Speech to Government Economics Network 2019 Conference

I want to talk about one of the most pressing issues in our national life: the housing crisis and the poor performance of our cities.

The argument I want to make to you is that generations of urban land use policy have lacked a decent grounding in economics. The consequences of that have been disastrous. And if we want to turn it around it is going to take bold reform and policies informed by an understanding of urban spatial economics.

The housing crisis has been relentless: the sheer scale of homelessness, poor quality rentals, falling home ownership, out of control housing costs, increased inequality, and intergenerational unfairness. I am sure for many it feels too big to fix, and the public debate is often clouded by single issue advocates.

In my view, only an explanation that looks at supply and demand can make sense of it.

Over the last two decades our housing market has experienced an accumulation of demand pressures, mainly population growth but compounded by tax settings that have encouraged a generation of investors to see rental properties as a uniquely desirable asset class.

Add to those demand pressures, abundant cheap mortgage credit particularly after the GFC when quantitative easing and lower interest rates saw vast amounts of low cost capital inflating asset bubbles all over the world.

Now if our land and housing markets were elastic, and able to respond to demand we might have seen supply ramp up.

Unfortunately those markets don’t respond well to demand.

I think there are three main reasons for that. Restrictive planning rules stop the city expanding on the fringes creating an artificial scarcity of land, and height and density rules stop the city growing up, effectively rationing floor space.

I want to give a hat tip at this point to Harvard professor Ed Glaeser who wrote Triumph of the City, one of the best explanations of how restrictive planning rules damage our cities and hurt the young and the less well-off.

The second factor that stops our markets responding to demand is a broken system for financing infrastructure that delays or prevents developments going ahead.

The third factor is a construction industry with low productivity and dominated by small and medium enterprises, that finds it very difficult to scale up in response to demand.

The effect of these three things is that we have a more or less fixed supply of land and floor space.

Under these conditions: rising demand, abundant credit, and a fixed supply of land and floor space, it is not surprising that house prices doubled in our biggest city and then doubled again over the last two decades.

And while only an economic explanation can make sense of this, it is also true that the consequences of this market dysfunction have had a harmful systemic effect on the health of our urban economies.

The housing crisis and the gridlock on our roads make us poorer.

PwC released a report on cities earlier this year that showed Auckland was the only city in Australasia to have experienced a significant drop in discretionary household incomes over the last decade. An average drop of some $5000 per household, at a time of sustained economic growth largely because of housing and transport costs.

This at a time when Brisbane, comparable to Auckland in growth rates and quality of life, experienced an increase in disposable household income of $20,000 over the same period.

We have lost our urban competitiveness because of spiralling housing and transport costs.

To get to the bottom of this problem, and to find solutions, we need to understand the spatial economics of cities.

I am indebted here to Alain Bertaud whose most recent book Order Without Design best articulates his view about cities as labour markets.

If you love cities that view might seem a bit reductionist, but it is a pretty good description. A well-functioning labour market makes possible every other aspect of urban life.

Large, dense and deep labour markets are more productive because of economies of scale, and knowledge spill overs stimulate innovation.

However the potential economic advantages of cities can only be realised if workers, consumers and suppliers are able to exchange their labour, products and ideas with minimum friction.

If cities do not build efficient transport networks mobility reduces, the effective size of the labour market shrinks because commuting times increase, the benefits of agglomeration are lost, and productivity drops.

Similarly if housing is so expensive people cannot afford to live close to where the jobs are, the same things happen.

Consider the effect on the country’s labour productivity of two-thirds of Kiwis not being able to afford to buy into the Auckland housing market and thus not being available for the city’s jobs. Real estate is so expensive it distorts the allocation of labour and capital to the detriment of our productive economy.

The efficient operation of the labour market requires affordability and mobility. These two things must be the primary objectives of urban policy.

 

I now want to look in a little more depth at housing and land markets, and transport.

I started by saying urban planning has lacked an economic underpinning. An example of this is the use of the urban growth boundary which is a common planning tool ostensibly to stop cities growing outwards, often described pejoratively as sprawl.

Sprawl is often meant as development on the fringes of a city, far from the centre. But I want to make the point that the better way to think of it is in relation to the time value of travel.

If you are building homes let us say in Pukekohe in the south of Auckland, where people who work in the city centre might face a drive of 90 minutes on a bad day, that might be characterised as sprawl. But when we electrify the rail line to Pukekohe, and build an additional line on the main north-south corridor, as we are about to do, those people will have a 30 min express commuter ride into the city, is it sprawl then? I don’t think so.

The most harmful effect of the urban growth boundary where there is rising demand is to create an artificial scarcity of land driving section prices up.

The boundary is much loved by land bankers whose business model is to buy up rural land and sit on it until the local council shifts the boundary in response to growth pressures, changing the zoning from rural to urban, and then sell it sometimes at ten times its former value.

