Housing policy and prospects

I’ve been wary for some time of Labour’s approach to the disgrace that is the New Zealand housing and urban land market –  a mess created, and/or presided over, by successive National and Labour-led governments.

Eric Crampton and Oliver Hartwich at the New Zealand Initiative (bastion of quasi-libertarian public policy analysis) had been consistently pretty upbeat about Labour’s proposals, and particularly about the stated desire of (then housing spokesman, now Minister of Housing, Phil Twyford) to free up the urban land market and fix problems around infrastructure financing.  There was the famous joint op-ed in the Herald a couple of years ago.    I have never been sure how much the NZI people really believed Labour was committed to letting the market work, how much they simply wanted to reinforce that strand of Labour’s thinking with support from a business-funded body, and how much it was just about building relationships with a party that would, one day, no doubt be back in government.   Perhaps there was an element of all three?

As for me

I’ve liked the talk, but have been a bit sceptical that it will come to much.  In part, I’m sceptical because no other country (or even large area) I’m aware of that once got into the morass of planning and land use laws has successfully cut through the mess and re-established a well-functioning housing and urban land market.  In such a hypothetical country, we wouldn’t need multiple ministers for different dimensions of housing policy.  I’m also sceptical because there is a great deal local government could do to free up urban land markets, but even though our big cities all have Labour-affiliated mayors, there has been no sign of such liberalisation.    The Deputy Mayor of Wellington for example leads the Wellington City Council ‘housing taskforce”.  Paul Eagle is about to step into a safe Labour seat.   His taskforce seems keen on the council building more houses, and tossing more out subsidies, but nothing is heard of simply freeing up the market in land.  Or even of looking for innovative ways to allow local communities to both protect existing interests and respond, over time, to changing opportunities.

There was also the fact that any Labour government was likely to depend on Green votes in Parliament, and there was no sign the Greens were keen on land-use liberalisation.

And then there was little sign of leadership commitment.

Labour’s leader, Andrew Little, devoted the bulk of his election year conference speech to housing, complete with the sorts of personal touches audiences like.  Media reports say the speech went down well with the faithful…….

But in the entire speech –  and recall that most of it was devoted to housing –  there was not a single mention of freeing up the market in urban land, reforming the planning system etc.  Not even a hint.    I understand that giving landowners choice etc probably isn’t the sort of stuff that gets the Labour faithful to their feet with applause.   But to include not a single mention of the key distortion that has given us some of the most expensive (relative to income) house prices in the advanced world, doesn’t inspire much confidence.

It has been no different since Jacinda Ardern took over as leader.

Sure, as defenders point out, reform of the planning system does appear in Labour’s manifesto, and there was a brief mention in the Speech from the Throne.  But mostly what we hear about are the same, consistently emphasised, lines they’ve been running for at least the last year:

  • the ban on non-resident non-citizens buying existing residential property,
  • the extension of the brightline test (from two years to five years),
  • ringfencing, so that rental property losses can’t be offset by other income, and
  • Kiwibuild.

As well as measures to impose new higher standard on rental properties.  In practice, the new Tax Working Group also seems likely to be focused on housing-related tax issues (capital gains tax in particular).

Two things in the last few days reinforced my unease.

The first was the new “independent stocktake of the housing crisis” the Minister has commissioned.  Given that it was announced on 25 November, and is to report “before Christmas”, it is hard to believe that the group will come up with much new and different.  Probably, that isn’t even the point.

Here is how the Minister framed the work

“Shamubeel Eaqub, Philippa Howden-Chapman, and Alan Johnson are among New Zealand’s foremost experts on housing. Their insight will be invaluable.

“This report will provide an authoritative picture of the state of housing in New Zealand today, drawing on the best data available. It will put firm figures on homelessness, the state of the rental market, the decline of homeownership, and other factors in the housing crisis.

“The Labour-led Government is already pushing ahead quickly with initiatives to make housing more affordable and healthy, including banning overseas speculators, passing the Healthy Homes Guarantee Bill, cancelling the state house selloff, and setting up KiwiBuild. This report will help the Government refine and focus that work where it is most needed.

Each of the members has some expertise in aspects of housing, but none has any expertise  in –  or known sympathy with arguments for – freeing up land-use restrictions, and allowing the physical footprint of cities to grow readily as the population does.  And then there is the third paragraph –  the same old list of direct interventions, with nothing at all about liberalisation of the land market, even though it is vital if the long-term structural problems are to be effectively addressed.

Now perhaps the Minister will argue that planning reform is proceeding on a separate track, or even point to the responsibility of his colleague, the Minister for the Environment, David Parker.  But the fact remains that in all the talk about fixing the badly-distorted housing market there is little open emphasis on land-use law, nothing on reducing the price of urban land, and nothing on (finally) letting the market work effectively.

And then there was a substantial interview  the other day with Phil Twyford on interest.co.nz.   And it was much the same again.  There was plenty of talk of the coming tax changes and the proposed foreign ownership ban.  And there was great deal of talk about Kiwibuild.  There was reference to using Crown and Council-owned land in Auckland to build on.  But there was nothing at all, in the entire 23 minute interview, on reforming or freeing up the market in urban land.  There were defensive references –  it would be hard to produce ‘affordable” houses in the $500-600K range because land was ‘absurdly expensive” –  but nothing,  not a word,  about reforms that might effectively, and enduringly, lower land prices.

There was. of course, lots of talk of how “we have to build more houses”, but no attempt to seriously address the argument that, given land-use restrictions, there may not be any material unmet demand for houses at the prevailing price.   Talk about a shortage of 71000 houses –  or whatever the latest guess is –  is mostly nonsense unless the land market is fixed, and the price of land falls considerably.  At much lower land prices, I think there is little doubt that there would be more effective demand for housing –  and no obvious reason why the private sector would not meet that additional effective demand.  That would be a highly desirable outcome, but in his interview the Minister studiously avoided any suggestion of land prices falling.   And at current (very high, but currently stable) prices, there isn’t obviously any unmet effective demand in Auckland at present.

All the Minister’s talk seems to be of state-led projects to build more houses, including more ‘affordable’ houses, and more state houses.   In some cases, it seems, it will just involve the state participating in developments that were already planned.    But unless land prices are going to fall materially, it is really hard to see how any big increase in state-associated housebuilding isn’t going to largely displace private sector building that might otherwise have taken place.    For all the talk about building at different price points, and actually building more so-called “affordable houses”, houses are substitutable, to a greater or lesser extent.  A new small place on a tiny amount of land at, say, $600,000 (a price point which even the minister conceded would be a stretch) is going to be competing with existing houses in that price range in, say, Manurewa.  Perhaps additional state-led building can alter relative prices a bit but (a) if so, it seems likely too be only by use of government subsidies (the Minister indicated that the government will not be charging for the development risk, in a way that any private developer would need to), and (b) nothing about the underlying scarcity (regulation-induced) of land will change.

In their recent Monetary Policy Statement, the Reserve Bank indicated that it was assuming that half of the Kiwibuild activity displaced other construction.    They didn’t elaborate on that point, but I have an Official Information Act request in with them asking for the analysis they did in support of that assumption.

(Incidentally, while I am keen to see LVR restrictions come off –  since they never should have been put on –  it would be quite curious to see them beginning to be removed at just the sort of time when –  on government policy –  the risks around housing lending might increase quite considerably.   If the government is to be taken at its word, and we really are to see a massive increase in housebuilding, led by government initiatives rather than market forces – and at a time when many forecasters expect net immigration to be dropping away –  the risks of an oversupply of physical housing (as in Spain, Ireland and parts of the United States) would have to be considerably greater than they’ve been in recent decades.  Of course, weirdly, LVR restrictions have never applied to the most risky type of housing lending, that for houses being built.)

Two final points:

The Minister indicated, again, that one of the government’s motivations in its housing reforms is to “shift investment”, so that people don’t so much buy houses, as buy shares etc.  On this point, they seem as confused as ever.  If there really is a physical shortage of, say, 71000 houses and that is to be met over the next few years, there will have to be much more physical investment in building houses.  And someone will need to own those houses –  whether owner-occupiers, the state, or private rental businesses.  Real resources devoted to one use can’t be devoted to another use.  And, for any given stock of houses, it isn’t that evident that it is likely to make much difference to economic performance who (among New Zealand residents) owns those houses.  I’m all for home ownership, but if owner-occupiers buy houses (with large mortgages) it isn’t obvious why capital markets etc, or investment choices by businesses elsewhere in the economy, will be much different than if rental property owners buy houses (with large mortgages).

In his interview, the Minister was also lamenting large boom-bust cycles in residential construction, and suggesting that was part of the problem in New Zealand. I was a bit puzzled by that suggestion, and wondered if there was any evidence that the fluctuations in residential building activity were larger here than in other advanced economies.  It was possible they were –  after all, our population growth rates are quite variable, mostly because of swings in the flow of New Zealanders going to Australia.  So I dug out the data, for residential investment as a share of GDP, going back to 1995 (when complete data is available for most OECD countries).  This chart shows the coefficient of variation (ie the standard deviaton divided by the mean).

construction coeff of var

At least over this period, residential building activity (as a share of GDP) in New Zealand has been less variable than in the median OECD country, and far less variable than in the countries to the far right of the chart.  Over a longer period, back to 1970, there is no sign that New Zealand’s residential investment cycles have been larger or more variable than those in Australia or the United States.  Investment is variable –  typically the most variable component of GDP.  It is how market economies work.

Where does all this leave me?  With the new government’s apparent determination to continue to pursue a “big New Zealand” approach, without any material change to immigration policy, the need for additional housing will continue to grow largely unabated (tax changes and foreign ownership bans won’t make much more sustained difference here than they have abroad).   Perhaps the government has plans, currently kept quiet, for far-reaching land use reforms that will enable the market to meet changing demands, at genuinely affordable prices –  as happens in much of the US.  But at present it looks disconcertingly as though the centrepiece is going to be a government-led house building programme that (a) never gets to grips with the land issues, (b) will substantially displace private sector building, and (c) runs all the sorts of risks that government-led investment projects are often prone to.

