Competition restrictions in housing production

Economic Modelling 1994 11 (2) 125 133

Competition restrictions in housing production A model for analysis Christer Bengs and Kimmo Ronka

In this paper we present models for the analysis of restrictions on competition in housing production in Finland and discuss the main restrictions on competition . A model of the housing market, broken down into submarkets, is presented . Keywords . Housing markets; Competition in housing markets

In this paper we present models for the analysis of competition restrictions in housing production and discuss the main restrictions on competition in Finland . First, we present a general model for how various restrictions on competition affect modes of competition . which in their turn have specific influences on the final commodity. The specific features of the commodity called 'housing' are also considered . A model of the housing market, broken down into submarkets, is presented, as well as models of different ways of organizing production, given various relations between developers, builders and consumers . The promotion model and submarket model are crosstabulated in order to identify restrictions on competition. Depending on the number of promotion models and submarkets considered, the accuracy of the picture can be improved . The paper also includes a brief presentation of some main obstacles to competition in Finnish housing . Finally, we conclude by presenting some suggestions on how to improve competition . To study competition restraints in housing production implies certain difficulties . In the late 1950s social scientists started to attack the positivist tradition and to defend an understanding of social phenomena by methods different in principle from those of the natural sciences. Researchers were said to achieve understanding (of the 'meaning') of behavioural data by interpreting the data in terms of the concepts and The authors are with the Technical Research Centre of Finland, Laboratory of Urban Planning and Building Design, [tatuulenkuja 11, 02100 Espoo, Finland .

rules which determined the social reality of the agents they were studying . The description and explanation of social behaviour employed the same conceptual framework as the social agents themselves.' This anti-positivist urge still seems relevant, taking into account the perennial criticism of the Hempelian subsumption theory of explanation . However, it seems relevant to make a distinction between causal facts (causal and subjectively understood reasons (ratio) . But the demand for explanations which conform with the conceptual framework of the social agents themselves faces some problems . Social agents often seem to employ two kinds of rationales, one corresponding to facts of crucial importance in the conduct of successful missions, another tallying with social demands . The first might be called 'real reasons', the latter 'justifications' or 'legitimizations' . The distinction between real reasons and justifications seems to be habitual when investigating specific social events or the action of social agents in historical studies . But applied to social sciences, this does not seem to be the case . The interest of whole disciplines, eg a great part of economics, seems to focus either on causal facts or justifications of economic activity, producing legitimations for various events and matters, but overlooking the real motivations of agents . Economists usually claim the opposite . (We recognize that these statements need further elaboration and support.) Anthropology is (almost by definition) a discipline applying an externalized view - researchers being ' For a discussion concerning this topic, see eg Von Wright [14],

Final manuscript received September 1992 .

0264-9993/94/020125-09

1994 Butterworth-Heinemann Ltd

pp 1-33 .

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Competition restrictions in hot 1 sinq production : C. Beny .s and k' . Riinkc3

aliens - and internalized understanding simultaneously . Anthropologists may therefore have a lot to teach economists about methodology . Let us quote Marshall Sahlins, who states that each type of society has a privileged institutional locus of the symbolic . meaning producing process. He thinks that the peculiarity of Western culture is the institutionalization of the process in and as the production of g oods. by comparison with a premodern world where the locus of symbolic differentiation remains social relations . But, he adds, 'the basic symbolic character of the process goes on entirely behind the backs of the participants - and usually economists as well, insofar as the meaningful structure of demands is an exogenous "given" of their analyses' . 2 To Sahlins 'the meaningful structure of demands' ie the creation of use values, is subordinate to the accumulation of exchange values . The effect, the use value, should not be mistaken for the cause, the exchange value . Applied to housing ; and construction in general, this might mean the following . The commonly applied functional aspect based on presumed societal use values, totally dominating and exogenously given in most of housing research, should be supplemented by a production aspect . The producers of towns and dwellings, including financers, landowners, producers of building materials, developers, contractors and marketing institutions, are the actors that have the real resources at their command . The conscious decisions of these agents are by necessity based on 'real reasons', the optimization of economic outcome. For obvious reasons, the production aspect is not commonly discussed in housing studies . The regular donors of housing research are too closely related to the owners of real resources to fund anything likely to be subversive. The legitimacy of Western society is based on the accumulation of commodities, claimed to be in response to ever-growing demands and the welfare of the broad masses . There is an abundance of data concerning supply and demand of the housing markets, but hardly any information on how the production of dwellings is organized . The latter kind of data would illuminate the tactics and action patterns of forceful societal lobbies . Researchers, trying to uncover the system of housing provision, face problems both in terms of proper funding and lack of data . Despite the type of difficulties mentioned above, the authors of this paper had the opportunity to carry out a study dealing with the system of housing provision, namely restrictions of competition in housing production .' New data were available on the system of housing provision in the Helsinki region : land owner2

