Dr David Law: Unintended consequences of New Zealand’s housing policy

OPINION:

In colonial India, Delhi had a little problem with cobras. Since cobras can cause unpleasant things, like death, a solution was needed.

To reduce the cobra population, a bounty was placed on their skins by the local government. For a while this seemed to work well. The bounty was generous enough that many people took up cobra hunting and the cobra population decreased.

However, as it became harder to find cobras in the wild, people’s entrepreneurial spirit was awakened. They started farming cobras in their homes so that they could still collect the bounty as before.

Eventually, local authorities noticed that while there appeared to be very few cobras out and about in the city, they were still paying just as much in bounty as before. The bounty was cancelled. Cobras were now worthless and so cobra entrepreneurs released all of their inventory back into the streets.

In the end, Delhi’s cobra problem was even worse than before the bounty on cobra skins had been introduced. The lesson here – even well-intentioned policies can fail and have unintended consequences. In fact, this happens often.

This brings me to housing policy in New Zealand – past, present, and future.

Most economists in New Zealand highlight barriers to increasing the supply of housing as the key driver of poor housing affordability. For example, the Resource Management Act, urban planning rules, and the incentives faced by local councils constrain supply and increase the time and cost of housing development.

New Zealand also has stringent restrictions on foreign direct investment, which limits construction. On top of this, accommodative monetary policy in response to Covid-19 has further fuelled housing demand.

However, instead of addressing supply constraints over recent decades, housing policy has focused on demand. We’ve seen an end to depreciation on housing and the ability to offset losses from rental activities against other forms of income for tax purposes.

The introduction and extension of the bright line test, stringent loan-to-value ratio restrictions, and the imposition of new regulatory burdens on landlords. Foreigners have also been banned from buying most types of homes in New Zealand.

Despite these measures, real house prices in New Zealand have, and continue to, increase at a remarkable pace.

Cue the government’s new ill-fated housing package, announced in March. Again, the focus is on trying to crush housing demand by increasing the costs faced by landlords.

This will increase rents and reduce the supply of rental accommodation to the detriment of many – it might as well have been called the tenant tax.

Unsurprisingly, pressure to intervene in the rental market is already mounting. The Housing Minister has requested advice from officials on rent controls.

The Green Party has released a discussion document on “Reasonable Rents”, extolling their virtues.

Renters United are advocating for rent controls and the Finance Minister is not ruling them out.

But, rent controls provide an even better lesson in policy failure than cobras and there is a huge body of both theory and practical evidence spanning 80 years to back this up.

Rent controls reduce the supply of rental accommodation, create shortages and queues. Rental accommodation is sold off, left vacant, or converted to alternative uses.

The problem is exacerbated if new supply of rental accommodation is also reduced.

Developers may be less inclined to build new housing, even when new buildings are not subject to existing regulation, as the possibility of future profit-curbing legislation makes building new residences less appealing.

Rent controls can also lead to a decline in the quality of rental accommodation. If landlords cannot recoup their costs by raising rents, they may not invest in maintenance.

Mobility is reduced and a mismatch between tenants and rental accommodation ensues.

Once a tenant has been able to secure rent-controlled accommodation, they may not want to move in the future, even if their housing needs change, since they would need to give up their rent control and pay more.

Families end up in small apartments while empty-nesters live in large homes they do not need, and people do not move to take up better employment opportunities.

Also, they destroy the value of properties that are rent-controlled and that of neighbouring housing. Affected neighbourhoods become less desirable places to live.

On top of that, rent controls do not even help those who need it the most. Evidence suggests that it is older and higher income tenants who benefit the most from rent controls.

It’s no wonder economist Assar Lindbeck famously said “In many cases rent control appears to be the most efficient technique presently known to destroy a city – except for bombing”.

He’s not wrong. In fact, repeated surveys show around 95 per cent of economists agree rent controls are a terrible idea.

Unfortunately, this is still not enough for some. Bypassing countless peer-reviewed studies highlighting the failures of rent controls, the Greens and Renters United both found the same blog that says they are not so bad after all. The blog’s author, J. W. Mason, is clearly confused.

Mason says the standard economic model of rent control fails in the real world.

He points to studies which find limited effects on the overall supply of housing while rent controls were effective at holding down rents on rent-controlled accommodation.

What Mason forgets is that the model is about the rental market. It predicts the supply of rental accommodation will fall, not that total housing supply will fall, although it may well do.

The papers Mason cites himself do an excellent job of showing rent controls reduce the supply of rental accommodation and that the standard economic model of rent controls stacks up.

Rent controls are a brilliant lesson in policy failure. The intent of rent controls is to lower rents, but the outcome is to reduce the supply of rental accommodation leading to shortages and queues.

Quality drops, mobility falls, and a mismatch between tenants and rental accommodation ensues. Rent controls can even make inequality worse and push rents up on uncontrolled accommodation.

This is not just an issue of poor design. Many variations of rent controls have been tried and failed. It’s unlikely that officials in Wellington will be the first to design rent controls with no negative consequences. If rent controls keep rents below market prices bad things will happen.

Unfortunately, even if sense prevails on rent controls, there are plenty more terrible policy interventions to choose from. The Treasury has recommended advice be provided to ministers on both stamp duties and a deemed rate of return for investment properties.

Stamp duties are a tax on the sale of houses. Among their worst effects, they reduce mobility of homeowners – disincentivising people to move for better jobs or when their housing needs change.

As for deemed rate of return on investment property – to the extent this keeps rents below market rates, as intended, we can expect similar outcomes as more conventional rent controls, albeit with higher administrative costs.

Just remember – a few cobras in your home will soon clear it of rats and mice, but you’ll still have the cobras. Unless, of course, you dump them in the street and make them someone else’s problem.

– Dr David Law is a Senior Research Fellow at The New Zealand Initiative.

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