The Australian economy, like much of the developed world, is in a demographic and financial vice. The combination of a low fertility rate and excessive house prices is creating the prospect of long-term economic decline and a sharply divided Australian society. Worse, the two things reinforce each other. Many younger people, unable to afford to buy a house, are choosing not to have children because they believe they cannot afford them.
Australia’s fertility rate is about 1.5 babies per woman: the replacement rate is 2.1. That is down from 3.55 babies per woman in the 1950s. There is every reason to believe that the situation will worsen as property prices remain excessive. To date, both political parties have been keen to look the other way, unwilling to alienate older voters who are heavily invested in the property market in order to take advantage of negative gearing to reduce their taxation.
The Reserve Bank and other financial authorities have also ignored the problem, arguing, in effect, that they cannot measure house price inflation because the transactions are lumpy – and all they do is work off transactions. A house can soar in price even if you do not sell it. Unless there is a sale, however, economists will not recognise the price rise, the asset inflation. Nothing to see here.
In truth, it is easy to measure how damaging house inflation in Australia has been and how much it has distorted the whole economy. Australian housing, now worth over $11 trillion, is more overpriced than real estate was in the infamous Japanese housing bubble in the 1980s which, when it was pricked, plunged that country into 35 years of recession. During its property bubble, Japan set the record for the ratio of the value of its residential land to GDP, at 330 per cent. Australia passed that level two years ago.
Put another way, according to Chapman University’s Demographia International Housing Affordability report, as late as 1990, national median house prices were about three times median household income incomes. Today, Sydney prices are 13.8 times median household income, Melbourne 9.8, Adelaide 9.7, Brisbane 8.1, and Perth 6.8.
The problem is well known; it is a figurative elephant in the room. Less obvious is what solutions can be pursued to alleviate the situation. Attention usually turns to making changes to tax policy: negative gearing and the capital gains tax regime. These have been unusually generous in Australia, and a big reason why house price rises have been so extreme.
About 2.24 million taxpayers in Australia are property investors, and collectively they own 3.25 million investment properties. That equates with more than a quarter of residential properties being owned by investors, which has crowded out first home buyers, including those who want to start families. For them, renting is often the only option.
'For now, the prospects of being able to afford to start a family are poor and unlikely to change. That means fertility rates will stay low and probably worsen. That, too, will eventually lead to a rebalancing because fewer people will mean weakening demand for houses and presumably lower prices.'
Changing tax policy might help slow the runaway train, but at this stage, even if political parties were willing to do it – and the major parties would never take the risk – it is too late. Attention should instead focus on the banks, whose out of control lending fuelled the excesses. In the early 1990s bank credit was about 40 per cent of GDP and the value of land about 100 per cent of GDP. Over the subsequent period bank lending more than tripled and is now 140 per cent of GDP. In direct correlation, house prices also more than tripled. The banks’ eagerness to lend caused the bubble, and they now almost exclusively rely on residential mortgages for their business.
Since financial deregulation in the 1980s banks have been allowed to do what they want; the government gave up any control over the quantity of money. But it is possible that the authorities could start leaning on the banks to stop lending so much, although given the power the banks wield over the political system it would be hard.
Another option might be to alert investors who are pushing up the price of houses that the financial strategy is inherently risky. Negative gearing entails making a loss on the renting of the property, then recouping some of those losses through reduced tax. The belief is that you incur losses in the short term but make windfall gains in the long term when you sell the property. That requires being able to sell the property for a much higher amount.
The assumption that property prices always rise is always true – until it is not. Informing investors about what risks they are taking might cool some of their ardour. At the moment what they mostly see is a way to lower taxes, which they view as a ‘win’ even though it is actually a loss.
Efforts to create more opportunities for investment could help. People choose to invest in property because there are so few other options in Australia. That is one reason why superannuation funds invest about a quarter of their capital offshore. Creating, for example, an agriculture fund that is diversified by geography and product type would be both good for the economy and give investors more choices.
There are other more radical options being discussed. The economist Steve Keen, for example, argues that the government should pay off much of people’s mortgages by issuing government-backed money with no interest rate on it. He calls this a shift from credit (bank money with an interest rate on it) to fiat money, with no interest rate. Keen freely admits that there is zero chance of this happening, however. For one thing, the banks will not take kindly to being put out of business.
In the long term there will be a rebalancing. About a third of the Australian population are in houses on which there is no debt, a third have stratospheric debt, and a third are renting. The first group will start dying off over the next decade or two, which should mean more supply of housing and lower prices. Assuming the banks do not keep the debt-driven game of musical chairs going, that is.
But for now, the prospects of being able to afford to start a family are poor and unlikely to change. That means fertility rates will stay low and probably worsen. That, too, will eventually lead to a rebalancing because fewer people will mean weakening demand for houses and presumably lower prices.
As the management theorist Peter Drucker said ‘demographics is destiny’. Once there is a big shift like plummeting fertility rates, there is nothing that will stop the consequences.
David James is the managing editor of personalsuperinvestor.com.au. He has a PhD in English literature and is author of the musical comedy The Bard Bites Back, which is about Shakespeare's ghost.