(This essay was published in South China Morning Post on 6 August 2014)
French economist Thomas Piketty’s Capital in the Twenty-First Century has made him an instant celebrity in the United States, even though his work hardly caused a stir when it first appeared in France.
The release of his book in the US has coincided with a great deal of public concern over the rising inequality of income and wealth, especially its concentration among a small fraction of the population. This has incited fears about the rise of crony capitalism, inherited wealth and the formation of a 21st century aristocracy. The French economist became an instant darling of the political left.
On closer examination, however, Piketty’s data can be given a totally different interpretation, with critical implications for advanced economies, such as Hong Kong, where home prices have soared.
Piketty’s study consists of three parts. First, he shows empirically that the ratio of capital to income, after falling between the two world wars and during the Depression, has been rising again. This, he argues, is because the rate of return to capital is higher than the growth rate of the economy.
Second, since capital ownership is heavily concentrated among a small minority, inequalities in wealth and income will be ever rising unless checked by wars, natural disasters or taxation of capital.
Third, Piketty calls for a worldwide, coordinated approach to tax capital in all nations so as to check this capitalist tendency. He believes the growing concentration of wealth, especially hereditary wealth, will undermine democratic institutions.
A study of Piketty’s data shows that by far the most important component of capital that has been rising as a share of national income over the period 1970-2010 is domestic housing capital.
Across all eight countries in his sample – France, Britain, Germany, Italy, Japan, Australia, Canada and the US – the average increase in the ratio of housing capital to income was 186 per cent, while the average increase in the ratio of other capital to income was only 44 per cent – making housing responsible for roughly 80 per cent of the overall increase. The US had the lowest increase in the ratio of housing capital to income.
Even more striking has been the share of net capital income from housing compared with the share from all other sources. From 1970 to 2010, the share of net capital income from housing in the eight countries increased by 3.4 per cent on average, while the share from non-housing capital decreased by 1.9 per cent on average.
Housing income thus accounts for over 100 per cent of the increase in net capital income in this period.
What is driving these results in the advanced industrialised economies?
Housing capital has greatly appreciated in value as a result of rising property prices. The higher cost of housing is mainly due to higher residential land values rather than elevated construction costs for the structures. High-density living in major metropolitan centres today accounts for the lion’s share of the increase in the value of housing capital.
As housing has become relatively more expensive, both its aggregate value and its share of household expenditure have risen across countries. This is a condition the people of Hong Kong are very familiar with.
Housing prices are determined by demand and supply. Rising housing prices reflect demand growing faster than supply. But why has supply failed to respond sufficiently?
Hong Kong is again very familiar with this condition. Most people in Hong Kong blame Tung Chee-hwa and Donald Tsang Yam-kuen for slowing down development. Others see property developers lurking behind the scenes, influencing their decisions.
But is this the correct interpretation? Why are the eight countries studied by Piketty all suffering from this same condition?
The economics literature on markets with high housing costs finds that these costs are driven in large part by artificial scarcity through land use regulation. In Hong Kong, we all know there is plenty of land. Regulation and politics have made it difficult to develop this land. We have plenty of industrial land but no industry; plenty of agricultural land but no agriculture; and vast country parks that most people at best visit only occasionally each year. A natural first step to address disproportionately rising housing wealth would be to re-examine the regulations to expand the housing supply.
Landlords and property developers have benefited from these regulations, and policymakers have taken the blame. But these regulations have been around for a very long time. They were imported from Britain over a century ago. The real cause behind escalating housing prices everywhere is regulatory inertia.