Affordable Housing: Five Basic Principles

By Seamus Hogan 04/08/2013 10


What is it about housing policy that leads to people forgetting basic economic principles? Following on from the extraordinary Labour Party policy that Matt and I jumped on
at the start of the week, we had this blog post from Susan Guthrie, and this
press release from Labour. Matt has commented expertly on these here and here,
and I don’t want to beat a dead horse. But in all the discussion about housing in the
blogsphere, a few basic principles keep being ignored, so I thought I would finish what has turned out to be housing week in the blogsphere by listing those prinicples in one place: 
  1. The price of housing depends on the supply of available houses and the
    number of people wanting to live in houses coupled with their willingness to
    pay for housing. The price of houses depends on the price of housing today and the expected price in the future. Policies that affect who
    owns
    houses and the incentive to purchase existing houses as an investment are
    sideshows unless they change the underlying stock or the underlying demand for housing
  2. Speculation works by buying assets when their price is expected to rise
    and selling when the price is expected to fall, thus reducing price volatility.
    Speculative investment that
    increases
    volatility in house prices is investment that loses money. If such speculation
    were coming from overseas, it would be a source of income to New Zealand.
  3. Speculation that leads to an increase in house prices and makes money,
    is only profitable because underlying factors are operating to push prices up
    even further in the future. Any policy that claims to be able to reduce
    house-price inflation by restricting speculative investment, is a policy that
    is an open admission of having no solution to the long-term problem. 
     
  4. Policy can reduce the demand for housing or for houses by imposing taxes, but that can only lead to a reduction in the before-tax price not to the after-tax price and hence is not a route to making housing more affordable.
  5. More specifically, there is a tax advantages to owner-occupied housing
    over renting. But to the extent that has any effect, it leads to too much
    investment in creating houses and hence to
    lower
    house prices than would otherwise be the case. There may be arguments for
    eliminating the tax preference, but affordability is not one of them. 

It would be nice if the main-stream media were to ask questions of politicians rather than just disseminating their press releases. Asking them to explain their policy proposals in light of these basic ECON-100 principles would be a good start.


10 Responses to “Affordable Housing: Five Basic Principles”

  • Sorry Seamus. You make one assumption too little.

    All these Sciblog blogs assume that people want to buy a house so that they can sell it at a profit.

    Rather, it is a fight to get a “right to housing” as spelt out by the Universal Declaration of Human Rights.

    Now. What don’t you economic gurus sort out a decent economic policy to do that in this country.

    It took a depression in the 30’s to get State Housing started in this country. Why can’t we do it when the economy is supposed to be a wee bit better in this day and age.

  • Ross, I am sorry, but I think you have completely missed the point of what we (all the “dismal science” bloggers) are saying. First, we are unanimous in saying that we should focus on the suppy of houses and the demand for *housing* (i.e. wanting a place to live), and are critical of analysis that focuses on speculation and bubbles (buying houses to sell at a profit) and of policies pretend that we can lower the price of housing by measures such as foreign-ownership restrictions and capital gains taxes.

    I think you will aslo find a constant theme running through all the blogs feeding into The Dismal Science calling for action to lift zoning restrictions and other measures restricting housing supply. We have a decent economic policy to allow affordable housing; we just need to see it implemented.

  • Seamus,

    While I and everybody of my generation was indoctrinated at school about the basic ECON-100 principles, there was little discussion of the underlying assumptions that these principles are based on. For example, free markets improve efficiency, which means that the total pool of wealth grows and therefore everyone involved gets wealthier through the “trickle down” effect. Given that this is a science blog, I’m interested to see your evidence – not theory based on oversimplified models and flawed assumptions – that this is actually what happens in the insanely complex world of macro-economics.

    Understanding some simplistic models, combined with groupthink among economists, is a dangerous combination. Physicists have a good understanding of thermal dynamics and the effects of pressure – but we cannot reliably predict the weather beyond 10 days or so. At least meteorologists admit that.

    For non-economists, treating housing as a speculative investment instead of a fundamental human right, seems inhumane. Given that there are around 1.7 million houses in New Zealand and 7 billion people who are allowed to buy them, this unprecedented free market experiment seems like a high-stakes game played by economists who have no prior experience on which to base their confidence. This is the same bunch of mainstream economists that collectively failed to predict the timing and severity of the GFC.

