(This essay was published in Hong Kong Economic Journal on 1 February 2017.)


When the first Chief Executive Mr. C H Tung took office in 1997, he made homeownership for 70 percent of the population his policy goal.  The Asian Financial Crisis derailed the plan, but only after starting to build a record 300,000 public housing (rental and ownership) units by 2002 and making available for sale 250,000 (subsequently revised to 183,700 units) public rental Tenant Purchase Scheme (TPS) units.


The second Chief Executive Mr. Donald Tsang took office amidst a ravaged and collapsed housing market but did not focus on housing and land issues; was keener to improve the built environment rather than increasing supply. He learnt towards the end of his term this was a poor judgment, when he tried to reintroduce a new subsidized ownership scheme for middle-income households and revived the halted Homeownership Scheme just as property prices took off in a fully revived market.


The third Chief Executive Mr. C Y Leung has spent maximal effort, facing multiple difficulties, to increase the supply of land and build more public rental and ownership housing units to accommodate the escalating demand for housing of the not well-off families and to curb price speculation through draconian punitive stamp duties.


Over the past three decades, opinion polls have shown time and again that housing is the top policy concern of the public. Unfortunately, the housing challenge remains unsolved. I believe the reason is because we have tried to tackle it as a housing problem and failed to appreciate that it is also a problem of economic inequality.


Tyranny of Long and Short-Term Factors


To view the housing challenge solely as a housing problem means to focus primarily on the shortage of accommodation units. So when housing prices and even rents continue to rise, we surmise the supply of housing must be falling behind demand. As a consequence, we then decide the solution is to increase housing supply, which of course takes time (say 3 years, but if land is not available it can take up to even 10 to 20 years).


Meanwhile, housing prices keep escalating, speculation remains rife, and the people who cannot afford the rising prices get angry. The government then quickly slaps on punitive transactions levies to halt prices temporarily, but at best this only curbs speculation. It does not address the underlying conditions of supply. Inevitably, even before the original housing shortage has been met, demand collapses unexpectedly and totally. Prices plummet, property owners are deeply hurt and upset, and housing policy quickly goes into reverse gear.


Housing policy has been so difficult to get right because the factors driving demand and supply do not work synchronously, which leads to the wrong policies being adopted. These factors are: (1) long-term housing demand, (2) short-term housing demand, (3) long-term housing supply, and (4) short-term housing supply.


The long-term drivers are slow-moving and more predictable and they have to be tackled by economically and politically sustainable policies focused on long-term goals, not short-term considerations. The short-term drivers are less predictable and faster-moving, and they may appear suddenly, often caused by external factors beyond the control of our policy makers, for example, the Asian financial crisis and US quantitative easing.


Housing policy is unfortunately too often (and unavoidably) compromised by short-term political considerations to the detriment of more long-term economic and social considerations. For these reasons, a housing policy that is not sustainable cannot succeed. A sustainable housing policy must meet all economic, social and political goals, and constantly so.


Economic Inequality and Housing


In the four decades leading up to the mid-1980s, the defining housing problem in Hong Kong was the shortage of housing quarters relative to the number of households, a situation created by the massive immigration wave that increased our population from 600,000 to 2.3 million between 1945 and 1951. The main housing issue was to build as many housing units as quickly as possible, often at affordable prices and with little regard to quality.


This was a task that a government body could undertake and perhaps there were some advantages in this. The Housing Authority and other public housing bodies tasked with meeting this goal succeeded and the ratio of domestic households to permanent housing units, known as the “degree of sharing”, fell from 1.27 in 1971 to 0.92 in 1991.


The “degree of sharing” ratio has since remained within the range of 0.89 to 0.93 despite considerable variations in supply and demand conditions. Meanwhile, public dissatisfaction with rising property prices and the worsening housing shortage has been escalating, particularly since the 1980s. Obviously the “degree of sharing” has ceased to be a relevant indicator of shortage in the housing market. There are two reasons for this.


