Can new roads pay for themselves?

It’s common to hear people say that because roads are paid for by their users (fn 1), we should build more roads. After all, the new roads will fund themselves!

At first glance, this seems convincing. But a closer look reveals that the “new roads pay for themselves” argument is based on a logical fallacy. Basically, the fact that the average road pays for itself does not mean that the next road will also pay for itself. In fact, there’s a large amount of recent evidence from the transport market that the next, or “marginal”, road will cost taxpayers more than it brings in revenue.

Economists understand the importance of marginal analysis when making decisions about what to build and how to charge for it. Businesses typically make pricing and production decisions “on the margin”. In other words, they look around for the next potential customer and ask: “Can I produce one additional unit and sell it to that person for a profit?” If the answer is yes, they produce it; if it’s no, they don’t as it would reduce their overall profits.

So what is the market telling us about demand for new roads? As always, it’s best to go and look at the empirical evidence. Over the last decade or two, there have been a number of efforts to get users to pay for new roads. Australia, the US, New Zealand, and a variety of other places have built toll roads – sometimes privately financed, sometimes publicly financed. In most cases, revenues from users were expected to pay the cost of the roads.

These costly investments have almost all failed. Toll roads have suffered from low traffic and low toll revenue. They have often required expensive taxpayer-funded bailouts. It looks as though people are not willing to pay for the marginal road.

In Australia none of the toll roads built after 2000 have been profitable:

Australia has some of the finest highway tunnels in the world, but for the private investors who trusted traffic usage projections from leading and respected consultancy firms the story has been a tale of insolvency and disappointment. Most of the privately owned toll highway projects constructed in the last 15 years in Australia have fallen into receivership or administration within a short time of opening to traffic when it became clear that toll revenue from actual traffic usage would be well short of covering its contribution to the construction costs.

The failures include the A$1bn Sydney Cross City Tunnel, which has seen traffic volumes less than half of forecasts, and the Brisbane Clem 7 and Airport Link tunnels, where traffic volumes have fallen short of forecasts by over 75%.

traffic avoids clem 7 tunnel

People would prefer to queue in traffic than pay the Clem 7 toll

In the US, an academic paper reviewing toll roads financed by Australia’s Macquarie Bank found that:

The record for these projects is abysmal.

Two of the projects declared bankruptcy. The assets of one, Pocahontas, were written down to zero by its new owner, and two were bought by the government jurisdictions where they were located. Another is in negotiations to be bought by the state of Virginia. None of these projects fulfilled their initial plans to operate successfully as profitable, private companies. Macquarie’s most substantial U.S. project, the Indiana Toll Road project, is near insolvency and attempting to restructure its loans.

In New Zealand, private finance has been slower off the mark, but there have been a couple of experiments with toll roads. In Tauranga, the Route K toll-road has been a financial millstone for the council since its opening in 2003. This year, NZTA agreed to pay off its remaining debt at public expense:

The New Zealand Transport Agency will take $62.5m of the remaining Route K debt from Tauranga City Council, it has today announced.

The council signed off the agreement with NZTA over the ownership of the debt on Route K in a meeting today.

The agency had already agreed to take ownership of the road from July 2015, but at a council meeting this afternoon, councillors discussed the agency also taking on the debt, less $1 million which the council would still owe.

The removal of the debt would see the council’s credit rating upgraded from A+ to AA-.

This is a clear market signal about the financial viability of new roads. It should not be surprising. After a half-century of road-building, Australia, the US, and New Zealand have extensive and mature road networks. There are seldom opportunities to dramatically improve the network by building another road. (Which is not to say that there are no opportunities to do so – it’s just that they’re bloody hard to find!)

In this context, it makes more sense to invest the marginal transport dollar in providing better transport choices. After half a century of underinvestment in public transport and walking and cycling facilities, there’s a lot of latent demand. As a result, every time Auckland has built a new piece of public transport infrastructure this century, demand has outstripped projections. Here, for example, is a graph from a few years ago that shows that Britomart met its 2021 patronage targets more than a decade early.

In other words, people aren’t willing to pay for new roads, but they are queuing up to get on the bus or train. Transport policy should recognise these market signals and invest in choice.

Britomart Projection Numbers Graph

The market has spoken. It wants some more trains.

Footnote 1: This is factually incorrect. Since 2004, the National Land Transport Fund, which consists of fuel taxes, road user charges, and vehicle license fees, has paid 100% of the cost state highways. However, it only pays 50% of the cost of local roads, which account for the majority of vehicle kilometres travelled. The remaining 50% are paid for by local council rates.

