(This essay was published in Hong Kong Economic Journal on 12 April 2017.)
Underestimating Demand Growth — Divorce and Remarriages
The most important source of growth in housing demand that has not been foreseen in Hong Kong is the rapidly escalating number of divorces and remarriages. This has meant many young adults wanting to have their own homes or planning to set up their own families cannot find affordable homes, and have grown increasingly frustrated.
Hong Kong today has the fifth highest divorce rate in the world. Divorces and remarriages here accelerated after China’s opening that eased social interaction and led to an explosion in the pace and scale of cross border marriages. One can literally read the pressure on housing by looking at the rising divorce and remarriage rates (see Figure 1).
During the period 1976-1995, the cumulative number of total marriages (both first marriages and remarriages) was 803,072, of divorces 84,788 and of remarriages 65,794. In the subsequent period 1996-2015, the corresponding figures were 878,552, 323,298, and 256,066. The rapid growth in divorces and remarriages was not and probably could not have been accurately forecasted. This is evident in housing figures.
The cumulative gross number of new domestic housing units built was 1,267,335 over the period 1976-1995. But in the period 1996-2015 the cumulative number was only 857,378. Housing production between the two periods dropped by one-third. The observed ratio of accommodation quarters to the number of households was 0.91 in 1976, 0.98 in 1986, 1.08 in 1996, 1.11 in 2006, and 1.08 in 2016. This ratio improved steadily from 1976 to 2001 but worsened afterwards.
The significance of divorces and remarriages for public housing policy is that these are mostly concentrated in the bottom half of the income distribution. So not only are the prosperous ‘haves’ demanding more housing, but so are those without means – the ‘have-nots’. The growing waiting list for public rental housing has been precipitated by rising divorces and remarriages among those without means, many of whom have not been able to afford private housing units as property prices continue to rise.
Today many young single persons do not want to live with their parents, including those planning to form their own homes. But they find themselves crowded out of the private market for lack of means.
Public rental housing allocation policy does not distinguish between first-time marriages and remarriages. Public housing tenants can reapply for admission to the program upon divorce and remarriage. So there is an implicit incentive to divorce and remarry for those without means. Unless this incentive is removed, then building more public rental housing units would only fuel more demand by subsidizing divorce and remarriage. Public housing policy has to be reviewed if it ever hopes to succeed in meeting the increasing housing demand among those without means.
The situation with the long waiting list worsened after Donald Tsang gave preference to housing the elderly poor during his time as Chief Executive. In 2011, some 50% of households above the age of 65 were living in public rental housing. Today the elderly have been by and large well taken care of in terms of housing access, it is the young that are frustrated.
Having said that, it would be a serious policy mistake to build more public rental housing units to meet the housing shortage. Divorces and remarriages at the expense of public resources should not be encouraged by our public housing policy. It is therefore imperative that public housing policy should be focused primarily if not exclusively on homeownership, and the benefit could then only be provided once in a lifetime. This would provide a serious disincentive among beneficiaries to breaking up the family.
A public homeownership policy would encourage family stability with positive effects on children, incentives to work and save, social cohesion, and narrowing of the economic and political divides due to the lack of propertied wealth among the ‘have-nots’.
Housing policy should not only seek to meet housing shortages by building more units. It must also address the divorce and remarriage that are an important source of rising housing demand. Supplying public homeownership rather than rental units is central to alleviating the housing shortage in a way that would not exacerbate the problem.
To reduce the housing demand driven by divorce and remarriage, it would be more impactful to privatize the stock of public rental units by selling units to existing tenants, especially those units built since 1997 and the stock of units still on the Tenant Purchase Scheme list. In one fell swoop, this would create a serious disincentive against divorce among households in the public rental-housing sector. And it would take a big step towards reducing the economic divide.
Fiscal Budgets and Economic Social Development
Hong Kong is a rapidly ageing society and in the absence of an aggressive immigration policy, she will increasingly rely on a non-growing labor force to support a rising share of the economically inactive elderly population for decades to come. Public expenditure on health and social welfare will therefore have to be steadily increased as a share of GDP.
The revenue base for funding these rising expenditures needs to be examined despite the huge surpluses we have reaped in the past decade. The main reason for our large surpluses has been the appreciation of land and property values. These have not only impacted capital revenues positively, but also recurrent revenues. How long will property values continue to rise? Even if the values remain stable, the revenues derived from land and property may stop growing.
On the other hand, tax revenues derived from individual salaries and small-and-medium businesses are unlikely to expand as a share of tax revenues and may well shrink in the future. If wages don’t rise by much, how can tax revenues grow substantially? This scenario can be seen from (1) the declining growth of real wage rates over time, and (2) the slower growth rate at the bottom half of the wage distribution compared to the top half (see Figure 2).
