I imagine it is a tough job being the nation's central banker. But the recent television interview with Glenn Stevens, RBA Governor, has made it quite clear the predicament he currently faces.
Stevens warned that property speculation is not the path to riches (the Real Estate Institute of Australia was apparently surprised by this statement). Obviously he is very worried about the stability of Australia's massive residential property market. But to achieve the desired outcome, he needs to fool us all.
As I have mentioned before, the interest rate lever as a monetary policy tool is not exactly akin to a car accelerator. Sometimes we don't notice a change in speed because we don't have a speedometer to provide information - all we have are the other cars beside us as a reference point. When interest rate moves are made in predictable baby steps, we barely notice the relative change in speed with the cars beside us, and may not change our behaviour. However, if interest rate changes were sudden and unpredictable, we might get the message.
Steve Keen, amongst others, has noted that for monetary policy to be effective the public must be fooled. The IS-LM-BP model that underpins our understanding of monetary policy transmission fails under rational expectations. If the public’s expectations are in line with monetary policy changes, they are ineffective. Expectations must not be met.
I am guessing his preferred outcome is for lenders to tighten standards on home loans and for buyers to be more cautious about taking on housing debt, so that he doesn’t actually need to increase the debt burden on the economy. He wants us to think interest rates are going to be higher in the future without actually having to follow through with the increases.
Tuesday, March 30, 2010
Monday, March 29, 2010
Is it all about GDP and growth?
(Guest post from Christian)
So if you believe the numbers, in the recent downturn, Australia managed to avoid 2 consecutive quarters of negative GDP growth and therefore had no recession. This is an often proudly quoted fact by various Australian politicians and economists as a sign of the strength and resilience of Australia's economy and its wise management. But what exactly does it all mean for the people of Australia?
GDP is one of the most often used measures of the wealth of a nation. Therefore wealth creation can be measured in terms of the growth rate of GDP, in either nominal or real terms. So in this sense, Australia avoided 2 consecutive quarters of diminishing wealth, and (again assuming you believe the numbers) is rolling along nicely with low inflation and a reasonable rate of growing wealth.
However, GDP is just one popular measure of a nation's wealth in dollar terms. In my opinion, if we are looking to value national wealth then it will necessitate a subjective measure, since each person places their own value on a dollar, a good, or a service. We also need to take into account the value each person places on social factors such as crime, or environmental factors such as air quality. Anything that contributes to bringing an emotion – positive or negative - to a person would be valued by that person. So, all these factors will contribute to national wealth.
When measuring a nations wealth on GDP growth some of these key elements of national wealth are not captured. So if a democratically elected government has a duty to maximise the wealth of its people then this definitely will cover factors which are not measured by GDP.
It looks like the French cottoned onto this a while ago, establishing establishing a commission to look at measures of progress with a wider scope.
In the end it comes down to each individuals expectations and perspective. And this means it is difficult, if not impossible, to measure a combined group of different people's values on all the above factors and arrive at an accurate aggregate. Even if we assume that each individual within a country has the same values and use a subjective survey to make an average measure, then we can't even compare the result between 2 or more different countries as the measure is subjective to each country. You can assume, but it is still just a plain false assumption that everyone has the same values.
So what is an alternative?
Quality of life is measured by the Human Development Index (HDI) published by the United Nations - but again it is using numbers which each person would value differently. Life expectancy, literacy rate etc etc. These measures miss what quality is all about. For example we need to measure NOT how long a person lives (quantity) but how much they actually live or the enjoyment they get from it (quality). I believe the HDI is a step in the right direction, but I fear that any statistical measure will continue to disregard the unquantifiable factors which really make up quality of life.
Recently, renowned economist Sir Partha Dasgupta put it like this -"As long as we rely on GDP and HDI, we will continue to paint a misleading picture of economic performance. So successful has this enterprise been that if someone exclaims, 'Economic growth!', no one needs to ask, 'Growth in what?' -- we all know they mean growth in GDP."
At the moment there seems to be an intense focus throughout the world on GDP growth and inflation in macro economic comparisions. The targets are maximum growth in a low inflation environment. However I feel, firstly, we can still improve national wealth without necessarily meeting these targets. Secondly, we could actually be destroying national wealth whilst meeting these targets. Any thoughts?
Thursday, March 25, 2010
Friday quick links
1. Most findings of statistical research are false, and can be easily demonstrated to be so. If I haven't convinced you to scrutinise statistics carefully, then this may. Warning: the linked paper is a little nerdy and mathematical.
2. Is prescribing a placebo a good idea?
3. One laptop per child and a computer on every student's desk - some evidence that computers help children learn computer skills, but detract from their learning of other more basic skills such as maths and English.
4. My interest rate bet looks shaky - straight from the horse's mouth.
5. Moral self-licensing is when doing something good in one part of your life helps you justify doing something bad in another part. This 'green' consumer experiment is a classic - ..green shoppers, however, earned on average 36¢ more, showing that they had lied to boost their income.
I must say that in moments of raw self-reflection I can see myself issuing a subconscious (sometimes conscious) moral licence. 'I've been good for a while, now I can justifiably do something bad"
Maybe it has something to do with our upbringing. I know that I often reward my son with otherwise 'bad' foods (he loves Jatz crackers) when he has behaved well. It would be nice to conduct a cross-cultural comparison on this topic.
It is also a example of actively reverting to the mean. People think they are at the extremes of socially normal behaviour, so they do something that is at the other end of the spectrum to keep themselves in line with others.
2. Is prescribing a placebo a good idea?
3. One laptop per child and a computer on every student's desk - some evidence that computers help children learn computer skills, but detract from their learning of other more basic skills such as maths and English.
