Sunday, September 30, 2018

What is land? It is not a product, but an ownership share of three-dimensional space

Is land an object that can be produced? The answer to this important question provides the foundation for properly analysing land and housing markets.

And the answer is no.

Land is not a newly-produced good of the type considered by standard economic theory. Instead, land is a bundle of legal rights held by the owner of a land title. Each land title refers to a unique three-dimensional location on the earth as described on a register of maps known as a cadastre. Together, the land title system is best thought of as a legal and financial instrument that carves up ownership and control of a nation’s finite three-dimensional space into smaller territorial containers.

Land is not the plants, animals, or even the soil, which can be produced. We know this because you can buy such objects produced within someone’s land container without buying the actual legal container itself. What is a farm but a location that produces plants and animals within their container and sells them to others? You can even put a house on a truck and sell it independently of the land title.

The legal and financial instrument of the land title provides a bundle of rights to owners via combined national, state, and local laws and regulations. A core right is to allow the title owner exclusive use of the space and to claim an income in the form of rent from others accessing the space. These rights are guaranteed and enforced by the relevant levels of government.

Another property ownership system

The land titles system shares the legal and financial control over the three-dimensional space within the boundary of a county. Each share of the nation’s land is identified on the cadastre, and the legal owner is identified on the database of tradable land titles.

Company shares (stocks) are probably the most similar system we have to land. Share systems carve up legal and financial ownership of a company, with each owner having a claim on the income generated by the real production that occurs within the boundary of the company.

Despite the common institutional design, most economists discuss the share market and land market in totally different ways.

When the market price of company shares increases no one says crazy things like “the supply of shares is not responding to demand”. It doesn’t make sense. We know that shares are not part of the real production economy for new goods and services.

But when we talk about land we forget that we are talking about a system of ownership claims. People say crazy things all the time, like “land supply is not responding to demand.” Huh?

There are only trades of financial instruments

In share markets, the supply curve is the ask price schedule of sellers, while the demand curve is the bid price schedule of buyers. In land markets the same price-dynamics of trading and speculating apply. There is no new land produced. All rights to three-dimensional space are already allocated to someone and the price is set by traders swapping those financial instruments back and forth.

But when economists say that the price of land is due to supply and demand they mean something completely different.

Economists pretend that land is a new product coming off the production line rather than an existing financial instrument. They confuse the ownership claim, the land title, with the production of new goods and services, like housing construction or the service of home occupation. While new homes can be made, new land cannot.

No one confuses the supply of Apple shares and the supply of iPhones — but call Apple shares land, and iPhones houses, and chaos reigns.

The fact that homeownership requires first owning a location (a financial instrument) in order build a house (a produced object) means that the land market primary determines whether new buyers can afford homes. It is like having to own Apple shares in order to buy an iPhone.

If the price of the bundled Apple-share-plus-iPhone became more expensive, fewer people would buy iPhones, creating to an iPhone affordability crisis. But the crisis would have nothing to do with the supply of iPhones.

Myth: Build up and no land is required

Some people argue that building taller buildings requires no new land, and hence higher density is a low-cost solution to housing affordability.

The economist Edward Glaeser makes such claims, which have been echoed recently by Australia’s Reserve Bank.
Although land is required to build an apartment block, this is a fixed cost – there is no marginal land cost involved with building higher on a given block.
But remember, the rights to all three-dimensional space are already carved up in the land titles system. If a title owner does not have the right to build above a certain height, say ten metres, due to zoning controls, it means that the rights to the space above ten metres in that location are retained by the government.

To build higher density requires a financial trade of the rights to the airspace above ten metres from the government to the title owner below. These rights can be sold by the government to the owner of the title below them, as they are in some places, or they can be given for free, as they usually are. But they are not valueless, or costless, as Glaeser and the Reserve Bank believe.

Think about it this way. If the three-dimensional space needed to build an extra storey of an apartment building is costless, then this should be true whether the space is used by building vertically into it, or horizontally into it.

I could, for example, start constructing on site, and then once above the ground, cantilever my building to occupy the free, costless, three-dimensional space that sits above the site next door. But when we think about it this way it becomes obvious that the space is owned and has a positive value. If the rights to that space are owned by the neighbouring title owner, then they can be sold at a positive value to the apartment developer so that they own the full territorial container in which they are building.

So why do many high-profile economists assume that this space is free?

In sum

The biggest mistake made in property market analysis is to ignore the fact that land is a share of the ownership of the three-dimensional space assets of a country. Pretending it is a newly-produced good or service will lead you to make fundamental errors in your analysis of land and housing markets.

