The moral case for immigration

In a post several weeks back, I talked about the economic case for immigration and population growth. In it, I hypothesised that:

New Zealand has a strong feedback loop between net migration and economic growth. When growth prospects get worse – as they did in the 1970 and 1980s – it dissuades people from coming here and encourages Kiwis to leave for greener pastures. This in turn worsens growth prospects by sucking consumer demand out of the economy and reducing perceived household wealth (i.e. lowering house prices).

By contrast, good growth prospects tend to attract migrants to New Zealand’s cities and encourage potential emigrants to stay. This in turn leads to a virtuous cycle between higher growth and increased migration.

In my view, building good cities that attract and efficiently accommodate population growth can make us better off by strengthening the agglomeration economies at work in New Zealand’s economy. It can also make us better off in non-economic ways: consider romantic relationships, for example. If you’re young and single (or old and single), you should absolutely prefer more people to be arriving than leaving. The more young, mobile people are staying or arriving in New Zealand cities, the better your odds are of ending up in a good relationship.

However, I don’t think the economic case for immigration is as strong as the “moral” case for immigration. That’s because immigration is one of the most powerful mechanisms for enabling people to lift their incomes and social status. Migration can offer individuals opportunities that they never would have had in their home countries.

I’m going to discuss some economic research on the topic, but first I want to explain why it’s important to me.

Basically, in the 200-400 years in which reasonable data on my ancestors is available, migration has been just about the only thing that has enabled us to have any significant social or income mobility. Ever.

Migration has worked out well for me. Moving back to New Zealand has given me opportunities that I might not have had in the United States. Thus far, I’ve had a more interesting and fulfilling career and I’ve been surrounded by interesting and friendly people while doing it.

Migration also worked out well for my parents and several of their siblings, who left New Zealand in the 1970s and 1980s during the wave of economic destruction caused by collapsing commodity prices and Muldoonist Think Big initiatives. Like many other New Zealanders, they’ve done well overseas.

And, back in the 1840s-1890s, migration to New Zealand opened up opportunities for social mobility and independence to my great-grandparents and great-great-grandparents. In fact, those were just about the first opportunities anyone in my family had to get ahead. If it weren’t for migration, we’d still be lower-middle class in some grim former mill town in northern England.

I’m grateful for the opportunities that migration has offered me and the opportunities that it’s offered to my family. Furthermore, I feel strongly that more people should have similar opportunities. I don’t believe in pulling up the ladder. If some hard-working folks from Nigeria, Guatemala, Bangladesh, Samoa, or wherever want to try their luck moving to an unknown country, I’m all for it. Give them a fair go.

Several recent papers by University of Otago economist Steven Stillman (another immigrant!) and several co-authors help quantify how valuable giving people the opportunity to immigrate can be. Stillman uses evidence from two “migration lotteries” operated by the New Zealand government. Under a programme started in 2002, a small number of Tongans and Samoans randomly selected from a pool of applicants are offered residency in New Zealand.

Evidence from the Tongan migration lottery shows significant improvements in well-being for migrants. Stillman and his co-authors found evidence of:

  • “Very large gains in objective well-being result from migrating to New Zealand (Table 2). The weekly wage of principal applicants rose by NZ$321 (US$200) within a year of first moving which is almost three times the weekly wages of the control group in Tonga (NZ$117).”
  • “More subtle and complex effects on subjective well-being…” After four years, they observed a “very substantial rise in the other components of mental health, of about three points, which is equivalent to one quarter of the wave 2 scores for the control group in Tonga.”

Evidence from the Samoan migration lottery shows that migration can also improve wellbeing for migrants’ families in the old country, at least in the short term. Stillman and his co-authors found that migration increased household consumption and reduced poverty in households that sent migrants to New Zealand, although these effects faded away over time.

In short, even after controlling for self-selection bias (i.e. the fact that migrants tend to have both motivation and resources to migrate), migration seems to make people better off. It doesn’t necessarily work for everyone, but it certainly works for most people.

In my view, the evidence suggests there are good economic and moral arguments for enabling migration, rather than cutting it off in the good times. If we want to manage house price inflation, it would be fairer and more sensible to pursue other policies instead. This could include (but certainly isn’t limited to):

  • Changes to tax policy to harmonise our property taxes with major trading and investment partners – as Stu highlighted, our unusually low property taxes distort people’s investment decisions and push cash into housing
  • Supply-side policies like a revitalised programme of state house construction or urban planning policies that enable people to build more housing in areas that are accessible to jobs and amenities.

What’s your experience with immigration? Remember, you or your ancestors came here relatively recently by boat or by airplane!

Do property taxes affect housing affordability?

A few weeks ago, I took a look at property taxation in the US, Canada, and New Zealand. I found that Auckland homes are taxed lightly by comparison – rates average 0.39% of house value. Property tax rates are twice as high in most of the other cities I looked at. In some cases – e.g. Houston, where property taxes average 2.31% of home value – they are much, much higher.

This should come as no surprise to anyone who’s read the literature. For example, Grimes and Coleman (2009) find that New Zealand under-taxes property:

McLeod et al (2001; p.26) showed that the proportion of taxation raised through property taxes was lower in New Zealand than in Australia or the United States. Taking into account all levels of government (federal, state and local), Grimes (2003) found New Zealand’s share of property taxes in government revenue was relatively low, at 5.7%, compared with a (20 country) OECD average of 8.3%. As a share of GDP, New Zealand’s property tax share was also relatively low at 1.8% compared with the average rate of 2.4%.

They go on to suggest that introducing even a relatively small land tax could result in fairly large changes to land prices. It’s intuitively sensible that higher property taxes would discourage people from bidding up prices – the more they pay for land, the more they pay in taxes!

Stu recently took a look at the same research, and some of the broader trends, and concluded that higher property taxes could take some heat off the housing market. But how much does property tax really matter for housing affordability?

To get a rough sense of the relationship, I’ve put together a chart showing the relationship between property tax rates (x axis) and Demographia’s “median multiple” measure of house prices relative to incomes (y axis). It includes data on all 59 US, Canadian, and New Zealand cities with a population over 1 million.