During 1976-1996, the real wage rates of men rose on average between 4.5-5.5%, but only by 1-2% during 1996-2016. Part of the lower growth rates can be attributed to the Asian financial crisis, but this cannot account for the entire drop. Another important reason has been the declining growth of human capital in the workforce amidst a global move towards the knowledge economy.
Another aspect that deserves attention is that the growth rate of wages is positively correlated with the level of the wage rate. This means over time the wage distribution is bulging at the lower end, i.e., there are now a higher proportion of individuals with below average wage rates. If this trend continues, and it is likely to do so, then the tax base will narrow further given our present tax regime.
Clearly, more investment in education will be necessary to sustain future growth, but this will take time to make an impact, perhaps a decade or two at the very least. It means that total government expenditures will rise even further as a share of GDP, but revenues from salaries and profits are unlikely to do so. Balancing the government budget will increasingly rely on land and property-related revenues for some significant period of time into the future.
Financing our economic and social future largely by land and property is appropriate given that our land values are unusually precious. This is because its values are securely protected by common law and supported by the high economic growth rates in the Asian region.
Consider the pattern of government spending in the past 20 years (see Figure 3). The fastest growth element has been social welfare expenditure. Health care expenditure has been rising but only modestly so far. Education expenditures have declined modestly as the number of young persons at school age has decreased. Public housing expenditures also declined significantly because less was spent on the public housing sector during Donald Tsang’s period. The significant point to note is that the overall public expenditure remained a constant share of GDP due largely to the decline in housing expenditure.
But this pattern will rapidly change in the decades ahead. Health care spending will rise rapidly, driven by an ageing population, and it is expected to at least double as a percentage of GDP by 2041. Social welfare expenditures will also double as percentage of GDP. Education spending will also rise as more young persons will enter schooling age and more investments will be made to enhance productivity to promote economic growth. The scale of the total expenditure growth in the coming decades will be a challenge for any Financial Secretary wanting to balance the recurrent fiscal budget, unless land and property values continue to stay high as they have done so in the past.
Without rising property values, fiscal revenues (both capital and recurrent ones) cannot continue to rise as a percentage of GDP as they have done in the past three decades. Public expenditures are going to escalate because for over two decades we have not been able to reform our financing arrangements for funding them.
It is unlikely that social welfare, education and health care financing can be reformed in the near future to pass on some of the expenditure growth to clients. So almost all the growth will have to come from the public purse. The existing model of financing public rental housing through the sale of Homeownership Scheme (HOS) units is not going to work in the future because the construction costs of public rental units have increased and the sales price of HOS units cannot be increased sufficiently because of limited affordability and the slow growth of wages.
Under these circumstances, reforming how we finance public housing offers the only real hope of balancing fiscal budgets in the future and providing the appropriate levels of education, health care and social welfare investments for realizing a better economic and social future. The huge fiscal surpluses realized in the past years were merely the windfall gains of an unforeseen property market boom and nobody should think that they can last forever.
At present, government provides land for the provisioning of public rental units and charges a low rent that could not even cover the annual maintenance cost of these units. In effect, the public is financing both the construction cost and the land value of these units. Tenants may be enjoying the value of the buildings, but both the tenant and the government fail to capture the land value. This value is lost forever because the land has no alternative use. The property cannot be rented out or transferred on the market. By contrast, Singapore allows its social housing occupants to do both.
Meanwhile, housing demand among the ‘have-nots’ has exploded in Hong Kong after three decades of global economic integration and cross-border marriages. This will increase the burden on the public purse and reverse the recent downward trend of the share of housing in public expenditures.
In today’s market, even the middle class cannot afford to become homeowners. They too have become a responsibility of the public purse, albeit inadvertently. Indeed, the income eligibility criterion for qualifying for an HOS unit is $50,500 per month; and believe it or not, according to the government’s census, 80 per cent of households are below this income level.
If we reform our public housing policy into an affordable ownership program for the ‘have-nots’, then we will create an opportunity for both tenants and the government to recover the lost land values. This is the only approach that can simultaneously provide a solution for our future budget challenge and allow the present ‘have-nots’ to become homeowners without the need to commit any new resources. It would just make the lost land values reappear.
And what a lot of value they represent. The entire stock of existing public rental housing units (excluding Tenant Purchase Scheme units) evaluated in 2016.Q3 prices was HK$2.95 trillion dollars, and most of this value is attributable to land. Today it is certainly even higher after the recent surge in property prices.
Next week I will look at how we should reform our public housing policy to reunite a divided society, renew our faith in our fiscal foundations, and hopefully amend our polarized politics so that our economic future will not be held hostage again and again.