The power of ideas

Dr Oliver Hartwich
The National Business Review
8 September, 2017

The popularity of John Maynard Keynes is as cyclical as the business cycles he wanted to abolish. But beyond his macroeconomics, Keynes left us a fine observation on the power of ideas.

In the closing chapter of his General Theory, Keynes wrote that “the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else.”

That statement may be hard to swallow for disciples of the ‘great man theory’ who ascribe achievement to heroism, charisma and leadership. But after some personal experience, I believe it is true: Ideas shape our world.

I was reminded of Keynes’ quote as I reflected on more than a decade of work on local government and housing reform.

Starting in Britain in 2005 and now here in New Zealand, I have been pushing one simple idea: To get local government to work better, you must give it better financial incentives.

This idea is hardly rocket science. Nor is it difficult to comprehend. But it goes against the prevailing mindset in most English-speaking countries.

In Britain, Australia and New Zealand, trust in local government has been hollowed out over the past decades. A blind faith in centralism has taken its place. But this development has come at a cost - a cost which is not immediately visible.

When I started researching Britain’s housing affordability crisis in 2005, there were two sides in the housing debate. On the one hand, there were economists blaming the crisis on restrictive planning laws and a lack of housing supply. On the other, there were experts claiming that affordability problems were caused by excessive demand from speculators, land-bankers and migrants.

I was new to the debate and hesitant to blame supply or demand for the resultant prices. It was Alfred Marshall, another great economist, who once said that “we might as reasonably dispute whether it is the upper or the lower blade of a pair of scissors that cuts a piece of paper.”

It was futile to debate whether housing demand or supply were responsible for affordability problems. Instead, I wanted to figure out why the market did not respond to price signals with increased supply as one would expect in other markets.

The answer was that there was a bottleneck in housing delivery, and that was local government.

That was perhaps not too surprising. But it was surprising to find out why local government did not allow more housing to be built.

In short, it turned out that new housing developments cost councils more in infrastructure investment than they could expect from new tax revenue. On top of that, there were political costs caused by local nimby resistance. Housing development was bad business for councils.

I then compared Britain’s experience with two countries which had kept house prices stable, Germany and Switzerland. In both cases, local government could keep a greater share of the extra tax revenue generated by new development.

The finding that local government incentives played such a big role for housing markets was later confirmed in dozens of interviews with housing market actors.

I have since campaigned in Britain, Australia and New Zealand for this “incentives approach”. In the beginning, the idea was met with scepticism, not least because it appeared too foreign (or just too German) to work in an English-speaking context.

But over the years, the recognition that incentives are crucial for the development of the housing market has gained much traction.

A few weeks ago, a leader in The Economist called “to do away with the perverse incentives arising from local-government taxation”. It explained “Councils miss out on much of the extra local tax revenue from new houses, because it is hoovered up and redistributed by central government. But they are lumbered with the cost of providing local services for newcomers. That should change.” I could not have expressed it better myself.

In New Zealand, meanwhile, both ACT and New Zealand First argue for returning some GST back to councils to incentivise them for growth. National and Labour had previously committed to bond-financing residential infrastructure, since it removes a negative incentive for councils when it comes to enabling growth.

Thus after years on the fringes, the incentives approach to local development is gaining traction in Britain and in New Zealand.

It proves Keynes right: “Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.”

Sometimes it is nice to be that academic scribbler.

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