How should we think through the dynamics of housing markets?
Conceptually, there’s a very simple answer and a very complex one. The simple version is that housing is just another market, shaped by the interaction of demand – i.e. people turning up with money to buy dwellings – and supply – people building new dwellings to meet demand. Policies can affect the supply side (e.g. by making it more costly or difficult to build new dwellings), the demand side (e.g. by subsidising home ownership), or both (e.g. by imposing supply restrictions to produce local amenities like parks).
And then there’s the complex story, in which we have to think about things like:
- Interactions between owner-occupation, renting, and property investment
- The impact of mortgage lending practices and asset values on housing
- The durable nature of housing, which means that prices can overshoot in a declining market
- The geography of jobs, amenities, and housing supply – not all locations are equally desirable, which means that houses in the wrong place don’t do much good
- Government provision of housing services (e.g. state homes) and subsidies for property ownership or renting
- Industrial organisation in the building sector, including firm size and structure and supply of skilled labour
- A wide range of local and central government regulations covering building materials, performance standards for dwellings, and the bulk, form, and location of dwellings
- Etc, etc, etc.
So it’s not usually possible to fully explain housing market dynamics with a simple supply and demand story. However, it’s often useful to start with a clear understanding of that story.
So with that in mind, here’s a key concept for analysing housing market dynamics: elasticity of housing supply. In an earlier post on public transport fares, I introduced the idea of elasticity of demand, which measures how responsive people’s demand for a good or service is to higher (or lower) prices. Supply elasticities are much same idea, but on the supply side of the equation.
Elasticity of housing supply is an important concept because it provides an indication of how many new dwellings will be constructed in response to an increase in prices (or demand). For example, an elasticity of less than 1 would indicate that developers are relatively unresponsive to increased demand – i.e. if prices rise by 10%, it will cause new housing construction to increase by less than 10%.
It’s easy to see why this is an important metric. In the aggregate, a relatively “inelastic” supply will mean that the housing stock will struggle to meet demand in a growing city. But aggregate lasticities aren’t everything – if new dwellings can’t be built in areas that are proximate to jobs and amenities, bad things will still happen
Supply elasticities can be measured empirically by looking at how markets have evolved in the past. In fact, a number of people have done just that.
In their 2012 housing affordability inquiry, the Productivity Commission surveyed some of this literature (see pages 33-34 of their final report). They published this chart comparing long-run elasticity of housing supply in 21 OECD countries, including New Zealand. Remember, higher numbers indicate more responsive housing supply:
New Zealand’s elasticity was around 0.7 – on the inelastic side, but still within the top 1/3 of the countries in the study. In other words, neither terrible nor fantastic. We have historically had a more elastic supply of housing than the UK or Australia, but we’ve lagged behind several Scandinavian countries as well as Japan, Canada, and the US.
Now, elasticity of supply is influenced by a number of factors. Building industry capability and productivity plays an important role. So do geographic constraints – a topic I’ll come back to in a future post. State house construction can also play a role, by ensuring that building activity doesn’t bottom out when prices dip. And, of course, planning regulations and consenting processes play a role. But how much of a role?
Unfortunately, we don’t have any good international comparisons of planning policies. However, the World Bank’s annual Ease of Doing Business report publishes some data on the ease of obtaining building consents, which provides a rough indication of the stringency of countries’ planning processes.
Here’s the upper echelons of their 2015 rankings. As you can see, New Zealand is ranked as the second easiest place to do business. When it comes with dealing with construction permits, we’re ranked 13th – ahead of countries like the United States (46) and United Kingdom (45) but behind Hong Kong (1), Singapore (2), and, oddly, Iraq (9).
Here’s a bit more detail on how Auckland’s consenting processes stack up. We have fewer procedures, a shorter consenting timeframe, and a lower consenting cost than the average OECD country:
So what does all this data mean? I think there are a few lessons we can – and can’t – learn from it.
The first is that perhaps we don’t have as many problems as we think we do. I have to admit that I was surprised by these figures. I was expecting our elasticity of supply to be lower and our consenting processes to be ranked lower. But perhaps – as with Auckland’s congestion – our problems aren’t that bad when put in international perspective. Kiwis do tend to prefer doing things efficiently, and NZ’s not large enough to require overly cumbersome bureaucratic machinery.
The second thing is that there is room to improve. There is almost always room to improve. New Zealand’s housing supply is still inelastic, which suggests that we may have trouble accommodating growth. Although the World Bank’s data on the ease of obtaining building permits seems to suggest that regulatory processes are less onerous here than many other places, who really knows? There are likely to be gremlins in any bureaucratic process.
The third lesson is that there are multiple paths to a well-functioning housing market. The countries with the highest elasticities of housing supply don’t have a lot in common with each other when it comes to policy frameworks. The US has a different set of policies than Japan or the Scandinavian countries. And it’s also the case that some countries have affordable and livable housing even though their elasticity of supply is low – Germany or the Netherlands, for example.
This is, in a way, really good news. We don’t have to go searching for a single “silver bullet” policy framework. There are different paths we could go down to improve the functioning of our housing market.
What do you make of these comparisons?