Is Australian housing more than 40% over-valued?

Source: Australian Bureau of Statistics

A recent article in The Economist suggests that “housing appears to be more than 40% overvalued in Australia, Britain and Canada” (“Hot in the city”, April 2, 2016 - possibly gated). This claim is based on the extent that the ratios of prices to disposable incomes and prices to rents are above their long term averages in those countries. By contrast, according to The Economist, housing prices in the United States are currently at “fair value” because those indicators are close to their long run average.

When they talk about “fair value” I guess what the authors of The Economist article have in mind is an equilibrium price that may differ from current market prices.  That raises some thorny conceptual issues, but I am prepared to accept that markets are sometimes affected by the irrational exuberance or pessimism of large numbers of investors.

The Economist has been using the same methodology for quite a few years now to suggest that housing prices are overvalued in countries in which they have risen strongly since the GFC.

When I wrote in 2011 about a previous article in The Economist using this methodology I pointed out that it was unrealistic to expect average rental yields (the inverse of the house price to rent ratio) in Australia to return to its long term average over the period since 1975 because over the first half of that period high nominal interest rates were suppressing demand for housing. As inflation rates and interest rates came down, housing affordability improved markedly during the 1990s, but this led to increased demand for housing, a sharp rise in house prices and a decline in rental yields. What we were seeing was a return to normality rather than the emergence of a house price bubble.

The Economist has published an infographic (ungated) which neatly illustrates how the ratios of prices to disposable incomes and prices to rents are currently above their long term averages in Australia, Britain and Canada. However, their infographic also illustrates the potential for large errors to be made by assuming that long term averages of house price to rent and house price to income ratios represent equilibrium prices. If you look at movements in the ratios of prices to disposable incomes and prices to rents over the whole period 1970 to 2016, you will notice that those ratios for Australia and Canada were well below the corresponding ratios for the US in the 1970s and ‘80’s. The same was true for Britain in the ‘90s. Even if actual price to income and price to rent ratios were currently the same in all four countries, the ratios for Australia, Canada and Britain could still be expected to be above their long run averages.

So, what does a comparison of actual ratios for Australia, Canada, Britain and the United States show? I haven’t attempted a complete assessment, but the latest data from Global Property Guide (GPG) on gross rental yields suggests yields of 4.4% for Australia (Sydney), 4.4% for Canada (Toronto), 3.2% for the UK (London) and 3.9% for the US (New York). The GPG data for the US relates to Manhattan which might be perceived by investors to offer better prospects for capital gains than most other localities in the US. The Economist’s data on price to rent ratio’s for the US implies a much higher gross rental yield for New York (about 7%) and even a somewhat higher yield for San Francisco (about 5%).

Given current and prospective interest rate levels, those comparisons do not seem to provide much evidence of irrationality in housing prices in any of those countries. It seems to me that there is no more reason to think housing investors in Australia, Canada and Britain have been irrationally exuberant in recent years than to think those in the United States have been irrationally pessimistic.  

What is the objective of superannuation?

This post is prompted by the Australian government’s discussion paper entitled “Objective of Superannuation” released yesterday. The government is raising the matters as part of a consultation process prior to introducing legislation to specify the objective of superannuation in legislation. The discussion paper uses the word “enshrine”, rather than “specify”, but that seems inappropriate.

Unfortunately, the paper fails to point out that in specifying the objective of super the government is (or should be) focused on public policy, rather than the wide range of different objectives of different individuals and firms with an interest in super. Some people use super to build wealth to pass to their children. Some people use it to save for retirement. I expect that many people don’t have a clear objective in mind, but view super as a useful savings mechanism. Employers may view super as a way of attracting staff or ensuring that valued staff are able to live comfortably after retirement. The financial institutions that provide superannuation products have different objectives again.

The question the legislation should be trying to clarify is:  What is the objective of government legislation with respect to superannuation?  If we have an answer to that question we may be in a better position to consider questions such as whether there might be a case for individuals to continue to be encouraged, nudged or even compelled (as at present) to save via superannuation .

The government proposes to legislate the objective recommended by the Financial System Inquiry:

“To provide income in retirement to substitute or supplement the Age Pension”.

