There was a very happy time in high school where I could get a Large Quarter Pounder Meal for under ten dollars. This was very cool. But just as the blue spring of my youth faded into the double bitterness of age and missed first round Economics Ball tickets, so too was the affordability of essential items done away by the inexorable passage of time. It keeps me up all night for sure.

$12.40 is just too much.

Still, it’s somewhat less than the price of a house. Increases in cost of living are not only being felt by McDonald’s enthusiasts. Readers looking to apply for a mortgage now or in the near future will be acutely aware of this fact. Some figures dated as recently as March have suggested that the median house value in Greater Brisbane is now over $856,000.[1] Housing markets across much of the world are pretty hot at the moment, but in Australia I think we can point to two specific factors that have contributed to the current situation. These would be negative gearing and urban consolidation. Sooner or later most of us will have to confront the effects of these policies in our ordinary lives. I’ll focus on urban consolidation here because the graphs — probably everyone’s favourite pastime — are super fun. What I want to do here is introduce how economics can help us morally assess if the housing market should be pushed in another direction.

What is urban consolidation, then? We could basically call it a process of restricting property development and housing construction in suburban zones. Many local councils in Australia place limitations on development projects outside designated urban boundaries, and this results in these developments being more costly to conceptualise and less likely to be approved. Less residential construction is pursued in suburban areas as a consequence. This aims to counteract urban sprawl. Conversely, we might expect an equivalent increase in the supply of housing in already emphasised urban areas. However, demand for urban land and housing tends to be consistently higher than demand for suburban land. This means that urban housing tends to be significantly more expensive than suburban housing. Melbourne gives us some nice stats. In 2019, the median price of houses sold in Melbourne City was $1,260,000, but the median price of houses sold in Melbourne’s overall metro area, including Melbourne City, was $720,000 — a lot lower.[2] It’s worth noting that Melbourne experienced major changes in its urban consolidation regulations in 1995, 2002, 2005, and 2014.[3] However, what we can see from these two sources together is that trends in the overall value of Melbourne’s housing market have been mostly independent of these changes in development regulation being tightened and loosened.

Figure 1: Total annual sale value of houses in Melbourne’s metropolitan area with overall trend and major regulation changes highlighted[4]

This suggests, albeit loosely, that urban consolidation does indeed incentivise developers to pursue projects in urban zones rather than in the suburbs. Specifically, this is to say that a kind of substation happens. Development in general still continues at a seemingly unaffected pace. Suppliers who would otherwise be working in suburban areas don’t leave the market altogether. However, it follows from the greater expense of urban housing that this substitution, with total housing investment unaffected by consolidation laws and suburban housing supply shifted to urban supply, results in an overall reduction in the provision of housing supply in terms of residences — the total number, as opposed to value, of vacancies constructed. Less houses end up getting made than what we would see in a freer market.

The idea here is that we can think of this as an economic rent. This is the value of a payment that exceeds the monetary or social value required to produce a good or service. Economic rents therefore specifically represent earnings beyond what would be required to maintain supply. It’s basically extra money that goes to suppliers who can take advantage of artificial scarcity. The rent created by urban consolidation can be seen in Figure 2 below. The graph shows that with the reduction of overall housing supply from Q* to Qu, the price of housing increases. As developers will sell houses at an average price of Pu instead of P*, they gain an economic rent on account of the average cost of housing construction on urban blocks of land being unchanged by urban consolidation policies.

Figure 2: Demand and supply graph of a housing market which adopts urban consolidation[5]

These rents, created from the development and redevelopment of residential land, then trickle down to other investors who earn money from residential enterprises following the initial development. An owner of an apartment, for example, would pay rents to the people from whom the apartment was purchased and then earn rents by leasing the apartment at a scarcity-inflated price to tenants. Residents would get the short end of the stick, as they supply rents to others but don’t collect any themselves. The increase in prices is pretty substantial. As seen in Figure 3 down below, economic rents collected from housing purchases in the four largest Australian housing markets have risen considerably in the form of a ‘zoning effect’ that increases the cost of housing due to the continued restriction of overall housing supply under urban consolidation.

