Finance

Thank you very much for the welcome.

I want to talk about the way that we approach economic policy in one area in particular – the housing market.

It’s certainly been topical lately.

The Government takes the approach that the best thing we can do for the economy is work to improve its resilience – its capacity to adapt.

That’s important because in New Zealand we have had times when our economy has not been resilient, when price signals have not been clear until it is too late – at which time they become extraordinarily clear.

I am old enough to remember the mid-1980s. After leaving university, I was involved in farming.

At that time we had a number of arrangements in New Zealand that meant people who were involved in farming weren’t getting the right price signals.

Then, suddenly, they did.

I was a part of communities that were drastically affected by that.

Farm subsidy systems were abruptly removed. Our communities changed drastically and dramatically.

That was a sharp personal lesson, and one that many New Zealanders also experienced.

A strong focus of our policy is to make sure our markets work.

And over the last 30 years New Zealand has done a reasonable job of this.

Over the last seven years our labour market has been tested.

It has accommodated a significant recession in 2008, and a pickup in demand particularly in Christchurch following the earthquakes.

The labour market was able to respond quickly to those shifts in supply and demand conditions.

Today New Zealand’s proportion of the working-age population in employment is among the highest in the OECD.

Another area that is now working well is the energy market.

For a long time, New Zealand energy markets were over-regulated and poorly-regulated.

Extensive government ownership further stunted price signals.

For instance, water management in the hydro-electricity system was, compared to today, very poor.

And advertising campaigns to urge the public to restrict their energy use were more frequent.

In the last few months there have been a number of decisions in the energy industry which indicate a working market.

We're shutting down excess capacity, and excess capital is being withdrawn and returned to the owners of that capital.

After years of litigation and legal contest over the rules, the energy market is now starting to work.

Which brings me to the housing market.

This is probably the largest market in New Zealand where the rules need to be reshaped.

The most evident indication of a problem is Auckland house prices.

I’m yet to find a housing market anywhere in the world where prices go up at over 20 per cent a year without stopping and then starting to come down again.

It may be that we are unique – but that seems unlikely.

So we're concerned about the housing market.

Because it's a large asset on the New Zealand balance sheet, worth around $600 billion.

And because what happens in our housing markets has a profound effect on every household.

I want to go through a number of the reasons why the Government worries about housing, why it matters to the economy, and some of the key issues around the way that market is regulated.

We have a better understanding of the significance of the planning process than we did in the past.

The process probably looks unexciting to most people – something busy-bodies and councils do.

But actually it’s the process by which one of our largest and most significant markets is regulated. And therefore we need to understand it.

As a group of young people, it is critical for you as potential future home buyers that we get this right.

There are three reasons why the Government is focused on planning – and each of these matter for you.

The first is that a housing market that is not properly functioning can have a significant effect on the macro-economy.

Over the last five years, the Auckland housing market has been the single biggest imbalance in our macro-economic system.

It takes around eight years for the housing market to respond to a shock to demand.

In part that is because changes to council plans can take years, in some cases over a decade.

Resource consents on a housing development regularly take 18 months, including pre-application times excluded from the official statistics.

When combined, those very real delays can exceed the length of the house price cycle.

The point is that when the supply of housing is relatively fixed, shocks to demand – like migration flows increasing sharply as they have recently – are absorbed through higher prices rather than the supply of more houses.

Long lead times in the planning process tend to drive prices higher in the upswing of the housing cycle.

And those lead times increase the risk that eight years later, when additional supply arrives, the demand shock that spurred the additional supply has reversed.

The resulting excess supply could produce a price crash.

This has been borne out by extensive studies in the United States following the Global Financial Crisis.

What they’ve found is that, across different markets subject to rules which vary by state, more-intense regulation of urban development is associated with higher house price volatility.

That is, the steepest price increases and the sharpest falls are in areas where regulation is strongest.

The effects of planning rules can extend to the macro-economy.

Cities are one of the extraordinary inventions of the human race.

Studies have shown that cities are an engine room of growth. Incomes in cities are higher than elsewhere. That is one explanation for high rates of urbanisation.

Research indicates that when planning rules prevent workers shifting to higher-productivity locations, then there is a cost in terms of foregone GDP.

It's only relatively recently that economists and politicians have understood the scale of those effects.