Perhaps it will work. But it is hard to be optimistic at present.

 

UPDATE: An interesting piece from today’s Herald on the way land prices render even moderate intensification not really consistent with more “affordable” house prices in Auckland.

UPDATE (Friday):  Twyford speech on the government’s housing policy does nothing to allay any of the concerns in this post.   Land use reforms appear, a little cryptically, very briefly and near the end of the speech.

 

 

The new government’s immigration policy

It was confirmed yesterday that the new government’s immigration policy will be the policy the Labour Party campaigned on (albeit very quietly).  And so we learned that the new government will remain a fully signed-up adherent of the same flawed, increasingly misguided, “big New Zealand” approach that has guided immigration policy for at least the last 25 years.

If that is disappointing, it shouldn’t really be any surprise.     The Green Party approach to immigration is pretty open –  the “globalist” strand in their thought apparently outweighing either concern for New Zealand’s natural environment or any sort of hard-headed analysis of the economic costs and benefits to New Zealanders.  Only a few months ago, they were at one with the New Zealand Initiative, tarring as “xenophobic” any serious debate around the appropriate rate of immigration to New Zealand.  Never mind that population growth is driving up carbon and methane emissions, in a country where marginal abatement costs are larger than in other advanced economies, and yet where the same party is determined that New Zealand should reach net zero emissions only 33 years hence.

As for New Zealand First, they talk a good talk.  But that’s it.   As I noted a few months ago, reading the New Zealand First immigration policy (itself very light on specifics)

If one took this page of policy seriously, one could vote for NZ First safe in the expectation that nothing very much would change at all about the broad direction, or scale, of our immigration policy.     Of course, there would be precedent for that.  The last times New Zealand First was part of a government, nothing happened about immigration either.

Even so, I was just slightly surprised that there wasn’t even a token departure from the Labour Party’s immigration policy that New Zealand First could claim credit for.   The New Zealand Initiative’s report on immigration policy earlier in the year was largely (and explicitly) motivated by concerns about what New Zealand First might mean for immigration policy.

Six months ago, when we started scoping the Initiative’s immigration report, we had a very specific audience in mind: Winston Peters. Our aim was to assemble all the available research and have a fact-based conversation with New Zealand’s most prominent immigration sceptic.

Turns out that, perhaps not surprisingly based on the past track record, that they needn’t have bothered.

And so Labour’s election policy will be the immigration policy of the new government.    The policy documents themselves are here and here.   I wrote about the policy here at the time it was released in June, before the Ardern ascendancy.   It was notable how little attention Labour gave to immigration policy during the campaign –  perhaps it didn’t fit easily with the “relentlessly positive” theme –  and I understand there was a conscious decision by the new leadership to downplay the subject.    It will be interesting to see now whether they follow through on their manifesto, but very little about immigration policy requires legislative change so, in principle, the changes should be able to be done quite quickly.  In fact, as the biggest proposed changes affect international students one would assume they will be wanting to have those measures in places in time for the new academic year.

What also remains quite remarkable is the extent to which Labour’s policy has been taken as a substantial change.  Serious overseas media and intelligent commentators have presented Labour’s proposals as some sort of major sustained change in New Zealand approach to immigration, and thus to expected immigrant numbers.    To read some of the Australian and American commentary you might have supposed, say, that in future New Zealand’s immigration approvals might be cut towards, say, the sorts of levels (per capita) that prevailed in the United States under Bush and Obama.

Labour’s policy is, of course, nothing of the sort.  Under the proposed policy, New Zealand will remain –  by international standards –  extraordinarily open to non-citizen migrants, with expected inflows three times (per capita) those of the United States, and exceeded only (among OECD countries) by Israel in a good year (for them).

What determines how many people from abroad get to settle permanently in New Zealand is the residence approvals programme.   Under that programme, at present the aim is to grant around 45000 approvals to non-citizens each year (Australians aren’t subject to visa requirements, but in most years the net inflow of Australians is very small).  The outgoing government reduced that target (from 47500) last year.   Labour’s immigration policy document does not, even once, mention the residence approvals programme.  That was, no doubt, a conscious choice.  They are quite happy with the baseline rate of non-citizen immigration we’ve had for the last 20 years; quite happy to have the highest planned rate of non-citizen immigration anywhere in the OECD.  Medium-term forecasts of the net non-citizen immigration inflow will not change, one iota, if Labour proceeds with their policy.  For some of course, that will be a desirable feature.  For others it is a serious flaw, that results from failing to come to grips with the damage large scale immigration is doing to the economic fortunes of New Zealanders.

Of course, there are planned policy changes.    There are various small things:

  • an increased refugee quota,
  • steps to increase the utilisation of the existing Pacific quotas,
  • more onerous requirements for investor visas (including requiring investment in new “government-issued infrastructure bonds”),
  • a new Exceptional Skills visa,
  • a KiwiBuild visa

Taken together, these won’t affect total numbers to any material extent.

There is also a (welcome) change under which they will

Remove the Skilled Migrant Category bonus points currently gained by studying or working in New Zealand and standardise the age points to 30 for everyone under 45.

All else equal, these changes won’t affect the number of people getting residence, or materially affect the average quality (skill level) of those getting residence.   That is a shame: at present, too many migrants aren’t that skilled at all, and maintaining such a large approvals target (in such a remote, not very prosperous, country) makes it hard to lift the average quality.

The bigger changes are under two headings.    The first is around temporary work visas.   Here is what they say they will do.

Labour will:

• Actively manage the essential skills in demand lists with a view to reducing the number of occupations included on those lists

• Develop regional skill shortage lists in consultation with regional councils and issue visas that require the visa holder to live and work within a region that is relevant to their identified skill

• For jobs outside of skills shortages lists, Labour will ensure visas are only issued when a genuine effort has been made to find Kiwi workers

• Strengthen the labour market test for Essential Skills Work Visas to require employers to have offered rates of pay and working conditions that are at least the market rate

• Require industries with occupations on the Essential Skills in Demand lists to have a plan for training people to have the skills they require developed together with Industry Training Organisations

• Review the accredited employers system to make sure it is operating properly.

The broad direction seems sensible enough –  after all, the rhetoric has been about lifting the average skill level of the people we take.   But as I noted in my comments in June, the policy is notable for its touching faith in the ability of bureaucrats to get things right, juggling and managing skills lists, and now extending that to a regional differentiation.   There is no suggestion, for example, of letting markets work, whether by (as I’ve proposed) imposing a flat (quite high) fee for work visas and then letting the market work out which jobs need temporary immigrant labour, or by requiring evidence that market wages for the skill concerned have already risen quite a lot.  The latter would have seemed an obvious consideration for a party with trade union affiliates.

On Labour’s own estimates, these changes won’t have a large effect on the number of people here on work visas at any one time, although in the year or so after any changes are implemented, the net inflows that year will be lower than they otherwise would have been.

Much the same goes for the biggest area of change Labour is proposing, around international students.

Labour will:

• Continue to issue student visas and associated work rights to international students studying at Level 7 or higher – usually university levels and higher

• Stop issuing student visas for courses below a bachelor’s degree which are not independently assessed by the TEC and NZQA to be of high quality

• Limit the ability to work while studying to international students studying at Bachelor-level or higher. For those below that level, their course will have to have the ability to work approved as part of the course

• Limit the “Post Study Work Visa – Open” after graduating from a course of study in New Zealand to those who have studied at Bachelor-level or higher.

In general, I think these are changes in the right direction.  Here were some of the comments I made earlier

I’m a little uneasy about the line drawn between bachelor’s degree and other lines of study.  It seems to prioritise more academic courses of study over more vocational ones, and while the former will often require a higher level of skill, the potential for the system to be gamed, and for smart tertiary operators to further degrade some of the quality of their (very numerous) bachelor’s degree offerings can’t be ignored.  …… I’d probably have been happier if the right to work while studying had been withdrawn, or more tightly limited, for all courses.   And if open post-study work visas had been restricted to those completing post-graduate qualifications.

The proposals are some mix of protecting foreign students themselves, protecting the reputation of the better bits of our export education industry, and changes in the temporary work visas rules themselves.     In Labour’s telling –  and it seems a plausible story –  the changes are not designed to produce a particular numerical outcome, but to realign the rules in ways that better balance various interests.  The numbers will adjust of course, but that isn’t the primary goal.

Labour estimates that these changes will lower the number of visas granted annually by around 20000.   That is presented, in their documents, as a reduction in annual net migration of around that amount.   But that is true only in a transition, immediately after the changes are introduced.  The stock of people here on such student and related visas will fall, but after the initial transitional period there will be little or no expected change in the net inflow over time (which is as one would expect, since the residence approvals target is the key consideration there).

To see this consider a scenario in which 100000 new short-term visas are issued each year, and all those people stay for a year and a day (just long enough to get into the PLT numbers).  In a typical year, there will then be 100000 new arrivals and 100000 departures.

Now change the rules so that in future only 75000 short-term visas are issued each year.  In the first year, there will be 75000 arrivals and (still) 100000 departures (people whose visas were issued under the old rules and who were already here).  But in the next year, there will be 75000 arrivals and 75000 departures.    Measured net PLT migration will have been 25000 lower than otherwise in the first year, but is not different than otherwise in the years beyond that.

That doesn’t mean the policy changes have no effect.  They will lower the stock of short-term non-citizens working and studying in New Zealand.    They will ease, a little, demand for housing.  In some specific sectors, with lots of short-term immigrant labour, they may ease downward pressures on wages (although in general, immigrants add more to demand than to supply, and that applies to students too).   But it won’t change the expected medium-term migration inflow.

Oh, and the student visa changes will, all else equal, reduce exports

Selling education to foreign students is an export industry, and tighter rules will (on Labour’s own numbers) mean a reduction in the total sales of that industry.   Does that bother me?  No, not really.  When you subsidise an activity you tend to get more of it.  We saw that with subsidies to manufacturing exporters in the 1970s and 80s, and with subsidies to farmers at around the same time.  We see it with film subsidies today.  Export incentives simply distort the economy, and leave us with lower levels of productivity, and wealth/income, than we would otherwise have.   In export education, we haven’t been giving out government cash with the export sales, but the work rights (during study and post-study) and the preferential access to points in applying for residence are subsidies nonetheless.  If the industry can stand on its own feet, with good quality educational offerings pitched at a price the market can stand, then good luck to it.  If not, we shouldn’t be wanting it here any more than we want car assembly plants or TV manufacturing operations here.

