independent

Sunday 20 April 2014

Here we go again? No – rising prices alone do not a bubble make

IF we haven't experienced something, we tend to underestimate the possibility of it ever happening to us. Conversely, when we do experience something, particularly if it is traumatic (such as being a victim of crime, for example), we tend to overestimate the probability of it happening again.

This is one of the many biases in the way we humans think that makes us less rational than once we might have thought we were.

This bias is of particular relevance in the discussion of property prices, the building industry and how both affect the wider economy.

During the bubble, far too little attention was paid to the risks of a property crash and none at all to a banking collapse – in no small part because there was so little collective memory of such things happening.

Now, having endured such a long period of national trauma as a result of property-related excess, there is something approaching paranoia that it will happen again.

Many people hear of house prices rebounding and say to themselves "here we go again". That fear is based on a belief that rising property prices can mean only one thing – a bubble. Thankfully, this is not the case.

Mostly when asset prices of any kind rise they do so because of real changes in either supply or demand (or both).

In cases when property prices do inflate unsustainably, excessive credit expansion is always a central factor. Without a credit surge there can be no property price bubble.

Very clearly, there is nothing approaching excessive credit growth in the Irish economy now. In short, there cannot be a new bubble at a time when a credit famine is taking place.

Many people are understandably sceptical of any rejection of the possibility of another bubble. In conversations on the subject, I have often been asked recently what I said about the risk of a bubble before the crash, with the subtext of the question essentially being whether I had dismissed the risks of bubble then, too?

Quite the opposite is the answer. (For those interested, click on www.independent.ie to listen to an April 2006 RTE Prime Time show on the property frenzy, which makes my views at the time very clear.)

Another view that causes many people to bristle is the suggestion that we need to get developers back in the business of building houses.

But, the sceptics ask, didn't builders and developers bankrupt the country by borrowing too much money to build too many houses?

And with all the houses they built at that time, surely we have enough to last for the next decade, the same people conclude?

Excessive lending and building certainly did bankrupt the country, but that does not mean no new building is needed now.

House building has been in a state of collapse for eight years. In the first nine months of last year, just 5,600 homes were completed in the State, a figure that is all but certain to ensure that 2013 was the slowest year ever for home-building. In the previous three years, the number of homes built averaged around 11,000, far below the long average of 25,000.

So while there certainly is an overhang in many parts of the country, under-supply is now a problem in some urban areas, particularly in and around the capital. Add to this rising demand for housing and it is very easy to explain the 20 per cent increase in residential property prices in Dublin since they hit bottom in August 2012.

This demand comes both from continued urbanisation and from a population that is growing, despite highish levels of emigration (outflow rates were considerably higher in the late 1980s and early 1990s). It is worth noting that since the economy plumbed the depths of depression in 2009, the population has increased by 140,000.

Building more houses now where they are needed would slow the pace of price increases, helping to maintain competitiveness. It would also get more people back to work, particularly those with low skills or the unemployed with building skills who haven't be able to reskill.

As the bigger chart illustrates, the share of builders in the working population is now very low by international standards. The most recent EU-wide figures show that employment in construction as a percentage of all employment is the third lowest in the 28-member bloc.

If the industry could return employment levels to the EU average, around 25,000 additional jobs would be created. That would make a good dent in the 280,000 people who currently have no work.

The property crash has left indelible scars on this nation. But it is important that we don't harm ourselves further by fighting the last war when it is long over.

Every healthy economy needs a healthy construction industry. Healthy economies also need to avoid sharp hikes in property prices. Ensuring that the supply of new homes matches demand is essential to achieving that.

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