Slicing the housing cake: Developer profits versus capital gains

Who benefits from enabling housing development? And who bears the costs of restricting it?

One common refrain is that reducing regulations to enable housing will deliver higher profits to developers, while disadvantaging existing homeowners, who must contend with more people living in the neighbourhood. Another view is that restricting housing supply primarily benefits existing homeowners, who earn (untaxed) capital gains, while disadvantaging people who don’t own homes.

Along with Fran O’Sullivan, Arthur Grimes, Bernard Hickey, and many other commentators, I tend to agree with the second viewpoint: The primary distributional impact of restrictions on housing supply is to benefit existing homeowners at the expense of future homeowners. In this post I will argue that 1) we face a choice between existing and future home owners and 2) profits from development pale in comparison to untaxed capital gains on property.

So if you’re concerned about rampant profiteering, then you should be in favour of enabling more housing development.

Profit, homeowners, and false dichotomies

Developers undoubtedly set out to make a profit. They are after all putting their own time and money into building something, which in the process exposes them to risks. In this context it seems reasonable that they get something in return, otherwise, why would they develop housing at all? Whether developers earn a reasonable profit then effectively comes down to competition, and the best way to encourage competition is to enable lots of people to be developers.

In general, the more we restrict and regulate the supply of housing, then we will get less supply and less competition.

Those who rally against developers making profits seem to ignore that most of Auckland’s existing housing stock resulted from profit-seeking developers. This includes many houses that are now protected for heritage reasons. So it’s not clear to me that simply because developers are look to make a profit today, that the resulting developments will not be valued.

It is certainly fair to say that developers will only able to make a profit from development if they build something that people are prepared to pay for today. This is another way of saying that developers must consider their customers , i.e. people who want somewhere to live. So it strikes me as a false dichotomy for people to argue that developers “put profit before people”: If developers didn’t meet the needs of at least ***some*** people, then they wouldn’t make a profit.

Instead, the main trade-off seems to be between existing and future homeowners. I think Arthur Grimes described the trade-off best when he said (source):

My call for policies to drive a house price collapse is driven by my personal value judgement that it’s great for young families and families on lower incomes, to be able to afford to buy a house if they wish to do so. My concern is not for older, richer families, couples or individuals who already own their own (highly appreciated) house.

In this quote Arthur observes that we primarily have a choice between existing homeowners and future homeowners. He doesn’t mention developers at all. So when councillors vote for regulations that restrict housing supply, they are effectively voting in favour of existing homeowners. This is fine, provided they are comfortable with adopting what I consider to be a typically conservative position. These councillors are, in effect, behaving like Tories; they are protecting those who already have wealth.

The effects of restricting supply: Dislocation and rampant profits

However, building new homes isn’t the only – or even the main – way to make a profit in Auckland’s current housing market. Due to restricted housing supply, we aren’t building enough homes to meet demand. As a result, prices have risen.

Rising prices has two primary effects. First, it squeezes low-income people out of the market. This is a well-documented phenomenon. As the California Legislative Analyst’s Office found in an analysis of the San Francisco Bay Area, suburbs that developed less housing experienced more displacement. Without new housing development, every new resident must displace an existing resident – a vicious dynamic that hits low-income households hardest:

LAO development and displacement chart

A lack of housing supply is compounded by distortionary tax policies – principally our unwillingness to tax unearned capital gains on housing – with the result that house prices are going up at a fast clip. This provides an unearned, untaxed capital gains windfall for people who are lucky enough to own property.

Unearned capital gains, unlike developer profits, are a win-lose scenario. People who own houses win, as the value of their assets rise. But people who are renting or trying to buy a home lose to an equal extent, as they face higher and higher prices.

So how large are capital gains compared to developer profits, anyway?

In recent years, untaxed capital gains on residential property have been very large relative to developer profits. According to data from the Reserve Bank, untaxed capital gains on residential property exceeded $100 billion last year:

  • In the first quarter of 2016, the total value of residential property in New Zealand was $905 billion
  • One year earlier, the value of residential property was only $791 billion.

By comparison, according to Statistics NZ’s most recent (2014) Annual Enterprise Survey, which tracks industry performance, residential housing construction firms (ANZSIC E301) made gross, before-tax profits of a mere $570 million. Even if we add in “other construction services” (ANZSIC E321, E322, E323, E324, and E329), which includes land development firms as well as a whole bunch of other stuff, total residential development profits add up to no more than $2 billion a year, before tax. And developers pay taxes on those profits! For the visual learners out there, here’s the data in a chart:

Developer profits vs capital gains chart

In other words, the profits that developers earn are relatively insignificant compared to the unearned, untaxed capital gains that have accrued to property owners. I would argue that the latter are largely the result of regulations that restrict housing supply, and hence represent a transfer from future homeowners, and to a lesser degree developers, to existing homeowners.

So what’s the takeaway message from all this? Well, if Councillors like Mike Lee and Cathy Casey are concerned about profiteering in New Zealand society (and they say they are), then they should start pushing to enable more housing development in Auckland. Yes, developers may make slightly more money in the process, but this increase pales in comparison to the reduction in untaxed capital gains that would accrue to existing home-owners. If you’re concerned about people making unearned profits, then regulations that restrict housing supply and which drive up the prices of existing dwellings should be your primary target.

Unitary Plan Recommendations Revealed

Yesterday the council released the recommendations from the Independent Hearing Panel (IHP) for the Proposed Auckland Unitary Plan (PAUP) and as expected when there are over 1000 pages of recommendations there’s a lot to talk about, way too much for one post. As we also expected there is a mix of outcomes, some are good and others not so good. An overview of the changes is provided in this 123 page report which is what I’ll mainly focus on for this post.

First up the council had a couple of big wins with the IHP agreeing with many of their high level objectives for managing growth, such as:

  1. Affirming the Auckland Plan’s development strategy of a quality compact urban form focussed on a hierarchy of business centres plus main transport nodes and corridors.
  2. Concentrating residential intensification and employment opportunities in and around existing centres, transport nodes and corridors so as to encourage consolidation of them while:
    • a. allowing for some future growth outside existing centres along transport corridors where demand is not well served by existing centres; and
    • b. enabling the establishment of new centres in greenfield areas after structure planning.
  3. Retaining the Rural Urban Boundary (together with a substantial area of land zoned Future Urban Zone inside it) as a means of managing large-scale growth and infrastructure planning (this last point has a bit of a catch though which I’ll cover off later.)

That means the IHP didn’t just throw everything out and start from scratch but have made changes that address many of the shortcomings from the notified plan and the biggest of these is that the notified plan simply didn’t allow for enough growth. In this regard the IHPs recommendations are said to lie somewhere between what the council originally notified and what submitters like Housing NZ were after which was much more widespread upzoning across the region.

