The myth of “over-investment” in housing

I have just been to a lovely presentation for the NZIER forecasts.  However, an issue was raised which brings me to some slight irritation.  During the Q&A session it was suggested that New Zealand “productivity is struggling” because we invested too much in housing and not in productive assets.

Such a load of tripe.  Here are the two reasons I would say why:

  1. Housing is “productive”.  It produces this thing called “somewhere to live”.  When someone consumes the house they are getting this service.  This is just as much of a service as getting a hair cut – the only difference is that it doesn’t require a labour input to keep it going!
  2. We have been told we have a SHORTAGE of housing.  How can we have invested too much in housing if we have too few houses – this is a contradiction.  And before anyone says “we borrowed to buy houses off each other” lets try to remember that if we buy something off someone else in the country it doesn’t change national debt – it is just a transfer.

There are issues with the housing market.  The tax status is a bit favourable and building costs have been held up by consent issues and industry bottlenecks.  But this doesn’t mean we have over-invested in housing – so lets stop propagating this urban myth aye.

  • Such a load of tripe.

    Well, yes, I agree — but it’s your response that I would call tripe. ;^)

    You said:
    1. Housing is “productive”. It produces this thing called “somewhere to live”. When someone consumes the house they are getting this service. This is just as much of a service as getting a haircut . . .

    This is just foolishness. If I eat a chocolate it produces something called satisfaction — but it doesn’t make eating chocolate productive.

    Look, you do understand the difference between producer goods and consumer goods, don’t you? I’ll explain the difference here for your readers, since confusion on this point has caused so many of our recent problems.

    Producer goods/investment goods/capital goods (whatever you want to call them) are “goods purchased for the purpose of making subsequent sales.” When we talk about “the means of production,” then this is what we’re talking about — they’re goods that produce their own replacement out of their own production (which is what is often meant by saying that capital is “wealth reproductively employed”).

    So the only thing I’m going to “produce” by eating lots of boxes of chocolates is illness — which is a reasonable metaphor for what the “housing-is-productive” delusion has just cost us.

    By contrast, consumer goods and services don’t produce profit enough for their enough for their own replacement out of their own production (not unless they’re an actual investment property, of which few genuine examples now actually exist). Whether they’re a chocolate, a haircut or a house, these consumer goods and services are not purchased for the purpose of making subsequent sales — they’re purchased to be used, and used up.

    And once they are used up, and we do want to replace them, we need to find the funds for replacement from elsewhere — they must be purchased out of other productive activity, by means of production that has been purchased for the purpose of making subsequent sales.

    So they’re not the same thing at all. Consumer goods are produced by producer goods. They’re purchased from the revenues so produced. Just because a house is a particularly durable consumer good doesn’t change its nature: it is not a means of production, it is a consumer good.

    Whatever else we can say about the NZIER forecasts, on this point at least they’re correct. Apart from those few houses genuinely produced for the purpose of making subsequent sales, houses are not a productive assets. They are not producer goods. They’re consumer goods.

    Which leads me to your second point. You said:

    2. . . How can we have invested too much in housing if we have too few houses – this is a contradiction.

    Well, no it’s not, as it’s easy enough to show.

    If we “invest” 200 monetary units in 100 houses costing two units each, then we’re going to “invest” more and in fewer houses than if we “invested” 100 monetary units in houses costing half that much – which would leave 100 monetary units for something genuinely productive.

    And that, the former, is essentially what we’ve done isn’t it.The cost of building new houses nearly doubled in the five years to 2008, which means the number of houses that could be built by the same amount of spending nearly halved. That’s what bubbles do. Housing costs were inflated by an excessive monetary demand financed almost completely by central-bank created credit (and lots of people trying to ride the bubble), while at the same time supply was restricted by land regulation, by building regulation and by rising labour and regulatory costs.

    So we’re still short of houses, there’s still demand for housing — New Zealand needs around 35,000 houses a year to keep up with demand, while home builders even in 2008 were restricted to producing just 24,000 houses every year — there’s still demand for houses but not at the prices at which house builders can now build them.

