Monday, July 30, 2018

A comment on property taxes and prices

Image source: Los Angeles Times

The low prices in the 'no-zoning' city of Houston, Texas, are repeatedly called upon as an example of how zoning increases home prices by reducing housing supply. I have debunked the 'Houston argument' before.

But I want to now briefly comment on how the property tax regime in Houston, and Texas generally, is a major factor keeping home prices lower than otherwise. To do this I calculate the price reduction that would occur to a home I own in Brisbane, Australia, from adopting the much higher property tax regime of Houston.

My home in Brisbane is worth about $430,000. I pay $2,260 per year in property taxes (or council rates as we call them).

Looking briefly at housing options in Houston, Texas, homes with a similar market value are paying between $6,800 and $10,000 per year in property taxes— more than three times as much (and up to five times as much, depending on location).

So, how much cheaper would my Brisbane property be if we adopted the property tax rates of Houston? Rather than taxes at 0.5% of market value, like mine, they were increased to 1.6% of market value.

The answer is that my home would be at least 22% cheaper. The extra 1.1% of market value per year tax liability would reduce the market value of my home from $430,000 to around $335,000, with the loss being the present value of this higher 1.6% tax obligation associated with ownership (at the new $335,000 market value).

In areas where the capitalisation rate of housing is lower than Brisbane, like Sydney and Melbourne, the price effect could easily be higher than 30% (as I have previously explained here).

Before we look to zoning and planning issues to reduce home prices, which even advocates believe could at best reduce prices by 10% over a decade[1], maybe a hard look at the property tax system would help.

fn[1].  This is conditional upon property developers voluntarily building so many new homes they force prices down, and that an extra 2.5% of the workforce, or 300,000 people, could be pulled from other industries to increase construction output by 30% more than the record high construction rates over the past decade.

Wednesday, July 18, 2018

July rants

1. Ocasio-Cortez
Trump says nonsense daily. Obama tells flat out lies. Yet a passionate new political player can send the 'twitter leftie economists’ crazy simply by answering an interview question about the unemployment rate in an ambiguous way (despite the answer as a whole having merit).

If you want to give a free pass to your enemies then keep attacking your allies.

2. Capitalism vs socialism
This whole debate is a waste of time. There is already extensive social control and ownership of the ‘means of production’ in all 'capitalist' countries (see video below). The public sector component of GDP is more than 37% in the ‘ultra capitalist’ US, while it is over 50% in many European countries. Even the apparently capitalist Singapore is, in reality, a massive socialist experiment.

Capitalism and socialism are just words you use to signal loyalty to your group, who will interpret them however they like. They don't help you lobby for specific policy changes that you think will make the world better.

3. Job guarantee vs basic income
Another case of groups with basically the same agenda undermining each other. There is nothing incompatible, technically, about these ideas. You can give everyone money unconditionally and offer anyone a job who wants it so they can earn even more money. This is what I think should be done, and we should make a big push, politically, in that direction.

One’s position on this often comes down to their moral philosophy about the value of work. Or in other words, is poverty the result of not having money, or not working for money?

This moral distinction is also important for related social questions. Do job guarantee advocates also think that offering our elderly a job is better than offering them money? Why not both?

4. Plastic straws
If our problem is plastic in the ocean making it uninhabitable of many species, I don’t see how banning straws is the solution. At best it is a distraction, and could just be an excuse for those companies or individuals going ‘strawless’ to feel good (moral licensing anyone?).

If your backyard was full of plastic would you stop buying straws? Would that fix it? Or would you get cracking on cleaning it up?

We put men on the moon. Some crazy billionaires are in a race to put us on Mars. We can spend trillions on military weapons suitable for fighting the last wars, not the next ones. How about a few billion dollars spent on ships, equipment, and manpower, to clean up our oceans and rivers? Call it ‘Ocean Force’ if it makes you feel better.

The environmental movement is plagued by these dilemmas. Should we reduce meat consumption because of the land use conflicts between grazing and native wildlife habitats? It’s easy, not effective, but provides a sense of moral superiority. Or should we organise to protect important wildlife habitats from being cleared for farming, but allow people to eat whatever they like? It’s not easy, but it’s the only thing that will work.

Sunday, May 6, 2018

Time to unwind the superannuation system

It is about time someone was honest about Australia’s superannuation system. This multi-trillion dollar financial monstrosity funnels money upwards to the wealthy via tax gifts while failing on its promise to reduce the ‘burden’ of the age pension.

Let's unwind the system.

The easiest way to unwind superannuation is to allow funds to be accessed by any account holder at any age up to a maximum value of, say, $20,000 per year, tax-free. Half of superannuation account holders would get all their money back in the first year as the median account is just $17,000. Over time this procedure would incrementally give back funds at a rate that is proportionally higher for lower-income households, improving fairness and equity — something the system itself was poorly lacking.

A rough guide to the cash refunds each year is shown in the chart below. In the first year, nearly $600 billion is returned to account-holders, trailing down to about $60 billion in the tenth year, and removing $1.7 trillion from the system over a decade.