One of the areas they haven’t changed are the residential zones themselves. There are still the main urban zones of Single House (SH), Mixed Housing Suburban (MHS), Mixed Housing Urban (MHU) and Terraced Housing and Apartment Building (THAB) and many of the rules for the zones, such as height limits, remain the same. One big change is the removal of density provisions on the MHS so it matches the MHU and THAB zones – although there are various development standards and levels at which resource consents apply. Importantly where each zone is applied has also changed, one example being that the council walkable catchments for higher density zones of 200-400m while the IHP have recommended it be doubled to 400-800m. It is those and other amendments which are behind the changes in development capacity.

The level of development capacity has been a crucial issue for the IHP. They have agreed with the high side predictions of need to provide around 400,000 dwellings over the next 30 years and that for planning purposes it’s better to err on that high side. In short better to allow too many dwellings to be built than not enough. To this end they also say:

It became apparent early in the hearings that in the development of the proposed Unitary Plan the Council had relied on the theoretical capacity enabled by the Unitary Plan, rather than on a measure of capacity that takes into account physical and commercial feasibility, which the Panel refers to as ‘feasible enabled capacity. Feasible enabled residential capacity means the total quantum of development that appears commercially feasible to supply, given the opportunities enabled by the recommended Unitary Plan, current costs to undertake development, and current prices for dwellings. The modelling of this capacity at this stage is not capable of identifying the likely timing of supply.

When you look at the PAUP in this regard there becomes a huge issue with it estimated to only be able to provide 213k dwellings, well short of the 400k needed. Through the changes they’ve made they estimate that the feasible enabled residential capacity has almost doubled, going from 213k to 422k. As you can also see, the biggest two changes have come from within existing residential areas and within centres and mixed use areas.

Recomended UP - Change in Feasible Capacity

The impact of the changes can be seen on the two maps below showing what was feasible under the PAUP on the left and what is feasible under these recommendations. As you can clearly see there is a lot more development that has been enabled – although it seems more still could have been done on the isthmus.

Recomended UP - PAUP vs Recomended Feasible Capacity

You may recall the Auckland Plan development strategy had a 70:40 split, up to 60-70% of development occurring within the existing urban area and 30-40% occurring on greenfield land. Yet thanks to council getting scared of the noisy groups opposing housing, the PAUP as effectively flipped those numbers around. While the IHP have recommended that spatial distribution be deleted, the changes above have helped to return the Unitary Plan to that level. This is shown below.

Recomended UP - Distribution of Capacity

The table below is based on some early analysis by council on the recommendations showing how much land was included in PAUP vs what is in the recommendation. As you can see there are some quite significant differences.

Recomended UP - Zoning ha Changes

As mentioned earlier, the Rural Urban Boundary (RUB) stays but it has been changed significantly, both in scale and how it will work in future. One key change is the IHP say the exact location of it should be decided at the district plan level. That means it could be changed in the future through private plan changes. That makes it a soft boundary and as I mentioned yesterday, could make it more difficult to plan big infrastructure projects.

Lastly just to quickly touch on one of the points I raised yesterday that I haven’t already covered, parking rules. The IHP have retained parking maximums in the City Centre Zone while the other Centre zones, the Business, Mixed Use and THAB zones and the Centre Fringe Office Control area have neither minimums or maximums with the main exception being for retail and commercial services activities where a minimum of 1 space per 30m² has been recommended. This is a big win for the major retailers who wanted minimums for anti-competitive reasons, making it harder for small businesses particularly in town centres to afford to compete. Outside of the zones mentioned previously, all other areas will have minimums applied.

In another post I’ll look at comparing the maps of the proposed plan and what has now been recommended.

The council are due to start formally debating the plan on August 10 and have that wrapped up on August 18 so the plan can be formalised. If they don’t agree with an IHP recommendation they can’t just reject it and instead have to provide an alternative solution and produce a cost benefit ratio for it. Overall the recommendations represent a vast improvement to the Unitary Plan and while not everything is what we hoped for, there was always going to need to be some compromises. After dragging on for about four years now, the finish line is in sight and it seems to me that councillors should just be encouraged to pass the plan as it is.

Govt ignored advice on allowing EVs in bus lanes

In May the government announced a package to try and increase the number of electric vehicles in New Zealand as a way of reducing emissions – a laudable goal but some of the government’s proposed some measures missed the mark. At or at least near the top of the list was the idea to allow for electric cars to use bus lanes and the Northern Busway.

Northern Busway

Enabling electric vehicles to access bus and high occupancy vehicle lanes

Access by electric vehicles to bus and high occupancy vehicle lanes (lanes where a vehicle must have more than a certain number of occupants) will be of value to households and businesses. Access to such lanes will mean electric vehicles will be able to travel more quickly than vehicles otherwise held up in traffic.

At the same time, the changes will also empower road controlling authorities to allow electric vehicles into special vehicle lanes (such as bus lanes) on their local roading networks.

The Government will make changes to the Land Transport Act and Rules to allow electric vehicles to drive in bus and high occupancy vehicle lanes on the State Highway network, which it controls. One example is the Northern Busway in Auckland.

As I said at the time, the idea is madness and defeats the whole purpose of having bus lanes which is to make buses:

  • faster, making them more attractive to use and can also make them time competitive with driving.
  • more efficient, because buses are faster they can run more services can be run for the same cost or alternatively fewer vehicles and drivers may be needed
  • more convenient as if they allow more services to be run it means higher frequencies so less time waiting at bus stops.
  • more reliable as they’re more likely to arrive at stops and the final destination on time.

It’s now been revealed by the Herald that the government ignored advice to at least consult with councils first before announcing the idea and highlighting that at least one council is ruling it out.

Andy Foster of the Wellington City Council said his city had the country’s highest rate of public transport use “by far” and did not foresee it opting for the change.

“Traffic getting in the buses’ way is not conducive to maintaining reliable timetables.”

Foster, who chairs the council’s transport and urban development committee, said he saw “no chance” that electric vehicles would be allowed to use the city’s bus-only lanes.

“Bus lanes are generally very well respected by motorists. If some vehicles start using bus lanes because they are [electric] there is a greater risk that others which are not [electric] will do so too.”

They also say Auckland Transport and the Christchurch City Council seem cool on the idea although the NZTA say they have begun initial discussions with Auckland Transport to investigate the potential of permitting electric vehicles on the Northern Busway

Back when this policy was announced I sent an Official Information Act request to the Ministry asking for details relating to the idea. I received back some excepts from a report looking at options for promoting EVs but it had been sitting in my inbox for a while. It includes the suggestion that the Minister consult councils on the idea first as well as a few other interesting comments. For example, not only did they recommend talking to road controlling authorities (RCAs) first, they say the NZTA expects none of the major RCAs would implement it.

