Home Editor's Pick Housing Costs: How They Undermine Western Prosperity and How to Fix the Problem

Housing Costs: How They Undermine Western Prosperity and How to Fix the Problem

by internationaldirector

Housing has underpinned the growth of human civilization. With the rise of capitalism, housing costs have become an important part of the household decision matrix. After the scientific revolution and the increase in medical science that accompanied it, housing demand has seen a boom alongside that of the global population. This demand has been further fueled by the rise of the nuclear family, which has guaranteed a fresh housing demand after every generation. Yet, over the last few decades, housing costs have seen unjustified rises due to various factors. These factors have adverse political, economic and social effects. Addressing the causes of housing increases can remove potential obstacles on the path to continued human prosperity.

House prices: a growing problem

Countries all over the world have seen an increase in their housing costs, regardless of whether they are developed or growing economies. According to the International Monetary Fund’s (IMF’s) Global Housing Watch, housing prices have seen a massive increase over the last 18 years. The image below depicts the general trend of increased housing prices.

From the above image, keen observers will glean the fact that the housing-price relief provided by the 2009 global housing financial crisis is no longer there. Prices are on a constant increase, and if the latest figures are any guide, this trend is expected to continue well into the future. Such conclusions are further confirmed by individual-country analyses. The following graph shows that housing prices in most of the countries of the world increased in the third quarter of 2018.

This price increase would not have been alarming if the income increase had matched or overtaken the increase in house prices. Unfortunately, that is not evident from the data provided by the Organisation for Economic Co-operation and Development (OECD). The data from the OECD shows that housing prices have increased more than income has. This is true for both highly developed countries as well as the rest of the world. The image below shows the data for highly developed countries.

Meanwhile, the following image summarizes the house-price-to-rent situation all over the world.

Implications of this growing problem

Ever since rising housing costs have become the norm, they have had a number of adverse effects on the households that form the backbone of any economy. The most direct effect has been the rise in the cost of living. The higher cost of living, not supported by a rise in wages, simply translates into decreasing standards of living—households will compromise their consumption of other goods to meet this basic necessity. Considering that housing is a basic need for any household, the government has an egalitarian responsibility to ensure that households can afford this necessity. Apart from leading to lower living standards, economists also need to pay attention to the fact that a rise in the price of a necessity leads to cannibalization of spending on luxury items. These luxury items can include the service sector as well as fast-moving consumer goods (FMCGs). A decrease in spending on these goods will lead to lower demand, which can lead to job losses for labor in the service and FMCG sectors.

Moreover, housing is often a big part of spending on other activities. Two of these areas include higher-education cost and take-home pay (net of housing costs) for migrating labor. A rise in housing cost raises the cost of attending college, most of which is done out of the local area. Take the example of American higher education. According to the National Center for Education Statistics (NCES), the cost of a college education has doubled since 1989, even after accounting for inflation. Such rising costs have promoted student debt to become the biggest source of non-housing debt. The image below provides a breakdown of the US non-housing debt.

School living costs contribute to the growth of student loans. This debt can become a toxic liability, especially when it comes with high interest rates that compound over time. In the long-run, this can lead to low spending power due to debt and interest payments. This debt can then become a mechanism for income transfer from the middle class to the elite class.

The influence of the housing crisis is not limited to the board room. Sometimes it can play havoc in the bedroom as well. Millennials are being forced to move their marriage dates because of rising housing costs. This decision is influenced by sharing the costs of marriage ceremonies with mortgage payments, and by the choice of rearing children. Since housing considerations influence decisions to bear children, one could say that housing prices are moving the age pyramid towards faster aging of the population. This can lead to shorter demographic-dividend periods for the global population.

Apart from making society older, housing crises also have a tendency to make societies more unequal. Rising housing prices, relative to wages, means that older owners have locked into the market. High house prices effectively function as a barrier to entry into the housing market. Historically, many nations have seen their house ownership being secured on the basis of race because of racist federal policies. For example, the United States has seen whites have higher homeownership rates as compared to black property owners. The following image gives a historical perspective on the disparities in ownership.

Rising prices could highlight that the racist designs of old governments are also enforced in the present time. Such disparities can compromise inter-class and inter-race harmony within society. All of these implications will make housing costs one of the main challenges for any political leadership.

Taking actions to tackle the rising challenge

There is no silver bullet that can kill the housing-crisis monster. Instead, the secret to countering rising housing costs lies in attacking the problem at its core. The housing problem emanates from a number of factors that either increase the demand for housing or constrain the supply of newly built units. If governments of the future want to continue on the path towards prosperity, they will have to tackle each of these factors. The following discussion will examine each of these factors and recommend various solutions for countering their effects on the housing market.

