(This essay was published in Hong Kong Economic Journal on 18 June 2014)


Thomas Piketty, a French academic economist working in Paris, recently became a celebrity in the United States with his new book Capital in the Twenty-First Century. I contributed to his superstar status by purchasing a copy of it. For me the most interesting parts of his book are the historical charts tracing the rise and fall of the value of capital as a share of national income in some of the old industrial nations. Some of the figures go as far back as the year 1700, thereby allowing us to see how capital has accumulated over the entire history of capitalism’s rise. Anyone who has worked on historical economic data knows that this is hard work. Piketty’s contribution to research is laudable.


His work has appeared in the United States at a time when there is a great deal of public concern over the rising inequality of income and wealth, especially its concentration in a small fraction of the population – the so-called top 1%. Piketty’s audacious prediction that inequality and concentration will worsen in the 21st century because this is an immutable law of capitalism has made him an instant hero with the political left. His proposal to tackle this situation by imposing a high rate of taxation on wealth holdings in all nations bestows upon him a halo effect precisely because it has almost zero probability of ever being implemented.


The merits and demerits of Piketty’s work are not the subject of this essay. But his findings are very relevant to a subject I have written a great deal about in the last few years: the incredibly high regulatory cost of land formation and property development in Hong Kong. What the evidence in his book shows is that the regulatory cost must also be incredibly high in France, the United Kingdom, Germany, Canada and the United States. And these incredibly high costs are likely to be one of the most important causes of rising inequality and the concentration of income and wealth in the past few decades.


Housing Capital is the Most Important Source of Capital Growth


Piketty’s main findings are quite simple. Historically, the ratio of capital to income was quite high. In France, the United Kingdom and Germany it was about 700%, and in Canada and the United States it was about 500% (see Figure 1, Figure 2, Figure 3, Figure 4, Figure 5).

These ratios fell significantly in the first half of the 20th Century as a result of the Great Depression and two world wars. In France, the United Kingdom and Germany it fell to between 200-300%. In Canada and the United States it fell more modestly to between 300-400%, as the devastation of the two world wars there was less severe. But the ratios began to rise again in the second half of the 20th Century.


What is particularly interesting is that the rising ratio of capital to income is almost entirely due to the rise of housing capital in these five countries. Piketty estimates housing capital as the value of the total stock of housing, in other words, the total sum of the price of every housing unit. The reason why the ratio of housing capital to income has risen over this period is due to the increase in housing prices and not just an increase in total housing stock.


Why Are Housing Prices So High?


Housing prices are determined by demand and supply. Rising housing prices reflect that demand is growing faster than supply. But why has supply failed to respond sufficiently to demand growth? Is it because the supply of land is limited? Surely the supply of land cannot be limited in all five countries. More likely, rising housing prices reflect regulation restrictions placed on land use conversion and housing development, especially in the major urban metropolitan centers.


From this perspective, housing properties are expensive because of artificial restrictions. Their high prices are the result of government regulations in planning, land zoning, and other building and construction activities. These barriers to development and construction delay the supply of housing. One can think of these regulations as induced delays that are driving a bigger wedge between housing prices and construction costs.


Hong Kong is very familiar with this situation from its long experience with escalating housing prices in the face of severe housing shortages. The wedge has certainly been growing here since the late 1980s. Figure 6 plots housing prices in the property sector per square foot, and tender prices per square foot for building works. (Both private sector and public sector tender prices are include here, based respectively on the Rider Levett Bucknall Index and the Architectural Services Department Index; their results are quite similar).

The chart shows that the gap between housing prices and construction costs in Hong Kong was quite narrow until the late 1980s. Between 1979.Q4 and 1988.Q4 it was 98%, but it increased to 170% between 1988.Q4 and 2014.Q1 – a jump of 82%.


That widened gap was present in both the inflationary period in the early 1990s and the deflationary period from 1997 to 2003 after the onset of the Asian Financial Crisis. It shows that supply failed to respond adequately to demand for over two decades.


Why is there a Gap between Property Prices and Construction Costs?


This gap is a combination of two things: the land value and what Professor Edward Glaeser of Harvard University called the regulation tax. It includes at the very minimum the cost of assembling land, acquiring planning and building permission, and overcoming political resistance and bureaucratic inertia. The cost of housing can be expressed in the formula:


P = C + L + R


Housing prices (P) and construction costs (C) can be found by observing the data. However, it is not possible to directly observe the land price (L) and the regulation tax (R) in the data. For this reason L and R cannot be directly identified. Indeed people commonly (and mistakenly) view the sum of L + R (equal to the difference of P – C) as the land value.


So which is the more significant driver of the wedge between housing and construction prices: land value or the regulation tax?


Glaeser found the estimated regulation tax in the 1990s was of the order of 20 times higher than land values in major cities like Boston, Chicago, New York and Los Angeles. In San Francisco it was around 10 times higher. His results clearly showed that in the United States the regulation cost of development (the regulation tax) was by far the most important driver of higher housing prices in the major urban metropolitan areas.


