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Will building more homes make housing cheaper? - May 2018

Proposition: "A sustained increase in the number of new homes constructed each year, all else equal, will make housing cheaper than otherwise."

Several Australian government, academic and private-sector studies have pointed to slow housing supply as an important driver in Australia’s high and rising housing prices.

RBA researchers recently estimated that zoning rules, which restrict the supply of new housing, contribute around 40 per cent to the price of houses in Sydney and Melbourne. A number of international studies find similar effects in New Zealand, the United Kingdom, and in parts of the United States.

But several Australian housing researchers disagree. They are sceptical that planning is limiting housing supply, or that limited housing supply is driving house prices up. They instead emphasise demand side drivers, including tax and rising household debt.

Collaborator credits: we would like to thank Brendan Coates for his assistance in framing this poll question and for his expert overview of the results.

Overview of poll results by Brendan Coates, Grattan Institute

Brendan Coates

Brendan Coates, Grattan Institute

Public anxiety about housing affordability is on the rise in Australia. According to one survey, housing affordability has risen to become the second most important issue people want governments to address.

Read more

NEP Q29 - Chart 1 (Responses)

NEP Q29 - Chart 2 (Responses weighted)


Responses (26)


 

Peter Abelson

Agree

8

There have been many studies of the impact of housing supply on house prices showing elasticities varying between -1.1 and -3.5. Girouard et al. cite 20 studies. Oxford Economics cite 4 studies. Two points should be noted. One, these are national studies. Increasing housing supply in one city alone would have much less effect because net immigration into that city would increase and restore the prior spatial equilibrium relativities. Two, these results refer to changes in housing stock, not housing flows. A 50% increase in completions (flow) in one year, will typically add only about 0.66% to the housing stock and reduce house prices by the order of 1.5%. Thus, increasing housing suppl;y would have a small impact on house prices. The much greater driver of house prices is interest rates. Abelson, P., Joyeux, R., Milunovich, G. and D. Chung, 2005, ‘Explaining House Prices in Australia: 1970 to 2003’, Economic Record, 81, pp. S1-S8. Girouard, N., Kennedy, M., van den Noord, P., and C. Andre, 2006, Recent House Price Developments: The Role of Fundamentals, Economics Department Working Paper, No. 475. OECD, Paris.Oxford Economics, 2016, Forecasting UK House Prices and Home Ownership (1992 to 2014).


 

Rachel Armstrong

Disagree

9

Simply building more housing will not make housing cheaper. The problem with high property prices is not purely a supply-side issue. Over the decades, various policy measures have been introduced which would have fuelled demand and competition for housing. These include negative gearing, CGT discounts, First Home Owners Grant, and historically declining interest rates. All may have contributed to an increase in housing prices. The problem of a lack of housing affordability in Australia reflects deep seated structural problems within our policy settings that have contributed to an inflationary bias in land and property markets. These problems will not be resolved by simply building more housing. It will take a mix of supply and demand measures to implement the kind of comprehensive reform required to make meaningful improvements to housing affordability in Australia.


 

Garry Barrett

Disagree

8

The proposition alludes to a shift in the supply curve for new housing stock. However, the motivating material is about the growth in house prices in Australia. To understand the Australian experience of rising housing prices, research shows that the relative growth in demand factors is critical.


 

Alison Booth

Uncertain (neither agree nor disagree)

2

Homes are heterogeneous- they can come in all different shapes and sizes and qualities . So without knowing the type of houses that would be built (supply) and if they are designed and marketed to attract investors in second homes or to attract those on lower incomes, it is hard to say whether or not they will be affordable by potential purchasers (demand).


 

Matthew Butlin

Agree

8


 

Bruce Chapman

Agree

5


 

Deborah Cobb-Clark2

Agree

8


 

Kevin Davis

Agree

9

Given the cet par assumption and "housing cheaper than otherwise" assertion its hard to disagree - but that doesn't rule out that other factors may have been responsible for past increase in housing prices.