EVs in Bus Lanes OIA - Considerations

I find the point that the NZTA highlighted that such and idea was unlikely to work as the RCAs wouldn’t want to implement it as much more damning than the fact he didn’t consult with them

They expand a bit on the efficiency impact portion below highlighting that it will likely impact PT and general traffic congestion. Even more so bottom paragraph below confirms the bus lanes will be full soon but that people will still want to drive in them.

EVs in Bus Lanes OIA - 1

As a way of implementing the idea, it was suggested to either use legislation to declare EVs as allowed in all bus or transit lanes or give RCA’s the power to decide on what lanes to allow EVs to use. Thankfully the Minister at least chose the second option but given the responses above, it seems unlikely to they’ll approve having EVs in bus lanes. That raises the prospect despite the government suggesting it, it won’t actually be possible anywhere. That in turns means the whole point of the policy would be a flop and will have wasted precious resource from the ministry. I wonder if the government will quietly drop it.

Of course if they really want to get more use out of bus lanes one idea would be to provide more funding to put more buses on which would have the added benefit of making PT much more useful.

How to reduce Auckland house prices

Arthur Grimes, the former chair of the Reserve Bank board, caused a stir with his proposal to crash Auckland house prices by 40% by building lots more housing:

My call for policies to drive a house price collapse is driven by my personal value judgement that it’s great for young families and families on lower incomes, to be able to afford to buy a house if they wish to do so. My concern is not for older, richer families, couples or individuals who already own their own (highly appreciated) house…

Research at Motu (accessible from www.motu.org.nz, and published in international scholarly journals) shows that (given current interest rates and incomes) a 1% increase in the number of dwellings relative to the population leads to a reduction in house prices of around 2.2%. Thus a 40% fall in house prices means that the number of dwellings in Auckland would have to expand by around 18% relative to the current dwelling stock. On top of that, the stock has to increase to reflect population growth. So with, 2% population growth per annum, the stock of dwellings in Auckland would have to increase by roughly 30% if prices were to fall by 40% over the next 6 years.

There are currently around 500,000 dwellings in Auckland. A 30% increase in dwelling numbers over 6 years translates into an extra 150,000 houses over that time – i.e. 25,000 extra houses per year for each of the next 6 years. This estimate contrasts with much smaller (and nonsensical) estimates of housing shortages that are often quoted. The reason is that those smaller estimates (e.g. 10,000 extra houses) would just leave prices where they are!

Now, I’m not quite as confident that the spillovers from a large drop in housing prices could be contained without significant effects on financial stability or the real economy. And there are definitely many challenges to technical feasibility, including zoning, infrastructure capacity, and availability of builders. But I fully agree with Arthur’s framework for thinking through supply and price dynamics.

It’s a welcome break from much of the usual commentary about the supply and demand balance in Auckland’s housing market. For example, it’s common to hear statements like, “Auckland’s population grew 22% between the 2001 and 2013 Censuses, while the number of dwellings in the city increased by 19%. Therefore we’re only 3% short.”

I’d describe this as the “quantity surveying” approach to market analysis – i.e. count up the number of people, count up the number of homes, and compare the difference. It’s not good economics, as it completely fails to consider:

  1. Desired outcomes from the housing market: As Arthur observes, an appropriate goal is for young people and low-income families to be able to access the housing market. We’re trying to achieve lower prices, not a certain ratio of dwellings to people.
  2. Underlying relationships between supply, demand, and prices: As Arthur points out, in order for prices to fall, the housing stock must be rising faster than population. Exactly how much faster depends upon the degree to which there is pent-up demand for housing that hasn’t been met in the past.

With that in mind, let’s take a closer look at Arthur’s figures. He argues that:

the stock of dwellings in Auckland would have to increase by roughly 30% if prices were to fall by 40% over the next 6 years… [which] translates into an extra 150,000 houses over that time – i.e. 25,000 extra houses per year for each of the next 6 years.

Why is an additional 30% increase in dwellings needed when Auckland’s population has only grown by around 30% over the last 15 years? Doesn’t that seem a bit too large?

From a quantity surveying perspective it does, but from an economic perspective, it’s totally sensible. To see why, we need to think about what rising housing prices mean. If the supply of a good – housing in this case – is constrained, prices must rise until some potential buyers give up and go elsewhere. In the Auckland housing market, that could mean:

  • Moving elsewhere in New Zealand – surely a factor behind recent price rises in Hamilton, Tauranga, and beyond
  • Moving overseas – a total loss of that person’s capabilities to the NZ economy
  • Staying in Auckland and living in overcrowded or unsafe housing – which disadvantages them and costs the public health system and social agencies
  • Living in a car or on the streets – it’s frankly appalling that I even have to mention this.

The fact that Auckland’s prices have been rising more rapidly than prices in the rest of the country (which are affected by the same bank lending conditions and macroeconomic trends as Auckland) is an indication that price-driven rationing is probably occurring. There is likely to be a significant amount of pent-up demand for Auckland housing – and if we figured out how to meet it, the city would get bigger. (Leading to, among other things, increased agglomeration economies.)

Finally, it’s worth discussing Arthur’s thoughts about where new housing should be constructed. He takes the SFBARF view: build absolutely everything everywhere:

So how can we get these extra houses and where can they go? Some people favour intensification and some favour expansion of the city’s footprint. The size of the task means that both are required.

Auckland is lucky that it has plenty of farmland around it and – contrary to popular myth – farmland is almost worthless in farming uses compared with residential use. Expansion is therefore required, but with a proviso. A change in the zoning of rural land to residential gives the existing landowner a massive uplift in value – i.e. a multi-million dollar gift from the community. To my mind, this value should accrue to the community that grants the zoning change. The Public Works Act could conceivably be used (or changed) to enable Council to buy rural land at a premium (say 50%) above the rural land value and then all extra value uplift would accrue to the Council to be used for infrastructure and services for the enlarged community.

Auckland also has plenty of opportunities for intensification in areas where developers would wish to intensify and where people wish to live. For instance, Tamaki Drive is ready made for high-rise apartments where tens of thousands of people would no doubt wish to purchase apartments. Of course climate change may make development on Tamaki Drive a risk, but a few blocks back from the sea – on the ridges overlooking the harbour – would work just as well. Lift the restrictions on the heights of new developments, and I expect that we would see an utter transformation in the intensity of housing from Orakei through to Glendowie.

Why can’t we do it with sprawl alone? There are two answers. The technical answer, which we’ve extensively covered on the blog in the past, is that new infrastructure to greenfield areas is expensive and time-consuming to develop. The time lag to intensify sites that are already served with infrastructure can be smaller, provided that consenting is straightforward.