So when we're talking about something as apparently dry as the Auckland Unitary Plan, we're talking about a set of rules that will have a major impact on the city, on current and future residents – but also on the wider economy.

The second reason we focus on planning and its consequences is that poor planning drives inequality.

In my view, poor urban planning is one of the significant drivers of inequality.

Poor regulation of housing has the largest proportionate effect on the lowest quartile of housing costs and rents.

So when we're having the debate about whether there is sufficient land available, we have to recognise that the people who lose the most from getting that decision wrong – and who stand the most to gain from fixing those decisions – are those on the lowest incomes.

Income inequality in New Zealand has been flat for 20 years, but the gap between incomes measured before housing costs and after housing costs is growing.

Housing costs are becoming a larger proportion of incomes – and that matters the most at the bottom end of incomes among people who have few choices.

And there are other measures of the effects on low-income households.

Twenty-five years ago, around 30 per cent of new homes coming into the market were priced in the lowest quartile. Another 30 per cent of new homes were priced in the upper quartile.

Today, only 5 per cent of new homes are priced in the lowest quartile. Nearly 60 per cent of new homes are priced in the upper quartile.

The new supply of lower-priced, affordable housing has dried up.

There are parts of Auckland where no new houses are entering the market priced at the affordable end of the market.

It is not surprising to see prices and rents rising disproportionately at the bottom end given this lack of supply.

Planning is often seen a public good activity that must address the needs of those who are most-vulnerable and have the lowest income.

In fact there is a strong argument to say it does exactly the opposite.

Poor planning favours "insiders" – homeowners – on high incomes and who have relatively high wealth.

Developers have told me that in Auckland they need to build a house worth $600,000 to make a development commercially viable.

That’s because it is difficult to build cheap housing on expensive land – particularly in view of the planning rules.

Those rules include urban limits, minimum lot sizes which prevent subdivision below a certain size, and maximum site coverage rules which prevent a house covering more than a certain proportion of the lot.

Working in combination, these rules reduce opportunities to develop affordable homes.

Now that planners are recognising these consequences, they are now creating even more rules to offset these effects; for example by requiring some developments to include up to 20 per cent affordable housing.

That is implicit recognition that planning rules have driven the costs up so much that another rule is required to offset it.

The impact of these rules on inequality, and on household incomes, leads to a third reason for why the Government is focused on the housing market.

That is the fiscal cost to Government.

As households have the proportion of their income spent on housing grow, the political pressure goes on governments to fill the gaps.

Today we spend $2 billion each year on accommodation subsidies. 60 per cent of all rentals in New Zealand are subsidised by the Government.

The state owns around $21 billion worth of houses.

One house in every 16 in Auckland is a Housing New Zealand property.

Many of these are three bedroom houses on quarter-acre sections only a few kilometres from the CBD – a massive misuse of scarce land. And all at the taxpayer's expense.

So these are the reasons why the Government pays attention to the housing market and issues stemming from poor planning.

For those among you who are economists, I would go so far as to say that while the justification for planning is to deal with externalities, what has actually happened is that planning in New Zealand has become the externality.

It has become a welfare-reducing activity.

And as with other externalities, such as pollution, the Government has a role to intervene, working with councils to manage the externality.

We're starting to get analysis that shows planning’s costs.

Too often the discussion about how our cities are planned is couched in vague terms of general good. "A world-class city." "Quality urban design." "A liveable, walkable city."

Those are all desirable, achievable objectives. But we need to understand the costs of achieving them so that we can make the trade-offs transparent.

Many of you will be living in inner city apartments.

Recent studies have shown rules setting minimum floor space requirements and minimum balcony requirements add $50,000 to $100,000 to the cost of an apartment.

That's in addition to costs associated with other rules, such as rules setting minimum ceiling heights.

Some progress has been made. A study examining minimum car parking requirements in Auckland showed the costs of that planning rule exceeded benefits by a factor of at least six.

That’s a rule that should never have been made. It has probably cost the economy millions of dollars.

Fortunately, now that we're digging in to these issues, that rule has been mostly scrapped – and credit is due to Auckland Council for doing so.

Another indicator relates to Auckland's former Metropolitan Urban Limit, now called the Rural-Urban Boundary.