I participated in a panel discussion on Radio New Zealand this morning on Labour’s proposed changes.  In that discussion I was surprised to hear Eric Crampton suggest that the changes would put material additional pressure on the finances of universities.    Perhaps, although (a) the changes are explicitly aimed at sub-degree level courses, and (b) to the extent that universities are getting students partly because of the residence points that have been on offer, it is just another form of “corporate welfare” or subsidy that one would typically expect the New Zealand Initiative to oppose.      Whether hidden or explicit, industry subsidies aren’t a desirable feature of economic policy.

Standing back, Labour’s proposal look as though they might make a big difference in only a small number of sectors, notably the lower end of the export education market.  If implemented, they will be likely to temporarily demand housing demand –  perhaps reinforcing the current weakness in the Auckland housing market, along with some of their other proposed legislation (eg the extension of the brightline test and the “healthy homes” bill).   But they aren’t any sort of solution to the house price problem either: after the single year adjustment, population growth projections will be as strong as ever, and in the face of those pressures only fixing the urban land market will solve that problem. Time will tell what Labour’s policy proposals in that area, which have sounded promising, will come to.

Two final thoughts.  One wonders if whatever heat there has been in the immigration issue –  and it didn’t figure hugely in the election –  will fade if the headline numbers start to turn down again anyway.   The net flow  of New Zealanders to Australia has not yet shown signs of picking up –  but it will resume as the Australian labour market recovers.  But in the latest numbers, there has been some sign of a downturn in the net inflow of non-citizens.

PLT non citizen

There is a long way to go to get back to the 11250 a quarter that is roughly consistent with the 45000 residence approvals planned for each year.  But, if sustained, this correction would provide at least some temporary relief on the housing and transport fronts.  As above, Labour’s changes will have a one-off effect on further reducing this net inflow in the next 12 or 18 months, but nothing material beyond that.

And in case this post is seen by the new Minister of Immigration, or that person’s advisers, could I make a case for two things:

  • first, better and more accessible data.  The readily useable migration approvals is published only once a year, with a lag even then of four or five months.  The latest Migration Trends and Outlook was released in November 2016, covering the year to June 2016.  It is inexcusably poor that we do not have this data readily, and easily useable, available monthly, within a few days of the end of the relevant month, and included (for example) as part of Statistics New Zealand’s Infoshare platform.  The monthly PLT data are useful for some things, but if you want a good quality discussion and debate around immigration policy, make the immigration approvals data more easily available.    As a comparison, building permits data is quickly and easily available, reported by SNZ.  Why not migration approvals?
  • second, considering referring the issue of the economics of New Zealand immigration to the Productivity Commission for an inquiry.   Perhaps the current policy, as Labour proposes to amend it, has all the net gains the advocates say it does.  If so, the Productivity Commission could helpfully, and in a non-partisan way, demonstrate that.  But there are still serious issues around New Zealand’s unusually liberal immigration policy, in a country so remote and with such a poor track record in increasing its international trade share.  Whatever the economic merits of immigration in some places, it is by no means sure that large scale immigration here is doing anything to improve the fortunes of most New Zealanders.  It may, in fact, be holding us back, being one part of the story as to why we’ve failed to make any progress in closing the productivity gaps with other advanced economies.  It would seem an obvious topic for the Productivity Commission, and a good way of lifting the quality of the policy debate around this really substantial policy intervention.

 

 

 

Disagreeing with Don Brash on monetary policy

The Labour Party is campaigning on a couple of changes to the Reserve Bank Act.  One would make a statutory committee, rather than the Governor alone, legally responsble for monetary policy decisions, and would require the minutes of that committee to be published fairly shortly after the relevant meeting.   I don’t think that change goes far enough – and it doesn’t deal at all with the extensive (and much less constrained) decisionmaking powers the Bank has around financial institution regulation –  but if not everyone actively favours change, there aren’t now that many defenders of the (single decisionmaker, secretive) status quo.  Even Steven Joyce got The Treasury to commission some advice on possible changes, although his officials now refuse to release that report.

There is more dispute around the other limb of Labour’s proposed changes, in which they proposed to amend the statutory goal of monetary policy from “stability in the general level of prices” only “to also include a commitment to full employment”.

Earlier this week, so NBR reports, Grant Robertson and former longserving Governor Don Brash came head to head at BusinessNZ election conference.   Don thinks the proposed change is wrong and was reported as pointing to two reviews undertaken during the term of the previous Labour government, both of which saw no reason to change the statutory objective for monetary policy.

My initial reaction to the proposed Labour change was also sceptical, and I initially went as far as to describe it as “virtue signalling”.  I was discussant at an Victoria University event a few months ago where Robertson launched his policy, and this is how I summarised my view in a post written the following day.

I was (and am) much more sceptical, and nothing that was said in response to questions really clarified things much.    I get that full employment is an historical aspiration of the labour movement, and one that the Labour Party wants to make quite a lot of this year.  In many respects I applaud that.  I’m often surprised by how little outrage there is that one in 20 of our labour force, ready to start work straight away, is unemployed.  That is about two years per person over a 45 year working life.  Two years……     How many readers of this blog envisage anything like that for themselves or their kids?

But still the question is one of what the role of monetary policy is in all this, over and above what is already implied by inflation targeting (ie when core inflation is persistently  below target then even on its own current terms monetary policy hasn’t been well run, and a looser monetary policy would have brought the unemployment rate closer to the NAIRU (probably now not much above 4 per cent)).

I noted that I’m sceptical that the wording of section 8 of the RB Act is much to blame.  After all, for several years prior to the recession, our unemployment rate was not just one of the lowest in the OECD, it was also below any NAIRU estimates.  And when I checked this morning, I found that our unemployment rate this century has averaged lower than those of Australia, Canada, the US and the UK, and our legislation hasn’t changed in that times.  Robertson often cites Australia and the US.

The last few years haven’t been so good relatively speaking.  But if the legislation hasn’t changed and the (relative) outcomes have, that suggests it is the people in the institution who made a mistake –  they used the wrong mental model and were slow to recognise their error and respond to it.  Getting the right people, and a well-functioning organisation, is probably more important than tweaking section 8.

I stand by most of those individual comments.  But as I thought about things further, I’ve come to conclude that the direction Labour is wanting to go is the right one (although details matter, and there are few/no details).   If anything, one could mount an argument that defence of the current statutory formulation risks being “virtue signalling”.

Don Brash relies in part on the two enquiries undertaken in the term of the previous Labour government.  The second, conducted by Parliament’s Finance and Expenditure Committee, can largely be discounted.  It was set up in 2007 at time when there was quite a bit of caucus (and ministerial) discontent with the Reserve Bank –  the OCR had been raised again, and the exchange rate was again strong.   A lot of work went into the inquiry, and it reported in 2008, just weeks before the 2008 election.  But however much grumpiness there had been, a government-dominated committee was never going to come out a few weeks before an election their party looked like losing arguing that a key aspect of macroeconomic policy had been done badly throughout their term in office.

The earlier inquiry, conducted by Swedish economist, Lars Svensson at the request of the incoming Minister of Finance in 2000/01 would normally be a more potent argument.    Svensson was an academic expert in matters around inflation targeting and he was content to recommend retaining the statutory goal for monetary policy as it was.

So what has changed?   Robertson is quoted in the NBR article as saying that monetary policy has “enormously changed” since the international crises of 2008/09.  Here I simply disagree with him, and find myself (I think) strongly agreeing with the outgoing Governor of the Reserve Bank, who  notes that for all the talk it is remarkable how little change there has been in monetary policy anywhere.  Sure, interest rates are a lot lower, and various major central banks resorted to unconventional quantity-based measures to supplement their toolkit.  But there is no sign of any material change in any of those countries in how the goals of monetary policy have been specified (whether in statute or in more-operational documents).  As the Governor often notes, no one has abandoned inflation targeting, and no one has lowered (or raised) their inflation target.

Of course, if there was once in some circles a degree of hubris around quite how much good stuff central banks can deliver, much of that has now dissipated.  And the use of unconventional tools has raised questions about accountability, given that some of those tools can verge quite close to fiscal policy, for which legislatures are typically responsible.

But perhaps two relevant things have changed.  The first is Lars Svensson, who –  having had several years experience as a senior policymaker – now quite openly argues that flexible inflation targeting should involve a clear and explicit specification of an inflation target and  the identification of a sustainable long-run unemployment rate, with explicit weights assigned to deviations from these two variables.      I wrote at some length about Svensson’s view of these things in a post in April.   As I noted then

I don’t know specifically what Svensson would make of the current debate in New Zealand, or of what the Labour Party (at quite a high level of generality) is proposing.    What we do know is that Labour is proposing nothing nearly as specific or formal as Svensson argues for: there would be no numerical unemployment target or an official external assessment of the NAIRU (or LSRU).  My impression would be that his reaction would be along the lines of “well, of course the unemployment rate –  and short to medium term deviations from the long-run level, determined by non-monetary factors – should be a key consideration for monetary policymakers; in fact it is more or less intrinsic to what flexible inflation targeting is”.   He might suggest there are already elements of that in the PTA, but that making it a little more high profile, with an explicit reference to unemployment, might be helpful.

At the time, I suggested they might find it useful to get in touch with Svensson, who retains an interest in New Zealand.    Should they form the government after the election next month, he would be someone that they would be wise to consult, both in making their proposed legislative change, and in articulating a social-democratic vision of what should be looked for from a central bank.