    I remember hearing a few years back some economists say that the price of housing will stabilise as the price increases because this will incentivise building more properties. Still waiting for that one. (waiting for the ‘too much regulation – market needs to be freer’ rebuttal..)

  • I can’t help but note that there are obvious counter-examples to speculation acting as a stabilising force, in the form of history’s various boom and bust cycles. Effectively, speculators become convinced that prices in some market can only go up.

    In such cases, speculation becomes self-reinforcing, with speculators’ expectations about prices driving further price rises. Then, when the crash eventually comes, you get mass sell-offs, driving prices far down.

    Far from speculation being a benign, stabilising process, it has the potential to amplify the peaks and troughs of the market cycle. People, after all, do not have perfect information, and are influenced in large part by their fellow investors. Far from being driven by underlying factors, prices wind up being driven by expectations about investor behaviour. Which may or may not be consistent with underlying factors.

  • Hey guys,

    I think there is an important point to keep in mind here – namely “what is the housing service people have an inalienable right over”? The house price doesn’t necessarily catch this – it is the rental equivalent of owning a property, it is the stream of services associated with it.

    This is the type of long-term affordability issue, the type of thing that relies on the evidence and discussion given here:

    http://www.treasury.govt.nz/publications/research-policy/wp/2013/13-14

    http://www.stats.govt.nz/browse_for_stats/people_and_communities/housing/Rental-affordability-1998-2012.aspx

    How does a short term increase in investor demand impact upon the this? Well, it should have no short-term impact on rental prices, but a distributional impact (where people without property are the losers) – this is how we want to conceptualise the issue. This provides a framework for trying to understand a specific policy recommendation.

    This is a clear argument regarding a specific policy suggestion – and to be fair both of your comments appear to be on side issues with regards to this. They are good issues to discuss, but they are a touch beside the point.

    “Understanding some simplistic models, combined with groupthink among economists, is a dangerous combination. Physicists have a good understanding of thermal dynamics and the effects of pressure – but we cannot reliably predict the weather beyond 10 days or so. At least meteorologists admit that.”

    On this issue in particular, no-one is saying they can forecast house prices – they are discussing the way an increase in demand has an impact on the market. This is intrinsically different. Policy advice, and the choice of policy, should be consistent with an underlying description.

    “Far from speculation being a benign, stabilising process, it has the potential to amplify the peaks and troughs of the market cycle”

    And as we’ve been trying to clarify, if this occurs because foriegn investors are overpaying for an asset it is equivalent to a wealth transfer to NZers – rather than focusing on short-term volatiliy we also need to consider direct impacts. This is why we need to articulate the market that is involved, and the distributional consequences, to have a clear idea about what is going on and the appropriateness of policy.

    “Given that this is a science blog, I’m interested to see your evidence – not theory based on oversimplified models and flawed assumptions – that this is actually what happens in the insanely complex world of macro-economics.”

    If we are going to pull the science line I will have to point out that there is a sharp distinction between describing, predicting, and making a policy relevant case – to do the third and judge policy you need to understand the structure of the model.

    You are completely right that macroeconomics is incredibly complicated, and that it can be hard (impossible even) to reduce down macroeconomic phenomenon to microeconomic arguments. However, we also have to deal with the fact we can’t measure the very factor that policy is supposed to maximise – social welfare.

    In that context, it is very important to articulate how policy could impact upon social welfare, and make sure that policy passes a firm burden of proof – first do no harm and all of that. This relies on making conditional models that are transparent and then having debate around that. Furthermore, there are cases where the burden of proof can be flipped (financial markets given they are regulated) – and the discussion about this is alive and well in the discipline.

    If you are interested I touch on the issue here:

    http://www.tvhe.co.nz/2013/06/20/on-economics-as-method/

  • @ Bart:

    Let’s say that I believe that the alignment of the planets and moon mean that there will be a devastating hurricane in Auckland in three weeks time, and that we should be getting people out of the city, and meterologists scoff at my theory. Is it sufficient for me to note that meterologists rely on faulty models, can’t predict the weather more than 10 days out anyway, and suffer from groupthink. Or should I be suggesting some reason why one might expect a link between heavenly bodies and Auckalnd hurricanes?

