by Adam S. Posen, Peterson Institute for International Economics
Op-ed in the Financial Times
July 26, 2013
© Financial Times
You would think that the residential property bubble and subsequent crisis of the past decade would make people leery of widespread home ownership, and governments reluctant to pump it up. Yet, here we are again.
Despite the continuing fiscal tightening, the UK coalition government is pressing on with its "Help to Buy" scheme and the US Congress continues its unquestioning protection of the home mortgage interest tax deduction. This is the economic policy equivalent of incurring the individual and social costs of an obesity epidemic while still subsidizing maize and beef production—but maybe more fixable.
Things do not have to be this way in the Anglo-American economies. Policies to increase home ownership do not necessarily improve the supply or distribution of housing, as the UK experience demonstrates, and often works against it. The Organization for Economic Cooperation and Development's (OECD) Better Life Index shows that no relationship exists between a country's home-ownership levels and its average housing satisfaction and quality. And there is no iron law that higher-income economies must have higher rates of home ownership: Mexico, Nepal, and Russia all have home-ownership rates of more than 80 percent, while the French, German, and Japanese rates are 30 to 40 percentage points lower. The US and the UK rates sit between them at about 65 to 70 percent.
The real issue, however, is the harm done by efforts in the United Kingdom and United States to maintain and increase that rate. Start with the distortion to savings behavior that mortgage subsidies and high loan-to-value ratios encourage. For many American and British households, their home equity is their primary financial asset. In other words, we incentivize middle-class households to leverage the bulk of their savings into a highly volatile, difficult to price asset, which is subject to disaster risk both idiosyncratic (fire, tree falling on the roof) and general (flood, local industry closure), and which—based on the economic fundamentals—should return at best the average rate of local wage and population growth.
Average individuals cannot calculate, let alone reasonably project, the running costs and financial risks of their housing investment as opposed to renting and putting their savings in more stable, liquid assets. But they constantly hear the misleading mantra that renting "is throwing money away" while incurring mortgage debt "builds equity." So their savings go into housing, which puts them to little productive purpose as compared to investing in new businesses, infrastructure, or research and development—or, for that matter, compared to rental housing that provides the same services but costs less (when individuals are not paying for the option on artificial capital gains that goes with ownership). Overinvesting in bricks and mortar is a losing proposition for the households involved—but also for the economy as a whole.
The mass movement of voters' savings into an inherently risky asset also creates demands on policymakers to provide capital gains on housing that their constituents otherwise would not receive. As a result, we get a combination of regulatory measures, local stimulus plans, subsidies to property lending, and bias towards inflation that promote housing bubbles. And it is housing booms and busts that wreak the most havoc on economies of all bubbles, including through the concomitant destruction of banking systems. This was evident from history even before our current crisis, as my colleague Tomas Hellebrandt and I have shown.
But if the disasters in the United Kingdom and United States were not enough, recent events, including overheated property markets in China and Turkey, further illustrate the point. This danger alone would be justification enough to having governments lean against housing price swings, as opposed to pursuing policies that promote real estate speculation by individuals.
The costs of excessive home ownership, however, go even further. The promotion of such ownership is fundamentally regressive. It perpetuates inherited wealth and subsidies of middle-class children. The accumulation of housing wealth benefits those simply lucky enough to have had grandparents who were homeowners. Any policies to promote younger people "getting on the property ladder" will disproportionately benefit those fortunate children who have been given savings, have parental co-signers, and can show stable prior residency. They come at the cost of spending that money elsewhere, say on housing credits for the poor. They also perpetuate an influential lobby to protect mortgage debt and housing assets from taxes, whether while living in the asset or passing it on to family members. Like all favoritism to the children of the relatively rich, this discourages the development of new talent and competition, and thus is economically harmful.
Home ownership also directly discourages economic flexibility. In new research, my colleague David Blanchflower and Andrew Oswald of Warwick University have found that rises in the home-ownership rate in a US state are a precursor to eventual greater rises in unemployment. Home ownership damages employment through three powerful channels: decreasing levels of labor mobility, increasing commuting times, and diminishing creation of businesses. Their evidence suggests that the housing market can produce negative "externalities" on the labor market.
Of course, in a free society, people who want to own homes and have the means should be able to purchase them, just as they would any other luxury item. But our governments do not need to subsidize that purchase. Increasing home ownership does not increase housing, least of all for the poor. Increasing home ownership in the United States and Britain beyond what the free market would generate does, however, distort capital allocation, put a large share of household savings at unnecessary risk, impede mobility, and creates a powerful lobby for government transfers to the wealthy. And it creates housing bubbles to devastating effect.
When we are attempting large fiscal consolidations, could we at least start by ending these destructive housing policies rather than cutting useful investment and progressive programs?
Working Paper 13-3: Does High Home-Ownership Impair the Labor Market? May 2013
Op-ed: Be Warned George Osborne: More Home Owners Just Really Means Higher Unemployment May 12, 2013