However, the economic answer is, to my mind, even more important. Research into the determinants of property prices in Auckland consistently finds that proximity to the coast and proximity to the centre are two of the most important attributes for buyers. People value the amenities that come with coastal living – that’s a significant part of the attraction of being in Auckland – and they value the consumer amenities and employment accessibility that are concentrated in the centre.

A sprawl-only plan may work from a quantity surveying perspective – it would raise the ratio of dwellings to people – but it would mean growing away from the coast and away from the centre. The next swathes of farmland to be developed – east of Flat Bush, west of Orewa, and north of Kumeu – are all a long way inland.

This will work for some people, but for many it will miss the point of living in Auckland. If we are to meet growing demand, we will also have to think hard about how new residents will access to the city’s man-made and natural amenities.

What are the preconditions for congestion pricing in Auckland?

The inclusion of congestion pricing in the recent Auckland Transport Alignment Project interim report has (helpfully) reignited the public debate on the topic. Transportblog’s authors have been pretty enthusiastic about the idea – see e.g. Stu Donovan’s posts on the topic.

But the announcement also raises some questions. For example, congestion pricing is certainly a good idea in principle, but could we put it into practice in Auckland without unintended consequences? And would people in Auckland get on board with it?

So I thought I’d open this up to readers: What do you think the preconditions are for congestion pricing in Auckland? In other words, what would we have to do in order to make the scheme work?

I have my own thoughts on the matter, but rather than putting them forward I thought I’d summarise some of the main things that come up in discussions. I’ve left aside the exact design and technical feasibility of congestion pricing – for now, let’s just assume that it’s going to be possible to implement a GPS-based pricing system that allows for variable tolls between different roads and time periods.

1. We don’t need to do anything else.

Some people argue that congestion pricing will work without any further changes to transport infrastructure or services. Stu, for example, put forward this case the other week.

The argument in favour of this view is that congestion is typically very concentrated in peak periods due to bottleneck delay, and that encouraging people to take some trips a bit earlier or a bit later will benefit the overall transport network without imposing large costs on people who re-time journeys to avoid tolls.

2. We need to provide more public transport infrastructure and/or walking and cycling options before implementing congestion pricing.

A second common view is that we need alternative, non-driving transport options in place prior to congestion pricing. Reasonable people could disagree on what would represent enough alternatives, but I’d suggest that a reasonable aspiration would be:

  • Bus routes that cover most of the city, with reasonable frequency
  • Spare rapid transit capacity through key pinch points such as the Auckland Harbour Bridge and Panmure Bridge
  • Cycle lanes running on or parallel to many urban arterials.

The argument in favour of this view is that it is unfair to ask people to pay a toll without giving them options for avoiding it. In that respect, it conflicts a bit with the first view, which holds that people will have the option of re-timing trips to avoid tolls.

3. We need to use the revenue from congestion pricing to improve transport infrastructure and services on busy corridors.

A third view is that we should spend any additional revenues from congestion pricing to build additional transport infrastructure. Some people argue that this should be more roads, while others argue for public transport.

It seems a bit perverse to implement a demand management measure (congestion pricing) and then turn around and spend more building infrastructure. However, the argument in favour of this view is that congestion pricing will give us a better indication of which corridors have high economic value – as evidenced by higher tolls – and hence that investment is needed to allow more people to use them.

4. We should “recycle” additional revenue from congestion pricing into lower taxes or rates.

Another view on what to do with the revenue from congestion pricing is that it should be returned to households. In other words, the scheme should be “revenue neutral” on the whole.

There are two main ways to do this:

  • Lowering income taxes, which will (all else equal) enhance incentives to work while discouraging car commuting at peak times
  • Distributing money equally to households, through lower uniform charges in the rates bill or AECT-style dividends.

The argument in favour of the first approach is that it will tax “bads” (i.e. excess congestion) while rewarding the “goods” (i.e. working). The second approach doesn’t improve incentives to work – people would get the money regardless of whether they are working or not – but it would ensure that every household had an additional chunk of money that they could choose to save, spend, or use to offset the cost of tolls.

5. We should liberalise residential and business zoning rules alongside implementing congestion pricing.

Separate from what to do with the revenues, another view is that it would be necessary to change our approach to land use planning in order to get the best result from congestion pricing.

The argument in favour of this view is that congestion pricing would influence people’s decisions about where to live and work. In other words, some people may choose to move closer to work to avoid paying tolls, while others would prefer to move further out of town to take advantage of faster drive times. However, zoning rules that, for example, held up intensification around employment centres may prevent this from happening.

6. We don’t need congestion pricing in the first place.

Finally, some people argue that congestion pricing is unnecessary. There seem to be two main reasons why someone may hold this view:

  • Contrary to popular perceptions, Auckland’s not really congested enough to need congestion pricing
  • If we just got on and built a lot of roads, like, immediately, traffic would flow smoothly and there would never be any congestion ever again.

The first reason seems to have at least some evidence supporting it, but the second evinces an insane disregard for basic economics (induced demand), financial realities, and the laws of geometry.

Leave your views in the comments, or answer the following poll:

What are the preconditions for congestion pricing in Auckland?

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The alternative route

Congestion pricing has once again hit the political radar, with the news that the Auckland Transport Alignment Project has recommended it as an option to more efficiently manage the transport network. They find that variable road tolls – highest during peak periods on busy roads and low (or even zero) at off-peak times – are the single most effective intervention to improve traffic flow.

ATAP - Interim Report - Manage Demand

On the whole, it looks like support for the idea is on the rise, which is positive. That suggests that the work that Auckland Council’s consensus building group did a few years back has contributed towards a better public conversation on the issue. That’s good, as it’s a challenging idea to sell to people.

The NZ Herald’s editorial on the topic was tentatively supportive and showed a reasonable understanding of the core principles of congestion pricing:

Transport Minister Simon Bridges conceded this week, “we can’t keep building new lanes on highways. We will need a combination of demand-side interventions if we are going to deal with congestion over the next couple of decades”. He prefers the term “demand-side interventions” to taxes, tolls or charges but those are what it means.

Unlike the council, the Government does not advance these for revenue raising but for reducing traffic on the roads. It clearly thinks road rationing is more politically acceptable than revenue raising and the AA agrees. Feedback from members, it says, showed support for tolls as long as people could be convinced it was for congestion benefits, not simply revenue.

However, the Herald’s editorial also exhibits a common misunderstanding about congestion pricing, arguing that free routes must be available as an alternative to tolled routes:

The joint report for the council and the Government this week did not suggest how road travel might be charged. Mr Bridges said one option was to track all traffic with GPS technology which is being trialled in Singapore and Japan. But that implies no roads would be free at times the charge applied. Travel is a basic freedom. We could welcome the chance to pay to use a fast lane when we need one, so long as free lanes remain.