    You say that for a non-economist, treating housing as a speculative investment instead of a fundamental human right seems inhumane. What do you mean by “treating”. Can it not be the case that it is both a human right and at the same time used by some as a speculative investment? Where in any of the housing posts on this blog have you seen any economist thinking of it as the one and not the other? What I have seen from the non-economists here and in the other places these blog posts have been published, is a confusion between housing and houses, and between foreign ownership and immigration. By all means, lets consider different theories, empirical evidence, etc. But that is all pointless, if we clear the confusion first.

    Chirs B:

    I agree entirely. Which is why I never said that speculation is a stabilising force–only that speculation that makes money is.

  • Seamus, take the telescope from your blind eye. Put it over your good eye and point it to Jupiter tonight (I cant remember if it is up tonight but I can predict it if I look for the data). Observe it with twice an hour apart. Did you see the dots closest to Jupiter move? I hope so. Thanks to Mr G, from that day onwards, we separated astrology from Astronomy. Today, not even a meteorologist would dare suggest the idea you propose. It WAS empirical evidence Galileo gathered. He saw, he copied. Then he thought about the consequences for quite a few days. Torture, death and general personal destruction entered his mind for some religious “reason”. Newton came along and offered quite a nice model. Thus my confidence I can predict when is a good time to observe Jupiter.

    Now. Back to predicting house prices.

  • On the contrary, Seamus, there is no need for speculation to be stabilising in order to make money. You can buy dear and still make money, so long as you are selling even dearer. Prices are pushed up as certainty spreads that the run will continue, but people are still making money, right up until the downturn rolls around.

    At which point the question becomes who holds the assets at that moment of truth? Are the speculators even speculating using their own money, or are they drawing salaries and bonuses based on their performance?

    As far as the housing market goes, even people who intend to live in their purchased houses are likely to be motivated to some extent by speculation about the future value of those homes. As are the banks lending them money. After all, there’s precious little risk in high loan to value ratios if you can simply sell the house at a profit if the borrower fails to make their payments.

    The sub-prime mortgage fiasco constitutes a pretty good example of what can happen if self-reinforcing speculation that housing prices will continue to go up sets in.

  • Chris: Yes, lesser fools can make money off the greater fools, but destabilising speculation has to lose money in aggregate. And yes, a boom and bust cycle resulting from a loss-making (in aggregate) speculative bubble can have bad consequences more generally. So I don’t have any problem with an analysis of the housing market that claims a) that house prices are inflated because of an irrational exhuberance speculative bubble and that it would be good to burst the bubble before it gets to big, and b) that a specific suggested policy will bring about that bursting. My 5 principles are a starting point for discussing policies. So, for instance, someome might claim that the Auckland house market is indeed in a bubble, that foreign owners are more irrationally exhuberant than domestics, and that the fall-out from a housing boom-bust would outweigh the benefits of the income the country would receive as a whole from foreigners buying high and selling low. And one could reasonably argue back that the price-to-rental ratios in Auckland are not so high as to not be consistent with expected future increases in rental rates purely as a function of predicted population growth and the lack of progress in freeing up more land for housing or creating more high-density development. The point is, that following on from Matt’s comment above, we would have clearly identified the different assumptions and value judgements that lead to different conclusions and can rationally discuss which seem more likley. This is a reasonable way of making progress in thinking about the issue.

    In contrast…

    @Ross: I propose a reductio ad absurdum and your response is that my absurdum is absurd?

  • Well when it comes to trying to predict “rational” behaviour by speculators. I think that falls into a category similar to astrology.

    “2. Speculation works by buying assets when their price is expected to rise and selling when the price is expected to fall, thus reducing price volatility. ”

    and

    “only that speculation that makes money is.”……..stabilising.

    Hang on, can you have that both ways? Your (2) says that if you follow that principle then speculation (should?) neither gain or lose money. If it does gain or lose money then surely that kind of speculation would be expected to increase volatility.

    But then, I have only ever been a self built “one house bloke”. Oblivious to the benefits of screwing other people. Even in some of my friends eyes that is seen as being pretty absurd behaviour.

    I’ll have to remain happy in my economic ignorance but at least I know when to look for a few moons floating around the heavens. And now Fonterra may look to be as exciting.