The Economist called it “the West’s biggest economic-policy mistake” undermining economic growth and the public’s faith in fairness and capitalism. The mistake the Economist is referring to is the misguided policies promoting home ownership which created the developed world’s most serious economic failure. At the root of this failure is the application of planning rules that have restricted housing supply, particularly close to major cities. This has led to soaring rents and house prices in the cities, hindering workers from moving to areas where the most plentiful and productive jobs are located, and ultimately slowing GDP growth.
Lost wages and productivity
The real costs to the economy of constricting supply in US major cities was identified in an analysis by economists Chang-Tai Hsieh and Enrico Moretti in 2015. They found lack of affordable housing in cities like New York, San Francisco and San Jose (home of Silicon Valley) costs the U.S. economy about $1.6 trillion a year in lost wages and productivity.
The effect has also been studied in New Zealand by Peter Nunns whose 2019 research found that housing supply constraints caused by restrictive zoning rules in our major cities have played a large part in rising house prices. It has also had significant economic impacts by pulling labour away from high-productivity regions in New Zealand, in particular Auckland and Wellington, and increasing net migration of New Zealanders to Australia. Nunns estimated that the total economic gains from reducing housing supply constraints in New Zealand amounted to as much as $21 billion per annum, or 7.7 percent of GDP.
Soaring house prices a recent phenomenon
House prices have not always risen at the rate we have seen in recent decades. In fact, prices in most industrial economies prices stayed constant from the 19th to mid-20th century (Knoll, 2017).
According to Fessler and Schürz, it was only during the 20th century that owning a single-family home became a focus and a sign of making it into the rising middle class. After WWII property also became a major vehicle for wealth accumulation, driven by rising land prices. They argue that land prices increased due to deliberate policies to restrict land use plus incentives to encourage people to funnel more money into the mortgage market.
The increasingly exclusive club of homeowners has meant the only way for most people to get into the market is with parental support or by taking on large amounts of debt. This has also made the housing market volatile, with many financial crises, including the 2007 GFC, emanating from housing bubbles.
Exacerbating the generational wealth gap
As real wages stagnate and house prices continue to rise it has increased the divide between the typically older home owners and the young who are finding it tough to enter the market. It may even be causing a political shift with the Economist report arguing that “young people’s view that housing is out of reach — unless you have rich parents — helps explain their drift towards ‘millennial socialism’.”
The Wealth Effect
Rising household debt can be positive in the short term, by boosting economic growth and employment according to a study by the IMF. However, within three to five year those effects are reversed as heavily-indebted households are forced to rein in their spending. Economic growth is slower than it would otherwise be and the likelihood of a financial crisis increases.
Fessler and Schürz argue when combined with the challenges of an aging population and climate change the dream of the single-family home has become a major problem. And it is one which policy makers are terrified of confronting head on even if it is harmful for society and the economy.
Housing New Zealand
It is well documented that New Zealand now has one of the most expensive housing markets relative to income in the OECD, with Auckland the fourth least affordable city in the world (according to Demographia). AWhile loose monetary policy has led to an explosion of house prices globally, Bloomberg describes New Zealand as “a poster child for the boom”.
Real house prices increased an average of 1 percent per annum from 1965–95 then jumped to 4 percent per annum from 1995–2015:
Home ownership is increasingly out of reach for many and ownership rates are now the lowest they have been since the 1950s. Home owners are also getting older: for those aged 25–29 years homeownership has dropped from 61 percent (in 1991) to 44 percent (in 2018). For those aged in their late 30s the rate has dropped from 79 percent to 59 percent over the same period.
An aging population has also seen the size of New Zealand households shrink — further exacerbating the housing shortage. According to Stats NZ in 1951 the average household size was 3.7 and in 1981 was 3.0. Today that figure is just 2.7. Consents for new homes are up with the numbers of houses consented in 2020 the highest for 46 years, however they are still below 1973 levels on a per capita basis.
As in other Western countries politicians on both sides of the political divide have supported house prices. CoreLogic’s head of research Nick Goodall said there were consistent messages from the current Labour government about the need to protect property wealth. This is not surprising as the majority of voters are homeowners meaning there is currently little political will to address the issue.
However, despite being politically unpalatable, the tide may be changing. Governments throughout the Western world face increasing anger at the shortage of houses and soaring housing wealth inequality. At some point they will have no choice but to address the housing affordability crisis that almost no homeowner wants to solve.