Tuesday, September 4, 2018

Free land, dirt cheap

127th Annual Henry George Dinner Speech

1. To make health care affordable we broke this monopolistic market. We now spend over $100 billion to give everyone who needs it high-quality health care for free.

2. We could break the monopolistic market in residential land and give everyone who needs it free land for one-tenth of the cost, or about $12 billion. After all, standard economics says to regulate monopolies to the point where price equals marginal cost, which in the case of land is zero.

Instead, we currently spend over $60 billion in subsidies and tax breaks that simply make housing more expensive.

3. The standard prescription by The Experts to reduce housing costs is to increase supply. I call it The Supply Side Distraction. This approach requires a construction boom of astronomical proportions, building an extra 500,000 homes over a decade, requiring an extra 300,000 people (the workforce of Canberra) to stop their current jobs and go into housing construction for a decade. And at best all that gets you is a 10% reduction in housing costs.

4. We could instead immediately reduce housing costs for renters by 37-50% by providing discounted access to land through public land rent schemes, or by facilitating the broad adoption of community land trusts. In Canberra 1,000 households currently save $9 million per year in housing costs in their Land Rent Scheme.

5. Reducing home prices by 25% will wipe off $1.7 trillion in wealth from over 7 million home-owning households, making policies that achieve this political suicide.

Simply confiscating the 2.7 million rented homes and giving them to their current tenants for free would be a similar transfer of wealth, but only affecting 1.5 million investors.

The second option must be more politically realistic than reducing prices by 25%.


18 minute interview followed by the speech


Thank you for that lovely introduction, Catherine. It is a privilege to be here.

I also want to thank you both for involving me in the amazing research and discussions happening at Prosper. If it wasn’t for the big ideas coming out of this group, I would never have been introduced to the huge range of policy options out there. I recommend Karl’s Renegade Economist podcast on 3CR radio to help expand your thinking — from Hong Kong cage homes to privatisation, to energy rorts, and more.

I want to also try and expand our thinking today, starting with the first big lesson I took away from reading Henry George — which is that most of our major economic problems stem from the distribution of ownership of land and capital. I remember reading a passage where George made the argument that there could not be involuntary unemployment if every person had a plot of land to farm.

It is much the same with housing. If everyone owned their own home, could there be a housing affordability problem?

I want to do something tonight that I believe almost no one has done — talk about ways to make land and housing cheaper, perhaps even free. Despite what you hear in the housing affordability debate, The Experts do not actually want to talk about fundamental changes to land and housing systems that would achieve this.

To make my case, and to change the way we think and talk about housing, I first need to take a few detours.

A thought experiment

Imagine there is a market with monopoly characteristics that is an essential input into everyone’s modern life. The high prices charged by monopolist suppliers are making life extremely difficult for the neediest in society who often go without life’s basics to cover their costs.

One group of people, The Experts, think the solution to the problem is to ‘market markets work’. They see complex market failures all around that are not only difficult to understand but extremely difficult to correct. But they want to try where they can to fix these failures, little by little.

Another group, The Radicals, thinks the solution is to ‘break the market’. They say that fundamentally this industry will never overcome its monopoly problem and associated market failures and that a totally different approach is needed. They argue that instead of market provision everyone should get what they need for free. The government should simply provide it, and if needed raise over $100 billion in extra taxes per year to do it.

The Experts— the make markets work team— laugh at how implausible that is.
“That’s over 6% of GDP. How could it even be possible to give people such a gargantuan freebie? How would anyone vote for it? No, it is much better to try make markets work by tinkering around the edges.”
The Experts release report after report showing how their proposals might reduce costs by a few percent here, and a few percent there. That is, apparently, the best we can aim for.

Luckily, with the exception of the United States, the second group— The Radicals who want to ‘break the market’— won the debate. Universal public health care has been established in just about every rich country; Australia and Canada’s Medicare systems, the French and British National Health Services, and many more. Just about every rich country decided that providing universal access to quality healthcare for free was a basic function of a modern wealthy country.

In healthcare, we solved the monopoly problem by breaking the market. We spend $100 billion of our tax money to do it. And now everyone is better for it.

Now, we can talk about land.

But first a special type of land to think about the problem in the abstract.

This land is where two roadways cross— an intersection. Imagine living a century ago in 1918 and seeing massive social failures at road intersections; fatal accidents and congestion, the rich with their fancy motor-carriages roaring zooming dangerously past the poor with their horses and hand-drawn carts. Being a common-sense person, you see this situation and propose a non-market system of turn-taking using a system of electronic lights run and paid for by a government agency. It makes total sense.