    But you know what: You’re right that there’s an urban myth here. It’s the myth that houses, all houses, are “an investment.” Except in very special cases, they’re not. They’re simply an especially durable consumer good with all the benefits that come from that — including being a reasonable store of value in a time of inflation — and allowing an income stream if you lease out the use of that good — and in a genuinely productive economy that’s how they’d be seen.

  • Ello Peter,

    “Well, yes, I agree — but it’s your response that I would call tripe. ;^)”

    Haha, good call 🙂

    Still I disagree 😉

    “Look, you do understand the difference between producer goods and consumer goods, don’t you? I’ll explain the difference here for your readers, since confusion on this point has caused so many of our recent problems.”

    The only purpose of productive goods is to create consumption – consumption is the final thing that gives satisfaction which is the purpose of policy.

    It is easy to split the “production” and “consumption” of chocolate cleanly – it is a perishable good. However, housing is a durable good.

    The construction of a house gives a stream of “consumption” over time once it is built – I don’t care if people aren’t continuing to produce houses once they are already there, what I can about is that people are consuming the stream of satisfaction associated with using the house.

    “So they’re not the same thing at all. Consumer goods are produced by producer goods. They’re purchased from the revenues so produced. Just because a house is a particularly durable consumer good doesn’t change its nature: it is not a means of production, it is a consumer good.”

    Yes – but people make producer goods in order to get future consumer goods. That is the point. There is no satisfaction gained directly from having a producer good that doesn’t do anything.

    If an individual believes they get more satisfaction from a house than from a machine that makes toilet paper they make a decision to buy the house – this is completely based on the final outcomes they want.

    “Whatever else we can say about the NZIER forecasts, on this point at least they’re correct.”

    To be clear this wasn’t from their forecasts – it was just another discussion during the presentation. I don’t want to put words in their mouth.

    “there’s still demand for houses but not at the prices at which house builders can now build them.”

    If that is the case then I wouldn’t say we have an under-supply. There is a contradiction – one of the claims must be wrong. It could be the under-supply one – it could be the over-building one.

    “But you know what: You’re right that there’s an urban myth here. It’s the myth that houses, all houses, are “an investment.” Except in very special cases, they’re not. They’re simply an especially durable consumer good with all the benefits that come from that”

    Durable goods ARE an investment. As investment is a good that provides consumer goods or services in the future – houses do that, fridges do that, factories that make chocolate do that.

  • I’m not sure I really understand this discussion so perhaps you could enlighten me. Houses may provide consumption streams, but utility isn’t a part of GDP, is it? Doesn’t productivity measure our efficiency at creating the houses (and other stuff), rather than the benefit we gain from consuming them? How can you boost productivity through consumption?

    It sounds like a bit of sleight of hand you’re using with your definition of investment here, Matt. Durable goods aren’t an input into future consumption, they’re a final product that produces a stream of future benefits. I don’t think you can really call durable goods capital investment.

    I agree with you that shortages show that we probably haven’t overspent on housing, but I think it’s a long bow you draw in suggesting that spending on housing boosts productivity. Like you say, not everything is, or should be, about productivity 😉

  • @rauparaha

    Indeed, I don’t disagree with what you have said. However, I would note that I put “productivity is struggling” in inverted comma’s for a reason.

    My critique is of the idea that we have “overbuilt houses” – which would imply that house building has been excessive relative to what is optimal. In this sense GDP measures are relatively poor at picking up what we are gaining satisfaction from – and any policy that is based on GDP targets will miss the point (something I think more economists need to realise).

    A house does produce a stream of consumption – as a result any mismeasurement occurs in the GDP statistics (given that they have a bias towards output that occurs during the time of work – not consumption), and any look solely at GDP stats (without trying to gleen anything from prices, which should represent the stream of consumption) understates the impact of durable goods including housing. Macroeconomists realise this, hell it is taught at every level of macroeconomic study, yet when it comes to forming policy macroeconomists keep turning around and arbitrarily stating that NZ as a whole has invested too much in housing.

  • Yes, building new houses is an investment.

    You might argue that there was over-investment in housing if the price of houses were lower (or did not increase as much) as people expected when they built or purchased those newly-built houses. Ex post, at the margin, some people would then regret their decisions.

