Fresh Economic Thinking

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What is the marginal cost of producing an extra home? This article gets into the weeds and was prompted by this tweet about where the price of homes comes from.

Price would equal MARGINAL construction cost. Otherwise, there would be an incentive to keep building.But marginal cost exceeds average cost.So P = MC > AC. P-AC is the value of land, often called the site value.

This idea dominates a lot of housing economics. Here’s Harvard Professor Ed Glaeser in the Journal of Economic Perspectives.

…we show that the cost [CM: market price] of Manhattan apartments are far higher than marginal construction costs

Comparing the market price of dwellings to marginal construction costs to claim regulations increase housing costs is the core piece of evidence relied upon to argue about the effects of planning regulations.

Here’s a study from RBA researchers Ross Kendall and Peter Tulip making a similar point. And below is a typical tweet making similar claims.

So what does price is higher than marginal cost even mean?

What’s the marginal cost of extra homes?

Let’s say it costs $1 million to build a five-storey apartment building with 10 apartments, so the average construction cost is $100,000 each (which is AC, or average cost). Before construction, it may be possible to redesign the building and incorporate an eleventh apartment. However, the total construction cost of this design might be $1.2 million, which means that the extra cost, or the marginal cost (MC), of the eleventh apartment is $200,000. It costs $1 million for ten dwellings, but $1.2 million for eleven.

Therefore, all similar apartments in this location, under these cost conditions, should be priced at $200,000, as this is the marginal construction cost of an extra apartment in this building.

If apartments were priced in the market at less than $200,000, it is certainly true that eleven apartments wouldn’t be constructed on this site, as the property owner makes less money compared to building ten apartments. If apartments were priced at $180,000, building ten apartments leaves you with $800,000 after construction costs ($180,000 x 10 minus $1 million), but building eleven leaves you with only $780,000 ($180,000 x 11 minus $1.2 million).

When the number of apartments in a building is unconstrained, it is true that when and if a building is developed, it is optimal to not build any denser than where the marginal cost of adding another apartment to the building equals the market price of an apartment.

But what is not true are the additional claims that a gap between price and marginal cost determines the price effect of regulations on density.

Here are three reasons why.

What’s wrong with this claim?

1. The coastline paradox or Russian doll problem

We have so far only looked at an extra marginal dwelling per site (the marginal dwelling density). But there is also the marginal storey per building (the marginal height), a marginal building in a housing project (the marginal building), and at each location there’s a marginal housing project (the marginal project)!

Within each dwelling, there is also the marginal square meter of extra space (the marginal size), which could come in the form of the marginal bathroom, bedroom, patio space, or extra car park, each with its own marginal cost. There are quality margins as well.

Let’s not forget that there is also the marginal dwelling built per period of time (the marginal absorption rate) to consider, something that is always ignored.

Here’s an illustration of this Russian doll of margins in new housing.

Here’s the first problem. On which of these margins should price equal marginal construction cost?

It can’t be all of them.

We know that construction cost for a dwelling with the same market value increases with density. Because of this, the smaller the margin you measure, the higher the marginal cost observed.

Here’s a table with a stylised round-number construction cost profile for these margins for a housing project with 20 dwellings in the following arrangement.

* Two buildings

* Five storeys each building

* Two dwellings per storey

* 100 square meters per dwelling

Notice anything? Many margins mean many marginal costs on a per-dwelling basis.

Now imagine that I go and look at construction costs and market prices of buildings traded and see that the marginal cost of a building is $1,000,000 but the market price is $4,000,000.

What can I infer here?

Now imagine that I go and look at construction costs and market prices of dwellings and find that the marginal cost is $200,000 and the market price is $400,000.

What can I infer here?

Finally, I look at the construction cost and market prices of square meters of apartment space. Here, I see that the marginal cost is $3,500 and the price is $4,000.

These are all just arbitrary units of measurement. One says that three-quarters of the market price is a deviation from marginal cost. Another says that half is a deviation. And another says an eighth is a deviation.

Which one shows the price effect of regulation?

This problem is akin to the coastline paradox. Depending on the length of the ruler you use, you get a different length of the coastline. A longer ruler means a shorter measured length. In our case of dwellings, this means that the larger your unit of measurement, the lower your marginal cost relative to the price of that unit.

2. The density problem

Another problem is that the marginal cost of adding an extra dwelling of equal value rises with the density of housing projects.

The extra marginal dwelling in a five-storey building has a much lower cost than the marginal dwelling in a 100-storey building. The marginal cost of adding height and dwellings when designing tall buildings can be double or more than that of smaller ones. The charts below are from my Feasibility Guide for Planners. They show the rising average cost per square meter for denser projects, and even faster rising marginal costs.

So which marginal cost sets the price of housing in an unregulated market? Is it $2,500 per square meter? Or $8,000 per square meter?

We can only know if the price is above marginal cost if we assume a particular density. But there is a density where the marginal cost will equal any price. There is not one marginal cost, but many different ones. The point where marginal cost equals price only tells us at a specific point in time what the profit-maximising density is at that time. Once a building is built, markets change and it immediately becomes the “wrong” density again. I explain this density equilibrium concept in detail in my new book The Great Housing Hijack.

Even if regulations limit density to a point where the marginal cost at that density is below the price, it doesn’t tell us anything about the quantity of homes, since density and quantity are not the same.

3. The true marginal cost problem

The difference between density and quantity brings us to the final problem. The input cost of constructing one extra dwelling of density on a site not the marginal cost of a dwelling per period. It is the marginal cost of density or dwellings per site area.

The marginal cost of building homes during this period (the marginal cost of production) must include the opportunity cost of the next best alternative. This includes the cost or benefit of waiting until the next period.