A study found that the value of land just inside the urban boundary was ten times higher than the value of land just outside it.

That huge price difference around an arbitrarily-selected line on a map indicates that there are housing opportunities outside that boundary that cannot be taken because of planning restrictions.

Consequently, first home buyers trying to access the housing market are being prevented by land prices inflated by an urban boundary.

Some important objectives set by planners simply aren't being achieved.

In Auckland, it can be summed up this way. Fifteen to 20 years ago, the city set an objective to grow up, not out.

It is easy to understand the logic behind this. Auckland wanted to make greater use of existing infrastructure, and get more people living around transport nodes.

This has not happened. Most of the new building in Auckland has been out, not up.

As we get more information about what actually happens, often we find planning doesn’t achieve what people think it is achieving.

Planners and councils have a very difficult job in planning our urban areas.

Cities are incredibly complex systems. They are the product of millions of individual choices.

The idea that a small group of people could understand what choices we're making is asking too much of them.

Not because they are in any way incapable. But because the task is overwhelming.

The Auckland Unitary Plan is 3,000 pages long.

It's trying to regulate everything from the size of bedrooms to biodiversity in the Waitakere Ranges. No one person could possibly understand all the trade-offs in that plan.

Which means many of its effects will be certainly be unintended.

Planners can’t know everything – so of course they can’t be perfect in making trade-offs on our behalf.

Successful planning requires an understanding of its own limitations.

One of the things that needs to change is extra accountability and transparency.

Your prospects of being able to buy a house are directly related to the decisions made by planning officials about the availability of land, the environmental standards they apply to building, and the way infrastructure is allocated.

It’s very difficult to understand how planners do that, even though the consequences for the community and the economy are significant.

Central government has had the opportunity to sit alongside councils to understand how they make their decisions.

Some of those decisions appear quite arbitrary.

They can be driven by the tastes of individuals who have the power to make decisions.

Some decisions are contradictory within one planning system. Decisions might not fit together. Urban designers, for example, don’t always see things the same way as a council’s engineers.

First home buyers will be subject to rules which are not transparent and cannot be known in advance.

One of the areas this is most apparent is infrastructure.

Like central government, councils have historically made decisions on substantial long-term infrastructure projects with a minimal understanding of costs and benefits, and how the infrastructure will be supported over time.

Like central government, councils do not always know a lot about their infrastructure. And therefore they don't know how to price it.

Pricing infrastructure is difficult. The nature of the asset makes it difficult to price. How do you price a stormwater system?

But that pricing matters. One of the big issues for getting a more-flexible supply of land is connecting the financing of the next piece of infrastructure with the value of the land it services.

Land is made more valuable when it is serviced by infrastructure. Infrastructure financing may sound a rather dry topic – but it is fundamental to allowing a city to grow.

Because if planners believe infrastructure supporting growth is too expensive, they'll be too reluctant to release land for development – up or out.

That's not a criticism – it's an observation.

The funding base for councils is increasingly people on low fixed incomes. That is a product of an ageing population.

So you can understand why councils are under pressure not to expand if they think an expanding city is going to push up rates for existing ratepayers.

Councils need clear funding models so that development worth having can occur and future homeowners and current renters who might want to buy are taken into account.

So that's a brief overview of how important it is that housing is regulated in a way that enables flexible supply, and I hope some indication of the progress we're making.

That progress is necessarily slow, because these issues are complex.

If we better understand the economics of what is happening we can make better choices about housing regulation.

And that depends on one of the most important parts of public policy, which is the institutional arrangements by which those decisions are made.

That means looking at the incentives confronting an individual sitting in a council when making a decision about whether to allow a new subdivision.

We need to understand the incentives councils are reacting to.

Next month the Productivity Commission will produce a further report on the regulation of land supply. It will be another input into further, ongoing improvements in this area.

And we are seeing new thinking on a range of issues affecting housing, including from councils.

Often politicians are accused of being focused on the short term. That’s one of the reasons this issue has never been dealt with properly in the past.

The Government is taking a long term view.

All of the things I've talked about today will take 10 to 15 years to sort out.

So it’s important that a broad group of people understand our single-biggest asset class – the most-important asset most of us will own – how is valued, how it is regulated, and how it can contribute to our general welfare.

Thank you.