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Opinion - Housing Prices Are Down - Hurrah!

On The Left - January 24, 2000

Housing prices are down - Hurrah!

In the media this weekend has been a bizarre focus on falling house sales. It appears, after being bombarded by the Weekend Herald, TV One News last night and the Sunday Star Times, that the number of house sales has fallen sharply, and that prices are on the way down.

"Very interesting," I thought, and then began to laugh as I realised that commentators have been running around speculating that the cause of the decline is last week's decision by the Reserve Bank to raise the Official Cash Rate by 0.25%.

In the simplest of terms, anything that cuts the value of housing and encourages investment into productive assets has to be a good thing for this country.

Allow me to explain.

One of the most bizarre aspects of the housing boom of the mid-1990's (a boom which, incidentally, caused the tight money policy that choked growth off at the end of the decade) was the sheer amount of investment that occurred in housing. All sorts of figures get talked about, but one I have seen more than once is that $50b was invested in housing in that decade. $50b is about five years added up of the entire economy's savings. It's a hell of a lot of money. We probably borrowed most of it, too, with the funds largely coming from the capital account surplus that is the inevitable consequence of our current account deficit.

The key question one has to ask is: was that money well spent? And the inevitable answer is: no, it wasn't.

Think about it like this. The key to delivering higher living standards and economic growth is increases in the productivity of the economy. One of the simplest ways to do that is to enhance investment in the capital stock. A flow of investment requires either the import of capital (which is what we did) or domestic savings (which is what we do too, though woefully little of it occurs). This investment is typically provided by buying stocks and shares, or alternatively is lent by banks and finance companies to businesses so they can upgrade their equipment and expand their production.

It is this investment in the productive capacity of the economy which allows it to grow and to deliver more jobs and more income for New Zealanders. It's also a fact that $50b which could have been spent on productive investment, wasn't. It was spent on housing. If you can explain to me how housing improvements ("Oh, shall we buy some new curtains? Or what about wallpaper?") enhances the productive capacity of the country then please do. I'd be most impressed.

Why was this money spent on housing?

A number of reasons. The first and foremost is history. (If you are a reader who believes in neo-classical economic theory, you're not going to like what follows very much.) In the 1970's and 1980's inflation was an enormously important part of life in New Zealand, and it showed in the way people saved. Putting money in housing was a safe bet. You got house prices rising faster than the (rapid) rate of inflation, and those gains were not taxed. It was a sensible form of saving.

With the great deceleration in inflation (one of the few successes of the New Zealand economic experiment) in the early 1990's, all of a sudden the return on housing became less attractive. You didn't need to protect yourself against inflation any more, so if you were rational, you would save in the most attractive sector that offered you the highest return. Property, unless fuelled by a speculative bubble, wasn't it.

Yet, in the 90's, property was in a speculative bubble, and money poured in. The speculation was worsened by the fact that capital gains on housing are not taxed, but investment in productive areas is. This distortion in the marketplace for capital (one of the few things where I agree with Gareth Morgan!) coupled with the speculative bubble made housing a giant sink for funds which could better have been spent elsewhere. Not only that, but the high interest rates that were used by the Reserve Bank to contain that speculative bubble not only pushed the currency up (leading to a worse trade balance and yet more capital being imported) but cut into the business investment (which is interest-rate sensitive) required for long term economic growth. It was a case of losers all round - householders with huge debts, and the economy worse off and hitting capacity due to lack of investment.

So, to jump back to the original situation, why is it good that house prices are falling? Simply this. If there is a downwards correction in the cost of housing, investment should flow into areas where it'd actually contribute something to the country's development. If people realise that saving via housing is no longer a sure bet, and that prices can go down as well as up, they will begin to look at other forms of savings.

It's critical for our economic future that just that happens. So looking at this downward movement in prices has made me happy. For those who currently do own land and housing: sorry. I imagine the declines won't be very large in scale, and I can't see the emergence of a massive negative equity problem like the UK suffered in the early 1990's. A capital gains tax would help speed the process along, by taxing housing investment the same way as any other form of investment is taxed.

But that will have to wait for the taxation review promised by the new Government, won't it?

Till next week,

Jordan Carter carters@ihug.co.nz


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