Right now land prices need to be stabilised, but wages and inflation need to accelerate so our debts don’t drag the economy into recession. Ideally land prices would stay constant, and wages would grow faster so the price of land in real terms (after inflation) falls. This is easier said than done…
After the Federal election, our hopes for reform to the Capital Gains Tax discount and Negative Gearing will not be fulfilled in this term of parliament. Some are suggesting that this is for the best, as housing (read: land) continues to dive, and the economic soothsayers are warning of recession. While we all want lower land prices relative to real wages, we don’t want fewer jobs and less business. That’s what a recession can bring.
Will reforming tax on land and housing really blow up the economy? It is worth taking a step back to assess what is really going on and what can be done about it.
The canary in the coal mine
At Prosper, we look to falling land prices as a leading indicator of economic recession. Notably, recession usually occurs within 2 years of peak prices. For this cycle, the market’s upward trajectory peaked in September 2017.
The Reserve Bank of Australia has re-examined the tea leaves, and divined that its estimation of the NAIRU (non-accelerating inflation rate of unemployment) is now too high. The NAIRU attempts (albeit poorly, if at all) to capture the fullness of “full employment”; how low unemployment can go before inflation takes off. Inflation has been persistently lower than expected, resembling the situation in the US and elsewhere.
That means the economy has more spare capacity than previously thought, the upshot of which is that the RBA is not doing enough to reduce unemployment. The RBA is mandated to fix the problem, but interest rates can’t go much lower. Rate cuts below 1% are also ineffective.
QE (Quantitative Easing) has been proposed, however recent international experience with quantitative easing is uninspiring. Providing cheaper debt to already heavily indebted workers and reluctant businesses has little impact. This is because the economic problems have little to do with the cost of borrowing for investment. Instead, QE inflates asset prices (e.g. shares, bonds and potentially property) to the benefit of the wealthy who already owned them.
Slow deflation or catastrophic bust?
The decline in property prices was triggered when prudential regulators actually started doing their job by enforcing proper lending standards on banks. The Royal Commision combined with more risk averse banks, resulted in a credit crunch. This has affected potential buyers, and also developers. The downturn has raised the spectre of knock on effects to construction and retail related businesses that cater to new housing investment.
During the election campaign, the government stoked fears that the ALP’s tax reforms would amplify the property market downturn into a recession-causing bust. However, it’s hard to see how winding back negative gearing and the capital gains tax discount could have done much more harm. The proposed changes were all grandfathered, and had no impact on existing investors. Potential investors may have been deterred from buying, but those impacts are stronger when prices are rising. Prices are falling. Had the ALPs policies come to pass, they would have softened the next boom, and prevented spiralling housing unaffordability.
The ALP also proposed to direct millions of dollars into social housing development and build-to-rent. Aside from providing targeted relief for those marginalised by soaring housing costs, this strategy made the government and superfunds a sort of “buyer of last resort” to bailout the market. Proposed large income tax cuts would have also fed back into higher property prices via the trickle up effect.
The current nominal decline in land prices (~10%) has been manageable, but much further would cause big problems. As Keynes (and other economists) have noted, capitalism has an easier time with prices going forwards rather than backwards. Debt becomes debilitating when prices fall but what’s owed does not – no one buys for capital loss. People stop spending, jobs stop opening, and the economy grinds to a halt.
Stabilising land prices. What can be done?
The RBA has been calling on the government to spend more on infrastructure and effectively engage in stimulus deficit spending. The GFC shows us this works in practice, although if rushed can be poorly executed. There is a problem though… Governments are already spending big on infrastructure. So big in fact, that Victoria is short on concrete. There is no spare resource capacity left in the construction sector to build more infrastructure on the east coast at the moment, let alone more housing. So in some ways it has been beneficial that developers have been stunted in building more housing.
The Government needs to throw money at something that doesn’t involve more concrete.
Income tax cuts (by raising tax brackets and wind back bracket creep), are one obvious option that will help significantly, especially considering the retail sector is already in recession. Tax cuts were taken to the election by both major parties, however they are not large enough, and alone are not enough to achieve the RBA’s desire to get an extra 100,000 jobs overnight.
The government needs to spend more on things we have a lot to spare… Maybe re-hiring those CSRIO scientists and public servants it’s sacked over the years? Although that assumes they’re still around, and would be a more long term commitment. Health, education and expansion of social services pose a similar issue. Spending more on these things would be beneficial, but limited in scope given stimulus is needed now. Now is the time for Australia to look at a Green New Deal and directly employ people to fix the planet. This could be a good fit for the re-elected Coalition Government, given their preferences for Direct Action.