First, the nature of the household is changing. Divorce rates have risen rapidly. The number of cross-border marriages has exploded (comprising about 40% of all marriages each year in the past 30 years), especially among low-income families. Together this has greatly increased the demand for both public and private rental housing among low-income households where divorce is far more prevalent.


The rising demand for sub-divided housing in the private renter market is a by-product of housing demand at the low end of the market. Most reports of the housing market have focused on the increasing demand from rich overseas investors with little awareness that the most important growth has come from low-income households.


Second, economic inequality (in both income and wealth) has increased significantly for a variety of reasons. And this has politicized housing policy enormously, creating a deep divide within society on what is to be done. Half the population wants government to curb prices; the other half wants the exact opposite. Housing policy today is totally held hostage to zero-sum politics and cannot be effectively tackled without finding a solution to economic inequality.


Income inequality everywhere has widened because of the rising relative wage differential between skilled and unskilled workers due to technological progress and global economic integration. This has pushed the middle-income class towards the low-income class. A sinking middle-income class is the single most important cause of the political divisiveness in societies everywhere.


In the US, the government responded to this situation with low interest mortgage loans and zero down payments to encourage homeownership. The resulting housing boom, assisted by poorly regulated mortgage market securitization, eventually collapsed in the 2008 financial crisis.


In Hong Kong, monetary authorities fearful of property market booms and busts and the danger they pose for systemic risk in the banking sector aggressively regulated the loan-to-value ratio on mortgage loans. With a 40 percent down payment required, the middle-income class became condemned to the same hopeless fate as the low-income class in dreaming of homeownership, unless their parents were lucky enough to be homeowners with considerable home equity. This was another blow to the sinking middle-income class.


Amazingly, increasing the supply of public rental housing is still seen by policy makers as the only imaginable solution to satisfy the rising housing demand among the low-income and middle-income classes.


Tackling Economic Inequality Through Housing


In Hong Kong today, the housing challenge is no longer merely about the shortage of housing units relative to the number of households. Rather, it is (1) the disappearing homeownership dream of the middle-income class as it sinks towards the low-income class, and (2) the growing share of low-income households in the housing market, which is creating more pressure for publicly-supplied housing units that the government can ill-afford.


Solving the housing challenge requires directly confronting the consequences of increasing economic inequality in a rising housing market. This cannot be done by increasing housing supply alone, as this will end up worsening economic inequality and harming fiscal budgets and the long-term health of the economy.


The share of publicly-supplied housing units has increased from 50% of total supply to 60%. It is a policy favored by populist politicians. But few neighborhoods welcome public rental housing units in their vicinity because of the adverse impact on property values. It is easy to accuse the people of being selfish, but it is not a crime to be so. And who came blame them when property values are so high and are the most important component of their wealth.


Developing large tracts of land assembled in the New Territories would require acquiring private land, often zoned for agricultural use and held by indigenous villagers and developers. Like neighborhood residents, they are unwilling to sell a large share of their land holdings for public rental housing uses since the compensation they will receive from government is not as attractive as other options.


The land issues today are even more difficult because rural squatters are now unwilling to relocate because the resettlement compensation packages from government only recognize accommodation needs, not economic livelihood issues. And rural squatter rights today have highly vocal champions who have formed political alliances with other built environment and conservation interest groups.


Another difficulty is that the development cost of public rental housing units has increased significantly over time. In the past the sale of a single Homeownership Scheme (HOS) unit could support the development and maintenance cost of two public rental housing units. This is no longer feasible today.


The problem is that the development cost of public rental units has risen significantly, but the sale price of HOS units cannot be increased commensurately because household incomes have not risen sufficiently. As a consequence, today the sale of a single HOS unit can only support a single public rental housing unit. This makes it very difficult for government to raise the acquisition cost for rural land that is needed to increase public rental housing supply in the long run.


So without serious increases in fiscal revenues (perhaps through taxation), it is highly doubtful that the government can finance a larger share of public housing units in the annual housing supply on a sustainable basis.


Adding to this is the demand from divorced individuals who remarry, who can continue to apply for public rental housing. The public rental housing program inadvertently provides an incentive and huge implicit subsidy for low-income households to divorce. The more you build, the more demand grows for public rental housing among low-income households.