At any density, whether this is regulated below a density that might otherwise be chosen, the marginal cost of developing homes today is the forgone benefit of waiting until tomorrow.

Developing housing is a portfolio reallocation. Waiting provides a return from the increasing value of owning an undeveloped site asset and a return from interest on the cash asset that needs to be combined with that undeveloped land to get a new housing asset. There are also effects of building faster today that depress prices tomorrow. Thus, the marginal cost of building an extra new home today (housing production, or supply) is the forgone return from waiting.

This is the problem I tried to explain in my Housing Supply Absorption Rate Equation paper in The Journal of Real Estate Finance and Economics.

But no one cares about this more appropriate marginal cost for some reason. Indeed, there is widespread confusion about density and supply. The whole idea that the marginal cost of extra housing density should equal the price stems from this misunderstanding.

So what?

We need to throw out the idea that when the price is above marginal cost we have learnt something about the quantity of homes in a market relative to some optimum. Instead, all we know is that today’s market prices mean higher densities are probably privately optimal for some property owners should they decide to build homes today. But will they? Because they know that there is a cost of developing today in the form of forgone returns to waiting.

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It costs $30 billion a year in fees alone and takes 11% of wages as a non-tax compulsory payment from families at the time they need the money most, yet there is no lobby group seeking to scrap the wasteful superannuation system.

Cameron and Jonathan discuss how interest groups sprung up around the super honeypot, and contemplate how to form such an anti-super lobby.

Please leave your comments if you want to be part of such a group!

Follow Cameron and Jonathan on X/Twitter. Buy The Great Housing Hijack here.

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Please consider supporting Fresh Economic Thinking — Australia’s newest one-man think-tank—by upgrading to a paid subscription.

Thank you to all my existing paid FET subscribers. You will get the audiobook of The Great Housing Hijack starting later this month via the FET podcast.

Your support helps me do things like a recent debate with Kevin Erdmann about “What makes housing more affordable? Public Investment vs. Market Liberalization”. You can watch it here.

Right now there is a Senate Inquiry into supermarket prices as well as a much more extensive and detailed inquiry by the Australian Competition and Consumer Commission (ACCC).

Supermarkets aren’t my highest priority in terms of the cost to consumers from their conduct (superannuation is far more costly - see here and here). But supermarkets nevertheless comprise a large share of household budgets and directly affect choices in our daily lives.

One dimension of supermarket competition revolves around location choices. Rules around these choices usually involve town planning regulations that seek to cluster retail activities in a hierarchy of locations.

This article is about how town planning rules are used as the basis for often frivolous anti-competitive legal cases, with some detail on a recent case in Brisbane.

But the bigger puzzle is this: Why have supermarkets for so long behaved so anti-competitively compared to other retailers or commercial and industrial businesses?

It might simply be the case that when there are few ways to innovate your product, you innovate on other regulatory margins to outcompete your rivals (see last week’s FET #29 podcast about the electricity pseudo-market).

What else is a supermarket to do to make more money?

A history of taming supermarket behaviour

Look at what has already come out of the initial testimony to the current Senate Inquiry on the topic of preventing competition through location choices.

The questions being put to Metcash CEO Grant Ramage during his session were mostly about land banking by Coles and Woolworths.

In the context of the supermarkets, land banking is a strategy  where they buy up large areas of land across the country even if they don't have plans (or permission) to build a store there, therefore reducing competition.

Mr Ramage was asked about this behaviour by Coles and Woolworths throughout his appearance before the committee, and he agrees that they are engaging in land banking.

Senator Ross Cadell gave an example about land banking in the Hunter Valley in NSW, and Mr Ramage agreed that it was an example, where supermarkets can buy a proxy through a developer, gain the centre, and remove the independence.

Senator Dean Smith followed up with more questions about land banking by the supermarket giants, and Mr Ramage responded that he didn't think it was "overt or obvious".

"It happens under the radar, there is no obligation for the majors to divulge when they acquire property, it's not illegal," Mr Ramage says, adding they notify the ACCC and councils when they see it happening.

But this is not the first time that supermarkets have been in the firing line for their anti-competitive conduct. It seems to be the nature of this industry. Brisbane-based property analyst Ross Elliot notes that a senior Westfield executive told him in the 1990s that “we would object to a competitor moving a plant pot if we thought it was in our interests to do so.”

In that 1990s era, we were equally concerned about such behaviour. Here’s a 1999 review of retail trade practices by supermarkets. It took the view that although there was a lot of consolidation in the sector, there were benefits from economies of scale to consumers. What is interesting to note from a quarter of a century in the future is that the market share of Coles and Woolworths hasn’t changed as much as you would think, up from around 55% to 65% (depending on how you count). But there is now no Franklins supermarket chain and we have ALDI doing more than a third of the revenue of Coles today.

There was then a 2002 Grocery Inquiry dealing with the behaviour of supermarkets in their contractual arrangements with suppliers.

Strangely, in 2003 there was a headline about the Trolley Wars. People were upset that Woolworths and Aldi were outcompeting other grocery stores. This demonstrates that we don’t know what we mean by competition. One company comes and outcompetes another and that is uncompetitive. You can’t have competition without winners and losers!

In that same year, the ACCC took action because of Woolworth's conduct around preventing liquor licences from potential competitors.