The other thing that has changed over the last 15 years or so is our own central bank.   It is striking how little public attention they ever pay to unemployment, even though it is the most tangible measure of excess capacity – and one directly involving people’s lives and livelihoods.  But perhaps more striking still is the way in which they have conducted monetary policy in a way that has left the unemployment rate above any reasonable estimates of the NAIRU for eight years.    That would have seemed staggering to us when we were looking at getting inflation under control in the late 1980s –  when we knew that temporarily higher unemployment was a price of getting inflation down.  It is pretty inexcusable in today’s climate –  which doesn’t stop people making excuses.

And so I come back to the point I made in the remarks quoted above.   Getting the right person –  and people –  into the senior positions responsible for the conduct of monetary policy probably matters more than changing the statutory objective.  At the moment, an incoming Minister of Finance has no way of putting his or her preferred types of people in those roles –  all that power rests with the Board (the company directors and the like appointed by the outgoing government, with almost no accountability).  That needs to be tackled directly, and quickly.

But the way the statutory goal is expressed should affect expectations on the new Governor (and any committee that is established as part of governance reforms).    Over recent years, fear of booms seems to have driven the Governor (and his staff)  – with no statutory mandate at all –  and there has been no pressure on them to focus on delivering low and sustainable rates of unemployment.    Changing the Act  –  in the generalised way Labour seems to be talking of  – and not changing the sort of people making the decisions won’t have much impact at all.  But changing the Act in this area, can be one part of an array of changes that lead the Reserve Bank in future to put much more emphasis on unemployment, in public and in private, in the way that many other advanced country central banks do.  Policy is, after all, supposed to be about people.

What array of changes should any new government make?

  • a move to a decisionmaking committee, appointed by the Minister, and subject to parliamentary hearings before taking up the appointment,
  • making a low sustainable rate of unemployment (“full employment” if you must) a part of the statutory goal of monetary policy,
  • require the Reserve Bank to publish estimates of the NAIRU and, in the Monetary Policy Statement,  require them to explain reasons for any material deviations from those NAIRU estimates,
  • require the timely publication of minutes of the decisionmaking committee and (with a longer lag) of the background analysis papers provided to the committee, and
  • in the immediate future, change the Act to allow the Minister and Cabinet to appoint the new Governor directly (this is the normal way such appointments are made in other countries).  Getting the right person to lead these reforms is vital and there is no reason to think people like the current Board would deliver that person.

And just briefly on the substantive issue: the reason we have active discretionary monetary policy is because people have judged, over decades, that, were we not to do so, output and employment would be much more variable, and in particular recessions –  and periods of high unemployment –  would be more more savage and sustained than they need to be.   That is not a novel proposition now, and it isn’t even a particular controversial one (although some free bankers will point out that, say, the worst US recessions have been since the central bank was set up) –  it is a standard insight of modern macroeconomics.  Greeece is a particularly nasty example of the alternative approach.   That’s why I’m uneasy about those defending a single price stability goal for monetary policy: it may well be the medium-term constraint on what else monetary policy can do, it is one of desired outcomes we want to preserve (I say preserve because sustained inflation is a phenomenon of the central banking era, whereas longer-term price stability was a feature of earlier centuries), but it isn’t the main reason why we have active discretionary central banks.  We have such institutions primarily because we care about minimising the bad times –  sustained periods of excess capacity and high unemployment.  We aren’t –  or shouldn’t be – averse to booms (except to the extent they portend busts) but we should be, and mostly are, very averse to significant deviations from “full employment”.  Keeping unemployment as low as the other labour market institutions (welfare systems, minimum wages etc) allow could reasonably be seen as the primary goal of monetary policy.     Rising inflation would then be an indicator that the central bank had overdone things, and thus price stability represents a useful constraint or check on over-optimism about how low the unemployment rate can be got at any particular point in time.   At present however, defenders of the current specification of the goal can almost come across as if it is a point of virtue not to care, let alone to mention, about those who are unemployed.

Things were a little different in 1989 when Parliament was first debating the Reserve Bank legislation. Arguably it made a lot of sense then to put in a single goal of price stability –  because having lost sight of the constraint (price stability) in earlier decades, it was important to establish confidence that inflation would in future be taken very seriously.    That isn’t the main message we, the markets, or the Reserve Bank need to hear after years of below-target inflation, and even more years of above-NAIRU unemployment rates.

So although I have a great deal of respect for Don Brash, and these days count him as a friend, on this occasion I think he’s wrong and Grant Robertson is much closer to right.

Debating housing

The centrepieces of the two weekend TV current affairs shows were political debates: The Nation had Phil Twyford and Amy Adams on housing, and Q&A had Grant Robertson and Steven Joyce on the economy more generally (but with a large chunk on housing).   I only saw the Q&A debate, but I have glanced through the transcript of Twyford/Adams.

In the course of his debate, Phil Twyford was asked how much house prices should be relative to income.    His response was excellent

Twyford: Ideally, they should be three times. If we had a housing market that was working properly, your housing would be— the median price would be about three to four times the median household income.

Grant Robertson repeated those sorts of numbers in his exchange with Steven Joyce.  It was good, clear, encouraging stuff.    A reminder of just how totally out of whack things are in the New Zealand house and urban land market.   And a suggestion that the main opposition party wants things to be materially different and better.

But I can’t help wondering in which decade they expect things to be more or less okay again.   In time for, say, my children –  perhaps 10 to 15 years from now –  or will it only be the grandchildren?

Don’t get me wrong.   Watching the Robertson/Joyce debate, as someone who has no idea who he will vote for, I thought Robertson had much the better of the housing side of the debate.   The current government seems reduced to some mix of lamenting that it is “a global problem”, reluctantly conceding that Auckland prices are a bit too high, and claiming that just over the horizon there is a wave of supply that will substantially address the problems.   So if I’m critical of Labour here, take for granted that almost all the criticisms apply with more force to National.

Here is Phil Twyford avoiding suggesting that Labour wants house prices to come down

So is it Labour’s goal to get it down to that – about four times?
Twyford: We want to stabilise the housing market and stop these ridiculous, year on year, capital gains that have made housing unaffordable for a whole generation of young Kiwis.
But in essence, you’re going to drop the value of houses, if you want them to be four times the price of the average income.
Twyford: Well, we’re going to build through KiwiBuild. We’re going to 100,000 affordable homes.
I want to come to KiwiBuild in a moment. I just want to talk to you about the price.
Twyford: That will make housing affordable for young Kiwi families. That’s our policy.

Stabilising the housing market, and ending rapid house price appreciation, isn’t a recipe for fixing up the housing market for the current generation of young people.

Grant Robertson was much the same –  reiterating the goal of house prices of 3 to 4 times income, but he couldn’t or wouldn’t say how long it would take.  There was plenty of talk about building “affordable houses” (around $600000?) and “cracking down on speculators” and beyond that it all seemed to be down to growing incomes.   But there wasn’t even a mention of freeing up land supply –  a topic where formal Labour policy looks better than anything else on offer from major parties.  Even though, the largest single component in the increase in New Zealand (especially Auckland) house prices has been the land component.

On the other side of the exchange Steven Joyce was taunting Robertson with the suggestion that “Labour wants to crash house prices with a punitive capital gains tax” –  as if, whatever the (de)merits of a CGT, much lower house prices would be the worst thing in the world.

Lifting growth in productivity and real incomes is highly desirable.   All else equal, flat nominal house prices and faster income growth is a recipe for improved housing affordability.  But how long might it take on reasonable assumptions?

I’ve shown similar charts on this point previously.  Here I assume a starting point of a price to income ratio of 10 (around current Auckland levels) and that (a) nominal house prices hold at current levels for the indefinite future, and (b) incomes grow at a rate equal to 2 per cent (midpoint inflation target) plus the rate of economywide productivity growth.  I’m just going to assume that the 2 per cent average inflation could be achieved quite easily if the government wanted to. Productivity is the harder issue.  Here I’m showing four lines using:

  • actual productivity growth (GDP per hour worked) over the last decade (just under 0.6 per cent per annum),
  • actual productivity growth over the last thirty years (for which we have quarterly real GDP and hours data), of just under 1.2 per cent per annum,
  • productivity growth of 1.5 per cent per annum, and
  • productivity growth of 2 per cent per annum.

The straight line on the chart is at a price to income ratio of 3.5 (ie the midpoint of the 3 to 4 times income Labour is talking of).

house price to income ratio with flat nominal house prices

On the best of these scenarios, price to income ratios get to 3.5 in about 27 years time.   If we manage productivity growth equal to that for the last 30 years –  which itself would be quite an achievement at present – we’d be waiting almost 35 years.

Affordable housing, and a functional housing market, for the current generation simply requires a fall in nominal house prices.   And yet no major party politicians seems to have the courage, or the self-belief (in their ability to communicate and take people with them), to make that simple point.

For most existing home-owners, the market value of their house does not matter a great deal.  A large proportion of home-owners have a modest mortgage or none at all, so negative equity isn’t a risk.  And since most people retire in the same city they’ve spent their working lives in, their house price doesn’t even affect very materially their own expected future purchasing power.

Fear of falling house prices seems to reduce to two particular dimensions:

  • people who, having bought in perhaps the last five years, would find themselves with negative equity if house prices fell markedly (in turn divisible between new owner-occupiers and purchasers of additional rental properties), and
  • some generalised fear that a fall in house prices goes hand in hand with economic disaster, serious recessions and the sort of experience the US or Ireland had.

The latter is mostly a category error.  In both the US and Ireland, there was material overbuilding (excess stocks of actual houses).  There is no prospect of that situation in New Zealand on any of the policies of the major parties.  In Ireland, the situation had been compounded by joining the euro, which gave Ireland interest rates set in Frankfurt that bore no relationship to the needs of the Irish economy.  In the US, there had been persistent official efforts –  from Congress, the Fed, and successive Administrations –  to encourage, or compel, the financial system to take on housing lending risk that the private sector would be unlikely to have assumed willingly.   None of that resembles New Zealand.  Not only do we set our own interest rates, but to the extent there is state involvement in the housing finance market it is reducing the supply of credit.

