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Padding pockets, not houses

Written By: - Date published: 12:45 pm, August 11th, 2009 - 45 comments
Categories: housing insulation - Tags: ,

Just a month into the Government’s housing insulation programme and John Key has had to launch an inquiry into rorting by contractors who are taking the subsidy but also increasing their prices, and so pocketing a good part of the subsidy themselves rather than passing it on to the consumer as intended. That’s a bad outcome because it doesn’t decrease the cost of insulation to homeowners as much as could be, and so fewer people are taking up the opportunity than otherwise might.

Why didn’t the Key Government see this coming? Basic economics tells you that without controls in place to prevent it any subsidy will be at least partially kept by the supplier – the tighter supply is (ie. the less elastic it is) the greater the portion of the subsidy the suppliers will keep.

daydream believerHere’s how it works. The higher price the higher supply (S) and lower demand (D).

Now, add a subsidy (thick green line). In dream world, all this subsidy is passed on to the consumer, so the price falls by the full amount of the subsidy (P->P1) and the suppliers supply the amount demanded by consumers at that price (Q->Q1).

In the real world, it’s different. A new supply curve (S1) can be plotted that is the amount of the subsidy below the original supply line. Where the new supply line intersects with D gives the new level of price and quantity – note, it’s not as low as the full subsidy and quantity is less than what would be demanded if the full subsidy was passed on.

That’s pretty basic stuff. It’s what happens if you just hand a wad of cash to suppliers and say ‘here, this is to pay for part of Jack and Jane’s insulation’ without any controls or oversight. It’s how markets work, why would the supplier pass on all the benefit to the consumer? They probably can’t afford to anyway because demand at the fully subsidised price would out-strip their ability to supply at that price plus subsidy, and they don’t need to because all suppliers are running full tilt – rather than being price takers, the suppliers have a lot of market power, they can charge higher prices if they choose, bringing down demand but pocketing more cash themselves.

The Key Government should have seen this coming and set up mechanisms to prevent it, such as the government doing the insulation itself with sub-contracting if need be as a monopolistic buyer. Again, this looks like more sloppy work from this government, with the result that what is meant to be assistance to make Kiwis’ homes warmer has become a gravy-train for business.

45 comments on “Padding pockets, not houses ”

  1. infused 1

    There is always going to be a few people that abuse it. Anything for a dig at the govt though eh?

    • Draco T Bastard 1.1

      Actually Infused, it’s a dig at private businesses rorting taxpayers – again.

      • Tigger 1.1.1

        I would have thought NACT would love this show of entrepreneurism – isn’t this just the free market at work? If you don’t like the prices, don’t shop there. Why an ‘investigation’? Why the need to put ‘controls’ in place? It goes against everything they stand for.

  2. vto 2

    You make a point mr marty, but it does make me laugh at the irony etc. I mean, what on earth do people expect? It has been shown time and time and time again over the years that govt interference creates anomolies and disturbances in pricing structures. This is the main cry of Act. And you have just shown that they are in fact right when it comes to exactly these situations.

    And then you advocate further interference to right the earlier interference.. hee hee, bound to fail.

    Govt interferes once and it doubles the complication, interferes twice and it quadruples, interfere three times and multiply it by nine.

    I truly do not understand the left’s blind allegiance to more govt.

    I’m not saying insulation is bad or anything else, just highlighting this minor but eternal truism. I do giggle …

    • Quoth the Raven 2.1

      I generally agree with what you’re saying vto, but don’t tar the left with the same social democrat brush.

    • r0b 2.2

      You do understand, don’t you vto, that the whole global economic crisis that is in progress right now, arose from the withdrawal of government regulation?

      Capitalism doesn’t work unless it is regulated by government. When governments relax regulation and capitalism eats itself, it needs rescuing by good old fashioned taxpayer funded socialist big government bailouts.

      For a local example on a small scale – look at leaky houses. Relax regulations, market forces screw up, leaky home owners turn to government to fix it.

      Capitalism doesn’t work unless it is regulated by government. (Even then it doesn’t work long term, as governments’ inability to deal with the inescapable boundaries of resource limitation and climate change are going to show us big time over the next few decades).

      • vto 2.2.1

        r0b, “the whole global economic crisis that is in progress right now, arose from the withdrawal of government regulation?”. Disagree – it is without doubt a part of the reason but it is simplistic in the extreme to place all liability there. Big topic for another day.