But if you tried to propose this system today, you would be labelled as mad by The Experts— the ‘make markets work’ crowd. Their solution would be to price access to the intersection. You know it would be! After all, their favoured modern solution to traffic congestion is real-time road pricing. “We shouldn’t break the market” they would say. “Make the market work” they would say. “A publicly run rationing system is completely implausible nonsense” they would say.

Yet back in the real world we do in fact spend hundreds of millions of tax dollars each year on the radical, crazy, implausible, leftie, nonsense scheme that breaks markets rather than makes them.

Turn-taking. Remember that. It is innate. I have never seen a parent at the playground teach their child to bribe other children for a turn on the swings. Even The Experts force their own children to take turns, even though their theories say it is nonsense to do so, and even though they would never impose such a system on the rest of us.

We can now finish this detour and talk about the land we need for housing. But once again I want to us to think abstractly, and not about the world as it currently is presented to us by The Experts.

Land for housing in the abstract

Imagine you are an explorer who has discovered a small island society.

You observe that the island comprises 4 families. Three of them appear to own their own homes and control all the land on the island. One family does not— The Murrays. So, The Smiths house The Murrays, who have nowhere else to go, for an exorbitant fee. No matter what The Murrays do, how hard they work, what they earn, their landlord is able to extract most of the economic gains they make. After all, these other families hold the land monopoly.

Do you, the explorer, the inquisitive adventurer, the anthropologist, think to yourself:

a) why can’t this society just cooperate and give The Murrays a plot of land for their own home rather than extorting them for a huge chunk of their income.

Or do you think:

b) look at The Murrays enjoying the spoils of the property market at work!

Because I can tell you when The Experts and the economics profession sees this society—a million times magnified across modern Australia—they think b) look at the magic of the property market at work. They have nothing to offer The Murrays. In fact, the current policy advice from mainstream economic Experts is for our island society to do nothing, or even perhaps subsidise The Smiths, the landlord, for renting space to The Murrays!

That is exactly what our discounts on developer charges are, for example. It doesn’t seem like a solution to me.

Or perhaps we should give The Murrays more money to specifically spent on housing? Would that go straight into the pocket of The Smiths perhaps? We have those schemes too. We call them First Home Owners Grants. 

Or, what if we were actually serious. Maybe we could limit the rent paid to 25% of The Murray’s income? We have such schemes as well in the form of public housing, and the National Rental Affordability Scheme. But even then, 25% of gross income is a long way from the 0% that the other Families on the island pay for housing.

This story shows why homeownership makes sense. Homeownership provides secure ‘non-market-priced’ access to housing in perpetuity. In fact, it is free. Once purchased, homeowners no longer need to participate in the monopoly land market. They have their own non-market supply of housing.

Housing policy fraud: An Australian story

When we return to the real world we seem to forget what it is that we want when we talk about affordable housing. The term affordable housing itself is used as a way to avoid confronting the reality that making land and housing cheaper is the only effective operational objective

I have had conversations with politicians at all levels about affordable housing policy before. I usually ask them “How much lower would you like prices to be? 20%, 30%, 50%?” They usually say “No, no, I don’t want prices to fall, just not grow as fast as they have been!”


I remember talking for almost two hours on the phone to John Alexander, Liberal member for Bennelong, and he was very concerned about making housing affordable and probably one of the more thoughtful and genuine politicians to try and tackle the issue.

But he did not want prices to fall. He had in mind a complicated financial scheme that would funnel foreign buying into new property. Specifically, his goal was for prices to rise at only 5% per year instead of the recent 10%! It was never clear exactly who would benefit, or how this was meant to make housing cheaper.

I asked him whether he understood what that actually meant? I said “Do you know what the median price will be in ten years if it grows at 5%? They will be 60% higher. If wages grow at 2% that would make housing 33% more expensive under your plan than they are now.”

But he felt like there was no other option.

I asked him “What happens if prices fall by 20% in the meantime due to market cycles?” This situation was apparently undesirable. Prices must rise. The market must be rescued.

I think we should be clear if we are going to talk about affordable housing. I think we could even avoid using that phrase and just say “cheaper housing”. We don’t talk about grocery affordability or petrol affordability. We say cheaper food and cheaper petrol.

Regardless, what I mean by affordable housing is that I want the price of secure housing to be lower. At the limit, we could make housing free, just like it is for the three families holding the land monopoly on my fictitious island society, and like it is for over 2.7 million households across Australia who own their home without a mortgage, and like hospital care is to every one of us.