4. My interest rate bet looks shaky - straight from the horse's mouth.
5. Moral self-licensing is when doing something good in one part of your life helps you justify doing something bad in another part. This 'green' consumer experiment is a classic - ..green shoppers, however, earned on average 36¢ more, showing that they had lied to boost their income.
I must say that in moments of raw self-reflection I can see myself issuing a subconscious (sometimes conscious) moral licence. 'I've been good for a while, now I can justifiably do something bad"
Maybe it has something to do with our upbringing. I know that I often reward my son with otherwise 'bad' foods (he loves Jatz crackers) when he has behaved well. It would be nice to conduct a cross-cultural comparison on this topic.
It is also a example of actively reverting to the mean. People think they are at the extremes of socially normal behaviour, so they do something that is at the other end of the spectrum to keep themselves in line with others.
Monday, March 22, 2010
Affordable housing supply from a market crash
It seems that no matter what the objective market conditions are like, the same lobby groups (the Housing Industry Association and the Property Council of Australia for example) and property spruikers continue to trot out the housing shortage claim in an appeal for government assistance.
If you truly believed there is a housing shortage and hence an affordability crisis, a market crash (price declines >20%) is the best solution. I will outline my reasoning by referring to the appropriate economic models – the same models misused by those who believe that government intervention is causing supply constraints.
Chris Joye, perfectionist, has lead the charge since the completion of the Home Ownership Taskforce report in 2003, bringing attention to the ‘fact’ that the supply of new homes in Australia is not responsive to price change and it is this phenomena that has lead to such a dire shortage (housing apparently has a low elasticity of supply, even though I have yet to see any quantification of the claim). Instead of producing a solid theoretical argument for his claims, backed up by rigorous empirical evidence, Chris instead repeats the same tired old property industry mantra with renewed vigour and wit.
But what of his ‘elastify the supply side’ solution to housing affordability? (from here)
Economists are also cautious. But Joye says they are wrong because he has plans up his sleeve to increase supply by cutting development costs. There are no shades of grey.
But when pressed he concedes his "supply side" case rests on some tenuous assumptions about the political, environmental and urban planning choices that state governments and local councils are willing to make.
Joye's last line of defence is to press his extraordinary achievements and repeat praise from an army of high-profile backers. But some of the conscripted say privately that their interest in Joye's work has been misconstrued as unconditional support. "Quoting people selectively and out of context is going to land him in trouble," says one who wished to remain anonymous. "You just shouldn't do that."
I agree that Joye’s case rests on tenuous assumptions, incongruous reasoning, and no evidence, and I would second the note of caution on his selective appeals to authority as a defense for his ideas.
My hesitation rests on the imaginative and unrealistic outcome Joye, and the property lobby at large, suggest - that if only Local and State government planning controls, infrastructure fees, and approval processes were streamlined, developers nationwide would be happy to build and sell more new homes, at lower prices.
Sure, that will happen.
And of course, the supply side has been the problem the world over. Hang on, except in Germany where strict lending standards and tax regimes rule out speculation on property prices- though they must have particularly lenient planning controls to keep prices so stable (see an international comparison of price-rent ratios in the figure below).
For those with common sense, we can simply say that if constraints on supply (of which there are none) caused Australia’s property boom, what on Earth caused the contemporaneous housing booms the worlds over? Oh yes,supply constraints irrational bubble investment fuelled by exuberant lending.
Spruikers, please don’t invoke the population growth argument now, or you’ll be asked to defend this argument for property markets around the world, and you know as well as I, that the argument is fallacious. Population growth can only drive up prices if the new people are willing and able to pay higher prices than the existing population.
Joye takes his analysis a step further than his predecessors by appealing to the mythical cross swords of demand and supply, a model we all learn in first year economics, yet generally one we fail to completely understand.
For those without an economics background,
1. The economic model where supply responds to price describes consumption goods over the ‘short run’ – a period of time so short that new capital investment cannot be undertaken.
2. The model does not apply to asset prices (remember that land prices, not construction prices, have increased dramatically this past decade) – asset supply, in the form of capital goods, should not be responsive to price, but can be responsive to returns and their associated risk (the price of future productive capacity of the asset).
3. Even if we assume that the above two points are wrong, a declining housing price will not reduce the supply of homes, but will allow prices to ‘reset’ and price growth from this lower base will continue to stimulate supply at a lower price.
But let us examine the three points above as a refresher in economic theory.
Most people with an economics degree still fail to make the (dis)connection between reality and the upward sloping supply curve of classical micro and macro theory. The only reason the supply curve is upward sloping, and hence supply should increase as a response to price, is that businesses are operating at the extremes of their capital capacity – so much so, that the cost to produce each extra good is in fact rising, rather than falling (increasing marginal costs as it is known). But how much does that reflect reality? Simply put, it doesn’t 99% of the time. It is rare that businesses will fail to respond to a situation in increasing marginal costs by not increasing their capital base in the longer run.
If we glance now at point number two, we can further see the absurdity in Joye’s supply elasticity argument. Supply of a given asset does not need to respond to increasing returns – prices can simply rise instead. If asset supply did respond in such a way, we would never see capital gains on the share market, as supply of company shares would continue to be increased in response to minor price changes. However, in the property context, it is higher rates of return that will increase supply, which can only come about from higher rents, or lower land prices.
Finally, if we ignore all the arguments I have already made, and assume that supply of new homes is indeed responsive to price, then the best way for governments to ensure a high rate of new dwelling supply is to let prices fall. When prices fall, development sites will be forced onto the market and snapped up by buyers at prices far below those paid by their previous owners. These new buyers will be able to profitably build new homes at prices below those seen prior to the crash. We can reset the market at 20% below current prices, and have supply stimulated from that new low price baseline.
