Urban spawl & house prices

An idea increasingly posing a challenge to State Governments is that house prices in Australia are high not because interest rates are relatively low but because State Governments have been excessively stingy in releasing land and are charging new settlers too much in upfront infrastructure provision fees.

The Reserve Bank’s Ian Macfarlane argues that high prices are due to these inappropriate policies and PM Howard has been quick to seize on these remarks blaming the States for high house prices. Macfarlane's remarks follow recent publication of a Housing Industry Association study and a report by Alan Moran from the Institute of Public Affairs that make similar claims. The issue is important because, as the OECD has reported, Australian housing is the most 'overpriced' in the world. Something is amiss and we need to work out what to do.

I am trying to sort out my attitudes to these views for a forthcoming seminar on urban congestion to which I have been invited. I have several provisional observations and welcome comments on these.

For economic efficiency, marginal infrastructure (and indeed pollution and congestion) costs due to development on an urban boundary should be levied on those settling on the boundary. This provides incentives for people to settle where social costs are lowest and inhibits the sprawl that is so damaging in Sydney’s west, for example. This seems to me an absolute. Past generations might have got away with inefficient infrastructure subsidies but that is no reason to stick with such bad policies. New settlers should pay for the costs they impose.

Land shortages will increase the price of housing. But house prices are responding to various influences. People over–capitalize housing from a social perspective because it is a tax free way of investing their wealth. McMansions are a fact of life because of our tax system. Moreover, because the favorable tax treatment of housing has persisted for a long time, the use of housing as a successful investment has become a self-fulfilling prophecy. Consumers over-invest in housing, in a way that almost exhausts their inter-temporal budget, since this seems like (and has proven to be) a sensible way of accumulating wealth free of capital gains tax. It is not just the supply of labnd but also the inappropriately excessive investment in housing on developed land which creates high house prices.

As argued before, urban sprawl has an undeservedly bad press. Large cities which include high quality housing for a substantial majority of the population are to be lauded not condemned. Travel costs might be higher in a spawled out city but the availability of facilities in much of what is described as urban sprawl is socially and economically advantageous. To be specific – my local suburb in metropolitan Melbourne (Banyule) has a symphony orchestra, an excellent local library, fantastic restaurants, good public sporting facilities and golf-courses, a university, private and public schools, substantial biodiversity conservation zones and a major public hospital. Snobs do contemptuously describe 'suburbs' distant from the CBD as urban sprawl but often residents don’t see it that way. Often we are doing well, thank you!

Congestion is an evil and should be priced but large sprawling cities might reflect rational choices by smart people interested in enjoying the good life. Urban intensification policies need to be based on externality considerations not snobbish resentment of the fact that ordinary people can enjoy the good life that was previously reserved for the gentry. There is no a priori expectation that compact urban structures are the best way to organise our lives in cities.

Issues of conserving the environment and preserving nature are important in large cities. Indeed conservation can be consistent with profit-seeking land development policy. But this is separate from the issue of having large 'sprawling' cities. Indeed, with significant attention to biodiversity conservation, cities might be more ‘sprawling’ than they otherwise are.

Land supply policies need to reflect marginal costs of development and the potential benefits from both more compact existing cities (if any) and the decentralisation advantages of developing new regional cities or cities in other lower cost environments. Extracting rents from land developers and from new home buyers should not be the basis for urban land-release policy.