In 2004, Westfield’s Frank Lowy tried to stop a supermarket on Brisbane Airport land near his Westfield Toombul shopping centre, as well as challenging a new shopping centre in Homebush in Sydney. This is a good line from that article:

The executive director of the Shopping Centre Council of Australia, Milton Cockburn, disputes the allegations of anti-competitive tactics (Westfield is a prominent member of the council). "Lodging legal action is not anti-competitive. What law says you can't defend the interests of your investors and retailers?" Perhaps Cockburn should have a look at the National Com­petition Council's report on planning and construction laws, which begins: "The major competition restriction in planning legislation is its potential to restrict the entry of new competitors into a market. This may result from ... manipulation of the process by commercial objectors to create delays in decision-making and significant additional costs for potential market entrants."

In 2005 the ACCC intervened to stop attempts by Coles and Woolworths leveraging their power to influence the sales of independent grocery stores.

Then in 2008, the ACCC conducted an inquiry into the competitiveness of grocery retailers, out of which came an undertaking with Coles and Woolworths to phase out restrictive leases that prevented other supermarkets from leasing within the same shopping centre.

During its Grocery Inquiry in 2008, the ACCC identified a practice where supermarket operators would include tenancy terms which may have prevented shopping centre managers leasing space to any competing supermarkets.  This had the potential to impose restrictions on the number of supermarket outlets in centres and consequently fewer options for consumers.

"Over 700 supermarket leases were identified through the ACCC investigation as potentially restrictive, and this agreement addresses all those existing leases involving Coles and Woolworths, as well as dealing with all future arrangements.  I welcome the cooperation of Coles and Woolworths in the development of this arrangement."

The agreement is in the form of a court enforceable undertaking that has been voluntarily provided by Coles and Woolworths.

More interesting for me is this 2010 report by SGS Economics for the Commonwealth Treasury about the planning system as a barrier to entry for supermarkets, and its comments that competition dimensions should not be a factor in planning decisions.

Yet courts were still busy with supermarkets trying to delay competition using planning appeals with frivolous legal cases even in 2012, as reported here.

Retail analysts say the result is that councils are lumbered with massive legal bills and shoppers face less choice and higher prices. More than 20 appeals against shopping centre and retail plans have been lodged in the Planning and Environment court in the past two years.

A 2009 voluntary undertaking by the supermarkets to remove restrictive lease clauses was a positive move for competition. Still, supermarkets were getting similarly effective outcomes with covenants on property when shopping centres were first developed. Here’s how that works:

"There are a large amount of centres where we are restricted from entering because of covenants," said Aldi's managing director for Victoria, Tom Daunt.

"It can be an outright restriction on the use of land by a previous owner who might be a developer for a major supermarket. The other case is clauses in leases of major supermarkets which effectively restrict competitors with quite dramatic rent reductions (if a rival becomes a tenant in the same centre).

"Covenants on available land and clauses in leases, they are all similar. They are all restrictions of trade."

It’s honestly quite something to see the frequency of these inquiries. I suspect this behaviour is economically motived in the same way that confusopolies emerge in undifferentiated industries like telephone, electricity, insurance, etc. Because there are no technology margins to innovate, you push hard on regulatory margins instead.

Of course, outside of the big two supermarkets, Aldi plays its own game, copying the colours and styles of food brands. The supermarkets have been upset about this.

He pointed to similarities between some of Aldi’s exclusive brands and national brands such as Bundaberg ­ginger beer, Procter & Gamble’s Pantene shampoo, General Mills’s Old El Paso taco kits and Kellogg’s Special K.

To wrap up this whirlwind history, supermarkets use their buying power to influence the actions of both suppliers and shopping centre owners to prevent competition.

Fine.

But there are also some puzzles.

Supermarkets defend their suppliers when it comes to protecting food brands from imitation. But then they also apparently squeeze these suppliers too. How do we reconcile this?

Shopping centre owners interfere with new supermarket locations on behalf of supermarkets. But I think this makes more sense because new venues compete with all tenancies and it is common to have turnover-based leases where landlords share in the turnover gains of tenants.

Also puzzling is that despite decades of concern about supermarket conduct, and what appear to be fairly aggressive tactics, grocery margins aren’t super high and the composition of players in the grocery market has changed quite a bit. There seem to be concerns when supermarkets are very competitive, squeezing down prices from suppliers, and also when they are anti-competitive.

I think a lot of the games we are playing here could benefit from clearer economic thinking on what competition really looks like.

The point I want to make today is to look at a recent case I’m aware of in Brisbane where the landlord of Woolworth’s at Newstead, is challenging a planning approval for a nearby shopping centre.

A Brisbane case of supermarket conduct

A new trend in Brisbane is the mixed-use retail, residential and commercial precinct. One of the more successful, and still yet-to-be-completed projects of this type is in my neighbourhood called West Village, a cluster of eight towers (seven residential and one commercial) above a retail precinct with medical facilities and other uses.

The model seems to work commercially and with many large sites with existing low-density retail and industrial uses in Brisbane suburbs, there are now planning strategies and rules that accommodate this type (such as the Suburban Industrial Strategy etc).

Another example of this type of project is called Buranda Village, on the site of a dated single-storey shopping centre, which is approved for seven towers (four being residential with around 700 apartments) over a 10,000 sqm retail centre.

The flood-ravaged and now under demolition Toombul shopping centre is likely to get a similar treatment when redeveloped.

But the project I want to talk about today is called Newstead Green, on the site of a car yard in the booming inner-city suburb of Newstead. It is approved for nearly 800 apartments, a major retail, commercial, showroom and lifestyle centre, the owner of the existing nearby shopping centre with Woolworths as the anchor tenant (AMP Capital, now owned by Dexus) is appealing the decision.

You can see the locations of the two sites below.

Notice also that on this map the purple, blue, and green shading are all new towers that have been proposed, and the grey are recently completed towers. This area is seriously developing. Thousands of apartments are already approved (including in this project). This seems enough local population to support an extra full-sized supermarket, which normally needs a catchment of about 5,000 people.

