Myth: Tight rental market boosts home prices

A common housing market myth is that low vacancy rates lead to rent increases, which lead to price increases (or at the very least, put a limit on any loss in home values). For example -

...this market imbalance will at some points cause an acceleration in rentals growth and a tightening in rental vacancies, so setting the stage for a recovery in prices through 2012.

Unfortunately, if history is anything to go by, this argument fails in real world conditions.

The two graphs below make the point clearly. In the early 1990s, vacancy rates soared and prices remained flat. But in the early 2000s, rental vacancies matched these highs during the strongest period of price growth observed in 25 years. How can these two opposing relationships been reconciled?

(Images from here and here)

I have a hypothesis.  During boom times overbuilding results in a slight glut in homes entering the rental market (eg 2000-2005). As the construction boom subsides, these homes are slowly absorbed by rental demand. When the market begins to fall (bringing much of the economy with it) potential sellers become reluctant landlords, boosting rental supply (eg 1990-1995). Additionally, nervous householders reign in spending on housing, resulting in an increased occupancy rate and lower rental demand.

There are many ways the occupancy rate increases, which don’t necessarily imply a shortage of homes. Downsizing leads to more efficient use of existing homes -

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

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

Other ways include university students moving home with their parents, and grandparents moving in with their children’s families.

If my hypothesis holds, then the ‘rental market cycle’ has two periods for each economic cycle, and tight markets are a signal of a price boom only if the previous trough was prior to a price fall. Therefore our next 'rental market cycle' will be one accompanied by falling prices, or flat at best.  The evidence in Brisbane seems to suggest that this pattern is beginning to occur (although prices have already fallen 10%).

(I also have a suspicion that auction results show a similar cycle - increasing in booms and busts, with low clearance rates at turning points.)

Interesting TEDx video on risk taking and helmets

...and a light read on safety measures that don't work (but probably make us feel better).

Helmet laws hit the headlines - again

The public debate about mandatory helmet wearing laws in Australia has raged since Sue Abbott won an appeal to the District Court last August defending her failure to wear a helmet. Since then media coverage on the matter has been generally poor, often confusing the effectiveness of helmets in reducing head injuries following a fall, with the net social benefits of the law itself.

The debate

The debate is about mandatory helmet laws (MHL). The pro-choice side advocates repealing the law so that helmet wearing is voluntary (not compulsory non-helmet wearing as some mistakenly believe).

The argument is about whether the law itself provides net social benefits – not about whether an individual rider involved in a fall is more or less likely to injure their head by wearing a helmet. Evidence points to the fact that yes, a falling rider with a helmet will, on average, suffer less severe head injuries than a bareheaded rider.

But is this a justification for a law?

Not at all. You see wearing a helmet while walking and driving will also prevent head injuries in the case of an accident. But one side of the debate seems happy to leave these other activities alone, even though it fits logically with their argument. 

Health Costs

Indeed, supporters of MHLs often cite taxpayer-funded public health care as a justification. Yet this makes no sense whatsoever for the MHL debate, the tobacco taxes, or any other preventative health care issue.

As I have said before 

…that increasing preventative health care, while having the benefits of a healthier and long life, often come at increased total lifetime health costs, rather than decreased costs as is often proposed. Remember, we all die some day, and any potential cause of death postponed will allow another to take its place, which of course has its own health costs.

Alternatively, a more healthy existence may make us more productive for longer and lead to us contributing more in taxes over our lifetime than the potential increase in health costs which were paid through the tax system for our preventative care.

Governments, and subsequently economists, worry about these things because many health care costs are borne by others though tax revenue, yet the net economic effect is anything but straightforward.

The arguments 

The only argument remaining in favour of MHLs is that we are saving people from themselves. It is a pretty weak argument for making law in my view.

The pro-choice advocates usually cite a variety of factors to demonstrate that any benefits an individual may receive by wearing a helmet can be significantly offset by their own risk compensation and the changes to the behaviour of other road users.

For example

1. Drivers will pass helmeted cyclists closer than bare headed cyclists (with cyclists with long blonde hair getting the most room).
2. Helmets make cyclists feel safer, and they adjust by taking more risks (risk compensation) 
3. Helmet laws decrease the number of cyclists on the road, making car drivers less familiar with cyclist behaviour and making each remaining cyclist less safe.
4. Helmets increase diffuse axonal injuries of the brain and neck due to their increased diameter (and increased the likelihood of impacts due to the larger volume). As Sue Abbott argued in her court case – a helmet can increase angular acceleration which an oblique impulse imparts to the head, increasing the risk of damage to the brain, especially diffuse axonal injury 
5. Helmets can be a hazard in many circumstances (with many child deaths recorded as a result of helmet wearing) 
6. Any deterrent to cycling is likely to increase time spent on sedentary activities, further contributing to the obesity epidemic. 
7. The law allows governments to appear to be acting in the interests of cyclist safety, while neglecting other measures to improve cyclist safety, such as bike lanes or driver education.

Added together, mandatory helmet laws are not a clear winner on any social benefit measure. 

Missing the point

Most media commentary has missed the point of the debate. The pro-choice side does not argue that helmets are worthless for any individual rider if they are to hit their head. They simply claim that helmets are not as effective at reducing injuries as they are made out to be and the many flow-on social effects that further reduce cyclist safety are not considered.

Even academics have a hard time finding strong evidence that helmet laws have reduced head injuries significantly. The Voukelatos and Rissel paper I referenced in a previous post, showed evidence that the benefits of helmet laws in reducing the ratio of head to arm injuries for hospitalized cyclists was insignificant compared to other road safety improvements in the late 1980s and early 1990s. It was later retracted after criticism over data inaccuracies (corrected data in the graph below), with the critics now publishing their own study using similar statistics to examine the effect of the law in NSW. They find that there is a statistically significant impact of the law in reducing the ratio of head to arm and leg injuries.

Unfortunately, their model also found that the helmet law led to fewer hospitalisations of pedestrians with arm injuries.

For cyclists who do fall in a manner leading to significant injuries, a helmet may reduce head injuries. That it is so difficult to see the effect of helmet laws in the data suggests that any benefits of helmet wearing must be very small, even at an individual level. MHL supporters usually feel that helmets prevent almost all head injuries. But this is not the case. They at best provide a marginal improvement in head safety.

I hope this brings a bit of perspective to the issue for readers who stumble across helmet headlines.

Go back to where you came from - Australia's talking

Last night SBS aired their new three part series Go Back To Where You Came From, where six Aussies take part in a 'reverse refugee' experience.

I think most viewers would agree that it was particularly interesting to watch the participant's reactions to meeting refugees and visiting detention centres.  Participants are from quite different backgrounds, and they have a variety of opinions on refugee policy.

The show apparently has twitter all a buzz, and is generating quite a deal of media commentary.  Much of the reaction focuses on the apparent ignorance of one particular participant to the real situation of refugees - especially in light of their strong opinions on the matter.

