Governments have a habit of meddling with things. This is largely due to the political imperative of being seen to be doing something to fix economic problems. The downside to this meddling is it that it tends to cause more damage than it solves. Take many of the panicked acts by Australian (and global) authorities during the GFC and the data that continues to emerge.
In 2008, the federal government increased the first home owner’s grant. The intention was presumably to make homes more affordable for first home buyers. The result was the exact opposite. First home buyers used the money to simply “bid up” the price of homes. The underlying value of those properties (which is based on the asset’s cash return, not what someone else is willing to pay or lend) didn’t change, so many (often young) buyers were lured into a lifelong debt trap buying an asset they can’t properly afford.
The real effect of the policy (aside from increasing debt levels and prices) was to bring forward demand. For example, instead of saving for three years to accumulate a deposit and buy a home, young people on lowish incomes were able to buy a property right away using the government grant. Their ultimate purchase decision was not altered, but rather, happened a couple of years earlier than it otherwise would have. As a result of the FHOG, the percentage of housing finance utilised first home buyers almost hit 30%. During the March quarter, that figure slumped to only 15.4%. What that means is that future generations effectively (through taxpayer grants) paid vendors to receive more for their properties.
This column warned of the problems with the FHOG on the day it was announced, way back in October 2008, so the result didn’t come as a surprise.
Meanwhile, ratings agency Fitch reported that delinquencies in the residential mortgage backed securities sector (which is partially funded by taxpayers) hit a record 1.79% in March — an increase of more than 30%.
It doesn’t take too much deep thinking to work out that government policy caused a misallocation of resources into the housing sector. This caused the prices of residential property to boom, and those prices are now starting to fall. This is somewhat of a problem given that most property purchases (especially by first home buyers) are largely funded by debt — which has contractually fixed obligations.
While the most poorly devised scheme, the first home owner’s grant wasn’t the only piece of foolhardy government policy. The federal government also created a policy to help the car industry, by allowing small businesses to claim a 50% tax deduction on new vehicles. This had the effect of businesses purchasing cars they didn’t really yet need, simply to get the tax break. A year after the tax break ended, and the Financial Review reported that sales of SUVs fell by 43% and large cars were down 32% compared with the previous year. In May alone, sales were down 13% from last year.
Of course, Australian authorities were hardly alone in their responses to the financial crisis. The Federal Reserve and US government spent trillions trying to stimulate their way out of recession. The result of their efforts are a monstrous debt (Congress is yet to approve the latest increase to the “debt ceiling”), near 10% unemployment and house prices continuing to fall. In fact, despite two rounds of quantitative easing, the New York Times reported that US house prices are down 33% since 2006, and are currently at the same levels as 2002.
Despite the failings, expect another round of ill-thought out policy when the economy starts to falter again.
I don’t think that the points you raised are necessarily bad things.
While you’re right in saying increasing the FHOG artificially increased housing prices, the alternative would have been declining prices on the back of reduced consumer confidence. This would have had a cascading effect on other areas of economic activity – e.g. building and construction and the associated increases in unemployment, as it did in the US to disastrous effect, on top declining levels of consumer spending and business investment throughout the rest of the economy.
Instead, what happened was housing prices (and its flow on effects through the economy) increased, and partially offset other declines in the economy, and are now moderating at a time when business investment is increasing.
This illustrates that the increase in the FHOG (and similarly the accelerated PPE tax depreciation) was a classic counter-cyclical policy – it increased activity when the rest of the economy was faltering, and lowers activity as the rest of the economy is performing strongly.
@C232
Wuhh?
I think the workers who retained a job through the Govt interventions would tend to disagree with much of this article. The US GOP campaigns on less Govt intervention and the free market economy. I’d argue that is precicely what led to the GFC in the first place. The “greed is good” mantra and loose lending arrangements meant that there was too much leveridge in the economy. Instead of having to save for houses, plasmas, holidays etc people were seduced into thinking they could have it all and have it now. The purveyers of credit did not care about tomorrow – they were only worried about their next bonus. If the Govt had wiped it’s hands and said “let the free market sort itself out” there would have been a depression to rival the 30s with the untold misery that accompanies it. Sure, it would have righted the economy eventually and more quickly – but at what human cost? It would be a travesty if the GOP in US win the next elections on the back of a rising recovery only to take the credit later after plunging the world into crisis in the first place. You only have to listen the doomsday whingers in US complaining that they were better of under Bush because petrol was cheaper and unemployment was low wheras Obama hasn’t fixed all their problems overnight! Makes me scared.
@ICU8
Under a simple model of economics, you can divide the economy into a number of components – consumer spending, government spending, business spending (investment) and net exports (or imports if negative).
When an economy goes into recession, the economy as a whole is shrinking, and by definition, one or multiple of the mentioned sectors are shrinking.
Keynesian economics advocates counter-cyclical economic policy. That is, if consumer spending and business investment are shrinking, government spending increases to offset some of the decline – thereby reducing the severity of the fall. In the opposite situation, when the economy is growing strongly, the government should raise more in taxes than it spends, in order to prevent the economy from overheating.
During the GFC, Australia saw sharp declines in consumer spending, business investment, and net exports, and the government intervened by increasing government spending, as is sound economic policy.
Adam’s point in the article is that the two particular areas of government expenditure, being an increase in the FHOG and allowing businesses to accelerate depreciation on PPE investments merely brought forward spending on houses, and artificially raised the prices of houses, and in the case of cars, created an artificial market for car sales, as evidenced by the subsequent decrease in the prices of houses, and the sales of cars.
My point was this wasn’t actually a bad thing in and of itself. Increasing the price of houses (even if this wasn’t reflected in the underlying value of the asset) prevented many negative economic effects, including a reduction in new home building activity (since building a new home = more people employed in construction), and a reduction in consumer spending (since people tend to spend less when they feel poorer, given the majority of a person’s wealth is tied to their houses). In the US, where the GFC was caused by a collapse in housing prices in only a few key states, consumer confidence was hit, since people felt poorer, so even if they weren’t personally worse off – i.e. they weren’t fired and still had their houses, they also reduced their own spending.
Back to my first point – consumer spending is also a driver of economic activity, since when you spend money, you keep people employed.
Given this, increasing the FHOG actually achieved what it meant to, and possibly more, by increasing government spending, increasing construction activity (remember that the FHOG was tripled for first homers constructing a house), and keeping consumer spending buoyant. If you go back to the first paragraph, business investment and net exports fell, but consumer spending and government spending increased or stayed the same, hence reducing the severity of the GFC on Australia.
Now if we go one step further, Alan’s article is saying that we are now seeing the negative after-effects of this ‘ill thought out’ economic stimulus, in the form of declining housing prices and a reduction in new car sales. But back to my first paragraph, we now see that business investment (particularly in the resources sector) is expanding rapidly, the economy is close to full employment, and Australia has a net trade surplus (we export more than we import, which isn’t a very common occurrence for Australia, historically). As such, it’s not such a bad thing that housing prices are moderating, and as a side-note, and that consumer spending is mostly stagnant.
All of the above is why I disagree with Alan’s article. The government spending increased economic activity when things were on the downside, and decreases economic activity when things are on the upswing.
It’s also why I cringe when I hear the words “Massive debt” being uttered from the lips of he who shall not be named, when things would be so much worse without said “Massive debt”.
C232, can you please approach Crikey and ask them if you can write the occasional article in stead of ADAM Schwab. You make far more sense and actually understand economics.