Successful cities understand spatial economics
Economics is about the allocation of scarce resources. For cities one of the scarcest resources is space. Privately built floor spaces, public spaces, street spaces, recreational spaces, parking spaces…. This article will discuss some concepts that underpin the allocation of city space and the difficulties the lack of application of these concepts can create for urbanisation, in New Zealand in particular.
To keep the paper a manageable size (well truthfully to prevent it from being the size of a book), I will only focus on four demand and four supply of city space concepts.
This paper is an attempt to synthesise many of the articles published on my blog-site -New Zealand needs an urbanisation project.
The demand for city space is a fascinating topic, because it is central to understanding the economic transformation the world is undertaking. For several hundred years the world has been going through an urbanisation process -driven by specialisation and agglomeration economic factors, this urbanisation process is the root cause of demand for city space.
The opportunities and challenges of the urbanisation process I think is best described by the NYU Stern Urbanization Project.
In my country -New Zealand, 85% of its 4.7 million population are clustered into urban environments, on less than 1% of New Zealand’s landmass. Over 50% of New Zealand’s population live in the metropolitan catchment areas of just three cities -Auckland, Christchurch and Wellington, with roughly populations of 1½ million, 1/2 million and 1/2 million respectively.
To understand a national economy, such as New Zealand’s, it is necessary to understand how urban areas function because that is where most of the economic activity occurs.
The first demand concept which I would like to introduce is agglomeration.
Agglomeration is a process by which concentrating economic activity in one place makes businesses more productive. It works through three main channels:
- Sharing -the ability to share inputs, supply chains and infrastructure;
- Matching -access to a large pool of workers;
- Learning -the ability to exchange ideas and information, known as ‘knowledge spill-overs’.
Agglomeration doesn’t only influence business demand for city space, it affects consumers too. Cities with amenities, such as, more and better shops, restaurants, culture -plays, shows, sporting events, educational facilities, clubs and societies etc have an attraction which is greater than the sum of each amenity part.
Floorspace is a normal good
The second demand concept I would like to discuss is that floorspace in an urban environment is a normal good. Meaning as incomes rise, people consume more space per person. This can be best seen in the following graphs and maps of Tokyo Prefecture. The graphs are from Jim @geographyjim on twitter who describes himself as a housing policy wonk and number cruncher at Greater London Authority. His sources for the graphs were official Tokyo statistics found here and here and here.
Although not the case for Tokyo, sometimes income growth and the desire for more personal space can be so strong that central urban areas lose population. This can be seen in Manhattan from 1910 to 1980. Improved urban transport links and modes, such as, the first affordable automobile -the Model T Ford -which went into production in 1908, meant overcrowded tenement building residents could move to more spacious dwellings in the expanding areas of metropolitan New York.
So, under some conditions, the normal good demand for personal space can cause a dispersal of a city’s population.
Centrally located roads are more congested
The third demand concept is congestion -a sign of excessive demand for road space -will occur in more centrally located roads first and then radiate outwards.
This demand concept holds even if a city’s population and businesses are evenly dispersed. The transport links which are closer to the centre of the city will have a greater amount of traffic than peripheral transport links.
This makes intuitive sense, consider the example of a circular shaped city with an evenly dispersed population, if half the residents randomly chose to visit the half, basic geometry indicates, more of those journeys would go through the centre, or near the centre of city, rather than the periphery.
Ring roads can help to divert some of this traffic.
But eventually with rising demand, the number of travellers being funnelled through fixed and narrow corridors in the central parts of towns and cities will be greater than those corridors can manage. Centrally located road space will then become congested.
A common response to congestion is to build more roads. I discuss how Auckland built motorways to its CBD from the 1970s in the article Tokyo does not subsidise its transport system!
Building more and wider roads can temporarily alleviate congestion as higher capacity is provided, but there is an effect called induced demand, which means that congestion reappears, as there is a behavioural change to utilise the new road space that has been freely provided.
Hotelling’s model for spatial competition
The fourth demand concept is an economic force which drives demand for more central city locations -it is called Hotelling’s model for spatial competition, which explains another reason for why competing firms have a tendency to cluster together in central locations.