That is our benchmark—free, secure, housing, just like homeowners have. That is what we should aim for. As a rule of thumb, we have one third of households own their home mortgage-free. One third own with a mortgage, and one third rent. Really, the housing affordability problem is one that only affects renters and new, recent, buyers. The 2.7 million renting households pay about $50 billion per year on rent to the 1.5 million landlords. The 3.3 million home-buyers with a mortgage pay around $60 billion in interest each year on the $1.1 trillion in owner-occupier homes loans. Only around that 300,000 of them bought their first home in the past 3 years, paying around $10 billion a year in interest.

Let me repeat that. To give everyone free access to housing, not free perpetual property rights, we could pay the $50 billion rent and $60 billion in mortgage interest from tax revenues, and it would cost much the same as our public healthcare system. This would be a situation of 100% free land and housing for everyone in their current home.

This is about the same as the profits of the banks, and the fees on superannuation, and the tax breaks on capital gains combined. If you think tackling these other economic challenges is possible, then making both land and housing free for everyone is totally achievable.

Instead, we often get distracted and talk about housing affordability as something completely unaffordable. For example, referencing benchmarks of rent-to-income ratios, of around 30%. Why taking a few hundred thousand household from paying 35% of their gross income on housing, to 30%, makes much difference to anything is beyond me. I couldn’t think of a worse benchmark for affordable housing.

We also need to stop thinking about making housing affordable in terms of the market price of housing, whether in the form of purchasing in perpetuity —what we typically mean when we say the house price— or renting for a fixed term.

As I have alluded to, we don’t have to supply housing only through market-pricing. We can have multiple cheap ways of accessing secure housing. We didn’t make healthcare free by making minor tweaks to the market price of drugs. We did it by pooling our resources through taxation and giving it away.

Yet none of what I have been talking about seems to be anywhere near Australia’s housing policy agenda, which is dominated by The Experts who can’t think beyond markets for economy policy – only for parenting. 

That noise you hear is busywork

Right now, the housing policy environment is best described as busywork— good intentions, plenty of noise and activity, achieving nothing. Making plans to make plans, to have an inquiry, to make recommendations, for a plan, to create a taskforce, and around the merry-go-round we go.

If an alien economist landed here and looked at our housing policies, would they think the rules designed to make housing cheaper and more secure, or more expensive and less secure.

Some academics, who have been trying to operate objectively amongst the fog of academic self-delusion have had enough. In 2015 Nicole Gurran and Peter Phibbs published an article entitled — Are Governments Really Interested in Fixing the Housing Problem? Policy Capture and Busy Work in Australia— which basically answered their title question in the negative.

Here are some of the plans to make plans:

• Menzies Research Centre: Prime Ministerial Taskforce on Home Ownership 2003

• The Productivity Commission’s First Home Ownership Report in 2004

• A Good House is Hard to Find Report from the Senate Select Committee on Housing Affordability in Australia in 2008

• Western Australia’s Affordable Housing Strategy 2010-2020

• NHSC: State of Supply Reports (2008, 2010, 2011, 2012, 2013 onwards)

• Senate Inquiry into Affordable Housing, 2014-2015.

• Parliamentary Inquiry into Home Ownership 2015

I could go on.

The madness of it all is that after the thousands or work-hours on these reports, there is no political interest in making housing cheaper, and the housing policy we currently have can be summarised as ‘do nothing’ and let the land monopolists flex their economic muscle.

All these reports have in common an economic framework that sees The Murrays on our fictitious island society and admires the market at work. The mainstream economists who dominate these inquiries, reports, and policy busywork, have nothing to offer the question of affordable housing as they have no deep understanding of land markets. The profession’s pet theories expressly assume away all the important monopoly characteristics of land markets leaving them on able to, at best, waffle aimlessly, stringing together loaded jargon like competition, elasticity, regulation, equilibrium, all the while saying nothing.

In short, we have a policy fraud built on an intellectual fraud, intentional or not.

We have policy analysts, think tanks, academics, and commentators, who battle the power of pharmaceutical and healthcare monopolists by taking away their pricing power with non-market systems, while at the same time ignoring the pricing power of land monopolists and even boosting it with even more gifts, grants and subsidies! These people probably sit in adjacent cubicles, taking radically different approaches to the same economic problem. I’m looking at you Grattan Institute.

We know that land is a monopoly for two reasons. First, it comprises the right, but no obligation, to be put to use. Second, there is no free entry— you cannot compete in land markets using inputs that are not also outputs of that same market.

Henry George knew it when he observed:
“What is it, then, that prevents labor from employing itself on this land? Simply, that it has been monopolized and is held at speculative prices, based not upon present value, but upon the added value that will come with the future growth of population.”
This is exactly what modern real options theory says — don’t build housing unless it beats waiting to build something better in the future, and don’t sell unless you are sure the future options are inferior to cashing out.

