Does Market Economics understand either Markets or Economics?

Over in our Insights newsletter, I go through a bit more of the background materials on the government's National Policy Statement on sensitive soils. 

I OIAed the supporting cabinet paper, which MPI released after the Ombudsman's office gave them a very helpful hurry-up. Thanks Ombudsman's office!

The rest of MPI's materials are here.

And last week, Treasury passed along their advice on this stuff (another OIA request). I expect it'll be up on their proactive release site in due course; I'll copy some of it below and will get it up at our website if Treasury doesn't have it up soon [okay, here you go].

Here's the column:

LOOKING-GLASS ECONOMICS AND HIGHLY PRODUCTIVE SOILS

When Alice tried to recite one of her lessons while down the rabbit-hole in Wonderland, she thought only a few words had come out wrong. The Caterpillar corrected her bluntly: “It is wrong from beginning to end.”

By contrast, the Cabinet Paper on the National Policy Statement protecting sensitive soils is not wrong from beginning to end.

Paragraphs 90, 91 and 92 contain sound advice from Treasury.

Otherwise, the paper has a few problems.

About a month ago, the government issued a proposed National Policy Statement allowing councils to designate areas of agricultural land where residential development would be banned.

I warned in Insights it risked undermining the urban growth agenda. Urban land makes up less than 1% of the country by area. It is utterly implausible that urban growth will take over the country’s agricultural land.

The normal operation of markets provides additional protection. The price of agricultural land incorporates buyers’ and sellers’ expectations of the future value that can come from agricultural uses of that land. If turning a paddock or a horticultural block into a subdivision is profitable, that means the services provided by that land in housing are more valuable than the crops that otherwise might have grown there.

So I requested the Cabinet Paper and Treasury’s advice.

Corwin Wallace’s advice from Treasury’s side in the Cabinet Paper is correct and trenchant. The difference in land value on either side of urban-rural boundaries means the land in an 80-hectare farm at that boundary would be worth between $120 million and $182 million more if it were allowed to help solve the housing crisis. Banning that conversion destroys value and risks exacerbating the housing shortage.

Treasury recommended deferring the NPS until a more rigorous cost-benefit assessment had been undertaken, and that the Ministry for Primary Industries be directed to provide options to reduce the risk of the NPS restricting housing supply.

The indicative CBA provided to the Ministry by Market Economics was astonishingly poor. Treasury provided instructive critique. And Market Economics’ response to Treasury revealed such a confused understanding of the concept of market failure that it would have earned a failing grade in the intermediate microeconomics course I once taught.

The NPS on sensitive soils is based on distorted, looking-glass-world economics. Without substantial improvement, it risks pushing us all further down the housing crisis rabbit-hole.

Here's the really depressing part from the Treasury OIA. Treasury challenged Market Economics, the team of mostly geographers who put together the indicative CBA for MPI, on problem definition. Treasury's Chris Parker notes that the CBA includes no problem definition that includes a market failure to be addressed.

Market Economics replies:

"The "market failure" is quite clear. Highly productive soils which have long term productive and sustainability benefits for the NZ economy and community are being lost as land is taken up for urban uses, and rural residential properties. The nature and structure of the land market means there is no mechanism through which those benefits can be protected and preserved for current and future generations. ... Commercial markets do not have a mechanism where the aggregate loss of soils is taken into account...."

This is hogwash. I expect that MPI wanted hogwash and contracted for hogwash, and was delivered the wanted hogwash - but we shouldn't pretend that this kind of thing passes any kind of bar for counting as economic analysis or a CBA. Whoever contracted it will get a pat on the head from MPI's CE and the Minister for having backfilled the necessary hogwash in support of the Minister's preferred policy rather than being fired for having wasted a pile of money on hogwash.

Let's try to make the best case out of this. There will be sensitive lands that provide ecosystem benefits that are not currently priced. Wetlands come to mind. Agricultural land will sequester some carbon, so that's good.

But there's just absolutely no way that ecosystem services provided by land in intensive horticultural use growing potatoes provides ecosystem services of $1-$2 million per hectare - the ballpark land price differential when land can be turned into housing.

And it's also wrong to say that there's no way for these benefits to be otherwise protected. Here's an alternative policy: pay the owners of land providing valuable ecosystem services an annual subsidy that is no higher than the value of those services. If they're still willing to sell to developers, then the land's more valuable in housing.

And it's also wrong to say that commercial land markets have no way of valuing things when there are lots of small decisions and purchases being made at the margin. That's exactly how markets work: equilibrium prices are the result of all those small decisions and purchases. Lots of small purchases of agricultural land results in the bidding up of the price agricultural land, and especially of larger contiguous blocks of agricultural land if those larger contiguous blocks are differentially more productive. When developers are no longer able to outbid agricultural uses, then the value of the land for agriculture is higher than the value of the land for residences.

Everywhere through this darned stuff you see the assertion that because developers can always outbid agricultural uses, there's inadequate protection of agricultural uses. But that has the whole world backwards. Housing can only outbid where the value of land in housing is higher than the value of land in agriculture. And that can't be an equilibrium phenomenon unless there is already overly strong protection of agricultural land! Otherwise, we would expect people to keep buying land to turn into housing, and that that would happen until the value of land for housing use dropped down to the bare paddock cost.

The fact of the differential instead points to that there is already too much protection of land against being used in housing.

Look, I get mad about BERL's silly work on the cost of alcohol. That nonsense can lead to bad policy around alcohol that imposes needless cost on moderate drinkers. But there are bounds to the losses there. Looking-glass economics applied to land use planning is orders of magnitude more destructive.

This is just so darned depressing. The government seems determined to push this policy through. The most we might be able to hope for is limiting the damage it causes. For example, maybe councils where the median house price is more than 8 times median income could be barred from putting protected designation over more than a very small proportion of their land area.

Minister Twyford used to talk a lot about the importance of letting cities grow up and out, and of abolishing urban growth boundaries. The soils NPS risks entrenching urban growth boundaries in worse form.

Previously: Precious Agricultural Land