Notice the substantial negative correlation between property taxes and median multiples. There is a strong tendency for places with lower property taxes to have higher house prices, and vice versa. The least “affordable” places all have relatively low property taxes.

property taxes and median multiples chart 1

Overall, this chart suggests two things: First, New Zealand’s relatively low property taxes may contribute to our relatively high house prices. Notice how Auckland’s house prices seem to fit the overall trend in the data.

Second, as I’ve previously argued, Demographia’s analysis is largely meaningless as they have failed to account for the full range of explanatory variables, from interest rates to tax policies to economic fortunes.

Here’s another view on the same data. I’ve taken the natural logarithm of both variables to smooth out the relationship, and put a trend-line through the data points. This simple bit of analysis suggests that:

  • About 44% of the variations in median multiple can be “explained” by differences in property tax rates. For a bivariate regression, this is quite high.
  • The slope of the regression line suggests that, within this sample of cities, a 10% increase in the property tax rate is associated with a 4.6% reduction in the median multiple. Again, that’s a quite strong relationship.

property taxes and median multiples chart 2

I don’t think we can draw any firm policy conclusions from this data, but it certainly suggests that our low property taxes are worth investigating as a cause of our high house prices. In the words of xkcd, “Correlation doesn’t imply causation, but it does waggle its eyebrows suggestively and gesture furtively while mouthing ‘look over there’.”

Correlation doesn't imply causation, but it does waggle its eyebrows suggestively and gesture furtively while mouthing 'look over there'.

Finally, it’s worth taking a closer look at the four US cities with the highest median multiples – the top data points on the left hand side of the first chart. They are all large cities in California – San Francisco, Los Angeles, San Jose (i.e. Silicon Valley), and Sacramento (the state capitol). They provide a great illustration of why failing to account for multiple, correlated explanatory variables can undermine an analysis of house prices.

But first, a California-themed music break:

In California, state-level legislation establishes a common planning framework. There are local variations, but if one city is constrained by regulations – as San Francisco and Silicon Valley are – the rest are likely to have similar problems. To give an example, the California Environmental Quality Act, which is the state’s equivalent of the Resource Management Act, has traditionally required all new developments to assess their impact on traffic congestion and mitigate it. As a 2011 Citylab article explains, this requirement has prevented the development of space-efficient forms of housing and transport:

There’s also a great irony underlying the use of LOS [traffic Level of Service] as part of CEQA’s environmental impact checklist. It seems self-evident that bike projects are favorable to the environment, but the use of LOS to evaluate them can sometimes imply quite the opposite. The person who filed the 2005 lawsuit against the San Francisco master bike plan, for instance, suggested that because bike lanes raise LOS they also raise congestion and car idling, and thereby cause pollution.

That’s not the only contradictory aspect of LOS. Case in point: a developer whose building fails an LOS threshold can mitigate the environmental impact by widening the street, which of course would attract more cars and pollution. So instead of encouraging dense development and lower vehicle mileage — the hallmarks of a transit-first city — San Francisco’s use of LOS as part of CEQA actually discourages livable design. In a three-part series on LOS at Streetsblog, one transportation consultant called LOS the “single greatest promoter of sprawl and the single greatest obstacle to transit oriented development” in California.

However, CEQA and its absurd requirements for traffic assessments (etc) aren’t the only thing going on in California. State-level laws have also constrained local governments’ ability to raise property taxes. Proposition 13, a citizen-initiated referendum passed in 1978, caps property tax rates at 1% and fixes them to the value of the house at the time it was purchased, plus a 2% annual increment for inflation.

This has had a number of perverse effects, including stripping away funding from California’s formerly excellent primary and secondary education and setting it on a path of decline. (Prop 13 is basically exhibit A in the case against binding referenda.) It has also distorted the housing market. Because home-owners know their property taxes won’t increase if the value of their house increases, they may be more willing to speculate on capital gains.

A 1982 paper by economist Kenneth Rosen offers empirical support for this hypothesis – he found that reductions in property tax rates were almost immediately followed by proportional increases in house prices.

Consequently, it would be foolish to analyse the Californian housing market without attempting to control for both taxation and planning policy. If you only looked at one policy, your conclusions would be biased by mis-attributing the effects of the other policy. (That’s precisely what Demographia seems to have done, by the way.)

What’s true for California is also true for New Zealand. I find it hard to take seriously the claims of people who attribute housing affordability solely to regulatory policy and fail to consider the potential impact of our low property taxes.

What do you make of the data on property taxes and house prices?

“Ravenously space-hungry monsters”

Stu’s talk at an IPENZ forum the other week put forth a lot of smart critiques of and recommendations for the transport profession. I was particularly taken by this slide:

Stu Donovan Cities

Stu argues that failing to account for the “opportunity cost” associated with using valuable land for moving cars can lead us to misallocate resources. This isn’t a new idea, but it’s an important one. Here’s what William Vickrey, who received the Nobel memorial prize in economics for his work on congestion pricing and auctions, had to say on the topic in 1963:

“a cost benefit analysis can justify devoting land to transportation only when the savings in transportation costs yield a return considerably greater than the gross rentals, including taxes, that private businesses would be willing to pay for the space. This in turn means that an even greater preference should be given to space economizing modes of transport than would be indicated by rent and tax levels. And our rubber-shod sacred cow is a ravenously space-hungry, shall I say, monster?”

Things have changed quite a bit since Vickrey’s time. For one thing, urban land prices have risen quite a lot in recent decades. For another, the long driving boom seems to have abated in most developed countries. In many cities, this means that the opportunity cost of space-hungry transport modes has increased.

I’ve had a go at putting together some evidence on this for Auckland (or New Zealand cities in general). Unfortunately, long time series on land prices and traffic volumes are not readily available, so I’ve had to use two proxy variables:

  • I’ve used RBNZ’s national house price index, which goes back to 1962, as a proxy for land costs. I deflated the index by RBNZ’s long-run consumer price index to net out the impact of inflation. It’s probably reasonable to use this as a proxy for land prices given the fact that land prices have driven most increases in house prices over this period.
  • I’ve used NZTA’s annual average daily traffic counts for the Auckland Harbour Bridge, which Matt’s compiled going back to 1961, as a proxy for overall traffic volumes. This is probably reasonable as they’ve followed similar trends – they boomed together in the 1960s and have flattened simultaneously over the last decade.