Figure 3: Australian major city housing price decomposition by mean house price with zoning effect representing economic rent[6]

The overall situation, then, is that urban consolidation reduces the overall supply of housing by redirecting investment (that would otherwise go to suburban areas) to urban projects that are more expensive per tenancy, resulting in housing in general becoming more expensive due to this artificial scarcity.

Is this bad? I’m inclined to say it is — more on this later — and so we might want to suggest a policy change in response. Maybe a tax on economic activities related to urban development. This could collect revenues from construction and demolition deals and the sale of land development rights and ownership. A tax could be flexible, allowing local governments to set rates that attempt to capture the economic rents estimated to have been generated by local zoning effects. If we note that rents are in specifically excess of earnings necessary to maintain supply, and then if this tax doesn’t exceed the rents generated by investment in housing development, then the overall supply of investment into housing construction shouldn’t actually decrease. This means that it wouldn’t reduce investment in housing development and further compromise supply. On the contrary, because urban consolidation boundaries incentivise developers to direct this investment toward urban areas, taxing housing rents specifically in these urban zones would offset these disincentives to suburban development and prompt a substitution of some urban investment for suburban investment. The end result is that this could increase the overall housing supply and bring prices down. Very cool.

What could morally justify this intervention as a good thing? There are people who benefit from rents, after all. We could start by considering an idea of diminishing marginal utility. This is to say that a rich person will enjoy less additional welfare from an extra dollar than what would be experienced by someone less well-off. We could imagine that someone with a $20,000 car would maybe experience some benefits by upgrading to a $40,000 car, but someone without a car at all would probably experience a greater welfare change by having a $20,000 car of their own. Forms of progressive taxation tend to embody this notion of utility maximisation, and the taxation of generally well-off property developers and owners will tend to redirect this money to government expenditures like social security that generally redistribute utility to less-advantaged parties. As net welfare would increase with this transfer of marginal wealth from wealthy parties to the broader public, and also contribute to housing affordability in general, this broad view of utilitarianism supports the taxation of economic rents. Still, we would do well to measure these gains in relation to the missed social benefits of discouraging urban sprawl.

On the other hand, we could consider a desert-based justification of property rents. The idea here is that, as much as it’s good to distribute the utility of the social product, it’s also useful to give extra compensation to people who contribute to the social product — a kind of incentive. We might simply want to believe that people are entitled to reap some of what they sow. Moreover, if people are encouraged to be productive and innovate to make the pie bigger, then (even if the pieces are cut unevenly) the people who get the smallest slices could still be better off. Under existing regulations, we might say that people who collect economic rents from the housing market facilitate the provision of consolidation’s social benefits (i.e. the negation of urban sprawl and promotion of efficient, high-density infrastructure) by owning, developing, and investing in projects within urban consolidation boundaries. However, this contention is a bit dubious to me, since the public infrastructure systems that offer urban consolidation its main social advantages are predominantly funded by government expenditure. In this sense, it would seem appropriate for at least some fraction of property rents to be taxed by the government such that rent-earners would be genuinely responsible for providing the social value from which any remaining rents might be justified. Even if we accept the principles of this point, then, it fails to actually reject the idea of an urban development tax. Nonetheless, the moral scope we could apply to the topic is much bigger than I’ve made it out to be, but I think it’s useful to get a taste of how economic concepts can play a role in affecting the justifiability of policy decisions that affect everyday life.

Anyway, if I don’t have to hand over as much money to my current landlord, maybe $12.40 will be easier to stomach. The future could be bright.

[1] Ruddick, B. (2022). Brisbane’s median property values race to a record high, jumping more than 40 per cent in some suburbs. ABC News. Retrieved from https://www.abc.net.au/news/2022-04-10/qld-real-estate-price-south-east-queensland/100979652

[2] Valuer-General Victoria. (2020). A guide to property values annual analysis of property sales data from Valuer-General Victoria January – December 2019. Melbourne: Victoria State Government

[3] Victoria State Government. (2020). Melbourne’s strategic planning history. Retrieved from https://www.planning.vic.gov.au/policy-and-strategy/planning-for-melbourne/melbournes-strategic-planning-history

[4] Data from Valuer-General Victoria, 2020

[5] Kendall, R. & Tulip, P. (2018). The effect of zoning on housing prices. Sydney: Economic Research Department Reserve Bank of Australia

[6] From Kendall & Tulip, 2018

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