Nobel laureate Paul Krugman once quipped that David Ricardo's theory of comparative advantage defined who counts as an economist. Because every economist understands comparative advantage and its related notion of "opportunity cost" and practically nobody else does.
With that in mind, we must assume that no economists were involved in the drafting of the Government's new National Policy Statement (NPS) for Highly Productive Land.
If anyone needed a textbook example for ignoring opportunity cost as a factor for analysing choices between different options for production, the Government has just delivered it. It shows the pitfalls of making policy that ignores basic economic insights.
Released last Sunday, the NPS is the culmination of more than four years of deliberations by the Ministries for the Environment and Primary Industries. It directs councils to map highly productive land within their territories. And it restricts them from rezoning this land for urban development unless a series of stringent tests are met. A specific prohibition targets the rezoning of productive land into rural lifestyle blocks.
The NPS applies to vast areas of the country, amounting to about 14% of New Zealand’s total land area. To put this in context, urban areas account for less than 2% of the country (and, on some measures, less than 1%). The overwhelming majority of the land covered by the NPS is used for pastoral farming, with just a small fraction dedicated to market gardening.
A joint press release from Environment Minister David Parker and Agriculture Minister Damien O’Connor explained the goal of the NPS. The ministers said it would “enhance protection for our most productive land, providing security for both our domestic food supply and primary exports.” Parker said the NPS would protect highly productive land from “inappropriate subdivision.”
But large tracts of the so-called highly productive land covered by the NPS are on the peripheries of growing urban areas, including Auckland. Consequently, the NPS runs headlong into a critical public policy goal: affordable housing.
The premise of the NPS suggests a terrible dilemma. Either we allow our cities to spread to reduce the cost of housing at the cost of rising food prices from the lack of highly productive land. Or we can preserve the highly productive land at the expense of affordable housing.
Even expressing the dilemma this way, it is by no means obvious that protecting land from housing is the right choice. After all, it is easier to import food than housing.
But it is precisely this type of dilemma that Ricardo’s insight helps solve. It forces us to ask the following question. What is the opportunity cost of restricting the use of highly productive land to agricultural activities?
Unfortunately, both the NPS itself and the Ministers’ announcement are silent on this issue. The announcement proudly proclaims that the NPS will facilitate adding $44 billion to primary sector exports over ten years. But it says nothing about the cost.
Consequently, to evaluate the NPS we are forced to look back at the Treasury’s assessment of the draft NPS back in 2019. The analysis is scathing. Treasury points to excessive costs of urban land at that time “perhaps in the order of $600 billion nationally.” Treasury concludes that the proposed NPS “appears likely to exacerbate this, which would undermine the achievement of central government’s primary objective… to ‘improve housing affordability’…”
Treasury also points to very large losses in welfare from owners of highly productive land not being able to sell their properties for urban development. It concludes, “These costs would dominate by several magnitudes the claimed net-benefits.”
That should have been enough to scotch such an economically illiterate idea. But the NPS has another fatal economic flaw.
Like other capital assets, land value reflects the present value of the future profits it can generate. Horticulturalists must therefore pay more for highly productive land than for less fertile land. Higher land values mean higher land costs per hectare for those farming highly productive land.
The alternative to highly productive land is less productive land. It may be harder to farm, but it is less costly to acquire because it is less fertile. Indeed, simple economics suggests the value of less productive land will be lower in proportion to its lower productivity.
This means the problem of the comparative scarcity of highly productive land is solved by the price mechanism. And without the need for regulation in the form of the restrictive NPS. The lower price of less productive land compensates for its lower productivity.
The price mechanism is also the solution to the apparent dilemma about whether highly productive land should be used for horticulture or housing. Well-being will be maximised by taking into account opportunity costs. Where land is more valuable for housing, we should build on it - and farm on less productive land. Less productive land may be harder for horticulturalists to farm, but the opportunity cost of the alternative is worse.
In 2019 Treasury advised Cabinet that the NPS had a “weak problem definition and rationale for intervention” and that this “creates risks of low benefits, high costs, unintended consequences and risks to achieving other policy objectives.”
Treasury’s criticisms remain just as applicable today. One wonders what hocus-pocus has seen the NPS reappear.