Labour’s Housing Policy

By Seamus Hogan 30/07/2013

I am baffled by the Labour Party proposal to ban foreign speculators
from owning houses in New Zealand. O.K. that is not strictly true; as Matt over
at TVHE notes, the policy is easy to understand as a cynical appeal to xenophobic
New Zealand First voters. But David Shearer is a better person than that, and
so I would prefer to remain baffled and try to think through the logic of the
Consider a very simple model of the New Zealand housing market in which
there is a fixed supply of identical houses that will not change over time, and
an unchanging demand. Let there be no on-going maintenance or other costs to
owning a house, just the one-off capital costs. Finally, let there be a risk-free
interest rate of 5%, let demanders be risk-neutral and indifferent between
renting and owning for a given cost, and let rental income to a landlord be
exempt from tax so that there is no tax advantage to owner-occupied housing. In
this world, there would be an unchanging equilibrium rental price for housing
over time, and an unchanging price of houses that would be equal to this rental
price times 20.
Now change the model a bit. Imagine that demand in one year’s time will
double and then stay constant from then on, but that will not be known in the
one year before the change. In this world, the equilibrium rental price and the
equilibrium house price will both double in one year’s time and current owners
of houses (both owner occupiers and landlords) will receive a one-off capital
gain at that time.
Now make one more change. Imagine that the future increase in demand becomes known now, but for some reason only known only to people who are not citizens or permanent residents
of New Zealand or Australia. In this version of the model, the rental rate
would continue to remain constant for a year before doubling, but foreigners would bid up
the price of houses now to the point where the capital gain between now and in
one-year’s time was sufficient to exactly offset the fact that current rentals
are insufficient to cover the capital cost of the house.

Now compare this model to the one where the demand increase was a surprise to everyone. Renters pay exactly the same amount of rent in each period, owner
occupiers receive exactly the same capital gain, but can realise it’s present value straight
away. Foreign speculators receive only the market rate of return on their
investments, just like any other inflow of capital that allows New Zealand to
fund investment in excess of its saving. The only distributional effect would
be a shift in the capital gain from those who would have bought houses during the
year before the demand increase to those who would have sold, but there seems
no particular reason for policy to favour one of these groups over the other.
In this world, it is hard to see what possible benefit there would be to
a policy of banning overseas speculators from owning houses, which is what
Labour are proposing. Of course, the assumptions in these three models are
extremely unrealistic. So what changes to the model or what
welfare function can make sense of this policy? We could relax all the
assumptions about indifference between renting and owning, risk neutrality, homogeneity
of the housing stock, no tax advantage to owner-occupancy, and no other changes
over time, but it wouldn’t change the basic intuition. We could assume that
supply is not perfectly elastic, but that would imply that the earlier rise in
price from speculation would generate an earlier supply response and hence more
housing affordability. And we could assume that, maybe, New Zealanders and
Australians know at least as much about the New Zealand housing market as
non-Australasians and so can bid up the price of housing without overseas help, in which case banning foreign speculators would have no
effect at all.
It is easier to make sense of other parts of Labour’s housing policy. Building 100,000
houses would obviously reduce prices if it added to rather than displaced
construction that would otherwise occur, although the policy is silent on how it
would find the land on which to build the houses given council zoning
restrictions. Similarly, a capital gains tax that excluded the family home,
while doing nothing to change supply and demand, would be a way to reduce
prices to owner occupiers while increasing prices to renters. Such a policy proposal
wouldn’t make much sense from a party representing lower-income households (who
are more likely to be renters), but it is perfectly consistent with a party
that proposed exempting fresh fruit and vegetables from the GST.

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

0 Responses to “Labour’s Housing Policy”

  • A couple things deserve response.

    First as you point out there are a huge number of assumptions in your models. That your models do not reflect reality tells you your assumptions are flawed, I’d suggest the assumption (not stated) that humans do not behave rationally is perhaps the critical flaw. Judgement of the policy based on the effects of such a policy on a flawed model is … unreasonable.

    Second you state “any politicians whose housing policy consists mainly …” in a post that is almost entirely critical of a policy that has at every point been stated as PART of a larger set of measures. This isolation and then criticism of one small part of an overall policy is unreasonable.

    Given the observably flawed nature of economic models of housing markets, as evidenced by the lack of spectacularly rich property speculators with economics degress, then perhaps you might accept that some experimentation is actually required to test alternative theories. IF nothing changes after the changes made then you could argue that such a result was consistant with your models. IF something did change in the market you could consider perhaps modifying your models.