In my view that is a sensible public policy objective. The government should be encouraging people to become more self-reliant rather than expecting taxpayers to support them in their old age. This is particularly important given the projected increases in the government spending on pensions in coming decades and the many other burdens being placed on taxpayers.

The subsidiary objectives raised for discussion tend to cloud the issues. For example, “facilitating consumption smoothing over the course of an individual’s life” is presumably also an objective of the age pension, unemployment benefits and other welfare payments. Some other suggested subsidiary objectives relate to prudential regulation and fiscal policy.

A potential problem I see with the proposed clarification of the objective is that pursuit of that objective in isolation could result in a less efficient tax system than we currently have. 

Even though they do not do as much as they should to substitute or supplement the aged pension, the current tax concessions for super do reduce the bias against savings and investment under the income tax system. The concessions reduce the extent that individuals who save, and re-invest income from their savings, pay a higher lifetime tax bill than people with similar earnings who choose to save less. The bias against savings and investment will be exacerbated if super tax concessions are reduced without more fundamental reforms being taken to improve incentives for savings and investment.

I was also concerned about this when writing about the potential for tax reform on this blog in April last year. Whilst suggesting that it made sense to include reductions in super tax concessions as part of a tax reform package, I hoped that the government did not forget to obtain a substantial reduction in tax on capital incomes as a quid pro quo.

It will be interesting to see whether specifying a sensible objective for superannuation policy helps to achieve a better overall tax policy outcome.

Was the great tax debate worth having?

The great tax debate began about a year ago when Joe Hockey, the former Treasurer, released a discussion paper prepared by Treasury. Rather than suggesting a small range of options for consideration, the discussion paper put 66 questions on the table.

The answer that the authors were hoping to be given to some questions was, nevertheless, fairly obvious. For example, when they asked how important is it to reform taxes to boost economic growth, it was fairly obvious that the authors were hoping to told it was important. When they asked how should Australia respond to the global trend toward reduced corporate tax rates, they were probably hoping to be told that Australia should seek to have a tax system that would not deter foreign investment. Information provided in the report implied fairly clearly that there could be economic gains from relying less heavily on company taxes and stamp duties levied by State governments and more heavily on GST and taxes on labour income.

However, the debate had hardly begun before Tony Abbott, the former prime minister, began taking options off the table. He might have had good reasons for that, but he kept them to himself. So, by the time Malcolm Turnbull took over as prime minister, the great tax debate was becoming a fiasco.

Not long after prime minister Turnbull declared that all options were back on the table, the Labor opposition began to claim that the government was intending to raise and/or broaden the GST. The pressure became so intense that the government announced a decision on the matter prior to announcing the tax policy reform proposals it plans to take to the next election. The PM stated:

"After you take into account all of the compensation that you would need to ensure the change was equitable, it simply is not justified in economic terms."

That has elicited a range of responses from economic commentators. The most general response seems to have been that if a GST increase is ruled out, that removes the potential for the government to go to the election with a major tax reform program that would encourage economic growth. Some commentators have suggested that such an outcome was predictable in any case, so there was no point in having the great tax debate.

I don't think either of those responses is appropriate. 

Time will tell whether the government is able to come up with a credible tax reform package that will encourage economic growth. There is potential to do so, but it will require the Commonwealth to transfer back to the States the responsibility for raising more of the revenue required to pay for schools and hospitals. The politics of the federation probably require the Commonwealth to take a leading role in the tax reforms required at state level to enable that to happen. The potential exists for the Commonwealth to play a leading role because the payroll tax was once a Commonwealth tax before being given to the States, in the forlorn hope that they would use it as a growing source of revenue and become less dependent on Commonwealth grants.

Even if the conclusion of the great tax debate is that there are no easy tax switch options to encourage economic growth, that doesn’t mean that the debate was not worth having. If enough people had read and understood the stuff I was writing on this blog (here and here) around this time last year, they might have concluded at that point that there are  no costless taxes and that the focus of the debate should be on how to reduce government spending. Other people were writing similar things - more people probably read and understood some of their contributions - but they still had a negligible impact on understanding of the issues by the general public.