        I dont disagree re the necessity for a central organisation to oversee relationships within a society. It too is a truism. It is just the extent that it goes too. imo, most of the time too far.

        For the record, leaky homes arose not just from what you say but also other factors.

        See the problem seems to be the lack of quality intervention and regulation. Leaky home / building code intervention is a classic example. Poor quality govt intervention. It is a very very common trait and until govt can demonstrate that quality will be a result then it should err on the side of caution and avoid interference. Unfortunately it seems to do the opposite all the time and just crash on in knocking things over and causing all manner of destruction – a bit like that ad a while ago which showed a bull wandering thru a china shop. Reckon you could get a bull to roam thru a china shop without knocking things all over the place ? ? ?

        • Akldnut 2.2.1.1

          vto correct me if I’m wrong but aren’t you agreeing with rOb!
          lack of quality intervention and regulation = Relax regulations, market forces screw up

          • vto 2.2.1.1.1

            Not quite. What I suggest is that in circumstances where govt intervention is required (which requires very careful thought and consideration (is that possible in politics?)) then that intervention should only proceed if it can be demonstrably proved that it will be quality intervention. example – clearly the insulation intervention is poor quality.

            It does not follow that a lack of intervention equates to market madness.

            Anyway, the insulation example may be a brilliant example of market forces, if it was left alone from this point. Imagine – all these ‘rip-off’ installers gouging the system by seeing an opportunity to hike prices and gain more profit will directly lead to more people entering the insulation installation business which in turns drives competition and better prices.

        • Draco T Bastard 2.2.1.2

          You seem to come at it far too simplistically vto. You see regulations that aren’t 100% effective and call for their total removal instead of the logical, but far more complex and costly, step of making the regulations better. I think part of the problem is that western society has become far too precise as far as the laws go. People stick to the letter of the law and manage to breach the spirit of it.

          Laws, IMO, need to be general which will catch actions that aren’t supposed to be caught but that can be defined in court.

      • Quoth the Raven 2.2.2

        r0b – Weren’t you reading some free-market anti-capitalist work? Maybe it isn’t ringing true for you, but you ought to read more of it. You’re mixing your terminology I thought at least you’d come away with getting that right.

        • Bill 2.2.2.1

          Quoth.

          Markets encourage buyers and sellers to seek advantage, ie rip one another off. The better you are at it, the richer you become and the richer you become, the more power gravitates towards you. And the more power you have, the better positioned you are to take advantage of market dynamics to rip off your neighbour….who should not, under any circumstances be considered to be your neighbour, as opposed to your competitor.

          Free markets can never be considered as anti-capitalist. Capitalism might reasonably be seen as the institutionalising of the power that gravitated towards those who were either very adept at securing ‘an edge’ ; ripping people off or who used military might to take what they couldn’t secure by other means in a free market environment.

          Government intervention keeps the whole shabang rolling along and offers some protection to the more disadvantaged, the environment etc…until the corporates and bankers capture the state apparatus and then, well the trains will run on time I guess.

          Before that point, it might be said that governments of a social democratic persuasion are in the business of regulation; trying to encourage a hyena (the market) to roll on it’s back to have its belly rubbed.

        • r0b 2.2.2.2

          Yeah sorry QtR – you are quite correct I’m behind in my reading!

  3. Bright Red 3

    One month in and it’s a big enough problem that an inquiry has to be launched. That’s not normal, background-level abuse infused.

  4. tsmithfield 4

    The obvious way to sort the problem is to increase the supply side of the equation. That is, make more contractors qualified to offer the insulation subsidy.

    I agree with VTO though, it is somewhat amusing to see people from the left side of the spectrum complaining about the effects of government intervention. Talk about the pot calling the kettle black.

    • Daveo 4.1

      The way I read it, the complaint is that the Government’s actions were poorly conceived.

      This isn’t an argument about the principle of Government “intervention”, which is a highly ideologically loaded term in the first place.

    • Draco T Bastard 4.2

      And the supply side is going to be fixed with Pixie Dust right?

    • Bright Red 4.3

      ts. Your argument is like if I were to complain that the baby had been thrown out with the bathwater and you said ‘well, that’s what giving the baby a bath gets you’.

