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?

Demographia fails Urban Economics 101

Every year since 2005, pro-sprawl think-tank Demographia has published a new edition of its “International Housing Affordability Survey“. They report a “median multiple” measure of housing affordability that compares median house prices to median household incomes within a number of cities, mostly in the English-speaking world.

Demographia’s aim, in publishing this data, is to argue that “if housing exceeds 3.0 times annual household incomes, that there is institutional failure at the local level. The political and regulatory impediments with respect to land supply and infrastructure provision must be dealt with.” By this, they mean building car-dependent suburbs on the urban fringe – and nothing else.

Another Demographia-approved urban paradise.

A number of people, including Todd Litman and Stu Donovan (on Transportblog), have taken aim at Demographia’s empirical analysis and choice of metrics. Unfortunately, Demographia is unwilling to open up its analysis and methodology for an independent peer reviewed, so it’s difficult to referee those claims.

Here, I want to take a look at the issue from a different perspective. Basically, the urban economics literature suggests that Demographia’s chosen measures do not mean what they think they mean. And they almost certainly do not prove the case they’re trying to make.Before I explain why, let’s start out with a quick look at the data. According to Demographia’s 2015 report:

  • The most “affordable” cities included the likes of Detroit (median multiple of 2.1), Cleveland (2.6), and Houston (3.5)
  • The “unaffordable” cities included most large Australian cities, including Sydney (9.8) and Melbourne (8.7), many “coastal” North American cities, such as Los Angeles (8.0), San Francisco (9.2), Vancouver (10.6), New York (6.1), and Boston (5.4)
  • All New Zealand cities were on the “unaffordable” end of the spectrum, ranging from Palmerston North (4.1) and Dunedin (4.6) to Christchurch (6.1), Tauranga (6.8) and Auckland (8.2).

In other words, there’s a quite large range of median multiples. This raises a quite obvious question: Why are people willing to pay so much more to live in some places? Why live in “unaffordable” San Francisco when “affordable” Houston is just down the road? Why live in Auckland when housing is relatively cheaper in Dunedin?

IMG_3218

Why would anyone want to live in a large, multicultural city located between two beautiful harbours in a subtropical climate? Sheer madness.

Urban economists have studied this phenomenon in detail, and observed that there is an omitted variable in Demographia’s equation: the differing amenities offered by different cities. If a city offers good natural amenities or consumer amenities, people will be willing to pay more to live there. Conversely, if a place isn’t particularly nice, people won’t be willing to pay much for houses there. (Common sense, really.)

In his fantastic survey of the urban economics literature, Harvard economist Ed Glaeser goes so far as to say that ratio measures, such the median multiple popularised by Demographia, are useless for analysis:

It is quite common in discussions of housing affordability to focus on the share of income being spent on housing, as if this is a natural measure of the degree to which housing affordability is a problem within an area. The spatial equilibrium assumption suggests that this measure is not particularly meaningful or helpful.

In short, urban economics suggests that we should interpret a high median multiple as an indication that a city offers great amenity for its residents, rather than an indication of bad policies. I tested this hypothesis by looking at the correlation between the (2012) Demographia median multiple figures and two international quality of living rankings. I found that there was a positive correlation between median multiples and livability.

Here’s the correlation between the median multiple (X axis) and the Economist Intelligence Unit’s 2012 Best Cities Ranking (Y axis). I was only able to match up 12 cities, but there’s a fairly strong positive trend:

Demographia median multiple vs EIU livability index

Here’s the correlation between the median multiple (X axis) and Mercer’s 2012 Quality of Living Survey (Y axis; lower numbers indicate higher rankings). Once again, a positive correlation, with 31 data points:

Demographia median multiple vs Mercer livability ranking

In other words, high house prices relative to incomes are a good indicator that a city is a nice place to live. Rather than proving that Metropolitan Urban Limits inevitably push up house prices, Demographia’s median multiple seems to simply measure cities’ relative levels of amenity. When they argue that all cities should have a median multiple of under three, they are arguing for an absurdity: that all cities should offer the exact same level of amenity to their residents.

