(This essay was published in Hong Kong Economic Journal on 11 March 2015.)
Hong Kong has recently introduced yet more measures to suppress demand in a bid to curb property prices. With the exception of the years following the Asian Financial Crisis, property prices have been rising steadily in Hong Kong. This phenomenon has been seen around the world. Demand has outstripped supply in all major international economic cities since 1980, when the global economy started to become far more integrated than before.
Globalization has made a lot of people in the world wealthier, which has fuelled a rapid increase in demand for property and higher property prices in the best economic cities. These cities invariably have secure rule of law, well-protected property rights, light or predictable regulations, low taxes, and sustained economic growth. Chinese cities do not have all these favorable conditions, but so far the unprecedented rapid pace of urbanization and economic growth has compensated for other weaknesses.
In recent years, the low interest rate environment, following the onset of the financial and economic crises in 2008, has also kept property prices buoyant. But the main reason why property prices have risen in major international economic cities is that so much wealth has been created by economic globalization. Hong Kong is no exception to this.
In addition, China’s opening in 1980 has contributed directly to making Hong Kong more prosperous, further driving up property prices here as the demand has grown much faster than supply.
A casual examination of the data in Hong Kong supports this. The total supply of domestic housing units in each of the three decades between 1981 and 2011 was, chronologically, 722,427, 662,331, and 423,182. The supply was lowest in the last two decades when wealth creation was the greatest.
In 1991, I wrote an essay titled “Greater Vision Needed to Curb Speculation” in the South China Morning Post explaining why demand suppression measures could not curb property price increases. Of course, hardly anyone was listening and the government began to introduce tough measures to suppress demand by imposing punitive stamp duties, increasing down payments on mortgage loans, and curbing confirmor transactions. These measures have become progressively more draconian over time. Nonetheless, property prices have continued to rise.
Meanwhile, government officials have congratulated themselves on the great job they have done in preventing a local banking crisis, like those that happened in Japan, the US, and Europe. This is of course right, but demand management cannot curb property price increases when demand continues to grow faster than supply. Punitive measures only bring temporary political relief for governments faced with mounting public pressure angrily demanding that something be done.
Unfortunately, when the government tries to curb property prices with punitive demand management measures, it sends the wrong messages by focusing attention on property prices rather than supply shortages. The public becomes frustrated when property prices are not successfully curbed, except in the short run. The government loses credibility as a consequence, and is tempted to impose ever more draconian demand management measures to appease the public.
The question is, why doesn’t government focus efforts on increasing supply? I can think of several possible explanations, some more plausible than others.
First, it has long been alleged that the Hong Kong government has a high land price policy in order to maximize revenues. This is a mistaken popular view. In the colonial days, the public readily believed that the British government simply extracted resources from Hong Kong for repatriation to London. I heard this allegation even as a child. The idea of a high land price policy for extracting resources from the public has been around for half a century.
As an economist, I don’t think this allegation makes any sense. A high land price policy is certainly not the best way to maximize revenue. A much better approach would be to adopt a broad-based tax regime with a low tax rate to promote economic growth. But this is not the tax regime that Hong Kong has in place.
Half the working population in Hong Kong is exempted from paying salary taxes. A modest consumption sales tax would make much more sense because it would not penalize investments in both physical and human capital, and it would promote economic growth and maximize the tax base.
It also seems very odd for government to adopt a high land price policy for revenue maximizing purposes, while at the same time it operates a public rental-housing program and a subsidized homeownership scheme. Surely government revenues are not maximized by selling half the annual supply of land at market prices for domestic use in the private sector, while making the other half available for use in the public sector at a zero or heavily subsidized price.
The notion of a high land price policy is a public perception with little economic logic behind it, and a convenient target for government-bashing rhetoric. This phenomenon is unique to Hong Kong because land is primarily owned and controlled by government.
The supply of land has consistently lagged behind demand ever since the end of World War II.
In the period after 1945, the massive influx of immigrants created enormous housing pressure. The population increased from 600,000 in 1945 to 2.3 million in 1951. It took 40 years of housing development to provide relief for the population. But then by the mid-1980s new pressures on property were created by the rapidly growing prosperity and the new wealth created by economic globalization and China’s opening.
A second popular explanation for why government does not focus on boosting housing supply is that government policy horizons are too shortsighted to make it worth their while to do so, based on political considerations. This notion derives from the “borrowed time borrowed place” mindset of the British colonial government, at least before the arrival of Murray MacLehose as governor.