My wife suggested that there was a clear pattern in the participant's attitudes - those with broad travel experience seem to have more tolerant views.  It was telling that a couple of participants had never left Australia before the show.

What I found missing from the show, which would have been a nice complement to the emotional dimension, is reference to the actual statistics on refugees, their country of origin, the proportion coming by boat, and the changes in refugee numbers over time.

This is important because the public debate usually overlooks a couple of key points.

1. Boat people are a minority of asylum seekers and a tiny fraction of total immigration (graph below from here)

2. The number of asylum seeker arriving in Australia correlates strongly with global numbers, suggesting that it is not so much the policy of the destination country that influences the number of arrivals, but the situation in the country of origin (see the graph below).

For more detailed analysis of the factors involved in refugee outcomes, read this detailed article. I look forward to the follow up episodes tonight and tomorrow, and recommend the program to anyone even slightly interested in the topic.

Concern over the AUD

The Aussie dollar has maintained its above USD parity levels for some time now.  Given Australia's reliance on imported consumer goods, this has raised many concerns.

Now it appears that the actions of foreign central banks might be another factor to consider. The Russian central bank recently bought $4.7billion of AUD.  It seems that our relatively good economic performance is  attracting a fair bit of attention.

There are suggestions that the RBA might want to intervene to take the pressure off the AUD, and indeed their current dealing reflect concern over the high value of the dollar.  Maybe this a partly a factor in their fx dealings, but it doesn't appear to be (see chart below for RBA fx dealings).

The question comes down to whether we choose to buffer our domestic firms from foreign economic upheaval, or are we ‘all in’ in this global economy game?

I think a reasonable middle ground is to support a mining resource tax and a sovereign wealth fund to balance our economy.  I recently suggested that Quarry Australia was not a desirable place to be, and some type of counterbalancing policy would be inherently stabilising.

Whether this would have much of an impact on the AUD I don’t know. But another part of me thinks – stuff it. Go all in. AUD to $1.25+. The non-mining sectors of the economy will get the shake up they really need to improve efficiency and competitiveness in the long term.   You see I wasn't thinking long term.  Maybe short term pain would give productivity the jolt it so desperately needs.

But of course, there are real people's lives to consider as well, and shake-ups like that are painful. 

The other argument to consider is that Australian businesses benefit when foreign markets are booming, so why not let them face the risks when foreign markets are failing?

Given the high probability that any government intervention will be an ineffective mess anyway, maybe we should just let the market function for a while.

There are plenty of questions, but unfortunately no easy answers.   Expect much more debate on this situation in the coming months.

Real estate commission madness

The Queensland government is set to remove the maximum commission that residential real estate agents can charge from the Property Agents and Motor Dealers Regulation 2001. Currently the regulation prescribes in Schedule 1A that

The maximum commission payable on the purchase or sale of residential property is—

(a) if the purchase or sale price is not more than $18000—5% of the price; or

(b) if the purchase or sale price is more than $18000—

(i) $900; and

(ii) 2.5% of 

The common practice since the introduction of the regulation has been for all agents to charge this maximum.

The Deputy Premir Paul Lucas is spinning that dergulation will somehow benefit home sellers. Yeah. Right.

Admittedly, NSW, Vic and the ACT don’t have regulated commissions for real estate agents, and the common practice in these states is to charge 2.5% for homes in urban areas, and between 2.5% and 4% for homes in outer and remote areas. It appears from this comparison that Queensland’s regulation mostly benefits those in outer areas and rural and remote areas - those with the lowest value homes.

The question you must ask, is whether the regulation is disrupting functioning markets such that there is an efficieny gain from removing it? I have yet to hear of a real estate agent refusing a listing because the commission is too low. There are always other agents willing to try their luck.

In fact, recent competition suggests that more agents are negotiating below this maximum. I wrote earlier how lower commissions could be a massive competitive advantage for new agencies.  

Indeed, when the regulation came in home prices across Queensland were less than half of their current levels. So for every sale, an agent now makes double from charging the same commission. If this regulation was a problem we should have felt it years ago, not now.

Poor REIQ Chairman Pamela Bennet reckons “the regulation of commission rates for residential property transactions has not kept pace with the changing market resulting in consumers not receiving the benefits originally intended” What now?

For the maximum to have kept pace with the changing market it should have been reduced over time so that the inflation adjusted average commission was constant – theoretically providing the same benefits as originally intended.

The only logic I can see is that the government thinka this change will stimulate sales and hand them back some stamp duty revenue? Sorry. That's not going to happen.

Population and housing all muddled up (and now corrected)

RBA governor Glenn Stevens needed to say something about house prices in his recent speech. What he said was a little muddled, but if it is meaningful, does not bode well for home prices.  The analysis however got quite a bit of support from one property commentator.

First to the governor’s housing commentary –

It surely is no coincidence that the two state capitals that have had the clearest evidence of declining house prices over the past couple of years – Brisbane and Perth – are the two that previously had the highest rate of population growth and that have since had the biggest decline in population growth. Moreover, it is hard to avoid the conclusion that changes in relative housing costs between states, while certainly not the only factor at work, have played an important role. Relative costs are affected by interstate population flows, but those costs then in turn have a feed-back effect on population flows. This is particularly so for Queensland.

Historically, Queensland has had faster population growth than the southern states, as it has seen a slightly higher natural increase, a rate of net international migration on par with other states and a very substantial net positive flow of interstate migrants. Net interstate migration to Queensland peaked around 2003 – not long after Sydney dwelling prices had reached a new high relative to other cities. Interstate migration at that time was contributing a full percentage point a year to Queensland's population growth. By 2008 this flow had slowed a bit, but international migration had picked up and Queensland's population growth increased, peaking at nearly 3 per cent. Western Australia's population growth was even higher, peaking at almost 3½ per cent.

Meanwhile, at least up to 2007, people were confident and finance was readily available. Brisbane housing prices, which had been a bit over half of the average level of Sydney and Melbourne prices in 2002, had risen to be almost the same by 2008, which was unusually high.

The rate of interstate migration to Queensland then slowed further, to be at its lowest in at least a decade. The effects of that on state population growth were compounded by a decline in international migration, something seen in all states. At the same time, finance became more difficult to obtain and lenders and borrowers alike became more risk averse. This happened everywhere, but its effects in Queensland seem to have been more pronounced. Since then, Brisbane housing prices have been declining relative to those in the southern capitals and the construction sector here has found it tough going.

I decided to check the facts. Below is a graph derived from the ABS Sept 2010 demographic statistics on State populations. The figures show that WA did in fact have a population growth spurt during 2008, but that WA and QLD still retain their claim to the highest population growth rates in the country. In fact, Vic also recorded declines in growth rates of a similar magnitude to QLD in 2009-2010, but home prices have been far better maintained there. 