The great tax debate was worth having as a public education exercise. In order for people to persuade themselves to think seriously about ways to reduce government spending they need to bring themselves to understand that there are no costless ways to raise additional government revenue. 

Postscript:
When I wrote this a couple of days ago I had assumed that after the government rejected their proposal to increase GST in order to reduce the company tax rate the Business Council of Australia (BCA) had probably picked up its bat and ball and gone home to sulk for another decade or so . Yesterday, however, they have come back into the game stronger than before. The BCA has now proposed a tax reform agenda that will be difficult for this government to sweep off the table. It is well worth taking a look. 

Could Larry Summers be half-right about secular stagnation?

When I read ‘The age of secular stagnation’ by Lawrence H Summers (published in Foreign Affairs (March/April 2016) I was pleasantly surprised to find that I agreed with part of his analysis.

I agree that economic growth has been relatively weak in most developed countries in recent years because levels of investment have been low, despite high levels of saving and low real interest rates. That is not quite how Summers puts it; he talks about “excess savings”. He might have reasons for that, but it makes his argument seem convoluted.

I tend to agree with Summers when he writes:

“Absent many good new investment opportunities, savings have tended to flow into existing assets, causing asset price inflation”.

My agreement is qualified because I think the absence of investment opportunities is more about perception than reality. Why I think that will become clearer later.

The solution Summers offers to the problem of low investment is an expansionary fiscal policy pursued through public investment. Writing about the United States he argues:

“A time of low real interest rates, low materials prices, and high construction unemployment is the ideal moment for a large public investment program. It is tragic … that net government investment is lower than at any time in nearly six decades”.

It is obviously problematic to be proposing an expansion in public investment at a time when rising government debt has been imposing a significant burden on later generations. But there may be ways around such concerns. In its article, ‘Fighting the next recession’ The Economist (Feb. 20) gave some prominence to the New South Wales Government model of privatising assets such as ports to fund public investment. I had not previously thought of the efforts of the NSW government to raise some cash for infrastructure spending as a model that might have wider application.

However, there are limits to the extent that additional public sector investment is likely to stimulate further private investment. Additional public investment in most economic sectors competes with private investment. If governments confine their investments to sectors where public investment might have a comparative advantage, they will, before long, end up investing in projects that have no hope of yielding even a modest return on investment. Such misallocations seem more likely to add to secular stagnation than to help overcome it. Japan’s efforts to stimulate economic growth by building roads to nowhere may be a good example of such counterproductive public investment.

Before proposing solutions to the problem of secular under-investment it would be a good idea to try to understand why it is occurring. In his recent article, ‘U.S. secular stagnation?’ Steve Hanke pointed to Robert Higgs’ concept of “regime uncertainty” as a possible explanation of the long term downward trend in net private domestic business investment as a percentage of GDP since the beginning of the 1970s. An index of economic policy uncertainty developed by Scott Baker, Nicholas Bloom and Steven Davis suggests that economic policy uncertainty is currently very high - at similar levels to the 1930s, and much higher than in the 50s and 60s.

An increase in policy uncertainty is also consistent with the observation by Kevin Lane and Tom Rosewall (RBA Bulletin 2015) that the hurdle rates of return that firms use to evaluate investment projects has not declined along with declines in interest rates that have occurred since the 1980s. This implies that profitable investment opportunities are being foregone because of greater uncertainty about future after-tax returns and costs. OECD researchers suggest that policy uncertainty (concerning regulation, macro policy and taxation policy) is one factor causing the hurdle rate that companies apply to capital spending to be higher than that applied by financial investors (Business and Financial Outlook 2015, p 60).

My conclusion is that Larry Summers might be about half right in his observations about secular stagnation. Investment has been too low, but the long-run solution can't lie in increased public investment. Governments should be thinking about how they can make businesses feel confident that regulatory and tax burdens are not likely to be further increased over the lifetime of new investments.

How did you react to the appointment of a Minister for Happiness in the UAE?

I chuckled. My initial reaction was that the appointment didn’t seem to be the kind of thing that should be taken seriously. But I wondered what the motives of the UAE government might be.