To be clear, the Brisbane City Council is now defending its planning decision to approve the project. The grounds of the appeal are of course many, but this part jumps out (pages 8-9).

i. The economic impact of the proposed development upon Gasworks Plaza will be significant due to the scale of the proposed retail component, its proximity to Gasworks Plaza and the extent of the proposed development’s trade area.

ii. The retail component of the proposed development seeks to replicate Gasworks Plaza which, given its close proximity to the proposed development, will provide no community benefit in terms of convenience or choice.

iii. These impacts will seriously erode the viability and vitality of the retail tenancies at Gasworks Plaza, thereby compromising the function of Gasworks Plaza.

iv. Centres provide a focus for public and private investment and community activity. Considerable investment has been made to provide infrastructure, buildings and businesses both within Gasworks Plaza and the adjoining area. This creates a vitality which is central to its function. By diluting economic activity to another location, direct economic impacts will be significant and the benefits intended by City Plan will be eroded to the detriment of the public interest.

v. The impact of the proposed development on Gasworks Plaza would exceed 15% of sales.

The last point gets to the heart of it.

I doubt there will be a 15% effect from today, especially considering the growth of the neighbourhood that will go along with a project of this scale. They are literally saying that the new centre will compete for customers and that they don’t like it.

Since we know that competition is not a valid argument in planning, this probably won’t fly — it will just cost time, money and the resources of the courts.

But now to the original question of supermarket bad boys.

If there was no supermarket here, but still plenty of retail space, the owner of a nearby shopping centre is unlikely to engage in this type of anti-competitive legal strategy.

If it was a new commercial building, owners of nearby buildings wouldn’t take these anti-competitive actions. If it was a new industrial project, again, the same.

Only supermarkets seem to be this actively engaged in anti-competitive behaviour in all domains, especially around real estate, lease conditions (stamped out by the ACCC), planning and zoning, contract conditions with suppliers, and other regulations.

Why?

Maybe it happens in the shadows more so in other sectors. But does it? Or are supermarkets just the bad boy because they have no other innovation to offer to increase their profits?

You might have heard this: “The biggest SCAM in life: Paying taxes on money that you make, taxes on money you spend, and taxes on things you own, that you already paid taxes on, with already taxed money.”

A previous FET article explained why this makes no sense, as money circulates and value accumulates. We chat more about why this is wrong and what are legitimate issues in the Australian tax system.

Follow Cameron and Jonathan on X/Twitter. Buy The Great Housing Hijack here.

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Do you suspect electricity retailers are scamming you?

You're probably right.

Jonathan rants about how a strange note on his power bill sent him down the rabbit hole to discover just how stupid and funny our energy retail pseudo-market is.

The long bureaucratic incubation of the Better Bills Guideline is here.

Former Greek Finance Minister Yanis Varoufakis says that if the energy market is complicated, it is because it was intended to be complicated so that people don't understand it's a scam.

Here’s Cameron’s first-ever blog post about confusopolies.

Follow Cameron and Jonathan on X/Twitter. Buy The Great Housing Hijack here.

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The economic performance of the United States in the past year has been exceptional compared to Australia, Canada and New Zealand.

Here’s why.

The United States is still stimulating its economy with Covid-era monetary policy because of its unique mortgage market with 30-year fixed interest rates.

Manipulating the price of mortgages and via this, housing investment and prices, is the main way we manage the macroeconomy.

We call it monetary policy.

The basic economic idea is that we need households to spend more money to combat a downturn in the macroeconomy. One way to relax the budget constraint of households is to lower interest rates. Doing so reduces mortgage payments for some households and financing costs for buying new homes (and cars and other durable goods) for all households. This extra spending stimulates economic production activity.

Other non-housing effects happen when we change nominal interest rates, or what we call transmission mechanisms. These include effects on business investment decisions which are moderated via the price of borrowing.

One important side effect of monetary policy is that asset prices are tied to interest rates, particularly housing assets, where debt financing is common and risks are relatively low. When interest rates go down it means you can rent money from the bank as a mortgage for a lower cost than renting a home from a landlord. So people do it! When everyone does it, that pushes up housing asset prices.

This is exactly what happened globally during the 2020-2022 Covid panic. I predicted at the time that home prices would rise, despite widespread commentary that they would crash due to economic disruption.

Central banks worldwide have now reversed that policy, raising interest rates to tighten households' budgets and reduce their spending.

But different financial setups in different countries mean that raising interest rates affects household spending quite differently and hence the same interest rate change is more contractionary in some places than others.

This is why currently there is such an economic boom in the United States more so than peer nations with similar monetary policy settings.

The difference is the 30-year fixed-rate mortgage.

When interest rates are lowered, existing mortgage holders can refinance at lower interest rates, which relaxes the budget constraint of households as it does in Australia with our variable rate mortgages.

But when interest rates are raised, this does not constrain the budgets of existing mortgage holders whose repayments are unchanged because of the long fixed rates. There is an asymmetry in monetary policy transmission in the United States that doesn’t exist in Australia.

The chart below shows how few fixed-rate mortgages exist in Australia, at around 15% of mortgages, relative to the United States (~95%) and countries like France (~93%), Belgium (~92%), Germany (~90%) and Mexico (~100%). Australian fixed-rate mortgages are also much shorter in duration, typically 2-4 years, whereas 30 years is the most common in the United States.

This matters. There are $2.2 trillion worth of outstanding mortgages in Australia. Every additional 1% point higher interest rate reduces spending power by $22 billion per year from mortgaged households. These households are likely to spend most of their budget and be saving little. That 1% point higher interest rate gives back most of this amount to bank deposit holders, but these households are holding long-term deposits because they want to save money, not spend it.