Sahlins ([13] . p213).

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ship and policy, the housing market, state financed housing, planning practices and the relations between developers and contractors . ° A substantial lack of data still prevails on housing finance . Models for analyses According to the Finnish competition law of 1988 concerning restrictions to competition, only tender cartels and agreed sales price specifications are explicitly forbidden . In fact there are a great many restrictions inherent in any market economy, such as : (i) horizontal integration : agreements between firms at the same stage of the production process with respect to the quantity or quality of (he commodity, prices, market shares etc ; (ii) vertical integration, when firms integrate along the processing line, either forward (towards the consumer), backward (towards the producers of raw materials), or in both directions ; (iii) firms obtaining a position where they can determine the price level, terms of distribution etc in a certain phase of the production chain or in a certain region ; (iv) non-competition commitments between firms : (v) supreme control of limited natural resources. usually in the form of land ownership ; and (vi) public regulations . A large variety of restrictions on competition give rise to different modes of competition or non-competition . Free or perfect competition is more or less an idealistic state of affairs . There should be a sufficient number of sellers and buyers. Each agent's decisions ought to concern solely the amount of goods exchanged at market prices . The commodity should be substitutable and exchange choices should be based purely on price . Sellers as well as purchasers should have complete information regarding supply . demand and prices in the market. The opposite of free competition is a monopoly, with only one seller of an unsubstitutable commodity, or a monopsony, with only one buyer . The normal case, however, is imperfect competition . Monopolistic competition implies a situation with a sufficient number of sellers and purchasers, but differentiated ' The

work was based on a commission by a state agency, the Office for Competition, see research reports Bengs and Ronka [5], and Ronka [It] . ' For an analysis concerning land ownership and planning in the Helsinki region, see Bengs et al [7] . For a study of the housing market, see Bengs [l, 2] . For an investigation of state-financed housing, see Manninen [9] . For a study of planning practices, see Rdnka [ 1 1] . For a documentation of the relation between promoters and contractors, see Bengs and Manninen [6] .

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1994

Competition restrictions in housing production : C . Bengs and K. Ronkk Final commodity

The restrictions on competition

Modes of competition

1 . Horizontal integration

1 . Free competition

1 . Price

2 . Vertical integration

2 . Oligopolistic or monopolistic competition

2 . Quality

3 . Determining market position 4 . Non-competition commitments

3 . Supply y

3 . Monopoly

5 . Control of limited natural resources 6 . Public control

Figure 1 . Competition restrictions in housing production : the analysis model .

commodities. Subsequently, the market is broken down into submarkets with only one seller in each . In an oligopolistic situation a limited number of sellers compete on the market, but are able to influence other sellers by their own actions . As the number of sellers decreases, reaction sensibility increases . Finally, the various modes of competition have different impacts on the prices, qualities and supply of the final commodities (see Figure 1) . A house is a very specific commodity, which distinguishes it from other commodities . It is fixed in location and therefore those in possession of building land or in the command of the allocation of building land are in an oligopolist situation . This also means that the future value (hope value) of real estate is partly outside the control of the landowner, owing to changes in its relative position. Fixity in location, in combination with the demand for heavy transport in construction, results in local markets for new dwellings . The production of building materials is heavily dependent on forestry, and especially on mining . An oligopolist control of natural resources is therefore inherent in production . This, in turn, is likely to increase vertical integration to the mutual interest of material producers and huge construction firms . A dwelling is expensive to produce and purchase, representing a major lifetime investment for the purchaser . Producers as well as purchasers are therefore dependent on factors other than self-funding . In addition to this, housing is a necessity, meaning that it produces effective `forced' saving, at least in societies with a high degree of owner occupation . Houses have a long lifetime . New production is marginal in comparison with the existing stock of houses. Therefore the regional price level of new production is determined by the price level of the existing stock, and small changes in effective demand can have a dramatic effect on prices . Houses are complicated to trade efficiently and, depending on the trade cycle, the related costs can be considerable . It ECONOMIC MODELLING April 1994