Over time, the 29 million superannuation accounts that currently hold $2.2 trillion in assets would be emptied out, allowing people to actually spend the money they have earned the way they want in the real economy (as opposed to the financial markets). The economic stimulus provided by this transition period would be epic, and the resulting boom will create exactly the type of capital investment that the superannuation system itself was intended to create. Unfortunately, misguided economics meant the superannuation system did the opposite — reducing spending in the real economy in favour of institutionalised mass financial speculation.

An added benefit is that asset prices, including property, may fall as a result of billions of dollars no longer being forced into financial markets each year.

To keep quiet the financial bullshit machine that sold us the superannuation system we can instead issue ‘pension options’ to taxpayers to ensure we 'pre-save', just like in the economic myths they recite. Issuing these new financial instruments would replicate the current financial nonsense going on, but in the public sphere, and for almost no real cost.

It would work like this.

When you pay your tax each year part of the money goes to buying a financial asset from the government in the form of a newly created ‘pension option’. Like other financial options, this is a valuable asset that you can hold to save for retirement. In retirement, to get the public age-pension, you must exercise the ‘pension option’ you previously bought with your tax money.

If you are concerned that this asset is also a liability to everyone else, then welcome to superannuation, where we have taken liabilities "off-budget" and into the financial markets at large.

Doing things this way, we get all the financial bullshit that should keep the pre-saving true-believers happy, but it won't cost us nearly $30 billion per year in tax breaks for the rich, and another $30 billion in fees for financial speculators to “manage” our money.

Tuesday, April 17, 2018

Delay or Develop? What really determines the rate of new housing supply

Recent reports by Grattan Institute and the Reserve Bank of Australia have argued that zoning is a significant cause of Australia’s high home prices. Yet neither organisation has applied the appropriate economic theory to the property market, leading to conclusions that are almost the complete opposite of reality.

The main issue in property is that the static equilibrium assumptions of short-run supply and demand economics do not apply. If you try to apply these models you will interpret the market, and policy effects on it, incorrectly. Please read this article for some background on the gap between reality and what static equilibrium means when applied to land markets.

I’m not being radical. I’m not trying to earn street cred by being the anti-establishment economist. All I am doing is applying the totally standard, but correct, economic framework of real options.

It took me a long time to learn about property markets and how important real options are to understanding them. When I began studying economics the stories most economists were telling about property markets conflicted with my previous experience as a trained valuer working in the development industry. I had to really search to dig out this often-ignored but crucially important part of economics.

I want to use this post to explain why static-equilibrium analysis of the supply and demand type does not apply to property, provide a quick lesson on real options, and show how real development behaviour is best predicted by a real options approach.

First, the monopoly question
Land is a monopoly. This is fundamental to understanding property markets.

The reason is that there is no free entry — any potential market entrant must buy land from an existing monopoly owner. In practice, this means that property developers cannot be in the business of maximising turnover or undercutting each other on price since once they have sold all their new dwellings on one parcel of land they are out of business. They must buy back into the market from another land monopolist.

It is only because of this monopolistic power that land has a non-zero market value at all. Indeed, for a land market to be competitive we must be able to produce land (locations) with non-land (non-location) inputs.

In practice this means that each landowner is their own ‘little monopolist’ and their individual incentives are reflective of the incentives of the market as a whole.

The vacant land problem
The trick to understanding the dynamics of land development is to ask the question ‘why is there vacant or underdeveloped land’? In a short-run equilibrium model of supply and demand this can’t happen — all options to develop must be taken up (this underlying model gets a geographical twist in the Alonso-Muth-Mills model).

Let me quote David Pines on this.
The static approach in the Alonso-Mills-Muth model is useless in explaining many stylized facts regarding the urban structure and its evolution through time.

The reason for the failure of the static model in explaining these ‘irregularities’ is that the housing stock is assumed to be perfectly malleable, which, of course, is highly unrealistic. 
What he means is that to ‘clear the market’ the model requires complete demolition and rebuilding of the city in response to any change in price, population, or preferences in order to ‘clear’ the market. This is obviously not how the dynamics of housing supply operate. In the model, there cannot be any vacant land nor opportunities to develop — all development has already taken place!

The reason there are still vacant plots of land able to be developed becomes clear only in a real options framework. A vacant plot, despite making no current income, contains options for future uses, such as to build a house, a new retail centre, or new commercial or industrial facility. It has a value because of the future options for income flows it represents.

Because development is a one-shot game, the decision for a landowner is a joint one of what to develop (residential or commercial, a 10 storey or 20 storey building, etc.), and most importantly, when to develop. Developing land now eliminates potentially valuable options to develop differently in the future.

A real options example 
Let me try and convey the basic idea of real options as they apply to land development with the aid of the below diagram. Only through this lens can we consider the crucial question when development will take place, as well as how much will take place on a particular plot of land.

If you are worried about the total growth in the housing supply then the ’when to develop’ question is the much more important one.

The diagram shows on the left a ‘binomial options tree’ with the available future options for apartment development in two years time compared to the optimal (profit-maximising) development today for a hypothetical plot of land without zoning controls or limits on development density.

