Tuesday, July 27, 2010

Economic myths - another dose

Population growth

I have written at length on why population growth does not improve welfare. Mark Crosby over at Core Economics reiterates these fundamental arguments.

The pro-population growth arguments are theoretically flawed, and empirically dismissed. Below is a chart of the relationship between population growth and GDP per capita for around 200 countries and localities, showing a distinctly inverse relationship. If I was in the business of improving welfare, low population growth would be a key avenue.
Another emerging myth is that population growth will decrease interest rates. Renowned property spruiker Chris Joye has created plenty of media fanfare recently with his spurious connection between population growth and interest rates. This table shows the interest rates in 23 countries, and if I’m not mistaken, shows that countries with the lowest population growth (and highest GDP per capita) also have the lowest interest rates.


Food myths are widespread. The environmental movement wants us to believe that vegetarianism is better for the environment and that ‘organic’ (what does that mean?) food is more nutritious and can solve hunger around the world. The agricultural lobby would have us believe that food self-sufficiency is of utmost importance, although their argument is shallow at best.

The latest myth to be busted is that chickens are pumped with artificial hormones and steroids to make them grow faster and larger. However, it appears that hormones are not part of the poultry picture at all.

While I firmly believe that raising animals for food should be conducted in a humane manner, those who push for change would garner more support if they were fully informed of current practices - their message could then be taken seriously by industry and government. Furthermore, the organic food movement could concentrate on promoting farming practices that reduce externalities, as a result of chemical use for instance, and improving land quality. The incentives for such change often align with the long term goals of the agricultural industry and may attract wider public support.


Under the rebound effect banner I have discussed how some innovations to improve safety can backfire if peoples’ behavioural response is to take on more risk. For example, the vigorous uptake in sunscreen use has led to a culture of sun exposure, offsetting the intended consequence of reduced skin cancer rates. The name for this behavioural response in the context of risk taking is the Peltzman Effect.

You can find this type of response in broad range of situations. Most recently, in trials of automatic lane correction technologies in cars, one participant noted:

...that she would love to have this feature in her own car. Then, after a night of drinking in the city, she would not have to sleep at a friend’s house before returning to her rural home

Minimum wage

The business lobby loves the textbook response to minimum wage laws, but even world renowned economists are sceptical.  No doubt this debate will continue.

Thursday, July 22, 2010

Stay informed for Election 2010 - Labor Factions: Basic Questions Answered

By Andrew McMicking

Why does the ALP have factions? What are the benefits?

Factions have been set up to serve a useful purpose in the ALP. In brief they:

• Allow support to be readily marshalled behind candidates and ideas.
• Provide for a sharing of power between different philosophical or ideological interests in the party.
• Serve as a mechanism to settle disputes.

Any organisation or group of people – be it the workplace, a golf club, church group or school classroom – will always see groups of like minded people associate more readily together. The ALP has recognised this and, through factions, has formalised such groupings. Members and unions in the ALP can now formally apply and join a faction. Each faction usually has a membership list, executive, AGM, bank account, fundraising activity and negotiation committee for dealing with other factions. This formalised nature allows the principle of solidarity to be applied i.e. a decision is made within a faction and all members are bound to abide by that decision.

What is Right and what is Left?

You often here the terms ‘left wing’ and ‘right wing’ applied to factions by both the media and in public discussion. In political/philosophical terms, ‘right wing’ means you tend to take a more conservative and pragmatic view of policy issues, whereas ‘left wing’ means you tend to take a more reformist or progressive view. Support for a budget surplus, tax cuts as opposed to more government spending, a close defence relationship with the US, free market economics, less red tape for business and uranium mining is regarded as ‘right wing’. Support for greater government spending on health, education, disability services and infrastructure, an Australian Republic, recognition of the rights of indigenous people and other minority groups, and opposition to the war in Iraq is regarded as ‘left wing’.

What do we currently have in Qld? Federally?

The ALP, in each State, have factions which can be classified as either Left or Right.

In Qld we have The Left as a left wing faction. However we have two right wing factions: Labor Unity known as the ‘Old Guard’ (refer page 3) and Labor Forum known as the ‘AWU’ faction (as the AWU, Qld’s biggest union, dominates this group). These two factions are now in close alliance together and many view them as one right faction. They technically remain separate entities, though, and many in Labor Unity would not see themselves as a right wing faction, but more in the centre between The Left and Labor Forum.

Monday, July 19, 2010

Is residential property Super?

The retirement plans of working families may soon succumb to Australia's residential property mania. If Chris Joye had his way, Australian super funds would invest in the emerging residential equity market to diversify their portfolios against highly correlated domestic and global equities markets. The argument for this move is summarised below.