If we wanted to accomplish that, we’d have to destroy most of the things that make great cities great. This might make housing cheaper, but it wouldn’t make us any better off in a broader sense. That’s because it would require us to:

  • Bulldoze the Waitakere Ranges and use the spoil to fill in the Hauraki Gulf – to ensure that Auckland didn’t have any natural advantages over a flat, inland city like Hamilton
  • Dynamite the historic boulevards of Paris and replace them with American-style subdivisions and malls – to ensure that Paris didn’t offer anything that Houston doesn’t
  • Ban any venture capital or startup activity in San Francisco, to ensure that it doesn’t offer any agglomeration economies that don’t exist in Detroit
  • Build large screens over sunny cities like Tauranga and Brisbane – to ensure that they don’t have nicer weather than Moscow or Toronto.

But Demographia’s not aware of this. Their analysis is overly simplistic. The only thing it reveals is the authors’ grievous failure to understand the basics of urban economics. It’s no wonder that Demographia has never tried to have its studies peer reviewed or published in academic journals. Their claims aren’t supported by any valid conceptual model. But I guess that’s what happens when you get an urban planner and a former property developer to do an economist’s job…

If you want more consumption choices, live near lots of other people

One of the many reasons that people choose to live in cities is that cities offer variety. As Stu Donovan has argued before, being around more people sometimes seems inconvenient, but it also exposes you to new ideas, new people, and new consumption choices.

I’ve previously written about the value that people place on choices in housing and transport markets, and how having more choices is particularly valuable for people on low incomes. This week, I want to look at how cities provide us with choice in the retail and restaurant markets.

My hypothesis is that there are economies of scale in the provision of both public and private goods. In more straightforward terms, that means that if you live closer to more people, you can have more public transport, more parks, more good restaurants, more shops, and so on and so forth. If this intuition is true, the best way to obtain variety at an affordable price is to live in a dense area of the city.

In order to test this hypothesis, I took a look at Statistics New Zealand’s Business Demography statistics, which provide information on the number of businesses (“geographic units”) and employment within particular industries. Very helpfully, Stats NZ publishes this data at a suburb level (“area units”, in Stats-speak).

I’ve focused on two particular types of businesses that serve households’ daily needs:

  • ANZSIC industry H45, which includes restaurants, bars, and clubs
  • ANZSIC industry G41, food retail, which includes supermarkets and other small-scale food retailers.

I mapped the density of these businesses throughout different Auckland suburbs. Blue colours show higher densities of restaurants/bars or food retailers; yellow colours show lower densities. A few clear patterns emerge. First, densities tend to be highest in inner city suburbs, and even more so in the city centre. Second, there are also pockets of higher density around satellite centres like Takapuna and New Lynn. Third, the density of retail and restaurants tends to be much lower on the fringe of the city.

Auckland restaurant and food retail density maps v1

How can we explain these patterns? Why are some areas so much better supplied with retail and dining options than others?

We can get some insights by looking at the built form retail and restaurants areas in different areas of the city.

Here’s what a retail street looks like in the city centre, where high residential and employment density sustain a lot of activity both day and night. This is O’Connell St before and after its shared space transformation. Notice how people are just walking up:

O'Connell Before and After 4

Here’s what retail looks like in an inner-city shopping and dining district, Ponsonby Road, which is surrounded by old suburbs of medium population density. It has lots of shops right on the street, plus a bit of parking tucked around the back:

Ponsonby Rd St Johns

And here’s what retail looks like in a newer suburb at the edge of town – Albany centre. It’s physically separated from nearby residential areas, highly car-dependent, and as a result, it requires large swathes of parking to support each shop or restaurant:

Albany Mall - Aucklands most modern Metropolitan Centre...

Albany Mall – Aucklands most modern Metropolitan Centre…

In other words, less parking is required to get shoppers to the door in densely populated areas – which should make it easier to sustain more shopping and dining options per square kilometre.

A simple econometric analysis seems to support this view. I attempted to explain the density of restaurants and food retailers in suburbs in terms of the population density and employment density of those areas. (Using Census and Business Demography data from Stats NZ.) As I hypothesised, there is a statistically significant, positive relationship between higher population and employment densities and the density of restaurants and food retailers. These two factors predict roughly 85% of the variation in restaurant and retail density in Auckland suburbs.

