The politics and economics of housing policy
By Dr John Humphreys, Australian Taxpayers’ Alliance Chief Economist
Ballooning prices, higher demand and a lack of supply have landed the issue of home ownership affordability back on the agenda in the approach to the election. During 2021, the price of housing across Australia’s eight capital cities spiked by an eye-watering 24%, bringing the total value of residential property up to nearly $10 trillion - five times larger than Australia’s GDP. During the same time average wages rose by just over 2%, a discrepancy leaving many people unable to enter the property market. This growing gap between home-owners and aspiring home buyers demands an urgent housing policy rethink.
As the nation’s largest grassroots advocacy group representing taxpayers, the Australian Taxpayers’ Alliance promotes evidence-based solutions that increase freedom and prosperity and minimise government waste. In this report, the ATA will unpack the incentives and economics at play in the housing solutions proposed by the major parties in the approach to the 2022 federal election.
The major political parties are promising to enact policies that claim to help people to buy their first home but the politics of home ownership has only a vague link to the underlying economics of the housing market. The issue is a lack of supply in relation to demand.
Broadly speaking there are only three approaches that the government could take to make houses more affordable to regular Australians:
impose price controls;
provide subsidies to buyers; or
increase the number of houses.
The vast majority of the policies presented from the major parties fall into the second category – including the long-standing first home buyers grant, Labor’s 40% shared-equity proposal, and the Liberals’ policy to allow use of super funds for a home deposit. These policies make it marginally easier for the beneficiaries to buy houses (the stated goal), which causes an increase in demand. Given that the current supply of housing is relatively inelastic, an increase in demand causes an increase in prices, which undermines the stated goal of the policy and further fuels the housing boom. Not a great plan.
These ideas are referred to as “demand-side” policies. While the economics of demand-side solutions doesn’t add up and instead promises to drive prices further upwards, a look at the politics of the situation provides a stark contrast. Politicians want to look like they are helping first home-buyers - but they also have a vested interest in pushing up house prices to benefit existing homeowners. By subsidising demand, politicians are able to pretend they are helping home-buyers while actually helping home-owners. With a slick political sales campaign, they hope to get support from both groups.
In contrast to the above Liberal-Labor approach, the Greens and Socialists have floated the prospect of rent caps in the rental market. This idea is even worse. The problem with price controls is that they inevitably lead to a shortage of rentable properties and the deterioration of standards. The long-run consequence is that fewer houses will be built, even fewer of those will be made available for renters, leading to an acute housing crisis.
The only effective way to improve access to affordable housing is by increasing the number of houses available, both for buyers and renters. More housing will mean more rental properties available at a more affordable price. This will flow on to lower house prices, which will make home ownership more achievable for the average working family.
While demand-side policies are economically dubious but politically popular, the situation with supply-side solutions is the reverse – economically sound but politically difficult. Lower rents and house prices are great for renters and new buyers, but they are not popular among landlords or existing property holders. Increasing the housing supply also runs up against the loud lobbying efforts of well-connected developers, planners, development bureaucrats, environmental extremists, and various other special interest groups that want to restrict new housing developments.
These hurdles are why we have not seen significant progress towards increasing the housing supply. Nonetheless, for people interested in genuinely making housing more affordable, the only serious solution is to increase the number of houses. This can be achieved in several different ways, such as:
(1) change zoning laws to allow more high-density living in cities;
(2) relax land-use restrictions to allow more low-density development in the outer suburbs;
(3) decrease the costs associated with building new houses; or
(4) government building new houses directly.
Below, we explore in more detail the benefits and costs associated with each option:
Option #1: Change zoning laws within cities to allow building up
Changing zoning laws is a common suggestion from economists, and this argument was made eloquently in a 2020 paper by Peter Tulip, published by the Centre for Independent Studies.
Tulip argues that strict zoning laws are responsible for limiting the supply of high-density living options, which drives up prices by around 70% in Sydney and Melbourne. He makes the case city planners need to allow for more high-density developments, with fewer limits on building height and number of dwellings per building. This increase in supply should help to push down the “zoning premium” so that prices more closely match the marginal cost of building new accommodation.
One complication with this approach is how to balance the interests of existing owners (who may benefit from zoning laws) and potential future owners (who would benefit from being able to access more affordable housing near the city). The need to balance these competing interests involves a political game of intermittent rezoning, which creates an incentive for political favouritism and corruption. Also, while pro-development rezoning does increase the supply of housing, it does not permanently change the elasticity of supply because each new development requires a new round of zoning approvals.
