You can't explain real estate bubbles by zoning controls

The Age reports that Wendell Cox’s Demographia hasreleased a study showing Melbourne to be 321^st on a list of 325 most affordable world property markets.

In other words, we’re almost the world’s most unaffordable market: almost the world’s dearest city. Incredibly, London, with a population of 7.6 million is said to be cheaper than the city of Geelong which is home to a population of only 200,000 souls.

Amongst more important things I’ll mention later, it could be argued that homes and sites in Geelong are generally larger than those in London, but that’s not mentioned by Cox. Instead, he shoehorns Melbourne’s astronomical residential property prices to square with the extraordinary claim that they're a result of its zoning regulations. Perhaps this means Melbourne also has the 321^st worst residential zoning regulations in the world?

A “shortage of land” to explain ludicrous land prices was also the story put about by real estate agents in California just before its real estate bubble burst in 2007. For one reason or another, they (and Cox) don’t want to accept the rather obvious connection between California’s high land prices and the ceiling Proposition 13 had put on its property tax in 1978.

A strong case may be made that it was a combination of a relatively low property tax regime, necessitating higher taxes on productivity, which turned the once golden State of California into America’s economic basket case. It is no coincidence that the highest property tax-paying states in the US have proven to be its best economic performers; the property tax warns off the land speculator whilst enabling other taxes to be kept to a minimum.

Ken Henry’s review of the tax system caught up with the principle of capturing publicly-created economic rent by taking taxes off productivity and putting them onto land and natural resources, but the government has run scared of any such fundamental reform, preferring not to attempt to educate people to the principles behind such a proposed revenue switch. There’s a vast property and mining lobby to be appeased. Such timorous leadership consigns Australians to repeat the sorry saga of property bubbles and ensuing economic busts.

Wendell Cox and his ilk don’t particularly like zoning controls. They smack of excessive government interference with development. But whilst many examples may be found of excessive bureaucratic intervention in the development process, the zoning of land is clearly not the culprit for high prices.

It cannot be, because there is no shortage of suitably zoned residential land in Melbourne, now, nor previously. Yet the Housing Industry Association, Urban Development Institute of Australia and the Property Council of Australia have signed up to this explanation instead of understanding the benefits to industry and development Ken Henry’s proposals would bring.

There’s more than enough residentially-zoned land around Melbourne, and a massive amount of vacant and underutilised land within its existing boundaries. Nevertheless, Wendell Cox has found such admirers as the Institute of Public Affairs’ Alan Moran to support his vacuous conclusion. The Ayn Rand-like baggage to limit zoning controls, if not get rid of them altogether, has come to override their logic.

Like most people untrained in the theory of valuations, Cox and Moran haven’t yet discerned that land price is the capitalization of that part of the economic rent of land which has not been captured to the public purse. The amount privatised simply becomes capitalized into the land price of a block of land.

Except for relative locational values, supply and demand plays little part in the price of a residential lot. Up-front government development costs play a far greater role. We allow too much publicly-generated economic rent to be privatised by a relatively few individuals, and Wendell Cox is their spokesperson.

As with real estate interests, who don’t appreciate the principles behind land-based revenues, Australia’s big mining companies recently also displayed a preference for retaining the public’s rent in their profits. Of course, banks also captured the economic rent of land from the public via interest and capital mortgage repayments on bubble-inflated prices. In both cases, the big boys will take it if the public doesn’t claim it.

For corroboration that a land price bubble is the result of inadequate rent capture, Cox and Moran could do worse than consider the early affects of Canberra’s land rent system. Public rent capture in the ACT initially kept both land prices and local taxation at bay, until the system was eventually undermined by the failure to maintain land rent payments at anywhere near market levels.

Since then, vested interests and ignorance have done their darndest in the ACT to ensure that there’s no difference between what is now only a nominal land rent system and freehold ownership in Australia.

Interestingly, when there was once no damaging income tax, it was often incumbent upon the freehold owner to pay his annual "quit rent" if he wished to remain in possession of his property. (Owe[n]er: Middle English: He who owes the land rent).

Contrary to Demographia’s conclusion, my 2007 study “Unlocking the Riches of Oz: A case study of the social and economic costs of real estate bubbles 1972 to 2006” shows the international fashion for reducing land and property taxes, which has amounted to a virtual contagion from the outset of the 1970s, to have been responsible for stimulating each of Australia’s four real estate bubbles.

In an explosion of purple rage to the Heartland Institute on 4 July 2007, Wendell Cox castigated me for being anti-suburban for having pointed out his logical error in blaming zoning controls for bubble residential prices. I also showed the US cities he held so close to his heart for having the least zoning controls also had the highest crime rates in the United States. His own home city of St Louis topped the US crime list with its incredibly high murder rate. To let municipalities grow in an unbridled fashion in an environment of high taxation and inadequate infrastructure invites poverty and criminal behaviour.

Hopefully, the strange conclusions Cox and his fellows draw from their data will one day come to be seen for the canards they are. Meanwhile, the press will continue to report them dutifully as fact.