As a result, Glaeser concluded that the United States was facing a nationwide crisis in affordable housing not because of high construction costs or high land values, but because of the high regulation cost imposed by zoning and other land use controls.


What Do Piketty and Glaeser Tell Us?


Piketty’s long time series on capital growth is almost entirely due to the growth of housing capital. A major reason why housing capital has risen in many developed countries is increasing property prices. Hong Kong is no exception. As Glaeser and I have shown in our separate studies, housing prices have risen in the United States and Hong Kong mostly because of the high regulation costs of development. There is no reason to believe this is not the case in other developed countries.


There are many implications from this result.


First, Piketty is wrong to interpret the rapid accumulation of capital in the latter half of the 20th Century as being a result of capitalism and capitalist competition. Rather, it is government regulation that is the cause. Why hasn’t housing supply increased in response to rising demand? Because in each of the developed countries, a very large array of complex regulations has made development difficult and effectively prevented housing supply from responding to demand. The problem is not market competition, but government regulations that prevent markets from functioning properly.


These regulations controlling land use and housing development have been in existence for decades. They are complex and are only understood by government regulators, developers, contractors, and professionals like lawyers and surveyors. Various interest groups exploit these regulations for their own purposes and very often pressure the legislature and government to introduce yet more laws and regulations.


For example, conservationist groups have often prevented development of large tracts of land in the interest of preserving that land for conservationist purposes.


Other interest groups that wish to preserve heritage structures often propose new regulations and use existing ones to prevent redevelopment. Large sections of London, Paris, Tokyo and other cities cannot be redeveloped, thereby effectively limiting supply. London’s financial center had to be built in Canary Wharf because redeveloping Central London was not feasible. As a result, the cost of supplying financial services became more expensive.


In Hong Kong, regulations on zoning and changes in land use have slowed down the redevelopment of industrial areas since industry moved across the border. The result has been to increase property prices due to a mismatch of usage. The slow rate of conversion of agricultural land into other uses has also contributed to higher property prices.


These phenomena are not unique to one or two places, but are universally found in most cities and countries.


Anti-market and anti-capitalism groups have also often singled out crony capitalism as the primary culprit of rising housing prices?. While crony capitalism exists in all societies, the true scale and scope is little documented and most probably exaggerated. In Hong Kong, Alice Poon has eloquently argued that there has been connivance between the government and property developers, in her book Land and the Ruling Class in Hong Kong. But her thesis has the causation completely reversed.  Hong Kong’s regulatory rules and systems governing land use and development were not created by the developers.  These regulatory rules have remained largely unchanged for decades. They were introduced into Hong Kong from Britain and have been followed since then. All developers in Hong Kong have had to work under such regulatory rules.


The problem is that these rules are not designed to accommodate the kind of rapid and large increases in housing demand experienced in Hong Kong in the last three decades. As a result they have prevented the market from being able to respond quickly. Every so often a few highly experienced developers or very lucky ones have been able to get their projects through the regulatory rules successfully. They then built on their experience and luck to grow even more competitive, making it difficult for smaller and less experienced developers to remain in the development business.


The growing concentration of the property development industry in Hong Kong and the slow supply response are both consequences of the complex regulatory environment. Only developers able to navigate through these complexities, i.e., able to afford the high regulation tax, can stay competitive in the industry. Property prices will continue to rise as long as the regulatory regime continues to be complex and the regulation tax stays high.


The last four decades have been a period of rapid globalization. Economies everywhere have prospered in real and material terms. People in numerous countries have become wealthier. They have demanded more and better housing, especially in prime locations all over the world. Supply in most developed countries has fallen way behind because of the high regulation tax or, equivalently, the complexity of the regulatory regime. These regimes are also easily exploited and hijacked by various organised groups for their own special interests and political purposes that further slow down development. The result is rapidly escalating property prices.


Piketty’s historical data on the rising ratio of housing capital to income shows that what has happened in Hong Kong is found elsewhere. What connects these similar experiences in different places is the high regulation tax.


Those who were lucky enough to be property owners at the early stages of the price increase have reaped huge capital gains. Those who were less lucky, however, have found themselves among the have-nots.


If the regulatory regime is not reformed to reduce the cost of development, this problem will not go away. The rising trend of housing prices – the most important component of the rising ratio of capital to income – is the main source of inequality in wealth in Hong Kong (like most other places). What begins initially as inequality in housing wealth gets transmitted into the next generation and is transformed into other forms of inequality, in particular, inequality in opportunities with other distributional consequences. Policymakers would do well to keep this in mind.




Edward L. Glaeser, Joseph Gyourko, and Raven Saks, “Why Have Housing Prices Gone Up?” NBER Working Paper No. 11129, February 2005.


Thomas Piketty, Capital in the Twenty First Century, Harvard, 2014


Alice Poon, Land and the Ruling Class in Hong Kong, Second Edition, Enrich Professional Publishing, 2011


Y C R Wong, “Why is Housing so Expensive?” Hong Kong Economic Journal, 14 March 2012

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