A fundamental irony, however, is that once you accept that land is a monopoly, standard economics says you can regulate the price down to the marginal cost. Since the marginal cost of land is zero, an efficiently regulated market would set the land price to zero.

Fraud: Supply is the problem, but don’t build homes

The greatest housing policy fraud is what I will call The Supply-side Distraction. A recent presentation by Grattan Institute’s Brendan Coates was called: “Supply sceptics beware: without more housing, it won’t be affordable.”

Sounds ominous. But here is the conclusion: “Building an extra 50,000 homes a year for a decade could see house prices 10-20% lower.”

Really? That’s less exciting than John Alexander’s preferred outcome of prices rising 5% per year instead of 10% per year! Now, I know Brendan really cares about this topic, and he is probably one of the smartest housing analysts out there. But like almost all others, he ignores the land monopoly, and that’s a fatal mistake in the economic analysis of housing. He knows my views, so what I’m going to say won’t surprise him.

A frank approach would see that in the three months to June 2015 Sydney home prices increased 9%. This is the scale of the ambition– reverse a few months price growth with an insanely large decade-long construction program.

And the economic cost of that low ambition? That would be a 25% increase on the already high number of homes being built of over 200,000 per year, enough to accommodate half a million people.

We are currently building a new Newcastle-worth of homes a year, and we would need to add to that a new Ballarat, Toowoomba, or Darwin’s worth, every year, for 10 years, to reduce prices by just the amount they grew in the second quarter of 2015 in Sydney, or the past 10 months in Hobart. Some suburbs of Sydney have seen prices fall by more than that in the past year from tightening of credit. It is a colossal investment task for a minute reduction in housing costs.

Currently, a record 9.5% of the labour force is in construction, which was just 7.5% prior to the financial crisis. To meet this supply ambition over ten years, to reverse a few month’s price growth, would take an extra 2.5% of the workforce to stop what they are doing, stop producing what they are producing, and shift into housing construction. That’s an extra 330,000 people, or about the labour force of the Gold Coast, and even higher than the labour force of Canberra.

The real resources required for this 10% price effect make me wonder how serious followers of this view can be. Even worse, The Supply-side Distraction does not involve actually building any new homes at all but hoping that minor tweaks to planning rules will stimulate the greatest construction boom in the history of the nation where property developers left, right, and centre, will be building thousands of new homes even though it reduces their profits by doing so because it reduces prices!

That’s the truly bizarre part of the story. Not only do the economics show that supply’s effect on price is tiny, making it a strange target for an affordable housing policy, but the way that supply-siders plan to get there is, essentially, to hope the market works like it does in their clearly flawed model!

I have many times asked that if you really believe this story, why not create a public agency tasked with building and selling 50,000 new homes a year, regardless of their own profitability. No. That’s getting too close to being an effective way trimming 10% off the price of housing. We wouldn’t want that!

The cost of the fraud: Doing the wrong things

The Experts’ affordable housing policies are costing us dearly and often making housing even more expensive.

State and the federal governments have spent around $1 billion a year on these programs, plus hundreds of millions in stamp duty discounts for first-time buyers.

Tax expenditures from the Capital Gains Tax exemption for owner-occupiers are nearly $50 billion per year and tax discounts that apply to property investors are around $3 billion per year.

We are rezoning land for free rather than charging for it, costing another $11 billion per year, chasing a non-solution of hoping land developers will voluntarily build so many houses that prices fall.

All up, we already spend $65 billion per year on policies that don’t make homes cheaper.

It would be madness if we spent all our health funding on energy crystals and psychics, and nothing on medicines and treatments that had passed scientific scrutiny. And yet, in the housing sector, that is what we have. A fraud of epic proportions if ever I saw one.

Politics of property

The politics of property is why it is so easy to perpetuate this fraud, even for those who genuinely care about cheap, secure housing. The simple fact is this—making housing cheaper is a multi-trillion-dollar transfer of wealth. In March 2018 the total value of residential dwellings in Australia was… and this is truly astonishing…. $6.9 trillion (or $680,000 per dwelling on average). It is hard to fathom such big numbers, but that is about four years of GDP, four times more than the market capitalisation the whole Australia equity market, and six times the value of the world’s highest valued company, Apple.

Now imagine that we want to make the market price of housing cheaper. Say 25% cheaper. This would take Sydney prices back to where they were in September 2014. If we did that nationally we would wipe out $1.7 trillion of value from the balance sheets of over 7 million property-owning households.