Cycling: the benefits of complete networks

A group of New Zealand researchers recently published an excellent paper on the costs and benefits of investing in a complete cycle network and safe street design. Their paper, which is available online, found that:

the benefits of all the intervention policies outweighed the harms, between 6 and 24 times. However, there were order-of-magnitude differences in estimated net benefits among policies. A universal approach to bicycle-friendly infrastructure will likely be required to achieve sufficient growth in bicycle commuting to meet strategic goals.

Our findings suggest that the most effective approach would involve physical segregation on arterial roads (with intersection treatments) and low speed, bicycle-friendly local streets.

We estimate that these changes would bring large benefits to public health over the coming decades, in the tens of dollars for every dollar spent on infrastructure. The greatest benefits accrue from reduced all-cause mortality due to population-level physical inactivity.

The researchers employed a system dynamics modelling approach that incorporated feedback loops between infrastructure provision and street design, people’s travel behaviours, and actual and perceived safety.

As a transport economist, I found their methodology incredibly interesting. It illustrates how you often need complex modelling tools to quantify things that are intuitively quite simple. In this case, the fact that if you make every street safe to cycle on, people will choose to get on their bikes.

Macmillan et al (2014) causal loop diagram

Feedback loops in cycle networks (Source: MacMillan et al, 2014)

Importantly, the researchers found that a larger, more ambitious programme of cycle upgrades will deliver a higher benefit-cost ratio than a smaller programme. This is what economists sometimes call the “complete network” effect – in effect, the more places you can get to easily and safely on a bicycle, the more likely you will be to cycle. (This is also why Facebook has so many users: You have to have an account because everybody else also has an account!)

Right now, Auckland’s obviously not doing too well when it comes to complete cycle networks. If you look at Auckland Transport’s online cycle maps, you’ll see some streets with strips of green paint down the side, and many more that you could in theory cycle on (if you were especially bold).

However, we’re lucky enough to have a local example of a city that is rolling out an ambitious complete cycle network. Since the 2011 Canterbury Earthquakes, Christchurch has planned a network of 13 major cycleways that will extend throughout the city, a re-jig of its city centre street network, and a new street design manual that will deliver better on-road cycle facilities. (Disclaimer: I have previously worked on the An Accessible City project as a consultant.) And they’re planning on getting it done over the next five years.

Christchurch Major Cycleways

Will Christchurch “go Dutch”?

It’s going to be interesting to watch Christchurch over the next few years. I expect they’ll provide a good example for a lot of other New Zealand cities.

The case for free-market urbanism

In the National Review, a conservative American magazine, Reihan Salam takes a look at the confused state of the American debate over intensification. His article, entitled “The Great Suburbia Debate” criticises the position taken by Joel Kotkin, a long-time campaigner for low-density suburban development. He writes:

Though I’m an admirer of Kotkin, and though I can’t speak for every conservative who has made the case for denser development, he gets a number of important things wrong…

For example, Kotkin claims that “some conservatives” (again, no names) have been “lured by their own class prejudice” into turning against market forces. “In reality,” Kotkin writes, “imposing Draconian planning is not even necessary for the growth of density.” Of course, this is exactly the argument that Edward Glaeser makes in The Triumph of the City, a manifesto for the pro-market, pro-density right. “In places that have both liberal planning regimes and economic growth, such as Houston and Dallas,” he observes, “there has been a more rapid increase in multifamily housing than in cities such as Boston, Los Angeles, San Francisco or New York.” Indeed, this is why many conservatives, myself included, have explicitly argued that cities like New York, San Francisco, and Los Angeles should look to the liberal planning regimes of Houston and Dallas as a model. (To be clear, by “liberal” planning regimes, Kotkin means less-restrictive, more market-oriented planning regimes, and so do I.)

The global cities that manage to be both highly productive and affordable, like Tokyo and Toronto, tend to have liberal planning regimes, which allow for rapid growth of housing stock, and in particular of the multifamily housing stock. These regions are characterized by rapid housing development in the suburbs and in the urban core, and their “suburbs” tend to be more urban than low-density suburbs in the U.S. governed by stringent planning regimes that tightly restrict multifamily development. When Glaeser makes the case for density, he does so not by calling for “imposing draconian planning” on cities and towns. Rather, he explicitly calls for the relaxation of land-use regulation.