But since the mid-1980s, our society has become more open and politically accountable. This has made the consensus building process required for approving development projects increasingly difficult, resulting in long delays, limited supply, and higher property prices. In other words, the transaction cost of development has become significantly higher. These costs started to rise in the late 1980s. Within five years they had added an additional 70 percent to property prices. The higher transaction costs have now become a permanent standard feature of our development process.
This is the price Hong Kong now pays for a more open and politically accountable process. Today, any party with an interest in the outcome of any development project can participate and influence its future outcome by raising an objection, regardless of whether the reason is legitimate.
Who benefits from a more open and therefore more costly consultation process that delays development? The answer is simple and straightforward: those with property.
In a democracy, where decision-making is by majority vote, the question of whether voters will favor a fast or slow increase in housing supply depends on whether the majority are homeowners. If 51% of the voters are homeowners, then it is in their interest to favor a slow increase because this will lead to rising housing prices due to higher demand. The democratic majority will therefore benefit.
In 2001, 50.8% of the households in Hong Kong were owner-occupiers, a figure that more or less still holds today. A pure economic analysis would only focus on the fact that limited supply and rising property prices since 2001 have made it easier for existing property owners to acquire new properties because they are more able to finance the high down payment. Those without property to start with find it more difficult to come up with the high down payment to enter the market.
A political economy analysis would suggest that a coalition of the majority of existing property owners would, out of self-interest, vote in favor of limiting housing supply. Of course, we may not observe a majority coalition that openly advocates such a politically incorrect policy agenda, but support for this agenda can be given indirectly and in a politically respectable manner by backing environmental and conservation causes that preserve country parks and heritage structures, and adopt expensive building standards. Cumbersome public consultation processes can also delay developments in the name of openness and accountability.
Let me make it clear: Environmental and conservation are respectable causes. Openness and accountability are worthy causes too. But this is what makes them perfect candidates to be hijacked by those who benefit from high property prices.
The wise global investor in housing properties knows that one should opt for those cities and locations where a majority of voters oppose urban growth, as this will protect their investments. Such majorities will be smart enough to support militant and activist minority groups to lead the opposition against growth.
Developers are seldom in favor of slower development and dread cumbersome consultation and approval processes because their profits depend directly on more development, and not just prices.
It is of course possible that some developers are more skilled at navigating the consultation and approval process and possess a competitive advantage over other less skilled developers. The skilled developers may favor cumbersome processes to reduce their competition. But this can be a dual edged sword if the process then becomes too cumbersome for profit maximization. It also makes them a target of enmity among voters without property.
Privatizing public rental housing is a public policy that should be highly popular, as it would in one fell stroke turn over 30 percent of voters into homeowners. Interestingly, there is always a very vocal minority that objects. Some opponents argue that this would amount to providing “double benefits” for the tenants. This is of course a concocted argument. Why don’t you call the original benefit a “half-baked” one? These terms are meaningless and mere political rhetoric intended to deceive and mislead public opinion.
It would be far more informative if we examined who loses from privatizing public housing so that sitting tenants benefit. In this case, it would seem logical to explore those whose livelihoods depend on the existence of a constituency anchored among public housing tenants. These tenants share a common collective interest. They invariably stay in the same premises they were initially assigned and form a natural voter base for those seeking to develop a career in politics. Then there is the bureau whose employees depend on the continuation of the public rental program for their careers.
Limited housing supply is not a new problem. Despite the massive influx of immigrants into Hong Kong after 1945, very little land was freed up for housing development. From 1945 to 1958 no more than 200 acres of land were made available for development in the urban areas, of which less than 30 acres were auctioned for housing development. An SCMP editorial urged “the government to form sites for sale to builders to resolve the housing shortage since many squatters can afford regular dwellings” (31 December 1958).
Of course, nobody listened then.
The situation was made worse by the rent control ordinance introduced by the British colonial government in 1947 passed, just as the huge influx of immigrants was arriving. The intention was to protect existing tenants in the old tenement units. This helped the existing tenants enormously as they were able to sublet their units to new immigrants. Landlords did not benefit at all. Obviously, existing tenants were the dominant political influence at that time. Landlords and developers were not.
History shows politics makes strange bedfellows indeed.