      It’s a question of making your policy so that you get to bath the baby then keep the baby but throw out the bathwater.

  5. darryl 5

    ACC, Insulation, DPB, Ministers housing subsidies, Ministers travel perks…. wherever you find a subsidy you will also find a rort.

  6. BLiP 6

    Classic National Inc – steal someone else’s idea, throw it to the wolves, and then feign shock horror when their business mates turn out to be greedy thieving bastards. Still, at least its keeping a couple more public servants employed – unless National Inc has contracted out the investigation?

    Bunch of numpties.

  7. TightyRighty 7

    Funny thing is, those same graphs can be used to show how beneficiaries, or bennies as the left like to call them, can exploit the system.

    • Ari 7.1

      What, by pocketing money they’re supposed to spend to stay alive?

      Yeah, sounds like a swell idea. *rolls eyes*

  8. Ari 8

    I can just imagine it now… “But we couldn’t POSSIBLY regulate a business subsidy! Regulations are bad on their own, but a regulated subsidy? That’s like scrubbing a slug!” 😉

  9. Zaphod Beeblebrox 9

    Maybe they could increase building apprenticeships and training courses for builders. Or is it a step to far for this government to think ten minutes ahead!

  10. bill brown 10

    “Well look, those Greens made us do it, and now look what a mess they’ve got us in”

  11. Tom M 11

    Marty, you’ve got your graphs a bit confused – you measure the subsidy differently in both (and incorrectly on the first one), which is why you get different results. The only way you’ll get a difference is if you adjust the elasticities – yours are the same on both graphs – all you’ve done is reduce the subsidy, which even you should admit isn’t going to affect its incidence.

    The real problem though is in your theoretical explanation. No microeconomist will ever tell you that the incidence of subsidy is determined by whether or not the subsidy is regulated, and they are right.

    The reason prices don’t go down all the way after a subsidy is simple – most businesses face upward sloping cost-curves, at least in the short run. So when they produce more (as is the goal of a subsidy), it costs them more per unit to produce their good. This is reflected in the price. So if you regulate to make them ‘pass on the subsidy’, you’ll just make them produce at a loss. That’s the standard supply and demand analysis, and it makes a great case for why we shouldn’t subsidise home insulation.

    • Bright Red 11.1

      The first graph is wrong on purpose… see it’s title?

      The second graph looks like this graph of the incidence of a subsidy http://hsc.csu.edu.au/economics/global_economy/tut10/image1.gif

      You’re failing to realise that the point was to make home insulation cheaper for people – increase consumer surplus without increasing producer surplus. Good policy design could have done that, a simple subsidy never could. That’s probably why the solution Marty presents isn’t regulation like, say, setting price controls on insulators. it’s:

      “The Key Government should have seen this coming and set up mechanisms to prevent it, such as the government doing the insulation itself with sub-contracting if need be as a monopolistic buyer. “

      • Tom M 11.1.1

        No, the first graph is identical to the second in all necessary features – he just gets the result he wants by measuring the amount subsidy incorrectly.

        If you have auxiliary goals, that’s fine. But that’s not what this post is about – it seems to be just complaining about how the price doesn’t drop by the same amount as the subsidy, as if that should be some sort of surprise, or is due to avarice on behalf of the insulation firms.

        If the producers are making monopoly profits, that’s a completely different argument. But even in perfect competition, the price would be unlikely to drop by the full magnitude of the subsidy.

        Of course if you want full incidence on the consumers and to maximise their utility, the best method is a cash handout… 😉

      • Matt Nolan 11.1.2

        I agree with Tom here. It is ridiculous to claim that an outcome is “bad” based on a counterfactual that can’t happen.

        Although Marty does state it can’t happen, he also stated:

        “fewer people are taking up the opportunity than otherwise might”

        In order to say that this is a bad thing. Now, when the counterfactual isn’t realistic this isn’t a fair claim.

  12. tsmithfield 12

    Tom, I think the scheme can work. As mentioned, the problem is at the supply end. There are a lot of insulation firms not in the scheme at the moment. If they could be brought on stream as well, then the laws of supply and demand will bring the pricing back down.