So the 3% increase means a decent share of $66 billion less in consumer spending compared to the same interest rate rise if outstanding mortgages all had fixed interest rates.

The data shows that an extra 5% of household income is now used to service debts compared to 2021, up from 13.5% to 18.5%. But this figure has fallen in the United States and almost no change in Germany.

Despite rising interest rates, the asymmetric transmission of monetary policy in the United States means it still has an expansionary monetary policy position, unlike countries such as Australia, Canada, and New Zealand. They also have quite a few fiscal policy programs now being enacted.

These smaller nations with more interest rate-sensitive mortgage markets are likely to see the heat come out of their economies much faster than the United States. Consumer spending is likely to fall sooner, with accompanying increases in unemployment. Perhaps this will lead to lower domestic inflationary pressure.

What then?

The likely reaction will be to lower interest rates.

One risk is that if these small nations start lowering their interest rates, their currency values will decline as traders seek to hold more USD relative to lower interest rate currencies, leading to more inflationary pressure on imported goods and things like petrol, which are very visible to consumers.

An alternative is to use more fiscal policy—perhaps build some public housing. But fiscal policy can be slow. Cash grants are a faster alternative to relax the budget constraint of households.

Whatever we do, these differences in how each country’s economy reacts to the same policy settings matter in understanding economic trends. They also matter when thinking about how to manage macroeconomic cycles as a small nation in a globally connected economy where one of the major economies has an asymmetric transmission of monetary policy relative to its peers.

NOTE: This article explains important differences in how inflation is measured in Australia versus the United States which is also still relevant.

ICYMI: Thanks to paid subscribers I can do things like speak to the students in the Economics Olympiad about careers in economics and housing markets. Watch that conversation below.

This is a different FET episode. It was recorded in December 2023 in Wellington with Bernard Hickey for his podcast at The Kaka. Tim Helm and I talk about important and often neglected economic details in the housing supply and price debates.

However, in the four months since, Hickey couldn’t find the time to post this conversation, despite the housing topic being a major media story and finding time to interview and upload conversations with many others on this topic. 

For some backstory on the heated Wellington zoning debate, please read this FET article.

Follow Cameron and Jonathan on X/Twitter. Buy The Great Housing Hijack here.

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What is The Great Housing Hijack? Who’s housing crisis is it anyway?

And why do we need to understand the economic concept of equilibrium to know whether our housing policy will work?

Jonathan and Cameron chat about the new book and the big ideas within it. Get The Great Housing Hijack on Amazon here.

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Thank you to paid FET supporters. Your support allows me to do things like:

* Appear as an expert witness at the Senate Inquiry into Shared Equity (was 5th March)

* Appear at the Senate Inquiry into Retirement (on Tuesday 12th March).

* Conduct a seminar on housing economics for NSW regulator IPART (also 12th March)

The season for change in higher learning is now.

Not only have I started Fresh Economic Thinking as an independent place to do science—conduct research, teach, and engage in public debate—I am also involved as a mentor and teacher at Academia Libera Mentis.

Academia Libera Mentis (ALM) is a new college based in a castle outside of Theux, Belgium, run by a team of academics to create an “academic oasis” for research and teaching and to challenge great minds.

The image above is the new campus. It makes me think of the X-men, where gifted students got together in a castle for intensive training in their craft but also to build life skills.

Here’s the pitch.

Where once you were challenged intellectually and became responsible adults, university students find themselves in large impersonal bureaucratic systems that treat you as fragile and in need of protection from wrongthink. You are taught compliance and dogma, leaving you unprepared for the demands of work and adulthood. We – a group of outspoken academics, thinkers, and citizens – have seen our universities abandon you.

Why waste your life in such soulless places? Come join our oasis in a beautiful castle in the Ardennes. Live on a campus with freedom of speech. Discover yourself and the world, and escape from constant fear and online distractions. An open community where art, aesthetics, movement, and genuine interactions are as important as academic content.

Is this for you? It is not a place for passive consumers: it is where you will expand your thinking, become a more responsible adult, set up creative activities for others to join, design solutions to economic and social problems, and prepare for future jobs and studies. Graduates and academics will have made friends, acquired valuable critical and job-relevant skills, and developed improvements to major sectors of our society.

Currently, the subject areas are economics, political economy, and health and well-being. If you are thinking of pursuing further education in these areas, consider this option.

To begin over the next couple of years, the basic course structures are one-year live-in programs that start with 6-months of core curriculum then specialisation and research.

* The Gap-Year Program is for high-school leavers and undergraduates looking for a challenge to expand their horizons and get exposure to new disciplines.

* The Finishing Year Program is for recent graduates and professionals looking to spend time in deep learning about a topic, perhaps one outside their technical expertise.

* The Avant-Garde Program is for young leaders looking to make a difference in the world.

There are two actions to take if this sparks your interest.

First, go here to the website to get the vibe of the place. It is very early days. Pricing is yet to be confirmed. At the moment, Nova Academia is for risk-takers and leaders. It is an experiment in learning.

Second, attend the online information session on 16th March 2024 (which is unfortunately around midnight in Australia).

As I noted, I am part of the mentorship group that students will have access to and will be teaching in early 2025 in some form about the economics of corruption and property markets.

More details about the vision for this new education project are in the below document.

Read more below from Paul Frijters about the problems he sees in modern universities that have left open a market niche for places like Academia Libera Mentis.

Problems With the Modern University

Professor Paul Frijters

We observe three interconnected problems with modern academia. Each problem hampers universities’ ability to deliver on their mission to curate free and critical thought, produce new knowledge, and graduate students prepared to serve the needs of their communities.