Two possible future states of the world are shown; one where price growth for apartments means a 20 storey building is optimal and profit-maximising at that point (providing a $15m profit), and one where prices rise only a little, and a 10 storey building is still best but at a lower total profit (of $12m). Each is judged to have a 50% chance of occurring.

Under this scenario, we can now consider the joint problem of the landowner — when to develop, and what to develop (10 or 20 storeys)?

The ‘when to develop’ question can be answered by comparing the present value of building now or waiting and having a 50% chance at each of the two future options. With a 10% per year discount rate we simply consider whether the present value of building today exceeds the expected present value of waiting.

Build now: PV = $10m
Wait two years: PV = ($12m x 0.5 + $15m x 0.5) / 1.21 = $11.2m

In this case, the best thing to do is wait and keep the property vacant for two more years. Then, in two years, the same decision will again be made, and perhaps then it will also be optimal to delay.

On the right part of the diagram I have shown a scenario with zoning that applies a strict height limit of 10 storeys. Here there is no upside option from waiting. In the language of real options we have ‘reduced uncertainty’.

We can then rerun our calculations to see whether waiting or building is the profit-maximising choice.

Build now: PV = $10m
Wait two years: PV = $12m x 1 / 1.21 = $9.9m

Look at that! Now the profit-maximising decision is to develop a 10 storey apartment building today. By imposing zoning we can increase the supply of housing by a 10 storey building’s worth of apartments compared to the alternative no-zoning situation!

Providing the option to build higher in the future increases the present value of the land, but also provides the incentive to delay development! The same logic applies to zoning rules that allow both commercial and residential uses. Removing commercial development options for landowners can bring forward residential housing supply.

If that sounds a bit crazy and contrary to ‘economic intuition’, maybe you will take more seriously Sheridan Titman who made the exact same argument in the American Economic Review back in 1987.
… if uncertainty is increased in a manner that keeps the state prices constant, prices of both land and building units as well as rental rates will increase, a larger portion of the land will remain vacant, but taller buildings will be constructed.
Let me translate. If “uncertainty is increased” means that more future options are added to a landowners rights, like what happens when zoning controls are removed. Keeping the “state prices constant” means that the relative prices of different types of dwellings or commercial buildings are expected to be the same when the uncertainty change happens. The rest I hope is straightforward. In effect, this is the opposite of what anti-zoning economists have been saying.

This logic applies to the land market as a whole, and to any individual parcel in it. There is no magic economic mechanism that means that removing zoning controls in one place increases those land values and can delay development there, but removing it everywhere decreases land values because somewhere else development has accelerated.

Shouldn’t prices of zoned and un-zoned land equalise?
No. Land is not a physical object. It is a set of legal rights that define the available real options. Property valuers and lawyers call this a ‘bundle of rights’ approach. Land is worth whatever the highest and best option is from the selection of legally defined rights. 

For example, you don’t own the minerals under your land, nor the airspace above it. If the law is changed to provide you the right to access and sell those minerals, your property will be worth more because of that option (if there is a positive probability of using the new minerals right). A new ‘property right’ that is separate and additional to the previous rights is now bundled together with those previous property rights.

The same applies to zoning. There is no economic logic to the often-repeated argument that land with different zoning rights should equalise in value under market conditions. New zoning creates a different set of property rights. The value of two different set of property rights will be different if the highest and best option available in each is different.

Actual development behaviour reflects real options
This real options approach is the only way to make sense of the actual behaviour of landowners and developers in the market. There is no point arguing for removing of planning controls to ‘let the market work’ without understanding how land markets actually work. 

Here are some examples.

1. The Brisbane City Council has been repeatedly up-zoning an inner-city industrial site owned by Parmalat. The problem here is that this increases the value of waiting to develop, offering the global dairy company a free boost to the balance sheet by sitting on the inner-city site rather than selling and it moving to an industrial area. 

2. When I was working for the property developer FKP we had a new building approved and ready to start off-the-plan sales at the Sunshine Coast during the early 2000s boom. There was a queue at the sales office on opening day, and by mid-morning dozens of sales were made. The prices were set months ago and market prices had unexpectedly increased since then.

 Continuing to sell quickly at these older prices and undercutting rivals was not the optimal thing to do in a real options world. So we closed the sales office early and put all the prices up. It then took nearly three years to sell the remaining apartments in that building. But that was profit-maximising in the sense of exercising our option to delay selling. There was only one chance to maximise profits from that site.

3. A recent paper on rent-control in San Francisco shows that when you eliminate the option to keep your current tenant at a higher rent next year, you are more likely to exercise your option to redevelop the site into apartments. This is a classic example of decreasing uncertainty in a real-options world and bringing forward in time execution of the remaining options. 

4. Adding costs to development on a per dwelling basis can bring forward development because it reduces the payoff to waiting to develop to more dense uses. This pattern was seen in Queensland when developer charges were changed suddenly and those areas where charges increased saw faster new development compared to those areas where charges were decreased. 

5. When Lend Lease had their site at Yarrabilba (in Queensland) rezoned from rural to residential they had argued that there was a housing shortage and that only if their site was rezoned could new homes be built. Once they got their approval they told their investors the project would take 'approx. 30 years’ to build those promised homes. Their optimal strategy is to delay and dribble out new homes, not to flood the market and undercut others on price. 