Investors, such as super funds, get extremely low-cost, highly enhanced and very long-dated exposures to what has, during the past three decades (including the recent calamity) been the largest and best performing of all investment classes: residential real estate. Historically, investors have only been able to access highly concentrated, risky development-style holdings comprising small parcels of properties that incur heinous transaction costs of about 12.5 per cent. By investing in a portfolio of thousands of shared equity interests, super funds could avoid all of these costs and secure the low risk diversification that they have never had before. Independent actuarial analysis suggests that about 15 to 30 per cent of all super fund capital should, in theory, be allocated to housing, in part because its returns are so unrelated to the performance of other investments. Compare the 50 per cent plus losses in shares and listed property trusts in the past year with the fact that the RP Data-Rismark Australian House Price Index has tapered by only -0.8 per cent. (emphasise added)

Is this idea worth embracing? Or to put it another way, how many people would actively choose to invest superannuation in the residential property market?

Super funds investing in residential property equity face a couple major of problems in my view:

1. decreasing the diversity of investor portfolios, and
2. moral hazard associated with residential equity finance.

Tuesday, July 13, 2010

Skilled labour immigration removes incentives for Australians to invest in education

The shrill from commentators warning of Australia’s apparent skills shortage is deafening. But there are a number of reasons why this claim, and the inevitable recommendation for government to increase quotas of skilled migrants, is flawed, and why the solution is not in the best interests of Australia in the long run.

For the acute observer the transparent falsehood of the claim jumps right out at you.

… skilled labour in an area like project construction is an international problem, so poaching what we need from overseas is not going to be easy.

ACIL Tasman points out that LNG project specialist workers are globally mobile, moving from site to site (and often between projects at varying stages of development) – wherever their services command the highest price. As the consultants warn, opting for less-experienced personnel carries with it the dangers of higher error rates in construction and resulting delivery delays and still more expense.

Translation: if you want the skills you need to pay.

A government with backbone, and an eye on long term prosperity, would tell industries crying poor to sort it out themselves. Large mining and gas projects have very long lead times - long enough in fact to train some of the existing workforce in skills that may be required for future projects. If you need the slam-dunk of skills and experience, you are inevitably poaching people from another project - experience only comes from a finite number of places.

Sunday, July 11, 2010

Generations of housing affordability

The degradation of housing affordability is widely acknowledged, but unfortunately mainstream explanations miss the fundamental stories of easy credit and tax rules encouraging property speculation.

One of the best collections of Australian residential property analysis on the web has emerged at The Unconventional Economist.  Leith's latest article explores changes to housing affordability since the 1970s and the key drivers behind the change. 

He summarises the article as follows:
  • It is the demand for, and supply of, credit that is the key determinant of house prices. Whilst demand-side factors such as tax concessions, benign economic conditions, and population growth might increase people's willingness to borrow for property, ultimately, if you cannot obtain the finance, you cannot pay a high price. Similarly, tight housing supply would have little impact on house prices when credit is not readily available.
  • Lower interest rates and easy credit do not make houses more affordable. Rather, they quickly get capitalised into house prices, increasing the amount that home buyers must borrow.
  • When examining interest rates and their effect on housing affordability, it is real interest rates (i.e. the mortgage interest rate less inflation) that matters. Whilst mortgage interest rates averaged a seemingly high 9% in the 1970s, due to high inflation (averaging 11%), real interest rates were negative, resulting in borrowers' mortgage debt being 'inflated away'.
  • Importantly, be very weary of offers of more credit and the promise that it will "improve housing affordability". Any scheme that increases home buyer's borrowing capacity, such as shared equity loans and the Never Ending Mortgage, will instead fuel further house price growth, thus eroding affordability.
  • Beware the property spruiker. Always be sceptical when reading property-related articles in the press, or when listening to politicians talk about housing affordability. Whilst they might, on the surface, sound reasonable, they are often talking their own book. Instead, think critically about their motives and who their constituents really are.

Tuesday, July 6, 2010

Effects of dwelling composition in the property market

Much popular property market analysis based on flawed principles.  A secret to identifying rubbish analysis is to note the following meaningless buzzwords and phrases; underlying demand, housing shortage, urbanisation or population growth.

These buzzwords are based on a fallacy.  The problems they have in common is that they are quantity based (thus ignore prices), and they ignore changes in the composition of dwellings.