It would be one of the biggest wealth transfers in history— from a huge majority to a tiny minority, just 3 to 4 % per year, who are first-home buyers. Reducing prices would be political suicide. And politicians know it.

I often wonder if we have politicians or political parties sophisticated enough to make big changes that will reduce home prices. I worry, for example, about the Labor party’s promise to both reduce the CGT discount and require quarantining of negative gearing losses. We know that when the Resources Super-Profits Tax on mining was proposed the government of the day faced extreme pressure for vested interests and caved immediately. What plan does Labor have to combat the vested interests in property development when they too launch a $20 million propaganda blitz against the policy? How serious are they? Do they have their own advertising agencies lined up? Do they have a sophisticated media and communications team ready to saturate the airwaves to such a degree that the vested interest counterpunch has no breathing room?

In my view, it would be more politically expedient to simply redistribute rental housing from landlords to tenants. It would amount to the same $1.7 trillion wealth transfer. But instead of from 7 million homeowners to potential future homebuyers, it would be from the 1.5 million landlords to the 2.7 million tenants, creating twice as many winners as losers.

If you think reducing home prices 25% is even remotely politically feasible, then acquiring all homes from landlords and given them to tenants is almost a done deal, politically speaking. I’m deadly serious. We could do this, shift any debts onto the central bank balance sheets, and wipe our hands, having solved the affordable housing problem for another generation.

Our goal should be free land

By I have a more modest goal than that—free land, for life, for all.

In our monopoly housing market, one third of households already get free land. One third own a home but have a mortgage, with the most recent of these buyers paying about 28% of their income on repayments on average. Another third pays about 21% of their income on rent on average— providing an income of over $50 billion per year to the nation’s 1.5 million landlords.

A free land option could be made available for those who don’t already own a home, targeting the 2.7 million renters, and some of the recent buyers.

Let note something Henry George wrote for some inspiration here. When discussing the situation of outside options and their effects on wages he said:
“Suppose there should arise from the English Channel or the German Ocean a No-man’s land on which common labor to an unlimited amount should be able to make ten shillings a day and which should remain unappropriated and of free access, like the commons which once comprised so large a part of English soil. What would be the effect upon wages in England?”
He would at once tell you that common wages throughout England must soon increase to ten shillings a day.”
What George is imagining here is a new option where workers get free land access, and because of this, their wage increases ‘remain unappropriated’. If everyone has the option to get free land, can there be unaffordable land and therefore housing?

The lesson is that we need, to some degree, to break the land monopoly with alternative land access options. What George had in mind was socialising the land and renting it rather than having perpetual obligation-free ownership. This way, the monopoly benefits of land ownership were shared widely through this common ownership.

But there are other ways to create access to housing that avoids the monopoly land market. My best proposal is this — a traffic light system of taking turns using land for housing, for free. Give us our earth rights. Our birthrights.

Henry George lived at a time when governments were just a few percent of the economy, so he might have regarded the supply of free land by a public entity as impossible, hence he instead imagined what would happen with the discovery of a new bountiful island that gave workers free access to land.

In the 21st century economies of the modern world, we certainly can provide free housing. After all, the government spends more on healthcare than homebuyers spend on loan interest, and renters spend on rent.

When something is really important, we never rely on markets to provide it. We bail out farmers in drought. We provide public education and healthcare. We run the courts, the military and the police. We run the road system.

What would a turn-taking traffic light system of free access to land for housing look like?

The Unspoken Housing Alternatives report

(Report link)

Luckily, we have an experiment running since 2008 now in Canberra where over 1,000 residents are currently saving more than $9 million per year in housing costs and will be 37% better off than renting the same home over a decade.

Here residents who do not already own property are given access to land in new subdivisions, not quite for free, but for a discounted access price of 2% of the market value each year, with a cap on the assessed market value growth of the local wage index.

For a $275,000 block of land, the average in the scheme, rather than pay to borrow the money needed to purchase at 5%, you simply pay to rent the land at 2%, a $9,000 per year saving. This is massive! Remember that what we are doing right now is hoping that we can build enough homes over the decade to reduce rents and prices by 10%, or about $2,000. It has been proven that we can do nearly five times better tomorrow if we want.

Over 2,000 people have taken up the scheme since it began, and over half of them have since left because they saved so much money they decided to buy their land or another house in the private market.

If a scheme of this scale had been implemented nationally it would have created about 125,000 homes, housing over 325,000 people, with half going on to buy their own home in the private markets. Those remaining would be saving over half a billion in housing costs per year.