Regression results are reported in the table below, for anyone who’s interested. These aren’t perfect models – I suspect that it would be worth testing some spatial regression models, as retailers often attract customers from a wider catchment than a single suburb. Furthermore, we’d have to analyse changes over time in order to establish that increasing population density in an area will in turn increase retail diversity. But these results do provide a reasonable indication of the underlying relationships.

OLS regression models for restaurant and retail density
Dependent variable:
log(restaurant_bar_density) log(food_retail_density)
(1) (2)
log(pop_density) 0.464*** 0.597***
(0.031) (0.033)
log(emp_density) 0.620*** 0.486***
(0.026) (0.027)
Constant -5.531*** -6.290***
(0.182) (0.191)
Observations 342 342
R2 0.856 0.835
Adjusted R2 0.856 0.834
Residual Std. Error (df = 339) 0.632 0.664
F Statistic (df = 2; 339) 1,011.219*** 860.694***
Note: *p<0.1; **p<0.05; ***p<0.01

What do these figures mean? The coefficients from the model – highlighted in bold – display the relationship (or “elasticity”) between population or employment density and density of restaurants or food retailers. They show that:

  • Areas with 10% higher population density have, on average, 4.6% more restaurants/bars and 6.0% more food retailers (including supermarkets)
  • Areas with 10% higher employment density have, on average, 6.2% more restaurants/bars and 4.9% more food retailers.

In short: Higher density can benefit people by giving them more choice in restaurant and retail markets. Having a mix of residential and commercial uses around is even better, as it can sustain activity throughout the entire day rather than just in the evenings or at lunchtime.

Stats NZ’s data isn’t granular enough to say, but I suspect that denser areas also have a greater diversity of dining and retail options. (This is intuitively obvious – if there are already two fish-and-chip shops in the neighbourhood, why would anyone choose to open up a third?)

What do you make of this data on density and retail choices?

We need to stop lying to ourselves about congestion

Without getting back on the topic of pohutukawas or St Luke’s Road again, I did notice something funny in the statement that Greg Edmonds, Auckland Transport’s Chief Operating Officer, made in Metro Magazine in response to the issue:

The founding premise of the Auckland super city was that the city’s congestion was costing $1 billion a year in lost productivity and this had to change.

[…]

Auckland Transport (AT) was created to solve the congestion problem…

Some people might think that this is a slightly too narrow view of Auckland Transport’s mandate. Whatever. Fair enough.

However, there is actually a much more serious problem with Mr Edmonds’ comments. Simply put: the notion that we can “solve the congestion problem” is not at all realistic. (Unless we are willing to try out road pricing, which is unlikely given the tepid response to the last few studies of the issue.)

I don’t want to pick on Mr Edmonds in particular. It’s common to hear politicians, bureaucrats, and advocates from all over say similar things. We constantly hear that Project X or Project Y will “fix congestion” or “solve gridlock” or “save us [some unthinkably large amount of money] in congestion costs”.

As an economist, I’m baffled by these statements. The empirical evidence on congestion overwhelmingly shows that it is not possible to reduce it by building more roads. This is because people change their behaviour in response to bigger roads. They shift from walking to the store to driving there; they buy a house further out of town; they travel at different times.

Here’s what two North American economists, Duranton and Turner, had to say on the topic after undertaking a comprehensive, multi-decade study on induced traffic in US cities:

Our data suggests a ‘fundamental law of road congestion’ where the extension of most major roads is met with a proportional increase in traffic. Not only do we provide direct evidence for this law, but also show find evidence that three implications of this law; near flat demand curve for VKT, convergence of traffic levels, and no effect of public transit on traffic levels.

All earlier studies, such as this comprehensive 1998 study of 70 US metro areas over a 15 year period cited by walkable city advocate Jeff Speck, have come up with identical findings:

Metro areas that invested heavily in road capacity expansion fared no better in easing congestion than metro areas that did not. Trends in congestion show that areas that exhibited greater growth in lane capacity spent roughly $22 billion more on road construction than those that didn’t, yet ended up with slightly higher congestion costs per person, wasted fuel, and travel delay.

Consequently, all we can realistically do about congestion is to give people good alternatives to participating in it. Other modes, such as grade-separated rapid transit and walking and cycling, do not get congested in the same way as roads do. While the research shows that providing alternatives to driving does not necessarily reduce road congestion, it does give people a way to reduce their exposure to it.