The simplest analogy to explain this concept is to consider the case of two ice-cream sellers on a beach. The socially optimum locations for ice-cream to be sold from the beachgoers perspective would be at the 1/4 and 3/4 positions along the length of the beach. That way beachgoers could evenly spread across the beach and only have to walk, at most, 1/4 of the length of beach to buy an ice-cream. But from the ice-cream sellers’ perspective they can get more market share the closer to the middle of the beach they locate themselves -so that is what happens.
Hotelling’s model is not an absolute law, the clustering of activity in the centre of cities that is commonly seen, can become more dispersed in real world cities. Frequently cities develop polycentric centres, as land costs, congestion and other factors create opportunities for other nodes within the urban environment to be competitive.
What is not seen though, is urban areas made of discrete urban villages which have no interactions with their neighbouring villages. Alain Bertaud who has spent a lifetime working in the urban planning field, shows this in his models of the spatial distribution of jobs and populations in urban environments;
So, in summary there are factors which drive demand for both the dispersal and centralisation of urban space. But that is not the whole story, cities are not just influenced by demand factors (including many other aspects of demand which I have not discussed). Supply also plays its part.
The first supply of city space concept I would like to introduce is the Making Room paradigm, which has been developed by the NYU Stern Urbanization project. Note -Alain Bertaud, since 2012, has been a senior research scholar at the NYU Stern Urbanization Project. I met Alain and his wife Marie-Agnes at a dinner, after a talk he gave in Christchurch, New Zealand in 2014.
Making Room for urban expansion is about the division of new urban areas into public and private spaces. It is a deceptively simple concept, which has a number of important implications:
The initial allocation of public spaces within a city
Firstly, the basic bones of a city are planned, they are the product of public decision making processes. The private sector does not spontaneously allocate public spaces for urbanisation. This is an uncomfortable fact for libertarians and free market ideologues. If city planning processes fail completely, the result will be sprawling slums or barrios, with little in the way of street spaces or public parks. This will take extreme measures after-the-fact to rectify.
What makes libertarians even more uncomfortable is that due to a particular type of market failure, to do with site assembly or contiguity, governments need to have the option of compulsory acquiring land for the network of transport right of ways and public parks. The reason for overriding private property rights is to prevent landowners holding out land which is vital for the completion of infrastructure networks and then extracting monopolistic prices for its use. The concept of contiguity is discussed further here.
There is a wide variation in the allocation of street space between cities. The UN have compared 30 cities in the following report.
The relevance of street patterns and public space in urban areas -UN Habitat Working Paper April 2013. This report notes that;
cities that have around 100 crossings per km2 , on average, which allows for walking distance between crossing 100 meters apart. This is considered walkable and appropriate in many cities, in order to generate street life and for moving goods and services productively and efficiently. Also, this pattern of around 100 crossings per km2 determines the size of blocks, around 9000 m2 each which provides for good plotting within each block.
Auckland, New Zealand’s largest city, only has 18.1% of its land area allocated for street space and 72.9 intersections per square km. Both of these figures place Auckland in the low-end group of cities, for its allocation of street space.
New Zealand’s central governments have long restricted local government’s ability to raise revenue to fund infrastructure, or to use off balance sheet debt instruments, such as developers who build infrastructure having access to municipal bonds which can be repaid by a targeted rate. Auckland Council in particular, due to facing the largest percent population growth, has had difficulty keeping up with the demand for infrastructure for new urban areas, without exceeding credit rating debt limits. Recently the New Zealand government responded by announcing it would invest $600 million into a new housing infrastructure company, which will provide infrastructure for expanding cities and keep the debt off the Council books.
This initiative has been criticised on the following grounds;
Labour’s housing spokesman Phil Twyford said the Government was copying Labour policy -slowly. “You certainly could not accuse this Government of being even a fast follower. Now weeks out from an election, and after nine years in office, they are desperate to look like they are doing something,” …. Twyford said that Labour advocated a debt-finance instrument in 2015…. “Auckland Council has been telling the Government for the last few years that its growth was hamstrung by lack of infrastructure, and a Council balance sheet already up against its debt limit,” Twyford said…. “National has spent nine years cynically blaming Auckland Council for the city’s failure to manage its growth, but it has done very little to reform the planning system or turn on the tap for infrastructure finance.”