Some commentators have suggested that the appointment of a Minister for Happiness in the UAE was Orwellian. That sent me looking to see whether Orwell had a Ministry of Happiness in Nineteen Eighty-Four. He didn’t. He had ministries of love, peace, plenty and truth. The distinguishing characteristic of each those ministries was the pursuit of policies that were the opposite of what was implied by the label. For example, the Ministry of Love pursued enforced loyalty to Big Brother through policies of fear and repression.

If North Korea establishes a Minister for Happiness it would be reasonable to presume an Orwellian motive, but I doubt that applies to the UAE.

I am not sure that the Orwellian motive even applies to the establishment of a Ministry of Supreme Social Happiness by president Nicolas Maduro of Venezuela in 2013. His motive was probably to distract people from the decline in their economic well-being, occurring even then as a consequence of the government’s economic mismanagement. It is unlikely that the Ministry is helping people to feel any less miserable as the Venezuelan economy now collapses around them, with falling crude oil prices adding to their woes.

Given the fall in oil prices over the last year, the distraction motive might also help to explain the appointment of a happiness minister in the UAE. The IMF has reduced its growth forecasts for the UAE, even though it is more diversified than many other oil-producing countries in the Middle East. The fall in oil prices is causing fiscal deficits to rise and the government is responding by reigning in government spending. The flow-on effects of this might make life more difficult for the large expatriate community (83.5% of the population) most of whom are from South Asia.

In announcing the appointment of a minister for happiness, the UAE prime minister, Sheikh Mohammed bin Rashid al-Maktoum, claimed that the objective was to "align and drive government policy to create social good and satisfaction". The appointed minister, Ahood Al Roumi, was previously Director-General of the prime minister’s department and will apparently retain that position.

The appointment is part of a government shake-up involving appointment of more young ministers and more females. Women now make up more than one-third of all ministers in the government. The government of the UAE has previously announced the vision for their country to be among the best in the world in the Human Development Index HDI and to be “the happiest of all nations”. The UAE currently ranks 41st of the 188 countries included in the HDI.

It is tempting to dismiss all that as window dressing, but there is a chance that the government of the UAE is actually trying to find a way forward toward a better society. In terms of the “good society” indicators I used in Free to Flourish there is a lot of room for improvement in the UAE, even though it stacks up better than a lot of other countries. Of the 110 countries included in the analysis, the UAE ranks 39^th in terms of peacefulness, 24^th in terms of opportunity and 17^th in terms of economic security.

It will be interesting to observe whether Ahood Al Roumi attempts to use her new role to make the UAE a better society. 

Should foreigners be allowed to buy agricultural land in Australia?

Cartoon by Nicholson from “The Australian” newspaper: www.nicholsoncartoons.com.au

I am surprised by the frequency with which concerns about foreign ownership of land in Australia are being expressed to me by friends who have fairly sensible views on most other issues. It is almost as though rationality disappears whenever foreign ownership and agricultural land become linked in their minds.

My response has been along the lines that foreign ownership of land in Australia isn’t something we should be worried about because it has been occurring since the beginning of European settlement and, these days, accounts for a small proportion of total agricultural land. (ABS data indicate that about 99% of Australian farm businesses are fully Australian owned and about 90% of farmland is fully Australian owned.) 

That usually provokes the assertion that Chinese ownership is new and worrying. 

When I suggest that the new owners can’t take the land home with them, I am asked to justify why foreigners should be able to buy land in Australia, when Australians are not allowed to buy land in their countries. My reply has been that Australia should adopt economic policies that serve the interests of Australians rather than following the policies that other countries adopt. 

At that point I am asked to explain how foreign ownership of agricultural land in Australia serves Australian interests.

That might seem like a reasonable question to ask, but it is actually a debating trick that puts the onus of proof in the wrong place. The basis of a market economy is that economic transactions are undertaken because they are mutually beneficial to sellers and buyers. If some third party considers that a particular kind of transaction should not take place, the onus should be on that party to make the case. 

If an Australian wants to buy the property at a lower price, that is not a legitimate argument for preventing the property from being sold to a foreigner. If their sole objection to the transaction is that the purchaser is foreign, why is that relevant?