[...]

Kotkin relies heavily on the work of Wendell Cox, a transportation consultant who seems to believe that denser development is necessarily a product of central planning. In desirable regions, however, less restrictive planning regimes will naturally lead to higher densities, as property owners will naturally seek to maximize the value of their investments. Restrictive land-use regulations tend to limit density, not impose it on unwilling landowners.

Salam’s article is excellent and I recommend reading it in full. I pulled out these excerpts as they highlight a few essential facts that often go missing from the debate over urban policy:

  • Denser development cannot be imposed by fiat – it will happen if and only if there is market demand for it (as there often is in places that are accessible to jobs and amenities). If nobody wants to buy apartments, then no apartments will get built!
  • Urban planners can’t simply require people to build at higher densities – but they can limit density to below what the market wants.
  • The rising demand for higher density development isn’t a market distortion, but evidence that the market is working.
MERCHANT Q

The market’s been at work in New Lynn (see also: Transportblog’s development tracker)

In short, we must interpret rising population densities as the result of many individual decisions rather than the whim of an urban planner. My research shows that population densities are rising rapidly in Auckland and several other large NZ cities, which suggests that we’re voting heavily for density with our feet and our wallets. This is, as Salam suggests, a natural outcome of market forces and should be accepted with equanimity. We should recognise this demand where it exists and make complementary public investments in walking and cycling facilities and public transport.

Lastly, I’d note that people from all across the political spectrum should be able to appreciate cities. As Jane Jacobs observed in The Death and Life of Great American Cities, a good urban neighbourhood demonstrates many of the virtues that conservatives celebrate, such as small business ownership, a close-knit community that watches out for itself, and independent-minded civil society (often battling against big government bureaucracy in the form of overreaching traffic engineers).

Jane Jacobs campaigned against this Pharaonic act of bureaucratic hubris (Source)

Jane Jacobs campaigned against this Pharaonic act of bureaucratic hubris (Source)

As a result, we often see centre-right mayors implementing good urban policies. Big-city mayors such as New York’s Michael Bloomberg, London’s Boris Johnson, and Buenos Aires’ Mauricio Macri have been right at the forefront of the movement for better cities. They’ve realised that better cities are more prosperous, and that it’s possible to improve a city by improving the choices available to people.

Why it’s not possible to build our way out of congestion

Wired magazine recently published a good, succinct explanation of induced traffic. It’s worth reading in full as it hits upon an incredibly important, often overlooked fact: it’s not possible to eliminate congestion by building more roads. Here are a few of the more interesting excerpts:

The concept is called induced demand, which is economist-speak for when increasing the supply of something (like roads) makes people want that thing even more. Though some traffic engineers made note of this phenomenon at least as early as the 1960s, it is only in recent years that social scientists have collected enough data to show how this happens pretty much every time we build new roads. These findings imply that the ways we traditionally go about trying to mitigate jams are essentially fruitless, and that we’d all be spending a lot less time in traffic if we could just be a little more rational.

But before we get to the solutions, we have to take a closer look at the problem. In 2009, two economists—Matthew Turner of the University of Toronto and Gilles Duranton of the University of Pennsylvania—decided to compare the amount of new roads and highways built in different U.S. cities between 1980 and 2000, and the total number of miles driven in those cities over the same period.

“We found that there’s this perfect one-to-one relationship,” said Turner.

If a city had increased its road capacity by 10 percent between 1980 and 1990, then the amount of driving in that city went up by 10 percent. If the amount of roads in the same city then went up by 11 percent between 1990 and 2000, the total number of miles driven also went up by 11 percent. It’s like the two figures were moving in perfect lockstep, changing at the same exact rate.

Los Angeles: Sitting in traffic after ignoring supply and demand for over 50 years.

In their excellent paper on the topic, Duranton and Turner describe this as “the fundamental law of road congestion: New roads will create new drivers, resulting in the intensity of traffic staying the same.” Their research also digs into a couple of other related and equally interesting phenomena:

  • Better public transport provision doesn’t actually reduce road congestion – but it does enable more people to move without being affected by congestion
  • Reducing road capacity has no measurable impact on congestion – if less road space is available, people take public transport or active modes instead, or avoid making low-value trips.

Urbanist.co also has some further discussion of Duranton and Turner’s work. The economists go on to suggest economists’ favourite answer to congestion: road pricing. (If you’re interested in reading more about that topic, Stu Donovan and I have written several posts about the economics of road pricing.)