The Herald’s position is basically in line with NZTA’s existing tolling policy, which states that:

…a road tolling scheme may be established to provide funds for the purposes of one of more of the following activities, namely, the planning, design, supervision, construction, maintenance, or operation of a new road, if the Minister of Transport is satisfied that:

  • the relevant public road controlling authorities (including the Transport Agency) have carried out adequate consultation on the proposed tolling scheme;
  • the level of community support for the proposed tolling scheme is sufficient;
  • if an existing road is included in the scope of the tolling scheme, it is physically and operationally integral to the new road in respect of which the tolling scheme will be applied;
  • a feasible, untolled, alternative route, is available; and
  • the proposed tolling scheme is efficient and effective.

However, I think that both NZTA and the Herald are being too hasty in assuming that the untolled alternative route has to run parallel to existing roads. Alternatives can exist in time as well as in space.

Stu Donovan described the maths behind this last week. Transportblog reader Bryce Pearce also dug up a good practical example: apparently Singapore’s road pricing scheme allows people to travel for free most of the day. For example, if you are trying to drive on Lorong 6 Toa Payoh at 8:30am, you’ll have to pay $1. But if you leave an hour earlier or an hour later, you won’t pay anything:

ATAP took a similar approach when choosing how to model congestion charges. As the following diagram shows, the ATAP scheme would increase peak and inter-peak pricing, relative to current fuel taxes, but decrease charges in evening periods. Consequently, people would have options to save money for certain types of trips, for example, by shifting supermarket trips from the afternoon to the evening:

ATAP - Interim Report - Road Pricing Differences

Arguably, being able to travel for free on the same road, at a slightly different time, is even better than being able to travel for free on a different, more circuitous road at the same time.

There are obvious user benefits to the approach of varying tolls by time of day. It allows people to make better choices that respect their individual preferences for time, timeliness, and money.

But there are also important system-wide benefits from variable tolls between different time periods. Because congestion can be quite sensitive to changes in the number of cars on the road at a given time, encouraging even a relatively small number of people to shift the time at which they travel can lead to large benefits.

That’s nicely illustrated in the following graph of Auckland Harbour Bridge traffic volumes. The AHB is essentially free-flowing during the middle of the day, when there are around 1300 vehicles per lane per hour. But it is considerably slower during the evening and morning peaks, when the bridge carries more like 1500-1700 vehicles per lane per hour.

Lane Capacities

Because the peakiest bits of the peak are relatively short – perhaps 2.5 hours in total across an average weekday – you could improve the performance of the bridge by charging tolls during a few short windows. People could still travel for free (or at any rate a lower price) during the remaining 21.5 hours of the day.

From my perspective, that’s a pretty good alternative for drivers! But what do you think about the issue?

Govt Offers a $1b Infrastructure Loan

Yesterday the Government announced its latest policy on addressing the housing crisis in Auckland and increasingly in other centres, a $1 billion infrastructure fund to pay for the bulk infrastructure needed to support *some* of the new houses needed in greenfield areas.

The Prime Minister today announced a new $1 billion Housing Infrastructure Fund to accelerate the supply of new housing where it’s needed most, Finance Minister Bill English and Building and Housing Minister Dr Nick Smith say.

The contestable fund will be open to applications from councils in the highest growth areas – currently Christchurch, Queenstown, Tauranga, Hamilton and Auckland.

Mr English says the Housing Infrastructure Fund will help bring forward the new roads and water infrastructure needed for new housing where financing is a constraint.

“The Government will invest up front to ensure the infrastructure is in place. But councils will have to repay the investment or buy back the assets once houses have been built and development contributions paid.”

As we know Auckland is growing at rate faster than any other region in the country – there are a few districts growing faster, such as Selwyn following the Earthquakes but they are also off a much lower base. The Q&A suggests that the high growth areas are defined as the areas expected to see a 10% growth in the 10 years to 2023. In that time frame, Stats NZ predictions suggest that Auckland will see 58% of the country’s population growth. That figure is even higher if just comparing the five areas listed with Auckland taking around 70% of that growth. As such we can expect the lion’s share of that $1 billion to be used in Auckland. Auckland’s growth over the following years doesn’t slow down either and in the 30 years to 2043 over 60% of all growth in NZ is expected in Auckland.

NZ Regional Population Growth

One big issue right from the start is that for those other cities, a share of $1 billion would go a long way. But in Auckland with its infrastructure needs on another scale, it would be gulped down so fast it would barely touch the sides. The recent work that AT and the NZTA have been doing on Transport for Future Urban Growth suggests that over 30 years around $10 billion is needed in the greenfield just for transport infrastructure. On top of more funding is needed for other physical and social infrastructure that will be required to ensure these new developments have the level of amenity that will be expected/required such as parks, community facilities and much more.

Future-Urban-Land-Stategy

There is of course a lot more infrastructure that’s needed in Auckland but seems that only the greenfield stuff counts for this funding.

Dr Smith says the fund will be available only for substantial new infrastructure investments that support more new housing, not to replace existing infrastructure.

“To access the fund, local councils must outline how many new houses will be built, where they will be built and when they will be available. Ideally, they will have agreements with developers on these issues.

“Funding may also have other conditions attached, such as faster processing of resource consents. All of this will require close collaboration between central and local government.”

Mr English says infrastructure, and its financing in particular, is one of the three key constraints to building more houses – alongside land supply and consenting requirements.

“Councils have strict debt limits which means some lack the headroom to invest in infrastructure now and then wait for future development contributions to recover the costs. The fund will help provide more infrastructure sooner by aligning the cost to councils with the timing of revenue from development contributions.”

Depending on the number and timing of applications, it will require the Government to temporarily borrow up to $1 billion, which will increase net debt until it is repaid.

Only funding new infrastructure is kind of understandable but it does raise some questions, such as just what constitutes new infrastructure. In many cases building new roads or pipes also requires upgrading existing infrastructure to cope with the demands of new areas. We know we can’t just build tens of thousands of dwellings on the edge of town and expect the motorways to work. We also know that there are plenty of areas within the existing urban area for which replacing existing infrastructure is likely to be needed to enable new development. One such example would be the NW Busway which enables growth in existing urban areas such as Te Atatu but also will be critical in enabling growth in the entire North West.

I guess that if councils can assume this fund will pay for some of the greenfield growth they would have otherwise needed to build, it enables them to re-prioritise budgets to focus their normal funding on improving existing infrastructure.