The only conclusion, to draw, if we believe the RBAs population explanation of home prices, is that with national population growth rates now down the gurgler, home prices nationwide can expect significant falls.

The eurozone is saving Germany

Over at Business Spectator, Oliver Marc Hartwich has laid out the reasons Germany is so keen to maintain the currency union even though Greece is effectively living on German welfare. A low value euro gives German exporters a massive advantage, probably more benefit than the cost of supporting Greece.

I recommend going over to BS and reading in full, but below is the crux of the article (with my emphasis in bold).

These figures explain why German politicians fear nothing more than a break-up of the eurozone. Apart from the inevitable repercussions for the global financial system, any scenario in which weaker eurozone countries departed from monetary union – let alone a scenario in which Germany itself pulled out – would inevitably have an impact on Germany’s exchange rate. It would appreciate substantially and thus undermine its export-dependent economy upon which much of Germany’s recent economic performance is built. No wonder then that German politicians still prefer to pay for Greece, Portugal and other struggling countries, however grudgingly.

Unfortunately, the current German strategy to keep the eurozone together at all costs is extremely short-sighted. It leaves countries like Greece and Portugal permanently dependent on German transfer payments while burdening German taxpayers with enormous liabilities and risks. All of that for the dubious benefit of prolonging and amplifying existing trade imbalances within Europe.

When I pointed out to the advisor that the German government’s policies effectively turned Greece into one big welfare recipient, the answer I got was little more than a ‘Yes, that’s true, but we can still afford it’.

Quarry Australia

Glenn Stevens' address to the Economic Society of Australia in Brisbane yesterday reiterated the RBAs forecast of our future - Quarry Australia. Is that where we want to be?

The speech was full of useful analysis and commentary on domestic and global economic trends, but I have many concerns.

First, I'm not sure why the benefits of the mining boom are not spreading to the States with the largest mining investments. The Queensland government is broke yet still feels the need to stimulate the construction sector to the tune of $10,000 per new home. Further, if the property market is a good indicator of overall economic performance, the resource states seem to be taking a hammering. And by the way, the federal government stimulus is still ongoing, with $2billion still to be spent even in June 2011. So the unstimulated state of the economy is yet to be seen in the data. I didn’t hear a peep about that.

Stevens did raise the issue of falling home prices in Brisbane and Perth, suggesting that the reasons were all down to population growth and risk aversion by households. If we believe his population explanation for home price (which is rubbish anyway), then we have to believe the whole country’s property market is due for a crash, with immigration rates falling rapidly since mid 2008 (see chart below).

Some of his comments on housing follow, but the bolded sentence still confuses me. I could paraphrase - "the bank has no idea why Brisbane and Perth prices are down, but most likely it is because they were too high. We have no idea if prices elsewhere are also too high"

It surely is no coincidence that the two state capitals that have had the clearest evidence of declining house prices over the past couple of years – Brisbane and Perth – are the two that previously had the highest rate of population growth and that have since had the biggest decline in population growth. Moreover, it is hard to avoid the conclusion that changes in relative housing costs between states, while certainly not the only factor at work, have played an important role. Relative costs are affected by interstate population flows, but those costs then in turn have a feed-back effect on population flows. This is particularly so for Queensland.
...
The rate of interstate migration to Queensland then slowed further, to be at its lowest in at least a decade. The effects of that on state population growth were compounded by a decline in international migration, something seen in all states. At the same time, finance became more difficult to obtain and lenders and borrowers alike became more risk averse. This happened everywhere, but its effects in Queensland seem to have been more pronounced. Since then, Brisbane housing prices have been declining relative to those in the southern capitals and the construction sector here has found it tough going.

My other major concern is the following comment which is the justification for placing all of Australia’s bets on mining and energy.

For a long time, the world price of foodstuffs and raw materials tended to decline relative to the prices of manufactures, services and assets. But for some years now the prices of things that are grown, dug up or otherwise extracted have been rising relative to those other prices. This is mainly due to trends in global demand. At any point in time for a particular product we can appeal to supply-side issues – a drought, a flood or a mine or well closure, or some geo political event that is seen as pushing up prices. But stepping back, the main supply problem is really that there has simply been more demand than suppliers were prepared or able to meet at the old prices.

We do not have to look far for the cause: hundreds of millions of people in the emerging world have seen growth in their incomes and associated changes in their living standards, and they want to live much more like we have been living for decades. This means they are moving towards a more energy- and steel-intensive way of life and a more protein-rich diet. That fact is fundamentally changing the shape of the world economy. Even if China's growth rate moderates this year, as it seems to be doing, these structural forces almost certainly will continue.

The graph of Autralia's terms of trade (below) show the pattern of declining raw material prices since WWII, which changed some time in the early 2000s (assuming that our terms of trade is somewhat representative of the relative prices of raw materials and manufactured tradeable goods).

As a general rule, raw materials should become relatively cheaper over time as capital makes us more productive and raw materials easier to extract. This is always true even if there are natural barriers to resource extraction. Changes from this trend caused by a surge in demand are almost by definition temporary.

The generic argument is that China and India are making huge capital investments, thus they need a lot of energy and minerals. These countries are also getting wealthier and consuming more (and meat in particular). But the boom is driven by capital investment – building roads, rail, bridges, dams, buildings etc – which cannot be sustained for long at such a high pace. 

Remember, this a change in relative prices, not quanitites. Prices can fall extremely easily with the smallest of changes to the volumes of minerals and fossil fuels being traded.

The RBA, however, seems to think this price structure will be sustained for some time even though it never has in the past - the natural limit for the terms of trade appears to be around 80.

My main concern is that frighteningly, the RBA, and probably much of the government, sees Australia’s future as a single bet on mining, and is willing to sacrifice much of the remaining economy for this to happen. Unfortunately this is a lose-lose proposition for most of the country.

All other sectors of the economy lose while the mining investment booms. When it crashes, we all lose because there is nothing else left in the economy to absorb capacity in a relatively short period. Remember, the minerals will be in the ground if we don’t mine them now, but the decades of production chains elsewhere in the economy are easily destroyed and slow to rebuild.

I acknowledge that the RBA has a single tool in its toolbox, but surely the message we should be hearing is that a strong and stable economy is a diverse economy. Quarry Australia is a very volatile and risky place to want to be.

Realities of cycling

I've probably whinged about the inadequacy of bike lanes before, but this guy makes the point with a little more style. Enjoy the video.

Australian retail playing catch up

Almost every day now I am drawn into conversations about how much cheaper common consumer products are to buy online. The following is a list of products my immediate circle of friends has bought online from overseas (mostly from US and UK web stores) in the past month – books, shoes, DVDs, dresses, tailor made shirts and suits, camera accessories, toys and computer parts.

The price differences are astounding. Books delivered to your door from the UK for $8 when local bookstores are asking $24 for the same book. Shoes that retail locally for $200 are just $100 delivered from the US. It seems that if you can’t find online prices for less than 50% of the local retail price you just aren’t trying.

