Wednesday, 15 July 2015

Labour and the Law of Costs: But doesn’t “Yoda” sound Chinese? [updated]

So the Labour Party probably figured they could make a splash with a bit of Asian-bashing, for which they’ll be pilloried for a few days but will be able to ride out because – underneath all the hooplah – despite all the criticism – after all the smoke has cleared –Labour thinks Joe & Josephine Voter will still be thinking in the back of their minds: “Hmmm, seems to me that if more Chinese are buying more of ‘our’ houses, then the prices of all ‘our’ houses will have to go up. Stands to reason.”

Joe and Josephine, Labour hopes, will forget all they’ve heard about all the errors in the analysis, about its racist under- and overtones, even about Labour’s nostrums that have been tried in other markets (like Sydney) in which CGTs and bans on foreign buyers have failed to make even an iota of difference. Because Joe & Josephine both know that the Laws of Supply and Demand says that when demand for something goes up, so do prices. See:

image

Everyone knows that. So if more foreign buyers buy more of ‘our’ houses, ipso facto the price of all houses will rise.

That, I suspect, is what the morons in Labour’s drip tank1 are banking on. (See, even morons in the Business Herald are buying it.2)

But that’s not all that the Laws of Supply & Demand say about the price of something. Because, crucially, it depends on how reproducible that something is. Which tells us something crucially missing in our housing market, and in Labour’s race-baiting.

CONSIDER AN IRREPLACEABLE ART work at auction in front of a hundred potential buyers—a piece like Gaugin’s ‘When Will You Marry?’ (right) that can never be made again. In whose hands will it end up? Answer: With the buyer who values it the most whose desire is backed with the necessary cash—at a price just under the degree to which he values that cash amount. Raise the amount of cash each of the hundred buyers has, the final price will go up. Add more enthusiasts flush with cash, the price will likely go up. But note that the price is going up because there is only one good, that can never be produced again.

This is how the market for rare goods work: the price is set on the demand-side, by the amount buyers are willing to pay. In this case, by the final buyer, who paid $300 million to bid it away from the buyer who valued it just that little less.

But how about things that aren’t rare? How about if we’re bidding instead on posters of Gaugin’s ‘When Will You Marry?’ Even if our friend values the look of the thing on his wall at $300 million, he only needs to pay a very small fraction of that for his poster. He only needs to pay that fraction because poster producers can churn out the poster at will just as long as the purchase price covers their costs  -- meaning that as long as demand continues, the price will tend towards the cost of production.3 Austrian economist Eugen Von Bohm-Bawerk called this the Law of Costs,4 explaining: “One is in fact correct, [in this context] when one says that costs govern [price].”

So we have two parts to the Laws of Supply & Demand. Let’s call them together the Law of Price:

image

The even better news here is that, if demand continues to increase, marginal costs themselves tend to decrease because economies of scale begin to kick in. (Just one reason Henry Ford’s factories can make a car cheaper than Aston Martin can, and houses in Levittown were churned out so cheaply.)

WHAT DOES THIS MEAN for our own housing market?

It means that no matter how many people with Chinese-sounding names are standing around hoovering up local houses, that matters not a jot to prices just as long as local houses are reproducible at will.

Put it another way, it’s better if our housing market looks more like the market for posters than it does the market for fine art.

Guess which one it most resembles now?

BECAUSE, DOES ANYONE THINK “reproducible at will” in any way at all describes the production of NZ housing?

It doesn’t.

But there’s really no reason it couldn’t.5

Because basically a house is just a fancy widget – albeit one that is “consumed” over a long while, will be bought with borrowed money (so demand crucially depends on how money is made available to borrowers) and that money can often take a long time to pay back. So it’s a durable good. But still, for any goods reproducible at will, their prices will tend towards their costs of production.6 As they have in cities like Houston, Kansas City, Atlanta … but not Auckland.