My intention is not to vilify land bankers. Their behaviour is a rational response to bad policy.

If the urban growth boundary wasn’t bad enough, restrictions on height and density, often justified as protecting the amenity of the low-rise garden suburb, ration floor space, stopping the city growing up and restricting the supply of apartments, and of course driving up prices across the market.

Urban planning has too often failed to grasp that whenever rules stop people building or living in places they want to (typically close to amenity, jobs or transport interchanges) they deny people housing choices, restrict supply and drive prices up.

As Ed Glaiser says, every time you place a restriction on intensification you deny a family access to the city.

This is one part of the story of our cities. The other is about mobility.

Our cities in large part grew into their current form in the latter half of the twentieth century, having consciously adopted an American-style development pattern based on private car ownership which enabled low density suburban expansion connected by motorways and roads.

This model has for some time now exceeded its limits.

As Auckland got larger the sheer distances made commutes longer and longer, in Bertaud’s terms shrinking the labour market.

The weakness of a model that relies so heavily on cars and roads, with decades of under-investment in public transport, has been exposed. Induced demand means that every new road, every lane added to a motorway, magically fills up with cars. Without options of course everyone drives. Morning and afternoon peaks are jammed, and we have some of the highest rates of car ownership in the world.

The counter-factual, seen in many overseas cities, and in specific examples like Auckland’s Northern Busway and Wellington’s commuter rail service, is that when you have efficient public transport alongside the motorways and roads, you get a kind of dynamic equilibrium where some people choose to leave their cars at home and take the train, allowing the roads to move more freely.

The reverse applies. When public transport is slow or inefficient people choose to drive which causes congestion which slows down the roads. So in this way, the efficiency and speed of public transport is what determines the speed and efficiency of the roading network.

Since the marginal cost of driving a car (that is the cost to the efficiency of the road network of adding one more driver) can be up to 30 times greater than the average cost, investing in quality public transport improvements can benefit both public transport users and private vehicle users.

The other thing that has caught up with the car-centric urban model is the sheer inefficiency of devoting so much of our scarce and expensive urban real estate to cars (and parking).

The average price of land in Auckland’s central city is $16,000/sq m, and in Welllington it is $6500/sq m. The opportunity cost of land in our most productive places is too high to continue to devote so much of it to single occupant vehicles.

Public transport and rapid transit can move people through our cities using a fraction of the space taken up by single occupant vehicles.

An example is the Auckland rail network that will, once the City Rail Link is complete, be able to carry 54,000 people (the equivalent of 16 lanes of motorway traffic) in and out of the city centre every hour.

So given all that, what are we doing about these problems?

In housing we’ve tried to rein in the excessive demand forces by changing the tax settings: shutting down negative gearing, and pushing the bright line out to five years.

We also banned foreign speculators from buying existing homes.

On the supply side, we want to foster competitive urban land markets by allowing private long-term debt finance to be used to build the roads and pipes to support urban growth.

Developments are not going ahead because the high growth Councils are up against their debt limits and yet there is a limitless pool of capital that would love to invest in the growth of our cities.

Through a National Policy Statement under the RMA we are going to direct Councils to free up their planning rules to make room for growth, both up and out, with the aim of massively expanding the number of development opportunities in the market.

That is also one of the drivers of David Parker’s RMA reform process. David is fond of saying there are only three things wrong with the RMA: it takes too long, it is too expensive, and it hasn’t done a great job of protecting the environment. I think that certainly applies to the RMA in the urban environment.

We have established Kainga Ora – Homes and Communities, an urban development authority. We are now legislating its powers so it can lead large scale urban development projects, building whole new communities at pace.

And of course the Government is doing its bit to increase supply through the state house build, and Kiwibuild. We are building more homes right now than any government has since the 1970s.

Kiwibuild has taken longer to ramp up than we intended, and it is increasingly clear innovations like off-site manufacturing and Kainga Ora’s large scale projects are needed.

In transport we are investing record amounts in building and maintaining roads, rail and public transport.

In Auckland alongside the Council we committed to a 10-year $28 billion programme of investments in the transport system.

We are retrofitting our cities with rapid transit and modern public transport so their networks can absorb the growth pressures and the congestion peaks with Rapid Transit acting as a pressure valve. It is the only sustainable solution to gridlock.

And we are taking a more market responsive and integrated approach to planning our cities. Instead of arguing over pet projects we are developing, central and local government together, 30 year plans that treat the city as a complex system, looking at all the things we need to do to make it succeed.

Planning should be an enabler of markets, not an inhibitor of markets.

It’s pretty simple really. We want you to get home to your family quickly and safely at the end of the day.

And we want everyone to be decently housed.

If we get the policy settings right, and deliver both affordability and mobility, the New Zealand city will be productive, inclusive and sustainable.

Planning our cities without economic thinking has got us into this mess.

Good policy informed by urban spatial economics will help get us out of it.