I’ve graphed the two indices below. Prior to 2000, traffic volumes generally increased faster than house prices. (Although you could argue that house prices started to rise faster in the 1990s.) Since 2000, house prices / land values have generally risen much faster than traffic volumes. (National-level data understates the degree to which land prices have risen in Auckland, in fact, as house prices flattened but never declined after the GFC.)

As an aside, in case anyone says that house prices have never fallen in NZ, take a look at the 1970s. Real house prices dropped by almost 40% from their peak in 1974 to the trough in 1980. In real terms, they didn’t recover for 20 years. However, this was masked by the overall high inflation rates prevailing in the 70s and 80s. If something similar happened today – and it could – it would have a catastrophic effect on household wealth and financial stability.

AHB traffic volumes and real house prices, 1961-2014

What can we conclude from this data? Potentially, quite a lot.

First, this data shows that Stu’s observation (and William Vickrey’s) is highly relevant for policymaking. Land prices are going up faster than vehicle demand, meaning that the opportunity cost of a space-hungry, car-based transport system is increasing. If this continues, our best option for achieving a transport system that uses resources productively will be to invest in space-efficient transport modes: rapid transit, cycleways, and the like.

Northern Busway efficiency

Hooray for rapid transit!

Second, this may help to explain why growth in driving has stalled and growth in public transport demand has accelerated. My hypothesis is that the increasing value of space, rather than increasing fuel prices, is a fundamental driver of the increased viability of PT and non-car modes.

When land prices rise faster than car use, it tends to create incentives for the use and development of more space-efficient transport modes. This happens through two channels:

  1. First, transport agencies, which have constrained budgets for transport investment, find that they can’t build as many space-hungry roads when land prices are high. They face the choice of spending lots of money to acquire land, or spending lots of money to tunnel underneath valuable properties. So while New Zealand has ramped up its spending on roads, it may be getting less bang for buck.
  2. Second, private individuals and businesses, face higher costs to use or provide parking. In the absence of serious market distortions, this will mean that people provide less parking and/or charge higher prices for it. This in turn encourages people to use alternative modes.

I’d like to close with a comment from another Nobel economics laureate, Paul Krugman: “Productivity isn’t everything, but in the long run it is almost everything.” One key to achieving higher productivity is to change your approach in response to changing prices and changing demands. If space is getting more expensive, it’s imperative to use it more efficiently!

Working paper: Trade-offs in urban planning

Back in April, I had the opportunity to present a paper on the economics of urban planning at the New Zealand Planning Institute’s annual conference. The paper, which benefited from the support of my employer, MRCagney, and discussions with a menagerie of planners and other economists, is now available online for anyone who’s interested. (As is inevitable, some of the table headings didn’t come out quite right in the online version. Oh well.)

The aim of the paper was to illuminate some of the trade-offs – and unintended consequences – that can occur as a result of urban planning. It presents three short case studies that illustrate different aspects of the choices facing us in urban planning:

  • Minimum parking requirements, which were aimed at managing congestion and keeping down parking search costs – but which actually managed to increase congestion, reduce the viability of public transport, walking, and cycling, and require us to use scarce land inefficiently
  • Heritage preservation policies, which are attempting to balance the preservation of “aesthetic externalities” from nice old buildings with the process of urban change
  • Opportunities for new development – is it possible to build affordable housing in areas where land prices are high? Can we just keep building standalone houses, or are higher density housing choices required?

As it’s a conference paper rather than a research paper, it focuses on pulling together some disparate perspectives on urban planning rather than evaluating policies and recommending specific approaches. If you’re interested in a brief, non-technical overview of the subject, give it a read. Here’s an excerpt:

I’d like to close by discussing one major trade-off we face: the choice between low-density cities and affordable cities. It is simply mathematically impossible to combine high land prices, low densities, and home affordability. In areas with high land prices – which we would expect to see in any economically successful city – we need to ask: would we prefer to have affordable housing or low densities?

urban policy trilemma

We can think of real-world examples of places that conform to each edge of the triangle. It’s easy to find low-density, affordable housing in (say) Pokeno or Huntly, as land values are low enough to sustain it. But in inner-city Auckland, high land prices mean that we must choose between our desire for space and our need for affordable housing. We’ve resolved these trade-offs differently in different areas. In Ponsonby, we’ve preferred to maintain lower-density heritage housing, which has priced many people out of the suburb entirely. By contrast, building many apartments at all price points has allowed the city centre itself to remain affordable.

Some people argue that Auckland should aim to bring land costs down in order to improve housing affordability. In my view, this view ignores the market realities. High land prices are an indicator of urban success – they demonstrate that people and businesses want to be there. We may be able to lower them through, say, a deep and prolonged recession or years of net emigration. But it’s unlikely that the benefits of reduced land prices would justify the economic and social costs of doing so.

Furthermore, greenfield land supply alone won’t solve our problems. While land does tend to be cheaper on the edge of the city, households that locate there tend to incur higher transport costs. Previous empirical work has shown that higher commuting costs entirely offset savings on housing cost in fringe suburbs (Mattingly and Morrissey, 2013; Nunns et al, 2014). As a result, if we want affordable housing we have no choice but to deliver it in places that are accessible to employment, education, and amenities.

Fortunately, we have choices. Technological innovations – steel-framed buildings, indoor plumbing, and elevators – have freed us from the tyranny of horizontally. We have the option to build up, if we are willing to take it.

Finally, while writing this paper, I put a fair bit of thought into how economists, urban planners, and citizens in general talk about urban policy issues. In my view, many of the disagreements that we have when talking about urban policies are best thought of as differences in terminology, not differences in values. At the end of the day, most people would like to live in a city that gives them good choices about how to live, work, and play, and doesn’t waste too much of their time or money. But sometimes we talk about that in different terms.

