In recent years another strand of research has emerged, which, rather like the political economists of yore, attributes many long-standing economic ills to land. It explores how high and rising land prices affect lending, investment and ultimately productivity…
The worrying conclusion is that high and rising property prices can also have damaging economic effects, by crowding out productive investment and leading to a misallocation of capital. In the most extreme cases, inflated land prices may already be the cause of a protracted slowdown in productivity growth…
Real estate is the largest asset class in the world. In 2020 it made up around 68% of the world’s non-financial assets (which includes plant and machinery as well as intangibles, such as intellectual property). Land, rather than the structures built on top of it, accounts for slightly over half of that 68%. As values have ballooned, the share of land in non-financial assets has increased sharply in some countries…
Firms’ ability to borrow tends to be determined by their existing assets, rather than their productive potential…
Rising property prices can also discourage productive lending, and lead to capital being misallocated… this is often accompanied by reduced lending to businesses…
I have written extensively on this issue since the birth of MB more than a decade ago.
In Australia’s case, resource allocation has been channeled away from the tradable sector and infrastructure investment towards the financial sector, as home buyers took on on ever-larger mortgages chasing house prices higher:
Extreme house price inflation.
This severe distortion in resource allocation is illustrated by the sharp rise in mortgage lending compared with business lending, which has starved productive sectors of the economy of credit.
In the early 1990s, Australia’s banks lent around two-thirds to businesses, with the balance split between mortgage and personal lending. But after the mid-1990s surge in house prices, these ratios flipped, with mortgage lending dominating at the expense of business lending:
Explosive growth in mortgage lending fuels house prices.
Businesses starved of credit.
The finance and insurance industries – which are dominated by mortgage lending – have in turn grown at around twice the pace of the rest of the economy since financial markets were deregulated in the mid-1980s:
Australian economy financialised.
Land is also a key input cost for most businesses. So when costs are inflated, it reduces the competitiveness of industry, making it harder for Australia to compete abroad. The associated higher housing costs also reduces households’ disposable income (other things equal).
Land inflation swallows Aussie economy.
One can only wonder how Australia would look if the trillions of dollars of capital that had been poured into pre-existing housing was instead funneled into businesses as occurs in productive places like Germany. Instead, Australia has been left with non-mining companies that are struggling to compete and stillborn productivity growth that now lags the OECD:
Australian productivity lowest in 60 years.
Would Australians be worse-off if the median capital city dwelling price was $375,000 instead of $750,000, mortgage debt was 70% of disposable incomes instead of 140%, and the banking sector was smaller, less profitable and more focused on businesses?
Obviously not. Lower debt burdens would make Australian households better-off, whereas the broader economy would benefit from the productivity-lifting effects of lower land prices, increased business lending (investment), and a more balanced macro economy.
Leith van Onselen is Chief Economist at the MB Fund and MB Super. He is also Chief Economist and co-founder of MacroBusiness.
Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.
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