The supply elasticity argument fails on its own grounds, and on more rigorous theoretical grounds. Like my previous arguments about subsidizing farmers to protect food supply, subsidizing developers to protect housing supply is the worst move a government can make. Letting asset markets reset (clear) is the best way forward.
If you truly believed there is a housing shortage and hence an affordability crisis, a market crash (price declines >20%) is the best solution. I will outline my reasoning by referring to the appropriate economic models – the same models misused by those who believe that government intervention is causing supply constraints.
Chris Joye, perfectionist, has lead the charge since the completion of the Home Ownership Taskforce report in 2003, bringing attention to the ‘fact’ that the supply of new homes in Australia is not responsive to price change and it is this phenomena that has lead to such a dire shortage (housing apparently has a low elasticity of supply, even though I have yet to see any quantification of the claim). Instead of producing a solid theoretical argument for his claims, backed up by rigorous empirical evidence, Chris instead repeats the same tired old property industry mantra with renewed vigour and wit.
But what of his ‘elastify the supply side’ solution to housing affordability? (from here)
Economists are also cautious. But Joye says they are wrong because he has plans up his sleeve to increase supply by cutting development costs. There are no shades of grey.
But when pressed he concedes his "supply side" case rests on some tenuous assumptions about the political, environmental and urban planning choices that state governments and local councils are willing to make.
Joye's last line of defence is to press his extraordinary achievements and repeat praise from an army of high-profile backers. But some of the conscripted say privately that their interest in Joye's work has been misconstrued as unconditional support. "Quoting people selectively and out of context is going to land him in trouble," says one who wished to remain anonymous. "You just shouldn't do that."
I agree that Joye’s case rests on tenuous assumptions, incongruous reasoning, and no evidence, and I would second the note of caution on his selective appeals to authority as a defense for his ideas.
My hesitation rests on the imaginative and unrealistic outcome Joye, and the property lobby at large, suggest - that if only Local and State government planning controls, infrastructure fees, and approval processes were streamlined, developers nationwide would be happy to build and sell more new homes, at lower prices.
Sure, that will happen.
And of course, the supply side has been the problem the world over. Hang on, except in Germany where strict lending standards and tax regimes rule out speculation on property prices- though they must have particularly lenient planning controls to keep prices so stable (see an international comparison of price-rent ratios in the figure below).
For those with common sense, we can simply say that if constraints on supply (of which there are none) caused Australia’s property boom, what on Earth caused the contemporaneous housing booms the worlds over? Oh yes,
Joye takes his analysis a step further than his predecessors by appealing to the mythical cross swords of demand and supply, a model we all learn in first year economics, yet generally one we fail to completely understand.
For those without an economics background,
1. The economic model where supply responds to price describes consumption goods over the ‘short run’ – a period of time so short that new capital investment cannot be undertaken.
2. The model does not apply to asset prices (remember that land prices, not construction prices, have increased dramatically this past decade) – asset supply, in the form of capital goods, should not be responsive to price, but can be responsive to returns and their associated risk (the price of future productive capacity of the asset).
3. Even if we assume that the above two points are wrong, a declining housing price will not reduce the supply of homes, but will allow prices to ‘reset’ and price growth from this lower base will continue to stimulate supply at a lower price.
But let us examine the three points above as a refresher in economic theory.
Most people with an economics degree still fail to make the (dis)connection between reality and the upward sloping supply curve of classical micro and macro theory. The only reason the supply curve is upward sloping, and hence supply should increase as a response to price, is that businesses are operating at the extremes of their capital capacity – so much so, that the cost to produce each extra good is in fact rising, rather than falling (increasing marginal costs as it is known). But how much does that reflect reality? Simply put, it doesn’t 99% of the time. It is rare that businesses will fail to respond to a situation in increasing marginal costs by not increasing their capital base in the longer run.
If we glance now at point number two, we can further see the absurdity in Joye’s supply elasticity argument. Supply of a given asset does not need to respond to increasing returns – prices can simply rise instead. If asset supply did respond in such a way, we would never see capital gains on the share market, as supply of company shares would continue to be increased in response to minor price changes. However, in the property context, it is higher rates of return that will increase supply, which can only come about from higher rents, or lower land prices.
Finally, if we ignore all the arguments I have already made, and assume that supply of new homes is indeed responsive to price, then the best way for governments to ensure a high rate of new dwelling supply is to let prices fall. When prices fall, development sites will be forced onto the market and snapped up by buyers at prices far below those paid by their previous owners. These new buyers will be able to profitably build new homes at prices below those seen prior to the crash. We can reset the market at 20% below current prices, and have supply stimulated from that new low price baseline.
The supply elasticity argument fails on its own grounds, and on more rigorous theoretical grounds. Like my previous arguments about subsidizing farmers to protect food supply, subsidizing developers to protect housing supply is the worst move a government can make. Letting asset markets reset (clear) is the best way forward.
Friday, March 19, 2010
Book review: Embracing the Wide Sky
Autistic savant Daniel Tammet wrote this gem, and yes that means he has ‘rainman' like mental skills. In fact, he learnt Icelandic (his 11th language) in the week prior to being interviewed for an Icelandic television program.