    I agree that a subsidy scheme in itself can be quite ineffective if the only goal is to make insulation cheaper for consumers. However, there are other gains to be had:

    1. Stimulation to the economy in a time of recession.
    2. Reduction of green house gasses.
    3. Less draw on our electricity network due to better insulation.

    Furthermore, even if there are price increases as a result of the increased demand, the consumer should still be better off pricewise because there should still be a net gain even allowing for increases in price.

  13. Marty G. Just for the record, the lines called S1 in your two diagrams are NOT supply curves. The lines S are the supply curves in both diagrams, both pre and post subsidy.

  14. lampie 14

    Marty G. Just for the record, the lines called S1 in your two diagrams are NOT supply curves. The lines S are the supply curves in both diagrams, both pre and post subsidy.

    actually he has that right. A subsidy pushes the supply curve out.

    No, the first graph is identical to the second in all necessary features he just gets the result he wants by measuring the amount subsidy incorrectly.

    Tom is right. the first graph shows just the desired outcome, i.e. the affect of the subsidy

    the subsidy in graph two should be from e down to where s1 meets q

    • “actually he has that right. A subsidy pushes the supply curve out.”

      No it doesn’t. There can be only one supply curve on the diagram, if there were two which one of them do you read the quantity supplied off, for a given price?

  15. lampie 15

    supply could be agured as well

  16. lampie 16

    No it doesn’t. There can be only one supply curve on the diagram, if there were two which one of them do you read the quantity supplied off, for a given price?

    s1 is the supply curve after subsidy. there is a shift in supply, in this case, an increase in supply due to the subsidy hence why i would argue about supply been inelastic.

  17. lampie 17

    which one of them do you read the quantity supplied off, for a given price?

    There is an increase in quantity demanded (Q1). The new price is P1, hence the affect of a subsidy

    the point of the article is that P is still basically the current price after subsidy has been given to the producer instead of P1.

    Toms explanation sounds reasonable

    “If the producers are making monopoly profits, that’s a completely different argument. But even in perfect competition, the price would be unlikely to drop by the full magnitude of the subsidy.”

    Basically you could say the same for the subsidy with doctors. Pe = $60, Govt. introduces $40 subsidy which increases quantity demanded for a $20 fee to the consumer. Doctors try to reduce this demand by charging $30, hence the producer (doctors) get actually $70 than the original $60.

  18. “The Key Government should have seen this coming and set up mechanisms to prevent it, such as the government doing the insulation itself with sub-contracting if need be as a monopolistic buyer”

    Two things here:

    1) The fact that the surplus is split between consumers and producers isn’t necessarily a bad thing – even in perfect competition the fact that the cost of insulating houses rises in the quantity is sufficient for this result to hold.

    2) If the government sub-contracts to a monopolistic buyer the pricing issue will be the same. If the government gave the money to consumers instead of producers the pricing issue would be the same. And finally, if the government decided to make the stuff itself I highly doubt they would do so more efficiently.

    I agree with you that the government complaining about the fact that some of the surplus accrued to firms is dumb. However, I don’t really agree that there are alternate structures that would have changed the allocation of the surplus – and if even if there was (like the government taking control of the industry) I don’t think they are preferable.

  19. SPC 19

    It costs $3 B over 3 years to give $1000 pa to those with Kiwi Saver accounts. This money is borrowed.

    The same $3B could be used to give every household a $1500 voucher. This voucher used for insulation, heat pumps, double glazing or otherwise cashed in a Kiwi Saver account (making them compulsory at 2% from the full-time employee and employer).

    The money would still be borrowed but within a year or so our housing stock would be upgraded (resulting in falling energy demand – reducing market rate power prices to business users). This faster installation would create more jobs and when we need them most, 2009 and 2010.

    Whereas the current scheme has waste and distortion (only some are authorised etc) and is over too long a time frame.

  20. SPC 20

    I am not buying into the opening argument or Matt Nolans (2) derived from it.

    Vouchers in the hands of consumers gives them power in the market – and they are either happy with deals now or they having the voucher in their hand can simply wait for a better deal. If they are not being restricted to only some suppliers, consumers can enable those businesses offering the best deals to grow their business.

    We already know what happened in solar water heating, so no one should be surprised by the problem that has arisen and it is not just supply and demand but a limited market (some are in the loop and some are not – consumers only access their saving via the business thus uncontrolled demand for the government largesse).

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