ACT (far-right party) leader David Seymour agreed with Twyford -kind of. “Responding to a problem by a creating a new arm of government sounds more like a Labour policy than an idea from the centre-right,” Seymour said. “Setting up yet another state entity to manage infrastructure will grow bureaucracy, suppress innovation, and risk cronyism…… Rather than having central government step in and build infrastructure, we could simply ensure that councils have the resources to build infrastructure themselves.”
Property Council NZ chief executive Connal Townsend welcomed the move. “The traditional way we have funded growth in our cities is way out of date and cannot deliver the infrastructure and housing we need,” Townsend said. “The handbrake has been a lack of infrastructure such as roading, water and sewerage that supports development. Building cities costs a lot of money and infrastructure is a large proportion of that cost.”
The under allocation of infrastructure and street space could explain why Auckland is particularly prone to traffic congestion and why it struggles to receive the agglomeration benefits its size indicates it should achieve. Although, as will become apparent from this general discussion on spatial economics, New Zealand struggles to efficiently allocate all kinds space for its cities. So, it is probably the general difficulty of managing urbanisation that is the better explanation for Auckland’s recent poor performance (from a high base), compared to the rest of New Zealand.
The allocation of privately built spaces within a city
The second implication of the Making Room concept, is that once public and private spaces have been allocated, it is best if private spaces are left as much as possible to spontaneously order themselves. Spontaneous order, or a tolerance of messiness within a structured framework, is something I tried to describe in my article, What is the secret to Tokyo’s affordable housing?
This tolerance for spontaneity is the issue that Marie-Agnes Bertaud Roy -marital and academic partner of Alain Bertaud -wanted to highlight when commenting on my Tokyo housing article.
Alain and I were in Tokyo and Toyama in November. We had long walk in suburban areas. We were stuck by the tolerance for large variations in lot sizes, type of buildings and commercial mix. This results in a kind of messy look, which is not unpleasant when moving around. Planners and city managers seems to concentrate on what they should always do: superb maintenance of road surface, signage and cleanness, but benign neglect for everything within private plot boundaries! What a good lesson for our New York City planners who restrict the type of zone where an «umbrella repair shop» or a « supply for artist retail shop» (no kidding, this is real) should be located!
Thus private spaces within a city, in particular built floorspace should be allocated as much as possible by market forces, without interference by costly restrictions.
If land-use restrictions are too tight. If a city is restricted from growing up and out, then this turns competitively derived land prices to monopolistic pricing. Land prices are the biggest influence over the price of different types of built floorspace -such as housing. A point well made by a friend of mine -Phil Hayward -in an article titled -Rocket scientists do not forget about gravity so why do planners forget about economic rent?
Not even direct government intervention, by compulsory purchasing the monopolistically priced land, can convert land prices back to competitively derived pricing. As construction company -Fletchers and the New Zealand government are finding out with their joint property development project. Six years post-earthquakes and they still have not been able to build and sell any of their proposed $1 billion Christchurch CBD residential development onto the market.
There are strongly held norms about fairly compensating landowners when governments acquire land, which prevent governments from using their monopoly buying position to bargain down land prices. Of course, if governments acquired land which had not been affected by monopolistic pricing, such as rural land on the periphery of the city and then provided good transport connections to the city, this could provide some competitively derived land pricing.
This is the approach the First Labour government of New Zealand took in the 1930s and 1940s, buying farmland for new state housing suburbs in the Hutt Valley and Porirua, in particular. These new urban areas were successful because fast and efficient transport links were established to the main urban area of Wellington -in particular by a new commuter rail service. In the subsequent decades in New Zealand, which were dominated by National (Conservative) government’s, private sector developments with roads and motorway transport connections were the preferred choice for city growth. Planning historian Chris Harris describes these public decisions as being the reason for the differing nature between Auckland and Wellington. Auckland being more automobile dependent and sprawling. Although, in the last decade it has been Christchurch which has been sprawling into road only connected satellite towns like Rolleston, while Auckland is finally investing in a rapid transit network.
In recent years the public in New Zealand have gradually come to terms with the fact that land-use restrictions increase the cost of new housing. Academically this has been known for a very long time -as Phil Hayward describes in the earlier mentioned, Rocket scientists do not forget about gravity so why do planners forget about economic rent? article.