One morning, I was lucky enough to run across a scene that illustrates how good urban policies can enable outcomes that different people may find pleasing in different ways. I took this picture on the Fort Street shared space, where a loading dock has been converted into a container cafe. They’ve slapped up a mural on the wall, put out a few chairs, and gone into business:

20150210_100533 copy

Now, as a dour, fun-averse economist I find this scene beautiful because it shows underutilised resources being put to higher and better uses. Multifactor productivity in action! An urban designer or architect may find it beautiful for the way it’s “activated” a blank loading bay as a people space. A passer-by may simply enjoy the way it looks, or be enticed to go in to try their coffee. Others may appreciate the employment opportunities it makes available.

All of which demonstrates one of the wonderful traits of cities: how their diversity and vitality can satisfy the needs and desires of many different people.

Are Aucklanders paying too much in rates?

Aucklanders (and, I suspect, people in general) complain about high and rising property taxes. But are our rates actually too high? Compared to what?

An article last year reported on what ratepayers are paying in each of New Zealand’s territorial authorities:

Not surprisingly, rates in the most sought-after areas are also high. Those living in Auckland, where the average household income is around $76,000, face annual bills of $2636. The average house price in Auckland was $678,533 in February.

But residents in Christchurch face comparatively low bills. At $1706 a year, they make the top 10 for cheapest rate bills.

In other words:

  • In 2014, the average Auckland ratepayer paid rates equal to 0.39% of their property’s value ($2636/$678,553). This year, of course, that figure will be lower as property values have increased much, much, much faster than rates bills.
  • In Christchurch, the average ratepayer paid rates equal to 0.37% of their property’s value ($1706 divided by the average home price of $462,086).

The article didn’t bother comparing New Zealand’s rates bills with property taxes in other countries, so I went out and gathered some data on property taxes in the US and Canada, two countries that are frequently cited as examples for New Zealand to follow. (Albeit sometimes for very different reasons.)

Before getting into the figures, I should say that this isn’t a perfect comparison, because:

  • There are more layers of government in Canada and the US, due to their federal systems
  • Local governments in Canada and the US have more fiscal responsibilities – schools are funded by local governments in the US and provincial governments in Canada, for example
  • But they also have more options for levying taxes – in the US, local governments can impose income taxes, sales taxes, and business taxes. In Canada, provincial governments can do the same.

Overall, the Canadian data is likely to be much more comparable than the US data, as municipal governments’ responsibilities and tax powers are more similar. With that in mind, here’s how Auckland stacks up to the major Canadian cities. The data is from a 2014 Globe and Mail article:

Canada residential property taxes chart

Basically, Auckland (and Christchurch) has quite low property taxes relative to most Canadian cities. The only city that pays a lower property tax rate is Vancouver. (More on that below.)

And here’s how Auckland’s residential property tax rates stack up to the five most-taxed and least-taxed American states. The data is from tax-rates.org:

US states residential property taxes chart

In keeping with American states’ reputations as “laboratories of democracy”, different states seem to be testing out very different property tax policies. If Auckland and Christchurch were in the US, they would be among the most lightly-taxed places in the country. Certainly much less so than that bastion of high property taxes, Texas.

Wait a minute, Texas?

Here’s what tax-rates.org had to say about Harris County, which contains Houston:

Harris County has one of the highest median property taxes in the United States, and is ranked 152nd of the 3143 counties in order of median property taxes.

The average yearly property tax paid by Harris County residents amounts to about 4.26% of their yearly income.

Here’s a chart comparing property tax rates between a selection of major US cities. Houston is head and shoulders above the rest, in terms of property taxes. And, nonwithstanding the disclaimers, Auckland seems to be relatively lightly taxed:

US cities residential property taxes chart

Perhaps the lesson is that if we want to be more like Houston, which some people cite as an example for Auckland to follow, we should start by raising property taxes. The median Houston homeowner pays US$3,040 in property tax. That’s roughly equivalent to NZ$4,100, or 50% more than Aucklanders pay.

Houston needs the cash to pay for all those roads, of course. But its relatively high property taxes are also likely to be one of the hidden causes of Houston’s relatively affordable housing. This is because high property taxes tend to discourage people from bidding up house prices – the more they pay for houses, the more they pay in taxes!

On the other side of the coin, literally, Vancouver offers much lower property taxes. Another analysis of Canadian property tax data shows that the average Vancouver homeowner pays CA$2,322 in property taxes. That’s roughly equivalent to NZ$2,500 – or slightly less than Auckland rates. It seems like Vancouver’s compact, transit-oriented urban form is quite cheap for local taxpayers.

And finally, there’s no evidence that rates are especially high in Auckland or other New Zealand cities. If anything, it’s the opposite – property is taxed unusually lightly in New Zealand.

What do you make of this data?

Is public transport an “inferior good”?

I’ve recently been taking a look at Statistics NZ’s Census data on car ownership in Auckland. One interesting observation is that low-income households are considerably more likely to not own a car. One implication is that minimum parking requirements, which require everyone to have carparks (or pay for their provision every time they go to the shops), are a quite regressive policy. (More on this in a future post!) And, of course, providing frequent, reliable public transport services and safe walking and cycling options throughout the city will benefit low-income households the most. (In other words, separated bike lanes are not just about hipster urbanism!)

Another interpretation of the data on car ownership is that it shows that a car is what economists call a “normal good“. In plain English, this means that when people’s incomes increase, they tend to have more of them. This seems to be true in Auckland: high-income households are less likely to own no cars and more likely to own three or more cars.

However, people commonly assume (or assert) that public transport is an “inferior good“, or something that people consume less of as their incomes increase. This assumption is deeply embedded in transport policymaking and transport modelling. It’s part of the reason that policymakers have been so eager to disinvest and underfund our public transport networks over the past half-century: “In the future, we’ll all be richer and drive more.”

But is this actually true? Let’s take a look at the data.

