Tuesday, 5 February 2008

Kevin Rudd's First Mistake

It couldn't last. Up until this week, the new Labor government of Kevin Rudd has managed to earn admiration for the surefooted, no-nonsense way it has set about governing Australia. Preparations are already underway for the government to say Sorry to the stolen generation of Aboriginal people and take a step towards reconciliation, something that John Howard remained churlishly unwilling to do. A good deal of imagination has been shown in including a thousand Australians from outside the political circle to discuss solutions to 10 strategic problems facing the country. Regardless of how well that works in practice, one must laud the innovative spirit behind it.

But alas, the government has disappointed me this week with a piece of flawed economics that will harm the very people it is projected to be helping.

That's the package aimed at solving the housing affordability crisis for first home buyers. Regardless of the mechanisms used to do this (e.g., a special savings account, a cheque from the government, etc.), the net result is that the government is going to end up pouring cash into the overheated housing market, to the tune of either $65 million or $850 million over 4 years (depending on which news report you read). That's pouring fuel into a fire.

The last time the government did this (thanks for nothing, John Howard), the government was paying first home buyers $10,000 ($14,000 during one period) to "help" them with their purchase. What happened? House prices went up even further. Is it surprising? It's simple market economics. If the government starts throwing money around, the market will gratefully raise prices to compensate.

It doesn't matter how it's done. Yes, the special savings account will encourage people to save. But the net effect is still that a huge amount of extra cash is going to find its way into the housing market, and that will push prices in exactly the direction the government claims it doesn't want them to go - up.

Well, what can the government do? Housing affordability is a crisis, isn't it? Well, the first thing to do is stop feeding the fire. I'm sure the economists in the government's employ know that. But I guess the political pressure was too great to let common sense triumph. No, in terms of direct action, all that the government should have done was wring its hands and offer soothing words.

But there's plenty the government can do (can still do!) to ease pressure on the real estate market. And that's to make other residential areas attractive (counter-magnets). Yes, the government will end up spending even more money in terms of urban development and public transport, but it will ease the concentration of demand that drives prices up in the best, most convenient living areas. There is affordable real estate available. The problem is that such areas are poorly connected or underdeveloped. If the government's policies result in the creation of a high average level of quality in the country's urban and suburban real estate, that will solve the affordability crisis. There will be more places to choose from. With the increase in supply, prices will go down. (The measures just announced, on the other hand, strengthen demand and hence raise prices.)

What I have recommended is not a solution that will provide results in a year or two. It may take a decade to start having an impact. But it will be real and lasting.

If the government is serious about finding strategic solutions to Australia's problems, they should look into this suggestion. I hope at least some of those 1000 people in the planning group stand up and tell the government to stop hurting first home buyers with expedient measures that are just bad economics.

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