Why didn’t economists see Australia’s property bubble?
By Philip Soos
This article first appeared at www.theconversation.edu.au and is republished under Creative Commons.
One aspect of housing and stock market bubbles continually repeats: the vast majority of economists either miss or deny their existence.
In recent years, enormous asset bubbles have burst in many countries.
The most notable have been in the United States. The first was a US$10 trillion stock market bubble, popularly known as the Dot-com bubble.
Worrying indicators ascended to astronomical heights in the late 1990s, but the mass popular delusion of ever-rising prices kept the economics profession, investors and the public from seeing that a bubble was forming. We know what happened later – the Dot-com bust.
This was followed by an US$8 trillion housing bubble, which saw an 86% run-up in housing prices between 1996 and 2006, climaxing with a spectacular crash that nearly bought down the entire banking and financial system in the US.
Again, economists either missed or denied the existence of a housing bubble, though many fundamental indictors clearly pointed to this reality.
In Australia, our $2 trillion housing bubble has seen prices rise by 127% from 1996-2010, and every fundamental indicator is off the chart.
But while it seems logical to conclude that Australia’s property bubble will inevitably burst, very few observers seem willing to do so.
A decade of hearing the drumbeat that prices always rise and never fall has been replaced with the more subdued claims of a return to affordability as housing prices decline slightly.
By definition, an asset bubble requires the vast majority of the public and economists to participate in the mass delusion that prices will endlessly rise.
If people believed otherwise, they would take rational individual action, which then would either prevent a bubble from forming or would quickly burst it in the early stages.
Unsurprisingly, a study by economist Dirk Bezemer found that only 12 economists correctly predicted the US housing bubble and global financial crisis. Similar to that study, 18 economists picked the largest housing bubble in Australia’s history.*
Why do economists continually get it wrong?
There are two causes. The first is a widely discredited form of economics that is taught in universities and practiced in government, industry and research institutes.
This is called “equilibrium economics” and is associated with the neoclassical school of economic thought. It teaches, using many unrealistic assumptions, that markets operate in equilibrium – a state in which economic resources are put to their most efficient use.
This worldview assumes, because markets operate efficiently, assets are almost always priced correctly – so bubbles cannot occur.
Neoclassical theories of equilibrium price statics, rational expectations, efficient markets hypothesis, capital assets pricing model, utility, and so on are doctrines with almost no empirical justification. This economic theory does not reflect reality. If it did, then why are so many countries generating the largest bubbles in history?
The second reason is one of wealth. During a bubble, the rich become much wealthier. This wealth is actually rent, which is unearned income.
We are told that in a capitalist economy, people make a living by either working or deploying capital in a productive enterprise.
The rich, however, are rich precisely because they manage to privatise the rents that land produces, including what is made from speculation (intellectual property is another). Rent stemming from residential land equates to about 30% of GDP in Australia.
Meanwhile, many leading economists whose analysis and commentary the public relies upon have so many conflicts of interest it would fill a small book. Consultancies, university chairs, endowments, six-figure salaries, and industry directorships comprise part of the package that ensures economic “thought leaders” within government, industry and universities speak the words pleasing to the rich.
Accordingly, economists do not go out of their way to question the astronomical wealth of the opulent minority, as that would be tantamount to heresy. Thus, it comes as no surprise that mainstream economists are bubble deniers.
Literally three months before the peak of the housing bubble in the US, the two leading economists in that country, Alan Greenspan and Ben Bernanke, testified before Congress that a bubble didn’t exist. If they couldn’t see it, what hope do Australia’s economists have?
So how do we get it right?
The answer is easy – give weight to the economists who picked the housing bubbles and global financial crisis and consider their comments carefully.
Follow their analysis and don’t be afraid to have an opinion different to that of the majority. Breaking free of the doctrinal system that says the rich earn their wealth and that there is no bubble takes time and effort, but is well worth the struggle.
*Four of the 18 who called the bubble are Prosper Australia principals: Bryan Kavanagh, Gavin Putland, Karl Fitzgerald and David Collyer.
Philip Soos is a Masters research student and employed researcher at Deakin University, working his way towards a doctorate in political economy. He specializes in the comparative analysis of domestic and international pharmaceutical research and development systems. Philip also holds MBA and IT degrees from RMIT University and Swinburne University of Technology, respectively.