The New Zealand Initiative’s Jason Krupp believes local authorities need incentives to be more open to economic growth while central government needs to be more responsive to local needs

By Jason Krupp*

Pick up a paper, log in to an online forum, or eavesdrop on a dinner conversation anywhere in New Zealand and it will not be long before the topic of house prices and housing affordability crops up. So ubiquitous is the topic that it invites all sorts of diagnosis, with the source of the problem variously attributed to urban planning, low interest rates, lack of infrastructure, foreign buyers, tight land supply, all the way to unrealistic demand among millennials.

Like all wicked problems, all of these factors have a hand, to a greater or lesser degree, in making New Zealand one of the most expensive places to buy a home. Indeed, many of these factors have been thrashed to death by the commentariat (not least this correspondent).

For all this attention, one factor appears to have slipped through the cracks, namely that the housing crisis is a reflection of political preference, albeit indirectly. This may seem a stretch to some readers, but that is what the Initiative’s latest report The Local Formula: Myths, Facts & Challenges has found.

The report initially set out to find the technical issue with the local government funding system that prevented local councils from investing in economic growth enhancing activities. Our theory going in was that since central government receives all the benefits from economic growth in the form of tax while local government picks up all the costs, councils would be loath to commit to major investments that expanded their rating base unless they really, really had to. Put simply, we suspected that under the current arrangements, councils were incentivised to shun economic growth.

This was a theory that did not stack up in the data. Councils, large and small, have a clear financial incentive to grow their ratepayer base as it increased their earnings while allowing them to dilute costs over a greater number of households.

Our next theory was that poor financial management was holding local government back. This is a common refrain among central government types, but again, it failed to stack up in the data. Rates have more-or-less remained stable since the 1940s when measured against the broader economy. At the same time the national population more than doubled over the same period.

Indeed, most councils in New Zealand maintained a low level of debt, with a median ratio of term debt to non-fixed assets of 4% in 2014. Even where high debt was an issue, some councils could liquidate substantial investment holdings to service their borrowing or funding requirements. Auckland Council’s investments, primarily Watercare and Ports of Auckland, were worth five times its infrastructure holdings in 2014.

Furthermore, for most local authorities, planned capital spending on core infrastructure (roading, water, sewerage, stormwater and flood protection) to meet additional demand between 2013 and 2022 was low relative to planned capital expenditure.

So why is it that councils, particularly in fast growing areas, are not investing in growth-enhancing initiatives?

The answer, as alluded to earlier, is that that there appears to be a political constraint holding councils back. In a democratic society members of a community ultimately bear the burden of local authority spending decisions. Investments in major projects, such providing the infrastructure necessary to free up additional land supply, may offer benefits in the long-term and on a national level, but are not welcome to the residents who variously oppose higher rates bills, greater borrowing or lower land values. Whether this is due to legitimate concerns over the quality of local government spending or self-interest factors (not in my back yard) is debatable, but either way their intractability remains.

Unable to bridge this political divide, some councils limit their infrastructure investments to keep voters happy, even where these would produce desirable outcomes on a broader basis. This was evident in the Productivity Commission’s inquiry into land supply in the 10 fastest growing councils in New Zealand. Many of these councils who made submissions to the commission noted that they limited the release of land onto the market because of the burden it placed on their finances. Instead they provided land and core infrastructure on a ‘just in time’ basis so as to carry these costs for as short a period as possible.

Although this strategy may be appropriate from a council finance perspective, it is “less satisfactory if the aim is to foster competitive tensions and downward price pressures in the supply of land for housing”, as noted by the commission.

The problem is further complicated by poor communication between local councils and their communities. A recent LGNZ survey found that the public rated local government performance as 29 out of 100, even though the vast majority of councils provide a perfectly acceptable level of service. After all, almost all local roads are driveable, rubbish is removed weekly, and water flows when the taps are turned.

This democratic divide would be acceptable if New Zealand did not have a number of major challenges heading its way. One such challenge is the need to renew New Zealand’s public infrastructure over the next 30 years at the same time that the tax base narrows due to an aging population. Giving answer to this will prove almost impossible with a recalcitrant voter base.

We at the Initiative believe that the answer to this problem is twofold. First, we need to encourage communities, through local government incentives, to be more open to economic growth. In the UK, for example, central government has entered into a revenue sharing arrangement with cities like Greater Manchester on investments that lift economic output.

Second, central government needs to be more responsive to local needs. It is fine for officials in the Beehive to bemoan the lack of land supply in places like Auckland, but the planning and environmental management regime is a creation of central government legislation. Many of these centrally-created-but-locally-felt issues were recently highlighted by the Rules Reduction Taskforce, but there appears little interest in Wellington to amend the legislation that created some of these local red-tape absurdities (at least at this stage).

The specifics on the incentives, and how to give local councils more say at a legislative level, are undefined at this stage. Indeed, our next research project will examine how different jurisdictions have tackled these challenges, and if these policy settings can be replicated in New Zealand.

What we can say with some degree of confidence is that unless new ideas are levelled at longstanding problems like housing affordability and their underlying causes, it would be unwise to expect improvements anytime soon. Potentially, things could get even worse.

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*Jason Krupp is a Research Fellow at The New Zealand Initiative, which provides a weekly column for interest.co.nz. jason.krupp@nzinitiative.org.nz