Choosing the Good Wood

We have a special guest post this week from John Alexander Gomez.  John is a student of environmental economics at the University of the Andes in Bogota,  Colombia.  John's post is about government policies designed  to reduce the level of illegal logging in Columbia.  These kinds of policies could be very useful for countries who import timber from countries where illegal logging is a problem, and will undoubtedly be useful in global efforts to reduce carbon dioxide emissions from deforestation.

"Currently, the World Bank affirms that 42% of the total timber production in Colombia comes from illegal logging (Ministerio de Ambiente, Vivienda y Desarrollo Territorial, 2011).   In Colombia, illegal wood is timber which is extracted, transported, processed, purchased or sold in ways that are contrary to the law. Illegal logging is associated with two interrelated problems.  First, illegal logging places pressure on forest ecosystems.  Second, it jeopardizes the survival of many endangered species.

The Colombian government has been working to control this phenomenon but there are several limitations. It recognizes that regulatory mechanisms are used poorly because of operational weaknesses, insufficient infrastructure and resources, and low local population participation. Additionally, because illegal forestry can be performed at low cost and with low investment, it can be performed either on big scales or just for satisfying basic needs, which makes it an activity that is difficult to detect.   

The fight against illegal timber is a priority for the current government. It is one of the stated goals in the National Development Plan 2010-2014, which provides the guidelines for national government policy. Up until now there have been no effective results on the topic.  The most relevant achievement to date has been a non-binding intersectoral agreement that has helped to highlight the problem of illegal logging on the national agenda.

Because the effects of illegal logging represent a welfare loss for society, different economic agents could be willing to compensate those timber producers who have responsible production methods. Whether they are the final consumer or just an intermediate producer, they could gain some type of reward for assuring their resources come from a legal activity. However, all producers have incentives to present themselves as legal producers, even if they are not. If the producer does not have an accurate way of signaling themselves as legal producers, those who derive utility from knowing their timber comes from a legal source have less incentive to reward legal producers.  In the end, the lack of information is punishing responsible producers who follow the law and because of that incur additional expenses.

If the government can provide the needed information to the market, the consumers could identify with more certainty which product comes from legal sources. Certifying responsible products could do this. That means that the government should assure that the certified products come from legal methods of extraction and management. It should assure also that intermediate producers should not lie to their customers about the legitimacy of the timber. Timber producers and suppliers would have three incentives to participate in a certification program. First, legal timber can fetch a price premium, so there is a market based incentive. Second, there may be a first mover advantage. The producers who achieve certification earliest will be able to capture a larger share of the early benefits and may therefore generate a comparative advantage in producing and selling certified timber. Finally, producers could be interested in protecting themselves against potential strengthening of the already existing government regulation, which could imply more onerous fines or greater probability of capturing banned activities of those producers or retailers who still use illegal timber. The certification procedure could help lead to an easier transition to a wholly legal and sustainable market for timber.

For this policy to be successful it needs industry support.  Because illegal wood implies activities against the law at different points of the supply chain, it is important to have support of the different agents involved in it.  Continued illegal logging could reduce the credibility of the certification scheme, so certified participants have an incentive to punish those who defect.  The government also needs to gain the trust of the relevant agents in the market.  The credibility of the information, as well as government’s capacity to disseminate that information is an essential feature for getting firms to participate. Even so, the government´s credibility could be doubtful.  It is still the institution with the greatest power of coercion in the country. The government might need to seek support from other entities to strengthen its credibility. Traditionally private-public or international alliances have been useful to gain credibility.  Institutions like the Forest Stewardship Council (FSC) already have experience in the timber certification process. Finally, the government should try to keep the program as cheap and simple as possible so really efficient results could be achieved. 

A successful policy would also use existing programs and experiences to complement certification policy programs. For example for guaranteeing the supply of legal timber this policy should work with the government’s commercial reforestation policy. This project has been an effort to provide incentives to producers of forest services and products to cultivate their own “forests”. Because of Colombia’s geographical characteristics, we have a comparative advantage in commercial reforestation, although it has not been used because it was cheaper to use natural forests (Ministerio de Agricultura y Desarrollo Rural, 2011). Commercial reforestation could be used to facilitate legal supply and provide an alternative to those who need to transition from illegal to legal activities. The government has already gained recognition with the non-binding agreement mentioned above. With it, government has already constructed a relationship with different agents at different points of the supply chain, and has obtained their commitment to achieve legality of the timber industry. 