But this amazingly successful land rent scheme only gives residents access to land for the equivalent of a little under half price. That 2% could just as easily be 1%, or 0%. If we worried about making land free, we could have a rising block system – if the market value of the land is less than $200,000, you pay 0%. But you pay 3% for the value above that.

If we adopt these systems nationally or in other states this rate is important to get right early, because changing it will arouse concerns about fairness (the report covers some of the sensitivities to changes made in the ACT scheme).

The amazing thing is that the budgetary effect of the ACT scheme is to break even. This is actually a free scheme to give people cheap housing! This is because the discount on costs to residents are offset by capital gains being held by the government. As long as the capital gains on average make up the difference between the land rent percentage and the government cost of borrowing, they have no net financial cost. If such a scheme was to be made zero percent, the cost would only be the difference between the capital growth rate and the borrowing rate, or around 2% of the land price.

You might be thinking that this is a problem— the residents miss out on capital gains while the government gets them. But of course, renters never get capital gains anyway! On net this scheme is an economic trade-off —give residents low-cost homeownership as long as they give up their capital gains. It’s another housing option, more secure and cheaper than renting, and this exactly what we need if we care about making housing cheaper without the multi-trillion-dollar political risks that come with depressing market prices.

But there is more. Not only do we have the ACT example, but globally there are examples of community land trusts (CLT) which accomplish the same trade-off of cheaper homeownership without the financial speculation. I will comment only briefly about such schemes, but I see no reason why we cannot have multiple alternative low-cost homeownership options available.

A CLT takes subsidised land and passes these lower costs onto residents through regulated pricing, again breaking the monopoly market. For example, rather than rezone a property developer, giving them new property rights for free rather than selling them, we could have planning rules that allow more density only for CLTs which must offer land to residents at prices that are at least 50% of the prevailing market price, just like the LRS. The economic mechanism here is a bit subtler, but in essence, the price control of resales ensure that capital gains can never be realised. One scheme that started with a subsidy from Bernie Sanders in Burlington, Vermont, has regulated prices around 40% below the nearby prevailing market. The modelling I did for this report showed that similar schemes based on Australia conditions could reduce housing costs by 50% compared to renting and be much more secure.

Like the land rent scheme, CLTs are a vehicle to make land free as well, if that’s what we want.

How much does free land cost?

Free homes in the form of paying rent and interest would cost over $100 billion. But free land access with social ownership is much cheaper.

A more than 50% discount on land has been achieved in the ACT at no economic cost to the government. It is break-even when residents pay 2% of the land value, so the net annual cost to the government for offering free land would be to forgo this 2% of the market value as revenue.

That’s our benchmark. 2% of the market value and we can give everyone who doesn’t own property free land for life.

Not all of the nearly 2.7 million renting households would enter the scheme — it would apply to Australian citizens, those who do not own any residential property — excluding rent-vestors unless they first sell — and would probably be unsuitable for very mobile households.

Let’s say our target is 2 million homes. At an average market value of land of around $300,000, a 2% subsidy to make land free amounts to just $12 billion per year! The is roughly the value we give away for free through rezoning decisions that could instead be sold. It is about a fifth of the current housing subsidies we have that make housing more expensive. Free land is dirt-cheap housing policy.

Getting land into the scheme

If we are to start a parallel land access system, we need to convert land into the scheme without having to outbid existing buyers in private land markets. The ACT has an advantage in that it already has a government entity supplying all new residential land. Qualifying buyers are simply provided the option purchase using the land rent scheme rather than pay up-front. The scheme is not tied to specific lots, but to specific buyers.

In other states without these agencies, it can be a bit trickier, though there are still some government developers around, like Landcom in NSW.

To get the 2 million homes into the scheme over 10 years is just 200,000 per year. For context, we built 170,000 new homes per year over the past ten years.

What are the ways to get land into the scheme on a national scale without sending new families to the housing auctions to outbid each other?

To get the first quarter of a million homes we can have a new land agency compulsorily acquire undeveloped subdivisions from private developers. We know from Prosper’s research in their Englobo reports that there are easily a quarter of a million plots of land ready to be developed. Like the public developer in the ACT, the agency can develop the infrastructure then supply the land to free for residents to build their homes.

We could get nearly another quarter of a million in dense areas using the land agency to acquire whole new buildings from developers who might be struggling to get presales, or simply acquire sites or use publicly-owned land to build apartment buildings with the right mix of dwellings for the scheme.

Homeowners could convert their own land into the scheme, being paid the assessed land value, and forgoing future capital gains, as long as there are controls that restrict the purchases being made prior to the date of the start of the scheme so as to not attract a flood of new buyers who overpay with the intention to convert to free land scheme if prices start falling.

