Monday, 29 July 2013

Labour's Housing Policy

I am baffled by the Labour Party proposal to ban foreign speculators from owning houses in New Zealand. O.K. that is not strictly true; as Matt over at TVHE notes, the policy is easy to understand as a cynical appeal to xenophobic New Zealand First voters. But David Shearer is a better person than that, and so I would prefer to remain baffled and try to think through the logic of the proposal.

Consider a very simple model of the New Zealand housing market in which there is a fixed supply of identical houses that will not change over time, and an unchanging demand. Let there be no on-going maintenance or other costs to owning a house, just the one-off capital costs. Finally, let there be a risk-free interest rate of 5%, let demanders be risk-neutral and indifferent between renting and owning for a given cost, and let rental income to a landlord be exempt from tax so that there is no tax advantage to owner-occupied housing. In this world, there would be an unchanging equilibrium rental price for housing over time, and an unchanging price of houses that would be equal to this rental price times 20.

Now change the model a bit. Imagine that demand in one year’s time will double and then stay constant from then on, but that will not be known in the one year before the change. In this world, the equilibrium rental price and the equilibrium house price will both double in one year’s time and current owners of houses (both owner occupiers and landlords) will receive a one-off capital gain at that time.

Now make one more change. Imagine that the future increase in demand becomes known now, but for some reason only known only to people who are not citizens or permanent residents of New Zealand or Australia. In this version of the model, the rental rate would continue to remain constant for a year before doubling, but foreigners would bid up the price of houses now to the point where the capital gain between now and in one-year’s time was sufficient to exactly offset the fact that current rentals are insufficient to cover the capital cost of the house.

Now compare this model to the one where the demand increase was a surprise to everyone. Renters pay exactly the same amount of rent in each period, owner occupiers receive exactly the same capital gain, but can realise it's present value straight away. Foreign speculators receive only the market rate of return on their investments, just like any other inflow of capital that allows New Zealand to fund investment in excess of its saving. The only distributional effect would be a shift in the capital gain from those who would have bought houses during the year before the demand increase to those who would have sold, but there seems no particular reason for policy to favour one of these groups over the other.

In this world, it is hard to see what possible benefit there would be to a policy of banning overseas speculators from owning houses, which is what Labour are proposing. Of course, the assumptions in these three models are extremely unrealistic. So what changes to the model or what welfare function can make sense of this policy? We could relax all the assumptions about indifference between renting and owning, risk neutrality, homogeneity of the housing stock, no tax advantage to owner-occupancy, and no other changes over time, but it wouldn’t change the basic intuition. We could assume that supply is not perfectly elastic, but that would imply that the earlier rise in price from speculation would generate an earlier supply response and hence more housing affordability. And we could assume that, maybe, New Zealanders and Australians know at least as much about the New Zealand housing market as non-Australasians and so can bid up the price of housing without overseas help, in which case banning foreign speculators would have no effect at all.

It is easier to make sense of other parts of Labour’s housing policy. Building 100,000 houses would obviously reduce prices if it added to rather than displaced construction that would otherwise occur, although the policy is silent on how it would find the land on which to build the houses given council zoning restrictions. Similarly, a capital gains tax that excluded the family home, while doing nothing to change supply and demand, would be a way to reduce prices to owner occupiers while increasing prices to renters. Such a policy proposal wouldn’t make much sense from a party representing lower-income households (who are more likely to be renters), but it is perfectly consistent with a party that proposed exempting fresh fruit and vegetables from the GST.

But Labour’s Press release focuses mostly on speculation. The point needs emphasising: speculation that pushes up prices is only profitable if those prices were going to increase anyway for non-speculative reasons. Preventing speculation (if it were possible to do so) only delays the eventual price rise. Doing something about the future price increases by addressing supply constraints would not only be a long-term solution, it would remove the incentive for speculation at the same time. In other words, any politicians whose housing policy consists mainly of an attack on speculation is essentially conceding that they have no long-term solutions at all. 


  1. As far as I see it, the proposal is to reduce demand (and therefore prices) by restricting the pool of buyers. I don't know why you would be baffled by this? Maybe it seems fatally flawed to you, but to this layman, the reasoning is at least plausible.
    Whether it will work or not, I can't tell. I suspect the money will come in anyway, through our foreign-owned banks, and while a Kiwi's name may be on the deed, the actual ownership will remain overseas.

  2. If the policy was to stop immigration (and hence reduce the number of people living in houses in NZ), I could see the policy having an effect on the cost of housing. But that is not what Labour has said. They want to stop non-PR, non-citizen investors from owning houses, which won't affect the number of people wanting to live in houses at all, absent some evidence that foreign buyers are just leaving homes empty while waiting for the capital gain.

  3. Fair point.
    If we only consider those transitioning from renting to owning, is there any benefit to them? There's no increase in demand, since they'll free up a home when they move. Reducing the number of competitors they face for the houses available for sale should reduce the price they pay, shouldn't it?
    Either that, or it is pure protectionism for kiwi landlords, who will show their gratitude by voting National as they always do.

  4. *If* you can effectively stop foreigners making speculative purchases, and *if* they wouldn't simply be replaced by local speculators with the same information, then, yes, stopping the foreign buyers would temporarily transfer wealth from sellers to buyers. But the effect would only be temporary, since, as I have noted, speculation is only profitable if prices are going to rise anyway. Find a long-term solution and speculation is irrelevant.

  5. Currently when there's a restriction on available housing, newly built subdivisions are likely to bought up by speculators, like recently happened in San Francisco, with house prices skyrocketing.

    It becomes a pyramid scheme, with regulation of new building and zoning signalling to investors that it's time to sell or get ready to buy more.

    Eventually the bubble bursts.

    A good long term solution might perhaps be thought about in terms of not just house prices but more in a social context.
    The human mind is best suited to small communities of 60-100 people.

    Likely future changes in robotics technology could allow land to be better utilised on a micro scale, while conventional jobs are being lost to the mechanical workers.
    Decentralisation with these points in mind could mean that communities of the future could be designed very differently to how they accumulate today. If new state sponsored housing is being proposed, perhaps it could be designed in a way that benefits everyone except the speculators?

  6. Seamus -- You focused on speculation because that's the focus of the press release. Regardless, we could analyse the situation with an H-O model of international trade (even though housing is non-tradable, the right to inhabit NZ housing is tradable). In that case, the comparative advantage of NZ in producing safe and quiet neighbourhoods would lead to us 'exporting' home ownership and raise the price above the autarky level. Since the autarky price is likely to be considered the 'right' or 'natural' price domestically, then the solution is to stop exporting. Any imbalance will show up somewhere else (balance of payments? commodity prices?) but won't be explicitly linked to the housing policy.

  7. Bill--This is an issue for whether we should be allowing foreigners to *occupy* houses (and hence reducing the net supply available to domestics). A policy directed towards non-citizen, non-PR, non-Australian people is hardly likely to affect home occupation numbers. The "why can't we get decent kiwifruit in NZ" argument might be relevant for immigration policy, but I can't see it being relevant to Labour's proposed policy.