A similar situation has happened at Springfield, where the developer has had their own act of Queensland parliament granting them extensive freedom to develop as they choose since 1997 — you can't get more freedom to develop than that. A good summary of these planning gifts is as follows. 

The Queensland and federal governments have invested more than $1.2 billion in the region’s infrastructure and the Springfield rail station is state of the art. But the most extra­ordinary gift from the Queensland government was the Local Government (Springfield Zoning) Act 1997. This law puts all the planning and development powers for Greater Springfield in the hands of Sinnathamby’s Springfield Development Corporation.
And yet, 20 years later, the area is one-third developed. They are optimally delaying development. 

Between Springfield, Yarrabilba, and the dozens of other similar developments in South East Queensland, there are hundreds of thousands of zoned plots of residential land waiting to be developed. The delay is because the landowners possess attractive future options.

A comment on the political economy of property
Developers hate zoning and planning rules because they want the flexibility to delay. If removing zoning controls did lead to a flood of new supply and lower prices, as the static supply and demand approach might suggest, then developers are the worst lobbyists you can imagine!

Is it plausible that they have been lobbying for years to drastically reduce their profit? Or more plausible that they use supply and demand economics as a cover story for what is really happening?

Only a real options view can make sense of this lobbying. Removing zoning gives current landowners, especially the large land-owning developers, more valuable future development options without requiring them to build them until they decide it maximises their profits!

In sum
It is time to start using the correct economic framework to analyse property markets. Only then can we make policies that deliver planning and housing outcomes we want. Otherwise, we will implement all the wrong policies, and in the process providing windfall gains to the development industry.

Friday, April 6, 2018

Queensland is giving its gas away

Australia's mining and energy industry often claims to be a significant source of public revenue. One case where that is not true is in Queensland's coal seam gas sector. Back in 2012, the sector gave the impression that it would provide a massive financial windfall for the State government via royalties. Even The Economist magazine noted the sector's "glittering promise of jobs and royalties for governments."

As you can see below, the forecast growth in royalties to over $600 million per year did not happen, nor does it seem likely to in the near future.

Coal seam gas companies had an incentive to overstate their economic benefits when applying to the Queensland government to approve their operations in the face of substantial opposition from farmers and environmentalists. Unfortunately, these exaggerations were taken seriously in the budget and were a likely influence in the approvals process as well.

One way to get a more accurate estimate of expected royalty revenues royalties is to insist on upfront payments of the first 5 years forecast royalties at a discounted rate. Companies that finance this payment will demonstrate that their royalty forecasts are credible. The economic claims of those that can't (or won't) can be dismissed as not credible.

Forcing the mining and energy sector to put their money where their mouth is one way to stop exaggerated economic claims being made. If approvals for resource projects are going to hinge on economic outcomes, including future royalty incomes for the State, it seems important to get a forecast backed up by dollars rather than by economic modelling and wishful thinking.

Saturday, March 24, 2018

Seven questions economists can't answer

I’m not saying all economists can’t answer these questions. I’m saying that collectively these are core parts of what the discipline of economics should be about and yet are topics dealt with by fringe groups whose key insights have not penetrated the textbooks or been shared widely across the discipline.

1. What is money and where does it come from?
There is only one textbook that gets this right.[1] Despite the economics discipline being told directly by the world’s second oldest central bank that their textbooks are wrong nothing has changed. Students continue to learn the debunked money multiplier model.

It is puzzling how an intellectual discipline that doesn't understand money invented, advocated for, and implemented, monetary policy—a tool that most nations almost exclusively rely upon to improve economic stability and growth.

2. What do prices do?
Prices best perform the function of clearing markets in those markets that are not in core economic theories—financial markets. But this is clearly not the main function of prices in markets for real goods and services.

Many firms choose to have shortages, queues, or wastage, rather than change prices. I think Fieke van der Lecq got it right—prices are just one of many rules that help form a coordinating system and stable prices facilitate long-term coordination. Imagine if your local supermarket adopted surge pricing and increased prices when there were checkout queues? That would disrupt coordination and mean some people will leave their goods on the shelf potentially coming back later or going to a supermarket where the prices are predictable. The predictability of price helps all actors in the economy plan ahead.

If prices are really the super-flexible rationing tool economic theory assumes you would expect them to be changing frequently. Instead, most firms change prices once a year or less. 

3. What are opportunity costs?
The most insightful idea in economics is that resources are scarce and there is an opportunity cost for using labour time, land, labour and capital equipment for one purpose over another.

This is the core idea of economics, and yet when you survey a bunch of professional economists at their annual conference they can’t answer their own textbook questions on it. Then they take to the journals to say that ‘opportunity cost is whatever I want it to be!’ Crazy.

Confusion over opportunity cost is pervasive even in core models. For example, cost curves (in the theory of the firm) are opportunity cost curves but we drop the logic of opportunity cost in the model and compare profits at different output levels without considering the different opportunity costs arising from the different amount of resources needed at each output level. More on that conundrum here.