The Australia Institute (TAI) conducted a survey of online shopping and has some great examples of the price differences between local and online foreign retailers. A Sony Bravia television is half the price to buy online from the US ($995 instead of $1999), DVDs are usually half the price online, and even high end bicycles are half price if you get them delivered from the UK ($1599 instead of $2999).

Even more bizarrely my local bottle shop has a six-pack of imported German beer for $10 – that’s $4 less than the XXXX that is delivered a mere two kilometres from the brewery (and yes that is the brewed in Germany beer, not the locally brewed German style).

And one thing that really bugged me was that at the Hofer supermarket in Vienna a couple of years ago - Australian wine was 2.5euros a bottle, but the same wine here is more than $10.

What is going on!

We have a situation where not only are Australian products more expensive locally, but so are imported products!

My theories are -

1. Adjustments to higher exchange rates are very slow. If the dollar appears to stabilise around $1.05USD we can expect local prices to slowly converge to international prices.

2. Australian retailers are simply years behind their European and US counterparts in terms of adopting more efficient business models (think Aldi, Ikea),and especially for online retailing. Again, we can expect this to change slowly.

3. Australians still feel wealthy and don’t feel compelled to hunt for the best deals. This is changing as the TAI survey showed.

4. Many have suggested high rents for well located retail space as part of the explanation. This might be a contributing factor but I imagine that the trend for retail rents is down.

5. People get upset when prices fall. Remember the milk wars, the beer wars?

6. Local producers have no incentive to sell locally below the price they receive from export markets (as I discussed here).

I’m open to any other suggestions, but there really doesn’t seem to be one factor to explain this retailing discrepancy. I also believe that the price differentials between local and foreign online retailers are likely to shrink from now on.

Dwelling finance springs back

The ABS released their April dwelling finance data today, and there was quite a bounce for owner occupiers across all States, but investor finance continues to fall.

Taking a look at the big picture it is hard to know whether this one month's data is particularly meaningful.

Great Stagnation?

Tyler Cowen has an ebook that presents his hypothesis that America is undergoing a great stagnation. What he means is that teh rate technological change and economic growth has slowed since about 1973. You can get most of his message from the TEDx talk in the below video.

While Cowen acknowledges the great leaps in communication technology, I feel his presentation glosses over a lot of medical technology which is highly valuable and has continued to improve life expectancy.

He also glosses over a lot of other changes that people value but don't get recorded in the statistics (for example greater equality of genders and races or lower crime rates). The more effort society directs towards these social advances, the less effort it can direct towards technological marvels.

Overall it's a very interesting video for anyone curious about economics and modern history.

Queensland’s Strategic Cropping Land

I have been critical about the farming lobby’s reaction to the Murray-Darling Basin Plan, and I have also been very critical about the value of food security, especially when used as a justification for agricultural subsidies.

My general belief is that farmers should be treated like any other business and face risks from their investment decisions.  Because this belief I strongly support Queensland’s new Strategic Cropping Land Policy. 

The policy under development gives farmers a chance to opt out of mining and gas production on their land. Currently land owners must allow mineral and gas exploration and development on their land. The mining industry has legislative power behind it to explore for, and mine, the States mineral resources (have a look at your title deed and you will note that even freehold land owners don’t own the minerals under their land).

This means that miners do not need to buy any property rights from existing land owners to conduct activities on privately owned land. They do however need to provide some compensation for disruption to activities (as prescribed under the relevant acts).

In the greatest of ironies, agricultural policies in this country have protected farmers from their own business decisions (eg. subsidising water supplies, making drought and flood payments - I argue these events are part of the natural weather cycle and should be anticipated), yet have not protected farmers from external threats to from mining.

It took a while for the food security lobby to realise that the food production of the country rests in the land, soil and water, not in the individual businesses of farmers. If a farm business fails, the productive capacity remains for the next buyer of the property. But if land, soil and water is irreversibly damaged, then potential food production capacity is destroyed.

With these bizarre policies in place it is possible to have the situation where a farmer is receiving drought relief payments on the one hand to save his business, while the government is supporting the demise of his ability to farm on the other hand by allowing coal seam gas wells to be peppered across his fields.

In the Darling Downs the preservation of the water quality in underground aquifers is especially important. These aquifers are a significant source of water for agriculture and there is a reasonable probability that drilling through this aquifer many thousands of times to reach the deeper coal seam will contaminate the water. And unlike a river system which flushes water readily, underground aquifers may take hundreds of years to recover (or water users will need to treat the now contaminated water before applying to crops).

The irreversibility of mining and coal seam gas impacts is one of the key reasons that farmers should be given some ability to opt out of such activities on (or even near in some cases) their land.

The outcomes from this type of policy should satisfy a broad range of interests.

1. Land use conflicts are more easily resolved by given some powers back to existing land owners.

2. By protecting the land itself those who want food security and local food produce benefit.

3. Those who want ‘agricultural open space’ benefit (people actually like knowing there are farming communities and driving through the country).

4. Farmers who want to be free to run their own business, protected from irreversible land damage benefit.

5. Those who want mining can do so if the impacts on surrounding land owners are sufficiently low.

Of course there will be problems to overcome during implementation, but in principle the policy appears sound. An indeed, the minerals and gas remain in the ground should future circumstances require their extraction.

The telco confusopoly

The one frustration that started me blogging more than three years ago was the confusing pricing practices of phone and internet service providers. It was quite obvious to me that their 'plans' where meant to be confusing to ensure the consumer could not easily identify the cheapest provider. Today, the Australian Communications and Media Authority (ACMA) has released a report that recommends improving price information for telecommunications contracts to avoid a 'confusopoly' (here).  Amongst other things -

The authority also wants to prohibit what it says are misleading advertising practices, such as the use of the term "cap" on mobile and broadband plans.

"It's not a cap, it's not a maximum, it's a minimum," Mr Chapman said

"We want to prohibit that unless its a genuine hard cap, so that if you exceed your limit the service ends or you get the opportunity to upgrade." (here)

Most recently I have been comparing mobile phone plans. Some of the cheap plans don't allow you to call 13, 1300 and 1800 numbers under the cap, and they all have different call rates, flag fall and penalties for exceeding cap limits. To actually compare providers you need to know your calling needs in advance and have the mathematical skills to run this call profile, and other scenarios, through a model of each available phone plan. Insanity.

As I previously wrote -

By consciously manipulating these two criteria of a free market [low barriers to entry and perfect, or at least good, information], all firms in the market are able to avoid a state of true competition that would produce the most efficient allocation of services, and are able to artificially inflate the value of the commodity, hence producing more profit for each firm in the market.

This is not meant to sound like a conspiracy, because indeed each firm does not need to meet in back rooms with the other firms in the market and all agree to limit customer information and the comparability of their products. They each simply need to aspire to the great marketing ideal of product differentiation, a concept that is fundamentally designed to artificially eliminate direct competition by removing direct comparability.
...