A severe recession could, at least for a time, lower New Zealand house prices.  Recessions –  severe or otherwise –  aren’t things to welcome.  But the sort of land market liberalisation (with associated infrastructure rules) that might, as a matter of policy, set out to materially lower New Zealand house and land prices would be most unlikely to materially dampen demand or economic activity.  If anything, it could represent a material boost to demand, as building became more affordable.   (And if some people would find themselves with negative equity, whole swathes of younger generations would suddenly face new opportunities and less of a desperate need to save.)

What about the people facing negative equity?  I don’t have any particular sympathy with those who’ve purchased investment properties in recent years and might face being wiped out.   They’d have taken a business and investment risk –  in this case on the regulatory distortions never being fixed –  and lost.  That happens in all sorts of market –  think of the people with exposures to shares after 1987, or in finance companies 10 years ago.  Or those with businesses based in import licenses in earlier decades.  It is tough for them individually, and almost all of them have votes.  But it was a business risk, and a conscious voluntary choice.

I’m much more sympathetic to those who bought a first house and could face a large chunk of negative equity.    I touched on this in a post a few weeks ago

No one will much care about rental property owners who might lose in this transition –  they bought a business, took a risk, and it didn’t pay off.  That is what happens when regulated industries are reformed and freed up.    It isn’t credible –  and arguably isn’t fair –  that existing owner-occupiers (especially those who just happened to buy in the last five years) should bear all the losses.   Compensation isn’t ideal but even the libertarians at the New Zealand Initiative recognise that sometimes it can be the path to enabling vital reforms to occur.  So promise a scheme in which, say, owner-occupiers selling within 10 years of purchase at less than, say, 75 per cent of what they paid for a house, could claim half of any additional losses back from the government (up to a maximum of say $100000).  It would be expensive but (a) the costs would spread over multiple years, and (b) who wants to pretend that the current disastrous housing market isn’t costly in all sorts of fiscal (accommodation supplements) and non-fiscal ways.

Those numbers were made up on the the fly, but even on later reflection they look like a reasonable basis for something that might not be unreasonable, and also might not be unbearably expensive.  It would recognise that people need to bear some material risk themselves (a 25 per cent fall in nominal house prices is not small).  But it is also designed in recognition of the fact that since 2013, it has been hard for first home buyers to get a mortgage above an initial LVR of 80 per cent, so that not many would be in negative equity now even if house prices fell by 25 per cent from here.

Since many people will stay in their existing house for a long time if they have to, and the scheme only compensates if the house is sold, that also limits the potential fiscal cost.  In fact, the biggest pool of owner-occupiers who would sell at a material loss would be those forced in the event of new severe recession (unemployment is typically the biggest threat to the ability to service mortgage debt) and (a) those people would naturally command a degree of public sympathy and (b) land liberalisation would be a stimulatory policy, reducing the chances of a near-term future recession.  There would be some voluntary sellers, to capture the compensation, but the cost of selling and buying a house, and of moving house, is not trivial.   If 100000 households were to claim the maximum compensation of $100000 that would be total additional government expenditure of around $1 billion, spread over a considerable period of time.   And to claim $100000, you’d have to have bought say a $1 million first house and seen house prices fall 45 per cent from your entry price.

It isn’t a perfect scheme by any means, and lots of details would need to be fleshed out.   One could relatively easily restrict it to apply only to those in a first owner-occupied house, again the people who will naturally command the most sympathy anyway.    But if something of this sort could be done for, say $1 billion, and it helped the pave the way for a genuine structural fix in the housing market –  a willingness to actively embrace lower house prices –  it would seem likely to offer more value than, say, the least valuable of the proposed 10 new “roads of national significance”, which are estimated to cost on  average just over $1 billion each.  How much congestion is there on the existing road from Levin to Sanson?

And three final points on housing:

  • it was depressing to read the housing section of Jacinda Ardern’s campaign opening speech.  It wasn’t the focus of her speech, but –  just like Andrew Little at his conference speech earlier in the year –  there was reference to dealing to “speculators”, barring foreign purchasers, and to the state building more houses, but not a word –  not even hint –  about freeing up the land market in a way that might make those price to income aspirations achievable,
  • it was slightly strange listening to Robertson and Joyce debating the possibilities of a capital gains tax, focused on housing.  Weirdly Robertson didn’t take the opportunity to rule out applying a CGT to unrealised gains –  even though he surely really realises that, whatever the theoretical appeal, there is no way anyone is going apply a CGT to anything other than realisations.  But it was even more strange to hear this debate going on after both sides were insisting they “had a plan” to fix housing.  If they really did then surely there would be few/no systematic capital gains in the housing market for decades to come?
  • and finally, Steven Joyce ran his line that house prices are a global problem.  This seemed to be a variant of the sort of “problems of success” line John Key often ran.  Out of curiosity, I dug out the OECD’s real house prices series this morning.   They don’t have data for quite every country, but here is the change in real house prices from 2007 to 2016 (annual data) for the countries they have the data for.    There are a few countries that have done worse, but not many.  In the median OECD country, real house prices have fallen over the last decade.

house prices last decade

Mostly, the countries that have been about as bad as us have also had quite rapid population growth (Israel, Australia and Luxembourg in the lead on that count) –  not, of course, that either Finance spokesperson suggested doing anything about that.

What about a longer-term comparison.  There are lots of gaps in the OECD data for earlier decades, but here are real house prices increases for the countries they have data for over the three decades to 2016.

house prices since 86

Worst of them all, without even the income growth to match.

We need to face up to the importance of lowering house prices, of adopting policies likely to sustainably make that happen, and – if necessary –  consider compensation packages for some to help make that transition possible.

A fresher approach for ordinary New Zealanders

I’m as fascinated by the rise of Jacinda Ardern as any other political junkie.  I’ve always been a bit puzzled, struggling to see what issue she has led or what blows she had managed to land on the government.    Then again, she seems to have something different –  perhaps even more electorally important.   I’ve been dipping into accounts of Bob Hawke’s rise –  the last case I’m aware of that where major opposition party changed leaders close to an election (in that case only four weeks out) and won.     It isn’t clear that Bob Hawke was a better Prime Minister than Bill Hayden might have been, or that David Lange was a better Prime Minister than Bill Rowling would have been, but in both cases the new leaders had something –  a degree of connection, engagement etc –  that the deposed leaders didn’t.     Reading the accounts of the last weeks of Bill Hayden’s leadership of the ALP, the party had become as disheartened and lacking belief in its own ability to win (despite still leading in the polls), as some suggest the New Zealand Labour Party had become.    Quite what the Ardern phenomenon amounts to I guess we’ll see over the next few weeks.  From her comments so far, I could imagine her campaigning as Hawke did –  both the upbeat theme of “reconciliation”, and the more cynical description in (sympathetic) leading Australian journalist Paul Kelly’s book “no avenue of vote-buying or economic expansion was left untouched”.

For now, we are told that the “Fresh Approach” slogan is apparently out, and a new slogan and some new policies are soon to be launched.  Since no party really seemed to be campaigning on policies that might make a real and decisive for ordinary New Zealanders’ prospects, in many respect a fresher approach should be welcome.  Of course, it rather depends what is in that policy mix.

My interests here are primarily economic.  In an interview with the Dominion-Post this morning, the journalist put it to Ardern that “National will campaign on its economic record. Is that where Labour is weak?”.     Perhaps it is Labour’s weak point.  But what sort of “record” is the government to campaign on?  An unemployment rate that, while inching down, has been above the level it was when they took office –  already almost a year into a recession –  every single quarter of their entire term?  An economy that has had no productivity growth for almost five years?     House prices that, in our largest city, have gone through the roof?  Exports that are shrinking as a share of GDP?    And, at best, anaemic per capita real GDP growth?   If it is a weakness for Labour, it must be in large part because (a) their messaging has been terrible, and (b) nothing they offer seems likely to make any very decisive difference to the mass of ordinary New Zealanders.

What might?   Here’s my list of three main sets of proposals.    An effective confident radical Labour Party could offer the public these sorts of measures –  in fact, on some points arguably only a left-wing party could effectively do so (Nixon to China, and all that).