requires a lot of information to maximize utility or profit . All the specific characteristics of a house as a commodity imply restrictions on competition . In order to scrutinize these restrictions in further detail, the production chain has to be broken down into submarkets . In our model the production chain consists of four submarkets : (i) the land market (allocation of building land, plot distribution modes of development); (ii) the input market (building materials, machinery, labour force); (iii) the construction market (contractors and building firms) ; and (iv) the house market (distribution of dwellings) . All the submarkets can be studied with respect to horizontal and vertical integration . These forms of integration can be called one dimensional . But a more elaborate concept can be introduced ie the twodimensional integration of finance and promotion . The financing of the production process transcends all four submarkets and, in the end, the funding of the house purchase . The effect is simultaneously vertical as well as horizontal integration (see Figure 2). Closely related to the financing of the production process are characteristic modes of promotion . Various kinds of promotion integrate the submarkets in different ways and also determine the forms of finance . In order to differentiate the picture of competition restrictions further, characteristic modes of promotion were defined (see Figure 3) . A general distinction was made between speculative and non-speculative promotion . In this context, speculative promotion means that the developer is acting on a maximum profit basis . Speculative promotion can be organized in such a way that the developer and builder are different agents, the developer's choice of builder being based on tender or agreement . Alternatively, the builder can also operate as developer, which for obvious reasons implies crucial

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Competition restrictions in housing production C . Beng .s and K . Ranka

or employ a contractor based on tender . Another major form of non-speculative house production is social housing, carried out either by public agencies or development associations . Consider the cross-tabulation of the submarket models and the promotion models . With an increase in the number of promotion models applied, the picture of the degree of competition in the various submarkets can be extended . The promotion models can be distinguished and analysed according to factual conditions . The promotion models can also he defined and their potentials analysed from a theoretical point of view . The degree of competition in the submarkets with respect to various modes of promotion can then be assessed . We shall return to this later, but first have a look at the practice of Finnish housing .

Finnish housing Finnish housing production seems to be subject to a number of competition restrictions . A major part of the house stock produced over the post-war years has been speculatively promoted . This does not, however, indicate unrestricted competition, but rather the opposite . Despite huge regional variations, the price level of new, speculatively built dwellings is determined by the price level of the existing stock, and not production costs . The price level of the old stock fluctuates in line with the credit available . As the volume of credit grows, the price level rises . In times of economic booms the volume of credit grows and prices rise rapidly, given inflexible supply in the housing market . During these periods speculative promotion has always been lucrative and consequently favoured . During recession the price level of price controlled state funded production (so called ARAVA production) is at its peak level, relatively speaking, and the largest construction firms gear their production to ARAVA . The stated objectives of state financed housing have been to restrain rapid price rises and smooth out building cycles . In reality ARAVA price setting has increased the general

-4 1111~ Restrictions due to horizontal integration

Figure 2. Submarkets . restrictions on competition and is common practice in Finland . Non-speculative promotion indicates promotion on a non-profit base, or that the profits are 'reasonable', just covering the expenses of the promotional activities . Two major non-speculative models can be distinguished . Self-promotion means that the future owner acts as developer. He may also build the house himself, Nori-specula Live A . Self promotion (PromoterIdevetoperl

Speculative

ti . Social promotion (Promotertdevelupe

(

Constructor

(

Dweller

C . Constructor promotion

D . Tender-based promotion

J

)

(

Constructor

)

(

neellor

)

(

Dweller

)

Figure 3 . Promotion models .

