Stephen Koukoulas (aka “the Kouk”) penned a confusing post yesterday in The Guardian entitled “Economics 101: house prices are surging because of low supply”, which is worthy of dissection:
…there is a basic economic principle that dominates these distortions over the longer run, and that is the interplay of housing supply and demand.
Until very recently, Australia’s strong population growth fuelled unrelenting growth in underlying demand for dwellings at a time when new building was not adding sufficiently to supply. This housing shortage, mixed with aggressive interest rate cuts and tax rules, underpinned strong house price gains.
Economics 101 suggests that for a given level of growth in demand (population growth and household formation rates) a larger increase in supply will lower prices, regardless of tax rules…
New housing supply relative to a given level of demand will lower house prices and address housing affordability and issues such as negative gearing and capital gains tax will be largely immaterial. One only has to look at the recent trend in house prices in Perth (down 10% from the peak), Darwin (down 7%) and Karratha (down 65%) to show how a drop in demand relative to supply affects prices and therefore affordability. Anecdotally, there are very few investors lining up in those cities.
The tax rules still apply in those cities, which makes it a furphy to focus on capital gains tax and negative gearing rules as a long-run driver of house prices. They are still absolutely vital issues in terms of tax efficiency, fairness and equity but in terms of driving house prices, they are a second-order issue behind supply…
The end point is that tax issues, however broad, would count for little if a surge in housing supply swamped demand.
To be sure, it is difficult to engineer a lift in supply in the short run given the state and local governments largely control this space and new supply needs to be serviced by high-quality infrastructure (transport, schools, shops and the like) to make it desirable. But if Australia was ever able to sustain a lift in new dwelling construction, affordability would improve and the tax system would be debated on issues of fairness, equity and distortions.
Economics 101 dictates that there are two sides to the housing equation: a demand-side and a supply-side. So why has the Kouk focused only on the supply-side, especially given that “it is difficult to engineer a lift in supply in the short run given the state and local governments largely control this space and new supply needs to be serviced by high-quality infrastructure”. His sole focus on supply is also inconsistent with his claim that a “drop in demand relative to supply affects prices and therefore affordability”.
The Kouk pretty much admits that Australia’s world-beating immigration program “fuelled unrelenting growth in underlying demand for dwellings at a time when new building was not adding sufficiently to supply” and that this “underpinned strong house price gains”, so why not argue for a moderation of this immigration intake back down to sensible levels to bring “the interplay of housing supply and demand” back into balance?
The Kouk’s arguments around reforming negative gearing and the capital gains tax (CGT) discount are also a classic strawman. Nobody ever said that these tax distortions were the only forces at work in house prices, nor is there any evidence that they are still not impacting prices despite the declines in Perth/Darwin/Karratha. It’s also a rather large mood swing from the Kouk who wrote in February that:
Labor’s reform proposal for negative gearing is well founded in fairness and economics. But like most reforms, particularly ones which remove a well-entrenched and significant market distortion, there are likely to be some consequences for the housing market and the economy as the reforms take effect…
It is the sort of policy change that has been needed for many decades and the good news is it probably means the risks for house price booms in the future are greatly diminished and housing affordability, in time, will improve and home ownership rates, which have been falling, should again pick up.
In the end, there are a whole bunch of measures that the government could implement to make housing more affordable, and these reside on both the demand and supply sides. These include:
- Reducing immigration down to sensible levels;
- Tax reform;
- Tighter rules and enforcement on foreign ownership; and
- Land-use and planning reforms.
Given the federal government has most control over the first three areas, it makes sense for it to reform these first while it works with the states over the longer-term to free-up land use and planning.
Unfortunately, the Coalition Government has ruled-out any demand-side fixes and has effectively pushed supply-side reform onto the states.
If anything, the federal government has shown a determination to juice demand even more by priming the immigration pump via allowing 6 year-olds and their guardians visa entry into Australia’s primary schools, as well as freeing-up rules to allow migrants to bring into Australia their elderly parents – both of which will further boost housing demand (other things equal).
In short, the federal government has no interest in fixing housing affordability. And judging by the above analysis, neither does the Kouk.