More recently, the economist Edward Glaeser, who is the author of the book -Triumph of the City -has been a champion for the easing of land-use restrictions. Wikipedia describing it as;
During the 2000s, Glaeser’s empirical research has offered a distinctive explanation for the increase in housing prices in many parts of the United States over the past several decades. Unlike many pundits and commentators, who attribute skyrocketing housing prices to a housing bubble created by Alan Greenspan’s monetary policies, Glaeser pointed out that the increase in housing prices was not uniform throughout the country (Glaeser and Gyourko 2002).
Glaeser and Gyourko (2002) argued that while the price of housing was significantly higher than construction costs in Boston, Massachusetts and San Francisco and California, in most of the United States, the price of housing remained “close to the marginal, physical costs of new construction.” They argued that dramatic differences in price of housing versus construction costs occurred in places where permits for new buildings had become difficult to obtain (since the 1970s). Compounded with strict zoning laws the supply of new housing in these cities was seriously disrupted. Real estate markets were thus unable to accommodate increases in demand, and housing prices skyrocketed. Glaeser also points to the experience of states such as Arizona and Texas, which experienced tremendous growth in demand for real estate during the same period but, because of looser regulations and the comparative ease of obtaining new building permits, did not witness abnormal increases in housing prices.
A series of events in 2016 helped educate the public of the consequences of restricting the building of new housing;
- Auckland’s housing affordability became significantly worse, with the city climbing from the world’s ninth most expensive city to fifth in a year.
- In May of 2016, in response to frustration over years of slow progress in ensuring New Zealand’s housing supply has the capability to cope with demand shocks, Labour’s Housing spokesman Phil Twyford called on the Government to use its upcoming National Policy Statement on housing and urban land use to abolish Auckland’s Rural Urban Growth Boundary (RUB) and to free up density rules to accelerate Auckland’s ability to grow housing supply both out and up. This move signalled the end of the established political/economic acceptance of the regulatory status quo around housing supply.
- The public were shocked by news stories of families living in cars in parts of Auckland.
The New Zealand government has responded, with various housing initiatives. Some people, such as, independent Australian economist Leith Van Onselen argue that New Zealand’s main opposition party -the Labour Party -has the more impressive housing policies, and that the New Zealand government is too late the hero on housing supply.
What is interesting, is that in New Zealand a political and economic consensus is forming that agrees with Edward Glaeser, in attributing the cause of house price bubbles, as largely being about land use restrictions. There is much agreement around the contention that constrained housing markets respond to positive demand shocks, by increasing house prices.
Note demand shocks could come in many forms -fast income growth, like New York experienced a century ago, easing of credit conditions like the US experienced during the Greenspan years and fast population growth, such as New Zealand is currently experiencing.
Statistics New Zealand reported that in recent years the country has experienced the largest annual increase in population ever. This has been driven by a high rate of net immigration which is showing no signs of falling, although past experience shows net migration is cyclical, in particular based on the relative economic opportunities in Australia versus New Zealand. A big contributor to New Zealand’s high net migration figures is that kiwis are no longer flooding across the Tasman to Australia’s mining boom which went bust in 2015.
Fuelled by strong net migration New Zealand’s population over the past five years has surged by nearly 390,000, which is more than the population of Christchurch city, Statistics New Zealand said.
In the year to June alone the population grew by 100,400, the biggest ever increase for a June year, lifting NZ’s estimated resident population to 4.79 million. Net migration, being arrivals minus departures, contributed 72,300 people, with the balance of 28,100 stemming from natural increase, being births minus deaths.
New Zealand’s population grew by 97,300, or 2.1 percent, in the year to June 2016. That was then recorded as the largest annual increase ever, with Statistics New Zealand commenting at the time that;
“Annual population growth over 2 percent is high by New Zealand standards,” said population statistics senior manager Jo-Anne Skinner. “The last time we experienced population growth over 2 percent was in 1974. And before that, at the peak of the baby boom in the 1950s and early 1960s.
Auckland is growing by 50,000 people per year, which means about 800 extra cars a week are joining the roading network in Auckland.
The government tells a big story about the building boom. Of course, a building boom is to be expected when population growth is high. Unfortunately, Auckland’s inelastic housing supply response is confirmed by the fact that while population is growing at the fastest rate for 40 years, its house building rate has not exceeded what was achieved 12–15 years ago. Simply, Auckland’s house building rate targets are not being achieved and house building forecasts are being downgraded. House building is not keeping up with population growth in Auckland.