Tammet takes us on a surprisingly entertaining journey through the current research on how our brains operate - how they remember, how they learn language, logic and mathematics. He proposes a very simple overarching theory about our brain functionality which can ultimately explain déjà vue, memory distortion, information overload, the difficulty learning a second language (there’s no reason to believe it gets harder with age, but only our first language is stored in the ‘language area’ of the brain, while second languages are stored elsewhere), why words, phrases or physical settings prompt unconscious memory retrieval associated with that stimulus (for example, why moving students form one classroom where they learned material to another for examinations has a negative impact one their ability to recall what they’ve learned), and why the typical English speaking adult can remember the meanings of more than 45,000 words.
His theory starts by debunking absolutely the idea that our brains work like computers – that we store and retrieve memories and use some kind of software to manage the data. Our brains are instead a simple instrument that uses in-built pattern recognition to re-create memories each time they are 'retrieved' - there is not memory bank to speak of. This pattern recognition system is a variant on Noam Chomsky’s theory that the brain has a built in system of grammar, and that a rules can allow a brain to quickly learn any language (as all languages conform to the basic rules of grammar in the human brain). The problem of course is that repeatedly re-creating memories can lead to an actual creation of something entirely new. I will never trust eyewitness evidence again.
These in built ‘grammatical’ rules even allow us to perform complex mathematics. Tammet explains his own mathematical ability as simply applying the grammar of mathematics. He sees a number and gets a feeling if it is prime, just as we see a new work for the first time and know, due to the pattern of letters, whether it could be a real english word, and possibly induce its meaning. We know instinctively that qwrsh is not a word, just like Tammet knows that 12391 is prime.
He compares the beauty of our built in system of information arrangement and recreation to the dewey decimal system:
Dewey's system is a marvel of organization, but I have given detailed examples here in order to make an important philosophical as well as practical point. Information is meaningless unless it can be made sense of, and to do that it requires an internal system of thought and ideas that can provide context and relate it to other information we have already learned
Ultimately, Tammet proposes that his autistic brain indeed functions like all others, but in a highly connected way. He uses the same inbuilt grammar of the mind for mathematics and language but in a highly connect way. He is not different, just enhanced in this way.
Monday, March 15, 2010
Why the next interest rate move is down
Most economists predict another rate hike by the RBA. I am not like most economists and predict the next move will be down. My reasoning is founded on the unfortunate necessity to maintain housing values in order to avoid serious disruption to our financial system. The RBA will move strongly to reduce the interest burden on debt should they see evidence of a fall in house prices (aka values). The following snippets are therefore worrying for the RBA:
1. The term deposit rates peak at 6months for most major banks, while yesterday we saw a number of banks lower their term deposit rates even further
2. Beijing real estate recorded its first price decline last month and a massive decline in sales volumes
3. Australian mortgage approvals have plummeted
4. The CBA is tightening lending standards
The graph below (courtesy of one of my favourite websites) shows a pretty clear relationship between asset prices and the willingness to take on debt. This time however we have more foreign money chasing our housing, so maybe the effect will be subdued. On the other hand, this could be the start of the ‘correction we had to have’.
My prediction is that the RBA to keep interest rates stable until evidence of price declines becomes more vivid, in which case they will make another round of severe cuts, all the while losing credibility.
1. The term deposit rates peak at 6months for most major banks, while yesterday we saw a number of banks lower their term deposit rates even further
2. Beijing real estate recorded its first price decline last month and a massive decline in sales volumes
3. Australian mortgage approvals have plummeted
4. The CBA is tightening lending standards
The graph below (courtesy of one of my favourite websites) shows a pretty clear relationship between asset prices and the willingness to take on debt. This time however we have more foreign money chasing our housing, so maybe the effect will be subdued. On the other hand, this could be the start of the ‘correction we had to have’.
My prediction is that the RBA to keep interest rates stable until evidence of price declines becomes more vivid, in which case they will make another round of severe cuts, all the while losing credibility.
Sunday, March 14, 2010
Random externalities
A complete reiteration of my arguments against exceptional circumstances provisions for farmers can be found on today on Business Spectator courtesy of David Leyonhjelm. Simply, we fear a non-existent negative externality of diminished food production should farm businesses fail.
As a parent I also found this article on the externalities of public advertising quite intriguing. It seems that movies (private consumption decisions) need to be classified to prepare the viewer for their level of violence and sexuality, yet advertising in public spaces seems to be M rated even when Parental Guidance is not possible. To avoid this negative externality on children and parents could we not adopt the G rating standard from the film and television industry as the standard for public advertising?
Those who are a fan of the movie Pay it Forward will ba happy to see that acts of kindness can spread through society very easily. Just another bit of evidence for how culture can change behaviour and how our preferences, expressed through our behaviour, are not fixed at all (as economists would have us believe). Given this is an example of a positive externality, economic theory would suggest we will face a constant battle to ensure a socially optimal level of kind acts. Luckily the research suggests that once we adopt a strategy of kindness we don't go back to selfishness very easily.
In the current study, Fowler and Christakis show that when one person gives money to help others in a "public-goods game," where people have the opportunity to cooperate with each other, the recipients are more likely to give their own money away to other people in future games. This creates a domino effect in which one person's generosity spreads first to three people and then to the nine people that those three people interact with in the future, and then to still other individuals in subsequent waves of the experiment.
The effect persists, Fowler said: "You don't go back to being your 'old selfish self.''' As a result, the money a person gives in the first round of the experiment is ultimately tripled by others who are subsequently (directly or indirectly) influenced to give more. "The network functions like a matching grant," Christakis said.
"Though the multiplier in the real world may be higher or lower than what we've found in the lab," Fowler said, "personally it's very exciting to learn that kindness spreads to people I don't know or have never met. We have direct experience of giving and seeing people's immediate reactions, but we don't typically see how our generosity cascades through the social network to affect the lives of dozens or maybe hundreds of other people."