  1. A serious commitment to cheap urban land and much lower construction costs.
    • In a country with abundant land, urban land prices are simply scandalous.   The system is rigged, intentionally or not, against the young and the poor, those just starting out.  Too many of Jacinda Ardern’s own generation simply cannot afford to buy a house.
    • To the extent that there are poverty and inequality issues in New Zealand, many of them increasingly trace back to the shocking unaffordability of decent housing.   With interest rates at record lows, housing should never have been cheaper or easier to put in place.
    • And yet instead of committing to get land and house prices down again, the Labour Party has been reluctant to go beyond talk of stabilising at current levels.  Talk about entrenching disadvantage……(and advantage).
    • It is fine to talk about the government building lots of houses, but the bigger –  and more fundamental –  issue is land prices.  It is outrageous, and should be shameful, for people to be talking of “affordable” houses of $500000, $600000 or even more, in a country of such modest incomes.  International experience shows one can have, sustainably, quite different –  much better –  outcomes, but only if the land market is substantially deregulated.
    • I don’t have any problem if people want to live in denser cities –  I suspect mostly they don’t –  but it is much easier and quicker to remove the boundaries on physical expansion of cities (while putting in place measure for the associated infrastructure).   Labour’s policy documents have talked of moves in this direction –  as National’s used to do –  but it is never a line that has been heard from the party leader.     If –  as I propose –  population growth is cut right back, there won’t be much more rapid expansion of cities, but make the legislative and regulatory changes, and choice and competition will quickly collapse the price of much urban, and potentially developable, land.
    • It is clear that there is also something deeply amiss with our construction products market –  no one seriously disputes that basic building products are much more expensive here than in Australia or the US.  Make a firm commitment to fix this.  Perhaps it involves Commerce Commission interventions (supported by new legislation?)?  Perhaps it might even involve –  somewhat heretically –  a government entity entering the market directly.     But commit to change, to producing something far better for New Zealanders.
    • The vision should be one in which house+land prices are quickly –  not over 20 years –  headed back to something around three times income.  A much better prospect for the next generation.
    • No one will much care about rental property owners who might lose in this transition –  they bought a business, took a risk, and it didn’t pay off.  That is what happens when regulated industries are reformed and freed up.    It isn’t credible –  and arguably isn’t fair –  that existing owner-occupiers (especially those who just happened to buy in the last five years) should bear all the losses.   Compensation isn’t ideal but even the libertarians at the New Zealand Initiative recognise that sometimes it can be the path to enabling vital reforms to occur.  So promise a scheme in which, say, owner-occupiers selling within 10 years of purchase at less than, say, 75 per cent of what they paid for a house, could claim half of any additional losses back from the government (up to a maximum of say $100000).  It would be expensive but (a) the costs would spread over multiple years, and (b) who wants to pretend that the current disastrous housing market isn’t costly in all sorts of fiscal (accommodation supplements) and non-fiscal ways.
  2. Deep cuts in taxes on business and capital income
    • the political tide is running the other way on this one –  calls for increased taxes on foreign multi-nationals and so on –   but it remains straightforwardly true that taxes on business activity are borne primarily not by “the rich”, but by workers, in the form of lower incomes than otherwise.  So if you really care about New Zealand workers’ prospects, cut those taxes, deeply.
    • and one of the bigger presenting symptoms of New Zealand’s economic problems is relatively low levels of business investment.   Taxes aren’t the only thing businesses  –  and owners of capital  –  think about, but they are almost pure cost.   Tax a discretionary activity and you’ll get a lot less of it.   That is especially true as regard foreign investment –  those owners of foreign capital have no need to be here if the after-tax returns aren’t great.  For all the (mostly misplaced) concerns about sovereignty, foreign investment benefits New Zealanders –  ordinary working New Zealanders.     Cut the tax rates on such activity  –  they are already higher than in most advanced countries –  and you’ll see more of it taking place.    More investment, and higher labour productivity, translates into meaningful prospects of much higher on-market wages –  the sorts of wages they have in the advanced countries we were once richer than.
    • simply cutting the company tax rate will make a material difference to potential foreign investors.   It won’t make much difference for New Zealanders’ looking to build or expand businesses here, because of our imputation system    That’s why I’ve argued previously for adopting a Nordic system of income taxation  –  in which capital income is taxed at a lower rate than labour income.  Note the description –  it is a system not run in some non-existent libertarian “paradise” but in those bastions of social democracy, the Nordic countries.  Not because they want to advantage owners of capital over providers of labour, but because the recognise the well-established economic proposition that taxes on capital are mostly borne in the former of lower returns to labour.
    • some argue against cuts to business taxes on the grounds that it will provide a windfall to firms (especially foreign firms) already operating here.  Mostly, that is false.  It might be true if foreign firms dominated our tradables sector –  where product selling prices are set internationally.  But in New Zealand, foreign investment is much more important in the non-tradables sectors.  Cut taxes on, say, the banks, and you’ll find the gains being competed away, flowing back to New Zealand firms and households in lower fees and interest margins.  If for some reason it doesn’t happen, feel free to invoke the Commerce Commission (and/or expand its powers).
    • much lower business taxes should be a no-brainer for an intellectually self-confident centre-left party serious about doing something about long-term economic underperformance and lifting medium-term returns to labour.     I’m not really a fan of capital gains taxes, but if you need political cover promise a well-designed CGT –  it probably won’t do much harm, especially if you take seriously the goal of delivering much cheaper houses and urban land (see above –  there won’t be many housing capital gains for a long time).
  3. Deep cuts to target levels of non-citizen immigration
    • This item might be entirely predictable from me, but it is no less important for that.    Labour started out with some rhetoric along these lines, but as I’ve noted previously what they actually came out with was a damp squib, that would change very little beyond a year or so.   So
      • Cut the number of annual residence approvals to 10000 to 15000 per annum –  the same rate, per capita, as in Barack Obama’s (or George Bush’s) United States,
      • Remove the existing rights of foreign students to work in New Zealand while studying here.
      • Institute work visa provisions that are  (a) capped in length of time (a single maximum term of three years, with at least a year overseas before any return on a subsequent work visa) and (b) subject to a fee, of perhaps $20000 per annum or 20 per cent of the employee’s annual income (whichever is greater).
    • In substance, you will be putting the interests of New Zealanders first, but you will also strongly give that impression –  a good feature if you are serious about lifting sustained economic performance, while being relentlessly positive about it, and about your aspirations for New Zealanders.
    • Change in this area would immediately take a fair degree of pressure off house prices, working together with the structural housing/land market reforms (see above) to quickly produce much much more affordable houses and land.  Markets trade on expectations –  land markets too.
    • You’ll also very quickly alter the trajectory of urban congestion –  those big numbers NZIER produced in a report earlier this week.
    • But much more importantly in the longer-term, you’ll be markedly reducing the pressures that give us persistently the highest real interest rates in the advanced world, and
    • In doing so you’ll remove a lot of pressure from the exchange rate.  Lets say the OCR was able to be reduced to around typical advanced country levels (say 0.25 per cent at present).  In that world, the NZD offers no great attraction to foreign (or NZ institutional) holders – it is just one of many reasonably well-governed countries, offering rather low interest rates.  In that world, why won’t the exchange rate be averaging 20 per cent (or more) lower than it is now?
    • And that should be an adjustment to be embraced.  Sure, it will make overseas holidays and Amazon books etc more expensive, but in sense that is part of the point.  We need a rebalanced economy, better-positioned for firms to take on the world from here.  Combine a lower exchange rate, lower interest rates, and lower business tax rates, and you’ll see a lot more investment occurring –  and firms successfully selling more stuff internationally.  And with more investment will come the opportunities for sustainably higher wages –  and all the good stuff the centre-left parties like to do with the fiscal fruits of growth.

I don’t suppose anything like this will actually be part of the fresher approach.  But if it were……we could really look forward to a better, more prosperous, and a fairer New Zealand.

Two sides of the same coin

When, a couple of months ago, the current National-led government announced plans to tighten immigration policy in several areas, I summed up the changes as “a modest step that ignores the big picture“.

Yesterday, the Labour Party announced the immigration policy it will campaign on.  I’d use exactly the same words to describe their proposals.  Some of the changes –  the largest ones –  seem broadly sensible, but they won’t come close to tackling the real problems with New Zealand’s immigration policy.

In some ways the biggest difference between the two parties’ approaches is that National provided us with no estimates about what impact their changes would have on numbers (and the Prime Minister apparently claimed yesterday they would,  in fact, have no impact on numbers), while Labour is touting large numerical impacts but not acknowledging that they will actually have little or no medium to long-term effect on the net inflows of non-New Zealand citizens.

In many ways, none of this should be a surprise.  The “big New Zealand” strategy, revitalised over the last 25 years, has been a bipartisan project.   On either party’s policy, it remains one.   There is really no material difference between them –  just details which, while not unimportant, don’t affect the underlying strategy.  A strategy which, to the extent it had an economic performance objective behind it (recall how MBIE used to call our immigration policy, “a critical economic enabler”), has simply failed.  There is no reason to expect anything much better if future if we keep on with the same policies.

What determines the medium-term contribution of immigration policy to population growth is the residence programme, which aims to give out around 45000 residence approvals each year.  The government cut that target a little last year.  Labour’s policy doesn’t even mention it.   At 45000 approvals, the programme is roughly three times the size, in per capita terms, of the equivalent programme is the United States (where about one million green cards are issued each year).

But what of the proposals Labour did put forward.  Their policy document is here.   It is misconceived from the first sentences where they state

Migrants bring to New Zealand the skills we need to grow our economy

Have they not seen the OECD data showing that New Zealanders are among the most highly-skilled people in the advanced world, and that –  on average –  immigrants are a bit less skilled than natives?    On the scale the New Zealand immigration programme attempts to operate at, the typical new additions to the labour force from non-citizen migration are not as highly skilled as the people who are already here, and our own young people who enter, and move up in, the workforce each year.   There are, of course, no doubt some exceptionally talented people.   But most are people from poorer countries looking for better opportunities here for themselves and their families –  typically, too, people who couldn’t get into the richer and more successful Anglo countries.  (None of this is a criticism of the migrants –  pursing the best for themselves and their families is probably what all of us seek to do too – but it is a criticism of the policy framework that enables such large inflows of not overly-skilled people.)

Mostly Labour’s policy seems to be about fixing some pretty dubious changes made to the student visa system over recent years.   In fact, three-quarters of the total numerical impact of their policy comes (on their own numbers) from student visa changes.

Labour will stop issuing student visas for courses below a bachelor’s degree which are not independently assessed by the TEC and NZQA to be of high quality.

Labour will also limit the ability to work while studying to international students studying at Bachelor-level or higher. For those below that level, their course will have to have the ability to work approved as part of the course.

Labour will limit the “Post Study Work Visa – Open” after graduating from a course of study in New Zealand to those who have studied at Bachelor-level or higher.

Mostly, those seem like a broadly sensible direction of change.   That said, I’m slightly uneasy about relying on bureaucratic agencies to decide whether courses are “high quality” –  in principle, surely the market can take care of reputational and branding issues?

And while it might look good on paper, I’m a little uneasy about the line drawn between bachelor’s degree and other lines of study.  It seems to prioritise more academic courses of study over more vocational ones, and while the former will often require a higher level of skill, the potential for the system to be gamed, and for smart tertiary operators to further degrade some of the quality of their (very numerous) bachelor’s degree offerings can’t be ignored.  In the student visa data we already see some slightly suspicious signs (bottom right chart) of switching from PTEs to universities  I’d probably have been happier if the right to work while studying had been withdrawn, or more tightly limited, for all courses.   And if open post-study work visas had been restricted to those completing post-graduate qualifications.

Selling education to foreign students is an export industry, and tighter rules will (on Labour’s own numbers) mean a reduction in the total sales of that industry.   Does that bother me?  No, not really.  When you subsidise an activity you tend to get more of it.  We saw that with subsidies to manufacturing exporters in the 1970s and 80s, and with subsidies to farmers at around the same time.  We see it with film subsidies today.  Export incentives simply distort the economy, and leave us with lower levels of productivity, and wealth/income, than we would otherwise have.   In export education, we haven’t been giving out government cash with the export sales, but the work rights (during study and post-study) and the preferential access to points in applying for residence are subsidies nonetheless.  If the industry can stand on its own feet, with good quality educational offerings pitched at a price the market can stand, then good luck to it.  If not, we shouldn’t be wanting it here any more than we want car assembly plants or TV manufacturing operations here.