Expanding public rental housing units, therefore, makes little sense on three grounds. First, it is financially unsustainable for government. This makes it even more difficult for government to make more attractive land acquisition offers and resettle rural squatters to reduce holdout time.


Second, it creates a perverse incentive that increases the demand for public rental housing by encouraging divorce among low-income households. This increases household income inequality by forming more low-income broken families and worsens society’s growing economic inequality.


Third, as more households are placed in public rental housing units, the prospect of homeownership dims because the housing ladder has been broken due to high property prices and exorbitant down payments. Alleviating growing economic inequality becomes an ever more remote possibility.


Virtues of Unlocking Public Land Values


A far better solution is to unlock the values of public land occupied by public rental, TPS, and HOS units. It can be a win-win solution for everyone. This would entail adopting three policy measures.


First, sell new public housing units as ownership units (with an option to rent initially and buy later with sales terms unchanged) to eligible families. All applicants for public rental and HOS units would be eligible. This would mean all households with monthly incomes below $50,500. The units built for eligible households would be starter homes suitable for those at the lower end of the housing ladder.


The key to revitalizing the housing ladder is to facilitate financing rather than offer price discounts. These units would be sold at development cost and purchasers would arrange for mortgage loans from banks with government guarantee (as in the present situation with HOS units) after paying a 5-10% down payment.


The unpaid land values of the unit at the time of the purchase would be financed by an interest-free loan (or at a low interest rate) by the government that has no maturity term and debt servicing requirements. These units could be sold on the open market subject to full repayment of the outstanding debt owed to government. Unlike the HOS units, the unpaid debt would be fixed and not change as land values appreciated or depreciated.


The owner would collect capital gains on the land values accumulated from the time of purchase. Government would collect the land values owed by the owner when the unit was sold or earlier when repayment was made. The new arrangement would turn the government’s role into a financier. It effectively corrects the problem of capital market imperfection created by the imposition of a loan-value regulation to avoid systemic risk in the banking sector.


Second, all existing public rental housing units could be sold to the sitting tenant under the same financing arrangements. Those who were unwilling to purchase at the present time could have the option to do so later on the same terms.


Third, all existing TPS and HOS units with outstanding unpaid premiums could now settle them using the same financing arrangements.


Land values would then be unlocked. Both the owner-purchaser and government-vendor would benefit as a consequence. The owner would acquire an asset that has appreciation potential and obtain a realistic opportunity to move up the housing ladder and seek a better life.


The government as the owner of the land stock on which public housing units are built could collect payments over time from the owners who are its debtors. Indeed, all public sector housing units could be developed from sales receipts and the fiscal burden on developing public housing would disappear.


Developers and other investors would have an opportunity to tap into a much bigger pool of domestic clients. Rural landholders would be far more willing to sell their land to a government willing to consider higher payments for developing public housing.


The government would not have to wait for years or decades to receive the payments. The outstanding loans of the public unit owners would be the government’s assets. These could be sold to the market for immediate return as long-term debt. If such debts had terms of maturity of say 30 years, then there would be more hope that a bond market with sufficient liquidity could be developed in Hong Kong with long term interest rates that could serve as a valuable benchmark to facilitate long-term borrowing and lending.


The unlocked land values of the existing stock of public sector housing units currently is estimated to be about $3.89 trillion, which is almost twice the gross domestic product. Even if a fraction of such funds were available, it would go a long way to pay for the anticipated growth in social spending on education, health, welfare, and infrastructure and project investments without having to find new sources of revenue.


It would also go a long way towards alleviating economic inequality in Hong Kong, while preserving the vitality of Hong Kong’s free market, limited government, and low tax rate private enterprise economic system. And it could pay for our growing social expenditures. Such is the beauty of a land-financed equitable society and vibrant economy. And all this is courtesy of a common law legal system that makes the land values of our capitalist economy so precious.


I hope the members of the Election Committee for our next Chief Executive are listening.


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