References

Ministerio de Agricultura y Desarrollo Rural. (2011). Plan de Acción para la Reforestación Comercial .

Ministerio de Ambiente, Vivienda y Desarrollo Territorial. (2011). Pacto Intersectorial por la Madera Legal en Colombia. Ministerio de Ambiente, Vivienda y Desarrollo Territorial."

"My house my castle"

By Fraser McKay, Intern, Motu Economic and Public Policy Research

“My house my castle.” This is a phrase uttered by countless New Zealanders from all walks of life, across different ethnicities, both genders and over a wide range of ages. Put simply, we like buying, selling and developing real estate. Talking about house prices, rental yields and leverage can sustain conversations well into the evenings at summer barbeques. There exists the persistent herd mentality that house prices will continue to rise – such beliefs can have disastrous economic consequences, as evidenced by the Great Depression. The fair value of an asset is the cumulative value of its expected future cash flows, which may be derived from future re-sale or from leasing, discounted back to today’s dollars at a rate of interest at which the capital tied up in the asset could be employed in an alternative use, for example by investing in government securities. Assets cannot sustainably maintain deviations from their fair values, though as Keynes famously noted, “The market can stay irrational longer than you can stay solvent.” Devout believers of laissez-faire would argue that there is nothing inherently harmful about housing bubbles and subsequent price corrections, on the basis that the market is merely reacting to the mutual forces of supply and demand. Few, if any, economists these days are completely anarchist: even Friedman acknowledges the role of government in upholding property rights and basic functioning of law and justice.

For most Western economies such as in New Zealand, it has been deemed appropriate to separate fiscal objectives from monetary and macro-prudential objectives, where the latter is the responsibility of the central bank. In particular, the Reserve Bank of New Zealand (RBNZ) is concerned with maintaining a healthy average level of inflation on the order of 1%-3% p.a., as measured by the Consumers Price Index (CPI). The CPI band does not take into account house price inflation, which for new home-buyers is very much a part of the cost of living. The RBNZ argues that house price inflation is largely attributable to two factors: housing shortages and easy credit, where loan-to-value ratios (LVRs) above 80% account for 30% of new lending. Of late, the monetary authorities have become concerned that this level may be threatened by upward pressure due to beliefs that Auckland housing is significantly overvalued, and due to the risk that house construction in Christchurch could otherwise be financed through high LVR loans. As such, they introduced a policy restricting LVRs greater than 80% on residential property to make up no more than 10% of the portfolio of each and every bank in the country.

The policy has been met with quite strong opposition, mostly from prospective first-home buyers and from the construction industry. While the former group is listed by the RBNZ as one of the reasons why the policy was introduced in the first place, it is the latter that is of more concern. Public opinion suggests dampening rising demand has come at the price of slowing supply. Research from consulting company, Branz, showed 5000 new houses could be jeopardised by applying LVRs to new house construction. RBNZ deputy governor Grant Spencer made a statement earlier this month claiming that while high LVR construction lending is only around 1% of total residential lending, it finances around 12% of residential building activity, which means that low deposit lending will fall outside the 10% speed limit if it is financing new construction. This fact contributed to the RBNZ’s decision to introduce an exemption clause allowing higher LVRs for new housing construction to generate new supply to ease inflationary pressure in the housing market. 

The exemption clause may enable continued development in Christchurch relative to the no-exemption situation. One may have similar expectations for the overheated Auckland housing market. Further, by relaxing the constraints on construction supply, the clause may help support and even boost employment in the construction industry as New Zealand construction workers may now have reduced incentives to migrate overseas in search of more attractive and abundant opportunities; likewise, foreign construction workers may be encouraged to migrate here.

One issue with the initial policy is that it has led to some banks charging higher interest rates on low-deposit loans, effectively imposing price discrimination on would-be first home buyers. This issue, in conjunction with the exemption clause, lends weight to the argument that these prospective home-owners would have increased incentives to obtain finance to construct new residential property, as opposed to saving for the required deposit on a mortgage under the new LVR restriction. 

The RBNZ cannot fix each and every problem within an economy. For political objectives, such as access to housing for those unable to afford it, to be achieved as well, government must take a long-term view and construct and implement appropriate fiscal policies that do not conflict with those of the central bank. What the RBNZ did not take into account in forming its initial LVR policy is the significant effect that wealthy investors, both domestic and foreign, are exerting on house prices – this responsibility may lie more in the hands of central government.