    Finally it is worth noting that this is a proposed policy by a party not in power. Even if everyone might be certain that such a policy would have no actual effect, it might be true that such a policy might gain the party sufficient votes to gain enough power to put in place policies that do have an effect (e.g. building 100k houses). An observer of behaviour might note that the effectiveness of this policy in gaining votes might be measured in the volume of opposing political parties responses.

    • Bart:
      1. Since Friedman, 1956 or so, the base standard in economics isn’t the realism of assumptions but whether the model tracks. Simplified models let us abstract from extraneous details and see what happens as we relax critical assumptions each in turn. You might as well go and critique the physicists for assuming vacuums. So: what critical bit of reality is missing from Seamus’s model which, if added, would change the analysis?
      2. The ancillary policies Labour has up do not change the merits of this part of the policy.
      3. Cute. You know that the modal prediction from economists on this sort of thing is that we shouldn’t be able to track whether prices are likely to rise or fall, right? Because if we could, then everybody would hop in and bump up the prices now (or push them down now).
      4. This is true. Economics as a positive science has nothing to say about the morality of, for example, inciting racial hatred as a way of gaining votes.

  • Bart:
    Let’s say I propose a policy that to make housing more affordable by putting an excise tax on bananas. You build a model that shows this will have no effect. Then I come back and say “you made lots of unrealistic assumptions, you assumed people are rational, and why not just give it a go and see what happens.” You would be quite justified in dismissing me entirely. You would (or should) say, all models are wrong, but if the conclusions of a model are wrong, they are wrong for a reason. Let’s have a discussion about what changes to the model would generate a different result and then discuss which version of the model seems to better capture reality.

  • If lack of supply is the problem, then will reducing demand help reduce price increases ?

    • Only if it actually reduces demand! If banning purchases means foreigners who would have moved here then decide not to, then it reduces demand. If it means they come here and rent, then it doesn’t really reduce demand. And if we’ve dissuaded people from coming here who Immigration NZ already decided would be great to have here, isn’t that a rather bad effect?

  • Eric, invoking Friedman and saying “ignoring the validity of assumptions is standard behaviour in economics” really doesn’t do anything for the reputation of economics as a discipline. Particularly since there seem to be a fair few models in use which do not, in fact, reflect reality.

    Whether or not the particular set of assumptions under discussion holds, trying to defend the use of unrealistic assumptions is a bad argument. Rather, we would expect to either demonstrate that the assumption is realistic, or the impact of the assumption is negligible.

    Physicists do not so much assume vacuums as they assume that the difference between the real situation they are modelling and one in which objects are in a vacuum are negligible. The classic example would be falling objects with or without an atmosphere. Easily demonstrated, valid assumption. Unless of course you’re dealing with objects such as feathers, in which case you have to drop the assumption because it isn’t realistic.

    Now, I have my doubts about the effectiveness of the proposed policy, and “People are not rational actors” has a bit of an all-purpose-objection feel to it (true though the statement is), but I don’t think you’ve helped Seamus’s case here.

    • The substantive point in (1) was asking “what critical bit of reality is missing from Seamus’s model which, if added, would change the analysis?” Plenty of real-world stuff differs from Seamus’s case, but I’ve yet to see a reasonable set of assumptions yielding “keep the foreigners out” conclusions.

  • Nevertheless, Eric, you invoked the argument that the realism of assumptions doesn’t matter. Now, you’ll forgive me if I think that’s a pretty important point to correct you on, regardless of the wider discussion.

    • If I were assuming that bananas caused houses, like in Seamus’s comment, you’d be right that the realism of assumption matters. The model’s tracking would then be purely spurious. But there’s a very plausible mechanism in the pared-down model Seamus presented. That it “unrealistically” abstracted away from other real world features, absent convincing argument showing how those factors would substantively change the model’s results, is hardly criticism of it.

  • Eric, you wrote :
    “Only if it actually reduces demand! If banning purchases means foreigners who would have moved here then decide not to, then it reduces demand. If it means they come here and rent, then it doesn’t really reduce demand. And if we’ve dissuaded people from coming here who Immigration NZ already decided would be great to have here, isn’t that a rather bad effect?”

    Your implicit assumption that foreigners who are buying homes intend to move here is incorrect. Tony Alexander has compiled data which shows that 3.6% of property sales are to overseas buyers who do not intend to move here. In addition, for the 5% of property sales that go to overseas buyers who do intend to move to New Zealand, it is likely it never eventuates for some of them.

    I’d say that a 4 to 5% reduction in housing demand is quite significant.