In light of these fundamental economic realities, it is essential that transport agencies stop talking about “fixing congestion”. This is nothing more than a dangerous fantasy.

Suggesting that we can solve congestion creates unrealistic hopes among the public. Every time a politician or transport agency opens a new road and promises that it will reduce congestion or speed up people’s journeys, they are feeding expectations that can never fully be met.

The result of this is that transport agencies are constantly dealing with demands for more roads that will not actually deliver long-term solutions to the problem of congestion. This sets the transport profession up to constantly fail to satisfy people’s desires and demands. This has to be a tremendously disheartening situation to be in.

My personal view is that instead of talking about “fixing congestion”, transport agencies should instead promise to deliver outcomes that are actually achievable.

This could include, for example, committing to deliver transport choice to underserved areas of the city by investing in rapid transit infrastructure, frequent bus services, and safe walking and cycling infrastructure. While transport agencies would have to work hard to deliver on all this, they could expect that the end result would be more transport choice for residents.

Transport agencies could even commit to some traditionally roads-centric goals, like, say, building new roads to enable the development of a new subdivision at the edge of the city. At least, as long as they weren’t making unrealistic promises of fast, frictionless commutes to the future residents…

MoT’s review of capital spending on roads, part 3

This is the second post in a series on the Ministry of Transport’s working paper on New Zealand’s capital spending on roads, which was prepared as an input to the 2015/16 Government Policy Statement (GPS) on Land Transport Funding. It was released to Matt under the Official Information Act just before Christmas. Previous posts:

In the previous post, I took a look at the MoT paper’s findings on the economic efficiency of state highway spending. MoT showed that since 2008 spending on the Roads of National Significance (RoNS) has gone up, while benefit-cost ratios have gone down. As a result, we have almost doubled our spending on state highways without achieving any more economic or social benefits from that spending.

This week, I’ll take a look at a different question: Is it possible to spend our road budget more efficiently? If we chose to build other roads instead, would we get more benefits from them?

The MoT paper examines this issue quite comprehensively, and comes up with an unambiguous “yes”. But before I get into it, it’s worth reviewing the system that the Government is currently using to assess transport investments. Projects are ranked on three criteria:

  • Strategic fit [i.e. is this project trying to do something that the Government cares about?]
  • Effectiveness [i.e. will this project actually do what it’s intended to do?]
  • Benefit and cost appraisal [i.e. will this project deliver more benefits than costs?]

In short, the BCR is only part of the picture. In practice, it’s less important than strategic fit. However, it’s still an important criteria for determining whether we are getting good value out of our transport investments, especially as many of the strategic outcomes that the Government wants are accounted for in a transport cost-benefit analysis.

With that in mind, Section 5.4 of the MoT paper compares BCRs for local road and state highway projects which have committed funding versus those that will probably receive funding or which will remain unfunded.

This analysis, summarised in the chart below, shows that BCRs for state highway projects tend to be lower than BCRs for local road projects whether or not they have committed funding or not. This might be an indication that too much money has been allocated to new state highways – effectively, there are worthy local roads that are going unfunded.

Another worrisome finding is that BCRs for “committed and approved” state highway projects are considerably lower than projects that are merely “probable” or which have not been given funding. This suggests that even within the state highway budget, funding isn’t going to the projects that offer the best returns.

MoT BCR by funding priority chart 1

However, the MoT paper notes that these figures include “significant spending on large strategic projects” – the Auckland Manukau Eastern Transport Initiative (AMETI) in  local roads and the RoNS in state highways. Is it simply the case that a few big funding calls are skewing the results?

Here’s what the chart looks like with those projects removed. As you can see, “committed and approved” state highway projects other than the RoNS also offer a lower return than the “probable and reserve” projects that may or may not get funding. What the hell is going on here?