So what can be done about all this? How could we actually reduce traffic congestion? Turner explained that the way we use roads right now is a bit like the Soviet Union’s method of distributing bread. Under the communist government, goods were given equally to all, with a central authority setting the price for each commodity. Because that price was often far less than what people were willing to pay for that good, comrades would rush to purchase it, forming lines around the block.

The U.S. government is also in the business of providing people with a good they really want: roads. And just like the old Soviets, Uncle Sam is giving this commodity away for next to nothing. Is the solution then to privatize all roads? Not unless you’re living in some libertarian fantasyland. What Turner and Duranton (and many others who’d like to see more rational transportation policy) actually advocate is known as congestion pricing.

Incidentally, I like Turner’s “Soviet Union” metaphor a lot – I’ve said on occasion that we’re running our transport system like a Polish shipyard.

Lastly, it’s incredibly important to consider induced traffic when making policy recommendations. As I wrote in my review of Alain Bertaud’s talks in Auckland, keeping commute times down is an important part of maintaining an efficient urban labour market. Some people seem to have taken Bertaud’s recommendation that policymakers focus on keeping average car commutes under 30 minutes (and PT commutes under 45 minutes) as a call for more roads. This is a superficially appealing but deeply wrongheaded idea.

Induced traffic means that building roads to keep commute times down will not work. And it will be expensive. While there is often a good case for specific road improvements to remove key bottlenecks or improve safety – the Victoria Park Tunnel comes to mind – Duranton and Turner’s work shows that a strategy of building lots of roads will not succeed in minimising commute times. An alternative approach is needed.

Where does the New Zealand economy happen?

Vox recently published a list of “surprising maps” that documented counterintuitive or little-known facts about the world. Number 15 on the list was this map, which shows that 50% of US GDP is produced in a mere 23 urban areas:

US economic activity split in half

This map shows the economic importance of cities, which are tremendously productive precisely because they concentrate a lot of skills, ideas, and capital in a small area. But surely things are different in New Zealand due to our much more agriculturally-based economy?

I was curious about this, so I got some data from Statistics New Zealand to see how economic activity is distributed in NZ. First, I got the Regional GDP statistics for 2013, which break down the economy at a regional council area. Second, because some regional councils are much bigger than the cities they contain – think Canterbury versus Christchurch – I used 2013 Census data on employment at a detailed geographic level to proportionately allocate out regional GDP based on the share of regional employment in a particular area (see footnote 1). Finally, I grouped the data up by main urban area – essentially, city boundaries plus satellite towns like Pukekohe and Rolleston.

The results are shown in this map. The majority of New Zealand’s economy is located in its three main cities – Auckland, Wellington, and Christchurch. There is more economic activity happening within these three orange blotches than outside of it:

City share of NZ GDP map v2

All together, 56% of New Zealand’s GDP is produced in a mere 0.9% of its total land area. While rural and urban economies are interdependent – they sell goods and services to each other – this data highlights the degree to which New Zealand’s economy is now an urban economy. This won’t change any time soon – if we are to generate new sources of wealth in the future, it will happen in the cities.

I also took a look at the GDP produced in New Zealand’s smaller cities. Overall, the 15 largest urban areas in New Zealand are home to over three-quarters of our national economy. The full results are shown in the following table:

City share of NZ GDP table v1

One other interesting fact drawn from this table is that Auckland’s economy outweighs, by a large margin, the non-urban economy (“Rest of NZ”).

Footnote 1: This is a fairly simple approach to allocating out regional GDP that ignores the effects of:

  • Differences in industrial structure between cities and adjacent rural areas – cities tend to be home to higher-productivity industries such as professional services and manufacturing
  • Within-industry differences in productivity that depend upon location – after controlling for firm characteristics, businesses located in denser areas tend to be more productive than similar firms in other areas.

It’s certainly possible to account for these well-documented effects. In my day job, I develop methods to take a much more detailed look at New Zealand’s economic geography. (But I prefer to get paid for that rather than doing it for free on a Sunday morning!) Not accounting for differences in industry structure and agglomeration economies means that I have probably underestimated the share of New Zealand’s economy produced in cities.

How congested is Auckland, really?

A lot of people think that Auckland’s got bad traffic congestion. The annual TomTom Traffic Index reinforces this perception – it regularly describes Auckland as one of the most congested cities in the region. (We’ve previously highlighted the methodological flaws with TomTom’s numbers – don’t take them at face value!)

