Wednesday, July 12, 2017

The IMF Forty Years Interview Part III: Progress and Challenges in Developing Country Housing Markets

4.      You have done a lot of work on housing markets in developing economies. In your view, what are some of the key signs of progress and challenges that remain in these economies?

Perhaps the greatest global progress comes from the simple fact that so many extremely poor families have seen their incomes rise (see for example recent research by Branko Milanovic) and their housing improve as a consequence (Angel and Mayo).

After that, housing economists and others can start by being Hippocratic: first, do no harm. We’ve learned that importing the design of institutions wholesale from developed countries may do more harm than good.  Financial institutions, systems for public housing, regulations like building codes and land use regulations In many countries, and the like, all need to be designed in line with local conditions, based on evidence of their effectiveness.

For example, in many countries, such evidence shows that the public housing model is self-limiting at best, can cause serious budgetary problems, and can lead to social strains as well (Buckley and Kalarickal).  In some countries, programs of low-cost land development – so-called “sites and services” – can make a contribution, but details such as design standards and cost recovery matter greatly (Mayo and Gross). Upgrading in place including basic infrastructure and no layout rationalizing the layout of streets can be high return relatively low risk activities.

We have learned a lot about housing subsidies for low income households, and many countries have put these lessons in practice. Both research and practical experience point away from bricks and mortar subsidies – i.e. subsidies directed towards housing units – and towards housing allowances, i.e. subsidies directed toward households. See Hills et al. for details of these advantages.

Just because more stringent land use and development regulations are associated with higher housing costs does not indicate that real estate markets should be completely deregulated. Appropriate planning and regulations can solve important coordination and information problems, and reduce negative spillovers or externalities. Concrete examples might include tackling traffic congestion and other tragedies of the commons, public health improvements from improved waters and supply and sanitation and so on. The test is whether regulation provides benefits in line with, or exceeding, the cost of that intervention.

One particular challenge that many countries face is what is now often called the problem of the “omitted middle.”  A good example can be found in Hannah et al.’s (1989) study of Malaysia’s housing market.  The genesis of the study was that the planning ministry and others were concerned that Malaysia developers were focusing on the high end of the market and neglecting the middle market, despite a number of government initiatives to try to help them lower costs and move down market.

It is worth noting that researchers have raised “missing middle” concerns in other economic contexts.  Pinto (2016) raises a similar issue in U.S. housing markets, for example.  Others have studied “missing middle” markets in more general industrial organization, such as Klapper, Leaven and Raja; Beck; Bannerjee and Duflo are examples of such studies.  Harvard’s Kennedy School has an instructive summary of this research, from which we borrowed the figure above.  The charts show a stylized and smoothed histogram of the the number of firms by size ("micro," "small and medium enterprises," and "large.")  In rich countries (left panel) there are a lot of larger "micros" and smaller SMEs; in poor countries, there are a lot of really small micros but they have difficulty growing in size, e.g. due to lack of finance, regulatory barriers, and the like.  Ayyagari, Beck and Demiguc-Kunt provide a database which can be used to study the size distribution across countries

The generic problem we find in housing in many markets is a formal development industry building houses for the top of the market, and what’s loosely referred to as an informal sector developing technically illegal housing at large scale for the bottom of the market. When we find this problem, it’s a puzzle.  After all, we’d expect part of the formal development sector to move to the middle of the market, which is after all where the bulk of the business and potential profits are to be found.

Our analysis of this problem in Malaysia’s emerging market showed that it had little to do with labor costs or construction materials or even land prices per se, and much more to do with development regulations that had unintended consequences, that artificially tilt profitability away from the middle of the market.  Some specific problems were easily spotted, such as an approvals process that required on the order of seven years to navigate for a plain-vanilla residential development, according to Malaysian developers’ own analyses.  Other problems were a little more subtle, such as minimum lot sizes and required back alleys almost doubled the required land for representative units in a number of urban locations.

This problem of the omitted middle is very common, and not only in developing countries. I read with great interest the recent posting on The Unassuming Economist about the work of the Center for Affordable Housing Finance in Africa.  That interview provided a lot of data and discussion of exactly this problem. Even ignoring extreme cases like that of Angola, Kecia Rust and colleagues have shown that in a wide range of African countries the minimum cost house built by a formal developer often ranges between $20,000 and $60,000, which in the context of local household incomes puts them well out of reach of much of the market.

Since that work on the omitted middle, Malaysia undertook a number of significant reforms to the planning process, e.g. “fast tracking” and/or “one-stop shopping” for certain development approvals (Sufian and Mohamad; World Bank 2017). We don’t take any particular credit for those improvements, since the real impetus for reforms were underway for some time from a number of government and private sector actors. As an aside, that makes an important point about the role of any external “experts,” whether from the World Bank, or IMF, or universities.

A number of challenges stem from the heterogeneity of countries and their housing policy requirements.  Life (including housing and related services) for a typical resident of, say, China is very different than for their Laotian counterpart; Angola is very different from South Africa. Ditto for their housing policies.

With 200 countries to deal with, we’ve all found it convenient to use broad categorizations like "developing countries" or "emerging markets" or "Africa;" sometimes when we shouldn’t. Especially when thinking about policy prescriptions.  Over-categorization encourages lazy “one size fits all” policy prescriptions. (And of course it's often an over-generalization to talk about a "country," which itself is usually pretty heterogeneous).

In extreme cases, over-categorization can lead those hoping to provide useful policy advice into proselytizing for particular country-specific models. For example, anyone who's worked in the field very long has encountered housing finance consultants who have a particular institutional model they want to push as a universal solution. The Fannie-Freddie models. Or the Bausparkassen model.  Or provident funds for housing. Or credit unions.  Or building societies.

Plenty of examples can be found from other areas.  How many former British colonies have suffered from the imposition of land use codes based on the Town and Country Planning Act of 1947?  (Arimah and Adeagbo)

A better way is to start by asking: what functions does Fannie Mae, or the Bausparkassen system, perform (on a good day)?  Enhance capital mobilization? Solve geographic mismatch? Standardize mortgage contracts?  Upgrade underwriting?  Mitigate some asymmetric information problem?  Which, if any, of these functions are important here?  What does the Town and Country Planning Act, or American zoning, try to address?  Efficient infrastructure development and utilization?  Lower congestion?  Reduced runoff? Which, if any, of these functions are important here?
Next, consider the pros and cons of existing institutional approaches, in this country and abroad.  Are there any unintended consequences lying in wait?  For example, large secondary market institutions may solve some problems of geographic mismatch in large countries, but the U.S. “government sponsored enterprise” model has demonstrated how a mixed public-private model can exhibit unintended perverse incentives, with privatized benefits and socialized costs. Rather than transplant an institution wholesale, ask the following questions: what are the functions of the sample institution; and how can we best perform those required functions in this country, while minimizing weaknesses and unintended consequences?

Real reforms in land use and housing development come from within a country, not from the advice of external experts (Malpezzi 1994).  True, on a good day external advice can play a catalytic role, for example serving as a clearinghouse for information including bringing data and experience from other countries.  But fundamental reforms never come primarily from ODA loan agreements, or the pontifications of professors like myself. The Malaysia experience was an example of how outside research might play a small catalytic role, but only because conditions were ripe for certain reforms.

In a separate post, I'll lay out some of the details of the Malaysia analysis, so readers can dig into this subject in more detail.


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Doing Business: Dealing with Construction Permits.