2020.11 The Taiwan Banker NO.131 / By Nan-kuang Chen (Vice President of the Central B
Continuously Rising Housing Prices may Harm GrowthBankers Digest
Taiwan has an 85% homeownership rate, and about 88% of those are single-family houses. Rising housing prices will make life more difficult for families with only one house – much less those with none. Higher prices mainly benefit real estate investors and those with multi-family houses. The negative effects on GDP and productivity need to be carefully considered. Some think that rising real estate prices make everyone richer. This “wealth effect” would drive consumption, and people would also be able to trade their houses for larger or better-located ones. The economists Chen Nan-kuang and Wang Hung-Jen however used Taiwanese data to show that changes in housing prices had an insignificant effect on overall consumption, in stark contrasts with the relationship found in Western countries. When prices increase, middle-aged and elderly homeowners increase their consumption only slightly, but consumption among the young, as well as renters, strongly contracts. These two effects roughly cancel each other out, resulting in almost no wealth effect. Economic driver or brakes? Higher prices for houses mean that the user cost of their housing services they provide (i.e. imputed rent) also increases. Thus, homeowners don’t necessarily become richer from higher housing prices. Taiwan has a much higher rate of homeownership than most other countries, at 85%. According to the 2019 House Tax Registered Personal Property Owner Count statistics published by the Financial Data Center of the Ministry of Finance, about 88% of homeowners own only one house. When prices rise, such families are unlikely to sell. That’s why some believe that “housing wealth is not real wealth.” Rising prices make it more difficult for these families to buy – much less those without houses. The main beneficiaries are real estate investors and those with multiple houses. We can also observe changes in contribution to GDP by industries related to housing over previous housing price cycles. According to annual income data from the Directorate General of Budget, Accounting and Statistics, these industries include construction, real estate, and residential services. Fig. 1 shows the total GDP contribution of construction and real estate from 1981-2018 (most of the value of residential services comes from imputed rent). During the period of surging prices from the late 1980s to early 1990s, this ratio increased from 4% to 6%. Afterwards, the housing market entered a period of consolidation for about ten years where the ratio gradually dropped to 3%. After 2003, the market improved, but the ratio still increased only to 4%. From 2009-2014, prices accelerated, but the ratio still remained largely unchanged. Construction and real estate have not contributed significantly more to GDP, despite over a decade of strong markets. As mentioned earlier, many people think that real estate is closely related to many industries and is therefore an important economic driver. Industry relationships can be divided into backward drivers (influencing the other industry) and forward drivers (affected by the other industry). If the relational degree is greater than 1, the effect is strong. Economic drivers refer to industries with strong backward relational degree, helping other industries develop. The total relational degree is the sum of forward and backward relevance. According to the 2016 Industry Relationship Analysis Report issued by the Directorate General of Budget, Accounting and Statistics, the industries with the highest relational degrees were chemicals (6.01), basic metals (5.24), petroleum and coal (3.59), and electronics components (2.58). A total of 11 driver industries had forward and backward relational degrees both above 1. Industries closely related to housing include construction (2.08), real estate (1.92), and residential services (0.96). Although the forward relational degree of construction is greater than 1, it’s still far from a driver industry. Further reviewing the previous industry relationship analysis reports (published every 3-5 years since 1986), real estate and residential services both had low relational degrees for a long time, with backwards and forwards relational degrees of 0.5 or 0.6. Therefore, industries related to housing have never been Taiwan’s economic locomotives. In fact, the “Shelless Snail Movement” Forum (2010) and the Housing Reform Alliance (2014) have long refuted this concept, but longstanding misconceptions take a long time to die. This concept not only influences policy planning by the government and central bank, but could also hinder normalization of the housing market. Moreover, the government has promoted the 5+2 industry innovation plan to accelerate Taiwan’s industry upgrade and structural transformation and drive the next generation of Taiwan’s industries, making it less likely that industries tied to housing could become the next drivers of the economy. It’s worth mentioning that residential services are still an underdeveloped industry with unrealized potential. Measures including charter escrow and leasing laws could improve the leasing market and professionalize operations. Not only could this alleviate problems caused by high housing prices, but also the resulting management fees could also contribute to GDP growth. Resource misallocation effect Recent research has begun to focus on the possible resource misallocation effects of high housing prices. The main idea is that as prices rise, capital and labor may be diverted to related industries, crowding out the labor and capital available to other industries. The channels for this effect may include banks (which provide more funds to sectors related to housing or to developers or invest more in real estate, crowding out other companies) or investment (companies buy more real estate, and invest less in other areas). Interestingly, these studies also found that reducing financial friction in the lending market doesn’t necessarily improve the efficiency of capital allocation, since capital may be allocated based on the value of land companies hold as collateral, rather than their productivity. Bank credit and collateral value mutually reinforce each other. This resource allocation distortion damages long-term productivity growth. Chen Nan-kuang, Chang Tien-huei, and Chu Hao-bang have used Taiwanese data to research the effects of changing housing prices on GDP, investment, and total factor productivity (TFP). Their preliminary results show that when prices rise, the output of the construction industry hasn’t changed significantly, but manufacturing declines significantly. Although employment in construction increases significantly, it does not change significantly in manufacturing; and finally, TFP in both industries declined significantly. Overall, surging housing prices have had a negative long-term impact on Taiwan’s GDP and TFP. One of the factors that reduce a company’s TFP is investment of funds that should be used for productive activities into real estate. Speculation in real estate reduces other investment, productivity, and economic growth. Taiwanese companies have invested increasing amounts of money in real estate over the past 1-2 years, which could crowd out more substantial investment. What's more, if prices are expected to rise in the future, even if not currently doing so, related industries still absorb resources. With loose monetary policy and low taxes, the cost of holding surplus homes is low, and developers can stock up in preparation for future price increases. They can even use these homes to apply for further lending, which means that liquidity can be used to buy land or promote projects, further increasing prices and making the price mechanism completely useless. Since the number of surplus houses hasn’t changed in recent years (remaining around 80,000), a large amount of resources has been idled, causing further misallocation. Over the past year, lending by domestic banks for surplus housing has increased at an annual rate over 120%, which warrants close attention. We also see that real estate lending in Taiwan (including loans for home purchase, repair, and construction) is growing to a record percentage of GDP. Resources are rapidly being concentrated in industries related to housing. The annual growth rate of construction lending was 15.46% as of July, and real estate loans reached 52.04% of GDP, with both numbers continuing to rise. Resource misallocation will not only drag down long-term growth, but even in the short term, excessive concentration of resources in industries related to real estate will promote the housing price cycle, increasing systemic risks and threatening the stability of the financial system. Therefore, the central bank, as part of its commitment to stability, should also take into account potential cyclical risks due to cross-sector resource misallocation. Continued price increases could hurt the real economy It is very important to understand the overall impact of real estate price changes on the behavior of corporations and households and the economy in the short and long term. A profitable real estate market certainly has positive effects on the real economy, but we cannot ignore its possible negative effects. The central bank should deploy macroprudential measures as soon as possible, before expectations of real estate price increases set in, to stabilize the housing market and financial system and prevent medium-term risks of a financial cycle. Not only do housing price increases have almost no wealth effect, but they have never driven growth in other industries. And even though prices rose in the 10 years from 2003-2014, the contribution of construction and real estate to Taiwan’s GDP did not increase. In an environment with low interest rates, high housing prices, and lots of surplus housing and lending based on it, further increases in housing prices may help the economic recovery, but could also lead to further misallocation. Taiwan needs to address the resulting long-term damage to productivity.