The power of product differentiation, through its ability to remove comparability and create an information gap to distort what could be a perfectly competitive market, can be demonstrated by the case of the term life insurance market in the US in the late 1990s. There was a mysterious and dramatic drop in prices across all firms that did not correlate to price drops in other forms of insurance, which themselves where steadily rising.

According to economist Steven D. Levitt, this can be attributed to the realisation of a perfect market through the power of the internet. Although term life insurance policies had been quite homogeneous before this period of time, the process of shopping around for the cheapest price had been convoluted and time consuming, whereas websites such as Quotesmith.com suddenly made the process almost instantaneous.

In just a few years, the value of the term life insurance market in the US had dropped by USD$1bilion because of the new found ease of comparability. What insurance firm would want this to happen? Even if you were a small player in the market, say a 1% market share, your turnover had just dropped by $10million. It is perhaps one of the great recent examples of the power of perfect competition in allocating resources efficiently, yet possibly one of the greatest blunders by the insurance industry.

I believe that the power of private enterprise is its innovative response to the financial risks it incurs, but with very simple regulation the innovative confusopoly, which comes at a cost to cosumers, can easily be avoided.  Indeed, most of the pushback against the telco confusopoly is from webpages which keep up-to-date tabs on plans from each service provider and enable you to take some rough guesses about future use and compare the cost effectiveness of each offering (eg here)

GDP down 1.2% for the March qtr

In the next 24 hours there will be a frenzy of economic commentary about the national accounts data and the importance of the last quarter's figure for the RBA board meeting next Tuesday.  My money is on no move by the RBA and more poor economic data this year.

For interest, below is the GDP per capita and Real net national disposable income per capita over the past deacde.  Notice the last few years (since end 2007) have been very flat for GDP per capita, and volatile but not really moving for net national disposable income per capita.

Brisbane and Perth housing slide continues

RP Data-Rismark released their dwelling price data for April today (here).  Brisbane and Perth are leading the price slide with Sydney and Canberra showing small gains.  This follows a stream of poor economic data recently.

I March 2010 I suggested that the next interest rate move by the RBA would be down.  I was wrong.  They increased another 75 basis points in total in their April, May and November decisions. 

My reason for suggesting they must move down is that the economy was much weaker than they anticipated, and the outlook far less bouyant.  Given this recent data one must think that their optimism is slowly fading.

2011 will be a very interesting year indeed. 

Learning to judge risk

No, this is not a post on financial risk. It is about child development and learning to judge risks yourself (a hot topic in my household).

As an economist parent this article, and the comments that follow, is very interesting. It begins...

Play equipment designed by  "safety nazis " doesn't allow children to learn from risk-taking, an expert has warned.

More kids aged two to seven were getting injured in playgrounds because they didn't know how to take calculated risks.

While it may seem obvious, learning to take risks involves... taking risks! There is an old saying that epitomises this attitude – if you want to learn to swim, jump in the water.

But it seems that Councils are not going to replace their plastic low velocity slippery slides and bouncy foam ground covers with splintered old wooden climbing frames in hurry. The experts still haven’t grasped the implications of their research. They conclude with the following advice.

To improve playgrounds, Ms Walsh suggested longer and bigger slides built into embankments to eliminate falls.

Also, smooth boulders for balancing, shallow ponds for exploring and plenty of vegetation to provide nooks and crannies for children to crawl around.

But if children learn from risk taking, shouldn’t they build high fast slides, with no ground protection and sharp jagged boulders for balancing and deep ponds for exploring?

In any case, the finger pointing at engineers and playground designers was thoroughly dismissed in the comments, with molly-coddling litigious parents copping a bit of heat.

Getting my head examined - a Chris Joye rebuttal

Don't get me wrong. I agree with Chris Joye on some things - lowering the inflation target (perhaps not right at the moment), pushing for a more streamlined NBN, and supporting Malcolm Turnbull's political ambitions.

But when it comes to the housing market the guy with all the numbers is happy to overlook the strikingly obvious and adores a verbal stouch with his foes - the group he calls 'housing nutters'. In fact he just recently recommended the following 

At the same time, anyone who claims that a 1% year-on-year retracement in dwelling values is a major asset-class event (cf. the share market frequently falling more than 5% on a given day) needs their head examined, with the greatest of respect. And I sincerely meant that latter caveat: you genuinely should seek medical advice if you are convinced that house prices are plummeting. 

Let's take his advice and examine what is in my head (noting that I don't believe a 1% year-on-year fall in national home prices in isolation is a concern). 

Joye often likes to draw attention to the low volatility of the housing market compared to the share market (eg here and here). But he neglects a few important differences. 

1. The housing market has at best monthly data only. Moreover each month's price data point is essentially an average. The share market would be far less volatile if you measured it that way and averaged away each month's price extremes. Not that volatility represent risk in any case. 

2. The share market is an equity market. If you want to compare like with like you need to compare the change in home equity to the change in share prices. If there is $1.7trillion in housing debt outstanding against $3.5trillion worth of housing, you can double any housing price change to calculate the change in equity of homeowners on average. Of course prices are set at the margins so perhaps for the price setting buyers and sellers the leverage, and importance of small price movements, is even greater. 

3. The negatively geared investor sets the market price (apart from the recent burst of FHBs). This means they are losing money every year. Any small decline in value decreases their equity substantially in addition to losses already incurred. 

4. The marginal homebuyer is heavily leveraged - 80% plus. This is not the case in the share market. Remember, leverage works to improve both gains and losses. 

5. The wealth effect is much stronger in the housing market than other markets, particularly due to leveraging and the sheer size of the asset compared to household incomes. 

6. Cost of home ownership is much greater than simply the interest cost. For most homes around 25% of the gross rent is spent on annual costs (refer to 3.) 

7. Housing market crashes, while they feel almost spontaneous, actually take some years to eventuate.

Irish housing - 5 years to fall 28%, or 0.41%/month

US housing - 6 years to fall 31%, or 0.38%/month

UK - 2 years to fall 21%, or 0.8%/month (and still 18% down from their peak 4 years later) 

8. Lastly, I feel sorry for anyone who shared Joye's property optimism and bought into the Brisbane or Perth property markets in the past two years.  While the share market hasn't been crash hot, 6% returns on cash has been pretty flash.

Anyway, if these notes are a sign of a mad man, well so be it ;-)

Wealth effect driven by the housing market

Leith van Onselen over at Macrobusiness has written a couple of very important and timely articles on the wealth effect. Put simply, the wealth effect is an increase in spending that accompanies and increase in perceived wealth.

In relation to housing, this paper suggests the wealth effect increases our propensity to consume by 9c per dollar of increased housing value (which is further supported here). So if the housing stock of Australia is valued at $3trillion (some say between 3.5 and 4 trillion), and market values increase 10% in a year, then we will spend on average 9% of the $300billion of new 'wealth', or $27 billion - with $6 billion of spending occurring prior to the end of the next quarter.