First, I took a look at the Household Economic Survey data, which Statistics NZ has very helpfully broken down by decile of household income. Here’s a chart showing the percent of household spending that goes to transport (including cars, petrol, public transport, etc) and passenger transport alone:

HES transport spending by decile 2013 chart

In short, higher-income households do seem to spend more money on passenger transport, both in absolute term (i.e. dollars per week) and as a share of their incomes. This may suggest that public transport isn’t an inferior good. Unfortunately, though, it’s not possible to draw any definitive conclusions from this data for two reasons. First, the Stats NZ data doesn’t allow us to split out urban areas (where average incomes tend to be higher and PT is available) from rural areas (which tend to be poorer and lacking in PT). Second, Stats NZ has grouped air travel into the passenger transport category… which means we might just be picking up the fact that richer people fly more.

So let’s take a look at a second set of data: 2013 Census data on household incomes and main commute mode. To avoid issues with comparing between rural and urban areas, I focused on data for Auckland alone. The following scatter-plot shows the correlation between PT mode share for commute journeys and median personal income for Auckland area units. (I’ve excluded area units with population densities less than 1 person per hectare, as they’re likely to be rural areas where PT isn’t available.)

Census 2013 personal incomes and PT mode share chart

There isn’t much of a pattern in this data. There are some higher-income areas with high PT mode share, and some with low PT mode share. But the trendline does seem to be moderately positive. In other words, the Census data doesn’t seem to indicate that PT is an inferior good – people in higher-income areas are slightly more likely to use PT.

Finally, it’s worth taking a look at changes over time. In other words: Are Aucklanders using PT more or less as average incomes increase? In order to examine this question, I looked at Statistics NZ’s data on household incomes by region as well as the public transport boardings data that Matt has diligently compiled. The Stats NZ data only reaches back to 1998, so we’re limited to looking at recent changes.

Matt’s data on patronage shows that total PT boardings in Auckland rose from 37.6 million in 1998 to 72.4 million in 2014 – significantly outpacing population growth. Incomes also rose over the same period. Here’s a chart comparing changes in (nominal) median household incomes with changes in PT boardings per capita for the Auckland region:

Auckland median household incomes and PT boardings chart

In recent years, Aucklanders haven’t reduced their use of public transport as incomes increased. In fact, we’ve seen the exact opposite – PT trips per capita have risen in line with median incomes. (Or even slightly faster, as I didn’t account for the effect of inflation on incomes.)

Is this conclusive evidence that PT is a “normal good” that people will demand more of when they get richer? Probably not – I don’t have the time, budget, or micro-data to analyse the behaviour of individual transport users. But it provides no empirical support whatsoever for the assumption that PT is an “inferior good” that people will want less of in the future.

In short, we should probably stop simply assuming that PT use will wither away with rising incomes. That might be true, but it’s not obviously apparent in the data. A better course of action would be to start planning to provide public transport that will be useful to people of all incomes.

In defense of population growth

Growth: what is it good for?

Accommodating a growing population can certainly be challenging. It means having to find more money to invest in transport and water infrastructure to enable new residents to live and travel in the city. As Auckland Council’s recent consultation on the Long Term Plan shows, asking people to pay more is never a very popular proposition – even if they like how the money’s being spent.

And, as Stu pointed out in his post on Auckland house prices this Monday, population growth can also put pressure on housing markets. Multiple research papers from the Reserve Bank have shown that increases in net migration tend to be followed by increases in house prices – shown in this chart. Obviously, homeowners do quite well out of this, but others face added costs:

RBNZ net migration and house prices chart

In short, it’s not surprising that some people feel trepidatious about population growth and migration. And it’s not surprising that those anxieties are especially present in Auckland, which is projected to continue growing rapidly over the next three decades.

While unease about population growth is understandable, I’d argue that it’s misplaced. In my view, the benefits of urban population growth in New Zealand far outweigh the costs. While large urban areas can become dysfunctional – think of Beijing’s astonishing smog problems or the high cost of infrastructure in sprawling American cities – New Zealand’s cities are nowhere near large enough for the diseconomies of scale to triumph over the economies of scale.

This is easy to see if we look at the periods when Auckland hasn’t been attracting migrants. Here’s a chart from a presentation on Auckland’s demographics by Auckland Council social researcher Alison Reid. It displays the composition of Auckland’s population growth since 1922. In recent decades, natural population increase – i.e. people having babies – has been the biggest source of growth. Net migration is important, but it can be quite volatile – surging up and then crashing back.

Auckland components of population growth 1922-2012

What stood out to me from this chart was that the years with little or no net migration to Auckland have not been good times for the city. Net migration slowed to a trickle during the Great Depression, and turned negative during the constrained years during and after World War Two. More recently, quite a few people fled Auckland during the economically calamitous Muldoon years. Net migration remained low during the painful adjustments imposed by the following two governments.

I wasn’t living in Auckland during the 1990s – my parents had joined the queues leaving via Auckland airport – but friends who were say that the city was turning into a ghost-town. History shows that shutting off the migration tap has never led to a better, more vibrant city or more opportunity for residents. It’s simply been a sign of failure.

My hypothesis is that New Zealand has a strong feedback loop between net migration and economic growth. When growth prospects get worse – as they did in the 1970 and 1980s – it dissuades people from coming here and encourages Kiwis to leave for greener pastures. This in turn worsens growth prospects by sucking consumer demand out of the economy and reducing perceived household wealth (i.e. lowering house prices).

By contrast, good growth prospects tend to attract migrants to New Zealand’s cities and encourage potential emigrants to stay. This in turn leads to a virtuous cycle between higher growth and increased migration.

We can’t fully control this process, as it depends in part on what’s happening in Australia and the rest of the world (not to mention macroeconomic variables that we don’t fully understand). But we can make sure that our cities are in a good position to take advantage of population growth.

The first, and most important thing we can do is to build better cities that are able to attract and efficiently accommodate more people. In Auckland, for example, we’ve got some challenges, including transport investment that’s been heavily skewed towards cars (and only cars) and rising house prices. But the flip-side of those is that we’ve got great opportunities to:

  • Improve transport choice by investing in Auckland’s “missing modes” – a frequent bus network throughout the city, rapid transit infrastructure, and safe walking and cycling infrastructure
  • Improve housing choice by providing opportunities for people to develop higher-density residential typologies in market-attractive areas
  • Invest in great public spaces, such as Auckland’s waterfront and increasing numbers of shared spaces.

