The housing market on the Gold Coast has been hit especially hard. Its economy is dependant to a large extent on tourism, and holidays are the first thing to go when people run into financial trouble in recessions, especially when the Aussie dollar is at record highs, making it more expensive to come here. With less tourists coming and spending money, businesses have lower sale, hire less workers, who then have less money, blah blah blah… demand for housing falls. It is suffering at the moment from an oversupply of housing which could take years to work through. This oversupply depresses the price of houses, and hence the price that construction companies can get for their finished product. Construction companies who are unprofitable at these prices go bankrupt, and the ones who can stay afloat build fewer houses at the lower price, a painful adjustment. What’s the obvious solution? Either reduce supply by knocking down houses, which I wouldn’t recommend (but I wouldn’t put it past some politicians to suggest it) or keep supply relatively constant and let demand catch up.
What’s the government’s solution? The government is deciding today whether or not to offer increased subsidies aimed predominantly at first home buyers purchasing, wait for it… new homes. When what the market needs is people to purchase existing homes which have already been built, the government is looking at construction companies crying out that there is no demand for new houses (a symptom of the problem of an oversupply of housing) and throwing money at the symptom instead of solving the problem of oversupply. Not only are they not getting at the root of the problem however, but they are exacerbating it by giving incentives to build new homes, increasing supply. And just to show how short term they are, the politicians are only offering these increased subsidies for six months, at which point demand goes back to where it was, except that we now have a greater supply of houses.
This is a fantastic example of a politician trying to think like an economist. And completely blowing it.
It is also a fantastic example of the government distorting the free market economy, and disturbing the Darwinian process which is supposed to guide our economy towards strength and efficiency. “Creative destruction” is this Darwinian idea; that by allowing fierce competition in the market, and letting weak companies fail, only the best will survive and the economy will be stronger for it. Of course this requires short term pain in recessions as weak companies who made bad decisions, aren’t nimble enough, or simply offer a product (like a house for example) that no one wants, go bankrupt. But in the long term a stronger, more nimble economy arises. Of course the government isn’t a fan of any short term pain, because it doesn’t win votes. When the government gives money away to people to keep a flailing industry alive, it is diverting resources towards an industry the free market is trying to say that no one wants.
The free market scenario, when allowed to play out, also snuffs out the stench of moral hazard, which no one will talk about but hangs quietly in the back of people’s minds. In the extreme moral hazard occurs when companies say, “I won’t worry about the fact that I’m building too many houses and that there is an oversupply, because if I am going to go bankrupt the government will bail me out,” and the government either does this explicitly by giving the company money (like the US government did for AIG) or it can do it implicitly in a number of ways, like offering people incentives to purchase a company’s product. Either way it gives a company the incentive be less careful when making decisions because it believes the government will bail it out. This mindset becomes an issue when it spreads throughout the whole economy. A construction firm under the influence of moral hazard in 2006 might have seen an oversupply of housing on the horizon, but thought I’m going to continue building houses while the going’s good and when the housing market hits the fan the government will bail us all out.
The government is keeping a flailing industry alive, when what the economy needs to do is to restructure. People need to go through the painful process of losing their jobs and finding new ones in booming industries. Unfortunately the long term good of the economy has a small voice, few lobbyists and no vote, and is often on the other side of a spike in short term pain, so policymakers rarely take note of it.
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