Option #2: Relax land-use restrictions around cities to build out
In contrast to the usual focus on city zoning laws, the American scholar Randal O’Toole has argued persuasively that land-use laws on the city edge are a more important driver of house prices. He points to the example in Texas, where Dallas has relatively strict zoning laws while Houston does not, and yet both cities have relatively low and stable house prices. What both cities share (along with various other cheap cities across the USA) is a relaxed approach to land use on the edge of the cities, allowing the cities to grow out as the demand rises.
O’Toole notes that there is a common mantra about the importance of “building up” with high density living close to the city, but he argues that such policies are ineffective and they are not what most home buyers want. When given the option, many home buyers are willing to sacrifice proximity to the city in favour of larger houses and low-density neighbourhoods in the suburbs.
The main benefit (and point of difference) this option offers is that it increases the elasticity of supply. Removing land-use restrictions on the edge of existing cities does not simply shift the supply curve but it also increases the elasticity of supply, meaning supply can increase and decrease in response to demand more easily. Landowners near the city are able to more quickly change their behaviour in response to changing conditions. A higher supply elasticity means that demand increases are more likely to be met with supply increases (instead of large price increases) and any reduction in building costs are more likely to be passed on to the consumer as lower prices.
Option #3: Decrease costs of building new houses and apartments
The above two options focus on the availability of land, but another approach is to decrease the costs associated with building and selling new houses. Former CEO of Master Builders South Australia Ian Markos has long lobbied for the removal of stamp duties for new houses. Other cost-saving measures could be achieved by reducing labour market and/or OHS regulations, though both of those involve trade-offs and difficult political battles.
Policies that reduce the cost of building and selling new houses will shift the house supply curve down, resulting in lower prices and more supply. Having said that, the size of the benefit will depend crucially on the elasticity of housing supply, with a low elasticity translating into a small benefit. Reducing production costs may be an appropriate part of good housing policy, but it needs to be supplemented by one of the other supply-side options in order to have maximum effect.
Option #4: Government-run housing projects
Prominent Australian economist Cameron Murray comes to a more dramatic conclusion, and argues that the only sure way to have more houses built is for the government to drive the development themselves. He makes the case that zoning changes can foster corruption and insider advantage, and he fears that the natural housing supply curve will remain stubbornly inelastic even after land-use deregulation.
These are reasonable arguments, though his proposal of a government-led approach opens up a new set of risks regarding a new type of corruption and the inevitable failings of central planners to correctly calculate opportunity costs and consumer preferences. People sceptical about the wisdom and benevolence of politicians may prefer one of the earlier options, but at least this approach directly addresses the underlying issue of housing supply.
None of these solutions are a silver bullet. Each involves trade-offs, and there is an honest debate to be had about exactly the best mix of supply-side policies to help improve house affordability. Sadly this debate is mostly missing from our politics, as both major parties stay stubbornly focused on ineffective demand-side policies that are more about buying votes than helping people buy houses.
The Australian Taxpayers’ Alliance is the nation’s largest grassroots advocacy group representing taxpayers. We are funded solely by civic-minded Australians passionate about the same issues for which we campaign: lower taxes, commonsense regulations, and no government waste.
References:
1 ABS Residential Property Price Indexes: Eight Capital Cities,
https://www.abs.gov.au/statistics/economy/price-indexes-and-inflation/residential-property-price-indexes-eight-capital-cities/latest-release#residential-property-price-indexes
2 ABS Key Economic Indicators, https://www.abs.gov.au/statistics/economy/key-indicators
3 ABS Wage Price Index, Australia, https://www.abs.gov.au/statistics/economy/price-indexes-and-
inflation/wage-price-index-australia/mar-2022
4 Tulip, P. (2020), Planning restrictions harm housing affordability, POLICY Paper 33, Centre for Independent Studies, Sydney.
5 O’Toole, R. (2016), More Regulation Won’t Make Housing Affordable, CATO at Liberty,
https://www.cato.org/blog/more-housing-regulation-wont-make-housing-affordable
6 O’Toole, R. (2021), Density Makes Housing Less Affordable, Not More, Real Clear Policy 26 April 2021,
https://www.cato.org/commentary/density-makes-housing-less-affordable-not-more
7 Master Builders South Australia (2017), First Home Buyers Need Help, Not a Noose, Media Release 10 April 2017, MBSA.
8 Murray, C. (2022), Why politicians must pretend to want cheap housing, UQPPES Stataecraft Autumn Lecture, 16 March 2022, as published on Fresh Economic Thinking,
https://fresheconomicthinking.substack.com/p/why-politicians-must-pretend-to-want?s=w