Commentators calculate underlying demand by dividing the quantity of population growth in a given period by the average occupancy rate.  This is supposed to give a measure of quantity of dwellings that ‘should’ be constructed of the period.  Unfortunately, the occupancy rate itself changes over time.  It has been declining dramatically for three decades.  If the trend continues we may soon be able to calculate a housing shortage even if we build a new home for every new person!

Calculating a ‘housing shortage’ is then a simple matter of subtracting the number of dwellings constructed over a time period from the underlying demand.  The graph below shows the result of this calculation for Australian from 1994 – 2009 using quarterly data (and the occupancy rate at each quarter – not the current occupancy rate).

Spruikers use this measure to justify the likelihood of price gains, yet the price changes observed seem to in fact be inversely correlated to underlying demand.  We had a price boom from 2002-2004 at the same time as a housing surplus!

These measures also fail to acknowledge the heterogeneity of housing.  Counting a studio apartment and a 5-bedroom house as equal in the calculation of a housing supply is a mere fallacy.  Clearly these two different dwellings will house different numbers of people.

Furthermore, the size of existing homes changes over time with renovations and extensions.  It has been widely acknowledged that many home owners have chosen to renovate instead of relocate in their search for more spacious accommodation.  It is easy enough to imagine a street of heritage homes, for example, being renovated and extended to allow a large increase in the population of the street.  No new homes, plenty of new people, and no housing shortage.

What we have seen in the latest property boom is a continuation of the trend to build larger homes with more bedrooms, while the occupancy rate continued to decline.  At some point you would expect the occupancy rate to bounce back before we all ended up living alone with three spare bedrooms.  And it did. 

The ABS summarises the long-term change in dwelling composition and occupancy as follows:
The average number of persons per household has declined from 3.1 in 1976 to 2.6 in 2007-08. In the same period, the proportion of dwellings with four or more bedrooms has risen from 17% to 29% and the average number of bedrooms per dwelling has increased from 2.8 to 3.1.
In 2007-08, most households enjoyed relatively spacious accommodation. For example, 86% of lone-person households were living in dwellings with two or more bedrooms; 75% of two-person households had three or more bedrooms; and 35% of three-person households had four or more bedrooms. Over a fifth (21%) of three-bedroom dwellings, and 8% of four-bedroom dwellings, had only one person living in them
Important demographic reasons explain why we should expect the declining occupancy trend to come to an end.  The aging population including baby-boomers downgrading is a key way in which this will occur (others include a rise in share housing by the forever young Gen-Y who are delaying family formation).

For example, the parents of a family whose adult children have moved out with friends or partners might find that the upkeep of a large house conflicts with their ‘grey nomad’ retirement plans.  They can sell their 5-bedroom house and move into a new 2-bedroom unit, pocketing the price difference for their retirement. 

In this scenario, the construction of a 2-bedroom apartment resulted in a 5-bedroom home being available to meet the housing needs of population growth.

The final fallacious buzzwords that provide property bulls justification for their position are urbanisation and population growth.  If we were discussing any other good or service the pattern of habitation would be of little consequence to the expected prices.  Increased urbanisation doesn’t drive up the price of food, petrol or any other goods – nor does population growth.  

Increased urbanisation can lead to increased land prices, but that doesn't necessarily lead to increases in median housing price measures due to compositional change.  Because new dwellings in outer areas are typically inferior locations to existing homes, the prices one would expect for identical dwellings in new estates would be lower.  Since there is more land at the fringes of cities, we would expect that proportionally more cheaper dwellings to be added to the mix of housing.  Prices for existing homes can rise, but due to the greater proportion of housing in outer areas in the mix, a price index can remain flat at the same time.

The table below shows a hypothetical city made up of identical dwellings, where new supply is mostly added at the fringes.  Even though the price of each individual dwelling increases 10% over the period, a city-wide mean price index would remain flat due to the greater proportion of cheaper dwellings.  The same effect can happen with new apartments in traditional detached housing areas.
Also constantly overlooked is the fact that urbanisation can only occur AFTER new urban dwellings are constructed unless driven by an increase in occupancy rates.  Until the end of 2005 prices was rising fast, urbanisation and population growth were occurring, but the occupancy rate continued to decline.  

Analysis of the property market should focus on returns in comparison with other investments, with renting (user cost approach), and historical returns.  Counting dwellings, and implying demand from population growth or urbanisation is problematic due to compositional factors.

Sunday, July 4, 2010

Automation and the housework rebound effect

As I have previously argued, innovations that aim to save time, increase safety, decrease energy consumption can be subject to flow-on rebound effects that lead to the opposite result. These counter-intuitive results have lead to ineffective government intervention and bizarre social norms.

A typical challenge to the idea of rebound effects goes like this.

