(This essay was published in Hong Kong Economic Journal on 31 January 2018.) 

 

In recent months, if not years, there has been an unending stream of shrill press reports about housing prices scaling new heights, and, even more, agonising that the size of new private housing units offered by developers has shrunk to further lows. Unit sizes below 200 square feet are often called “nano-units.” Some press reports even include emotive messages saying: “developers’ greed knows no bound!” or “how low can developers stoop?”

 

I shall not speak about these emotive outbursts, but the question of why the units are so small is an interesting one for economics. From the bird’s eye view, there is the trivial answer: Hong Kong today simply has a huge housing shortage that is expected to remain for some time.

 

If we descend down to ground level, we can see this has to do with not only economic growth in the city and the region, favorable global macroeconomic conditions (like low interest rates), and a restrictive supply of housing and land, but also the structure and history of our housing market and our previous housing policies. Let me focus on the latter situation.

 

First, Hong Kong has a mix of public and private sector units. Prices between the two sectors are still related even though the units in each are targeted at different client groups and there is considerable restriction in the movement of occupants between them. For example, many households do not qualify for public rental units and such units cannot be sublet to unauthorized occupants. But these restrictions have not prevented some movement across sectors. This is a result of the development history of public housing.

 

More than one million public sector tenants were admitted into resettlement units a long time ago, when there were no means tests. At that time, the British Hong Kong government was interested in redeveloping Crown land that had been illegally occupied by squatters. The resettlement units were very small in size, often around 200 square feet per unit for an entire household. These small units would set the initial condition – a benchmark size – for future housing development in Hong Kong.

 

Since average household numbers then were much larger then than they are now, often exceeding six or more people, it is obvious the living conditions of these people were extremely cramped. Singapore, which also started to build public housing units in the postwar period, decided to build units of around 1,000 square feet. In setting a different and much more spacious initial condition, Singapore’s subsequent housing provision developed into something much more comfortable than Hong Kong’s – a predicament that has become more or less permanently irreversible.

 

Why?

 

Over time, as the Hong Kong economy prospered, some public housing tenants wanted to improve their living conditions by moving into the private housing sector, and some wanted to become homeowners. Given their very cramped existing living conditions, private sector developers only had to build somewhat larger units to make private units sufficiently attractive and entice public housing occupants to move out.

 

One must remember that even 40 years ago, living conditions for most people in the private sector were just as cramped. In 1976, the degree of sharing (defined as the ratio of the number of households to the number of quarters) was 1.55. Households living in public rental housing were not economically very different from those living elsewhere.

 

In 1976, 47% of the 20-65 year-old households living in public rental housing had household incomes above the median household income of the population. In other words, the widespread perception that households living in public rental housing have always come predominantly from the lower end of the income distribution is just incorrect.

 

Interestingly, the size of public rental units increased over time to around 300 square feet, and their quality also improved. This suggests that one would now expect private developers to build larger private housing units in order to attract these clients.

 

Well, that did not happen because something changed among public rental housing tenants. In 2016, fewer than 20% of public rental housing households aged 20 to 65 years old had incomes above the median level. Those from below the median increasingly occupied public rental housing units. As a result, fewer and fewer of them are now potential clients of the private developers.

 

The housing ladder from public rental housing to private homeownership has been broken.

 

The reason for this is not only because property prices have soared, but also because a large share of potential clients have move down the income distribution. Given such a situation, there is really no reason why developers will want to build larger units.

 

Public housing tenants, for their part, are no longer motivated to move into the private sector as a long-term goal. Rather, they hope to apply for another public rental housing unit for some of their members (of the next generation) – this is how they can realistically improve their living condition. In the interim, some household members may have to rent a unit (or sub-divided unit) in the private sector while they wait their turn on the waiting list.

 

One reason why young members of public rental households choose to wait in the private rental sector, rather than at the their parents’ home in the public sector, is the “Well-off Tenants Policies” that were implemented in 1987. The original purpose was multi-fold.

 

At the beginning, there was concern that public rental housing units may become hereditary if grown up children continued to occupy these units after their parents passed away. This would put enormous pressure on public resources because there would be too little recirculation of the units, requiring the government to permanently inject more and more resources with each generation.

 

The underlying concern was how to safeguard the rational allocation of public housing resources so that more deserving households would get higher priority. The final solution was to make well-off tenants pay 1.5 times or double rent. The policy had little teeth in getting tenants to surrender their units.

 

In 2016, more stringent requirements were imposed in a further bid to give some more teeth to a toothless policy. But it is unlikely to make much difference.

 

The most tangible outcome of these measures has been to prompt adult working children to deregister from the household in order to avoid paying higher rent. Many then apply for another unit to re-enter the public rental housing program. But does this really make public rental housing units less hereditary?

 

Of course not, except in name. The young adults are not living in the same unit their parents occupy, nor do they inherit the unit. But they inherit the program, which is probably even better for them and worse for the Housing Authority.

 

Given today’s long life expectancy some households are able to enjoy more than one unit at a time. This makes allowing public housing tenants to have a hereditary right actually a better deal for the public. It would represent a more rational use of public housing resources.

 

Of course, to have hereditary rights the public rental housing program must first be changed into an ownership program and existing rental units must be sold to the tenants. This demonstrates that a more rational public housing program has to be an ownership program.

 

If public rental housing could be privatized fully, the housing shortage problem would be less severe because more rational use of public housing units would become possible.

 

Another amazing development is that while the new supply of private housing units has become smaller in size, public rental units have not become smaller at all. This means that waiting for a public rental housing units is now even more attractive. As a result, local housing demand has shifted structurally in favor of public housing units.

 

In 2014, the government announced its long-term housing strategy in which 60% of future housing targets would be met by public sector housing. Given existing planning restrictions and the short supply of land, the probability of meeting the stated housing targets remains uncertain. While it is likely that private sector targets will be met because they are indeed building smaller units, public housing targets are more likely to fall short of targets since unit sizes are unlikely to be changed.

 

Two results emerge from this analysis. First, the small size of our housing units is rooted in the small size of the early public resettlement housing units that set the initial benchmark for housing units in Hong Kong. This has resulted in a path-dependent development process from which it is difficult to escape.

 

Second, the private housing sector has responded to rising housing demand by producing smaller units but the public housing sector has not. This will increase the demand for public housing leading to the gradual demise of the private housing market and locking more and more people out of the opportunity to accumulate housing wealth.

 

It seems to me that given our severe housing crisis  the government now has a political crisis on its hands. A far more radical change in housing policies must be contemplated. This should include allowing higher plot ratios for all developments and building smaller unit sizes in the public sector. And of course, the existing stock of public housing units should be privatized to incentivize greater use efficiency.

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