Out of interest, the question that stumped trained economists is this. 
You won a free ticket to see an Eric Clapton concert (which has no resale value). Bob Dylan is performing on the same night and is your next‐best alternative activity. Tickets to see Dylan cost $40. On any given day, you would be willing to pay up to $50 to see Dylan. There are no other costs of seeing either performer.
What is the opportunity cost of seeing Eric Clapton? A. 0, B. 10, C. 40, D. 50.
4. Why do firms exist?
It may surprise some readers but the core economic theories that show how markets create a socially optimal outcome rely on the existence of a central planner to do it (Walrasian auctioneer or some equivalent). The organising mechanism is assumed away rather than being the focus of analysis.

This approach is typical. The layers of organisation and non-price rule systems that exist in a society that coordinate production between and within firms are mostly neglected or assumed away. Firms themselves also come in many types.

Of course, there is a literature on this (like everything) but it is not ‘standard’ economics and most students will never hear much discussion about it in their classes beyond some simple transaction costs escape clause.

5. How can poor countries become rich?
You would think this would be a key insight of economists, but no, it remains a puzzle. For example, economists are divided on how to manage international trade to local advantage—specialise or protect industries to promote more diverse productive capabilities—and have little to say about workable ways for the public sector to productively set rules and administer them to guide development that brings widespread prosperity.

6. What is competition?
Economists have pointed the finger at a lack of competition as the cause of many of our social ills. And yet competition is clearly inefficient in markets where economies of scale exist and under a host of other well-known conditions.

We also know that for a fixed number of firms in a market for an identical product that naive price experimentation will lead to the monopoly outcome across the whole market (see here and here). Any economic value from competition must be a story more like that of monopolistic competition, and must be more about expanding the ‘product-space’ rather than under-bidding on price in well-defined markets with known competitors.

Many economists proclaim that more competition will help in just about every circumstance without really teasing out the details of how exactly that would happen. Because if you know the details of what investment would be made and what products and prices would be desirable under competition then the logical question is whether these outcomes can be achieved more efficiently in other ways. Competition is often just a convenient excuse to do nothing rather than make tough decisions as a community, and economists go along with it.

"Banks are ripping us off, what can you do?"

"Housing is too expensive, what can you do?"

"Schools aren't well resourced, what can you do?"

"The public transit system is failing, what can you do?"

In practice, the word has lost all meaning. It is a feel-good religious mantra.

Indeed, I would argue the ‘peril of monopoly' is more a failure of politicians and law-makers to operate in the interests of the broader public. Often the prevalence of monopolies and cartels correlates with high rates of economic growth.

Here’s an interesting take from Richard Werner.
Considering therefore the half-century from 1950 to 2000, we would expect the best performance in those economies that are more market-oriented, and the worst performance in economies that have chosen to practice intervention, ‘guidance’ and the use of production cartels. 
By the late 1960s, Japan was effectively not a market economy, but a ‘guided economy’ in which over 1000 cartels (official exemptions to the anti-monopoly law) had been established, in which tens of thousands of economic regulations allowed the bureaucrats to intervene in the economy, in which the stock and bond markets were largely irrelevant (as most funding came from banks), and in which the labour market was famously full of ‘rigidities’ and ‘inflexibilities’, with life-time employment, seniority pay and company unions.

7. What is capital?
Lastly, a big one. Capital is either machines, or it is property rights. If it is machines and equipment it seems strange that these machines need to earn a rate of return for themselves. If capital is property rights then we have just exploded all economic theories that rely on the 'cost of capital’ since we can make this cost whatever we want through the legal system governing these property rights which can change their value, and hence the cost of capital.

This is a massive unresolved debate that economists no longer seem to have an interest in, and yet incorrect conceptions of capital still underpin theoretical reasoning in just about every aspect of economics.
fn. [1] The new CORE Econ textbook is the only one I am aware of that gets it right. I picked up 10 random economics textbooks off the library shelf recently all of them present the money multiplier story.

** Some people on Twitter seem to take issue with What Do Prices Do and Why Do Firms Exist as being well-established questions dealt with satisfactorily so that your average trained economist would have a decent insight. After all, sticky pricing is an old problem and there are many theories about firm behaviour, agency problems, team production etc.

To be more clear, economists think that the thing prices do (which was my question) is clear markets. Sticky prices come from a growing ad hoc list of restrictions on this primary function. Alan Blinder also had concerns about this approach, many of which apply to questions about firm existence.
It is not that economists have ignored these questions. One could literally fill many volumes with good empirical studies of wage and price stickiness, and many more with clever theories purporting to explain these phenomena. Yet, despite all this work, the range of admissible theories is wider than ever, and new theories continue to crop up faster than old ones are rejected. (The study I am about to describe, for example, tests 12 theories; and my list is not exhaustive.) This lack of scientific progress makes one wonder about the basic research strategy that economists have been pursuing. 