People have previously suggested that happiness too can spread through social networks, although it may partly be that happy people are attracted to other happy people. But all this new research does tend to suggest that you should choose your friends wisely, keep you children in cinemas instead of on the street, and buy a farm to ensure a government supported lifestyle.
As a parent I also found this article on the externalities of public advertising quite intriguing. It seems that movies (private consumption decisions) need to be classified to prepare the viewer for their level of violence and sexuality, yet advertising in public spaces seems to be M rated even when Parental Guidance is not possible. To avoid this negative externality on children and parents could we not adopt the G rating standard from the film and television industry as the standard for public advertising?
Those who are a fan of the movie Pay it Forward will ba happy to see that acts of kindness can spread through society very easily. Just another bit of evidence for how culture can change behaviour and how our preferences, expressed through our behaviour, are not fixed at all (as economists would have us believe). Given this is an example of a positive externality, economic theory would suggest we will face a constant battle to ensure a socially optimal level of kind acts. Luckily the research suggests that once we adopt a strategy of kindness we don't go back to selfishness very easily.
In the current study, Fowler and Christakis show that when one person gives money to help others in a "public-goods game," where people have the opportunity to cooperate with each other, the recipients are more likely to give their own money away to other people in future games. This creates a domino effect in which one person's generosity spreads first to three people and then to the nine people that those three people interact with in the future, and then to still other individuals in subsequent waves of the experiment.
The effect persists, Fowler said: "You don't go back to being your 'old selfish self.''' As a result, the money a person gives in the first round of the experiment is ultimately tripled by others who are subsequently (directly or indirectly) influenced to give more. "The network functions like a matching grant," Christakis said.
"Though the multiplier in the real world may be higher or lower than what we've found in the lab," Fowler said, "personally it's very exciting to learn that kindness spreads to people I don't know or have never met. We have direct experience of giving and seeing people's immediate reactions, but we don't typically see how our generosity cascades through the social network to affect the lives of dozens or maybe hundreds of other people."
People have previously suggested that happiness too can spread through social networks, although it may partly be that happy people are attracted to other happy people. But all this new research does tend to suggest that you should choose your friends wisely, keep you children in cinemas instead of on the street, and buy a farm to ensure a government supported lifestyle.
Wednesday, March 10, 2010
Newsflash: Property Council of Australia makes a reasonable point
The Property Council of Australia is a powerful lobby group known for ignoring truth and reason in its appeals for support from all levels of government. The PCA’s latest battle surrounds the proposed amendment to the Valuation of Land Act 1944 (the Act), which will clarify a number of definitions for determining the ‘unimproved’ value of commercial buildings – a value upon which land tax liabilities and local government rates are calculated.
(As a strong proponent of land taxes I should be paying particular attention to the necessary practicality of valuing unimproved land.)
The property lobby sees this Bill as a tax grab due to the likelihood of higher land valuations, and they have mustered plenty of support from other industry associations to stop it getting passed.
What follows is a brief analysis that suggests the Bill is quite unworkable, that the PCA has actually raised real issues with the practicality of the Bill, and also suggests extreme incompetence by the Queensland government.
To be clear the changes to Valuation of Land Act 1944 proposed in the Bill are outlined in my previous post.
1. That these changes will affect mum and dad investors, farms, shopping centres, CBD locations and more – virtually anyone who pays land tax. (if you own commercial property - the heartstring appeals from mum and dad investors is a bit over the top)
2. They will massively increase the cost of living and doing business in Queensland (only if net State tax revenues increase as a result and are not used for the public benefit)
3. We know the proposed changes will destroy property values and capital investment in Queensland (same response as 2)
4. And contrary to the Government's claim, the Bill will have an effect on residential properties by increasing the value of residential land (only if residential leases add value to the property, which they generally do not)
5. This Bill makes the ‘un’ in ‘unimproved value’ redundant. But instead of dropping the ‘un’ the State wants to re-write the dictionary so that the word unimproved actually means improved (the State can make a term mean whatever it wants in legislation, as it usually does).
However, they make a strong and valid case against unimproved valuations having consideration of commercial leases while not incorporating a profit and risk factor when making comparisons to improved sites.
The Queensland Government has a slightly different take on the matter (available here and here). They claim that a recent Court of Appeal decision led to uncertainty about the inclusion of certain items, such as leases and goodwill, which are used to determine the 'highest and best use' of land if it were sold in today’s market. They claim these changes will confirm the valuations previously issued on or from 30 June 2002 and provide certainty for the future.
There is no theoretical problem with the inclusion of leases in the ‘unimproved’ valuation. Instead the problem rests on the workability of this method. One valid theoretical justification for the inclusion of commercial leases rests on the assumption that the purpose of unimproved values is to determine the value of the title to the property - that piece of paper that grants rights from the State to the property owner. Because commercial leases are recorded on the property title the benefit they give the property owner should be considered.
Further, a lease or agreement for future rental of a building still to be constructed may increase the value of a vacant block prior to any construction work. In this way, the value of the land is affected by the lease without the need for the improvement. A market valuation of an identical site without the lease would also include the discounted future value of hypothetical leases (as sites with a highest and best use for development should be valued with recognition of potential future income), and whether or not an actual lease would increase or decrease this figure is not certain.
The alternative, and much more sound theoretical position, suggests leases should not be included. If the purpose of unimproved values to value the rights vested to the property owner by the State, then they should be excluded, as the licences on the title are simply records that improve security of contracts upon land. This is unlike water licences (which are also attached to land and require improvements to be realised), as water licences are a right granted to the owner from the State.