MoT BCR by funding priority chart 2

Elsewhere in the paper, MoT sums up the situation as follows, with a nod to the idea that traffic forecasts are over-predicting growth:

MoT state highway benefits

It also compares these figures with BCRs for other transport spending, including NZTA-funded PT infrastructure and services and walking and cycling projects, and concludes that:

MoT BCR by activity class summary

In other words, the focus on big state highway projects means that the Government is passing up higher-value spending that serves other modes. Unfortunately, the paper doesn’t offer a lot of additional analysis. But it would be interesting to know how much analysis NZTA or MoT has done on the bus infrastructure projects that are needed to get good transport outcomes in Auckland, such as the Northern Busway extension, the Northwest Busway, extensions of the AMETI busway, and bus interchanges to support Auckland’s New Network.

With all that in mind, how would we be spending money if cost-benefit analysis was the key criteria?

Section 6.2 of the MoT report contains a number of colourful charts to illustrate how we could be doing things differently. Here’s the bit that stuck out for me. It classifies new state highway projects, excluding RoNS, according to their BCR (vertical axis), funding priority (horizontal axis), and total cost (size of bubble).

If BCRs were the key criteria for project funding, the black-coloured bubbles would be de-funded and the red-coloured bubbles funded in their place:

MoT de-prioritised projects 1

MoT de-prioritised projects 2

As you can see, if the Government were focused on getting the highest benefits out of its transport budget, it would have to de-fund most large state highway projects that are currently underway. Yikes.

It’s not clear what conclusions MoT’s drawing from this analysis, as the final paragraphs are entirely blacked out. However, I’d be surprised if they weren’t a bit skeptical of the way that public money is being spent…

Next week: MoT’s analysis of roads spending by region. Preview: Canterbury’s getting a raw deal.

Upcoming seminar: New ideas in economic evaluation

Next Tuesday, the Government Economics Network and Auckland Council are hosting a seminar entitled “Economic evaluation in Auckland – new ideas and challenges“. It’s on a topic that I personally find very interesting – some readers may also be keen:

Estimating the economic impact of transport interventions using the Gross Value Added approach.

Current transport appraisal methods, with their focus on the economic welfare benefits and costs of transport investment, are well grounded in theory and widely used. However, these methods do not provide estimates of extra Gross Domestic Product and extra jobs, nor the spatial distribution of any economic gains and losses. Gross Value Added (GVA) models, have recently applied in the United Kingdom and the United States to account for some of these effects.

In this presentation, Anthony Byett, outlines the results of NZTA-commissioned research on the development of a GVA model for New Zealand. The research uses 2001 and 2006 census data from the 72 sub-national territories, and applies the model to a proposed additional Waitematā Harbour crossing. Promisingly, the model reveals productivity gains from local agglomeration and points to some productivity gains from wider connectivity as well. However, the building and use of the model also reveals shortcomings with the measurement of effective densities and the ability to reach inferences about regional distribution. Nonetheless, the model did prove insightful in highlighting where the benefits of another harbour crossing will likely lie.

Economic evaluation and Cost Benefit Analysis: Implications for practitioners, government agencies and Auckland Council.

Chris Parker, Auckland Council’s recently appointed Chief Economist, will reflect on recent developments in economic evaluation, including the NZTA research using the Gross Value added approach, and discuss some of the implications for practitioners, government agencies and Auckland Council.

The two speakers promise to be pretty interesting. Anthony Byett has led some pretty interesting work into the productivity of road networks. Chris Parker has just been appointed as the Council’s new Chief Economist following on quite a bit of work in transport appraisal at consultancy NZIER.

The seminar is being held at the Council Chambers in the Auckland Town Hall from 1pm to 2:30pm on Tuesday 17 February. You can RSVP at the GEN website.

MoT’s review of capital spending on roads, part 2

This is the second post in a series on the Ministry of Transport’s working paper on New Zealand’s capital spending on roads, which was prepared as an input to the 2015/16 Government Policy Statement (GPS) on Land Transport Funding. It was released to Matt under the Official Information Act just before Christmas. Previous posts:

As I said last week, MoT’s paper suggests that there are big issues with the land transport budget. Current road spending does not seem to represent good value for money. To their credit, MoT appear to be acknowledging this. However, it doesn’t seem to have percolated up into the investment decisions being made by the Government.

This week, I want to look at what NZTA’s money (the National Land Transport Fund, or NLTF) is being spent on, and how economically efficient that expenditure has been.

