An article in Qiushi magazine on the first day of the year carried the title: Improving and Stabilizing Expectations in the Housing Market. It made the point that stabilizing home prices should be a policy priority and is the key to bringing about a vibrant and healthy economy. Declining home prices will produce a serious negative effect on consumption. Erosion of the value of savings implies a need to cut consumption to restore the savings to the former level and even to raise those levels if the economic outlook is grim. Falling housing prices will also reduce the ability of small and medium-sized businesses to borrow money. Most financial institutions are unwilling to lend money to small and medium-sized businesses without collateral. In a weak housing market, banks’ valuations of properties tend to be very conservative. The collateral value of homes will be reduced, directly hitting the ability of these businesses to borrow.
Economists have learned that the housing market is subject to cyclical swings and have developed the cobweb theorem to formalize the cyclical working of the market. Because housing development, and by extension, property development for other uses, takes years, without coordination, overbuilding will happen when demand is high. By the time the new developments reach market, the glut will cause prices to fall. Declining prices and profits will slow down development significantly, eventually leading to a shortage down the road. Shortage will drive prices up, leading to another round of overbuilding. Because of a significant glut, housing prices on the Chinese mainland remain weak notwithstanding efforts to stimulate purchases. A negative wealth effect in turn weakens consumption and investment.
Housing price fluctuations can be very disruptive of the economy because housing for many households represents the key instrument to store their life savings. No one wants to buy when prices are falling, because further declines could mean losing one’s hard-earned savings. So, when prices are falling, people tend to stay on the sidelines and wait until prices have stopped falling. This will, however, lead to further price weaknesses.
Property development also has both upstream and downstream linkages to many other sectors of the economy. Upstream means steel, cement, glass, elevators, air-conditioners and other key appliances, professional services, etc. Downstream means brokerages, banking, accounting, legal services, furniture, home design, and even retail and transportation.
Significantly, the continuation of the “cobweb phenomenon” is not necessary, even if it had already appeared. Even when there is already an overhang of excess supply, it is possible to prevent the overhang from hurting market sentiments. In particular, the government can set a yearly quota of sales for different classes of housing and offer these quotas for bidding by developers. These quotas will be set according to projected demands based on demographics and other socioeconomic factors. Those who want to sell will have to bid for these quotas. The revenue from these auctions will be recycled back to all the buyers to reduce the taxes that need to be paid. This way, expectations for a supply glut to drag prices down further can be averted, while the cost of buying homes can be reduced.
We can think of developers with a lot of units to sell as members in a crowd. A rush to sell will lead to price declines. A price decline will scare buyers away and prompt sellers to sell sooner rather than later. This is like a stampede that must be averted in order to avoid disaster
Requiring quotas to sell is very much like managing the movement of crowds when streets are overcrowded. To celebrate the arrival of the 1993 new year, huge crowds assembled in Lan Kwai Fong, Central. After the countdown to the new year, tragedy struck. The crowd pushed and shoved on D’Aguilar Street. A stampede was triggered when some people fell and other people continued to move forward. In the end, 21 people died and 63 were injured. Since then, crowd movements on Hong Kong’s roads and streets have become much better managed, and no serious stampede incidents have happened again in Hong Kong. Sadly, similar tragedies continued to happen around the world from time to time.
How do we relate a stampede from a crowd in which everyone wants to move forward to a housing market facing a supply glut? We can think of developers with a lot of units to sell as members in a crowd. A rush to sell will lead to price declines. A price decline will scare buyers away and prompt sellers to sell sooner rather than later. This is like a stampede that must be averted in order to avoid disaster.
It is important that the design of the proposal be “revenue-neutral”. Requiring a quota to sell would normally be regarded as unfair to developers because that would mean an additional cost. According to my proposal, however, all revenues collected are returned to the buyers, who are the customers of the developers. This will encourage buyers to come forward. Naturally, it is not possible to accurately predict the revenues from the auctions. Yet auctions are efficient. Those who need liquidity most will be able to sell first, and at a better price than without the auction. If in the end the government runs a small loss or a small surplus from the operation, it will be put on record and effort should be made so that over the long term it is revenue neutral. A surplus would allow the government to offer more incentives or help for a home purchase down the road. A deficit should be absorbed readily by the government. This would be a small cost for a big gain for the economy.
The author is an honorary research fellow at the Pan Sutong Shanghai-Hong Kong Economic Policy Research Institute, Lingnan University, and an adjunct professor at the Academy for Applied Policy Studies and Education Futures, the Education University of Hong Kong.
The views do not necessarily reflect those of China Daily.