 

Brian Dollery

Strongly disagree

10

While obviously an increase in the the housing stock ceteris paribus will put downward pressure on prices, the question is biased since the ceteris paribus assumption is ridiculous in current policy context. The massive increase in both the absolute and the relative price of housing in Australia, most marked in capital cities, can be ascribed predominantly to historically unprecedented levels of immigration. Immigration has not only resulted in a massive increase in housing prices, but also suppressed per capita increases in income. Quite apart from its negative impact on social capital, immigration has thus served to depress the living standards of Australians in both of these ways.


 

Uwe Dulleck

Strongly agree

10

Yes, the laws of demand and supply apply to housing as well. I may miss the subtlety in the question, "all else equal" is maybe problematic as it will be difficult to build more houses as close to city centers as we did in the past. Economics at its best?


 

Saul Eslake

Agree

8

While I agree that a sustained increase in housing supply will, all else being equal, make housing cheaper than otherwise, all else is unlikely to be equal, and I have long favoured eliminating (or at least curtailing) the myriad ways in which the tax system, and other government policies, have had the effect of inflating demand (particularly from investors), as well as policies which would boost housing supply. In other words, it's not an "either-or" proposition.


 

Allan Fels

Disagree

5

The question as framed requires the answer "yes" but the question of whether it would make a significant difference gets a "no" from me.


 

Gigi Foster

Agree

10

As written, this is an econ 101 sniff-test question. Of course increasing the supply of a good drives down its equilibrium price, holding everything else constant. In the case of the Australian housing market, however, the signs indicate that much of the housing supply being created is actually not meeting the demand in the market that is feeling the unaffordable prices. Many new homes are built in areas where few people want to live (sometimes due to zoning restrictions, as indicated in the RBA report), and many homes are snapped up by rich and/or foreign investors (because they can, and are further encouraged by various Australian tax and other laws) who are not the less well-off Australian residents presently prevented from accessing good housing to live in who generate a lot of what we think of as the unmet demand in the market. Phillips and Joseph find that housing supply growth has outstripped local household growth, yet still this seemingly steep growth has not saturated the market to the point that prices stop rising. This perhaps perplexing fact is a signal of the disconnect between who is trading in the goods being supplied, on the one hand, and who is forming the demand-side source of the felt shortage, on the other. Through this lens, the Australian housing market is a dual market: one for the rich and/or foreign investors, and another one for Australian residents who need homes in decent places to live in. The first of these markets is humming along fine, and the second is massively under-supplied. All of this said, there is some overlap between these two markets. In a counterfactual world where the houses recently built had not been built, and everything else was held constant, prices would have been even higher than they are in our actual world.


 

john freebairn

Strongly agree

10

So long as demand is less than perfectly elastic, as is supported by many studies, an outwards shift of supply brings a lower price, ceteris paribus.


 

Geoffrey Kingston

Agree

7

This proposition makes sense.


 

Michael KNOX

Strongly agree

9

The underlying problem in the availability of homes in Australia is under investment in Urban Transport Infrastructure. Increased investment in Urban Transport infrastructure will allow the development of land for an increased number of home sites. This in turn will allow the building of an increased number of homes. This increase in supply will put downward pressure on real home prices.


 

Tony Makin

Strongly agree

8

This statement borders on being an economic truism. Simple textbook demand-supply analysis suggests that if housing demand is rising continuously, house prices will be higher to the extent that demand is not being met by increased supply. Population increase, amongst other factors, is an important driver of housing demand, whereas zoning and other construction constraints limit housing supply. How much housing supply needs to increase to prevent house prices rising excessively depends on how much housing demand is likely to increase. In other words, both housing demand and supply are important. As Alfred Marshall said "We might as well reasonably dispute whether it is the upper or the under blade of a pair of scissors that cuts a piece of paper, as whether value is governed by demand or supply."