One aspect I do like is the idea of linking funding to developments, the last thing we want is the council or government spending precious funds building infrastructure to an area only for a developer not to build anything and then profit off the increased land value. That of course also raises the question of why the government doesn’t just build a heap of homes themselves.

Perhaps the biggest issue with this announcement is that it’s not going to have any real short term impact. Even if the funding tap was turned on tomorrow – and it seems the details are yet to be worked out – the types of infrastructure projects that this fund will help deliver are not quick things to enable. They normally take years of planning, consenting and construction before any house can be built and so it will be many years before any housing this fund enables will have any impact on our current crisis.

Overall the fund seems useful but not quite as useful as the government’s headline suggest. A lot of it is going to end up coming down to the details and rules put in place and those have yet to be worked out. Ultimately the whole thing just seems like a way of loaning money to councils in a way that sits on their books differently. It will also be critical to see just what projects get built with this funding. If it just results in trying to quickly build a pile of auto-dependant sprawl that would be a terrible outcome but if it also is focuses on good quality outcomes such as decent walking, cycling and PT facilities it could be quite useful.

In addition to the infrastructure fund, the government have also said they’re looking at setting up urban development authorities.

Dr Smith says the Government is also considering establishing Urban Development Authorities (UDAs) to help further speed up the supply of new housing.

UDAs have streamlined powers to override barriers to large-scale development, including potentially taking responsibility for planning and consenting and other powers.

In some form or another we already have a few of these with the likes of Panuku Development Auckland, the Tamaki Redevelopment Company and the Hobsonville Land Company. How will a government UDA be different from these, with the possible exception of having the power to compulsory acquire land. If they did allow for compulsory acquisition it would be interesting to see if they also extended that to at least Panuku.

 

Road pricing #2 – economic benefits

In last week’s post I waded through some of the political mud that was thrown about in response to the recommendation to consider road pricing in Auckland. I concluded there’s not many good reasons to avoid talking about road pricing, even if we don’t need to rush.

In doing so, however, I noticed that much of the discussion on road pricing occurs at what my friend Jarrett Walker calls “low altitude“. By this I mean the discussions tend to quickly descend into debates over things like the level of pricing, payment systems, and what to do with revenue. While I acknowledge these are important questions, they are also questions of detail: They relate to the “how” rather than the “why“. In my experience a good understanding of “why” helps answer the “how”.

In this post I want to look at two ways in which road pricing generate economic benefits. It’s a story of two brilliant people: One named Pigou and one named Vickrey …

1. Static efficiencies – The poisoned chalice of Pigouvian pricing

If you happen to search for “economics of road pricing”, then it’s likely something similar to the following image will pop up on your screen (source). In a nutshell, this graph illustrates the static efficiencies generated by road pricing.

Let’s walk through the details a bit. First, the graph measures traffic volumes on the horizontal axis and trip costs on the vertical axis.

The line marked “Demand” slopes down: As costs fall, traffic volumes rise. That’s sensible: If it is cheaper to travel by car, then more people drive – and vice versa. Now consider the ski-jump shaped curve labelled “average cost”. This shows the average cost of driving from the perspective of drivers; it curves upwards because your travel-time will increase as traffic volumes increase. Now look at the ski jump shaped curve labelled “marginal cost”, which refers to the social cost of each additional vehicle trip. The reason it curves upwards faster than the average cost is because each new car causes additional delays to all existing users. These delays are not reflected in an individual’s decisions, i.e. they are external.

Two important points are also marked on the graph; these are 1) the “Untolled equilbrium” and 2) the (somewhat vaguely named) “Objective”. The untolled equilibrium is where drivers don’t pay the costs of the delays they cause, i.e. it represents the status quo. This point is associated with higher traffic volumes and lower costs than the point marked “Objective”. The latter includes the costs of delays caused to others, and so is associated with lower traffic volumes.

So where do the benefits from road pricing arise? Well, because congestion is an external cost imposed on other people, more people choose to drive than is socially optimal. In this context, internalising congestion costs by way of a toll, a’ la road pricing, reduces demand to a more efficient level, i.e. society as a whole is better off. I should note at this point that congestion is but one externality associated with driving. Noise, air pollution, and accidents are also examples of externalities that drivers should probably pay for. The concept of internalising externalities from traffic congestion was first articulated by an English chap called Pigou, hence the moniker “Pigouvian pricing”.

At this point, many people close the road pricing story book, turn to their friends and family and ask: So shall we price the poor beggars off the roads then? To which the answer is usually “no”, or at best an uncomfortable “maybe”. But we’ll be better off, you might exclaim. Only to be chased out of town by angry people with pitchforks.

Thankfully, the road pricing storybook has another, often forgotten, chapter. Look carefully at the horizontal axis of the above figure, which shows traffic volumes as a function of price, and price only. Can you think of another variable that predictably affects traffic demands and the congestion arising therefrom? Like perhaps time of day? Hmm …

2. Dynamic efficiencies – Get onboard the Vickrey express

The image below is not one that’s easy to find online. I looked and couldn’t find any. Instead, it’s taken directly from my lecture slides (Acknowledgement: This guy).

Bottleneck model

Believe it or not, this psychedelic rectangle is the so-called “bottleneck model”. The vertical axis measures cost, whereas the horizontal axis measures clock time. The point labelled t* is the preferred arrival time at your destination, say 8am at work. The points tq and tq’ represent the start and end of the peak period respectively, say 6-9am, during which time queues form in front of a “bottleneck”, i.e. a capacity constraint. All users are the same (homogenous).

The bottleneck model was developed by Vickrey. One of his key insights is that all travelers face the same cost; the only difference is how costs are split between 1) schedule delay and 2) queuing delay. Another way to think about it: You can either 1) travel early/late and face a shorter queue (but arrive at work early/late) or 2) leave home at the time that gets you to work at the preferred time t* (but sit in queues on your way). Vickrey shows that in equilibrium, options 1 and 2 cost the same (hence why the top of the rectangle, which represents the sum of schedule delay and queuing delay, is flat).

The two green triangles in the above figure represents schedule delay; this is the cost associated with arriving at your destination before or after the preferred time t*. Note that the two green triangles are different shapes, because people generally place a higher value on arriving later than arriving early (NB: This doesn’t change the story). The red area represents the cost of time spent queuing, or “congestion”; it increases from 0 (at tq) to c0 (at t*) and then declines to 0 again (at tq’).

Vickrey showed the optimal toll at any point in time is equal to the length of the vertical red line. That is, if you want to maximise people’s welfare, then you would set a time-varying toll that started off at zero at t = tq and increased to c0 at t*, before decreasing to zero again by tq. This toll would encourage people to leave later, and therefore avoid queues forming early in the morning. In essence, this makes use of underutilised capacity that exists later in the morning; it is a dynamic efficiency.

