Submission: The market study into residential building supplies preliminary issues paper

Dr Eric Crampton
4 February, 2022

This submission in response to the Commerce Commission’s (Commission) Residential Building Supplies Market Study Preliminary Issues Paperi is made by The New Zealand Initiative (the Initiative), a think tank supported primarily by major New Zealand businesses. In combination, our members employ more than 150,000 people.

In summary, we submit:

(a) That the Commission should begin its inquiry with a simple question: if building material costs in New Zealand are higher than the Commission believes to be warranted, what prevents new suppliers from entering the market?

(b) That the Commission should look through current Covid-related supply chain constraints except to the extent that they point to fragilities induced by regulatory arrangements making it very difficult to shift supply chains in response to circumstances;

(c) That the Commission should put itself in the place of a potential new entrant wishing to build homes using imported materials from trustworthy comparable markets like Seattle, Vancouver and Tokyo. What, if anything, would stop that entrant from building houses, townhouses, and apartments here?

(d) That the Commission should not end lines of inquiry with observations that imply a substantial restraint on competition elsewhere in the system that itself needs to be investigated. For example, the Commission observes that architects and engineers seem to prefer some standard materials. If the Commission also believes that those materials are overpriced relative to their quality, surely there is an opportunity for a developer to deliver higher quality homes to market at lower prices by hiring engineers and architects who are more competent. If they are not, what barrier prevents it? Potential explanations should not imply that substantial profit opportunities sit unexploited unless they also explain the real barrier that prevents those opportunities from being taken up.

(e) That the most plausible and fruitful line of investigation for the Commission runs as follows.

  • Councils face joint and several liability, along with builders, if a building fails. If other parties under joint and several liability have ceased trading by the time a building fails, Council can be left to bear the entire cost of any settlement. Councils are also liable if they approve buildings in which builders substituted equivalent materials rather than follow architect plans exactly.

  • Councils seek to limit that potential liability by exercising far greater diligence and more expensive (to the developer and builder) process when faced with less familiar building materials or building techniques.

  • Consequently, architects and engineers will wish to provide councils with plans that are easy to consent, with standard features applying standard solutions using standard materials. Even if the resulting home is more expensive and lower quality than it otherwise could be, that path of least regulatory resistance is attractive for developers facing very high compliance cost in the alternative.

  • Councils fearing joint and several liability guard against the downside risk of less familiar materials; they see none of the upside benefit. Council risk aversion, caused by liability rules, creates a regulatory barrier to entry against novel building materials unless those materials provide a very substantial advantage over existing materials in large-scale developments.

  • The up-front fixed costs of bringing new building solutions to the New Zealand market are high. They include sourcing supply chains, ensuring batch quality for materials delivered from far-away markets, securing appraisal for parts requiring it, training work crews in construction methods relying on new materials, and building council confidence in the use of those materials when councils are very nervous about bearing downside risk and know that they are not particularly competent in assessing the merits of new materials and methods. When only small-scale building is allowed under restrictive council zoning, few builders would find it worth the cost. Zoning constraints will ease substantially with NPS-UD and the Enabling Housing Supply legislation. The scale of building now enabled may make it more worthwhile to secure competitive sources of materials from abroad. Easing formal regulatory constraints and informal consenting barriers is critical.

  • The Commission could spend all of the coming year exploring vertical separation of material retailers, builders, and material manufacturers; estimating profit margins in any of those businesses and deciding whether they are high relative to overseas competitors; arguing with existing businesses about how the Commission has failed to account for differences affecting weighted cost of capital and profit margins here as compared to abroad, and tying up critical staff in each of those companies for months when they should be helping to get more houses built. Or, it could spend the coming year delving deeply into the regulatory and consenting constraints that may together form a substantial barrier to entry. It could make recommendations that would enable far stronger competition from overseas material suppliers and developers. And it could thereby help open the market so better houses could be built more cost-effectively. The latter would enable market discovery of whether excess profits exist in building material supply by enabling greater competition for them.

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