Thursday, March 15, 2018

Replicating the RBA's housing analysis

Last week the RBA released a research paper which sought to unravel the potential effect of planning controls, like zoning, on home prices in Australia. I think the results of their analysis are wrongly interpreted to be due to zoning, and I quickly made my views known on Twitter.
But, like the good researcher I am, I wanted to check their method. So I put together a sample of land sales from my area and replicated the method, just be 100% certain I understood. Lo and behold, I get the same result. Using twenty-nine neighbouring land sales and estimating ln(p) = A + B ln(area) + e, I get the following result.

The coefficient of 0.54 for ln(area) indicates that a 1% increase in land area only increases the total land price by 0.54%. So if the average price was $100/sqm for a 1,000sqm block (total price of $100,000), an extra 10sqm (1%) would cost just $540, or only $54/sqm.

This indicates that indeed, because of zoning constraints, people are unable to assemble marginal pieces of land at $54/sqm and thus must pay on average $100/sqm instead. The zoning effect clearly accounts for 46% of land value. Quite a stark result.

In my data the actual average land price of a lot was 0.1 pence per square metre while the marginal price was just 0.052 pence.


Yes, my average lot size was 4 acres, 1 rood, and 34 perches and sold at 19 pounds, 6 shillings and 9 pence. My randomly selected sample of sales occurred in December 1851 in South Brisbane. Zoning was still nearly a century away from being invented, and the population of the whole state of Queensland was less than 17,000 people or about half the normal attendance at a Broncos football match.

Let me be clear. Either it is true that the method used by the RBA does identify zoning effects, and therefore also identifies zoning effects of a similar scale 167 years ago in a remote and deserted convict colony that we know did not have planning controls. Or, it is true that the method does not identify zoning effects.

You decide.

*Here is a look at some of the data used for this post.

Tuesday, March 13, 2018

Who really owns Antarctica?

I have often argued with libertarians (and anarchists) that the existence of property rights first requires the existence of a government with a monopoly on coercive force (ie. government requires the largest armed force). If such an entity didn’t exist, then the largest armed force would simply take control and become the government. Many voices in these debates suggested that I need only look to international treaties to show how cooperative we can be without the need for world police.

Putting aside the obvious point that the US is the current world police, with their military budget making up 43% of the world total military spend, and that their international military presence often conflicting with international treaties, we can examine whether libertarian views are vindicated by one of the shining examples of international cooperation – Antarctica.

Back in 1959, twelve countries active in the Antarctic signed the Antarctic Treaty (implemented in 1961), which led to further treaties and conventions to manage activities and resource use (especially fisheries) in the whole Antarctic region south of 60% latitude. Collectively these treaties are known as the Antarctic Treaty System. With the shadow of the Second World War still looming large, the top priority of the original treaty was to ensure that the area remained conflict-free by outlawing a military presence – prescribed in Article I of the treaty. Other peace-inspired provisions include Article V, prohibiting nuclear explosions and the disposal of radioactive material. Who knew that the dominant ideologies of 1960s youth originated in Antarctica?

Since that time the Montreal Protocol was adopted as part of the Antarctic Treaty System with the explicit intention of preserving the Antarctic as a natural reserve devoted to peace and science. Critically, Article 7 of the Protocol prohibited all non-scientific mineral resource activities.

The Antarctic Treaty was a bold and lasting agreement, recently celebrating its 50th year. The treaty’s anniversary gave rise to some optimistic claims
The lesson of fifty years of the Antarctic Treaty System is that the nations of the world can set aside their political and territorial aspirations to share in the management of a vast region of the planet, says Paul Berkman, chair of the International Board for the Antarctic Treaty Summit.
But I wouldn’t make such strong claims so fast.

Geopolitics was not cast aside by the free love of the original Antarctic Treaty. The US does not recognise the territorial claims of other governments and reserves the right to assert claims. The USSR, and later Russia, made the same non-commitment to the Treaty. The success of the Antarctic treaties over the past fifty years was perhaps more the result of the low value of any commercial or strategic military operations in the Antarctic.

While the US has no current claim over territory, it has positioned its Amundsen-Scott research base at the South Pole so as to maintain a presence in all claimed territories (shown in the map below). The US may very well have secured a right to claim territory that existing claimants leave unoccupied.

We also know Australia does not have the capacity to visit the inland areas of its territorial claim. This may be problematic as the original Antarctic Treaty has a provision in Article XII allowing a contracting party to call a review of the operation of the treaty after thirty years. One could expect that our absence, or lack of presence, in our claimed territory puts us in a poor position for any future treaty negotiations that may establish new claims based on current activities.

The rise of new entrants into Antarctica is also concerning for existing territorial claimants.
Russia has seven stations in the AAT; China opened its second station last year; India will start construction on its first over summer; and South Korea is planning to set up a new station near the Easter sector by 2014.
With renewed interest from emerging global economic powers, and the ice sheets receding in some areas, mining the Antarctic is attraction a lot of attention (and here).

So it seems that the ingredients for conflict are slowly being added to the spicy Antarctic political stew (these concerns have been noted elsewhere). How one resolves these new interests in the mineral rights of Antarctica, with the interests of the existing parties to the Antarctic Treaty System, I am not sure. But let’s be clear. The US will not lose out in any future negotiations that allow further exploitation of the Antarctic. In a hypothetical future scenario where mining becomes allowable under the treaty system, does anyone really expect the US to respect the rights established by existing territorial claims? I don’t.