The recent Pacific Fair case is the most recent case to consider the inclusion of leases in the unimproved value. The decision in this case was based on the fact that leases imply improvements, and if the State wanted them to be included they would have specified such requirements in the Act. The Bill has been prepared as a response to this decision (maybe the Government just doesn't want to admit that mistakes were made in some valuations?).
Now on to the main problem at hand. To implement the new Bill the State would need to know the intricate details of all commercial property leases across the State. It is difficult enough to value a single building knowing all the current leases and conditions. It is a mystery how the Queensland government proposes to accomplish this feat for every commercial building in the State on a regular basis.
The second unworkable part is the exclusion of a profit and risk factor when deducting the cost of buildings to make a comparison to improved sites. Apart from being a little extreme, this allowance means the end result of the ‘unimproved’ valuation is simply a market valuation minus construction costs. Clearly it is costly and unworkable to determine market valuations for all commercial buildings, nor does such a method meet any theoretical arguments for a land tax.
So, does this mean we should start trusting the PCA? Probably not. I'll continue to consider any of their claims on its own merit.
Finally, is the State simply stupid, or is the Bill part of an intentional negotiation strategy with the property lobby? On this question I am torn, as I have seen evidence of both utter stupidity and extreme cunning from the State government (but I have on good authority that stupidity should be the default position).
Proposed changes to Section 3 of the Valuation of Land Act 1944
(1) For the purposes of this Act—
unimproved value of land means—
(a) in relation to unimproved land—the capital sum which the fee simple of the land might be expected to realise if offered for sale on such reasonable terms and conditions as a bona fide seller would require negotiated as a bona fide sale; and
b) in relation to improved land—the capital sum which the fee simple of the land might be expected to realise if offered for sale on such reasonable terms and conditions as a bona fide seller would require, assuming that, at the time as at which the value is required to be ascertained for the purposes of this Act, the improvements did not exist. negotiated as a bona fide sale, assuming the improvements did not exist.
(2) However, the unimproved value shall in no case be less than the sum that would be obtained by deducting the value of improvements from the improved value at the time as at which the value is required to be ascertained for the purposes of this Act.
(2) However, the unimproved value of improved land can not be less than the sum that would be obtained by deducting the value of improvements from the improved value on the date of valuation.
(2A) The assumption mentioned in subsection (1), definition unimproved value, paragraph (b) is limited to the notional removal of the improvements only as at the time of valuation.
(2A) The assumption mentioned in subsection (1)(b) is limited to the instant in time when the valuation is to be made on the date of valuation.
(2B) For subsections (1) and (2), the unimproved value of land includes any increase in the value of the land that has happened in connection with—
(a) a local planning instrument; or
(b) a development approval or other approval or authority under an Act, other than a hotel licence, relating to the land or an improvement of the land.
(c) the making or use of an improvement to land.
(2C) Nothing in subsection (1) or (2) (b) requires an assumption, in relation to improved land, that the improvements have never been made.
(3) In addition, the restrictions and limitations in any deed of grant or certificate of title in respect of any racecourse shall be disregarded in ascertaining the unimproved value of the land of the racecourse concerned.
(4) Notwithstanding anything contained in this section, in determining the unimproved value of any land it shall be assumed that—
(a) the land may be used, or may continue to be used, for any purpose for which it was being used, or for which it could be used, at the date to which the valuation relates; and
(b) such improvements may be continued or made on the land as may be required in order to enable the land to continue to be so used; but nothing in this subsection prevents regard being had, in determining that value, to any other purpose for which the land may be used on the assumption that any improvements referred to in subsection (1) had not been made.
(c) there is no greater risk than that which applied to the actual use of the land in its actual condition, on the date of valuation, in realising the use of the land, or continuing the use of the land, for any purpose for which it was being used on the date of valuation;
(5) To remove any doubt it is declared that-
(a) the benefit of a lease, agreement for lease or any other instrument of any type relating to land, or improvements on land that enhances the value of the land, as unimproved or improved must be included in its unimproved value; and
(b) the following apply for assessing the unimproved value of land—
(i) the bond rate must be adopted in analysing—
(A) the added value of improvements on the land including any allowance to be made under this section or section 5; and
(B) the added value of improvements involved in any comparable sale of improved land;
(ii) no amount can be deducted for goodwill whether in analysing the improvements on the land, or any comparable sale of improved land, or otherwise;
(iii) no deduction for any profit and risk allowance or development premium can be made for the realisation of the use of the land, or for continuing the use of the land, for any purpose for which it was being used on the date of valuation;
(iv) if the land is improved and the assessment includes a comparison with sales of vacant or lightly improved land, or with sales for redevelopment, an amount representing the development premium inherent in the value of the land as improved must be added to the level of value established by the sales;
(v) the benefit to the land of the payment of infrastructure charges or of infrastructure construction must be included; and
(c) the term ‘unimproved value’ defined under this section has been given a special meaning that must be applied whether or not that definition
Tuesday, March 9, 2010
Thinking like an economist
This article is the first I have come across that compares housing prices and costs to hours worked, which is the ultimate measure for comparing housing affordability across countries or over time (although hours worked for average rent would also be a good measure).
According to the CommSec analysis it now takes 19,374 working hours to pay for an average house at the average hourly rate of pay, compared to just 7,500 hours in 1960. That's ten years of full time work in 2010 versus 3.9 years in 1960. I admit the data may be a little skewed if it is truly generated using averages (means), rather than medians, however there seems to be a strong message coming through.
It also supports my claim about the leisure dilemma, and the ability of others to bid up prices if they choose to work more hours.
