The real estate bubble is all but over. As abandoned towns increasingly characterise the suburban landscape of the United States, Spain and Ireland after the end of the last decade’s bonanza, the excess liquidity coming from quantitative easing in advanced countries is now pumping up asset inflation among emerging countries. Since QE1 onwards, property values rose by 62% in China, 69% in India, 100% in Brazil, 70% in Colombia, 120% in Uruguay, with Africa looming large on the horizon as the next big prey.
Investors look for rapid returns away from exhausted and highly indebted advanced economies. This is the poisoned outcome of the globalisation of real estate, where excess liquidity interacts with structural interventions at the micro-level such as the opening up of formerly closed economies in the developing world and the liberalisation of business licensing, taxation and property ownership regulations in many large emerging real estate markets. The aim of this article is to highlight the externalities of property hypertrophy, understand the difficulties of tackling it through policy action and list some policy recommendation to be taken at the relevant policy level on the basis of some empirical evidence.
What makes property bubbles exceptionally disruptive is that they show no positive externalities. A rough comparison with the macro and microeconomic consequences of commodity bubbles might be helpful. Commodity price rallies can provoke inflation and supply-side shocks, but also increase the relative cost of fossil fuels, therefore reducing the cost of the transition towards a less carbon-based economy. Real estate bubbles are negative for the environment due to a rise of suburbs faster than the rise of connecting infrastructures, translating into growing distance between residential areas and workplaces, which means increased use of cars.
Additionally, the distortion of wage structures between tradable and non-tradable sectors – an observable effect of real estate bubbles negatively impacting competitiveness and external accounts – pushes young people away from training, which leads to a destruction of human capital that will not easily find new opportunities once the cycle of the property market turns bad. For instance, during the years of the property boom (2001-2008) Spain experienced a 7.4% increase of early leavers from education between 16 and 24 years, against a general backdrop of a decrease of early leavings (-13.6%) in the Eurozone.
On the contrary, commodity bubbles tend to push people towards high-skill sectors such as engineering or towards the innovation in the field of renewables. Finally, there are no increases of private debt associated to rising commodity prices for the very reason that fuel is not sold on credit whilst real estate financing is significantly leveraged through mortgage loans and other complex debt instruments. As the crisis demonstrates, once this debt is maliciously channelled through toxic vehicles it can end up increasing systemic risk in the economy.
The political management of these negative externalities is not easy. The politics of real estate cycles is undertaken by very volatile constituencies, in both number and size. This makes policy interventions extremely unlikely during the high part of the cycle, when the occasional participants to the game – meaning middle and low-income households and small industry actors – increase along with the electoral returns they give. It has also to be taken into consideration that the construction sector is labour-intensive and extremely linked to territory, due to the high transport costs for construction materials. This makes reform efforts difficult not only within democratic contexts, but also within authoritarian contexts. Before adopting limitations to home ownership, the Chinese government – which initiated the construction boom through heavy subsidisation in order to diversify the drivers of growth away from manufacturing – encountered severe obstacles dealing with local governments, usually the most prone to accommodate construction booms and the most permeable to the lobbying of financial and construction industries, due to their reliance on revenues from land sales and property transactions.
The market does not adjust itself in this sector, because when the bubble bursts property ends up concentrating more and more, providing incentives to keep redundant residential areas abandoned in order to keep the sector profitable. A market where prices are based on expectations about scarcity, rather than on physical availability, cannot function properly when expectations can be enforced by wealthy market actors. As such, in order to prevent this enforcement of scarcity ways to limit concentration of property must be considered.
First, the policy of construction permits should be centralised in order to break the perverse interaction between local governments, local finance and the construction industry. Permits should be granted on the basis of reasonable forecasts on both population growth and households’ income trends. The income factor is fundamental in order not to maliciously play statistics on immigration and to disincentivise property developers from focusing on luxury apartments.
Second, despite the strong regulatory and taxation dimension of the current speculative patterns, one should avoid putting all the confidence in these measures alone. The Chinese attempt to cool down the property market by raising capital requirements failed to reverse the asset price trends, since in many contexts – especially emerging markets – local financial actors can overinvest without massively hindering the soundness of their exposure; as for tax shifts, the current structure of constituencies makes them extremely unlikely. Asset inflation is usually accompanied by a growing sense of alienation of the middle class towards the state and traditional welfare and the tax system. Relying upon asset value-based insurance, vast constituencies tend to reduce their support for welfare guarantees and their costs. Not to mention the fact that targeted countries are increasingly those where tax collection and the rule of law show a very poor enforcement record. Some counter-intuition on the effect of tax shifts alone is provided by the Italian experience: despite the removal of taxes on home ownership, Italy did not experience a property boom over the last decade, mainly because lenders adopted a conservative behaviour taking into consideration income and population prospects.
Third, limitations on home ownership should not be ruled out. China managed to timidly cool down the market only once market actors started factoring in the impact of price caps and limitations to second-home ownership.
The coherence of all these attempts should be found in the need of de-globalising the property market. This means to scale down and be more sector-selective as for the integration of capital markets. Renouncing policy measures means to accept the shift towards a form of extractive capitalism where instability is not a bump in the road, but a structural characteristic of the economy. This means a more insecure environment for innovative and productive long-term investment, threatening the legitimacy of capitalism itself.