Supply-side

Starting with the supply-side, the supply of new houses is constrained by legal and resource factors. Laws of various nations create artificial constraints on the supply of new housing units via zoning laws, layered-approval processes and rent control. Zoning is a process through which certain land portions are dedicated to specific uses. Generally, these uses can include commercial, residential and mixed-use buildings; however, further categorization is not uncommon. Zoning is implemented on various grounds, such as maintaining greenbelts and meeting the needs of various income groups. Sometimes, these zoning laws can become an impediment to building much-needed housing units. Some zoning laws have limitations on floor-coverage area, which forces builders to leave empty space that can be utilized by housing units. Other zoning laws place a cap on the number of floors per building. This raises the cost per house in cities with expensive land prices, such as London and Mumbai. Redesigning zoning laws in light of modern conditions will help lessen the effects of zoning laws on housing prices.

Even if zoning laws allow appropriate area coverage and don’t carry height restrictions, other impediments can cause house prices to be higher than they need to be. The most counterintuitive of these include “rent controls”. Rent controls give maximum limits for the rent that tenants can be charged. This law seemingly benefits the consumer in the short-term while decreasing the rate of return for the owner in the long-run. Like any other asset, housing will stop attracting investment once its rate of return starts falling compared to that of other assets. That lack of investment has translated into fewer houses being built as compared to when controls were not enforced. Lawmakers must realize that allowing higher rent will push the market to build additional housing units that will ultimately bring down house rents.

Apart from rent controls, the layered-approval process is another artificial burden that slows down the construction industry. This burden comes from the local bureaucracy as well as the population. Local bureaucracy often presents itself as a myriad of bodies, the approval of which is necessary before the construction of a housing unit. Often a NOC (no-objection certificate) from one body is required before applying for approval from another government body. This staggered approach delays the critical path (minimum time required for the completion of a project) for housing projects. The approval process  can be hampered by the “not in my backyard” attitude of the population. This allows any small group of individuals to throw a spanner in the workings of house construction. As it turns out, local and provincial governments have a vested interest in keeping housing costs unconstrained. Higher housing costs mean that local governments make more in property taxes. National governments need to recognize this vested interest and provide local governments with alternate sources of funding in order to battle this issue.

All of the above-mentioned artificial factors can be eased using holistic and prudent decision-making. Other than the artificial factors, high resources pricing also slows down the supply of new housing units to the market. Most of the increase in supply costs comes from labor and imported materials. Housing-construction labor is often in surplus supply in the national economy. However, scarcity of local labor can be a major bottleneck in the construction industry. Furthermore, just like many industries, the construction industry relies on a global supply chain to source its inputs. It’s no surprise, then, that tariffs are driving up construction costs . The economists of the nation need to ensure that the tariff-setting committees include the inflationary effects of tariffs in their decision-making.

Demand-side

Although many factors constrain the supply of housing, other elements are responsible for driving the demand for housing units. For the sake of policy implications, this section will discuss only those demand-side (DS) factors that can be influenced by government action. More often than not, these DS factors are more local in nature as compared to supply-side factors.

The most regrettable DS factor for rising house prices is speculation (speculation refers to holding on to land for the purpose of making a high return). Speculation can be in effect for a number of reasons. These reasons include lack of other good investment opportunities and market expectations. Speculation, by nature, tends to benefit the few at the cost of the many. Therefore, governments need to implement anti-speculation measures in their tax strategies. An example of an anti-speculation tax includes taxing at a higher rate before a certain number of years of ownership.

Another reason for rising housing costs often comes from foreign demand. Foreign sellers invest in housing, which drives up the cost for local buyers. This threat has been recognized in many countries, and New Zealand has gone so far as to ban foreign investment into its property market. Finally, housing prices in some areas can change because of drastic improvements in local-government services. While this can be a boon for local homeowners, the same cannot be said for individuals who pay rent. By tackling all of these factors, governments can ensure affordable and high-quality housing for their middle classes.

Conclusion

Housing is one of the basic needs of any household in a modern economy. This makes high housing prices a threat to the stability of the modern family’s living standards. This economic hazard has its roots in supply-side and demand-side factors that drive up the price of housing. Governments, local as well as national, need to tackle each of these issues in order to ensure that this danger is addressed before it causes real damage to the economy and society.

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