However, I don’t think this perception matches up with reality. My experience is that Auckland has much better congestion than cities overseas. It’s incredibly easy to drive in Auckland. I’ve noticed that:

  • Although speeds on motorways and arterial roads drop during rush hour, traffic keeps flowing at a relatively constant rate. It seems uncommon to get totally deadlocked traffic in Auckland – unlike in California, where it’s common to see speeds of under 20km/hr on freeways.
  • The rush hour is incredibly short in Auckland – when I have to drive up to the North Shore after work to visit family, I find that traffic’s basically free-flowing after around 6:30. In other cities serious congestion starts much earlier and ends much later.
  • Counter-peak traffic is shockingly low – on the occasions when I have to drive to Takapuna in the morning, I’ve found that I encounter few queues and no congestion on Pitt St, Victoria Park Tunnel, and the bridge.

Of course, Auckland is more congested than small New Zealand cities with one-tenth its population. That’s only to be expected. But is Auckland really more congested than other large cities overseas?

Jarrett Walker points us toward some new data that can help shed some light on this issue. A recent study (pdf) of commute times in Brazilian cities provides comparative estimates of average commute travel times for thirty large cities all around the world. I used data from New Zealand’s Household Travel Survey to add Auckland to the list. Here are the results:

Avg commute times in large cities

As you can see, Aucklanders enjoy some of the fastest commutes of any city on the list. We travel faster than people in London, Stockholm, Sydney, Los Angeles, and Vancouver. Only Barcelona, a compact city with a densely-developed subway system, offers faster trips to work. (However, it would be good to see a few more Australian cities, like Perth and Brisbane, on the list for comparison.)

While population growth will put some pressure on Auckland’s transport infrastructure, this data suggests that our congestion problems are not severe at all. We look pretty good on Alain Bertaud’s preferred measure of transport accessibility! It seems like the impending completion of Auckland’s motorway network and the significant fall in vehicle kilometres travelled per capita over the last decade has given us a lot of breathing room on congestion.

Rather than trying to solve problems that can’t be observed in the data, we should use this breathing room to invest in real transport choices for Aucklanders. That means getting ambitious about building Auckland’s “missing modes”:

  • A rapid transit network that reaches all parts of the city – starting with the City Rail Link and continuing with something like the Congestion Free Network
  • A frequent bus network that is useful for more Aucklanders, more often – which Auckland Transport is currently doing
  • Safe cycle infrastructure throughout the city – while Auckland Transport and NZTA are starting to deliver great projects like the Grafton Gully and Beach Road cycleways, there are still many holes in the network
  • Good pedestrian-oriented streets – Auckland Council’s shared spaces in the city centre are fantastic but change hasn’t been as rapid in other parts of the city.

What’s your perception of Auckland’s transport problems?

Better cities can answer New Zealand’s export woes

In recent years the New Zealand economy has benefitted from tailwinds – strong Chinese demand for milk powder and raw logs, net inward migration driving up house prices, and, sadly, the need to rebuild our second-largest city. But should we be so happy to rest on our good fortunes, or are there long-term risks we need to manage? If so, how can we address them?

History teaches us that bad things can happen to small, wealthy agricultural exporting nations that don’t succeed in evolving up the value chain. Argentina is a great – and troubling – example. In 1900 it was one of the wealthiest countries in the world, with GDP per capita close to the US. At the time, Argentineans were living well off beef and wheat exports. But its agriculturally-based, heavily overseas-owned economy failed to generate new sources of wealth.

The result was a steady, century-long relative decline in living standards, punctuated by the occasional economic crisis:

Source: Wikipedia

Source: Wikipedia

Could the same thing happen here? It’s certainly a risk. Arguably, it is already happening. In the 1970s New Zealand’s GDP per capita began to slide below the OECD average, and it’s never really recovered in spite of the radical interventions of successive governments.

Can we do anything to avoid turning out like Argentina? In short: Yes, but it will take some re-thinking. Most importantly, it will require New Zealand to invest in better cities, as cities are the engines of future economic growth. Let me explain.

In 2008, a new National government promised that it would achieve two things by 2025. It would:

  • Raise New Zealand’s economic growth rate to enable it to catch up with Australia in terms of GDP per capita
  • Boost exports to 40% of GDP, a significant increase from contemporary levels of around 30%.