Section 4 of the MoT report contains a lot of useful data on past and future spending on roads. Here’s what’s happened to the roads budget over the last 15 years, and what’s expected to happen over the next decade:

MoT spending on new roads 1997-2022 chart

Basically, about a decade ago we started spending a lot more on new or improved roads. A lion’s share of new spending went to state highways, in spite of the fact that local roads carry more traffic. As we have previously discussed at length, this spend-up coincided with a flattening of growth in vehicle kilometres travelled. (It also coincided with an acceleration in price inflation for civil construction.)

In other words, we’ve spent a decade spending increasing amounts of money on roads for which demand is not increasing. And the last three Government Policy Statements plan for state highway spending to increase further.

In order to pay for state highway spending, it’s been necessary to divert money from other activities – local roads, maintenance, PT, and walking and cycling have all taken a hit. The Government has also raised petrol taxes several times. The MoT report offers some analysis of how spending priorities changed between the 2008 GPS and the 2012 GPS.

The following chart compares projected spending ranges for new and improved state highways (the darker uppermost bands) and new and improved local roads (the thinner, lower bands). It shows that funding for state highways – the Roads of National Significance – was raised by around half a billion dollars a year, while local road funding was cut back.

MoT GPS 08 12 road spending comparison

One would hope that the Government’s decision to allocate vast amounts of funds to state highway projects was based on a sound economic rationale. Unfortunately, there is no hard evidence of this in the MoT paper. Section 5 of the MoT paper analyses benefit-cost ratios (BCRs) for road spending. It notes some caveats with the data – BCRs for some projects had to be inferred from “efficiency scores” – but there is enough data to paint a picture.

Here is MoT’s picture. It is not a pretty one:

MoT state highway BCRs 2005-2012

Essentially, MoT finds that average benefit cost ratios for state highway projects declined significantly in 2008/09 and have stayed low ever since. An eyeballing of the graph suggests that BCRs prior to 2008 averaged a bit over 3.5 – meaning that state highway projects were expected to return $3.5 in social benefits for every dollar invested. Since 2008, they have averaged a bit over 2 – meaning that state highway projects now only return $2 in social benefits for every dollar invested.

MoT’s analysis of this graph is entirely blacked out in the released document. Nonetheless, the implications are simple: we have almost doubled our spending on state highways without achieving any more benefits from that spending. BCRs aren’t everything, but it’s really, really hard to understand why the Government would want to spend money so ineffectively.

The answer is that they feel that the Roads of National Significance offer a better “strategic fit” with their overall objectives for the land transport budget. I’m not necessarily opposed to this evaluation approach. In my experience, cost-benefit analysis invariably has some blind spots. Using qualitative “strategic fit” criteria can allow policymakers to take account of broader goals that aren’t well covered in NZTA’s Economic Evaluation Manual.

However, I don’t think that strategic fit should override all other analysis. If you think that a project is important for supporting a productive economy, that’s fair enough. But if an evaluation of the project’s impact on freight costs and agglomeration effects in urban areas results in a low BCR, you should question your prior assumptions about its economic benefits. It’s foolish to think that four-lane divided highways are magical devices for creating economic growth. Economics simply doesn’t work that way.

Next week: Do we have better options for spending the transport budget?

Big city, small firms

Urbanists often argue for better cities by appealing to our desire to be happier, healthier, or more environmentally sustainable. Cities, they argue, can improve our well-being in all sorts of ways. There is definitely something to this idea. As I’ve previously written, good urban policies, such as mixed-use developments, denser neighbourhoods, shared spaces, and useful public transport, can make us better off in all sorts of ways.

However, cities are not just places of consumption – they are also sites of production. As an economist, I’m particularly interested in how better cities can create greater economic opportunities for people. In a series of previous posts, I have observed that:

In this post, I want to take a closer look at this issue. Why are cities important to economic growth? What makes them such good places to do business? How do they help people create, adapt, and commercialise ideas?

My starting place, as always, is what we can observe. Here’s my map of the NZ economy. The orange blobs on the map – Auckland, Wellington, and Christchurch – make up less than 1% of New Zealand’s land area, but over half of all economic activity. Businesses and workers, when offered the choice to disperse themselves widely over a wide rural expanse, have chosen instead to agglomerate in a few small areas. This is an immensely important fact.