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ECONOMIC MODELLING April 1994

Competition restrictions in housing production : C . Bengs and K. Ronkd

price level during recessions and offered the largest speculative developers a way through slumps via state financed production . The high profitability of speculative promotion during booms is based on the rapid price increases of real estate. The large speculative developers possess large land banks and are able to pace their production according to favourable phases in the economic cycle . Potential building land is purchased as cheaply as possible and developed, whenever possible, during booms . The large construction corporations, and a few related development associations, have had the best opportunities of utilizing the expected values of landed property by controlling contract-based development . The mechanism is as follows . In the Helsinki region, the biggest construction corporations, which are also the major speculative developers, have purchased vast areas of land extremely cheaply . These areas have been planned by the municipalities of the region in accordance with development contracts established between the developers and the municipalities. The large developers have in fact been able to dictate the allocation of building land of the region . Small-scale developers have not had this chance, nor have individual self-builders . Contract-based development has seriously hampered competition in housing production . As a result of this practice, the largest speculative developers own a majority of the land allocated for housing in the region and control the housing market . The whole system is based on close relations between the construction industry and the influential political parties, land use being a politically operated municipal monopoly .' Thanks to their large land banks, the speculative developers favour the development of the Helsinki region at the expense of the rest of the country . This tendency was strongly encouraged by the former mayor of the city of Helsinki . In 1989 he proposed a plan for the development of the region which proposed an increase in the existing building stock of 60% by the year 2010 . In the plan's land-use proposals, the large developers were strongly favoured . The city mayor also suggested joint ventures between construction corporations and the municipalities of the region in order to purchase building land . Only firms with a sufficient land bank, or sufficient funds for land purchase, would be considered . The total planned building volumes would be handed over to the shareholding firms of these joint ventures . In addition to this, the purchase of undeveloped land would be restricted . Needless to say, such a system would reinforce the already strong monopolistic position of ' See

Bengs [4] .

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a few large speculative developers and construction corporations. The control of building land seems to be a major way of restricting competition and controlling production markets to the advantage of the largest firms and development associations . Accordingly, the real estate share of the turnover of the big construction corporations has grown steadily over the last decade . Many of the development associations labelled `societies of common benefit' are directly owned by construction firms or by shared owners . Statistical analyses indicate that development associations favour contractors related to them by ownership . Although tenders may be used, the outcome seems to be predictable . From the competitive point of view the situation is complicated further by the fact that the main development associations are the major developers of state funded housing . In 1981 the government of Finland made a decision that 8 development associations out of 80 applicants should receive the status of `common benefit' and be favoured in state-financed production. Most of these development associations are directly related to large construction corporations and political parties, Consequently, the degree of concentration is bigger in ARAVA production than in freely financed production . The largest construction firms obtain the bulk of ARAVA production through their specific relations with the main development associations . The role of the responsible state agency (the Housing Board) is fundamental to this situation . In the speculative development organized by construction firms, there is no tender with respect to the main contractor . The firm naturally carries out the construction itself . The Finnish construction market is reputed to be one of the most concentrated in the world, and the reason for this is presumably the advantageous situation for construction firms, which have the dual role of developer and contractor (see Figures 4 and 5) . Joint ventures are a new feature in the development of competition restrictions in the construction market . The biggest firms get together in single projects, one acting as the developer and the other as the contractor . They also get together on a larger scale, sharing the land bank of contract areas or dividing planned housing volume . The reasons are economical and also political, the two largest construction companies having slightly different political affiliations . The production of building materials is concentrated and to a large degree monopolistic . The trading agents are hierarchically organized . Large clients deal directly with the factory, smaller ones have to deal with local sales offices, while ordinary self-builders must bargain with retail traders . Vertical integration is reinforced by ownership . The main material producers and construction firms have shared owners . 129



Competition restrietions In houebiq production : C . Bents and K. Rouki

Figure 4 . The market shares of large construction companies in 1987 . Pajakkala and Nierni [10] .