In the end, current Antarctic territorial claims are only valid as long as they are not challenged. So I ask the anarchists and libertarians, exactly how does one negotiate a territorial claim (or defend their property right) with an unmatchable armed force that happens to be a necessary military ally?

Monday, February 5, 2018

New paper: Developers pay developer charges

I have a new paper out — Developers pay developer charges in Cities: The International Journal of Urban Policy and Planning.

In this paper, I estimate the economic incidence of developer charges (taxes paid upon approval to use land for a higher value purpose) using a natural experiment in Queensland, Australia, where a surprise political announcement varied the charges. Using data on developer charges and dwelling prices during this ‘natural experiment’ period I estimate their economic incidence. The data clearly shows that the administrative incidence on the landowner (developer) happens to also be the economic incidence. An increase in the charge comes at no cost to the buyer of a new dwelling but instead decreases the land value by an equal amount.

The motivation for doing this analysis was an article in The Conversation that suggested the opposite — that the economic incidence was on the buyers of new dwellings, against all logic and reason. In fact, this research showed a significant correlation between developer charges and home prices at a ratio of 1:4. Erroneously interpreting this relationship as causal would mean that increasing charges by $1 would increase home prices by $4.

Can you see the nonsense here? If there really is a causal link property developers would be lobbying to massively increase charges in order to earn a 400% markup on them! In reality, the development industry has been lobbying hard to remove them.

In my paper, I demonstrate the problem with this causal interpretation, which arises because the variation in the developer charges is due to the way they are set by regulations. The regulations state that the charge per new dwelling of 2 bedrooms or less can be a maximum of $20,000. The charge for a 3 bedroom or larger dwelling can be a maximum of $28,000. Because councils have no incentive to charge less than this maximum this was the size of the charges in their data. The regression analysis merely showed that the average 3-bedroom or larger dwelling is 4 x $8,000, or $32,000, more than the average 2-bedroom or smaller dwelling (controlling for other quality and location factors).

Because my study covered a period where surprise political decisions varied the charges themselves for each dwelling type, my analysis shows no relationship. In fact, if you take out this surprise variation in my data and leave the charge at the fixed price for each size dwelling I can replicate the earlier results of a 1:4 correlation.

Why is this important?

This result is significant because the economics of property is almost the exact opposite of the economics taught in most modern university degrees, and bad economics is being used to justify bad policy. All too often I see the following implicit assumption about causality:

Cost of capital ⇒ Rental price of capital.

If you increase the cost of investing in capital, you increase the rental price of capital. That is the logic behind the idea that developer charges, or a land tax, can be passed on to users.

But this clearly makes no sense in the case of land. Land is costless to produce. It is obviously not costless to buy it from someone else, but ultimately, there is no prior investment that provides its value. It is merely a legal right to claim certain incomes associated with that location. So for land (and ownership rights in general), the direction of causality must be:

Rental price of capital ⇒ Cost of capital.

This is not a secret. It has been widely known for hundreds of years in the property valuation profession, which uses variations of the ‘residual value’ method to isolate the pure rental price of land and use it to determine the cost (price) of land.

So what?

Vested interests in the property industry continue to argue that shifting the tax base to land will increase the cost of housing — after all, they argue, the rental price is caused by the cost of land plus other costs, including taxes and charges.

We know this argument is bogus because it simply begs the question that if prices come from input costs, why does land have any value at all? All land rents should be zero.

And again, if the rental price of capital was the result of a summation of costs, the property industry would have nothing to fear from increasing developer charges, as they could pass on those costs in the price of new dwellings.

One step further

We can take this logic another step and see that because the economic incidence of land taxes (or development charges) is on the landowner, increasing these taxes can encourage more development sooner since it reduces the payoff from delaying investment in new housing.

Consider the table below. It comes from my paper. I use it to demonstrate the changed incentives to delay or bring forward new housing development from increasing land taxes (which effectively decreases the net rental price of land).

The table shows three scenarios where the discount rate is 5%. In each scenario, the price in time one (t=1) reflects the expected rate of growth. The present value (PV) is the price at t=1 discounted at the 5% rate. Where that present value is higher than the current price, there is an incentive to delay sales, which feeds back into delayed construction [1].

If the rate of price growth is higher than the discount rate (the rate of return on the sale price available from investing it elsewhere) it makes sense to delay the sale to get the higher price (Scenario A). If the rate of price growth is low, there is an incentive to bring forward sales to get your money out of this property to put it somewhere else an get a higher return (Scenario C).

The property industry likes to promote the myth that they would never delay selling. Yet, when I worked for a major property developer during a price boom period, we did exactly that. The decision was made to close the sales office one Saturday because there were too many sales. These rapid sales meant that the price was too low and that delaying the sales would fetch a higher price (and a higher PV of that future price). So instead of selling the whole building in one day and starting construction, the prices were raised, and it took years afterward to sell the whole building and massively delayed construction.

