Recently, I wrote several articles onHong Kong’s public sector housing policy and the value of creating a market in public sector housing units.  Several Hong Kong Economic Journal bloggers subsequently made important comments about whether justice is served by providing an asset on subsidized terms to less well-off households. On the issue of social justice there are general considerations which I will take up in this article. There are also considerations specific toHong Kong’s situation, which will be taken up in next week’s article.


Some of the commentators disapprove of using taxpayers’ money to subsidize less-well off households when they purchase an asset. These commentators at the same time support using taxpayers’ money to provide these households with shelter. This sounds like a very sensible position on the surface. But let us think through carefully what it means.


To make it simple, consider the public sector housing unit as two separate components: the physical premises and the land which it occupies. This entire unit is both an asset and a shelter. As an asset let us suppose the market value of the unit when it was completed in 1980 was $500. This value is divided between the land value assumed to be $400 and the construction cost of the housing premises assumed to be $100. Now let’s say a household is willing to pay $200 for use of the unit. This is the shelter value of the unit to that household. The household obviously cannot afford the unit so the government steps in and lets the household use it at the price of $200. If the household wishes to sell the unit in future – and thereby convert it from a shelter only to an asset – then the unpaid land premium must first be repaid.  In 1980 this unpaid premium would be $300.


If the unit is to be used only as shelter, some commentators argue the occupant should not benefit if its value appreciates over time. So if the land value doubles from $400 to $800 by 1990, these commentators would only agree to convert the unit to an asset if the household pays the unpaid land premium of $700. And the land value doubles again to $1600 by 2000, then the unpaid land premium would rise to $1500.


The rapid increase of land values inHong Kongimplies that a relatively low percentage of households would be able to afford to convert their units from shelter to assets. They would thus not be able to realize the appreciation of land values. They are in effect only allowed to use the unit as a shelter. It appears from the comments I have received that commentators are quite happy with this outcome. They believe they have defended the interests of taxpayers.


Evaporation of Resources Benefits No One


But let me point out two consequences. First, the taxpayer hardly ever collects the unpaid land premium because very few households ever pay it. A receivable that cannot be collected after many years should be written off and not carried on the books. It is foolish to believe that it is still there. What is even worse is that by the year 2080 these units would be so run down that they would have to be redeveloped. I can easily imagine the unpaid land premium would be astronomical by then (assumingHong Kongcontinues to prosper). The only party that could redevelop these units would be the government. And taxpayers would be forced to foot the bill again.


Second, the subsidy provided by taxpayers to the household is the difference between the market value of the unit and the price the household pays for its use as shelter. This is $500-$200=$300. Over time the amount of the subsidy will increase as land values increase. The odd situation here is that the cost of the subsidy paid by the taxpayer is larger than the benefits received by the household. The taxpayer pays for the asset value of the unit, but the household only receives the shelter value of the unit.


This difference is the deadweight social welfare loss to society. Nobody gets it. It is evaporated. Let me use another way of explaining this idea as it is not familiar to those who have not studied economics.


Society in general supports subsidizing education for children from less well-off households so they have opportunities in life without being constrained by a lack of family resources. This is called investing in their human capital. It is the same as providing them with an asset, but this asset is embodied in the person. Sometimes the subsidy is provided in the form of a loan (usually a low interest loan) and the student has to repay the loan; but still the amount to be repaid is equal to the cost of the education and not the future value of that education in the market place.


The student becomes the full owner of the knowledge and skills he acquires and society does not usually put any restrictions on how he uses them.  Any attempt to do so is considered to be tampering with his personal freedom. Moreover, imposing such restrictions as limiting the student to applying his human capital in only one country or one line of business would reduce the value of the education to the student.


Different Economic Consequences of Housing Programs in Hong Kong and Singapore


The mechanism through which people can change their jobs voluntarily is the job market. Not everyone changes their jobs or indeed their line of business, but without a market it is not possible to change either voluntarily. Similarly, not many people change their residence, but the right to do so from time to time is a very valuable option. This can only be done if there is a market for public housing in which they have full ownership of their housing unit.  The real issue is not whether households will reap a windfall that they can realize, but whether they have the option to exercise choice when there is a need for them to do so.


It may be useful to consider what taxpayers lose when they give away a housing asset but then limit the recipient to using it only as a shelter. In my article published in the HKEJ on 14 September 2011, I reported that estimates of this loss were 0.95% of GDP in 1981 and 0.53% of GDP in 1991.  These are very large losses for society in one year. And when we compound such losses over more than 50 years of public housing, the losses are enormous. I believe these are likely to be low estimates because the losses depend on the market value of the land premium. The premiums have increased considerably since 1981 and 1991 when these estimates were made.


Just to illustrate the magnitude of the losses it is useful to compare the per capita GDP growth rates ofSingapore and Hong Kong, starting fromSingapore’s independence in 1965 to 2010. The Figure below gives the real per capita GDP profiles for the two cities in their own currency. For ease of comparison the values have both been normalized to 100 in 1965. The two lines show that throughout the period Singapore grew faster than Hong Kongat an average annual rate of approximately 1.35%. As a consequence, a Singaporean who started with $100 in 1965 was making $1,167 in 2010, but theirHong Kongcounterpart was making only $655. The Singaporean had 78% more.

As I explained in my article published in the HKEJ on 7 September 2011,Singaporeallows for an active market in public housing units. This means it does not suffer the kind of deadweight social welfare losses that are present inHong Kongin both public rental housing and Homeownership Scheme (HOS) units. This factor alone could easily account for most, if not all, of the differences in per capita real GDP growth betweenSingaporeandHong Kong. The same Figure below plots the projected real per capita GDP profiles forHong Kongunder two scenarios.  Scenario 1 adds 0.5% to the growth rate and Scenario 2 adds 1%.