A lot of people welcomed this – it seemed like the sort of ambitious, long-term programme that could prevent us from becoming Argentina. Unfortunately, we haven’t heard much about the government’s 2025 targets in the last few years.

As it turns out, closing the gap with Australia and transforming New Zealand’s export mix is extremely hard. Here’s a graph of New Zealand’s exports of goods and services as a share of GDP. As you can see, there has been precious little export-led growth over the last six years:

Source: World Bank

Source: World Bank

In a recent column for the Herald on Sunday, business journalist Rod Oram diagnosed the reasons for the failure to lift exports. In essence, we’re increasingly reliant upon a small number of commodified agricultural products. Like Argentina, we are currently failing to generate new sources of wealth. Oram is worth quoting at length:

The trade data are revealing. In the year to June, the value of our exports to China rose 50 per cent, dairy exports were up 40 per cent, logs 20 per cent and our overall exports were up 12 per cent, thanks to the commodity spikes.

But net of spikes, the data show we are becoming increasing dependent on selling fewer, simpler products to one customer. China is our largest trading partner, taking 23 per cent of our exports in the year to June. While China accounts for some new business, a big chunk is merely redirected from other markets.

The growing dominance of commodity dairy exports is striking. They have doubled their share of our total exports over the past 20 years to about 27 per cent today.

However, the upside is limited. For example, Dairy NZ estimates milk production will grow at 2.5 per cent a year, below its long term average. This reflects farming limits imposed by new freshwater regulations and less land available for conversion to dairying.

[...]

We need a broader, more sophisticated range of exports to overcome our commodity constraints. But we’re going in the opposite direction. Manufactured goods have fallen from about 37 per cent of exports in 2003 to about 22 per cent today.

This increasing simplification of our economy towards low value commodities has accelerated in recent years, according to data from a long-term study of countries’ economic complexity run by Harvard and the Massachusetts Institute of Technology.

In 2008, we ranked 39th in the world in terms of economic complexity, in the company of countries such as Brazil, Russia and Greece. But by 2012 we had fallen to 52nd.

This is the kind of thing that sets off alarm bells in the minds of economists. But how can we fix it?

The one thing that will not work, long-term, is continuing to rely upon milk powder and raw logs to support our living standards. We can’t keep doing the same thing and hoping for different results.

Fortunately, New Zealand has a unique opportunity to do things differently. Investing in better cities can create an environment for the development of new ideas and the growth of new, innovative businesses. Agglomeration and productivity growth in large, dense cities is an integral part of economic growth in the 21st century.

If we look beyond our own dairy exports, we can see the role of agglomeration everywhere. Economists have extensively studied the role of cities in economic growth, and businesses are actively taking advantage of it. It’s why:

  • One-third of the world’s major companies are headquartered in just 20 cities
  • The tech revolution started in, and is still based in, Silicon Valley and San Francisco
  • London and New York sell financial services to the rest of the world
  • Auckland’s city centre is home to New Zealand’s most productive jobs – the average city centre job is 139% more productive than jobs outside Auckland.

Urban businesses are often innovative, highly productive, and actively looking for export opportunities. We’re already seeing how cities can create new sources of wealth for New Zealand:

  • Cloud-based accounting software firm Xero (based in Wellington and Auckland) is growing rapidly and creating opportunities for other Kiwi software firms
  • Video game developers are hiring fast and growing sales globally: “The New Zealand Game Developers Association’s 33 member studios collectively hiked their earnings to $36.3 million in the year to March, up 86 per on the previous year… Kiwi-made mobile games had been downloaded about 130 million times in the year.”
  • Weta Workshops and Weta Digital export expertise to the global film industry from Wellington
  • I work for a company that exports public transport planning services from the Auckland city centre to Australia and the broader Asia-Pacific region.

As the late, great New Zealand physicist Paul Callaghan argued, in order to grow in the long term we need more firms like this. And in order to get them, we need to create an environment that attracts talented people and smart businesses and supports knowledge spillovers and innovation.

Triumph of the City

Cities are fantastic environments for generating new ideas and new sources of wealth.

We call that environment a city. If we want to get better economic outcomes, we need to invest in better cities, starting with Auckland.

That means delivering a great bus network and integrated ticketing (as Auckland Transport is doing). It means expanding transport choice by investing in the City Rail Link and the Congestion Free Network. It means enabling people to build the medium-density, mixed use neighbourhoods that the market’s crying out for. It means delivering great people-oriented public spaces (as Auckland Council and Waterfront Auckland are doing). It’s not that hard!

