House price inflation is not proof of a recovering economy
Published 07/06/2014 | 02:30
The great social scientist Ed Leamer coined the term "housing 'is' the business cycle". Home ownership, home building and home 'flipping' characterised the 2002 to 2007 period. Now Dublin house prices and rental prices are rising while the rest of the country remains largely static.
When the value of your equity rises, you feel wealthier, even though you aren't unless you sell the home. When you feel wealthier, you are more likely to consume more, borrow more and report feeling better about the world. This is known, cleverly, as the wealth effect.
Research by the Central Bank's Yvonne McCarthy and Kieran McQuinn in 2013 found that house price expectations were of major importance in influencing wealth effects.
So it is important to understand how our expectations about the future are connected to how 'rich' we feel in a given moment. There might not be any difference regionally other than the difference in these perceived wealth effects.
Sixty-six per cent of the 1,019 respondents of the Millward Brown poll believe Dublin is benefiting disproportionately from the economic upturn. Seventy-six per cent of respondents in Connacht and Ulster, where house prices and rental yields are lowest and have fallen in some places, believe this, as do 72pc from Munster.
There is an economic upturn, especially if you believe an increase in house prices in south County Dublin is what an upturn looks like. I've argued in these pages many times that we shouldn't pay any heed to bond yields as indicators of financial health. Today, for example, Ireland's sovereign debt trades at around 2.5pc, down from 15pc in 2011, and cheaper than the UK's debt at the moment. That is evidence of only one thing: the markets still don't know how to price sovereign debt. It says practically nothing about Ireland's recovery from crisis.
Instead, let's look at the regional improvement in employment from the first quarter of 2013 to the first quarter of 2014. What do we see? We see Dublin experiencing the largest increase of 0.7pc, followed by the south-east with 0.2pc, with the west and south-west experiencing decreases over the year. The survey may well be reflecting respondents' correct perceptions that we are now seeing employment growth largely taking place in Dublin.
Another way to look at the gains from any economic recovery is to examine changes in gross value added by region. Gross value added is a productivity measure that measures the difference between output and intermediate consumption. It provides a value for the amount of goods and services that have been produced, taking away the cost of all inputs and raw materials that are directly attributable to that production.
In 2013, Dublin's gross value added was 52pc above the national average, while the mid-west was 14pc below. There is a clear difference in productivity by region, which should translate into people feeling the recovery is happening in Dublin, as opposed to elsewhere.
Interestingly, the south-west is 20pc above the national average in productivity but it doesn't seem to believe it is reaping some of the rewards of the upturn in the Millward Brown poll's results, so changes in productivity may not be driving the results we're seeing.
So are we seeing wealth effects – people simply 'feeling' that Dublin is better off – or are we seeing real domestic recovery in employment?
I think it's more likely that wealth effects are driving the results of the poll and that is not a good thing, because when people start making decisions based on the likely market value of their home or other assets, crazy things start happening in the economy and we really, really don't want to go back to that.
One of my biggest fears is that as a society so many of us are invested, literally, in housing that another house-price appreciation will be perceived as a good thing when it emphatically is not. House prices should track incomes, which should track employment, and little else.
Stephen Kinsella is Senior Lecturer in Economics at the University of Limerick