“If a business has to pay each worker more due to government intervention on wages, they are clearly going to employ fewer employers. Are you challenging the Law of Demand? If the price of labour is higher, demand will be lower.”

No, I don’t argue that if we hold everything in the world outside of an individual business constant that the business will employ more people. I argue that to believe the world is held constant robs you of the vision to see flow-on effects to society and the ability to estimate the real net effect of a policy or action.

Today's rebound effect concerns time saving and housework.

Wednesday, June 30, 2010

End of Financial Year Wrap Up

All things considered, the Australian housing market looks ready to dive.  My conversations with real estate agents are the only ones they've been having - no buyers are willing to even make a call at the moment.  Home lending is down, prices are taking a u-turn, sales are down, and first home buyers are lost somewhere in the mist of winter mornings.

There has been some interesting analysis from Steve Keen lately, along with the more spruikung from renouned pro-housing, anti-commerical property, anti-shares, anti-all other investments, man on the spot Chris Joye.

My outlook – a surprise drop in home prices leading a significant decline in economic activity in Australia. The Reserve Bank will act promptly to reduce interest rates while pointing fingers to troubles abroad. Bulls will then promptly join the finger pointing, noting how exceptional strong Australia’s housing market has been and the supply shortages still threaten to create future unaffordable housing.

Aspirational home buyers should take a look at a true financial comparison of home ownership and renting before making any major decisions.

The Australian dollar will not be safe.  Think September 2008 all over again.

Two new blogs worthy of mention are Delusional Economics, where you will be enlightened by some straight talking no-nonsense commentary, and a special mention for the Unconventional Economist for some very high quality articles on the Australian property market.

My attitude on helmet law rebound effects has been seen as quite controversial. But for those interested this site articulates my position quite accurately. 

Experience shows helmets give only limited head protection. Studies in Australia show some prevention of superficial injuries (such as scalp lacerations) but only marginal prevention of “mild” head injuries and no effect on severe head injuries or death. When helmets were made compulsory in Australia, admissions from head injury fell by 15-20%, but the level of cycling fell by 35%.

To summarise, helmet laws led to a major decline in cycling.  Fewer cyclist on the road decreased awareness of them by drivers, leading to cycling in general becoming less safe.  Further, helmets themselves offer limited head protection in a limited number of crash circumstances - a helmet doesn't help much if you go over the handle bars and land on your face for example. And if you get hit by a truck (the classic pro-helmet argument) you are stuffed whatever you are wearing on your head.

If the financial and economic circus of 2009/10 has been all too mauch, it might be time for a holoiday.  For those who take this advice but want to optimise their holiday time, have a read of this quality article.

Sunday, June 27, 2010

Creating road space without building roads

This unreliable article suggests that each passenger trip on the QR passenger network is subsidised in the order of $9 – probably double the average fare price. How this figure was determined is anyone’s guess, but the issues surrounding such apparently high subsidies are interesting.

While at first the $9/trip figure may seem high, it is important to acknowledge that the benefits of subsidising public transport do not go solely to the users. Each time a person uses the rail network they are not using the road network (either car or bus trips) - thus simultaneously improving traffic conditions for road users. What looks like a rail subsidy could easily be classified as a road subsidy. The reduction in road usage has a similar effect to increasing road capacity.

Most public transport systems around the world are subsidised from the public purse. If you subscribe to the belief that a degree of government support is warranted due to external benefits for road users, the two key questions to consider are:
1. How much of a subsidy is acceptable?
2. How can incentives be provided to improve the efficiency of the whole transport network?

Some guidance on the first question could be gained by looking at a cross-country comparison; however the second question is far more interesting.

We can see examples of the failure to consider multiple types of transport as a single efficient solution to urban (and regional) mobility. The profitability of the Airtrain has been completely undermined by subsidised expansion of competing road networks. Had the government instead heavily subsidised the Airtrain link itself (to make ticket prices an attractive alternative to taxis and car pickups), the demand for road space would have reduced as train use increased.

Further, the success of the rail network rests on the failure of its competition. We can never reach a situation where there is high public transport patronage while at the same time having cheap uncongested private automotive alternatives. These two networks are in competition and the direction of government assistance can tip the advantage either way it chooses.

The ignorance of this reality and the external benefits from new transport connections may be one reason that the traffic forecasting for Brisbane’s major road projects grossly overstated traffic demand.

Using this case study we can make a couple of pertinent observations:
1. New transport connections provide internal benefits to users, as well as benefits to users of competing transport connections
2. Subsidies to incentivise rail use can provide the net effect of increasing road capacity through road spending.