How does charging a toll equivalent to the cost of queuing delays leave people better off? Well, for the simple reason that time spent queuing (red area) has been “monetized. And unlike time spent in traffic, monetary revenue from tolls can be spent on other things, say lower taxes or increased government investment (depending on the colour of your political pajamas). Basically, road pricing takes wasted time and turns it into something useful (toll revenue).

One point to emphasise; These so-called “dynamic efficiencies” are achieved by changes in departure times (specifically leaving home later), not changes in demand. Moreover, the cost people face is the same with or without the toll. All the latter does is take a time cost and turn it into a monetary cost. The Vickrey model is in this respect very different from the Pigouvian model discussed in the previous section, where benefits arose from suppressing demand.

Conclusions

In this post I’ve presented two simple economic models that help illustrate two different types of benefits from road pricing.

The Pigouvian model focuses on demand. It concludes that a fixed toll should be used to internalise congestion externalities and price some drivers off the road. In contrast, Vickrey’s model argues that a time-varying toll can be used to monetize time spent queuing. The toll encourages people to change departure times, eliminating queues, and generating revenue that can be used for other things. This is as close to a free lunch as you tend to get in economic terms.

Discussions on road pricing often ignore dynamic efficiencies. I think this is unfortunate because I think they are potentially the largest source of benefits. Consider the productivity benefits to commercial vehicles from eliminating queues. Faster and more reliable travel-times would mean that commercial vehicles, and their drivers, could get through more work every day. Think of all the times your tradespeople or deliveries have been delayed en route. It’s frustrating for them, as well as you, but ultimately it’s you and I who pay the price of those delays: Inefficiencies arising from congestion are factored into the price of almost everything we buy.

Real life is obviously more complicated than these economic models imply; real people are not identical and actual tolls are not able to vary by infinitesimal amounts. In response to these realities, some modern road pricing schemes, such as that implemented in Stockholm, blend a fixed toll (a’ la Pigou) with a time-varying toll (a’ la Vickrey). Hybrid road pricing schemes like Stockholm’s have struck a reasonable balance between pricing some drivers off the road, while also encouraging others to adjust their departure times. You can read more about the history and politics of Stockholm’s scheme here.

I want to finish with a final comment on revenue recycling, because I think it’s essential to the potential viability of any road pricing scheme and is something that I will look to cover in future posts. One option would be to use toll revenues generated by road pricing to make a direct, annual per capita payment to Auckland households. This might be similar to the electricity trust payment paid to some households, and would ensure that everyone faced the marginal costs of travelling at peak times – with some money paid back later. A second option would be to use the money to reduce rates. For example, revenue from road pricing could be applied to reduce or eliminate the uniform annual general charge (UAGC). Let me know if you think of other options.

Anyway, that’s more than enough poppycock from me. Keen to hear what others think, and if there are particular aspects of road pricing that you’d like us to research, then please let us know in the comments and we’ll see if we can build it into future posts.

City size, variety, and consumer surplus

In the 1990s, in the early years of the information technology revolution, economist Robert Solow famously commented that “you can see the computer age everywhere but in the productivity statistics.” Two decades on, that still rings true. Social life has been profoundly transformed by new technology: It has altered the way we communicate with friends and family, how we entertain ourselves, and even how we date.

how people meet romantic partners chart

When I read Douglas Adams’ Hitchhiker’s Guide to the Galaxy in the early 2000s, the titular device still seemed like a fantastical idea: a handheld device you could use to access information (much of it inaccurate or incomplete) on anything, from anywhere.

Now, we all have smartphones. But productivity growth has stubbornly failed to take off over this period. Does this mean that technological progress has failed to deliver?

Journalist Ezra Klein (Vox) recently reviewed the current debate over technological progress. One perspective he discusses is that the benefits of information and communication technologies (ICTs) have largely accrued to consumers rather than producers:

Measures of productivity are based on the sum total of goods and services the economy produces for sale. But many digital-era products are given away for free, and so never have an opportunity to show themselves in GDP statistics.

Take Google Maps. I have a crap sense of direction, so it’s no exaggeration to say Google Maps has changed my life. I would pay hundreds of dollars a year for the product. In practice, I pay nothing. In terms of its direct contribution to GDP, Google Maps boosts Google’s advertising business by feeding my data back to the company so they can target ads more effectively, and it probably boosts the amount of money I fork over to Verizon for my data plan. But that’s not worth hundreds of dollars to Google, or to the economy as a whole. The result is that GDP data might undercount the value of Google Maps in a way it didn’t undercount the value of, say, Garmin GPS devices.

As Klein goes on to observe, ICTs have transformed our leisure time more than our work time – in large part, by giving us many more choices about where to dine, what television shows to watch, and who to talk to.

Interestingly, what’s true for technology might also be true for cities. The conventional narrative about agglomeration economies – the economic benefits of scale and density – is that their main effect is to lift productivity. But, as Stu and I have discussed in the past, there’s an increasing body of evidence that suggests that agglomeration also has significant benefits for consumers.

In recent years, economists have used micro-data on household consumption patterns to build a much richer picture of the impact of city size and structure on consumption choices. In short, larger cities don’t always offer lower prices – as you’d expect if higher productivity made it cheaper to produce goods and services. But they do offer a much greater variety of goods and services, which in turn translates into higher wellbeing for households.

A 2015 paper by Jessie Handbury and David Weinstein uses barcode data on retail sales in 49 large US cities to analyse prices and product varieties. They find that:

There are approximately four times more types of grocery products available in New York [metro population 21 million] than in Des Moines [population 456,000].

Because people in larger cities tend to buy a wider range of goods, including more expensive products, a naïve comparison of average retail prices would suggest that larger cities are more expensive. But Handbury and Weinstein’s analysis shows that, after accounting for product variety, prices in large cities are no more expensive than smaller cities. If anything, they tend to be lower:

When we use the data to construct a theoretically rigorous price index that corrects for product, purchaser, and retailer heterogeneity and accounts for variety differences across locations, we find that the price level is actually lower in larger cities. Consumers spend less, on average, to get the same amount of consumption utility in larger cities.

Moreover, what’s true in grocery stores is also true in restaurants. In a 2012 paper, Nathan Schiff took a look at the impact of city size and population density on restaurant markets in 726 urban places in the US. His key finding is that:

For the 182 cities in the top quartile by land area of my data (mean population 331,000), a one standard deviation increase in log population is associated with a 57% increase in the count of unique cuisines. A one standard deviation decrease in log land area–which increases population density without changing the size of the population–is associated with a 10% increase in cuisine count, equivalent to increasing the percentage of the population with a college degree by one standard deviation and larger than the effect of increasing the ethnic population associated with each cuisine by one standard deviation.