Instead, ours have been tending towards being set by the competition of buyers for the limited supply. Yet instead of properly fixing the pressing problem of limited supply (and by “fixing” I don’t mean the tinkering of Nick Smith, I mean the wholesale dismantling of planning departments), we’re now demonising the buyers who are bidding for that limited supply.

And instead of fixing it, there are calls instead to ban the buyers. This is more than just moronic, it’s utterly deluded. Because as Eric Crampton points out:

If Auckland zoning were sane, all of that capital could be helping to build new subdivisions, new apartment buildings, new townhouses, new mid-rises - new housing. There would likely be less of that capital, as expected price increases would be lower, but the capital would be giving us new housing.
Instead, it's bidding up house prices. …
    Bit depressing that the knee-jerk reaction is [not to open up zoning to allow new building under very rapid consenting - again, both up and out --- but] to put controls on foreign investment ….

PUT SIMPLY, SO EVEN Labour MPs and the Business Herald can understand, if the Chinese are buying up all our houses, then let’s use their money to build more.

Instead of this, too many wish to do the reverse: to unleash xenophobia while maintaining restraint of housing supply.

So our negative conclusion can be framed very simply. As Yoda says:

Embedded image permalink

But doesn’t “Yoda” sound Chinese?


1. Well, it’s clearly not a “think” tank, is it.

2. Mind you, Fran O’Sullivan does have history

3. One big problem here already: as the price of housing has risen so too have the costs to produce houses—and so too have the restrictions on undertaking more of it.  So there are no higher rates of profit, no new house-builders in the market (quite the reverse!), just one reason the housing market is transformed from one like cars, computers and clothing with all the characteristics of one with goods reproducible at will (i.e., one having virtually a horizontal supply curve) to one in which the goods are no longer reproducible at will, but are produced sparingly (like paintings or jewellery) or only in batches, or seasonally (like mining or agricultural products).
Reduce costs, and if housing producers could “reproduce at will” new houses to get higher rates of profit then those higher rates of profit should induce new house builders into the market (and encourage back the spec builders who used to be such an important feature of the local housing market).

4. Basically for widgets that are able to be reproduced at will, the Law of Costs

tells us that the market price of goods reproducible at will tends to equalise itself, in the long-run, with Costs of Production. The following perfectly valid line of argument is usually adduced in proof of this. The market price of goods reproducible at will cannot, in the long-run, be maintained either much above or much below their cost.  If at any time the price of an article rises appreciably above the cost, its production will be particularly profitable to the undertakers. This will not only induce the latter to extend their already flourishing businesses, but will encourage new undertakers to enter the same remunerative branch of industry. Thus the amount of product brought to market will be increased, and finally--according to the law of supply and demand--a fall in price will ensue. [Eugen Von Boehm-Bawerk, from “The Law of Costs,” in ‘A Positive Theory of Capital.’]

Consequently, when prices are determined by costs of production, what they are ultimately determined by is still supply and demand, but supply and demand operating in a wide context--that is, by supply and demand operating in the context of the labour market and in certain broad commodity markets, not in the relatively narrow [partial] market of the individual product itself. [George Reisman, from “Elements of Price Theory: Demand, Supply & Cost of Production,” in Capitalism: A Treatise of Economics]

5. Sure, land is a little limited; but New Zealand's urban areas account for less than 1 percent of the total country, one quarter of that in the Auckland region. (If all of NZ's 1,471,476 existing households were to be rebuilt on an acre of land -- which was the sort of thing proposed by Frank Lloyd Wright in his Broadacre project-- we'd all fit in an area less than one-quarter the size of the Waikato , and just think how easy it'd be to thumb a lift out to Raglan!) And even in Auckland, the boundaries of 1984 are little different to those boundaries in 2012 (one major reason land just inside that boundary can sell for up to ten times the same or similar land just outside).

6. And, of course, their costs of production will tend towards what consumers say they are willing and able to pay, but that’s part of a longer story

UPDATE: China’s Shanghai Daily reports ‘New Zealand housing market debate descends into race row’ … and Macrobusiness Australia reports: ‘NZ war erupts over Chinese property buying.’

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