Importantly, this money is spent before it is earned by selling the asset. The easy access to home equity lending has been a contributing factor to the size of this effect, enabling households to spend their capital gains before they have been realised which increases their financial risk.

There are few readily available studies about the size of this effect in reverse, but if the same values hold in both directions we can look at some interesting scenarios.

If prices fall 2.5% nationally over a quarter then we lose $75billion of perceived wealth, with an immediate reduction in spending in the following quarter/half year of about $1.5billion and ongoing reductions in spending totalling $7billion

With about $1.7trillion of bank loans outstanding, that is about the same effect on spending as an increase in interest rates of 0.25% and keeping them there for two years (which will mean $4billion extra is spent on interest repayments per year). This of course assumes that house prices are not dramatically affected.  Indeed, if we consider that interest rate moves are likely to also bring down home prices, we can expect a much greater effect from the monetary lever.

That’s why house price falls of just a few percent can cascade into a crash so easily.

I would suggest the reason the wealth effect in relation to housing is much higher than found elsewhere is that many people who benefit/lose from house price changes are highly geared, which increases/decreases their equity more quickly for a given price change.

On this note I would add that you can’t directly compare share market volatility to house price volatility, since the share market is an equity market. To make a direct comparison you need to compare the volatility of the equity component of the housing market with share market, or the volatility of the share market value plus the value of debts held by those listed businesses to the housing market.

Peter Schiff predictions

Peter Schiff was ridiculed for years when he predicted that the US housing bubble and credit binge would result in a massive asset price bust and recession.  You could describe his economic philosophy as Austrian, and as the recent Keynes and Hayek rap video explains, the bust is a direct consequence of the boom, not some seperate economic event that can be avoided through government intervention.

In this early 2009 video Schiff predicts the collapse of the US dollar and makes some very astute observations that may resonate with Australians.  Enjoy.

1980s Texas Housing Bubble Myth - A Reply

Recently the debate on the price impacts of planning regulations has been a hot topic here and elsewhere. Leith van Onselen at Macrobusiness is one of the more sophisticated proponents of supply side impacts on home prices and recently responded to a comment of mine about Houston Texas. My comment was that if Houston is an example of how responsive supply can help cities avoid house price volatility, why did Houston experience a house price bubble in the 1980s?

Leith argued that Houston's apparent price bubble was a mere blip on the grounds of price to income multiples. In his typically evenhanded fashion Leith also notes many of the demand side factors at play during that time— the oil boom, liberalisation of loan standards, and population growth. He brings together these points with the following conclusion.

What makes Texas’ home price performance in the early 1980s particularly impressive is that prices managed to remain relatively stable in the face of significant demand-side influences that should have caused home prices to rise significantly and then crash.

An additional point is made that Houston has managed to avoid the 2000s property bubble infecting most of the US and much of the world.

My reply.

Houston prices declined around 40% in real terms following the 1982 market peak—that is indeed volatile—and it took 15 years for prices to recover in nominal terms.  The Case-Shiller 10 city index has dropped by a similar amount since the US peak in 2006 (30.5% nominally). So much for the volatility aspect.

But why do prices in Houston still appear so dramatically affordable when compared to incomes?

One major reason is the relatively high property tax rate.

Property tax rates in Houston more that doubled from 1984 to 2007 becoming one of the highest rates in the US. Depending on your area you can pay between 2-3% of your properties improved market value in annual State taxes, while the US National average is 1.04%.

One would expect areas with higher property taxes to have structurally lower prices, reduced price volatility, and much lower price to income ratios.

An illustrative example is shown below. The three comparisons are intended to roughly represent the early 1980s, the early 2000s, and today. The Houston property tax rates increase from two to three percent, while the comparison taxes increase from half to one percent. Interest rates also represent mortgage rates at the time.

From these examples we can see that from just this single factor, the property tax differential, we should expect prices in Houston to currently be structurally around 30% lower than national averages (more on the impact of the property tax differential here).

An important factor at play in this example is that at lower interest rates a fixed percentage property tax leads to greater price differences. Therefore, over time, we would expect Houston to home prices to be a smaller fraction of comparable homes elsewhere as the property tax differential has a greater price impact at lower interest rates. Remember that in the table above, rents and returns are the same for each comparison - only the tax rate is different.

Of course, this does not mean that housing is lower cost. It just means that the cost of housing is borne by annual tax obligations rather than capitalised in the price. A far better comparison of whether housing is structurally cheaper in Houston would be to compare quality-adjusted rents to incomes over time and across cities.

Perhaps once the property tax differential and other demand-side factors are properly considered we will see Houston's supply-side impact on housing prices diminish to zero.

Lastly, I would add that the memory of such a deep and prolonged property price slump would be motivation enough to dampen speculative housing demand in Houston. Who in their right mind would bid up prices in Houston knowing that increased tax liability and the history of dramatic losses on the property market?

Evidence of supply-side effects on home prices remains elusive.  

A sign of desperate times?

Saw this advertisement today in the Financial Review.  I haven't seen anything like it before but it reeks of desperation.  Is it some kind of joke?

I like the first part of the fine print "Real Estate agents tell me I can get $2.1million for my luxury home but..."

Rent seeking behaviour - scare campaigns

From the Hungry Beast

Housing stimulus idea

From Crikey:

Local bike paths mean higher house prices

That is one housing stimulus package I would be happy to see implemented.  From the comments section:

More accurate take on alternate headline –
Bikeways found to be desirable trait amongst urban home buyers.
Temporary shortage of bikeways elevates prices in areas with bike paths.
Once all areas have bike paths, price distortion will be nil.
Captain Planet

Demand shocks – the details

Many pundits claim that increasing population increases demand. In technical economic jargon it shifts the curve to the right. But what we rarely see is an exploration of the two types of demand shock and the different potential price impacts.

The first type, as mentioned above, shifts the downward sloping demand curve to the right. This means there are more people with the same willingness to pay.

The second type is a shift of the demand curve up upwards. This represents a willingness to pay more for the same goods from the same number of people.

It’s pretty clear from this distinction which of these factors is in play in Australian housing.

Let’s examine the first case. Consider an auction with 10 cars for sale and 50 bidders willing to pay $1000 for a car. You add another 50 people to the mix each also willing to pay $1000. If I’m not being clear enough, this is analogous to increasing population in the housing context.

When the auction is run with the original 50 bidders each car sells for $1,000. When the auction is run with 100 bidders, the 10 cars still sell for $1,000 each.

This is an extreme scenario but does demonstrate a very real point. Unless the new potential buyers are willing to pay more for the same items as the existing buyers, the price won’t rise. At most, a second price auction (the result of an English open auction with heterogeneous preferences) becomes closer to a first price sealed bid auction by the addition of another bidder willing to bid at a price between the second and first price (read up on some auction theory here).