I conjecture that even Scenario 2 underestimates the losses to society of not allowing a market for public sector housing units because it measures only static losses – those that result from denying households the ability to capture the appreciation in land values. The dynamic losses have not been included – these would be the potential gains that could be realized if a person with more resources spends them on enhancing his productivity and that of others.


So what is social justice?


If we do not allow public sector housing occupants to trade their units on the housing market, then society will lose the value inherent in that asset. Such a loss is borne by everyone, including taxpayers. What is happening is this: well-off households are giving $500 worth of assets to less well-off households, but their use is restricted to shelter only. The land values are partly evaporated and therefore lost to all. All households suffer a decline in income as resources are destroyed by limiting their use.


If instead we allow a market to exist, then the less well-off households gain a share of the value of the land that would otherwise be lost, and in so doing they put the land resources to better use and raise the income of everyone. It is a win-win scenario. Which outcome is more socially just?


Surely what we want is to yield more resources for all, allow people to have greater freedom of choice, and build a better community. These are the central concerns of justice among the great philosophers in the last century. John Rawls was concerned about helping the poor and this depended upon having resources; Peter Nozick wanted to uphold the rights of individuals and argued for more freedom of choice; and Michael Sandel was concerned with how to achieve justice through a better community.


Another issue raised in the comments is the appropriate level of subsidy and what form it should take.


In a functioning public sector housing market, the crucial issue is whether the household can afford to purchase another unit when he sells his original unit. If this is largely impractical – for instance, if a substantial portion of the proceeds from the sale have to be returned to the Housing Authority as unpaid land premium – then there is no incentive to sell and the market ends up with very few transactions.  So the issue is not one of greed or windfall gains, but whether the market is a real one or simply exists on paper.


“Phantom Banks” and Government’s Role


Consider the following three conceptual options as to how the unpaid land premium could be settled. I shall ignore for the time being whether the units are existing HOS or Tenant Purchase Scheme (TPS) units, or new units to be built in the future.


Option 1: The owner of an HOS or TPS unit has the right to pay the unpaid land premium at a time of his choice after an initial holding period during which sale is prohibited. This was initially 10 years then later modified to 5 years. So if Mr. Wong purchased an HOS unit in 1985, he could choose to repay the land premium any time after 1995.


Suppose he decides to repay in 1999 when the property market hits bottom. If he cannot afford the required amount, he can theoretically find a “phantom banker” to mortgage his unit at an interest rate of 3%, which is approximately the average real mortgage interest rate after inflation over the period 1980-2010. He then signs his unit over to the bank as collateral and structures his loan so that he will pay back both the accumulated interest and the loan principal at the time when he actually sells the unit. He and the banker can agree that the period where he can exercise such an option is very long, say 50 years. He then takes the borrowed money from the banker and repays the Housing Authority and settles the land premium.


The problem of course is that such a banker does not exist in the market place. No banker would be willing to make such a deal. This is a case of capital market imperfection. Bankers are unwilling to lend to a household with a poor credit rating on such terms; so that is why this is a “phantom banker”.


The government is ideally positioned to step in and become this “phantom banker” and even make the 3% real interest rate. This would enable Mr. Wong to exercise his right to “fix” his land premium in 1999. When he sells the unit on the market in 2008, he will just have to surrender to the Housing Authority a sum equal to the land premium as fixed in 1999 plus 9 years of interest accumulated at a 3% real rate. Actually there is no subsidy in this interest rate since 3% is the market rate. It is possible the rate could be set below 3% or even at zero if that is what society feels is acceptable. The public may even be willing to grant an unlimited time period for Mr. Wong to sell his unit.


This method of settling the unpaid land premium is exactly the present arrangement, except for having government step in to play the role of a “phantom banker”. In other words, government is stepping in to correct a capital market imperfection that not well-off households face in borrowing money. The right to choose the date to fix the land premium is a right Mr. Wong already has now. All government has to do is to help him exercise it.


Since society, including taxpayers, benefits from establishing a market in public sector housing units, then there is a case for government to charge less than a 3% real rate. Indeed without an active market in public sector housing it is unlikely for the taxpayer to every collect any significant amount of the unpaid land premium because there will be no transactions.


Feudal Practices to be Unbound


Option 2: An alternative approach is to fix the unpaid land premium at the original date of purchase. In the case of Mr. Wong this would be 1985 rather than anytime after 1995 as proposed in Option 1 above. Once the land premium has been so fixed, the government would show up to perform the role of the “government as banker”. Of course if 1985 is at the bottom of the market this will be great for Mr. Wong, but if it is at the peak then he would have a nightmare and most likely would refuse to accept the unit if given a choice. Once the land premium has been fixed, the government would then perform the role of the “phantom banker”.


Option 3: A third approach is to fix the unpaid land premium as a multiple of the qualifying household income for admission into the program. While this has clear predictability, it is ad hoc and may from time to time diverge substantially from market levels. As with the other two options, once the land premium has been fixed, the government would be the “phantom banker”.


To fix the unpaid land premium for future public sector housing units, one can adopt either Option 1 or Option 3. For existing or old HOS and TPS units, Option 2 or Option 3 could apply. Personally I prefer Option 1 for future units and Option 2 for existing or old units. This is largely because I find Option 3 ad hoc and arbitrary, but I am not dogmatic about this.


For government to sell a unit at a discount and retain an equity interest in the land value is almost a feudal practice. This is almost like serf masters telling their serfs, your offspring must work for me and so must their offspring too. With “phantom bankers” the worst you get is a 3% real interest rate.





長空無二:評王于漸活化公營房屋市場之建議, 2011年09月28日 17:23,

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