According to the CommSec analysis it now takes 19,374 working hours to pay for an average house at the average hourly rate of pay, compared to just 7,500 hours in 1960. That's ten years of full time work in 2010 versus 3.9 years in 1960. I admit the data may be a little skewed if it is truly generated using averages (means), rather than medians, however there seems to be a strong message coming through.
It also supports my claim about the leisure dilemma, and the ability of others to bid up prices if they choose to work more hours.
Sunday, March 7, 2010
An alternative way to gamble on the markets
I have previously mentioned on this blog how investing and gambling share many traits in the short term. Now, you can literally combine the two with Centrebet now taking bets on the value of the ASX200 at the end of the month. I would suggest that the odds generated by Centrebet on this gamble will become a salient leading indicator for economic commentators worth their salt. Currently the outlook is positive for March.
Wednesday, March 3, 2010
The week's best economic commentary
The best Australian economic commentary I have read all week is here.
Drought is not exceptional
The front page of yesterday's Australian newspaper reports Agricultural Minister Tony Burke's recent speech outlining his intention to reform Australian drought policy. The specific part of the Exceptional Circumstances subsidies targeted by the Minister's speech was the interest rate subsidy. Under this scheme farmers in drought declared areas can have 80% of the interest on their farm debts paid for by Australian taxpayers. Farmers were provided $61 million per month in drought assistance at the end December 2009 - or about $730 million per year.
As a side note, it makes me wonder how substantial agricultural subsidies must be in Europe. Australian direct agricultural subsidies amount to approximately 8% of farm income, while in most European nations subsidies account for greater than 60% of farm income.
What I find particularly interesting about drought policy is the logical dilemma encountered when determining what are in fact 'exceptional circumstances'.
Applications for areas to be declared under Exceptional Circumstances must demonstrate that the event:
1. was rare (a one in 20-25 year event) and severe
2. resulted in a severe downturn in farm income over a prolonged period (eg. more than 12 months) for a significant number of farmers in a region or industry, and
3. was not predictable or part of a process of structural adjustment (the policy does not cover downturns in commodity prices).
Yet criteria 1 and 3 logically conflict. If we know the probability of a drought event occurring it must be predictable, or at least foreseeable. Most parts of the country have at least a century of reliable rainfall data to determine the long term rainfall variability. Under the assumption that this climate pattern is representative of long term patterns, we have a solid probabilistic framework to determine likely future rainfall, and solid base to determine future farm investment risks.
These illogical policies have far reaching impacts. For example, prices achieved for agricultural properties appear to factor in this expected government assistance as a future income. There are very few farms in the country that can be bought at market prices and make a return greater than the cost of debt funding without any government assistance. Farm land prices already incorporate the capitalised value of future subsidies. The need for this type of government assistance is self-reinforcing as it develops a future dependence on yet more assistance from those who have bought into farming.
Additionaly, such assistance rewards famers who make poor investment decision, while providing nothing for those who were prepared to support themselves during inevitable drought periods.
Drought policy may also be driven by the prevailing myth that if we don't support farmers we won't benefit from their food production. That is patently wrong. If a single farmer's business fails they can sell up and move on. They may cover their debts and move on with cash in hand, or they may incur a loss on their investment (such as Cubbie Station). But whoever buys the farm will, in all probability, continue to farm and produce food. Agricultural will not cease if some farm businesses fail. It may even increase as more efficient operators come into business.
I'm not saying we should scrap all subsidies or government assistance to the agricultural industry. But we need to let farmers take their own risks and use their own innovation to overcome these foreseeable climate variations.
Instead, it may be more appropriate to secure the future of Australian agriculture by the use of land use/planning controls. For example, we could make the decision as a country (or state) to preserve some areas for agriculture by removing the State's rights to minerals on productive agricultural areas (as some farmers have proposed). Alternatively, we could make planning decisions to preserve 'green belts' of agriculture on city outskirts to eliminate sprawl and maintain agricultural communities.
There are many more ways in which we can support the agricultural industry as a whole (if we choose to) without having governments take on the risk from private investment decisions. Drought is not exceptional, and anyone entering the agricultural industry should be aware of that.
As a side note, it makes me wonder how substantial agricultural subsidies must be in Europe. Australian direct agricultural subsidies amount to approximately 8% of farm income, while in most European nations subsidies account for greater than 60% of farm income.
What I find particularly interesting about drought policy is the logical dilemma encountered when determining what are in fact 'exceptional circumstances'.
Applications for areas to be declared under Exceptional Circumstances must demonstrate that the event:
1. was rare (a one in 20-25 year event) and severe
2. resulted in a severe downturn in farm income over a prolonged period (eg. more than 12 months) for a significant number of farmers in a region or industry, and
3. was not predictable or part of a process of structural adjustment (the policy does not cover downturns in commodity prices).
Yet criteria 1 and 3 logically conflict. If we know the probability of a drought event occurring it must be predictable, or at least foreseeable. Most parts of the country have at least a century of reliable rainfall data to determine the long term rainfall variability. Under the assumption that this climate pattern is representative of long term patterns, we have a solid probabilistic framework to determine likely future rainfall, and solid base to determine future farm investment risks.
These illogical policies have far reaching impacts. For example, prices achieved for agricultural properties appear to factor in this expected government assistance as a future income. There are very few farms in the country that can be bought at market prices and make a return greater than the cost of debt funding without any government assistance. Farm land prices already incorporate the capitalised value of future subsidies. The need for this type of government assistance is self-reinforcing as it develops a future dependence on yet more assistance from those who have bought into farming.