As I said before, new buyers, even a small cohort of the total market, can influence the price level if they are willing to pay more than the existing buyers, since prices are set at the margins. Imagine our car auction once again, and we give 10 of our original 50 bidders and extra $500 to spend on the car. What is the new result? All cars sell for $1500 each to these 10 bidders. Even though they were just 20% of the original market of buyers, they dragged the price up 50%. In fact even if there were thousands of buyers willing and able to pay $1000 for those 10 cars, the ten people willing to pay $1500 would always win.

Prices are set at the margin by those with the highest willingness to pay.

This example, where the demand curve is shifted vertically to reflect an increased willingness to pay by the same number of buyers, is shown graphically in the right hand side graph above.

But, you say, the key problem here is that supply is being overlooked - in the simplified examples demand curves are horizontal and there is no supply response. But look at the graphs again. Not only is the demand curve a more acceptable shape, but supply does respond in both circumstances. In the first, where the demand profile of buyers shifts horizontally supply does respond enabling prices to remain at their equilibrium level.

However, when the demand curve shifts vertically, it doesn’t matter how much supply responds to price increases, it cannot be a mechanism to bring prices back down (except under extreme assumptions about the shape of demand and supply and the limits of peoples willingness to pay at the top and bottom of the market).

Of course, in the end this analysis is probably unecessary. The value of housing arises from the rents - its ability to generate revenue or provide a service. Since we haven’t seen rents outpace inflation significantly for any extended period in the past two decades, one must be quite certain that the cause of prices being much higher than a rational present value of future cash flows is pure demand side speculation.

Economics, Real Estate and the Supply of Land

As a general rule, economists relying on supply and demand curves without properly discussing the assumptions that sit underneath their graphs can be ignored.

Alan Evans' book Economics, Real Estate and the Supply of Land is an effort to refute Ricardian notions of land supply and rent, and offer an alternative neoclassical theory of land supply. The arguments in this book are taken by many who believe that reducing government involvement in town planning will decrease the price of housing. Evans’ reasoning is questionable to say the least, and supported by elaborate graphs with often biased assumptions and interpretations.

One of Evans’ aims is to refute the Ricardian proposition ‘that the price of land is high because the price of corn [read: houses] is high, and not vice versa’.

To do this he constructs a model economy with a fixed land supply where two agricultural uses compete for land – potatoes and corn. In the figure below we see his construction of this economy on the left, with demand for corn inverted so that the intersection of corn and potato demand determines the equilibrium share of land devoted to each crop, and the equilibrium rent of land at point A.

He then proceeds to add a demand shock to potatoes ‘for some reason’. The new blue line represents the new increased demand for potatoes which enables potato growers to bid up prices for land previously grown for corn and reduce the amount of land used to grow corn. He concludes with the following -

Now it is quite clear that the increase in the rent of land is not caused by the increase in the price of corn. Exactly the reverse is true. The price of corn has risen because the price of land has risen.
...
The rent for land is not solely determined by the demand for the product.

His conclusions are wrong.

First, it is still quite clear that at the new equilibrium the price of land for corn is still determined by the new higher price for corn. You could just as easily argue that every time a potato grower buys land from a corn grower he decreases the output of corn and the price of corn rises, thereby leading to an increase in the rents of land available for growing corn.

Second, he fails to notice that all he has done with the model is to demonstrate the inflation mechanism following an increase in money supply for one purpose. He increases total demand (potatoes plus corn) but shifts preferences towards potatoes so that corn demand is constant. The end result of his demand increase is to increase all prices in the model economy – potatoes, corn and rent.

Followers of Say would jump straight to this conclusion. You can’t simply increase total demand in the economy – demand is comprised of supply.

An actual demand shock, which models a change in preferences from corn to potatoes, is shown in the right hand side figure. You will notice that total demand remains constant and therefore the rents for this fixed quantity of land also remain constant.

So no, land rents do not determine prices. Prices determine rents.

Another example of poor reasoning is when Evans argues against a 100% land value tax. He argues that a tax of that nature would ‘freeze’ land development because there would be no incentive for a owner of agricultural land to sell his land to a developer for housing development, since he would not capture any of the value uplift. The rent achieved by the owner of the land will remain the same as when it is rented to the farmer – zero.

Yet in chapter 8 he argues that the value of land grows in anticipation of future higher value uses. In these cases, when the site is genuinely worth more as housing, the tax would be at a rate that reflects that higher value, and not the agricultural value. Therefore, the owner of the land will be facing a tax on the land value for housing while only receiving rents at agricultural values. As the city expands and the value of his land for housing surpasses the value for agriculture, he has a great incentive to sell or develop immediately to avoid losses.

Although I don’t support a 100% land value tax, I do support shifting the tax burden towards land and fixed rights to natural resources.

What we do learn from this book is that even the experts are prone to bias that affects their ability to apply objective logic and reason.

Faulty Reasoning

I’ve come across some fine examples of faulty reasoning lately in two key areas.

1. Analysing the economic importance of declining environmental quality, and
2. Assessing the impact of price drops in the Australian property market.

So let us take a closer look.

Pro-urban sprawl advocates (I didn’t really know there were so many until just recently) try to shrug off the claim of deterimental impacts on agricultural production from urban sprawl due to irreversibly land use changes. For example –

Suburban Development is not destroying farmland. Smart growth activists claim farmland is disappearing at dangerous rates and that government needs to protect farmland lest we lose the ability to feed ourselves. As growth expert Julian Simon wrote, this claim is "the most conclusively discredited environmental-political fraud of recent times." United States Department of Agriculture data show that from 1945 to 1992 cropland area remained constant at 24 percent of the United States. Though urban land uses increased, they now account for only 3 percent of the land area of the United States. Today, American farmers produce more food per acre than ever before. In fact, the number of acres used for crops peaked in 1930, but because of the ingenuity and innovation of American farmers, the United States continues to produce more food on less land. (here)

Why is this argument based on faulty reasoning?

Not pretty

Latest Econ Theory Keynes v Hayek rap video

Milk wars and Anti-Dumping

While there are many questionable assumptions in some economic theories, there are also many solid foundations to economic analysis. One of these was identified by Coles in its submission to the Senate inquiry into milk pricing (available in the Coles factsheet here).

The farm gate price dairy farmers receive is set by the world price because most Australian milk products are exported.


The first implication of this fact is that because prices are set by global markets, domestic buyers cannot buy at prices below the export market price - although they could perhaps be higher.

By following this logic Coles, or any other domestic dairy retailer, cannot exhibit bargaining power as a buyer from milk processors (or distributors). Dairy processors would simply sell all their products abroad, whereas the only alternative for retailers is to buy imported dairy products with associated freight costs.  Processors can then bargain the price up to the price of the retailers next best alternative of imported products. Thus, even though we are net exporters of dairy products we still pay a retail price for domestic dairy products very close to the retail price for imported dairy products.