The absolutely crucial lesson in from the Scenarios in this table that the imposition of a developer charge can turn Scenario A into Scenario C by reducing the net revenue from each future dwelling sale to a developer due to the charge. For example, if a charge of $10,000 is announced to be imposed in the next financial year in Scenario A, it becomes Scenario C in net terms, and the developer will prefer to bring forward planning applications to get a lower charge and incur sales in the current period.

Increase taxes on land to get more construction, not less!

To be clear, this is not some crazy idea I just invented. This is the standard result of real options theory, and it applies equally to increasing costs to landowners and decreasing their future development options. Here’s a 1985 paper from the AER making the point.
… the initiation of height restrictions, perhaps for the purpose of limiting growth in an area, may lead to an increase in building activity in the area because of the consequent decrease in uncertainty…
Imposing height restrictions can turn Scenario A, where future revenues (price x number of dwellings) are higher because of the option for increased density, to Scenario C, where future revenues are lower because the number of dwellings able to be built on the site is fixed. This brings forward sales and construction.

In sum

My new paper is a small contribution that demonstrates the well-established economics of property markets, but which flies in the face of conventional theory. Understanding land and property markets helps to understand how backward the standard economic understanding of ‘capital’ really is.

fn [1]. Another thing many economists get wrong about the property market is they ignore the fact that most sales come before construction, not after. This means that when people just say “increase supply” they don’t realise that market incentives mean this will never happen — supply only responds to demand. Only a housing developer without a profit motive would increase supply at a rate that would depress local prices, and yet we hear nothing from the ‘supply-siders’ about the creation of a public housing company that could do just that.

Wednesday, January 24, 2018

Facts don't matter

Review of Win Bigly: Persuasion in a World Where Facts Don’t Matter

I can save you $13 and summarise this book for you — a rich white guy from New York dating a model half his age who didn’t travel outside of North America till age 59 finds Donald Trump persuasive.

There is more to it than that. But according to Win Bigly’s author Scott Adams, the first piece of information about a topic matters when it comes to persuading. It’s called Anchoring.

On its surface Win Bigly is a lesson in the art of persuasion. Adams uses his experience blogging about the total misreading of Trump’s election persuasion by the established media as a backdrop to his own lessons in persuasion. He also provides a language to help understand and communicate persuasion techniques — The High-Ground Manoeuvre, Two Ways To Win and No Way to Lose, Setting The Table, Visual Persuasion. It’s all good stuff. To anyone who has an interest in cognitive science (not many of us), and skills in objectivity (even fewer of us), a lot of the book is a well-packaged presentation of established material paired with Adams’ persuasion hunches. For everyone else, you will find a lot of new and interesting stuff in there.

I probably enjoyed the book more because I have some views in common with Adams that few seem to share. For example, for years I have been bamboozled by people who have a love of facts yet continually try to persuade with facts. The facts are clear on this — facts don’t persuade. So why ignore this if you are a fact-lover? One of Adams’ main points, as you might have guessed from the title, is exactly this.

I also wrote about the misreading of Trump here. And of Brexit here. So I clearly do identify with Adams, which gives him a headstart in his persuasion.

But while I agree with much of his analysis of Trump’s persuasion methods, Adams persuaded me that he is, like many (most?), a bit of selfish bloke with a chip on his shoulder. This explains my opening sentence.

You see, despite repeated humble-brags throughout the book, ‘good guy’ Adams ends by changing the tone and being a dick about Clinton’s proposed estate tax, responding to it as follows.
This was personal. I started life with almost nothing and worked seven days a week for decades to build the wealth I have now. I wasn’t in the mood to let the government decide what happens to my money when I die.
But once Clinton announced her plans to use government force to rob me on my deathbed, it was war.
He also recites the nonsense double taxation myth favoured by one-percenters. Maybe it is good persuasion if your audience is other rich people or those who believe they will be rich when they die. To me, an expert in economics and taxation, it is idiotic and stupid. Inheritance taxes make the world better and fairer. These views starkly reveal a naivety and selfishness. It shows me that for all the interesting things in the book that I agree with, a lot of Adams’ filter of the world seems to be him identifying as a rich guy with German heritage and conservative tendencies who wanted Trump to win to validate that. He was very lucky to get his prediction right. As he admits.

Maybe one reason that I have had this reaction is that unlike most readers of Win Bigly I am simultaneously reading The Great Leveler: Violence and the history of inequality from the Stone Age to the twenty-first century. But that’s another story.

The book is worth a read if you want to better understand the Trump phenomena. It may persuade you to drop some of your beliefs in “facts” that don’t really stand up to scrutiny. But for all the insight in the book, I guess I was disappointed to see that even those most alert to our tendency to believe in myths, or facts that suit our own interests, are driven by their own myths.

One thing I have always found strange is how rich conservatives who ‘worked hard for their money’ want their children to never have to by leaving massive inheritances. At the same time, many will promote how noble the experience of poverty and hard work is for everyone else’s children. Such reasoning ignores the fact that plenty of people have usually worked harder for less money — after all if Scott Adams went on strike no one would declare it a State emergency. Apparently, you get what you deserve in life because you work hard for it, unless, of course, you are born into the right family. Life isn’t fair. But that doesn’t mean we shouldn’t make it fairer if we can.