Unfortunately, the views I have presented above tend not to have been particularly persuasive. My friends seem to want me to explain how Australians can benefit from foreign ownership of agricultural land. Well, now I have now calmed down a little, I will try to do that.

The most obvious way Australians benefit from foreign land ownership is from associated investments which create increased employment opportunities, and generate additional wealth, some of which adds to government revenues and enables more services to be provided to Australians. 

So, what about the situation where the foreign owner does not undertake any new investment? In that situation it is quite likely that the former owner will invest the proceeds of the sale in ways that will generate additional income. It is also likely that the new owner will find ways to use the resources more productively, perhaps by using better management practices. The fact that a new owner is prepared to pay more than the former owner’s reserve price usually implies that the new owner can see potential to generate more income from the property than the former owner.

Is there any more reason to question the benefits to Australians of foreign investment in agricultural land than any other foreign investment, or of new investment in agricultural land by Australians? I don’t think so, but various arguments to the contrary are raised. It has been suggested that ownership that is encouraged by foreign governments to improve food security may endanger future food security of Australians. It has also been suggested that enclaves of foreign ownership could have a deleterious cultural impact on rural communities. The people who promote those views seem to overlook the fact that foreign ownership or agricultural land in Australia is a small proportion of the total.

The opponents of foreign ownership of agricultural land also raise such issues as whether foreign firms pay tax, whether they are able to import foreign labour more easily, and whether they can be trusted to comply with Australian labour and environmental regulations. Those arguments seem to me to be scraping the barrel. It is hard to see why Australian tax and regulatory authorities should have any greater difficulty in dealing with foreigners than with Australians.

As far as I can see there is no case for foreign ownership of agricultural land in Australia to be subjected to more stringent regulation than any other foreign investment in this country.

How should researchers combine different aspects of happiness into a single measure?

A recent paper by Gus O’Donnell and Andrew Oswald considers the question of how to combine measures of different aspects of subjective well-being into a single overall measure.

The authors focused specifically on the four aspects of well-being measured in annual surveys by the UK Office of National Statistics. These are:

• how satisfied you are with your life nowadays;
• to what extent you feel that the things you do in your life are worthwhile;
• how happy you felt yesterday; and
• how anxious you felt yesterday.

All aspects are measured on an 11 point scale from 0 to 10.

The approach taken by O’Donnell and Oswald in their exploratory study implies that all aspects of happiness should be weighted according to their “social importance” as determined by the average weight given to them by citizens in opinion surveys. The specific method they employ involves asking people to allocate 100 points across the four measures. For example, if all four measures were considered to be equally important, 25% would be allocated to each measure.

This method of developing weights seems to me to be much better suited to combining well-being indicators such as those included in the OECD’s Better Life index (e.g. income, education, health, environment) than to combining survey data relating to different aspects of subjective well-being.

I feel uneasy about the method adopted because I don’t think individual citizens are equipped to make judgments about the “social importance” of the feelings of others. For example, the majority view about the “social importance” of feelings of anxiety might understate the impact of anxiety on the well-being of people who suffer from anxiety.

The authors have reported results from the use of their method of obtaining weights from four different samples: economics students, MBA students, professional economists, and a wider group of citizens chosen using web-based methods. All groups gave anxiety the lowest average weight, but apart from that there is not much common ground in the views of the different groups. The wider group of citizens gave happiness the greatest weight, but the other groups all gave life satisfaction the greatest weight. The economics and MBA students gave “doing worthwhile things” a much higher weight than happiness, but professional economists gave it about the same weight as happiness.

It seems to me that a better way to proceed would be to attempt to estimate the well-being of individuals by using weighting systems that individuals consider to be relevant to their own lives. There are potentially several ways to do that.

First, there is the approach adopted by Daniel Benjamin et al in their paper, “Beyond Happiness and Satisfaction”, discussed on this blog, in which people were asked to choose between hypothetical situations using different measures of happiness and a range of different ratings.

