The housing bubble has a lot to answer for in terms of holding back real wealth creation in this country, argues Peter Lyons.
No country in history has ever got rich from its people buying and selling houses. Despite recent urgings from some bank economists and real estate pundits that a housing rebound is imminent, the likelihood of a sustained renewal of the housing boom is negligible.
Adam Smith highlighted what makes countries wealthy in his book, An Inquiry into the Nature and Causes of the Wealth of Nations, published in 1776.
He stated the wealth of a country derives from the production and exchange of goods and services. In the modern era, the value of the output of a country is measured by Gross Domestic Product. This is the value of final goods and services produced by an economy and is used as an indicator of economic growth.
The buying and selling of existing houses adds little to this measure of national prosperity. It represents a transfer of wealth. Let's consider a simple transaction of a person buying a $500,000 house with a 20% deposit. The net effect is the buyer ends up with an existing asset of $500,000. In return, they have reduced their own cash asset by $100,000 and acquired a mortgage liability of $400,000.
There is no net increase in production or wealth for the economy. The seller has exchanged a $500,000 house for $500,000 cash. If the $400,000 mortgage has been borrowed from overseas then some of the country's future income will be given to the overseas lender in the form of interest and debt repayments.
Over the past decade, this process became turbo-charged in New Zealand as mortgage finance flooded in from overseas, attracted by our relatively high interest rates. These overseas funds were used to bid up our house prices.
This process did little to enhance our future prosperity. It resembles a giant game of pass the parcel. hosted very profitably by the banking sector.
The real cost to the economy of this process is what economists call opportunity cost. The funds that were borrowed to bid up house prices could have been used to increase the productive capacity of New Zealand through investing in machinery, factories and new businesses.
The cost to New Zealand has been this wasted opportunity. This would have generated the income to service the debt. Unless we face up to this reality we are likely to repeat it once the current financial crisis is over and credit is flowing again.
House prices should reflect national prosperity, not the other way around. In recent years, house prices have driven national prosperity in an illusionary process based on debt. The key function of a house should be to provide a dwelling for people to live in. Using houses as speculative assets does not enhance national prosperity.
A nation that borrows heavily to finance a housing bubble is kneecapping itself in terms of future prosperity. Until we recognise this and make the appropriate policy changes, our relative economic decline will continue.
There are several key reasons why this process has occurred. The first is a lack of political gumption to address the favourable tax treatment of investment in residential property. New Zealand politicians have a tendency to run for cover when a capital gains taxes on property is mentioned. This maintains a major distortion in the investment landscape in New Zealand.
The other reason is called the fallacy of composition. This states that what holds true in part may not hold true in the whole.
An individual can become rich by buying and selling houses but a country cannot.
We all know someone who has done well out of property investment. We seldom hear anyone boasting about how much they lost on the sale of a property.
There is also the myth of the wealthy expats and migrants bidding up house prices. While this may have had some affect on price levels it still represents a transfer of wealth rather than the creation of new wealth for New Zealand.
The money spent on inflated housing could have been used for investing in new business ventures which would have created jobs and output in the real economy. There is still an opportunity cost.
In the current era of globalisation, a country can be severely penalised for distorted economic policies. Our tax policy has heavily favoured investment in property.
Easy access to funds from abroad in the past decade helped fuel a housing boom that was neither sustainable nor desirable in terms of enhancing long-term national prosperity.
A country should pride itself on the affordability of houses for its citizens. This ensures they do not have to indenture a large part of their future earnings to banks and other lenders just to own the roof over their heads. They can then invest their savings in ventures that enhance the prosperity of the country through the production of saleable goods and services.
- Peter Lyons teaches economics at Saint Peters College in Epsom and has written several economics texts.