Second, as we attract more people to our cities, we need to accommodate them in an efficient and environmentally responsible way. This means enabling people to live in areas that are accessible to jobs, shops, and other amenities. As I found when I looked at carbon emissions from commutes in New Zealand cities, people in inner-city areas are considerably more environmentally friendly than their co-workers from the urban fringe.

Annual CO2 emissions per commuter DRAFT v1

Moreover, the data shows that increasing density can be a positive-sum game for existing communities as well as for the environment. At the city level, we can’t observe any relationship between rising population densities and congestion – fears of traffic-choked streets just don’t seem to have materialised in practice. (So much for diseconomies of scale!)

On the other side of the ledger, suburbs with higher population densities have better consumption choices. Many of the services that people rely upon – from vege shops to Japanese restaurants to public transport to roads – exhibit strong economies of scale, which means that they get better when there are more people around.

Which suggests that there is also a third important thing that we need to do, which is to tell good stories about the opportunities that urban growth will offer us. New Zealand’s used to thinking of itself as a rural economy with some cities sprinkled around as afterthoughts. That’s a dated and inaccurate self-image when over half the economy is located in our three largest cities.

So, what’s your perspective on urban growth?

Demographia and omitted variable bias

My last two posts about Demographia’s analysis of house prices prompted quite a bit of discussion. I thought that it may be worth expanding on my points and clarifying why they mean that we should take Demographia’s conclusions with a large grain of salt.

Economists (and statisticians) have a term for what Demographia has done: “omitted variable bias”. This can occur when there are multiple variables that have a causal impact on an outcome. If we attempt to understand that outcome without considering all explanatory variables, we run the risk of biasing our conclusions.

Economists are trained to identify and address issues arising from omitted variable bias. Here, for example, is a comment on the topic from a widely used undergraduate econometrics textbook:

Now suppose that, rather than including an irrelevant variable, we omit a variable that actually belongs in the true (or population) model. This is often called the problem of excluding a relevant variable or underspecifying the model. We claimed in Chapter 2 and earlier in this chapter that this problem generally causes the OLS [ordinary least squares regression] estimators to be biased.

Now, I realise that’s a bit obscure, so let me be more specific. Here’s a list of (some) factors that can influence house prices, with a view on their expected impact:

Variable Expected impact
Expectations for future population and economic growth Future expectations tend to be capitalised into house prices – i.e. prices will tend to be higher in areas with better growth prospects
Consumer and natural amenities People are willing to pay more to live in nicer places
Interest rates (and availability of finance) Lower interest rates enable people to afford a larger mortgage on a given level of income
Construction sector productivity Lower productivity will increase the cost of supplying new dwellings
Tax policies, including capital gains taxes and mortgage interest deductions Taxation of capital gains will reduce willingness to invest in housing for capital gains
Tax subsidies for mortgage-holders will tend to push prices up
Other housing market policies, such as rent subsidies or public housing provision Rent subsidies tend to be captured by landlords and thus will tend to push up prices
Ongoing construction of state housing will add supply to the low end of the market and thus constrain price increases
Urban planning policies Policies that constrain the development of new housing in desirable areas, or make it more costly or uncertain to develop, will reduce supply and push up prices

Demographia only addresses one of those seven variables. Because they fail to account for the other six potentially explanatory variables, their estimates of the welfare impact of urban planning policies are not likely to be reliable. Without controlling for other potential explanations for high housing prices, it’s impossible to say whether their conclusions about any individual city are correct or not.

Consequently, my recommendation to people seeking to understand the impact of urban planning policies on housing costs is simple: Ignore Demographia and go read the relevant economics literature instead. For those who are interested in doing so, here are a few papers that I have learned a lot from. They apply a range of modelling approaches, but what they have in common is that they undertake a detailed analysis of rules, rather than making sweeping and unsupported generalisations:

  • Glaeser, Gyourko and Saks (2005) studied the impact of building height limits in Manhattan by looking at the gap between observed sale prices and the marginal cost to add another floor to high-rise buildings. They find that constraining the supply of high-rise apartments imposed a significant “regulatory tax” on residents.
  • Grimes and Liang (2007) took at look at land prices around Auckland’s Metropolitan Urban Limit, finding evidence of a “boundary discontinuity”. They interpreted this as evidence that the the MUL is overly restrictive.
  • Kulish et al (2011) developed a hypothetical model of the impact of several factors on housing and transport costs. They modelled density restrictions as well as increased transport costs and lower building productivity, finding that building height limits raise housing costs and increase sprawl. I have previously discussed their findings.
  • MRCagney (2013) examined the impact of minimum parking requirements in Auckland, finding that they impose a loss on developers and businesses by forcing them to over-supply parking. They also cause worse congestion, meaning that not even drivers benefit. Luke C briefly discussed this study in a post on the Unitary Plan parking rules.

My favourite economics paper on planning regulations is Cheshire and Sheppard’s 2002 study on the impact of greenbelt rules in Reading, UK. The authors observed that greenbelts have both positive and negative effects. On one hand, they limit the supply of land for new housing, which drives up costs. On the other hand, they give residents access to public open spaces, which people like. Rather than ignoring this trade-off, they used house price data to model it.

Overall, Cheshire and Sheppard did find that allowing development in Reading’s greenbelt would make people better off. However, they also found that a failure to consider the amenities produced by planning rules would have resulted in too high an estimate of the gains in wellbeing. In other words: right direction, wrong magnitude.

In light of the evidence, my view is that failing to account for urban amenities and other explanatory variables in an analysis of the impact of supply restrictions can result in two errors:

  • First, it can make us over-optimistic about the degree to which loosening rules will affect housing prices. That’s not to say that less restrictive planning regulations couldn’t make us better off – just that we should not expect house prices to fall by 60-75% as Demographia implies when it says that Auckland should have a median multiple of 3.
  • Second, it can lead to perverse outcomes, by encouraging us to eliminate rules that are serving a useful purpose. Often (although not always) planning rules are managing the external social or environmental costs associated with some developments. A proper cost-benefit analysis – which Demographia has not done – will consider both the pluses and minuses of rules.