City share of NZ GDP map v2

Businesses are not doing this because they are irrational – they choose to locate (or start up) in cities because it offers them better chances of success. A good city, it turns out, is a fantastic ecosystem for firms. It offers them the inputs they need – employees, financing, ideas – and provides them with access to a range of customers. In addition, it surrounds them with other firms, who may act as competitors, collaborators, or suppliers.

In his book Triumph of the City, Harvard economist Ed Glaeser looked at how this process once worked in Detroit:

…there was an explosion in automotive entrepreneurship in Detroit in the early 1900s. Detroit seemed to have a budding automotive genius on every street corner. Ford, Ransom Olds, the Dodge brothers, David Dunbar Buick, and the Fisher brothers all worked in the Motor City. Some of these men made cars, but Detroit also had plenty of independent suppliers, like the Fisher Brothers, who could cater to start-ups. Ford was able to open a new company with backing from the Dodge brothers who were making engine and chassis components. They supplied Ford with both financing and parts. (p 48)

Glaeser’s account of Detroit illustrates some important features of successful cities. They are diverse yet connected environments in which ideas can travel. A good city should enable people to learn from each other by placing them in close proximity.

As a result, a city is an especially favourable environment for startups and small, innovative firms. Although Henry Ford’s company went on to dominate the car industry, he had to start somewhere – and was fortunate enough to begin in a city where he could access venture capital, suppliers, and cutting-edge ideas. That would have been hard to do in a small town or out in the countryside.

However, Glaeser’s account of Detroit’s economic rise and fall also suggests that large firms can lose touch with the urban environments that enabled their growth:

The irony and ultimately the tragedy of Detroit is that its small, dynamic firms and independent suppliers gave rise to gigantic, wholly integrated car companies, which then became synonymous with stagnation…

Successful car companies bought up their suppliers, like Fisher Body, and their competitors. By the 1930s, only the most foolhardy and well-financed businessman would have dared take on General Motors or Ford. The intellectually fertile world of independent urban entrepreneurs had been replaced by a few big companies that had everything to lose and little to gain from radical experimentation. (p 49)

Detroit’s economic fall from grace shows that cities need startups and small businesses just as much as small firms need cities. A healthy firm ecosystem is one in which there are a lot of firms competing with each other, selling to each other, and learning from each other.

Big corporations can’t sustain a dynamic urban economy on their own, as often use cities in different ways than small firms. For one thing, they tend to produce a lot of their own inputs to production. For example, a large company may have its own finance department, an in-house legal team, its own building management services, and so on and so forth. As a result, they can choose to do without other urban firms, and, in some cases, exit the city altogether.

Consequently, in the long term a country’s economic success depends on its ability to foster innovation, entrepreneurialism, and the growth of new firms. Good urban policies are essential to this process. A successful city will connect people and puts them in contact with new ideas and new opportunities. An economically dysfunctional city, by contrast, will sever them from each other or maroon them down the end of distant cul-de-sacs.

There is no substitute for an urban firm ecosystem. Governments often try other things, like subsidising agricultural and extractive industries or writing regulations that favour existing large firms. However, these activities all offer limited prospects for future growth. (To say nothing of the fact that the economic record of these policies in New Zealand is dismal.)

A focus on building better cities represents an alternative to the frustrations of economic development policy in New Zealand. Fortunately, we’re lucky enough to have many, many opportunities for building better cities. In Auckland, but also in Wellington, Christchurch, and smaller centres, we can do many things to improve the way our cities function, by:

  • Investing in efficient and useful public transport networks, including rapid transit networks in major cities (CRL now!)
  • Building streets that are safe and inviting for people to walk and cycle on – acknowledging that people, not cars, are the drivers of economic activity
  • Enabling market-led intensification, including the construction of townhouses and apartment buildings in the places where people want to live
  • Creating great public spaces that encourage people to get out and make fortuitous connections with each other.

Cities, small firms, and economic growth – what do you think?

Parking is massively oversupplied in US cities

When people discuss the costs of car-centric transport systems, they tend to tend to talk about congestion, fuel costs, crashes, or, if they’re environmentally-minded, carbon emissions.