In other words, cities that are larger or denser offer people more choices about where and what to eat. Density is especially crucial in large cities, as people generally don’t travel long distances to dine. (Incidentally, relatively open migration policies are also an important enabler of restaurant choice in cities, as migrants bring new cuisines with them.)

Distances travelled to jobs and retail in Auckland

What does this mean for urban policy? I think there are two main lessons.

The first is that although agglomeration economies in production are important to long-run economic outcomes, we might be looking for the benefits of cities in the wrong places. They might not always appear in productivity statistics or price indices, but in the consumption choices that cities offer people. Measuring variety – and how people respond to it – is therefore crucial to understanding agglomeration economies.

The second is that conventional urban policy might be based on false premises. Ever since the “dark Satanic mills” of the Industrial Revolution, policymakers have assumed that cities are good for businesses but bad for people. Accordingly, they designed transport systems and planning policies that aimed to disperse the city and to separate people from their workplaces and from each other.

That made sense when cholera was a major cause of death, but it’s increasingly illogical in today’s world. Urban disamenities such as air quality, crime rates, and infectious diseases are all improving, and the evidence increasingly shows that the consumer choices offered by cities (and dense urban places) have benefits for households. In this context, policies that enable urbanisation are likely to have larger benefits than commonly assumed.

What do you think about the role of consumer choice in cities?

Apartments, proximity, and living space

Housing is a normal good. That is, it’s something that people tend to want more of as their incomes increase.

“More” doesn’t necessarily mean “larger”. People do tend to prefer larger homes as they get wealthier, but that’s not the only thing that matters. They may be willing to compromise on space in exchange for a higher-quality living space – bring on the granite countertops! – or a home in a better location. A “better location” could in turn mean anything from proximity to jobs (resulting in efficient use of valuable time), proximity to shops or cultural amenities, location in a good school zone, or access to parks or beaches.

One interesting phenomenon is that people seem to be willing to travel further to work than to consumption amenities (ranging from retail to concerts). In their fantastic book Cities and the Urban Land Premium, Dutch economist Henri de Groot and several co-authors provide some data that shows that people are, on average, willing to travel considerably further to work than to consume. They show that this results in a higher urban land premium for accessible inner-city areas, as vibrant downtown areas have the most varied and interesting consumption opportunities.

Furthermore, you’d expect this premium to rise as incomes rise, as people with more disposable income will have an increasing preference for close proximity to consumption and cultural amenities.

Is the same thing likely to be true in Auckland? Nobody’s done a survey, but we’ve got some data on the distance that people actually travel to access jobs and retail.

In a paper two years ago, I analysed Census data on commuting distances in order to understand what Auckland households spend on housing and transport. I went back and re-analysed that data to get an estimate of the distribution of commuting distances in Auckland. This data suggests that 50% of Aucklanders commute less than 9km, while less than 2% are super-commuters travelling longer than 50km.

As a point of comparison, I used data on retail spending patterns compiled by economist Susan Fairgray in a 2013 report on the Auckland retail sector. Based on electronic card spending data, Fairgray estimates that 50% of Auckland retail spending is done within 5km of people’s homes. (See Table 3 on page 58 of her report.)

Here’s the chart. As in the Netherlands, distances travelled to consume drop off more rapidly than distances travelled to produce.

Distances travelled to jobs and retail in Auckland

There are several implications for how we build cities. The first is that we should expect retail, personal services, and recreation to be widely distributed throughout the city. Large tracts of houses without good access to shops and recreation are not likely to be awesome in the future. There are various ways to cater to these needs, ranging from mixed-use zoning that allows retail and housing to colocate to distributing small retail centres throughout suburbs (a la Auckland’s tramway suburbs).

The second thing is that we should think more carefully about how preferences for centrality are changing. The consumption amenities that cities offer play an increasing role in their success or failure. Some important consumer amenities tend to be located centrally. For example, nightlife and entertainment districts are almost always located near the city centre – think of Ponsonby or K Road in Auckland. Likewise, museums and public art galleries are usually located downtown – e.g. Te Papa in Wellington or the Auckland Art Gallery – to maximise the number of people that can access them.

Auckland Art Gallery

Auckland Art Gallery

As demand for consumer amenities will tend to increase with rising incomes, we’d expect demand to live close to them to increase in the future. Meeting this demand in a growing city will, in turn, mean building more apartments.

But wait! If people also want more living area as they get wealthier, doesn’t that mean that they’ll reject apartment living? Won’t apartments simply be too small to meet their needs, even after taking location into account?

Interesting question.

It is the case that new apartments tend to be smaller than new standalone houses in New Zealand. Over the last five years, the average standalone house consented in Auckland was about twice as large as the average apartment consented in Auckland.

However, there’s no universal law that says that apartments have to be small. Policy can play a big role in keeping apartment sizes down, or enabling them to be more spacious. As LSE economist Paul Cheshire observes, planning policies (and other things like tax policies) can have the unintended consequence of discouraging adequately-sized housing:

If you really want to plan to protect and provide better access to green space and open countryside without artificially constraining land supply and forcing up house prices, then Green Fingers (or Green Wedges) would seem to be the best solution. That is what more egalitarian Scandinavians have. Copenhagen has its Green Fingers – really brown urbanisation along the radial routes out of the city with protected countryside each side. Denmark has not just got cheaper housing: according to the Dallas Fed’s data, the real house price has increased by a factor of 1.6 in Denmark compared to 3.4 in the UK since 1975 but new houses in Denmark are a lot bigger: 80% bigger in fact.

As Cheshire’s example of Copenhagen shows, it’s possible to build dwellings that meet people’s needs for living space and preserve usable open space around cities. You just need to be willing to build intensively where you do build – and integrate it with rapid transit.

copenhagen finger plan

Source: Living Rail

For a less anecdotal look at the issue, I used Eurostat data to measure the relationship between dwelling size and dwelling type in 29 European countries. Here’s a scatterplot showing the relationship between the share of dwellings that are detached houses (X axis) and average dwelling size (Y axis). Observe how there is almost no relationship whatsoever. If anything, there’s a slight negative relationship – countries with more standalone houses may have slightly smaller dwellings, on average. (There’s probably an income effect in there that I haven’t controlled for – richer countries tend to be more urbanised, which will tend to mean more apartments, and also have larger dwellings.)

Eurostat detached houses and average dwelling size chart

But basically, there doesn’t seem to be an inescapable trade-off between dwelling type and size. Apartments can be small… but they can also be large. And cities that are willing to let people more apartments get built will, in addition to being more affordable, give people more opportunities to realise their demands for both space and proximity.

What do you think of this data?