Choice matters: an economic parable

Lately I’ve been thinking about the role of choice in transport and housing. People often underestimate the power of choice in these particular markets. But it’s important to have options – even if someone wants to drive 90% of the time, having the option to take the bus or cycle instead the remaining 10% of the time can make them better off. Morever, even if taking the bus isn’t a good option for you, it might make your neighbour (or your children) better off.

Perhaps it’s best to illustrate this point with a parable. Picture your neighbourhood shops. They might have a post shop, a drycleaner, a dairy, and a couple restaurants or takeaway joints. Basically, businesses that provide services to local residents.

Imagine, for a moment, that your neighbourhood shops have only two eating options, both of which are fish-and-chip shops. If you’re too tired to cook dinner for yourself after a long day of work, and you don’t want to drive to a bigger centre, your options are limited to fish and chips.

Now imagine that a new restaurant is opening up in the neighbourhood. Would you prefer it to be:

  • A third fish-and-chip shop, which would compete directly with the existing takeaways and maybe bring down the price of a snapper fillet by twenty cents, or
  • An Indian restaurant, which would offer you an entirely new option for dining out?

I think most people would choose the Indian restaurant, hands down. Having more dining options would be good for local residents. Even if they continued to get fish and chips most of the time, the Indian restaurant would be available as an alternative when they couldn’t stomach any more greasy chips.

(Incidentally, I didn’t choose this example at random. Auckland is now a fantastic city to dine in, due to the abundant choices of cuisines that recent migrants have brought to the city. But it wasn’t when my parents were young – it was fish and chips, meat pies, or nothing. Increasing choice has revolutionised the restaurant market.)

At the moment, Aucklanders have constrained transport or housing options. For many trips, driving is the only feasible option. For most households, living in a detached three-bedroom house is the only option on offer. But these options aren’t always well suited for all trips or all households.

Successive governments have tried to improve our wellbeing by, basically, opening more fish-and-chip shops. That means widening roads or duplicating them rather than adding bus lanes or protected cycle lanes. It means building new subdivisions on the edge of the city rather than allowing terraced houses and low-rise apartments to be constructed in existing suburbs.

Our transport budget? (Source)

Our transport budget? (Source)

Aucklanders would be much better off if we had more choices about how to get around and what type of home to live in. Policymakers could stand to take a few examples from the restaurant market.

The importance of housing choices in cities

Good cities should provide choices to their inhabitants. Any big (or small!) city is composed of a variety of people with various preferences, needs, and budgets. Look around you: Aucklanders are a bloody diverse bunch, and we’re getting more so as I type these words.

The Aucklanders of the future will want to get around in different ways, live in different places, and entertain themselves in different ways. In fact, this is already happening. It’s the reason for the success of the innovative mixed-use developments on the waterfront, the runaway success of Britomart and other rail upgrades, and, on the flip side, declines in vehicle kilometres travelled per capita.

At Transportblog, we recognise the importance of choice in cities, which is why we’re so enthusiastic about opportunities to invest in a better public transport network and better walking and cycling options. We believe that offering Aucklanders more travel choices at an affordable price will improve our living standards. Full stop.

What’s true in the transport market is also true in the housing market. Offering a greater range of housing choices will raise the living standards of Aucklanders, because we want to live in different types of homes. Enabling higher-density development in more areas will make some people much better off, because they want to live in dense environments, without making anyone else worse off.

Critics of intensification often fail to understand this argument. They say: “Oh, you just want to make everyone live in a tiny shoebox apartment!” In fact, the exact opposite is true. Enabling some people to choose to live in apartments or terraced houses will ensure that there is more land available for others who would prefer a lifestyle block in Dairy Flat or a quarter acre in Flat Bush.

Essentially, urban planning that enables housing choice allows for both high-density and medium-density living options and more low-density suburban living. This isn’t idle conjecture – it’s a well-established finding in urban economic theory and the empirical literature.

A few years ago a team of economists from the Reserve Bank of Australia put this idea to the test using economic modelling techniques. Their paper, entitled “Urban Structure and Housing Prices: Some Evidence from Australian Cities” (pdf), tested the impact of different urban policies. (NZIER economist Kirdan Lees has also done some similar work for New Zealand, but his initial paper (pdf) did not look at building height limits. In any case, the results are similar.)