    Individual regret at past investment would signify that past investment was greater than socially optimal, if current house prices reflected fundamental values. But maybe they have fallen below fundamentals? (I don’t know what the NZ housing market looks like currently). Also, maybe all asset values are low relative to previous expectations.

  • Where I’m at

    “New Zealand “productivity is struggling” because we invested too much in housing and not in productive assets.”

    because housing “always goes up in value” we don’t have to think so much about the utility value of the house (like a bar of gold its value exceeds it’s industrial use). By investing in housing we become rich and therefore can consume. So we pour money into realestate, and better insulation will be a selling point but isn’t the main thing.
    Housing isn’t worker housing it is the factory (always going up in value and giving us the means to consume)?

  • @ Peter: So a house the rental income from which is at least sufficient to replace the house down the line counts as productive investment rather than consumption, if I read you correctly. Right? Why does it then matter if I rent a house to someone else and take their rental income rather than renting the house to myself and paying myself a market rent?

    I don’t disagree with you one whit about the inelastic supply curve generated by regulation. Owen McShane’s been great on this issue; Arthur Grimes had a very nice article showing the effects of Auckland’s urban limits on house prices.

    Do note Cowen’s bananas critique though, which runs as follows. Sure, the central banks have mucked up interest rates by setting them well below market rates. But nobody forced you to invest in housing. Imagine that the government mucked up the price of bananas with extensive subsidies such that they were almost free. If you then went and bought 10 tons of bananas and put them on your roof and your roof collapsed, the fault doesn’t lie entirely with the banana subsidy.

  • Has anyone considered Manhattan as a housing model to follow?

    I think the real problems are the proliferation of McMansions with one-child nuclear families, and the attitudes of the ‘Quarter Acre Cartel’. The Quarter Acre Cartel is basically an unholy alliance of green-rinsers who think Manhattan is the ultimate eco-disaster, and blue-rinsers who equate Manhattan with the Bronx (think John Key’s NIMBYism towards the Hobsonville proposal, and the ‘Gangs of Khandallah’ episode). Throw in a white-shoe brigade which develops worthless rabbit hutches, and the unholy alliance is complete. I didn’t include the bureaucracy, because it merely seems to reflect the attitudes of the QA Cartel.

    The US Democrats have a proposal to remove tax benefits on large suburban plots (above 3000 sq ft, or about 280 sq m), which NZ could consider emulating if a CGT is politically untouchable.

  • Miguel Sanchez

    “And before anyone says “we borrowed to buy houses off each other” lets try to remember that if we buy something off someone else in the country it doesn’t change national debt – it is just a transfer.”

    It does increase national debt if we choose to fund those same houses with a higher proportion of debt over equity, which has been the case in the last, I dunno, twenty years.

  • @Miguel Sanchez

    If one household borrows $X to buy a house of another household it is just a transfer – it doesn’t matter what the ratio of debt to equity is.

    If the other household then spends the money on consumption this does lead to higher debt – however, the issue isn’t the transfer between households, it is “what might be” excessive consumption.

  • @Nick Rowe

    Very true.

    In NZ house prices are above any sort of long run trend. Many believe that the reason for this is a lack of building activity. There are two main reasons building activity is low:

    1) Building costs are comparably high in NZ nowadays,
    2) The collapse of our finance companies has lead to severe credit constraints in the industry.

    As a result, high house prices seem supported by current “fundamentals” – namely the high cost of building and strong migrant arrival numbers.

    If we haven’t been borrowing to build too many houses, which it appears we haven’t, then I refuse to say that New Zealand as a whole has over-invested in housing.

    I just refuse to believe that housing in of itself has put us in our poor debt position – the numbers don’t fit that story. We could have over-consumed, we could have invested poorly in business assets (it appears we have), but we haven’t “over-invested” in residential building construction in NZ.

  • @Where I’m at

    “By investing in housing we become rich and therefore can consume”

    The idea that rising transfers between households constituted real wealth WAS an issue – definitely.

    Rising perceived wealth that didn’t exist lead to excess consumption which DID help to cause our bad debt position. I buy that argument

  • @Eric Crampton

    The Grimes paper was very good.

    Good example with the banana subsidy as well.

  • @DeepRed

    Interesting. There is talk of a CGT in NZ at the moment – it will be a tough one to ever get through though.