David Hargreaves of Interest.co.nz also reported on Auckland’s slow response to building more housing compared to its fast population growth, saying;
The problem is not going to go away -just because house prices aren’t shooting up at the moment. The problem of a constrained Auckland market and out of control prices will resurface at some point unless there is some practical solution arrived at by which the supply of houses can be easily ramped up.
If the experiences of this Government prove anything, it is that you can’t just talk something into happening. You can have your housing accords and the like and pass all sorts of rules, but if you can’t make builders put a spade in the ground, and the bankers give them the money, it ain’t going to work.
I would add to David’s comment that if only expensive houses can be built, it is unrealistic to expect a high number of sales.
Given these ongoing demand shock issues, constrained cities like Auckland need better supply responses.
The Finance Minister of New Zealand -Steven Joyce commissioned a report, called -Quantifying the impact of land use regulation: Evidence from New Zealand -July 2017, which almost exclusively used Edward Glaeser’s techniques to show that the cost of new housing in many urban areas of New Zealand, had deviated above its marginal cost due to land use restrictions.
Note, land use restrictions are not just zoning which prevents the outward expansion of a city, it is also restrictions, such as, height, setback, shade planes, heritage, view shafts, minimum car parking requirements etc, which limit the upward expansion of a city.
Auckland’s house building restrictions were assessed as being the worst of any urban centre in New Zealand.
This new and evolving land-use political/economic consensus (in voice at least, if not deed), is increasingly isolating the Reserve Bank of New Zealand, which has been treating the symptoms of the housing bubble by restricting lending to owner-occupiers and property investors -with various loan to value restrictions -collectively called Macroprudential tools. Yet despite undertaking such heavy-handed interventions, the Reserve Bank has not shown that it has a model for the causes of housing bubbles. Former Reserve Bank economist Michael Reddell has written an article titled -Intervening without understanding: the RB and the housing market, illustrating this point.
The Reserve Bank of New Zealand first introduced lending restrictions for the housing market in October 2013. Their rationale was to attempt to reduce demand for housing and thereby make the housing market more financially stable. The Reserve Bank’s last intervention in the housing market was an announcement in September 2016 where it increased the deposit requirement for property investors to 40%, while leaving owner-occupiers with a 20% deposit requirement. In the months prior to the Reserve Bank making that decision, the then leader of the National Party led government -Prime Minister John Key signalled loudly to the Reserve Bank that it should extend existing loan to value ratio (LVR) restriction on investors to curb house price rises.
In August 2017, retiring Reserve Bank Governor -Graeme Wheeler defended his performance in his final press conference. One of his defences was taking credit for decreasing annual house price increases from 15 % to 1.5%.
Macro-prudential credit restrictions combined with uncertainty from the coming election are being attributed as the reasons for Auckland’s recent cooling house prices.
While the Reserve Bank has been using monetary policy to ration borrowing for house purchases, the current New Zealand government, despite its talk of focusing on improving housing supply, has a new $435 million fiscal policy scheme, to subsidise demand for home buyers to borrow for their first house purchase. In the first 12 months of the new scheme, 11,943 government grants have been paid out, totalling more than $55.6 million and the current government hopes to issue 90,000 grants over five years.
The government also subsidises rental housing -in the last Budget, increasing the accommodation grant by a further $380 million a year. Two years ago the government had decided not to boost the accommodation supplement because of Treasury advice that landlords, not tenants, would pocket much of the extra grant by pushing up rents. Eric Crampton, a New Zealand economist describes in an article titled -Who benefits from government grants to renters? that in constrained housing markets, with inelastic supply, it is landlords not tenants, who benefit from accommodation grants.
In summary, despite at some levels there being political/economic agreement about the causes of housing bubbles, in New Zealand fiscal and monetary policy are at cross purposes on the issue of housing. So there remains some confusion about how best to confront the housing crisis in New Zealand.
The allocation of car parking spaces within cities
Donald Shoup is considered the economist with the most expertise on how a city should allocate car parking spaces. According to Donald Shoup 30% of US cities is car parking.
