Which is better placed to provide good housing for all at fair prices? The free market or active governments? The question is crucial in many developing countries, as people around the world move in their billions from the countryside to cities. It is also important in many developed countries, where housing plays a crucial role in the financial system. Hong Kong, which has had to deal with a rapidly growing population and has a fairly competent government, is a good place to compare the two organising principles.
The market mechanism relies on the desire for capital gains. A house or apartment building is built or purchased in the hope that the eventual selling price will be much higher than the cost. And almost all gains or losses very often come from changes in the value of the location rather than from changes in the value of the actual structure.
In Hong Kong, as in any other expensive housing market, market forces have made land far more expensive than the building. For example, buyers of apartments in a new development at Tsuen Wan West, in the New Territories, will be paying about HK$5,000 per square foot for the land and the related financing costs, more than twice as much as the HK$2,000 per square foot cost of construction. For prime locations, the ratio is much higher.
Cheung Kong, the developer of Tsuen Wan West, must hope that ratio increases further. Over the decades, such hope has encouraged Hong Kong developers to build and citizens to buy thousands of apartment buildings. Sometimes the hopes have been realised, but land value is fundamentally unstable. Changes in financing costs and the confidence of buyers lead to dramatic shifts.
If land represented only a small portion of the cost of property, the price of housing, like the price of most consumer goods, would change relatively slowly. In fact, since land accounts for most of the cost of housing, property prices are extremely volatile. In Hong Kong, during the course of the last three decades, the average price of an apartment has doubled twice, and has twice fallen by half.
Free market instability has three big disadvantages. First, it forces purchasers, in Tsuen Wan West and everywhere from Paris to Peoria, to become speculators, but the basic good of shelter should not be a financial plaything. Second, as British homeowners can ruefully testify, when land values are the preeminent concern, the quality and size of buildings may suffer. Finally, when loans secured by the volatile value of land account for a significant portion of all financial assets in an economy, as is the case in the United States, financial crises are much more likely.
What about the government? When it is the owner, the market value of land is irrelevant. The authorities can set rents which are appropriate for the income of citizens. That is exactly what the Hong Kong government does for the 30 percent of the dwellings that it owns. Over the years, it has tried various regulatory techniques and subsidy programmes to isolate more of the population from the open market price of land.
The Hong Kong government has an advantage: it owns all the undeveloped land in the Special Administrative Region. In theory, it could build enough attractive housing with effective transport links to reduce substantially the ratio of land value to building value. In practice, limited funds, an ideological enthusiasm for market mechanisms, and the political influence of developers have restrained the pace of government construction.
In some ways, relations between state and market in Hong Kong residential housing are too cosy. Bolder governments could have tried harder to keep the value of land down and to improve the housing of the poor. However, without privately funded and organised developments such as the Tsuen Wan West, the housing situation would undoubtedly be worse. Besides, people like owning their houses, and usually take good care of them. A competitive, profit-driven housing market has much to offer.
Still, the lesson of Hong Kong is clear: governments should play a leading role in the housing sector. They should coordinate development, as the Hong Kong government has done, and use their regulatory authority to keep land values lower and steadier than Hong Kong has managed. In many countries, this would require a shift in the agenda of housing and financial regulators, from monitoring practices to monitoring outcomes, but that is quite possible.
It is not easy for governments to find the right role. They should avoid the British trap of giving in to the pressure of existing owners to limit new construction. They should also avoid the American trap of favouring home ownership over the provision of decent housing. Instead, they should focus on a simple goal: to take housing off the list of financial assets.