Labour estimates that their changes to student visas and post-work study visas will reduce numbers by around 17000, roughly evenly split between the two classes of changes.  But what they don’t tell you is that these will be one-off reductions in the total number of people here on those visas.    Since the number of people who settle here permanently is determined by the residence approvals programme, and that hasn’t changed, the changes Labour is promising around student visas –  while broadly sensible –  while make a difference to the net migration flow in the first year they are implemented (the transition to the lower stock level) and none at all thereafter.   They might change, a little, who ends up with a residence visa, but not how many are issued.  If you favour high levels of non-citizen immigration but just want the “rorts” tidied up, it makes quite a lot of sense.

The changes Labour proposes to work visas are also something of a mixed bag.  They are promising (but with few/no specifics) to make it harder for people to get work visas

Since 2011/12, the number of low-skill (ANZSCO 4 and 5) work visas issued has surged from 14,000 to 22,000. For example, the number of “retail supervisor” work visas has increased from 700 to 1,700. Labour will work with firms to train New Zealanders to fill skills gaps so we don’t have to permanently rely on immigration. A developed nation should be able to train enough retail staff to meet its own needs. Immigration should be a stop-gap to meet skills shortages, not a permanent crutch.

Labour will make changes that preserve and enhance the ability of businesses to get skilled workers to fill real skills gaps but which prevent the abuses of the system that currently happen.

The broad direction seems sensible enough –  after all, the official rhetoric about the gains from immigration relate to really highly-skilled people, but what does it mean specifically?

And I get much more wary about proposals to move to a more regional approach (on top of the additional points for regional jobs the government introduced last year, thus further reducing the skill level of the average migrant).  This is what they say:

Currently, few skill shortages are regionalised. This makes it hard for a region with a skills shortage in a specific occupation to get on the list if the shortage is not nationwide. Importantly it means that work visas are issued for jobs in regions where there is not actually a shortage which puts unnecessary pressures on housing and transport infrastructure there.

Labour’s regionalised system will work with local councils, unions and business to determine where shortages exist and will require that skilled immigrants work in the region that their visa is issued for. This will prevent skills shortages in one region being used to justify work visas in another, while also making it easier for regions with specific needs to have those skills shortages met.

Where skills shortages are identified, Labour will develop training plans with Industry Training Organisations so that the need for skilled workers is met domestically in the long-term. We will invest in training through Dole for Apprenticeships and Three Years Fees Free policies.

Frankly, it seems like a bureaucrat’s paradise, and just the thing for influential business groups that get the ear of some local council or other.  It is hard enough to ensure that local authorities operate in the interests of their people, without setting up more incentives that will allow local authorities to be used to pursue the interests of one particular class of voters.

More generally, it is an approach that suggests no confidence at all in market mechanisms to deal with incipient labour market pressures.  There is no suggestion in the document, at all, that higher wages might be a natural adjustment mechanism, whether to deal with increased demand in a particular region or for a particular set of skills.  Even the Prime Minister was running that line recently  –  and he isn’t from the party supported by the union movement.

Again, changes to reduce the number of work visas granted to people for fairly low-skilled occupations aren’t a bad thing, but they won’t make any difference to the average net inflow of non New Zealanders beyond the initial (quite small) one-off level adjustment.     And there is no willingness to rely on market mechanisms –  eg set a (say) $15000 per annum fee, and allow limited work visas for jobs where the employer is willing to pay the taxpayer that additional price.

There were two other initiatives in the package.  The first was the proposed new Exceptional Skills visa.

Labour will introduce an Exceptional Skills Visa. This visa will enable people with exceptional skills and talents that will enrich New Zealand society — not just its economy — to gain residency here. 

It will be available to people who can show they are in an occupation on the long-terms skills list and have significant experience or qualifications beyond that required (for example, experienced paediatric oncologist) or are internationally renowned for their skills or talents. Successful applicants will avoid the usual points system requirements for a Skilled Migrant Category visa and would be able to bring their partner and children within the visa. This visa will help grow high-tech new industries, meet the increasingly complex needs of the 21st Century and enrich our society. Exceptional Skills Visas for up to 1,000 people, including partners and children, will be offered every year

When I first saw reference to this I was quite encouraged.  And if it makes a little easier for people who are genuinely highly-skilled to get first claim on those 45000 residence approvals each year, then I don’t have any problem with it.   But it isn’t exactly the American exceptional ability visa, and we need to be realistic about New Zealand’s relative attractiveness (or lack of it) to people with really exceptional talents.   The suggestion that the programme will “help growth high-tech new industries, meet the increasingly complex needs of the 21st century” is probably little more than late 20th century vapourware.

As for the proposed KiwiBuild visas, I suppose they were politically necessary. You leave yourself open if you campaign on both big reductions in migrant numbers, and massive increases in house-building, if you don’t prioritise construction workers.  In fact, of course, this programme makes a one-off reduction in the number of people here –  reductions concentrated in the population group that probably has the least housing needs..  None of the medium-term pressures will have been eased at all, even if some dodgy rules around students do end tightened.

In passing, I was also interested in this comment

We will investigate ways to ensure that the Pacific Access Quota and Samoan Quota which are currently underutilised are fully met.

I guess there are really large numbers of Pacific voters in Labour’s South Auckland heartland.    These Pacific quotas, again, lower the average skill level of those we given residence approval too (since people only come in on those quotas if they can’t qualify otherwise, all within the 45000 approvals per annum total).  I imagine, too, that the Australian High Commission will have taken note of that line.

Overall, some interesting steps, some of which are genuinely in the right direction.  But, like the government, Labour is still in the thrall of the “big New Zealand” mentality, and its immigration policy –  like the government’s – remain this generation’s version of Think Big.  And it is just as damaging.    The policy doesn’t face up to the symptoms of our longer-term economic underperformance –  the feeble productivity growth, the persistently high real interest and exchange rates, the failure to see market-led exports growing as a share of GDP, and the constraints of extreme distance.  None of those suggest it makes any sense to keep running one here of the large non-citizen immigration programmes anywhere in the world, pulling in lots of new people year after year, even as decade after decade we drift slowly further behind other advanced countries, and se the opportunities for our own very able people deteriorate.

But that is Labour’s policy.  And that is National’s policy.

For anyone interested, the Law and Economics Association is hosting a seminar on immigration policy and economic performance on Monday evening 26 June.   Eric Crampton of the New Zealand Initiative and I will be speaking.  Details are here.

UPDATE: Here is what I said to Radio New Zealand yesterday afternoon on immigration, in a reasonably extended interview, partly on Labour’s announcement, but mostly on the more general issues.

Labour on housing

There was nothing positive to be said about the previous Labour-led government’s approach to housing and house prices.  There is nothing positive to be said about the current National-led government’s approach.  The rhetoric while they were in Opposition had been encouraging.  The substance of reform has been almost non-existent, all the while cloaked in fairly brazen, even offensive, rhetoric from both Prime Ministers (Key and English) suggesting that it was all a mark of success, a quality problem, and so on, along with suggestions that the government’s approach was working.    By that standard, I hope I don’t live to see a failed housing policy.

There have been some hopes, in some circles, that the Labour Party, if they were to lead a new government after this year’s election, might be different.  Their housing spokesman seems pretty impressive, and seems to understand the issues.  In a no doubt mutually beneficial move, he and Oliver Hartwich, head of the business-funded New Zealand Initiative, even did a joint op-ed on freeing-up the market in urban land.   Places where landowners can use their land pretty freely tend not to have the sorts of grossly dysfunctional housing markets New Zealand (and Australia, and the UK, and much of the US east and west coasts) have, even if those places are big and fast-growing.

I’ve liked the talk, but have been a bit sceptical that it will come to much.  In part, I’m sceptical because no other country (or even large area) I’m aware of that once got into the morass of planning and land use laws has successfully cut through the mess and re-established a well-functioning housing and urban land market.  In such a hypothetical country, we wouldn’t need multiple ministers for different dimensions of housing policy.  I’m also sceptical because there is a great deal local government could do to free up urban land markets, but even though our big cities all have Labour-affiliated mayors, there has been no sign of such liberalisation.    The Deputy Mayor of Wellington for example leads the Wellington City Council ‘housing taskforce”.  Paul Eagle is about to step into a safe Labour seat.   His taskforce seems keen on the council building more houses, and tossing more out subsidies, but nothing is heard of simply freeing up the market in land.  Or even of looking for innovative ways to allow local communities to both protect existing interests and respond, over time, to changing opportunities.

I first wrote about this last October, when Phil Twyford had put out a substantial piece on Labour’s housing programme.   There was a five point plan.  Reform of the planning system appeared on the list, but briefly and well down the list.    As I noted then

It has the feel of a ritual incantation –  feeling the need to acknowledge the point –  rather than being any sort of centrepiece of a housing reform programme.

Yesterday, my doubts only intensified.  Labour’s leader, Andrew Little, devoted the bulk of his election year conference speech to housing, complete with the sorts of personal touches audiences like (although he didn’t mention the tasteful lavender out the front of his current house, which I walk past each day).  Media reports say the speech went down well with the faithful.

This time there was a four point plan.  It was a lot like Twyford’s plan from late last year, with one omission.   The continuing features were:

  • the state building more “affordable” houses,
  • restrictions on “overseas speculators” buying existing houses,
  • making “speculators who flip houses with five years pay tax on their profits,
  • “ring-fencing” losses on investment properties.