  • Brent:
    The point is that it is the demand for housing not the demand for houses that needs to fall. Eric’s point was that the policy will succeed in reducing demand if it induces someone who would otherwise have come here and lived in a house then not coming here. If, as you say, the foreigners were buying houses but not intending to live in them but instead rent them out, then there is no change to the supply and demand for housing services. If, however, the 4%-5% represents foreigners who want to buy NZ houses, not live in them and leave them empty, then banning those purchases would have a significant effect on price, but no-one has produced any data saying that that is occurring.

  • Disclaimer: I do not endorse this policy, but…

    You know, the more I think on it, the more dissatisfied I am with this thought exercise. If only because Seamus has seen fit to call it a “very simple model of the New Zealand housing market.”

    It really isn’t. It’s simply a fictional market with certain highly abstract asserted properties. No more realistic or useful than the various maths exercises from my own university level economics classes.

    So. Let’s run through the assumptions:
    1) Rational actors (might as well get that one out of the way early).
    2) Fixed supply – no matter how high demand gets, no new houses will be built.
    3) Identical houses – Presumably in identical locations, for identical prices too. Effectively, the ‘market’ consists of one representative house, multiplied up. Are the owners and renters identical as well? Their tastes must be.
    4) A single finance market – foreign buyers borrow at the same interest rates as domestic buyers.
    5) Fixed interest rates
    6) People borrow at the risk-free interest rate – This is a bit of a clanger. The math is not altered if we say “the market interest rate is 5%” so the assumption is both unrealistic and easily dropped. No, the correction doesn’t alter the result, but that’s no good reason to keep the assumption.
    7) Risk-neutral demanders – Hang on, the exercise incorporates risk? Where? Housing supply is fixed, there’s no depreciation, maintenance or disasters, and everybody’s borrowing at the risk-free rate.
    8) Comparative statics – We move instantaneously from one equilibrium to another. No lag time, no overshooting, perfect (rational) knowledge of what the new equilibrium will be.
    9) Can I say comparative statics again? – Real markets are dynamic. Equilibrium is a fragile, impermanent state, if it is seen at all.
    10) In the second equilibrium, demand has doubled – Why, out of curiosity? Has the population changed? That would seem to have implications for the number of people per house, unless some people are doing without. Have buying versus renting preferences changed? Interest rates? Is housing now more attractive than other forms of investment?
    11) Come to think of it, what was the impact of the original demand on prices? Prices look to have been calculated based off of interest rates. “Demand doubles therefore price doubles” isn’t exactly an ironclad statement.

    Okay, I’m going to stop now. Plainly the exercise does not remotely resemble the New Zealand housing market. Why, then, should we have any particular faith in our ability to extrapolate from the thought exercise to what will happen in the real-world economy?

    Perhaps a better approach to arguing against the policy on economic grounds would be to identify other places where it has been implemented and talk about the impacts which have resulted. Potentially tricky to isolate the impacts of the policy from other confounding factors, but if it can be done, there’s the advantage of being able to present some empirical evidence against it.

    Alternatively, perhaps we might drop the thought exercise entirely as extraneous and talk specifically about how we expect foreign buyers will react to future restrictions on their activities, consequences for investment decisions and the like.

  • Seamus,

    “the policy is easy to understand as a cynical appeal to xenophobic New Zealand First voters”

    That is quite an assumption don’t you think. A good way to pre-empt anyone with a different view as being xenophobic?

    One of the curious things in this debate is that most other countries restrict the ability of non-citizens to purchase property in their country (including China) so it seems a little odd that New Zealand would allow such purchases?
    (And this makes it hypocritical for those in countries which restrict property purchases to their own citizens to accuse NZ of being xenophobic)
    Given this, I think the argument should not be that allowing such purchases does no harm, to actually demonstrating BENEFIT of such purchases. if there is no benefit why should we allow it?

  • Chris B: Since your comment is more about methodology than housing policy, I thought I’d write a methodology post and we can continue the discussion there. Hopefully, I will have it up on Offsetting on Monday.

    Michael. What I meant was that the policy is easily understood as one playing to xenophobic sentiment for policital gain; it is less easily understood as a genuine attempt to solve a problem, but that I would try to debate the policy on its merits, not just dismiss it as motivated by xenophobia.

    For the burden of proof argument, you seem to be thinking of this as a policy that imposes direct costs only on foreigners, by refusing them permission to buy. But it is also a policy that imposes costs on domestic house owners by restricting who they can sell their private property to. Shouldn’t the burden of proof be on those who want to use the power of government to restrict people’s right to dispose of their own property to show a social benefit from such restrictions? And given that the proposed policy (the foreign ownership part) would targetted neither the number of people wanting to live in houses or the stock of houses, the balance of probabilities has to lie pretty solidyly on the side of seeing no reason for restricting property rights.