More on Housing Affordability: Supply versus Demand

By Seamus Hogan 08/11/2012

Over at TVHE, Matt has followed up on my post here on Gareth Morgan versus the Productivity Commission, arguing that we shouldn’t view supply and demand explanations as mutually exclusive. Now I think Matt and I are pretty much in total agreement, but slight differences in language might make our posts seem at cross purposes, so I thought a couple of clarifications are in order.

First, the interesting question is not whether the cause of house-price inflation in New Zealand is supply, demand, or some combination of both. Obviously, since house prices are set by mutual agreement between buyers and sellers, prices are always and everywhere the result of both supply and demand. Rather the issue is, to the extent that house prices are inappropriate for some reason, whether the source of the inappropriateness is acting through supply or demand. Matt frames this by asking whether something is pushing demand for housing beyond what is “socially optimal” (or, by extension, restricting supply below what is socially optimal). Another way of saying this is to ask whether the policy response to high house prices would work by increasing supply (say changes to zoning or consent processes) or demand (say, changes in the tax treatment of housing).

The second clarification is that saying that supply and demand are not mutually exclusive is more than just saying that influences on both sides can contribute to the final effect. In the case of tax policies, the purpoted cause of house-price inflation only makes sense if there is an underlying problem with supply. To illustrate, consider Matt’s statement

The key point against supply side issues will be fact that rental growth hasn’t gotten as scary at any point — if there are “too few” houses, then we should really see the cost of housing services/rent pick up.

The idea here is that if house prices are going up faster than rent, then the opportunity cost of owning a rental property must be rising faster than the direct income derived from it, so the only motivation must be the expectation of capital gain. This is true, but the expectation of capital gain only makes sense if the underlying trend is for the demand for housing for non-investment purposes to grow faster than supply. That is, to explain house inflation today as driven by tax-favoured investment, we need to assume a problem with restrictions on supply in the future.

Furthermore, consider what we would observe if there were no favourable tax treatment for owner-occupied housing or income derived from capital gains, but still an expectation of demand growth outstripping supply growth in the future. As long as the capital gains tax rate were not set at 100%, it would still be the case that expectations of future house price inflation would drive inflation in house prices today, there would be a positive after-tax return from capital gains, and hence a slower rise in rents, exactly the observations that Matt suggests might imply the problem is not exclusively on the supply side.

The bottom line here is that the favourable-tax-treatment story simply implies that problems due to insufficient supply will bite a bit earlier than they otherwise would have done. If there is no problem with supply being unable to keep pace with underlying demand, the tax-treatment issue is irrelevant.

0 Responses to “More on Housing Affordability: Supply versus Demand”

  • Great if you have a place not so good if your young. No wonder the suicide rate is so high.
    Low wages no chance of buying a house, say a wage slave.
    Foreign investment is bad for the younger generation as it puts prices out of reach.
    So whilst you drink champagne from the money your rents supply spare a thought for the young ones.

  • @electrickiwi: Which is why the focus of housing policy should be squarely on land-use rules and consent processes, and not sideshows like tax policy.

  • Electric, I don’t think that any of the economists who blog at Dismal Science like the current housing equilibrium. I think we have all argued that policy needs to ease up on the zoning and RMA constraints that work to artificially inflate housing prices by restricting supply. We don’t have enough houses largely because the government makes it very difficult to build more houses.

    Please note that further comments that are this insulting will yield blocking.

  • Excuse me what is insulting about what I said ?
    Low wages .. true which leads to wage slaves due to high out going expenses. They work just to survive. true
    40,000 million dollar homes in NZ owned by foreigners.
    Supply and demand dictates that if we have increased demand due to foreigners, the supply is the same prices go up and out of reach of the young ones <— true
    Suicide rates are twice the road toll, how about we try and find out why so many people are killing themselves. I bet the prospect of staying a wage slave your whole life and never owning a house comes up in a number of cases.
    Is this insulting ? or is it reality ?
    It would be good if the supply was eased so that young people can think about earning a dollar and being able to buy their own house. National government is doing some good here me thinks.

  • electrickiwi – The main insulting comment is your suggestion that people who own houses are in some way responsible for youth suicide.

    “how about we try and find out why so many people are killing themselves”. We already know. NZ’s high youth suicide rates have a lot to do with alcohol abuse, which is also a factor in other high youth suicide countries like Ireland and Finland. Thta’s the reality. Alcohol also has a lot to do with the road toll. What we don’t know is how to stop people binge drinking.

    There are around 40,000 homes in NZ worth over $1m altogether. Foreigners own just a very small fraction of them. If they all sold their houses and left it would make hardly any differene to the price of houses for first home buyers. The supply and demand issue that makes houses expensive is stated above – local government restrictions on land supply.

  • alcohol and drug abuse, unemployment (wage slaves generally are not topping themselves…), low education levels, limited vision. And hormones. These broadly are the drivers of youth suicide

    It potentially is a factor adding to a sense of helplessness/hopelessness, but I am not aware of any coroners report that has identified inability to purchase a house as the cause of suicide.

  • Electric: you said “So whilst you drink champagne from the money your rents supply spare a thought for the young ones”.

    1. I don’t like champagne.
    2. I’m paying a mortgage on the house we live in; I have no other properties.
    3. The econ bloggers at Dismal are the VERY LAST people you should be castigating for not thinking about the young folks priced out of the NZ housing markets. We’re some of the ones shouting loudest about how we need to allow property owners to subdivide, ease up on urban boundaries, allow increased density within town – all to increase housing supply and push prices down. I at least take some stick for it occasionally from those-who-like-to-think-themselves-progressive about how sprawl is evil. Want somebody to go insult? Go pick on those guys who care more about grand central plans than about the effects of their schemes on folks priced out of housing.