Negotiated agreements between landlords and tenants could covert land into the scheme if landlords want to cash-out without the sale costs, subject to valuations and approval from the agency.

There are many more ways, like acquiring deceased estates, negotiating to acquire homes from mortgagees in possession, and more.

Political elements

Though it may decrease market prices by providing a new option for renters and homebuyers, I think this type of approach is politically more palatable because the objective is not to remove $1.7 trillion in asset values from the powerful voter base of homeowners and investors. Like having a public health care system doesn’t directly target the price of private health insurance, the existence of this option certainly does help reduce the price in the private market.

Such schemes can be marketed like as having no retrospective changes. You keep your land value under the current private system, but we will simply build a new system in parallel.

The free land scheme also can’t be challenged by those who think we need to build more housing to make it cheaper. What could be better than building more housing and giving people access to it for free for their whole lives?!

Where to now?

Let me conclude then with how I think we should talk about housing affordability. Our benchmark should be free land for everyone. We never talk about affordability for homeowners because they have free land. They have already escaped the monopoly land market.
  • First, we should aim high— not this meagre 25% of household incomes on rental being classed as affordable.
  • We should call out policy fraud where we see it — counterproductive policies, and others that do not get anywhere near making land free. We should simply not give them let them control the debate by agreeing with them when they say how difficult or expensive it would be to make housing affordable. It’s not a wicked problem. Stuff that. 
  • We should especially ignore anyone whose analysis ignores the land monopoly and talks about market solutions. That is, most of The Experts. 
  • We should show that many of the most effective systems we have are non-market, in public health care, on our roads, our education system, our military, our courts and more. 
  • We should emphasise how cheap it is to make land, and even possibly houses, free for all — it would cost far less than the ineffective housing policies we already have that making housing more expensive! It would cost less than we pay to money-managers each year to extort our super, and less than the banks make in profits.
  • We should never justify policies to make housing cheaper by their government budgetary impact. This is admitting defeat before you even start. None of the current ineffective policies were sold that way. Expensive policy is a good thing because politicians get to say they are investing $25 billion on housing! Think about the jobs!
The political problem is what Henry George identified when he remarked:
“Everywhere, in all times, among all peoples, the possession of land is the base of aristocracy, the foundation of fortunes, the source of power.”
Thank you for listening. I look forward to your questions.

Wednesday, August 29, 2018

The absurd scale of Australia’s financial rip-offs

Australia has transformed over the past three decades into a land of financial rip-offs, tax loopholes, and political gifts to takers rather than makers.

I should know. I've spent nearly a decade studying political favouritism in Australia and even wrote a book about it— Game of Mates: How favours bleed the nation.

To show the absurd scale of the rip-offs in just a few areas, let us consider the economic savings available if we scrapped dodgy superannuation, taxed bank profits to reflect their privilege, and removed the discount on capital gains tax.

The big picture effect

In round numbers, these actions would—

Increase public revenue by:
$10 billion from bank profits (out of $30 billion of total bank profits)
$30 billion in tax by removing superannuation tax breaks
$5 billion from CGT discounts

And decrease private spending by:
$25 billion spent on fees to manage superannuation
$70 billion of after-tax wages 

Total effect: $140 billion (or $14,000 per household per year)

How big is that?

For an indication of the ridiculous scale of these numbers, if we scrapped this economic waste we could instead provide every household with:
  • Free electricity and/or gas ($20 billion per year)
  • Free internet ($10 billion per year)
  • A free house for life for those who don’t have one ($20 billion per year)
As well as:
  • Increase the age pension by 50% ($20 billion)
  • Get an immediate 7% wage increase ($70 million)

What about public services?

Adelaide’s new hospital is one of the most expensive in the world, at $2.3 billion. We could build 70 of them every year with the savings. 

Sydney’s new inner-city high rise school at Surry Hills had a cost blowout to $225 million. We could build over 700 of these every year.

We could build the newly proposed $50 billion Victorian rail line three times over, every single year. 

A personal note

Contrary to my priors, our children's local school in Queensland actually relies on fundraising from the P&C to buy library books and sports equipment. They are even now fundraising to put turf on the oval. 

One of the staff once told me that "the government pays for the buildings and teacher salaries and nothing else."

It is madness to skimp on a few million dollars here and there rather than make schooling a great experience for teachers and students while letting the financial industry take our country to the cleaners. Why can't we buy books and sports equipment for our schools? Why can't we air-condition every school classroom and power our schools by solar? This stuff is so cheap when put in the context of the financial waste we have created in the economy.

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.