Source:

1980

1987

Relative market share 1%) 0-10

10-20

20 - 40

40-

Figure 5. The market share of four construction corporations in 1980 and 1987 . Source: Pajakkala and Nieml [10] . Some construction firms have their own panel factories . In Finland large resources have been invested in the factorization of the construction process . In particular, the panel technique has been favoured more than in other Nordic countries . This has not been to the

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benefit of house purchasers, because prices have remained high. But construction based on the use of prefabricated panels has made house builders extremely dependent on material producers . The relative share of materials in average total construction costs is ECONOMIC MODELLING April 1994

Competition restrictions in housing production : C . Bengs and K . Ronkd

higher in Finland than in other Nordic countries . Small and medium-size construction firms are the losers in this game. The panel technique is especially suitable for speculative promotion, because it can easily be adjusted to economic cycles . Houses can be built rapidly during booms . If there is a lack of panels, certain construction firms can be favoured . The relative share of labour costs has continually fallen over the years . The rise in labour productivity has been far more rapid than the rise in net incomes of workers .' In other words, the effect of wage increases has been marginal, without direct effect on the sales prices of dwellings . In 1988 the demand for construction labour exceeded supply for the first time since 1973 . At the moment the rate of unemployment is among construction workers is high . The restraints of competition with respect to the supply of construction labour are structural . There seems to be a constant lack of traditional craftsmen such as carpenters and bricklayers, but those who suffer most from this are the self-builders . The role of financers is essential throughout the production process and the purchase of the final product . Contrary to international practice, real estate banks specializing in mortgage loans are not commonplace in Finland. The role of ordinary banks, either business banks or savings banks, is fundamental . Ordinary banks prefer to fund projects with the best profit prospects, and usually on very short redemption terms. Consequently, speculative promotion and the biggest developers have been favoured . The local role of banks has been strong as one and the same bank prefers to finance a project from the start to finish, including the final purchase of the dwelling . Banks have applied a savings system for their `own' projects . Savers are often obliged to use their savings for a dwelling financed by the particular bank in question . The private banks have also become more directly involved in the housing business, as developers and purchasers of real estate . Unfortunately the role of Finnish financers has been little studied . The Bank of Finland has been very influential, being the chief regulator of lending . The interest rate mechanism hardly operated at all before 1987 . In that year the Bank of Finland liberalized lending, which resulted in a tremendous explosion of prices and a restructuring of production markets on the basis of a new wave of development contracts, escalating planning activity and construction by special building permits. Public regulations have implied restraints on competition in many ways . The role of the Housing Board has already been discussed . The major effects of state 'See Junka [8] .

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funding are the dispersion of the urban fabric due to regulations concerning the stipulated maximum price of plots for ARAVA production, concentration in the construction trade brought about by favouring certain development associations (and by other measures as well), price increase during recessions, increased speculation caused by the funding of speculative development, and finally the implementation of a multitude of quality standards . Legislation regulating company trade has favoured land ownership, and thereby speculative development. By a special taxation law the development of commercial and office buildings was made impossible during the boom of the late 1980s . The huge housing producers in the Helsinki region could therefore concentrate their entire capacity on lucrative housing with no fear of outsiders poaching the commercial and office building market . In the late 1980s a special tax on owners of unutilized building land hit small landowners . Construction firms, in cases where the tax applied to them, could deduct it from other taxes until a recent change in the law . The increase in real estate taxation will hit minor real estate owners harshly, especially retired people in the Helsinki region where the value of landed property has been rising in the long run . One result of this could be that the possibilities of self-development are severely limited and that speculative developers will get hold of this building land as well .

Conclusions A reference analysis of the Nordic countries shows that the large Finnish construction firms are the most cost effective. When labour expenses were compared to market value output the profitability of Finnish firms, irrespective of size, was superior . From 1980 to 1988 the increase in construction costs was the smallest in Finland . All the same, the price level of dwellings in Denmark and Seeden was one-third below that of Finland . One reason for this is presumably the speculative organization of Finnish housing provision and the lack of competition in all phases of the production chain . Consider the restrictions on competition according to modes of promotion and submarkets . Self-development is the best way of stimulating competition. In a way this result is peculiar: when promotion is not commodified, competition prevails on the various submarkets of housing production . Speculative housing, especially the typically Finnish case where huge construction corporations are the developers, backed by political party lobbies on a local and national level a substantial part of the party funding supposedly coming from the construction industry - hampers

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Compeilfoe tot mctio/tc in housing prorlurlion : C'. Bent's gnri k . 2iinka

Decisive restrictions

Restrictions

Not commodified (outside markets)

Figure 6 . Promotion models .

competition .' Speculative development decisively restricts competition in the land and construction markets . In non-profit social housing, restrictions on competition are reduced but are still greater than in self-promotion . The discussion on restrictions in competition, based on the models presented, highlights the necessity of differentiating between the competitive

For a brief discussion concerning politics and the construction industry, see Bengs [3] .

