It is clear that so far both sides of politics have failed to address the ongoing problem of housing unaffordability. It’s been more than five years since the leaders of both major political parties acknowledged the housing crisis. Now, it’s 2020 and housing has become even more unaffordable with prices increasing by 19.8% with the median price of $725,000. Despite Covid-19 ‘supposedly’ cutting aggregate demand, how on earth did this phenomenon occur? It’s caused by multifaceted reasons which I will explore by sections:
Migration and Foreign Investment – Not the core factor
There is a fundamental misunderstanding of the housing crisis. Many New Zealanders believe that migration flow and population growth are the core reasons for growing housing prices. On face value, that is correct. Growing demography does mean growing housing demand. However, this would not be a problem if the growing demand is matched by a growing supply. Anti-developmental sentiments from central and local government artificially restricted land supply and housing development. In fact, migration is critical to our prosperity (especially those that are young with high skills and educated). The housing crisis is a supply problem rather than a demand problem.
Foreign investment and speculation are also conjectured by many in the public as the cause of housing hyperinflation. This is also incorrect. Much of the housing inflation is caused by local New Zealanders purchasing property and spurring up demand. In fact, only 3% of housing purchases were from foreigners between January and February 2016. Whilst further should be done to see the extent of the speculation over a long period of time, such evidence suggests that the effects are minimal.
Housing Supply < Housing Demand = Price increase
The core reason for the housing crisis is simply because growth in demand has exceeded growth in supply. One of the core fundamental economic principles is supply and demand. Housing has become extremely expensive because we have not built enough housing in New Zealand to address growing demand. In 1974, New Zealand was building 34,400 annually. However, because of the oil crisis in the 1980s and our unsustainable fiscal position, new annual dwellings dropped to 15,000 in that era. The current government have made some changes that resulted in a growing supply with 24,100 houses built in 2019. We need to note that the population in NZ was 3 million and now just over 5 million. Population growth and demographic ageing do mean that there is consequently excess demand. My research paper released in the new few months will explore this.
In the last three years, the current government has attempted to curb aggregate demand and expand supply with Kiwibuild. There has been progress with better infrastructure financing to aid local councils and important changes to the National Policy Statement on Urban Development. This removes unnecessary regulations that so far prevented intensification. On the negative side, the government passed new laws such as the ban of foreign buyers (with the exception of Singaporeans and Australians), extended the bright-line test to 5 years, amended the Overseas Investment Act, and tried to legislate a new capital gains tax. For supply, Kiwibuild was a colossal failure with only 548 houses being built. There has been some definite progression in contrast to the previous government, but also multiple failures.
The Reserve Bank’s Impact in Housing
The global Covid-19 pandemic has forced many central banks around the world towards expansionary monetary policies. The Reserve Bank of New Zealand (RBNZ) is no exception. Under Adrian Orr, the bank committed to $100 billion of quantitative easing and also cut the OCR rates to 0.25%. This is unprecedented regarding the scale of the policy (a third of our GDP). These two decisions alone will raise the returns from investment in housing and increase pressure on house prices. Low-interest rates mean cheaper mortgages incentivise investors and consumers into the housing market. These policies led to higher equity and asset prices. Although, some of their policies are completely understandable considering Covid-19’s impact on employment and the economy. However, regardless of the pandemic, this level of quantitative easing is unprecedented. Saying this, it is undeniable that RBNZ’s policies have made a significant contribution to greater aggregate housing demand.
Lacking incentives for local government
One of the key reasons for the current state of the housing market is because of poor local government incentives. Much of the infrastructure financing is imposed on the local councils, meanwhile, the revenue is centralised to government officials in Wellington. The current system gives far too much political leverage for those in central government, rather than allowing local officials to make important decisions on urban development. There are questions on whether the centralisation of such power into a larger government institution such as the Super City of Auckland Council led to efficient outcomes.
New Zealand’s current system does not incentivise local councils to grow but slows down development. Local government officials don’t want more people in their area, because that means greater demand for water, schools, housing, local parks, and other public infrastructure to accommodate growing demand. Meanwhile, the central government does not allocate funds based on proportionality, but rather on ‘democratic means’ of serving respective electorates and other political factors. The finance gets imposed on the councils with growing demand, but not given the finance from the central government. For example, more than 40% of newly arrived migrants settle in Auckland rather than other regions that need people. Auckland Council currently has growing debt and it wants to tackle that problem rather than expand urban development outwards. The same applies to many other local councils across the country. Without sufficient revenue provided by the central government, why would they want to grow? They would not want to free enough brownfield nor greenfield areas for housing development because all the costs are imposed on them.
To address these problems for New Zealand’s local governments, I advocate for ‘localism’ as it provides greater political leverage to local governments and decentralises decision-making. Countries such as Germany and Switzerland follow this form of local administration. In the United States, Houston in Texas also has a very decentralised governance system. At the federal level, they simply set out basic regulatory frameworks and for the implementation of policies, they leave it to local councils.
For instance, let’s take the case of Essen and Dortmund – the two regions have a competitive and cooperative governance arrangement. The reason is that the tax revenue created is tied to the number of residents in their area. It is essentially a form of a ‘means-test’ requirement for local officials to get their revenue. Because of the incentives to have more residents in their area, the government understands that they need to have good institutions, a clean and green environment, affordable housing and sound public infrastructure. the two cities needed to allow enough land supply available in their area to deal with growing demand. If certain residents leave their regions, they lose tax revenue consequently. In essence, a solid local structure that incentivises competition. Currently, both Essen and Dortmund have affordable housing. Since the 1980s, prices have only risen by 10% in the last 30 years. Simply by changing the tax incentives with a decentralised local government system, it leads to more optimal urban development that matches growing demand with sufficient supply.
Germany’s economic system is a strongly Keynesian-oriented system with high levels of taxation, a generous welfare system and a decentralised form of governance. Localism is neither a right nor left policy subscription, but an example that has worked in these areas. Experimentation in New Zealand wouldn’t be a bad start and we can learn from these international examples. I am not advocating for the de-amalgamation of Auckland Council, but rather changing the tax structure so that local councils get the incentives. Decentralisation of command towards district councils, for instance, is a potential alternative without removing the Super City’s institutional arrangement. As stated by renowned American investor Charlie Munger stated,
“I think I’ve been in the top 5 per cent of my age cohort all my life in understanding the power of incentives, and all my life I’ve underestimated it.”
Basic economics is about incentives. Incentivising local government to grow public infrastructure and push for housing development requires the officials to have the incentives. This will help the expansion of supply – both housing and infrastructure.
These are the many reasons why housing is unaffordable. Housing is an extremely complicated subject but this post attempted to explore fundamental factors as to why house prices increased in New Zealand despite housing demand ‘supposedly’ very low under the current era of Covid-19. It is clear that housing supply has not expanded fast enough to accommodate growing demand. RBNZ’s policies have exacerbated the problem fueling investment into the property market, and the current set-up of local governments prevents them from wanting to expand development because most of the costs are imposed on them, rather than the central government.
It is imperative for the new Labour government to push for the expansion of housing and land supply rather than continuing to just curb growing housing demand.