The RBA economists model a relatively simple, monocentric city with employment and amenities concentrated in the centre and the residential population radiating out in a circle – the basic workhorse model in urban economics. While this is a simplification, it can easily be generalised to a polycentric city – just imagine multiple centres rather than a single centre. Their “unconstrained equilibrium” looks like this:

Kulish et al (2011) unconstrained

In short, densities – and building heights – are highest in the areas that are most accessible to employment and amenities. Land prices are also highest in these areas. This doesn’t occur as a result of a planner’s fiat – it happens because lots of people want to live close to the action. Others, of course, would prefer to be a bit further away with more space – and that is what they get in the unconstrained urban equilibrium.

Next, the RBA economists simulated the effects of imposing a building height limit. In effect, limiting building heights would prevent people from choosing to live at high densities near employment and amenities. Here are the results – the magenta lines show the effects of the constraint:

Kulish et al (2011) building height limit

Pay close attention to the middle two panels. They show that a building height limit does not just restrict high-density development in the centre – it also raises densities in the outskirts of the city. In short, a city that constrains medium to high density development doesn’t just fail to provide options for people who want to live in apartments. It also fails to provide options for people who want quarter acre sections or lifestyle blocks.

Has this happened in Auckland? It’s difficult to say for certain, but my research on population densities in NZ and Australian cities found that Auckland was missing out on both medium-density suburbs and low-density exurbs.

Finally, as the first panel shows, these restrictions are expected to raise the cost of housing for everybody, regardless of location or housing preference. As I said at the start, good cities provide choices for their inhabitants. Failing to provide for choice in the housing market just means that we all pay too much for homes that don’t suit our preferences.

So, what’s your dream Auckland home? Subject to budget constraints, of course…

Auckland can’t afford to price out the young

It’s no secret that Auckland has a problem with high-cost housing. House prices have risen significantly faster than average incomes in recent years. As a recent Treasury working paper (Skidmore, 2014) documented, Auckland’s house prices have quadrupled in the last generation, and rents have more than doubled.

Skidmore (2014) house price indexSkidmore (2014) rental price index

This is widely acknowledged as a problem, but it’s important to understand that it’s not necessarily a problem for all Aucklanders. Another Treasury working paper (Law and Meehan, 2013) shows that young New Zealanders – singles and couples between 25 and 34 – are significantly less likely to own their own homes.

Most middle-aged and retired people are on the property ladder and thus able to benefit from capital gains from Auckland’s housing market. Rising prices are often positive for older people. But they’re not very good for the young, who don’t own property and, increasingly, find themselves shut out by rising prices.

Law and Meehan (2013) home ownership rate

To make matters worse for young Aucklanders, rising house prices are coupled with falling real incomes. We aren’t merely standing still – we’re rapidly falling behind.

The chart below shows real income growth for employed people by age group from Statistics NZ’s LEED data on median earnings of full quarter jobs, deflated by the consumer price index. Since the global financial crisis, real median wages for people under 35 have fallen. But people over 35 have done pretty well over the same time period:

Generational divergence in incomes

Generational divergence in incomes

In short, Auckland seems to be developing a dangerous “two-speed” economy. Most middle-aged people can expect their wages to rise and the value of their houses to boom. Most young people are experiencing wages that are stagnating or falling while being shut out of the housing market by high prices.

This is the point at which older Aucklanders sometimes seem to shrug their shoulders and say, “so what – I’ve got it good.” But they shouldn’t be so complacent, because we don’t have to be here. If it becomes too hard to live in Auckland, young Aucklanders will leave. If we can get a better deal elsewhere – higher wages or cheaper housing – we can go there instead. And for many of us, this will mean leaving New Zealand.

Young New Zealanders are mobile. We’ve seen our friends and family abscond to Melbourne or Sydney, or go to London on OE and choose not to come back. We may have moved here from other places. While we want to be able to live in Auckland and participate in the city’s revitalisation, we’re keenly aware that we have options.

I’ve written before about how New Zealand has the opportunity to raise its living standards by investing in better cities. Well, the reverse is also true. Expensive housing and lower wages for the young is a recipe for long-term economic failure. If you’re middle-aged, this should worry you: We might not be around to pay your pensions and buy your expensive houses when you want to downsize. We’d like to stay and pay for your retirement – we really would! – but we need a pay rise and affordable housing options.

So what’s your plan to make Auckland affordable for young people?