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potential of different modes of housing promotion, and the prevailing restrictions within different modes of promotion (see Figure 6) . The conclusions may sound moralistic, but in this case a moralistic tone is in order . A society based on expanding markets and the perpetual commodification of all aspects of human life almost by necessity distorts traditional values, or rather applies new (commodified) meanings to products. But one value is not to be tampered with: that is competition, the ethos of the market economy . In order to regain some of the

ECONOMIC MODELLING April 1994

Competition restrictions in housing production : C. Bengs and K . Ronka

competition in housing production we suggest the following measures : (i) Firms should not extend their economic activities outside their own submarket . First and foremost, construction firms should not be allowed to practise development . (ii) Alternatives to speculative development should be created . Non-profit making provision of housing in the genuine interests of the future dwellers should be encouraged . State funding for housing should be available solely for non-profit development, and tendering should be compulsory . (iii) The municipal purchase of building land should be encouraged . With a huge land bank municipalities could apply tenders as a compulsory condition for developers receiving plots from the municipality . Municipalities could also support non-speculative housing development by keeping the price level of building land low . Development contracts between speculative developers and municipalities should be forbidden altogether . This would not only counteract concentration of the construction trade, but also improve the quality of the environment . Returning to our introductory remarks on the philosophy of social studies, a study of restrictions on competition in housing must consider `causal facts' and the 'rationale of agents' of the production process simultaneously. But agents do not operate with the main objective of justifying the market economy or econometric theories . They operate basically in order to obtain profits, and possibly to achieve some other

ECONOMIC MODELLING April 1994

goals . It is therefore legitimate for the researcher to use concepts like `speculative', to respond to the exigency of the philosophy of science .

References

1

C . Bengs,

Pda'kaupunkiseudun asuntojen hinnat vuosina

1965-1988, VTT Tiedotteita 1007, Espoo, 1989 .

2 C . Bengs, 'Romppaisesta Ramboon kilpailu asuntotuotannossa', Arkkitehti, Vol 5, 1990, pp 74-72. 3 C. Bengs. 'Asuntotuotanto spekulaation kohteena', in E . Taivalsaari, ed, Naenndinen Demokratia, Arthouse, Jyvaskyla, pp86-127, 1991 . 4 C . Bengs, 'Aluerakentaminen - ikuinen laiskantaksy', Arkkitehti, Vol 1 . pp 72 81, 1991 . 5 C . Bengs and K . Ronka, Kilpailu asuntotuotmmosca, Kilpailuvirasto Selvityksia 2 B/1990, Helsinki, 1990 . 6 C . Bengs and U . Manninen, Paakaupunkiseudun rakennuttajat ja rakentajat vuosina 1950. 1985, VTT Tiedotteita 1144. Espoo, 1990. 7 C . Bengs, V . Lehtimaki and K . Ronka, Paiikaupunk8 9 10 11 12 13 14

iseudun aluerakentamissopimusalueiden maanomistus ja -hinnat 1950-1985, VTT Tiedotteita 1006, Espoo,1989 . T . Junka, Kipailu ja keskittyminen talonrakennusalalla,

Taloudellinen sunnittelukeskus, Helsinki, 1988 . U . Manninen, Aravarakenlaminen pda'kaupunkiseudulla vuosina 1950-1985, VTT Tiedoteita 1068, Espoo, 1989 . P . Pajakkala and O. Niemi, Rakentamisen teollistaminen, Rakentajain kustannus Oy, 1989 . K . Ronka, Aluerakentamissopimukset ja kaavoitus Espoossa ja Vantaalla, VTT Tiedotteita 1062, Espoo, 1989K . Ronka, Maamarkkinoiden kilpailurajoitukset, Kilpailuvirasto Selvityksia 3/1991, Helsinki, 1991 . M . Sahlins, Culture and Practical Reason, The University of Chicago Press, 1976 . G . H . v . Wright, Explanation and Understanding, Routledge and Kegan Paul, London, 1975 .

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