In short, housing markets are complex, and any analysis needs to consider that fact. To reiterate my point from last week: Demographia takes an inappropriate, overly simplistic view of house prices. This may be good for grabbing headlines, but it’s not good economics.

Alternative explanations for Auckland house prices

Last week I took a look at the economics underlying Demographia’s “International Housing Affordability Survey” and found them severely lacking. As it turns out, Demographia’s data isn’t much good as a measure of the costs of poor planning rules – but it does seem to provide some information about people’s “revealed preference” for urban amenity.

To recap: urban economics suggests that differences in the level of the median house price to median household income ratio between cities can be interpreted as differences in livability. All else equal, people should be willing to pay more to live in cities that offer better quality of life.

But how should we interpret changes to the median multiple from year to year? If a city’s median multiple rises from 5 to 5.5, does that mean that the city suddenly got 10% more livable? Or did something else happen?

Demographia is very certain that higher median multiples are the product of one thing, and one thing only: limits on sprawl into greenfield areas. Here’s Don Brash, former Governor of the Reserve Bank of New Zealand and former head of several right-wing political parties, laying out that view in Demographia’s 2008 report:

Once again, the Demographia survey leads inevitably to one clear conclusion: the affordability of housing is overwhelmingly a function of just one thing, the extent to which governments place artificial restrictions on the supply of residential land.

With that in mind, Demographia’s data seems to indicate that housing in Los Angeles and Las Vegas (as well as many other US cities) suddenly became a lot more affordable in the late 2000s. It’s obvious that they must have removed their Metropolitan Urban Limits – how else to explain such a big drop? Oh, wait…

Demographia Los Angeles Las Vegas median multiple

(It’s slightly disturbing that our Reserve Bank used to be run by a man who doesn’t believe that interest rates and credit conditions can affect house prices. But I digress.)

Here’s a graph of changes in Demographia’s median multiple estimate for Auckland since 2004. We haven’t seen the same drastic swings as in the US, where the housing bubble and bust was pronounced, but house prices have risen relative to incomes. (Although, as Stu found in his analysis of different measures of housing costs, this hasn’t flowed through to rents or mortgage payments, due in part to changes in interest rates.)

Demographia Auckland median multiple

This change has been especially pronounced in the last few years. Since 2012, Auckland’s median multiple has risen roughly 22%. Does this mean that we’ve become 22% more “livable” during that time?

With all due respect to the good work done by Auckland Council and Auckland Transport since their inception, probably not. So we need to look for alternative explanations, of which there are several. I’ll focus on three in particular.

The first potential explanation is that there has been a market failure. Residential construction slumped massively during the Global Financial Crisis, with the most significant reductions occurring in the supply of apartments and attached dwellings. Here’s a graph that John Polkinghorne put together illustrating that trend:

NZ building consents

Incomes and employment have mostly come back from the recession, but construction has been a bit slow to respond. I suspect this reflects technical constraints within the development sector, as it takes a while to organise finance, find sites, and hire the cranes, bulldozers, and blokes/blokesses in hardhats. Until they get into gear, there may be a bit of an undersupply – but one that will tend to sort itself out.

The second potential explanation is that the introduction of Auckland’s Unitary Plan has caused people to expect housing supply to be more constrained in the future. While the Unitary Plan envisages the gradual expansion of the city’s Metropolitan Urban Limit to meet new demand for greenfield suburbs, it maintains extensive controls on the supply of new dwellings in accessible, high amenity areas. Moreover, the plan actually got significantly more restrictive following the consultation process.

Transportblog has highlighted this issue a number of times before. To recap, here’s a map (from Koordinates) that shows where the Unitary Plan got more restrictive as a result of consultation. The areas in red have been down-zoned to restrict development, while areas in green have been up-zoned. The large orange areas show future greenfield land. As you can see, there are not a lot of opportunities to develop new dwellings in the isthmus and lower North Shore, while West Auckland has been happy to facilitate growth:


Unitary Plan changes from draft to proposed version on Koordinates

Timing is important here. Demographia’s figures suggest that there was a jump in house prices relative to incomes between the end of 2012 and the end of 2013. This coincides with the notification of the Unitary Plan in September 2013, which, as described above, will ease greenfield land supply while limiting development opportunities in the inner suburbs.

However, there is also a third potential explanation: that our rising house prices reflect increasing awareness of Auckland’s great quality of life. For most of the last decade, our city has been near the top in Mercer’s Quality of Living Survey. It’s been ranked third for five years running.

So maybe the story is that potential migrants and investors have observed that, by international standards, Auckland offers high quality of life at an affordable price. And they are in the process of arbitraging that away.

I’ve illustrated that process in the following graph, which shows the relationship between Demographia’s median multiple (X axis) and Mercer’s Quality of Living Survey (Y axis). The trend-line is estimated based on 2012 data. I’ve also plotted Auckland’s median multiple and Mercer index in 2015.

The red dot that represents Auckland is moving towards the trend-line, suggest that its prices are catching up with its livability.

Demographia Auckland median multiple change 2012-2015

Previous studies have found that growth in New Zealand house prices is strongly correlated with net migration – i.e. migrants tend to bid up house prices. Net migration to New Zealand did, in fact, start picking up in 2013 – around the time that Demographia’s estimate of the price to income ratio began to rise. Perhaps this is evidence for the “amenity arbitrage” hypothesis?

NZ net migration Feb 2005-2015

So, which explanation is true? Honestly, it’s impossible to say without a lot more detailed analysis. My point in writing this is not to argue that there is a single explanation for changes in Auckland’s house prices, but to point out that there are many possible explanations. Housing markets are affected by a number of factors, and it’s inappropriate to focus on one without controlling for the rest.