1. Bureaucratic bloat

Universities today are administratively bloated, a phenomenon also noted by many others (e.g., Raewyn Connell) that self-perpetuates via national and international bureaucracies. Bureaucracy naturally expands and expands, costing the time of academics and students. US universities in 2010 were found to function perfectly well with an administration-to-faculty personnel ratio of just 1 to 3, but the typical ratio observed that year was at least 5 to 3, and getting worse. Yale recently reported that it has as many administrators as it has students. This bloat represents easily 50 percent of all expenses in a university and perhaps more than that in terms of lost productivity, if one includes both additional expenses and the production prevented by over-regulation.

An example of how this bureaucracy is self-perpetuating is seen in the process of accreditation. Accreditation agencies, whether private or public, largely measure the presence of administrative staff, policies, and requirements (processes, procedures, KPIs, progress reports, databases, ethics committees, and so on). In turn, accreditation is used as a prerequisite for student access to state loans, for purposes of fulfilling job requirements, or for academics to be able to apply for research grants from state agencies. Receipt of research income is then used in marketing to students and to pursue higher levels of accreditation. In this way, the university bureaucracy is both mandated and protected by the associated national and international institutions around accreditation, research grants, state job applications, and state loans. Only institutions with large endowments – either private endowments, as in the States, or state subsidies in the form of free public land or other state-provided resources – are able to keep up and become known as high-status universities in this bureaucratic race.

Administrative bloat has many other consequences, amongst which is that many university functions now follow bureaucratic rather than academic logic, ignoring the purely academic benefits to activities and focusing instead on finding and privileging reasons for the bureaucracy’s own existence. This leads to a perennial search for problems that can be exaggerated and turned into a justification for more administration (e.g., ‘Is there a problem I can pretend to solve by creating an additional compliance problem?’).

A clear example of this is seen in human subjects ethics policies, which today involve many committees and result in the strange reality that social science academics, whose job it is to do research about humanity, are bound by rules that in no way bind millions of businesses and government departments that treat people far worse than they are treated in most research involving human subjects. The bureaucracy has created a kind of administrative ritual, justified by the need to be careful when doing research with human subjects, that demands yet more administration, goes far further than the law of the land, and naturally crowds out individual responsibility.

2. Universities as businesses

The modern university has become a business run for the personal glory and profit of its management, rather than an institution serving a public-good function that reflects the desire for knowledge in a whole community. Universities are now large property owners, suppliers of visas, organisers of consultancy services and places where business and management careers are made, all of which feed a commercial but not necessarily a community mission. Universities today play a real ‘game of mates’ (Murray and Frijters, 2022).

This new orientation has many consequences. One is an inability to effectively caretake the physical and mental health of students, because the question of ‘what good could we do’ is neither the starting point nor any longer built into the self-image of the university. A second is the loss of a positive community story, leaving a vacuum that is now filled with self-hatred and divisive doomsday stories. A third is that relevant research has been replaced by performative research. Fourth, truth is no longer treated seriously, having been replaced by feel-good promises. Fifth, public lectures have reduced in importance and publishing is increasingly seen as a pure status game, leading to territorial issues. Worst of all perhaps is the demise of the university as a place where people try to solve community problems. 

3. Mediocrity and cowardice

Second-rate and disconnected teaching, based on what students with limited understanding enjoy hearing, is coupled in today’s universities with disconnected theories that are largely for sale (e.g., content for schools of medicine influenced by Big Pharma, theories on taxation and private property pushed by billionaire think tanks, and old textbooks rehashing tired theories that dominate the market and from which disciplines cannot escape). With mass teaching have come low-quality students, dragging standards down, but also the reality that university activities become relevant to institutions (including the state) wishing to manipulate whole populations – reducing universities’ independence.

Immersive teaching and travel are seen today merely as risks, rather than core activities, by university managers who do not weigh the risks versus benefits of university activities with respect to fulfilling a community service role.

The result of these trends, coupled with broader social trends over the past generation, are alarming. Cognitive outcomes and several indicators of university success in the West are now visibly suffering relative to a mere 20 years ago. Not only do our children have lower IQs and a reduced capacity to think abstractly, but the mobility of young people is lower. On top of this, the returns to college graduation vary widely by degree, and facing large numbers of negative-return degrees, over 50 per cent of Americans think degrees are not worth the cost.

These problems feed into each other and mutually reinforce a bad equilibrium for the system as a whole. The incentives are strong for university staff who are low-quality and demotivated to find ways of avoiding higher-quality demands or demands to reduce bureaucracy (which would lead to layoffs). A peer-review system that has metastasized into a mechanism for punishing real innovation and reward for super-specialists by established territorial groups spawns textbooks and academic societies reflecting those territories, creating more barriers to real renewal. The increased importance of research status signaling makes all of this worse, as ‘winning’ on the terms of the existing system becomes more important, punishing innovation and broad thinking even more.

Joy and spiritual meaning have been replaced in today’s universities by dull, low-quality mass teaching and mass research. Strong lock-in effects make escape for existing universities nigh impossible. As early as 2012, we observed that an Australian university wanting to do something about quality or bureaucracy would upset the unions, the existing students, the local politicians, and even the alumni (who would suddenly hear from their own university that the degree they thought was great was in fact not great). New entrants would face extreme pressures to copy the basic failed model, both due to demands for bureaucracy by accreditors and students, and due to the need to look good on signalling measures (rankings, research income, etc.). A pessimist might think the only way to change is for the whole system to eventually lose legitimacy and then implode as the demand for education finds substitutes abroad and in external institutions, like homeschooling.