Donald describes how this situation came about. In the 1920’s the sides of city streets were congested with parked cars. Cities came up with two policy responses -parking meters and requiring private landowners to create off street parking -also known as mandatory parking minimums. Local government liked the second option because it created a huge supply of parking at no cost to them and it answered the question of “how did you let such and such building be built if there is not enough parking”.
The problem though is that parking requirements are set arbitrarily, planners do not have any training on how to allocate parking space. In the US, parking minimums can be based on hospital beds, gallons of water in swimming pools, the square footage of restaurant dining areas….. Donald Shoup calls this a pseudoscience, like bloodletting.
Parking minimums is an expense that drivers do not have to pay. Land which is expensive for housing, commercial or other uses becomes free for parking. This expense is added to business costs which all consumers pay. Thus non-driving consumers pay a subsidy to driving consumers.
Even worse, parking minimums mean that businesses have to dedicate more space to parking than to the business itself. This pushes businesses further and further away from each other. Making it hard to walk from business to business, thus necessitating more driving and more car parking……
The ongoing allocation of road space within a city
The choices city residents make around transport modes has a large effect on how congested a fixed quantity of road spaces becomes. Cities need to make strategic choices on what transport options are available and individuals need to face the full costs of those choices.
A friend of mine David Lupton -an economist and international transport consultant introduced me to the concept of congestion road pricing. David has long been an advocate of congestion road pricing. His interest dating back to personally meeting William Vickrey, who was an early congestion pricing economic theorist. William Vickrey had Georgist beliefs as do Harold Hotelling and Donald Shoup. Georgism dates from the writings of the economist and social reformer Henry George, the Georgist paradigm seeks solutions to social and ecological problems, based on principles of land rights and public finance which attempt to integrate economic efficiency with social justice.
With regard to congestion road pricing;
Hotelling pointed out that when local public goods like roads and trains become congested, users create an additional marginal cost of excluding others. Hotelling became an early advocate of Georgist congestion pricing and stated that the purpose of this unique type of toll fee was in no way to recoup investment costs but was instead a way of changing behavior and compensating those who are excluded.
Road pricing helps best allocate the space set aside for transport corridors. Travelers have various transport options, each with a different demand for space, including taking alternative routes or delaying travel to non-peak/non-congested times.
Auckland is reaching its limits for its ability to increase road capacity for private automobiles cheaply. It needs a mechanism like road pricing to change behaviour and even up the playing field between private automobiles and other transport modes. Even new technology, such as electric vehicles, which if taken up widely will mean a decrease fuel taxation revenue, will encourage reform in the direction of electronic/GPS road user charges. Frank McRae lays out a logical argument for why autonomous vehicles, should they become viable, will necessitate road pricing -in an article titled Driverless cars, sprawl and density.
An economist -Peter Nunns- who writes for Greater Auckland blog explains why road building costs in Auckland are escalating. He notes it is comparatively cheap to lay down highways on empty paddocks, and expensive to retrofit them into built-up urban areas or thread them through geographic pinch-points.
Going forward, Peter Nunns gives four options for new motorway corridors in Auckland:
- Dig a tunnel (eg Waterview);
- Build a bridge or viaduct (eg Reeves Road flyover);
- Reclaim some land (eg East West Connections); or
- Buy and bowl some houses.
All of these options are very costly, as can be seen in the above graph showing increasing costs for additional lane-km’s in Auckland. This rising cost pressure is the reason why the allocation of road space by congestion charging needs to be considered.
David Lupton has a plan for the affordable development of cities, focused on the New Zealand regulatory environment, although the broad principles could be applied to any city. It takes into account two of the spatial supply considerations -the allocation of private space and the ongoing allocation of road space.
I would like to conclude that a successful urbanisation project for city development should take into account the economics of allocating all the various types of spaces in a city. I hope this article encourages this process.
New Zealand is reaching its agricultural production limits. In the future New Zealand’s urban areas will need to do more of the country’s economic heavy lifting, by embracing an affordable diversified urban based economy. I believe that if the principles of efficiently allocating city space were applied, then there would be significant productivity gains to be made. I make that argument in an article titled -Does New Zealand need an urbanisation project to improve productivity?
It is my firm belief that the best way for New Zealand to successfully progress into the future is to conduct a well managed urbanisation project.