And to provide further evidence against dairy industry claims, even if Coles did have market power, one must question why Coles would not already be getting milk for the lowest price anyone would be willing to produce for?

The sceptic in me might even go so far as to suggest that upsetting the political milk cart might have been a publicity strategy for Coles itself. News outlets have told the public that Coles is aggressively dropping prices for months now – all free of charge. You really can't buy publicity like that.

Of even greater concern than the media beat-up, and public perception of danger from falling milk prices, is that the law entrenches protection of local industries from international competitors through anti-dumping laws. As the Productivity Commission describes

Housing supply follow up – more evidence (UPDATED)

I promised to search around for some more evidence that local councils approve far more dwellings than are built. This would go some way to addressing the argument than planning is restrict, particularly zoning controls and approvals processes.

This report, by the Queensland Office of Economic and Statistical Reseach, adds to the previous evidence on a deevlopment approvals for subdivisions greatly exceeding the ability of the market to absorb the new land.  It outlines the number of development approvals for infill multiple unit dwellings in the pipeline at various stages of approval for South East Queensland.

The telling figure is that there are 48,152 approved new infill dwellings in SEQ, with another 29,014 at earlier stages of approval.  Remembering that there are also 30,566 approved subdividede housing blocks, we have a total approved supply in this region of 88,718 dwellings! Even at its recent peak population growth in SEQ was only 88,000 per year.  That makes about 2.5 years supply of dwellings already approved.

Other government reports which have compiled useful information on the potential housing supply available under current planning regimes.

This report notes the following

“...there appears to be a very low risk of the current broadhectare land not providing at least 15 years supply, particularly when the increased density and infill targets set by the SEQ Regional Plan are considered. Based on the SEQ Regional Plan assumptions for infill, then only 244,000 lots would be required over a fifteen year period”

Moreover it explains that the stock of approved lots represents 3.3 years supply.

We can take a look at a national level here and see that current planning schemes have the potential to yield 131,000 new homes per year for a decade from 2008! This excludes the increase in housing stock from developments with less than 10 dwellings.  In the abovelinked OESR report they state that smaller developments of 10 or fewer dwellings accounted for 69.5 per cent of projects at June 2010. This means the estimate of 131,000 new homes accounts for only 40% of the actual supply available under current planning schemes.

Even so, they sum up their analysis of land supply by stating that there was approximately 7–8 years supply of zoned broadhectare land in 2007.  

If this doesn't blow your mind...

I stumbled across this video on the web.  It's about growing organs... from scratch.  Absolutely amazing! 12 minutes very well spent.

Risk homeostasis, Munich Taxi-cabs and the Nanny State

There is an odd coexistence between two conflicting safety policies that may well be pursued by the same accident prevention agency. The first seeks to improve safety by alleviating the consequences of risky behaviour. It may take the form of seat belt installation and wearing, airbags, crashworthy vehicle design, or forgiving roads (collapsible lamp posts and barriers). This policy offers forgiveness for a moment of inattention or carelessness. The second policy seeks to improve safety by making the consequences of imprudent behaviour more severe and includes things such as speed bumps, narrow street passages, and fines for violations. Here, people are threatened into adopting a safe behaviour; a moment of inattention or carelessness may have a dire outcome. 

While these two policies seem logically contradictory, neither is likely to reduce the injury rate, because people adapt their behaviour to changes in environmental conditions. Both theory and data indicate that safety and lifestyle dependent health is unlikely to improve unless the amount of risk people are willing to take is reduced. (here - my emphasis) 

The above passage points out a common logical absurdity, and contains an important lesson for Australian’s with and overeager obsession of controlling personal choices through ‘nanny state’ regulations. More on the nanny state a little later. 

First, it is important to examine the hypothesis of risk homeostasis to properly understand the implication of the opening quote, since it claims that neither of the two contradictory policies aimed towards improving safety are effective. 

The essential argument of risk homeostasis is that humans have an inbuilt level or risk that they gravitate towards in response to their external environment. If we reduce the risk of an activity, people will compensate by finding other risky activities as a replacement, or undertaking the activity in a more extreme manner. For example, if we ban smoking tobacco, which doesn’t seem like such a remote possibility, do we really expect smokers to replace their habit with fruit snacks and yoga? Or might they compensate by increasing their alcohol consumption or perhaps smoking dope instead. 

Risk homeostasis is not to be confused with risk compensation, which suggests that individuals will behave less cautiously in situations where they feel "safer" or more protected, but that we don’t necessary return to a predetermined risk equilibrium point. 

Improving transport safety is an area where there is strong evidence risk compensation, and indeed of risk homeostasis. 

No evidence of supply-side constraints in approvals data

Possibly the central lesson of my previous post was that planning controls and development approvals by local councils are not a factor that limits the quantity of new homes constructed. Council behaviour in these areas could limit housing supply if councils began a system of quotas for approvals. But they don’t. They provide limitations on the location of new supply in their planning instruments, and they approve the quantity of homes demanded by the development industry - which is a reflection of the number of new home sales. Sales volumes of new homes and land determine the rate of supply of new dwellings. 

In my last post I provided no evidence for my assertion apart from logically examining the process of development in a hypothetical scenario.

So is there evidence that councils are limiting the supply of new dwelling through their planning controls and approvals processes?

No.

Let’s look at my home town of Brisbane. The following table shows the stock of approved house lots in Brisbane and surrounding local council areas that are yet to be developed (All data from here - Table 1. Excludes building units and retirement homes).



In Brisbane, where broadacre land is arguable more physically constrained, the stock of approved housing lots has remained relatively constant. And as you would expect, in the fringe areas, the stock of new house lots has grown far more rapidly than sales of lots or construction of housing. This indicates that councils approve far more housing lots than the market can absorb.

Yet it is this development approval that many claim is a hold-up to development.

In Brisbane, this reserve stock equates to about two years supply, while in surrounding areas there is between 3 and 10 years supply (Logan City and Somerset respectively) already approved. Of course, there are many thousands more lots that could be approved under existing planning schemes should demand arise.

Remember, this is just the stock of new land developments. If data were more readily available for unit developments there will no doubt be a similar story (in Brisbane attached homes are about 50% of new stock).

The clear message that comes from actual data on planning approvals is that they are not a constraint to supply. This might be one reason why these figures are never mentioned by ‘supply-siders’, even in the most detailed documents outlining supply side concerns in the housing market such as the 2003 Prime Ministers Taskforce on Home Ownership Report.

8 Economic Lessons on Planning and Housing Supply

The housing bubble debate often leads to claims that town planning controls and approvals processes are a contributing factor to the price boom. It is argued that such controls can constrain the rate of housing supply during periods of high demand, allowing prices to ratchet up. But there is no case for the argument that planning controls can influence the general price level of housing.

For those unfamiliar with property development, the following lessons may be of interest.