Additionaly, such assistance rewards famers who make poor investment decision, while providing nothing for those who were prepared to support themselves during inevitable drought periods.
Drought policy may also be driven by the prevailing myth that if we don't support farmers we won't benefit from their food production. That is patently wrong. If a single farmer's business fails they can sell up and move on. They may cover their debts and move on with cash in hand, or they may incur a loss on their investment (such as Cubbie Station). But whoever buys the farm will, in all probability, continue to farm and produce food. Agricultural will not cease if some farm businesses fail. It may even increase as more efficient operators come into business.
I'm not saying we should scrap all subsidies or government assistance to the agricultural industry. But we need to let farmers take their own risks and use their own innovation to overcome these foreseeable climate variations.
Instead, it may be more appropriate to secure the future of Australian agriculture by the use of land use/planning controls. For example, we could make the decision as a country (or state) to preserve some areas for agriculture by removing the State's rights to minerals on productive agricultural areas (as some farmers have proposed). Alternatively, we could make planning decisions to preserve 'green belts' of agriculture on city outskirts to eliminate sprawl and maintain agricultural communities.
There are many more ways in which we can support the agricultural industry as a whole (if we choose to) without having governments take on the risk from private investment decisions. Drought is not exceptional, and anyone entering the agricultural industry should be aware of that.
Tuesday, March 2, 2010
Money can buy happiness after all
I came across some fascinating research showing that money can buy happiness if we use it well. My favourite paragraph below.
Dunn and others are beginning to offer an intriguing explanation for the poor wealth-to-happiness exchange rate: The problem isn’t money, it’s us. For deep-seated psychological reasons, when it comes to spending money, we tend to value goods over experiences, ourselves over others, things over people. When it comes to happiness, none of these decisions are right: The spending that make us happy, it turns out, is often spending where the money vanishes and leaves something ineffable in its place.
Dunn and others are beginning to offer an intriguing explanation for the poor wealth-to-happiness exchange rate: The problem isn’t money, it’s us. For deep-seated psychological reasons, when it comes to spending money, we tend to value goods over experiences, ourselves over others, things over people. When it comes to happiness, none of these decisions are right: The spending that make us happy, it turns out, is often spending where the money vanishes and leaves something ineffable in its place.
Monday, March 1, 2010
The leisure dilemma: Rebound effects from productivity improvements
A recent report from UK think tank New Economics Foundation generated plenty of publicity recently by suggesting that a 21hour standard work week would significantly improve well being by giving people more time for family, friends, neighbours, and leisure activities. My own experience is that reducing work time has surprisingly large positive impacts on well-being.
Interestingly, economist John Maynard Keynes envisaged in a 1930 essay on the Economic Possibilities for our Grandchildren the following situation
Thus for the first time since his creation, man will be faced with his real, his permanent problem-- how to use his freedom from pressing economic cares, how to occupy the leisure, which science and compound interest will have won for him, to live wisely and agreeably and well.
The productivity gains imagined by Keynes did eventuate. Everywhere we look we can see far greater output per hour of labour, from agricultural production all the way through the production processes in our complex 21st century economy.
However recent research suggests that leisure time has been relatively constant since 1900, and time spent on home production activities (cooking, cleaning etc) has actually slightly increased. Additionally, while time spent at work over a lifetime has decreased since 1900, most of this is the result of more time spent studying.
How is it that we continue to fill our time not with leisure, but with work, study, and household chores?
There is a rebound effect at play.
To properly explain how this rebound effect occurs at a national (and sometimes international level), we need an analogy closer to home. Instead of businesses and industries improving productivity across the economy, imagine yourself improving your productivity during your working life. You start on low pay as a youngster, and edge your way up the ladder to better paying jobs over time.
Immediately we can see the analogy is sound. Most people don’t take their gains in productivity (as reflected by increases in their salary) as leisure time. Rather, they continue to work the same hours (or more) and receive the higher income.
Why?
The problem is one of cooperation and it has striking similarities to the classic prisoner's dilemma. You see, if you take your productivity gains as leisure time, and the next person doesn’t, they can bid up prices for things you might like to buy (such as land). However, if you both cooperate and each take more leisure time, you will both face accessible prices.
In our analogy, if everyone took their gains as leisure time, incomes would be relativity even, but each person’s work/leisure ratio would be different. The most productive people would work the fewest hours and vice-versa. Because each person’s income is the same, there would be little opportunity for people to outbid each other on prices, or out consume each other in status displays.
Furthermore, as our productivity increases (or our hourly rate of pay in this analogy) the gains at the margin from working just one more hour are far greater. Compared to when you were the local barista making $15 an hour if you worked longer, you might now make $60 per hour and find that you can make in a couple of hours in the evening what you used to make in a day.
How do we overcome this cooperation problem?
There is a simple answer at an individual level, and that is to decrease your consumption expectations and take your productivity gains as leisure (as I have done). There is also a more difficult answer at a society wide level. Yes, we can regulate maximum working hours and penalty rates for overtime. However, penalty rates increase marginal benefits from overtime hours. Maybe instead we could have anti-penalty rates. After a certain number of hours by law your pay decreases per hour, until after say 30hours, there is zero benefit from working any longer.
But, as I have discussed before, regulating working hours is a tricky game. Such a law would encourage a cash economy for labour in order to avoid the laws (and avoid taxes), allowing individual workers to get ahead.
In fact, in the spirit of free choice, I would discourage further regulation of hours. Instead I would opt for solutions such as more pubic holidays (which also allow a coincidence of leisure for more workers), and labour laws that encourage flexibility and part time work.
Maybe my grandchildren will be so lucky as to face Keynes’ leisure dilemma.
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