This is, essentially, why Demographia’s analysis fails. Rather than articulating a model that encompasses all of the potential explanatory factors, they have settled on a single number and insisted that it must be interpreted in a single way. It’s hard to see the value in that approach. And it’s definitely not good economics.

Should we relocate the Ports of Auckland?

Disclaimer: in professional life I have done some work on ports, including co-authoring the 2012 PwC report on future scenarios for Upper North Island ports. This post doesn’t reflect the views of my present or past employers or clients. It’s just a quick thought experiment, based on some data and a few assumptions.

The Ports of Auckland (POA) are back in the news due to their new reclamation plans. As usual, this has attracted both critics and proponents. POA’s plans have been criticised for their negative environmental impacts on the Waitemata Harbour, the loss of views of the Hauraki Gulf, and the fact that they will limit our ability to re-use port land for other purposes. On the other hand, they’ve been defended due to the economic role that POA plays in Auckland – it’s New Zealand’s largest port of import and also a significant port of export.

Ports of Auckland

As this suggests, there are both pros and cons to having a port located right on Auckland’s front door. How should we weigh them up?

Here’s one way of thinking about the question of whether we should prefer having POA in Auckland, or whether we would rather close it down and move our freight elsewhere:

  • The costs of moving the port would primarily relate to the added freight cost for Auckland’s imports and exports
  • The main benefit would be that we could repurpose POA’s land for alternative uses, such as housing, offices and retail, or public spaces.

How large are these costs and benefits?

The costs of relocating the port

One realistic way to look at the cost of port relocation is to ask: How much more would we have to spend to get the same outcomes?

If we closed down POA and shipped Auckland’s imports and exports through the Port of Tauranga (POT) instead, we would have to pay more to move those goods by land between the two cities. This would represent a net cost to New Zealand’s economy.

We can get a rough sense of these added costs by looking at current land transport costs and port volumes. According to an NZIER report published last month, in the year ended June 2014 POA handled:

  • around 968,000 twenty-foot-equivalent containers per year, 203,000 of which were trans-shipped to other ports in NZ;
  • around 207,000 cars; and
  • some other random stuff, like bulk cement.

Now, based on figures published in the 2012 PwC report (see Table 4 on page 76), the cheapest way to move goods between Tauranga and Auckland is by rail. It costs approximately $600 to move a single container by rail between the two cities. (Or around $750 to move a container by road.) While KiwiRail doesn’t currently ship cars by rail, rail operators in other countries do. Let’s assume, therefore, that it costs around the same amount ($600) to ship a single car.

Based on these land transport costs, we’re looking at an added annual cost of around $580 million. Yikes. A quite large sum. In reality, this is probably a bit on the high side, given that some of these goods will not originate from or be destined for Auckland.

In addition, we would forego the $66 million in annual dividends that POA pays to Auckland Council. So the total annual cost of relocating the port would be around $650 million.

The benefits of port relocation

Although the costs of moving POA entirely out of Auckland are high, we might be willing to bear them if the profits from land development were sufficiently high. So: How much would the land have to be worth to justify relocating POA?

Well, we know that, in order for it to be worth doing, repurposing the port land for residential and commercial uses, or public space, would have to yield at least $650 million per annum. That figure represents the minimum annual return that we would require from POA’s land.

Let’s assume, for a moment, that Auckland Council could get an average rate of return of 8% on its port land if it were put to other uses. This suggests that in order to obtain an annual return of $650 million, POA’s land would have to be worth a total of around $8.1 billion. (Calculated as follows: $650 million in annual profits / 8% rate of return = $8.1 billion.)

According to Wikipedia, POA has a total of 55 hectares of wharves and storage areas. If that were worth $8.1 billion in total, it would mean that the land would be worth around $15,000 per square metre. That’s roughly what it would take for moving the port to be a net benefit for the economy – city centre land values above $15,000 per square metre.

Now, this is in the range of current land values in the city centre – albeit on the high side. So redeveloping the port could, in principle, provide net benefits for Auckland. The case might get stronger if land values continue increasing and if the downtown revival continues at pace.

However, I don’t think this quick, back-of-the-envelope analysis proves much. For one thing, the benefits of port relocation are probably overstated due to the fact that it would be quite difficult to redevelop 55 hectares of downtown land quickly. It might take decades to realise the value of port land for alternative uses.

For another, it would be quite difficult to compensate the “losers” from the process – the firms and workers who would be worse off as a result of higher transport costs to their location in Auckland.

So, what should we do with the port?

As this analysis has (hopefully) shown, there are both costs and benefits to moving POA. And, for that matter, to leaving it in place or expanding it.

Moreover, the costs of moving POA are not infinite, which means that the benefits of doing so may at some point be large enough to justify the move. But they are very large, which means that we would have to be confident that we could actually redevelop port land in a reasonable timeframe.

It’s also important to recognise that there are other risks in moving the port, as well as uncertainty about some of the costs that I’ve cited. In my view, there are three main limitations to this analysis:

  • First, I’ve assumed that there are no technical constraints to doubling freight volumes at POT. This is probably not realistic – expanding that port would be costly both financially and environmentally.
  • Second, I’ve assumed that shipping lots more goods by rail between Tauranga and Auckland won’t drive up the price of rail freight. In reality, KiwiRail (or the government) would have to pay for quite a few track upgrades and purchases of rolling stock, which may drive up the costs of rail freight.
  • Third, I’ve assumed that it would actually be feasible to redevelop POA’s land, and that redevelopment of port land would create added value rather than simply diverting growth from elsewhere in Auckland. This is not unreasonable, but it won’t be a rapid process. As the Wynyard Quarter shows, it can take over a decade to active and develop a substantial chunk of new land.

Lastly, there are likely to be problems with the timing of funds. In principle, land development profits could be used to pay for infrastructure upgrades. In practice, it won’t work so neatly, as infrastructure requirements will be front-loaded while development profits trickle in over a period of years or decades.

In other words, actually moving the port is likely to be a costly and risky enterprise. It will be difficult to overcome the risks and up-front costs associated with doing so – meaning that we should expect the port to stay in downtown Auckland.

Port location: What do you think?