Another possible approach would to ask survey respondents questions along the following lines: “If you were offered an opportunity that would add a 1 point improvement in your feeling that the things you do in life are worthwhile, how much life satisfaction would you be willing to forgo in order to obtain that benefit?” When I ask myself that question the answer I obtained seemed to make sense, but my mind went blank when I ask myself how much life satisfaction I would be willing to forgo in order to obtain a 1 point increase in happiness. The same happened when I asked myself how much happiness I would be willing to forgo in order to obtain a 1 point increase in life satisfaction. So I can hardly recommend that approach!

The third approach is to simply ask survey respondents to allocate 100 points across the four measures according to the weight that they consider should give to the different measures in assessing changes over time in their own personal well-being. That approach has the virtue of being simple and directly related to estimation of relevant weights.

In order to obtain an accurate overall impression of subjective well-being at a national level it is important to know to what extent the weights that individuals consider to be relevant to assessment of their own personal well-being vary according to the circumstances of their lives.

What would self-actualizing politics look like?

It is difficult to observe democratic politics without getting the impression that it brings out the worst in people. We frequently see politicians elbowing each other out of the way as they struggle to gain power and influence. We often see them make promises they are not likely to be able to keep. We see some of them endlessly repeating slogans whose only virtue is that they once appealed to our basest instincts. We see others stating the obvious with great gravitas. We see quite a few advancing their personal interests at the expense of the people they are meant to serve.

So, how come there has been so much economic and social progress in the western democracies over the last century or so? If democratic politics brings out the worst in people, wouldn’t you expect outcomes to have been are a lot worse than they have been?

The findings of Christian Welzel’s research - which I reviewed on this blog- suggests that as a consequence of economic development people in an increasing number of countries have been able to climb an emancipation ladder (Welzel refers to it as a utility ladder of freedoms) analogous to Abraham Maslow’s hierarchy of needs. As economic development has proceeded in an increasing number of societies, people in those societies have tended to adopt emancipative values reflecting concern about such matters as personal autonomy, respect for the choices people make in their personal lives, having a say in community decisions, and equality of opportunity.

In an article published in Policy in 2014 I considered whether emancipative values might be morphing into an ‘entitlement culture’ that could threaten economic freedom and material living standards. My research left me feeling optimistic that if such a tendency exists, there is a good chance that it will be remedied by democratic political processes.

If my optimism about the future outcomes of democratic politics in high-income countries is well grounded the impression that politics brings out the worst in people cannot be entirely accurate. Actually, that cynical impression doesn’t even stand up to scrutiny when I consider the behaviour of some politicians I have met.

Those thoughts came to mind when I was reading Michael Hall’s Political Coaching:Self-Actualizing Politics and Politicians, published last year. Michael is a psychologist who writes about and teaches an approach to personal development strongly related to Maslow’s hierarchy of needs. I have read many of his books and attended a couple of his seminars, so I thought it might be interesting to see how he applied his ideas to politics.

Michael describes the political ideal as follows:

“Politics is designed to cultivate the good life. We create politics so that people in our social group can live the kind and quality of lives that they wish to live – to satisfy the basic human needs and then to fulfil the highest of human dreams and potentials. The design of politics is to create a human system whereby people can develop their own powers and freely use those powers in appropriate ways that simultaneously facilitates their highest and best and that supports the same for all in the community” (p15).

Immediately afterwards he acknowledges that the ideal he has described is not what immediately comes to mind when most people think of politics.

Michael argues that politics is inevitable because humans are social beings. The problem is not with the existence of politics but with how we do our politics. That depends on the quality of our relationships with each other, which in turn depend on our understandings, beliefs, meanings and experiences. He implies that a change in political culture can only occur if more people engaged in politics become self-actualizing.

I think the book is at its best in discussing principles for positive political conversations (Chapter 11). These principles include: showing willingness to listen to opposing views; approaching issues in a spirit of respectful inquiry; trying to understanding where other people are coming from; and looking for positive intentions and values in opposing views.

Unfortunately, Michael Hall doesn’t discuss the potential role of social media in promoting more positive political conversations and a better political culture. In my view social media has potential to make a large contribution to lifting the quality of political debate. However, that will not happen until more participants who are capable of lifting the quality of discussions actually seek to do so. I should be making more of an effort to lift my own performance in that regard.