whether there is still a net health benefit from sunscreen. But due to the plethora of uncontrollable variable in any longitudinal study, I'm not sure that we will ever have definitive statistical evidence for this.

Thursday, January 7, 2010

Are economists cheapskates: A case study

Lately, economists have been copping it from all angles.  They have been widely acknowledged as cheapskates, following this Wall Street Journal article.

My personal view is that economists are either; (a) more aware of the satisfaction they derive from various goods, services and activities (they know their utility), or (b) studying economics makes us more aware of which choices provide more satisfaction.

I tend to agree with this point about economists, and myself in particular (from here):
They are cheap in the sense that they need to be convinced of an item's value—and be convinced of the fact that there is no cheaper way of getting that item—before paying up. They hate being wasteful, and they take a cold, scientific approach to maximizing efficiency.

Tuesday, January 5, 2010

GI Joe and the Market for Lemons

GI Joe is possibly the worst movie ever (see the number of goofs and plot holes here). But I still spent 2 hours watching it, even though there were plenty of better things to do with my time. Am I simply a fool?

The answer is, well, maybe. The reason I sat all the way through is that I thought the movie might redeem itself by having a nice twist at the end, or even a few cheesy lines that I could laugh at. But no.

Considering the number of terrible films made this type of situation is relatively rare. It is easy to get a number of honest reviews to narrow down the quality before watching a film.

In any case, it got me thinking that movie markets are similar to lemon markets because the quality of the good cannot be known in advance. In a true lemon market the quality cannot generally even be known after the good is consumed.

Sunday, January 3, 2010

Economics of work and leisure

Recently, I cut back work to 4 days a week with a surprising result. Rather than feeling like I am enduring marginally less of a bad thing, I am actually finding work more challenging and interesting – even though I am surrounded by the same public sector circus.

I feel like a 20% cut in work has resulted in an 80% improvement in my work satisfaction, rather than merely a 20% boost.

As an economist I really shouldn’t be surprised. Economic theory suggests an optimal work time – there are decreasing marginal benefits to work (in terms of pay), and increasing marginal costs (in terms of time, level of stress, level of frustration etc).

But this experience (and the popularity of this television show) has got me thinking about how the wellbeing of society at large can be improved by working less.