However, one of the largest costs of auto-dependency is hidden in plain sight: the cost of providing parking spaces. The financial cost of providing parking spaces can be staggering. According to Todd Litman, “most communities have three to six parking spaces per vehicle (one a home, one at the worksite, plus spaces at various destinations such as stores, schools and parks)”. As car parks occupy around 30 m2 apiece, this means 90-180 m2 per car.

In Auckland, where suburban land prices range from around $250/m2 (west and south Auckland) to over $1000/m2 (inner isthmus, lower North Shore), surface parking would cost $22-90,000 per car. That’s more expensive than the cars that occupy those spaces!

mcc-coloured

Buildings are in red. Parks are in green. Everything else is roads and carparking.

Moreover,  land that is devoted solely to cars cannot be put to higher and better uses, such as dwellings, businesses, or public spaces. In a successful city, we would expect the value of those other uses to continue rising, meaning that the opportunity cost of car parking will also rise. Space is expensive in cities, and parking is an inherently inefficient use of land.

This spatial inefficiency is exacerbated by the fact that many cities have ended up with more car parking than is necessary. Eric Jaffe in Citylab reports on some important new research on parking oversupply in US cities:

Some new research reminds us just how oversupplied parking really tends to be in American metro areas: in a word, enormously. Rachel Weinberger and Joshua Karlin-Resnick of Nelson\Nygaard Consulting Associates analyzed parking studies of 27 mixed-use districts across the United States and found “parking was universally oversupplied, in many cases quite significantly.” On average across the cases, parking supply exceeded demand by 65 percent.

[…]

The researchers focused on districts with both residential and retail developments in a variety of settings—17 suburbs, 6 cities, and 4 towns—mostly in New England or California. (Interestingly, a third of the areas were documented as having the impression that local parking was scarce.) By looking at previous parking studies in these areas, as well as satellite imagery via Google Earth, they identified existing parking supplies and peak weekday and weekend demands.

Critically, the researchers also took into account the accepted practice of supplying 15 percent more spaces than necessary—a sort of buffer zone that reduces the congestion caused by drivers circling for spaces.

In all 27 districts, spanning places with 420 spaces to those with 6,600 spaces, Weinberger and Karlin-Resnick found an oversupply of parking over and above the buffer zone. The oversupply ranged from 6 percent up to 253 percent across the study areas (below, the highest over-suppliers). And in the nine areas that had believed parking to be scarce, the oversupply ranged from 6 percent to 82 percent.

us parking oversupply

These are pretty extraordinary findings. An average oversupply of 65% means that two out of every five parking spaces are, essentially, useless. We would never tolerate such waste in any other part of our economy – if, for example, two out of every five meatworks were sitting idle, we would start shutting down the unprofitable ones.

I highly recommend reading the rest of the article, as there are a number of other interesting findings in the research. One in particular stood out:

Interestingly, a third of the areas were documented as having the impression that local parking was scarce.

The researchers found that this was not correct – parking was in fact oversupplied in each one of these areas. Policymakers and businesses in these areas significantly overestimated the amount of parking that was truly required. It’s common to hear retailers complaining about the loss of on-street parking for cycle lanes and bus lanes, but the evidence suggests that we should treat their claims with caution.

The same thought occurred to me when reading the recent Motu paper on the cost of planning regulations. Based on a survey of 16 Auckland-based developers, the authors concluded that:

There were diverse views of the impact of car parking requirements on developments, reflecting differing development types. CBD apartment developers, particularly those developing at the affordable end of the market, prefer to include fewer car parks. They saw car parks as a cost to the development as the market value of a park was less than the cost of including them on the development. In contrast to CBD apartment developers’ views, suburban apartment developers tended to favour offering more car parks.

However, some of the comments from developers made me wonder whether they had also fallen into the trap of overestimating parking requirements:

“The optimal number of car parks in a suburban apartment development targeting the mid to upper end of the market is 2 to 3 per unit with additional common parking for guests”

Now, I haven’t been keeping a close eye on suburban apartment developments, but I’d be extremely surprised if developers were actually building three car parks per unit. If anything, the trend seems to be for fewer car parks. For example, the Merchant Quarter apartments in New Lynn have unbundled parking, while the apartments planned for Alexandra Park will have only one car park apiece.

Do you think Auckland has a parking oversupply? If so, what should we do about it?