But in the entire speech –  and recall that most of it was devoted to housing –  there was not a single mention of freeing up the market in urban land, reforming the planning system etc.  Not even a hint.    I understand that giving landowners choice etc probably isn’t the sort of stuff that gets the Labour faithful to their feet with applause.   But to include not a single mention of the key distortion that has given us some of the most expensive (relative to income) house prices in the advanced world, doesn’t inspire much confidence.     Planning reform isn’t going to be easy.  Few big reforms are under MMP.  It probably isn’t something the Greens are keen on.  And if the putative Prime Minister isn’t on-board, hasn’t yet internalised (or even been willing to simply state it openly) that this is where the biggest problems lie, it is hard to believe that a new government would really be willing to spend much political capital in reforming and freeing up the system, no matter how capable, hardworking and insightful a portfolio minister might be.

Probably reforms of this sort don’t play well in focus groups (although surely there is some responsibility on political leaders to help shape the debate, and change what people respond positively to?)   On the other hand, presumably the data suggest that people react well to attacks on “speculators”, “loopholes”, “subsidies”, which appeared numerous time in Little’s speech.

The headlines around the speech were around the leader’s official confirmation that Labour will prohibit people from offsetting tax losses from investment properties against other non-property income.   This is, apparently, to “close a loophole” to stop “speculators” receiving “subsidies”.     In fact, it is nothing of the sort.

For better or worse, New Zealand has a comprehensive income tax system in which different types of factor income are treated much the same, and taxed at much the same rate.  There are various exceptions, and lots of devil in the detail (thus, for example, the establishment of the PIE regime a decade or so gave an advantage to funds in widely-held entities over individually-held assets).  It has long been pretty fundamental to that system that one tots up all the gains and losses over the course of the year, and then pays tax only on the overall net income.  It would be absurd, for example, to take a business with five operating divisions and tax them on the basis only of the lines of business that made profits, even though several of the other divisions may have made large losses.    Since time is money, it wouldn’t be much consolation to say “oh, don’t worry, you can offset those losses against future profits in those particular operating divisions”.

But that is just what Labour proposes to do.    There is no “subsidy”, there is no “loophole”.   There is simply a conventional comprehensive income tax system at work.  If you lose money on one activity, you can offset it against gains on other activities.

And, if you are concerned about favourable tax treatments then, within the comprehensive income tax model, the clear and unambiguous feature of the tax system that favours one group of potential house purchasers over another is the non-taxation of imputed rents on owner-occupied houses.    Relative to other potential purchasers, this feature provides a big advantage to unleveraged owner-occupiers (ie mostly those in late middle age and the elderly).   This isn’t some idle Reddellian claim.  You can see the calculations worked out carefully in a Reserve Bank discussion paper, The tax system and housing demand in New Zealand, from a few years ago, showing how the features of the New Zealand tax system affect what different types of potential purchasers will be willing to pay.

Within a comprehensive income tax system, I’m at a loss to understand the economic logic behind Labour’s proposed policy.  Presumably it will be fine to buy a farm (or shares in a farm) and offset losses on that investment against labour income?  Presumably it will still be okay to set up a small sideline business which makes losses for several years in the establishment phase, and to offset those losses against labour income?   But not for residential investment properties (or, one assumes, for shares in companies mainly devoted to holding such properties?)   Even though setting oneself up as the owner of an investment property, renting a house to tenants, is a small business.  In fact, it is a way that many people get into business, taking risks to get ahead.

Much of the discussion in the time since Little gave his speech has been on what sort of people will be affected –  whether it is the evil “speculators”, as opposed to “Mum and Dad”.  I’m not sure if there is much data available on that in New Zealand, but they are having a very similar debate in Australia, and I was interested to see a list from Australian Tax Office data published on the ABC website as to who had claimed rental losses in Australia, by occupational group.  People can make of it what they will.  The occupational groups most likely to claim rental losses in 2013/14 were anaesthetists (28.7 per cent of them).  But 22 per cent of Police did as well.

I’m opposed to ring-fencing, if we are going to have a comprehensive income tax system.  And, I’m doubly opposed to singling out housing for ring-fencing.   If there is an economic logic to ring-fencing, apply it more generally or leave it alone.  As it happens, we tried something similar before.  From 1982 to 1991, there were restrictions put on loss-offsetting against labour income for “specified activities” (at the time, the bugbear was people investing in things like kiwifruit orchards).  Even then, loss-offsetting was limited to $10000 per annum (rather than zero).

Are there problems with the current tax treatment?  Arguably so.  Some would claim that the absence of a full capital gains tax is such a distortion, allowing people to run operating losses in the expectation of future capital gains.     As it happens, Labour proposes to address that by, in effect, imposing a capital gains tax on any sales of investment properties within five years (presumably these are typically the “speculators”).  But even if they weren’t, the argument still fails.  In even a moderately efficient market, there are no rationally-expected real future capital gains on offer across the market as a whole.  If there were, people would bid up the prices further now to take advantage of (and thus eliminate) those gains.     There are windfalls –  gains and losses –  from large actual changes in capital values of assets, but it isn’t a systematic distortion in the system.     (In principle, I don’t have too much problem with a capital gains tax that (a) applies only to real (inflation-adjusted) gains, (b) applies on a valuation basis rather than a realisations basis, and (c) treats gains and losses symmetrically.  In practice, no such systems exist).

Where there is a systematic distortion in the system is around the treatment of inflation.  In an ideal system, there would be no systematically expected inflation.  In practice, we have an inflation target centred on 2 per cent annual inflation.  As a result, roughly speaking, nominal interest rates are around 2 percentage points higher than real interest rates, and real assets should be expected to increase in value by around 2 per cent per annum, even if there is no change in their real value.      The two percentage point component of interest rates that is just inflation compensation isn’t real income (no one is better off as a result of receiving it; no one’s purchasing power is improved).  And yet it is taxed as real income.  And for those borrowers who can deduct expenses, interest is fully deductible, even though the inflation compensation component doesn’t reduce the borrower’s real income.   That is a systematic advantage to such borrowers, and one for which there is not a shred of economic logic.

In my preferred approach, the inflation compensation component of interest income would not be taxed.  And the inflation compensation component of interest expenses would not be tax deductible for anyone.    As the Reserve Bank discussion paper I linked to earlier showed, this change alone would make quite a substantial difference to how much highly-geared investment borrowers would be willing to pay.  And it would be a genuine improvement in the comprehensive income tax system as well, without singling out on class of purchasers of one class of asset.

But it is worth bearing in mind, that none of these issues can explain anything about house price inflation behaviour in the last 10 or 15 years.  Over that period:

  • the loss-offsetting rules have been much the same,
  • the introduction of the PIE system disadvantaged individual holders of investment properties relative to, say, holders of financial assets in PIE vehicles,
  • in 2005, the tax depreciation rules were tightened,
  • from 2010, depreciation on properties was no longer tax deductible,
  • the inflation target was raised in 2002, but for the last eight or nine years, inflation expectations have been trending down again,
  • maximum personal income tax rates were also cut in 2010 (reducing the value of deductibility and loss-offsetting).

Any of these “distortions” should be capitalised into the price pretty quickly once they are announced and understood,  The only new measures in the last decade or so have reduced the relative attractiveness of property investment  (and that is before even mentioning LVR controls).  It typically takes shocks to displace markets.  In principle, the advent of non-resident foreign purchasers could have been an example (in the presence of supply constraints), but we don’t have good data.  So could unexpected population growth.

We should probably also be sceptical as to how much difference ring-fencing, as Labour propose, might make.  When I was at the Reserve Bank we came and went in our views on tax issues around housing.  But the one consistent observation over the years was to point out that many different countries had quite different regimes for the tax treatment of housing.  Some allowed loss-offsetting, some didn’t.  Some had capital gains taxes, some didn’t (and all those who did had various different rules).  Some had differential income tax rates for capital and labour income. Some even made a stab at taxing imputed rentals.  But it wasn’t obvious that the differences in tax treatments explained much about the levels of house prices, or about cycles in them.    And in a well-functioning land market, land –  the asset value that is, in principle, affected by tax system changes –  is only a fairly small component of a typical house+land price.

What tax rules do is affect who owns which assets.  Thus, for decades our tax system has tended to treat all owners of investment properties pretty equally.   Loss-offsetting was part of that.   But so was the fact that we didn’t give favourable tax treatment (generally) to insurance companies and superannuation funds.  In many countries, assets held in those sorts of vehicles are more lightly taxed.  Not surprisingly, managers of those vehicles can afford to pay more for the assets, and a larger share of the assets end up in such vehicles.

Ring-fencing rules can be expected to have similar effects.     If “Mum and Dad” with one investment property can’t offset a bad year’s losses against other income, but have to carry it forward and wait for a good income year from property, while a superannuation fund with lots of investment properties can (either because it is less leveraged or because losses on some properties can be offset against profits on others) more properties will be held in such vehicles.  It isn’t clear what the public policy interest is in such an outcome?  More generally, the change will disadvantage people starting out in the rental services businesses relative to those who are better-established and have larger equity.

In the end, so-called “speculative” opportunities, on any sort of widespread scale, arise mostly because governments got themselves into the land market, and by regulatory interventions, disabled the market from working smoothly to increase supply in response to increases in demand, or changes in tastes.   Wouldn’t it be better, more in the interests of middle New Zealand (and economic efficiency) to address the problem at source –  fix the regulatory failures –  rather than falling back on rhetoric about speculators and subsidies, which at best in tackling symptoms, not grappling with causes?

Fix up the planning system and all this will be yesterday’s issue.  Fix up the inflation distortion and you’ll also have a better tax system.  But if the planning system isn’t fixed then, whatever other short-term stuff Labour does (including immigration changes) will only provide temporary relief, and in a few years time we’ll be back with the same old housing affordability problems.  What a lost opportunity that would have been.

PS.  I see that Labour is invoking the Reserve Bank in support of ring-fencing.  Perhaps the current Governor does favour such a change –  although we’ve not seen any economic analysis in support of it from them –  but if so, it is an example of a proposal which the Bank was against before it was for.    In 2005, at the request of the then Minister of Finance, a group of senior Reserve Bank and Treasury staff was asked to review policy options for dealing with house prices.  I was part of that group (as was Adrian Orr, and incoming acting Governor Grant Spencer, and the current Chief Economist at The Treasury).  There is a nice treatment of the ring-fencing issues on pages 19 to 22 of our report.