With great upheavals, making a portion of the population lose faith in the state and in the many institutions associated with power and money, come new opportunities. The signs that we may be at such a juncture now are seen in the increasing percentage of people who have lost faith in the news and in local politicians (shown in surveys like this one), the prevalence of beliefs that standards have fallen, and the rising percentage of people opting out by homeschooling or paying for private education rather than trusting the state.

Don’t forget to pick up a copy of The Great Housing Hijack. Upcoming in-person events:

* Brisbane: 13th March 2024, 6pm at Avid Reader, West End

* Melbourne: 20th March, 12.20pm, John Cain Luncheon with Per Capita

* Melbourne: 20th March, 3.30pm at RMIT

* Canberra: 21st of March, 6.30pm hosted by The Australia Institute

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Universal welfare services are a good thing.

I like that we get to drive on public roads, kick a footy at the park, use a public library, and send our children to school, without having to jump through eligibility hoops to make sure our income is low enough to qualify.

After all, higher-income households can afford books, backyards, toll roads, and tuition, so it seems silly to just let these households use these services for free. Right?

One thing that is widely thought to be very bad is middle-class welfare.

But when middle-class welfare comes in a non-cash form we all love it, whether that form is schools, roads, hospitals, and other services. But cash? Nope. That’s a problem.

So our cash welfare system has evolved into a maze of hoop-jumping and arbitrary phase-outs of a huge range of different specific welfare programs to accommodate political whims.

Take a look at this guide and see if you understand the system.

And the closer we can inch towards universal cash welfare, which relies on the tax system to recover revenue rather than restrictive qualifying criteria and income-based phase-outs, the better that system will be for rewarding work and productive endeavours while saving billions in administrative costs.

Some cash welfare payments are already like this. And people love them.

Universality works

In New Zealand, the age pension (called NZ Super) is a universal basic income (UBI) for old people. It has no income or assets test for eligibility. Instead, age pensioners simply pay tax on their income if they work and earn above this UBI amount.

Australia’s age pension, in contrast, has an income and asset test that hits about 800,000 out of 2.6 million age pensioners and phases out the pension payment at 50c for every dollar earned. This is equivalent to an extra 50% tax rate on earnings, above and beyond any other income taxes. So if pensioners work they will lose 69c to 82.5c from every dollar earned!

Because people in New Zealand over 65 aren’t punished as much financially for working, more older people work in New Zealand (25%) than in Australia (15%). Sure, there is higher churn—meaning the same people both receive welfare and pay taxes—but churn is not a real economic concern or cost.

Churn is a made-up, and very Australian, marketing phrase used for political convenience. Churn is costless because it simply requires two instant and free electronic payments, but administrating systems to avoid it cost billions in manpower, resources, and much more in bad work incentives.

Because of its great work incentives and efficiency, New Zealand’s over-65s UBI has even attracted the interest of the Institute of Public Affairs (IPA), which published a report about it and not only recommended copying this for pensioners, but for students as well. An ode to generous and broad welfare if ever I’ve seen one.

The relevant economic concept we should be discussing when it comes to welfare design is the Effective Marginal Tax Rate (EMTR). It is an income earner’s marginal tax rate plus the marginal rate at which you lose other income or benefits. So for age pensioners, their EMTR is 69-82.5%. Is it worth working and only keeping 17-30c out of every dollar? Not really.

And that’s the problem with our aversion to middle-class welfare. In reality, it punishes work rather than incentivising it. And unfortunately, those high EMTRs hit a huge range of Australian households.

Consider the chart below (thanks to Dave Plunkett for the analysis here). It shows the situation of a single-income family that rents their home with two children and a HECS student loan debt.

The blue line shows their take-home disposable income, after the combined effect of welfare and taxes, given the private income earned which is along the x-axis.

So if the income earner in the household makes zero income, then the family gets about $55,000 in total welfare and hence that is their disposable income. If they earn $50,000 from a job, then they get about $73,000. So out of the $50,000 they earned, they only increased their income by $18,000, so the EMTR in this range is 66%—every dollar they earned only increased their disposable income by 34c.

But it gets worse! Much worse.

If they go and get a new job earning $150,000, which is an extra $100,000 of private income, they lose all their various family-related welfare payments, must repay HECS debts as well as pay tax, so their disposable income only rises by $18,400 to about $92,000.

They make $100,000 of extra income, but only increase their net take-home disposable income by $18,000. Across that whole income range, which is what most Australian households earn, there is an EMTR of 82%. They only keep 18c out of every extra dollar they earn.

The huge difference between the marginal income tax and the total EMTR is shown below. For most Australian families with incomes less than $150,000 per year, their EMTR is way above the income tax rate. If we care about work incentives, we must consider the tax and welfare systems together.

For me, these punishingly high EMTRs, especially for family households and age pensioner households, are a huge economic cost we could avoid by redesigning welfare to be more like a UBI.

Is UBI equivalent, or better?

It is worth noting that you can design a welfare and tax system that gets the same net outcome by either means-testing or by letting the income tax system do its thing.

I’m going to borrow a nice clean example from the Tax Foundation to show that a UBI and a means-tested welfare program can be equivalent.

Here’s the case of the means-tested program. You get a $12,000 base rate of payment, but once you start earning income, you lose 20c of the payment per dollar of income. That’s the phase-out.

So if you earn $30,000 of private income, you lose $6,000 of the payment to have a net income of $36,000.

By the time you earn $60,000, you get no welfare payment.

But then, after $60,000, you pay a 20% marginal tax rate, then you get $84,000 of net income if earn $90,000.

Because means-testing involves reporting income changes, checking in with welfare administrators, and dealing with over- and under-payment as circumstances change, you can make the same payment with no phase-out. Just give everyone $12,000. And instead, you can use the tax system to take back 20c for every dollar earned.