 

Flavio Menezes

Strongly agree

10

The proposition, as stated, has to be true – if demand doesn’t change (‘all else equal’), and supply increases (presumably above and beyond population growth), prices have to fall. The policy debate, however, is mostly about what levers (demand versus supply) would be most effective in improving house affordability. Resolving the policy debate ultimately requires sound empirical evidence.


 

James Morley

Strongly agree

10


 

John Piggott

Strongly agree

10


 

Rana Roy

Agree

9

Given the phrasing of this proposition, it is difficult to disagree that “a sustained increase in the number of new homes constructed each year, all else equal, will make housing cheaper than otherwise”. But it would be equally difficult to disagree with this proposition: “the withdrawal of one or more or all of the various demand-side incentives to bid up house prices – the tax treatment of negative gearing/the capital tax discount/the capital tax exemption on the primary residence/policy rates set at near-zero or negative in real terms/etc. – all else equal will make housing cheaper than otherwise”. Therefore, whilst I welcome the RBA Discussion Paper as a valuable addition to the evidence base, I am not persuaded that the question of the quantitative contribution of the various “drivers” to house price inflation has a settled answer that will not vary from place to place and from year to year. The key point here is that, as the document notes, “rising house values in supply constrained markets … [are] a driver of changes in the distribution of wealth and income”. Tightening supply is one among several means of achieving the same end –to facilitate rising house values and therewith a regressive redistribution of wealth and income. If for any reason one of these means is temporarily disabled, other means are likely to be deployed more fully and to greater effect. As a general rule, the relevant decision-makers, in the lending institutions as well as in national, state and local government, will be led, by an invisible hand as it were, to take decisions that have the effect of enriching themselves and their kind. (See, inter alia, ABC News). Of course, we could as a society make a collective choice to take the punch-bowl away from the rent-seekers, treat housing as an essential consumer good and enact a suite of policies designed explicitly to bring down the cost of housing to the benefit of the majority. The relaxation and reform of planning restrictions would follow from that choice, as would various other means, including taxing away all residual economic rents, but they would do so as a means to that end. Sadly, we have yet to make that choice.


 

Jeffrey Sheen

Strongly agree

10


 

Hugh Sibly

Strongly agree

10

This proposition, as stated, will necessarily be true. Of course the important caveat is 'everything being equal'. What happens to the actual price of housing over time will depend not only on changes to the number of dwellings, but to the quality/character of those dwellings, as well as changes to demand conditions. For instance it is also certainly true that reducing demand for housing (for example by reducing tax concessions) would also lower house prices. The relative strength of these various effects could well differ across geographic areas.


 

Nigel Stapledon

Strongly agree

10

Clearly demand (and tax) factors do matter. But Australia is not unique in having high house prices so blaming factors (pretty much) unique to Australia (e.g. negative gearing, capital gains (our cg rate is not low)) is 'easy' but does not stand up to scrutiny no matter how many times it is repeated. More importantly, on the argument that says that supply does not matter, the issue is that restricted supply (zoning, urban boundaries) means that the market for land is not competitive, or the supply curve is highly inelastic. The argument that households grew by 10,000 and we supplied 10,000, therefore supply could not have been the issue, misses that point entirely. Outside the overly-defensive planning fraternity there is very little support for the supply does not matter proposition - because it is based on dodgy economics. (Would anyone argue that building less would reduce prices?) In the US, the Obama report of 2016 very clearly stated that supply was the crucial factor, explaining in their case the high cost of housing in say San Francisco, etc - cities like our Australian cities and without the easy excuse of negative gearing. See my Chapter 1 in the CEDA report.


 

Julie Toth

Agree

8

'All else equal' is the key. If housing supply rises, and there is no increase in demand at all, for any reason whatsoever, then prices should, theoretically, fall. In practice, there are far too many distortions in the housing market on both the supply and demand sides, so it is not easy to tease out the effects of any single factor.


 

Joaquin Vespignani

Agree

9

There is an evident lack of supply of housing in Australia, in particular in Sydney and Melbourne. The fact that house prices have increased more rapidly than household income in the last decade supports the hypothesis of lack of housing supply.