Planning regulation is regularly singled out as the prime culprit in Australia’s housing crisis. 

RBA researchers set the ball rolling back in 2018 with a headline grabbing piece that concluded “as of 2016, zoning raised detached house prices 73 per cent above marginal costs in Sydney, 69 per cent in Melbourne, 42 per cent in Brisbane and 54 per cent in Perth…..  and …  Zoning has also raised the price of apartments well above the marginal cost of supply, especially in Sydney (Kendall & Tulip, 2018).”

Celebrated economic commentator, Allan Kohler, draws heavily on this RBA research in his widely cited essay on Australia’s housing woes  (Kohler 2023).  He says … “Those are astonishing numbers, and that’s without including the effect of local government planning decisions, which are, by definition, haphazard and unquantifiable but mostly aimed at keeping local councillors in a job by keeping the existing residents happy by making sure they don’t let in too many new ones.”  Kohler further opines that … “The way real estate works in Australia is that the federal government and banks encourage demand for it and state and local governments restrict the supply of it. The states restrict supply through zoning, and local councils do it by their planning decisions every day.”

More recently, no less than the International Monetary Fund has pointed to the “criticality of supportive planning and land‑use policies” in improving housing affordability in Australia (IMF 2023).

In the face of the gathering conventional wisdom that planning deregulation is essential if we’re to get through Australia’s housing challenges, it is worth pausing to ask why we have these regulations, what value do they generate, and what can be done through planning reform to improve availability and affordability of dwellings.

Many markets require regulation if they are to properly serve customers and produce the best welfare outcome for the resources being deployed.  Consider commercial fisheries.  Left to their own devices, profit oriented operators with no control or influence over their competitors would race to pull out as many fish as they could, even fishing their target species into extinction.  Consumers would likely benefit in the near term; more fish in the market might mean lower prices.  But ultimately, stocks would become so depleted as to push prices sky high, and the environment would be left irreparably degraded.

Regulation of commercial fisheries is essential because the rational behaviour of buyers and sellers in the market has ‘external’ effects, that is, it generates costs for non-transacting parties.  These costs are not reflected in the market price of fish.  If the ecology were somehow a commercial party to the fishery supply chain, and if fishers were obliged to pay a price for drawing on this resource, they would produce less fish for the contemporary market, but long term supply would be sustained, and bio-diversity values would be preserved.

Regulation of commercial fishing by way of quota licences is necessary to avoid more damage than value being created through rational market behaviour.

These fishing licences carry a commercial value in themselves.  This is given by the achievable market price for the fish under the licenced quota minus a normal profit margin for the fisher and their direct costs of production – boat, fuel, nets, refrigeration and business services like accounting and marketing.  The residual would be the amount that a rational operator would pay for a quota licence.

One could calculate, as Kendall & Tulip did for housing, how much higher the price of fish is due to regulated access to fishing licences.  This would likely be substantial (at least in the near term while fish populations survive).  But what conclusions might be drawn from this finding about the appropriateness or otherwise of the regulations?

Regulated access to development rights, for housing or any other land use, is essential if city and neighbourhood building is to optimize economic value for community and environment.  This is because urbanization involves a mess of externalities which, to repeat, are costs and benefits which transacting parties in an unregulated market are not obliged to factor into their commercial decisions.  So, if developers were free to build whatever they liked where they saw a profitable opportunity, it is inevitable that the resultant urbanism would be less than efficient; that is, it would not generate the best value for the resources being used.

As in the classic illustration, factories would spew smoke, odours and noise on neighbouring houses with impunity.  Many other externalities would require mitigation – encroachment on sensitive habitat, destruction of culture and heritage, lost opportunities for clustering of service and industrial activities to the detriment of consumer convenience and enterprise productivity, and foregone opportunities for efficient infrastructure provision.

Planning regulation is therefore necessary if markets are to do their best work.  It involves state reservation of, and rationed access to, development rights in accordance with a designed future.

As in the fisheries example, these rationed development rights carry their own commercial value, which is given by the residual after the developer’s direct costs and required profit are deducted from the market price for their finished product.  Unlike fishing quotas, however, access to land development rights is not subject to a licence fee in Australian jurisdictions with exception of the ACT.  Instead, the value of these regulated development rights is typically captured privately by the owners of development sites.

In this light, how is the ‘zoning effect’ measured by the RBA researchers to be interpreted?  There is undoubtedly a value to regulated development rights which form part of the total price of housing.  But there is also a value to the benefits of regulation, many of which are also factored into the total price of housing.  Would community and environment be better off through, say, radical planning deregulation to reduce the value of rationed development rights?  Or would we be piling up externality costs to the point of compromising the efficiency, that is, the net community benefit, of urbanization?

Put another way, the price premium above the marginal cost of producing housing measured by the RBA researchers is the cost of mitigating the multiple externalities in the urbanization process.  It is no less a necessary input to the efficient creation of housing than the bricks and mortar which go into the construction of a dwelling.  The 73% price premium identified for Sydney detached housing could not, in principle, be reduced to zero if welfare optimization in residential development is to be achieved.  The question is, is the price premium too high or too low given the externalities at play.  Unfortunately, the RBA research does not help us with this.  It infers that a hefty price is being paid by the community as result of planning regulation, and that, perhaps, substantial deregulation is in order.  But it offers no evidence that the welfare benefits generated by regulation fall short of the costs associated with it.

The fisheries example is useful in illustrating the need for regulation in the face of externalities.  Indeed, it highlights the need for licence fees to redirect the residual value of regulated development rights from private to public capture for, potentially, reinvestment in infrastructure and social housing.  Nevertheless, the example only takes us so far.  While conceptually, there will be discrete limits to the quantum of housing development rights which can be secured in particular areas if neighbourhood building is to optimize welfare within environmental limits, planning can ensure that there is an ample pool of housing development rights available across wider urban districts.  This is, in fact, a core job of urban planning.  Most jurisdictions explicitly mandate that sufficient land (horizontally and vertically) be made available for housing (and other) development to cover some multiples of projected demand.  If housing is not being developed in response to demand, it is likely not for want of planned capacity but rather the withholding of development sites by land owners, the fragmentation of planned development sites, inadequate infrastructure to support housing development or unrelated prevailing market conditions.

All too often in the current discussion about housing supply, planning is portrayed as ham fisted, exclusionary, regulation intended primarily to protect the interests of sitting property owners.  Rather it needs to be understood as an essential ingredient in the efficient development of cities, including creation of housing stock.  There will certainly be opportunities for better planning regulation to improve housing outcomes, but to demonize it as the principal cause of the housing crisis is unhelpful.

By Dr Marcus Spiller, Principal & Partner, SGS Economics & Planning Pty Ltd