This situation is summarised in the below table.

Notice anything? The net income is the same for every amount of private income earned. The difference is in administration.

It is this equivalence that makes sense of calls for more universal welfare payment. Targeted welfare is just a more difficult administrative way to get the same outcome as universal welfare and a simple income tax system.

An indicative proposal

Most welfare payments fall into these categories

* Old age

* Unemployed

* Families

* Disabled

Within each category, Australia has multiple distinct welfare programs, with rent assistance sprinkled through as well.

A UBI could fix the bad work incentives with the age pension by copying New Zealand’s approach. I don’t see why that can’t also be extended to all working-age individuals as well, which covers off the unemployed category as well.

Families could get a smaller child-size UBI for each child and a high-needs UBI for disabled family members.

That’s it. All the categories are covered.

To recover more tax revenue to maintain a reasonable tax balance, the first marginal tax rate could start at something like 35c in the dollar from the first dollar earned for all individuals, then perhaps a higher 40c marginal rate at higher income levels.

Then let the system fly!

Of course, you don’t need to fully recover to cost of payments via income taxes alone, as other tax bases can be adjusted during a transition period towards universal welfare.

What do we get from this?

We would save billions in the administrative cost of the welfare system, which currently costs about $7 billion. These costs could easily be reduced by $4 to $5 billion per year. We would also have much more sensible labour force incentives across all household types, which could have enormous efficiency and output effects.

Concerns

The beauty of universal welfare is that it lets the tax system do the work rather than obsessing over non-issues of churn and middle-class welfare.

But surely it’s not that easy.

Unfortunately, it is that easy. The barriers are all political. We just don’t want simple, fair and universal welfare.

Consider the case of Poland. In 2016 it introduced its Family 500+ child payment scheme of 500 PLN per month (about USD $125, or 18% of Poland’s minimum full-time wage) for each child after your first, and for all children in low-income households. It was intended to stimulate fertility and was expanded to include all children in 2019.

It has been a huge success in terms of keeping children out of poverty and helping families, and it has buy-in now across the political spectrum. It is politically untouchable, despite failing to get its desired effect of boosting fertility.

A Polish-style child payment and a New Zealand-style age pension get you most of the way to a UBI. If their experiences are anything to go by, people will love it and it will be hard to reverse.

One concern is that some people will want a UBI cash welfare system to replace non-cash welfare like education, health and other public services. But these services will always have a place and I think a mix of public and private provision makes sense in many situations.

But I don’t see that happening in New Zealand or Poland to any serious degree.

I can already hear cries from the political left that “If the right-wing IPA likes it, there must be a catch!”

The issue for the “progressive” side of politics in Poland was that a child-UBI achieved directly much of the income security and workforce flexibility for families they were trying to achieve indirectly (as noted here).

For progressives and other PiS opponents, these programs’ popularity leave them with little room to maneuver, except to call for more investment in public institutions such as child care, schools, and hospitals. Barbara Nowacka, a politician who ran the campaign on social policy for a left-wing coalition in 2015, told me its message, which included promises to invest in kindergartens and encourage employers to offer women better job protection and flexible work, was admittedly “boring” in comparison. She would prefer to see the program’s budget—estimated by the labor ministry at 31 billion złoty in 2019 and 41 billion złoty in 2020—directed toward services such as warm meals in schools and school-based medical services, such as nurses and dentists. “But we know that this 500+ satisfies people,” she said. “Everyone believes that it is better to have money than trust the state.”

I think this quote also shows the weird debate. On the one hand, we don’t trust the state so want the cash. On the other, the cash relies directly on the state.

A UBI for children could replace income-tested child-care subsidies which only further add to punishing working parents. With cash, you can pay child-care, pay grandparents or friends, or even look after your own children.

One feminist professor noted the following about the success of Poland’s child UBI.

… Family 500+ recognizes the economic value of caregiving, an acknowledgment that, ironically, could give women more power within their households, even as it may discourage them from joining the formal labor market.

At the same time, it keeps conservatives happy because it

… reinforces traditional values that still resonate widely among the country’s conservative voters.

Another concern with universal welfare is that people live in units called families, or households, that pool resources. If each individual gets a UBI, this advantages larger households over smaller ones.

For example, if you have six children, all eight of you will get a UBI either at a child or adult rate, and you will have huge economies of scale advantages over eight single-person households getting the same adult rate UBI.

This is of course an issue for the welfare system to some degree, but so what? Should our tax and welfare system not incentivise people to live in economically sensible-sized households?

A final political concern could stem from the fact that Poland’s child UBI reduced the workforce participation of mothers. Some people might see this as a bad outcome. But of course, this can only be due to the choice better reflecting the desire of mothers. After all, they are punished less for working with a child benefit that doesn’t phase out when they earn money. This is consistent with findings that the program didn’t increase fertility but massively reduced poverty in family households.

As a final comment, fixing welfare with universal cash programs works for everyone, so traditional political dividing lines don’t make much sense anymore.

I’m wary that since the IPA supports an old-age UBI like New Zealand’s age pension, Australia’s progressives will find reasons to oppose it. One reason they could latch onto is the fact that because family households typically are in the upper half of the income distribution (because of dual incomes, working age, etc) UBI might be on balance an upward wealth distribution over certain income ranges when measuring by household rather than by individual.

But that’s politics I guess.

Once that political leap is made, universal systems like this become entrenched. They don’t become costs. They become investments, birth rights, and hard to unwind. They also make us forget our foolish obsession with churn.

It is the targeted and means-tested welfare programs that face the most political risk, yet they also come with the biggest economic costs because of administrative burdens and ridiculously high EMTRs.