    A clean up of LAQC (loss attributing qualifying companies) rules on rental property and a flattening of the tax base would be a good start to reducing the incentive for household investment in property.

  • John

    If you compare a leaky home with an energy efficient one then it strengthens the idea of a house a productive and with some productive land around a person may be able to be self sufficient, in which case they have produced enough and a bell rings somewhere. If you look at our housing stock many older houses are cold and new ones are much better but still not very good. In addition a lot of concrete has been laid as vehicle pathway meaning it can’t grow food or absorb energy.It isn’t an issue if you believe that there is and will be plenty of oil into the future or that if there isn’t there will be a technological fix. The point is that we ought to look more closely at houses and street layout and consequent social ligatures as productive goods??? Maybe because houses are such a big item the majority of houses have been not as good as they could have been so that a low standard has become the norm but also developers place houses in suboptimal positions to extract as much profit as possible.

  • Matt: interesting. The NZ housing market looks very different from other countries’ (I’m in Canada).

    If the NZ supply curve of building new housing were lower than socially optimal (because of problems in the credit market for house builders, so they had difficulty getting finance, if I understand you correctly), then that would mean there were too little investment in housing, as you say.

    This is almost the exact opposite of other countries, where problems in the credit markets meant that loans were arguably too cheap, both for home builders and buyers, because they underpriced risk and were based on ex post unrealistic expectations of house price appreciation.

    NZ =/= US

    I don’t see why it matters whether people (individually or in NZ aggregate) have been borrowing to finance the investment in housing. Though there is a separate question of whether savings might be too low.

    I’m tempted to write a Canadian version of your post.

  • John

    If we haven’t over invested in houses but haven’t invested enough in capital perhaps it demonstrates that there is a significant sector of the economy that serves inward migration?

  • Miguel Sanchez

    Matt Nolan :@Miguel Sanchez
    If one household borrows $X to buy a house of another household it is just a transfer – it doesn’t matter what the ratio of debt to equity is.
    If the other household then spends the money on consumption this does lead to higher debt – however, the issue isn’t the transfer between households, it is “what might be” excessive consumption.

    What do you mean “if”? What else do you think they’d do with the borrowed money – leave it in the bank? The fact is that we couldn’t have borrowed nearly as much as we have for consumption purposes without putting up our houses as collateral (even though it makes no difference to our ability to repay, which comes down to expected future income). So the problem is that our current rules encourage overinvestment in housing as a vehicle for excessive consumption – you can’t separate the two and say “step A is okay as long as step B doesn’t follow”.

  • Matt: I just decided to write a short post on housing as investment: http://worthwhile.typepad.com/worthwhile_canadian_initi/2009/06/investment-in-housing.html

  • Where I’m at

    Where does “bubble” or “boom” fit in?

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  • BJ Chippindale

    Small Mistake.

    “Investing in housing” is not the same as “building new houses”. It never was in this country.

    We have not “overbuilt” in terms of numbers but We have certainly overpaid in terms of each house built or sold, particularly given the quality (lack of) of the housing stock in the country.

    The tax structure favors the passive investment in housing by not ring-fencing the LAQC and by not providing for Cap.Gains on the house. The rest of the investment examples (getting taxed and so many going BK) help us NOT to invest in anything else.

    So citing the failed investments in/of the business community is quite accurate and an important point to be made.

    As for calling the housing “productive” – it can be argued but I won’t. Y’all can take that any way you like. 🙂

    respectfully
    BJ

  • swan

    Matt,

    I totally agree with your post.

    I think the real problem is some people decided that rising equity in their own home made them somehow richer and then they have gone and spent some of the equity. This is a fallacy because someone who owns their own home is invested as a producer of ‘accommodation’ AND is a consumer of the accommodation they produce. Therefore they do not really see any benefit from this increase in the price of the accommodation. At best they are fully ‘hedged’ against increases in the price of accommodation.

    To use an analogy – The UK is an oil producer that now produces about the same amount of oil as it consumes. If the price of oil increases, does this increase the wealth of the UK? Is it sensible for the UK to start importing more goods? I wouldn’t have thought so.

  • John

    Matt why don’t you do a series on contemporary economic myths/ misconceptions?