(This essay was published in the South China Morning Post 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 the size of new private housing units shrinking to new lows. The small size of the units is an interesting question for economics.


The trivial answer is that Hong Kong simply has a huge housing shortage that is expected to remain for some time, due to local and regional economic growth, favorable global macroeconomic conditions (like low interest rates), and a restrictive supply of housing and land.


But causal factors can also be found in the structure and history of our housing market and policies.


Starting in the 1950s, more than one million public sector tenants were admitted into resettlement units without means tests, as the British Hong Kong government sought to redevelop Crown land illegally occupied by squatters.


The resettlement units were very small, often around 200 square feet per unit for an entire household, and set the benchmark for future housing development in Hong Kong.


Over time, as the economy prospered, some public housing tenants wanted to improve their living conditions and bought homes in the private housing sector. Private sector developers only had to build somewhat larger units to make their units sufficiently attractive to these buyers.


Interestingly, the size of public rental housing units gradually increased to around 300 square feet. One might have expected private developers to build larger units to attract tenants, but that did not happen. Instead, the housing ladder from public rental housing to private home ownership broke down.


In 1976, 47 per cent of the households aged 20 to 65 years old living in public rental housing had household incomes above the median household income of the population. By 2016, fewer than 20 per cent did. Given such a situation, there is 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 the next generation – this is how they can realistically improve their living condition.


While waiting for their turn to come up, some household members may have to rent a unit (or sub-divided unit) in the private sector. This is inadvertently encouraged by the “Well-off Tenants Policies” that were implemented from 1987.


Provisions were made for well-off tenants to pay extra, in part to avoid public rental housing units becoming hereditary, which would put enormous pressure on public resources. But these policies have proven to be toothless.


The most tangible outcome 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.


So, while young adults do not inherit the unit, they do inherit the program, which is probably even better for them and worse for the Housing Authority.


In fact, allowing public rental tenants have a hereditary right would be a better deal for the public and represent a more rational use of public housing resources.


Of course, this would mean changing the public rental housing program into an ownership program and selling existing rental units to the tenants. But it would make the housing shortage less severe because there would be more rational use of the units.


Apart from the tenant profile, another amazing development has been that while new private housing units have become smaller, public rental units have not. This makes waiting for a public rental housing units even more attractive.


When this trend is combined with existing planning restrictions and the short supply of land, it means the government is unlikely to hit its 2014 target of meeting 60 per cent of future housing needs through public housing. Only the private sector target will be met because their units are smaller.


Two results emerge from this analysis. First, the small size of our housing units is rooted in the early resettlement housing program, which created 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 demand for public housing leading to the gradual demise of the private housing market and locking more people out of the opportunity to accumulate housing wealth.


Given the severity of our 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 public housing units. And of course, privatizing the existing stock of public housing units to incentivize greater efficiency.

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